FROM PERIPHERAL SOVIET REPUBLICS TO LOW- INCOME , HIGHLY-INDEBTED INDEPENDENT STATES – R.V.Lago

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14 May 2003 FROM PERIPHERAL SOVIET REPUBLICS TO LOW-INCOME AND HIGHDEBT INDEPENDENT STATES IN TRANSITION: SUCCESS OR FAILURE? Ricardo Lago12 I.INTRODUCTION The new frontier of the European Union will move further east with the accession of eight countries in 2004 and two more in 2007 of the Central and Eastern European region . The economic and political fate of the countries beyond the boundaries of the new , enlarged Union will have stronger repercussions on its political and economic stability , particularly regarding migration flows and security ( including terrorism ) .

From this angle, the developments in the countries of the Caucasus and Central Asia should feature high in the European Union aid and development agenda .Since their independence at the dissolution of the Soviet Union in 1991 until today, the economic reform process of these countries has been guided –to a larger extent that any other developing / transition countries - by the tutelage of the International Financial Institutions. Indeed the financial support , and related policy advice , of the IMF , the World Bank and the Regional Development Banks ( the Asian Development Bank and the EBRD ) have been the main - virtually the sole -source of financial investment and policy dialogue .

Some analysts have viewed the low income and high debt ratios of these countries, twelve years after independence, as signs of failure of the international assistance followed so far. Yet others have emphasised that given the severity of the initial conditions confronted by these countries, the developments could have been much worse, and that in fact the outcomes are rather a success story.

In this paper I analyse the merits of these diametrically opposed appraisals and attempt to offer some recommendations for the future policies of aid and development of the European Union and the International Financial Institutions.

The former Soviet Republics of the Caucasus and Central Asia ( henceforth referred to as the CIS-7 countries ) provide a singular case study quite distinct from other transition economies .In 1991 , these countries confronted the formidable challenge of 1. Economist. Former Deputy Chief Economist of the European Bank for Reconstruction and Development ( 1993-2002) ; Division Chief of the Inter-American Development Bank ( 1991-93) ; Senior Economist of the World Bank ( 1985-91) ; and Director of Economic Policy of the Mexican Ministry of Finance( 1982-85) .

2. Paper commissioned by the IMF (John Odling –Smee. Director Europe II). Disclaimers .First draft for comments. Not to be quoted without the author’s permission. The views expressed here are those of the author alone and do not necessarily reflect the views of any institution with which the author has been associated in the past.

2 creating the political , administrative , social , and economic institutions of independent states without the benefit of drawing on any period in recorded history of identity as independent political entities . The existence of ethnic divisions in most of them , civil wars ( in Georgia , Moldova , and Tajikistan ) , territorial wars ( Armenia and Azerbaijan ) , and surging fundamentalism ( Uzbekistan and Tajikistan ) rendered the task more formidable .

Unlike Russia and the Ukraine , the CIS 7 lacked large and diversified economies .They never were administrative centres of any empire to which they had belonged : neither in Soviet nor in Russian imperial days nor under Ottoman rule. These countries had always been peripheral . Unlike the Baltics , they did not have the benefit of being able to reinstitute the Commercial Codes and other laws the Baltics had once had as independent nations in the 1930s .The Baltics left the Soviet Union with destiny to the European Union , the CIS -7 left the Soviet Union to be on their own !.

Furthermore, their remoteness failed to attract media interest beyond idyllic stories of the Silk Route. With the exception of Armenia , they lacked a populous and influential Diaspora abroad in the United States , the European Union , or Canada. Save for Azerbaijan - and to a lesser extent Uzbekistan - they lacked visible natural resources to elicit the appetite of foreign investors. They inherited infrastructure and productive capacity - created to cater to and from the Soviet Union - compounded the transportation costs of their remoteness and the price unattractiveness of their products in international markets.

The odds for building market economies and democracy were clearly unfavourable.

Save for few enclave investments, those who looked at the region viewed it as a bet with high risks and low returns.

The tragedy of September 11 put these countries on the map. In a blow, the West realised that these countries were far more strategic than it had been thought The relative neglect by bilateral donors and investors ( particularly of the non oil producing) after the demise of the Soviet Union had been a unfortunate happening .

Long before, Halford Mackinder, the British founder of geopolitical theory, had labelled the region as the “Heartland of History” and argued that “he who controls Central Asia controls the World”. The region started to feature with prominence in the press and television .Overnight political analysts mastered on the political , ethnic , and security complexities of the Caucasus and the Fergana valley . Many of us finally were able to figure out why on earth the Soviet Union invaded Afghanistan in 1979. There was a surge of reading of books on the so called “great game”3 between Britain and Russia during 19th Century. A new “tournament of shadows” – to use the terminology of the Count Nesselrode , once the Czar´s Foreign Minister – was being played .

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See Hopkirk, P (1994); and Meyer ,K and Brysac ,S (1999)

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A decade before September 11, the IFIs became heavily involved in policy dialogue with, and invested heavily in, these countries. In ten years ,most of them ( particularly the CIS-5 ) accumulated high public external debt ratios in proportion to their GDP , their exports ,or their fiscal revenues . The evolution of the ratio of public external debt to GDP for the CIS-7 as a group is provided in Chart 1 .It can be seen how this indicator started from virtually zero at independence to reach a level comparable to the average for transition economies ( around 40 % ) and eventually, in 2000-2001, a level of 60 % of GDP , thus higher than that the average for other transition economies . To the point that some of CIS- 5 countries eventually reached ratios close to the HIPC benchmarks (of 150% of exports and /or 250% of fiscal revenues). As Chart 2 shows, this is clearly the case of Kyrgyzstan for both ratios. In the case of Armenia , Georgia , Moldova , and Tajikistan only the debt to fiscal revenue ratios exceeds the HIPC references ; therefore the debt problem of these countries is to a larger extent one of low fiscal revenues ( an internal transfer problem ) than one of low exports ( an external transfer problem ).

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Finally, the public external debt structure of these countries is quite distinct from that of developing and transition economies as a group. As Chart 3 shows , more than 40 % of the total external public debt of developing countries is owed to private creditors with the remainder shared between bilateral official creditors ( about 35 % ) and multilateral creditors ( about 25 % ) . By contrast , as Chart 4 indicates only 5% of the debt of the CIS- 7 is owed to private creditors and more than one half of the total debt is owed to multilateral creditors : the World Bank , the IMF , the ADB and the EBRD Several questions stand out: did the IFIs not foresee this debt dynamics? ; did they lend excessively to these countries? ; did IFI lending come in support policies that failed to yield a supply response? ; Or was it the case that the policies deserved to be supported and the IFIs acted as “suppliers of last resort� in the absence of other donors

5 and lenders? ; And finally was IFI lending justified by the policies amidst adverse initial conditions external negative shocks? .Let us examine these questions in the next section.

II. SIX POSSIBLE HYPOTHESES HYPOTHESIS-1 : WERE THE POLICIES ADEQUATE? A side by side comparison of the matrices of policy based loans and the developmental and commercial investments ( by the EBRD and the IFC ) shows that policy design and conditionality was in general not any different from the programs supported by the IFIs in other developing and transition economies .Indeed , demand management policies placed the emphasis on progressive control of budget deficits and monetary aggregates and supply side policies focused on : freer markets and prices ( liberalisation ) ; enhanced factor mobility ( unburdening of enterprises ; including their social services ) ; strengthened entry ( competition ) and exit ( bankruptcy procedures ).

The improvement of fiscal and monetary performance is unquestionable . Prior to 1995 most of these countries were invariably running budget deficits larger than 10 % and their annual inflation rates ranked in the hundreds if not in the thousands following the introduction of their national currencies and Central Banks in 1993. Since them these countries have managed to reduce their budget deficits to less than 5 % in 2001 -2002 and their inflation rates to less than 10 %. The process of reduction in the budget deficits has been faster than in many Latin American countries from the 1980s to the 1990s.

In turn, the transition indicators of the EBRD shed light on the progress with structural reforms. While in 2000 the average of the mean transition indicator for each of the seven countries (2.5) was significantly lower than the average for the countries of Central and Eastern Europe (3.25), the level was comparable to those of Russia and Ukraine. Further and more importantly, the incremental improvement of the average transition indicator since 1991 (1.5) was not much less than the improvement in the average of the Central and Eastern European Countries.

HYPOTHESIS 2: WAS POLICY IMPLEMENTATION SATISFACTORY? The lack of implementation capacity at departure was a strong obstacle to reform. The skill distribution inherited from collectivism was at variance with the skills and mentality needed to administer the institutions of a market economy . Moreover , the institutions had to be built from scratch. To compound the challenges , in these countries - unlike in many developing countries - one cannot assume that the policy makers knew the direction that policies had to take nor can it be assumed either that the behaviour of economic players in reaction to the policies would be initially foreseeable or in the direction desirable . It was in this field of policy advice, and technical assistance that the IFIs pioneered and made a difference: providing guidance

6 to the authorities of these nascent states in the basics of hard budget constraints and market-based resource allocation.

The reduced-choice -cum -little risk mentality inherent to the social insurance system of the collectivism made people believe that debts, arrears, and insolvents would be eventually bailed out by the State; as they were indeed repeatedly in the initial years of independence. Most citizens lacked the ability and the habit of paying taxes ( since taxes in the communist days at been withheld at source ) ; the authorities lacked the capacity and even the will to enforce the payments . Citizens and firms viewed electricity and other public services as a free of charge acquired right ; the authorities were unwilling and even unable to set the right tariffs, meter consumption and enforce payments. Hence, the utilities became real “lenders of first resort� for inefficient enterprises and cost- unconscious consumers . The electricity tariffs prevailing in these countries are shown in Chart 5 and the ratio of cash collections to billings is provided in Chart 6 . (Data from Fankhauser, Kennedy and Raiser, 2002)

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These forces worked to perpetuate unsustainable expenditure patterns and thus fiscal, monetary, and balance of payments disequilibria. The initial external debt build up of these countries from nought to 40 % of GDP in 1991-1993 was largely a result of this process Unlike what it is broadly believed these debts pre-dated sizeable IFI lending .They came into being during the two years of the “rouble zone” either in the form of debits owed to the Central Bank of Russia by the new National Banks of the other CIS countries or in the form of arrears in settlements for energy deliveries from the oil- rich to the oil- poor new republics.

Therefore , it more accurate to state that these countries began meaningful interaction with the IFIs with a debt –to-GDP of 40% in 1993 than that they initiated transition with a debt-to-GDP of nought .

The IFIs have always emphasized the importance of cost-recovery pricing for the public utilities . However, the record of reform of the CIS-7 in this field is mixed. For example , a strong reformer as Kyrgyzstan - which has benefited from repeated and sizeable policy based loans from the IFIs and donors ( i.e. Japan ) - still registers power tariffs lower than US$1.5 cents per Kw/hr ( compared to the international norm of the US$ 6 to10 cents per Kw/hr ) and cash collection rates of less than 50 % . These dismal parameters are responsible for : protracted restructuring of energy- intensive enterprises; de-capitalisation of the power utilities; and build up of energy related external debt and arrears.

By contrast, energy poorest Moldova has been able to increase tariffs to over US$ 5 cents and double cash recoveries in one year. Central to this achievement has been the

8 earlier unbundling of the power sector and the privatisation of three of the five distribution companies to a strategic investor in co-financing with the EBRD and IFC. This has eloquently shown that power sector liberalisation and reform can succeed in Moldova even though it failed in California. .Consequently, IFI advice and conditional lending to these countries should be ambitious in this field of energy reform rather than minimalist since, given their poor initial resource condition no time can be wasted Georgia has also made some progress in power sector reform, including privatisation of one Distribution Company (Telasi serving Tbilisi) which collects 70 % of the billings compared to a ratio of 15 % collected by the public company which serves the rest of the country. In 1992, Armenia too has managed to sell the distribution of electricity to an international strategic investor.

These three countries should deepen the process of reform of the power , heating , telecom , water and other utilities .The other countries : Azerbaijan , Kyrgyzstan , Tajikistan , and Uzbekistan should learn from those experiences with a view to reduce their very high quasi-fiscal deficits and to promote enterprise restructuring .As a positive move , Kyrgyzstan has finally initiated the unbundling of the sector by establishing four distribution companies .

Two arguments are frequently brought forward to delay power sector reform: that those poor consumers would be unable to pay; and that strong international sponsors have no appetite to bid for utilities in these low income, high risk countries (in which public services are viewed as an entitlement. ) The utilities of these countries, nevertheless, can be made commercially viable while protecting a safety net of consumption by the poor) by the implementation of , a policy of comprehensive well-targeted subsidies .These subsidies would be paid out of the budget and -ideally- should be financed by earmarked grants donors and soft loans from the IFIs) could. Under the scheme, aid resources earmarked this way would cease to be disbursed if adequate commercial pricing were interrupted .The World Bank has developed comprehensive subsidy targeting systems for many of these countries .The policy prescription is to put into effect generalised targeting of subsidies that would be paid for by the donor grants This policy would require prior pledges of grants by donors. Also, the World Bank could give consideration to disbursing policy based loans directly against vouchers of targeted subsidies collected by the utilities and conditional upon strong pricing and full collection to all non -subsidised users.

Another area in which the IFIs should strengthen conditionality is banking sector reform. Much of the banking crises that these countries have endured owes to the lax entry policy coupled with a very broad conception of the banking business .Often, commercial banks have been allowed to perform the myriad of types of operations that they perform in the developed countries but without the economic framework and the supervision required. Consequently, in many countries banks have been straight vehicles for theft rather than genuine financial intermediaries. Banks should be closely supervised- if necessary by international auditors - and the type of operations they are allowed to engage in should be narrowed down. Also, entry should be strictly limited to strong professional bankers with no industrial, commercial, or agricultural interests and ideally with the EBRD, IFC or other developmental institutions (DEG, the Agha Khan Fund, or the EU) as shareholders.

9 Clearly, there are many other policy areas in which relative successes and failures have been registered. In Uzbekistan, the practices of multiple exchange rates and state procurement of cotton have been very detrimental...Also , detrimental has been the policy of de facto restrictive entry to some sectors ( unless the National Bank of Uzbekistan is brought as a business partner and shareholder ) The IFIs have raised these issues repeatedly with the authorities of this country .By contrast , the design and implementation of the “Oil Stabilisation Fund “ in Azerbaijan has been a success in helping sterilise some of the increasing oil exports This success comes against the background of failure to introduce this institution -. as simple to design in theory as is difficult to put in practice- by Venezuela in the 1970s and Mexico in the 1980s and many other developing countries However, Azerbaijan has yet to come to grips with the excruciatingly high quasi-fiscal deficits in the energy sector, including the domestic –export price differential for oil and gas. Corruption seems to be a problems in all the CIS-7 countries ( though these countries do not have the monopoly of corruption ,for it is a serious problem in most developing and OECD countries ) So a myriad of challenges – beyond the scope of this short paper- lay ahead In these instance , we have chosen to emphasize the policies of power and utilities reform that has so many far reaching effects and implications and that appears to be so much simpler to tackle .For it is unrealistic to expect that citizens and enterprises pay taxes ( an non –secured transaction until a country enjoys an effective revenue service ) while they neglect to pay for utility services ( a transaction that can be secure by disconnection in supply .)

HYPOTHESIS -3: UNFORESEABLE OR SLUGGISH SUPPLY RESPONSE TO POLICIES? Ultimately the eventual supply response to policies is the factor that wills unable countries to repay their loans and\or preserve their solvency. Was the supply response overestimated?

Structural adjustment means qualitative change and quantitative flux, and systemic transition is the most extreme example of structural adjustment. In turn, the CIS-7 countries represent the most formidable and challenging case of transition. Estimating the supply response and its timing that policies may have on target variables( such as GDP , exports , employment , and wages ) in the CIS-7 by regression and formulae is an elusive fantasy :structural change is the main enemy of econometrics. Empirical studies such as those by DeMelo , Denizer and Gelb ( 1995 ) are a praiseworthy attempt to gauge and systematizethe evidence ex-post but they are far and from giving as a precise empirical relationships ex-ante for prediction and also far from controlling for all the relevant differential variables applicable to the CIS-7 .

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Thus, it is fair to say that no analyst had the analytical tools for predicting the extent of the initial collapse of economic activity and the strength of the posterior recovery. Chart 7 depicts the path of GDP for the different sub-regions of transition economies .It can be seen that the “transitional depression� of the CIS-7 was deeper and longer than in the other sub-regions. At the same time, Chart 8 illustrates the strength of growth after the Russian crisis of 1998. Their average annual growth in 1999 -2002, close to 5%, was stronger than the average for the other transition economies and the EU accession group .Consequently, it can be concluded that there has been a considerable supply response of GDP since 1996.

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The supply response of exports since the Russian crisis has been significant for Armenia and Moldova, but sluggish for Georgia, Kyrgyzstan and Tajikistan, as Chart 9 illustrates. Hence the importance that these countries join the WTO and anchor their trade frameworks to its “rules of the game�. Georgia, Kyrgyzstan and Moldova have already joined the WTO and Armenia is close to joining.

Beyond multilateral trade, the resolution of neighbourhood conflicts and beyond this mistrust is of the essence for regional trade. On one estimate, the exports of Armenia to Turkey and Azerbaijan could increase by as much as 30% with the resolution of the

12 Nagorno –Karabakh conflict (see Transition Report 2002 , page 114 , under liberalisation ) .Finally, the EU and the USA could help these countries´ growth prospects most by offering them to possibility to negotiate free trade agreements.

HYPOTHESIS-4: WERE THE INITIAL CONDITIONS SO ADVERSE? Much has been discussed above and elsewhere about the severity of the initial conditions and particularly for the CIS-5 that lack oil resources. Absence of institutions , remoteness , civil and international conflicts , ethnic divisions , secessionism , undiversified economies , i , absence of a strong Diaspora in the West save for Armenia etc .

Dianne Smith (1996) of the US Army War College vividly and eloquently described the initial conditions of the Central Asian States with the following words (this description could be extended mutatis mutandis to the Caucasus and Moldova: in many respects): “The greatest threats to Central Asian security are internal. The painstaking process of nation-building, the legitimacy crisis, rapid social and economic transformation, decolonization, ethnic diversity, border disputes, and a catalogue of other issues are all sources of instability in the post-Soviet republics.

The core issue is the ethnic composition of each state. Since no nation-states existed in the centuries before Russian conquest, substantial transmigration of ethnic groups characterized the region. As a result, major concentrations of ethnic minorities reside within countries other than their titular nation, to include: one million Uzbeks in the Khojent province of Tajikistan, half a million in the Osh area of the Fergana valley in Kyrgyzstan, and 280,000 in the Chimkent region of Kazakhstan; one to two million Tajiks in Samarkand and Bukhara, Uzbekistan; nearly a million Kazakhs in Uzbekistan; and roughly eight million (a number declining daily due to emigration) Russians, Ukrainians, and Germans in the northern part of Kazakhstan. The percentage of the titular nationality (and the ruling elite) in each republic may be less than half. Ethnic populations are also split by international boundaries; for example, there are more ethnic Tajiks in Afghanistan than in Tajikistan itself.

These titular nationalities are caught outside their home republic because artificial boundaries, established during the Stalinist era, purposefully cut across nationalities, to “divide and conquer.” Central authorities meant these boundaries as internal administrative lines of demarcation—no one dreamed the Soviet Socialist Republics would ever become actual states. This ethnic mix was further complicated when the area became a wartime dumping ground for exiled nationalities, such as Volga Germans, as well as the relocation of war industries during the early 1940s, the Virgin Land program of the 1950s, and Moscow’s systematic immigration of ethnic Slavs (to dilute the titular nationality) after Stalin’s death.

All five republics have suffered sharp economic dislocation since gaining independence.

They were suddenly cut off from the centralized command economy that directed their resource allocation, long-range planning, investment funding, and management.

Exploitation of rich natural energy and mineral resources has been stalled; no longer a part of the Soviet Union, the five republics are all landlocked, and goods must transit through a second nation via transportation networks that do not yet exist (other than through Russia).

13 Economic reform and movement toward a market economy have been uneven, as states fear that further economic dislocation will produce massive internal unrest and political instability. The lack of modern financial systems, transportation networks, banking institutions, and enforceable legal systems all hamper foreign investment.

Migration of ethnic Slavs to Russia has cost the republics a large cadre of skilled technicians and managers; migration of ethnic Germans has cost the republics the group most responsible for cultivated agriculture. Many local nationalities are a generation or two from being nomads or herdsmen. At the same time, overpopulation pressures from large Central Asian families(often having five to six times the birth rate of urbanized Slavic states) have produced an underclass of poor un- or underemployed ,less-educated workers whose dissatisfaction in the1980s often provoked the riots leading up to independence. Ethnic discrimination during the Soviet era produced few senior, local leaders in the military, industrial, legal, diplomatic, or managerial fields from the Central Asian republics.

Soviet degradation of the environment created massive economic distortions and mammoth health problems that have resulted in rival demands for finite state funds. Huge tracts of land were used to test Soviet weapons of mass destruction—with little regard for the local nationalities living downwind, many of whom now suffer disproportionate cancer rates.

Under the Soviet economic system, cotton monoculture produced 90 percent of the USSR’s cotton requirements and 17 percent of the total world cotton production. Cotton usurped practically all grain crops and has taken over land used previously for fruits and vegetables.

As a result, not only does the once agricultural heartland suffer from an insufficiency of vegetables, wheat, meat, and milk, but the region is beset with ecological disaster created by defoliants, airborne salts, industrial pollution, over fertilization, water diversion schemes (the Aral Sea). Irrigation, the water distribution system, and control of waterways all threaten to become major issues in the next decade.

Efforts to resolve economic ills through inter-republican or regional associations have not flourished, Democracy has been sacrificed on the altar of stability in all five republics. None of the Central Asian Communist leaders wanted independence; indeed, most favoured the 1991 coup attemptin Moscow1 Early constitutional efforts lacked real checks and balances or public commitment to their survival. When legislatures attempted to play a genuine role in the decision making process, the executive branch progressively usurped their power, and in the case of Kyrgyzstan (September 1994) and Kazakhstan (March 1995) the presidents dissolved them outright. Authorities repressed organized opposition political parties, especially those Islamic in nature.

The continuing civil war in Tajikistan remains the most crucial threat to inter-regional security. Initially portrayed as the result of radical Islamic fundamentalism, the civil war is, in reality, less about religion or ideology and more about economic, linguistic, ethnic, clan, and regional rivalries for access to political and economic spoils...

The ongoing civil war in Afghanistan remains the most immediate extra-regional threat to security. Afghanistan faces the real prospect of disintegration if the power struggle between northern ethnic groups and the Pashtun leadership degenerate into a conflict along ethnic lines. Such a split might eventually draw in Afghanistan’s neighbours, notably Iran, Pakistan, and the Central Asian republics (relatively unstable themselves), which have close

14 ethnic-religious ties across the border. An Islamic regime in Kabul could encourage the religious resurgence already growing across the border in Central Asia. Political alignments within Central Asia could be profoundly affected by events in Afghanistan.

Tajikistan, Uzbekistan, and Turkmenistan have large numbers of ethnic kinsmen across the border. The disintegration of state power occurring in Afghanistan could result in a new regional realignment; northern Afghanistan nationalities might forge new links with their ethnic kinsmen across the Amu Darya, rather than being subordinate to a Pashtundominated government in Kabul.

Whether Islam itself is an element of instability are debatable, but central authorities’ fears—provoking arrest, imprisonment, and exile—fuel the flames of intolerance and authoritarianism that surely do destabilize the region. These centrifugal forces (and the threatened spill over if they should explode into ethnic, religious, and social conflict) alarm the region’s Asian neighbours. Each seeks to promote stability within all the Central Asian states through a variety of bilateral and multilateral means. Geographic, political, financial, religious, and ethnic factors affect the ability of each to achieve its security goals and promote its hegemonic aspirations.”

So adverse initial conditions? It is difficult to visualise more difficult initial condition eve in history save for some countries in the African continent.

HYPOTHESIS- 5: WERE EXTERNAL SHOCKS A SERIOUS PROBLEM? Beyond the internal shocks, problems and conflicts, the economies of these countries had to withstand the trade disruption that came with the dissolution first of the COMECON, second of the Soviet Union, and third of the rouble zone. From 1994 they were hit by the contagion of the successive emerging market crises and in particular of the Russian crisis of August 1998 which underscored how important trade links with Russia had stayed despite the trade destruction since 1993.In turn, Georgia has been affected by the war in Chechnya and all the Central Asian Countries by the instability in Afghanistan A Mexican president once lamented that Mexico was “so far from God and so near the United States”. One can re-state this thought for some of the CIS-7 Countries as “so far from God and so near Afghanistan”.

HYPOTHESIS-6 : DID THE IFIs LEND IN EXCESS? Multilateral lending , and in particular policy based lending, is predicated on a brighter economic future provided that reform policies are carried out effectively and in a timely fashion. Multilateral funds smooth out inter-temporal consumption by enabling countries to both consume more and invest more today thanks to the extra funds .Ideally , multilateral funds should bear a clear divide between what is lent against future creditworthiness and what is given out as aid . On one side of the spectrum, we have the EBRD and IFC funds provided on harder terms and, on the other side; we have pure grants given by some donors; in between lay soft loans such as IDA and PRGF.

15 Did the IFIs lent too much to these countries? With hindsight, the short answer could be: yes. Other things being equal , for these countries to show respectable debt ratios today either lending should have been at lower scale or else more concessional .

At the same time , it should be said that the IFIs can take credit - probably more so than in their work in other regions – for having provided guidance on policies , institutional development ( from central banks and customs services to pledge laws and enforcement of contracts ) , and adequate road maps and benchmarks to assess progress .. Indeed, success could have been more profound in some specific areas (but an inventory of the progress in every area of reform is beyond the scope of this paper)

. For example, the successes of Moldova. Kazakhstan , and Georgia , with power sector reform ( see Chart 10 ) , shows that commitment ( and possibly IFI conditionality ) as regards to this critical reform could have been broader , stronger and earlier . Had this been the case, a fair share of the public debt could have been saved. Quasi-fiscal deficits in the energy sectors to the tune of 7 % in Tajikistan (2000 ) and Kyrgyzstan (2001 ) and 27% in Azerbaijan ( 2000 ) can and should be tackled urgently .Also , as noted above , more should have been done in the area of banking sector reform .

Would the progress in transition achieved have occurred without significant IFI lending? Clearly not! Much of IFI advice and technical assistance would have just fallen into deaf ears or even been unwelcome without significant IFI lending.

16 Furthermore , much of the meagre US$150 per capita in cumulative FDI from 1991 to 2002 (compared to US$1,400 in Central and Eastern Europe ) would not have taken place :from most telecom , power or water supply privatisations to gold mining investments in Uzbekistan and Kyrgyzstan - to quote few examples of investments sponsored by the participation of either the EBRD , the IFC or both.

Side by side with the minute figures of FDI (and to some extent as a mirror image) is the meagre bilateral lending? As Chart 11 shows , of the 40 % of the debt owed to bilaterals , one half is owed to Russia and other CIS countries ( the later mostly Georgian debt to Turkmenistan ) and relates to debt originating in energy deliveries .

Only 15 % of the debt corresponds to Paris Club creditors other than Russia. With Japan featuring high in (soft) lending - to Kyrgyzstan and Uzbekistan, - not much is left for the other OECD creditors.

Beyond the lack of sufficient assistance by donors, the behaviour of some of the foreign investors and western investment banks has often left much to be desired. In one instance a reputable investment bank charged a high percentage of the privatisation proceeds for advising the government of Armenia to sell the Telecom Company to a European Telecom sponsor; the advice consisted in selling a 15 year monopoly for fixed line, mobile and paging. In another instance, another investment bank provided a loan to the Central of Tajikistan, secured with “good value� international reserves, for an interest rate of 15 %. And yet in another instance, a third investment bank persuaded the Government of Moldova and bondholders that the country was creditworthy to float a US$ 75 million (about 5% of GDP) Eurobond.

III.DONOR FUNDING It is not accurate to state that donor funding has been generous .If at all, IFI funding may have been generous to compensate for the meagreness of bilateral resources.

17 Bilateral funding -, particularly the softer terms ODA funds- have in general been lower in per-capita terms and as percentage of total debt than those received by many countries of comparable or better per-capita incomes and of similar or even less indebtedness .Furthermore, the Paris Club creditors have been much less generous in their rescheduling than with other comparable and better off countries Below, we compare the terms offered to Georgia and Kyrgyzstan in the recent Paris Club rescheduling with the terms offered to Yugoslavia and Bolivia in their last Paris Club rescheduling. According to the World Bank classification system Georgia as Yugoslavia are both in the less indebted category. Notwithstanding the fact that Georgia belongs to the lowest income category and Yugoslavia to the next less bad category of lower middle income , the latter was given a write off equivalent to 23 % of its total debt ( bilateral debt was thus reduced from 37% of the total to 14% ) while poorer Georgia was left with its bilateral debt intact at 29% of the total debt.

Likewise, Kyrgyzstan is –again according to the World Bank classification – is registered as both poorer and more indebted than Bolivia. However , Bolivia was offered by the Paris Club a write off equivalent to 16% of its total debt - the last write off in a series – ( that made bilateral debt to decline from 32% to 16 % of the total ) whereas Kyrgyzstan did not benefit from any write offs with its bilateral debt left intact at 30 % of the total .

Chart 12

IV. SOME CONCLUSIONS

18 In all certainty labelling the current situation of the CIS -7 as a success story would be an overstatement. At the same time, it is not difficult to visualise how much worse these countries would be today, had IFI assistance not taken place. It is reasonable to say that up until September 11, some of the CIS-7 countries were beyond the radar screen of most bilateral aid agencies. And off –limits their Exim Banks and Export Credit Insurance Agencies. Japan, Turkey, Russia and few others were exceptions .

Yet these countries had to build not only market economies but nation states and institutions from scratch .in the midst of the most adverse conditions. More so than countries in other regions of the world, the IFIs were compelled to assume the collective responsibility of the international community .IFI lending was both necessary and also an inescapable tool for maintaining leverage in the policy dialogue.

Even though donor focus in these countries has strengthened after September 11, the less than generous ( “Houston”) terms obtained by Georgia ( on 6 March 2001 ) and Kyrgyzstan(on 7 March 2002 ) in their Paris Club rescheduling eloquently shows that we are still far from coming to grips with the reality and the Official Development Assistance (ODA ) required for these countries .The outcome has been one of heavy concentration of IFI exposure to these countries.

Debating for the years to come whether or not the CIS-5 fall under HIPC is not a very productive avenue, for in the interim these countries will be condemned to the category of international financial pariahs and as such un-creditworthy. This seems inequitable when many other countries have gone through successive rounds of debt reduction including HIPC to return to renewed debt build-ups.

Three actions by bilateral donors seem a adequate and urgent : (i) that bilateral creditors provide Naples or Cologne terms to these countries in the coming rescheduling of the Paris Club ; and / or (ii) that donors put sufficient ODA funds and grants on the table ( in Consultative Group Meetings or otherwise ) , including funds for paying for targeted subsidies that would allow for full pricing of utilities ; and / or (iii ) that donors provide grant funding to pay for a fraction of IFI debt service , conditional on continued strong policies .

The debts owed to Russia -most of it arising from oil and gas deliveries- , constitute a critical problem. It would be of great help for the CIS-5 that the power utilities are allowed to start reform with no or little debt .In this direction, some bilateral creditors of Russia willing to help the CIS -5 countries, may want to consider debt –for –debt swaps whereby they would write down bilateral claims on Russia conditional upon Russia to white down its claims on the CIS-5 countries by at least the same amount. These types of swaps were proposed by Buiter and Lago (2002).

It is of the essence that the IFIs are able to stay actively engaged in policy dialogue and conditionality with these countries for the years to come and for this they need the tool and leverage of strong continued lending.

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REFERENCES

Buiter , W, and Lago , R(2002 ); “Debt in Transition Economies :Where is it Heading ?; What to do About it ? Ten Years of Transition. Revue d´Economie Financiere”. Paris.

DeMelo, M, Denizer, C, and Gelb, A (1996); “From Plan to Market: Patterns of Transition; World Bank Economic Review, Vol10.

EBRD; Office of the Chief Economist” Transition Report “(2000, 2001 and 2002).

EBRD .London.

Fankhauser, S, Kennedy D, and Raiser, M. (2002); “Low pressure High Tension: Energy-Water Nexus and Regional Co-operation in Central Asia and the South Caucasus”. Paper presented to the CIS-7 Conference in Lucerne January 2003. Office of the Chief Economist, EBRD.London.

Hopkirk, P (1994); The Great Game; the Struggle for Empire in Central Asia” .Koshanda Globe .New York.

Meyer ,K and Brysac ,S (1999) ;Tournament of Shadows: the Great Game and the Race for Empire in Central Asia “ . Counterpoint.

Smith D (1996); “Central Asia: A New Great Game”. Strategic Studies Institute .US Army War College, Carlisle Barracks, PA. USA. **********************************************************************