Mission Concluding Statement 

Tajikistan: Staff Concluding Statement of the 2022 Article IV Mission

December 23, 2022

Recent Developments, Outlook and Risks

1. Strong growth has continued in 2022, with minimal disruption from the war in Ukraine. After growing by 9.2 percent in 2021, real GDP increased 8 percent (year-on-year) during January-October, reflecting broad-based growth in industry (including mining), agriculture, and construction. Adverse spillovers from the war have not materialized as expected, while strong financial inflows have supported domestic demand and liquidity. Remittances slowed immediately after the beginning of the war but rebounded sharply in Q2. This helped keep the current account in surplus and boost FX reserves from $2.5 billion at end-2021 to $3.4 billion in October, more than 8 months import coverage.

2. Inflation has been well-contained during 2022 despite higher international commodity prices. Twelve-month inflation decreased from 8 percent at end-2021 to 4.5 percent in November, below the mid-point of the NBT’s medium-term target range of 6 (±2) percent. A tight monetary stance has helped contain inflationary pressures, while rising international prices for imported food and fuel in the first half of the year appear to have been mitigated by a stronger somoni and the release of strategic food reserves. Strong domestic agricultural production oriented towards internal consumption has also contained prices for local food products. The NBT reduced the refinancing rate by 50 bps in late October to 13 percent, in line with subdued inflation.

3. Significant uncertainty remains over the near-term outlook. While negative spillovers from the war have not materialized so far, it remains unclear to what extent Tajikistan will continue to be immune from weaker economic activity in Russia. Real GDP growth is projected to decelerate from 7.5 percent this year to 5 percent in 2023 as the positive impact of this year’s strong inflows diminishes. Over the medium-term, growth is expected to converge to its potential of about 4 percent, with inflation staying within the NBT’s target range and FX reserves remaining at around 8 months of imports through 2027.

4. Risks to the outlook appear tilted to the downside. Russia is likely to be increasingly affected as the war continues, against the backdrop of a deteriorating global environment and tighter financing conditions. A decline in remittances would have a negative impact on growth, with possible spillovers to the banking system, while the return of migrant workers from Russia could increase the need to scale up social assistance. Tajikistan’s economy is especially exposed to climate-related risks. On the upside, increased FX reserves have helped reduce near-term vulnerabilities, and further development of Tajikistan’s large proven gold reserves provides scope to build external buffers and increase fiscal resources.

Fiscal Policy

5. The fiscal deficit is estimated at 1.4 percent of GDP in 2022, implying a modest expansion from last year’s deficit of 0.7 percent due to increased capital spending. Tax collection has benefitted from increased revenue from the mining sector, reflecting strong growth in mining and an increase in the income tax rate for mining companies, together with steps to begin phasing out some tax exemptions. This helped keep revenues broadly unchanged as a share of GDP from 2021, despite reductions in VAT and income tax rates introduced at the beginning of 2022. In addition, spending pressures from higher food prices and border security have been managed within the existing spending envelope. The 2023 budget envisages a fiscal deficit of 2 percent of GDP, with a possible widening to 2.5 percent if external financing for capital expenditure materializes.

6. The fiscal deficit target of 2.5 percent of GDP remains an important anchor to ensure that debt remains on a downward trajectory over the medium term. This should be reinforced by phasing out quasi-fiscal activities, including through state-owned enterprises. Public debt continues to be assessed as sustainable, but with high risk of debt distress. Spending pressures (including on large infrastructure projects and SOE contingent liabilities) remain large, while revenue flows and financing sources remain uncertain. Maintaining the medium-term fiscal deficit target of 2.5 percent of GDP would anchor a decline in public debt from 36 percent of GDP projected for 2022 to about 32 percent by 2027.

7. Continuing to improve domestic revenue mobilization would create space for high priority spending. Limited fiscal space is further constrained by infrastructure-related spending planned over the next decade. Sustained efforts to broaden the tax base by fully phasing out tax exemptions and improving tax administration are essential to increase space for critical investments in health care, education, social protection, and infrastructure that are needed to achieve Tajikistan’s development goals under the National Development Strategy-2030. Development of a medium-term term revenue strategy would provide a framework to anchor improved domestic revenue mobilization. Accelerating the transition to GFSM2014 for fiscal reporting is also essential to upgrade the quality of fiscal statistics. Given the sensitivity of revenues from the mining sector to international commodity prices, collecting data on mining-related revenues is important for revenue forecasts and fiscal policy purposes.

8. Development of the domestic debt market would help increase resilience and diversify sources of financing. The budget continues to be heavily externally financed, with the limited local government securities market constraining scope for domestic budget financing. In addition, while there are relatively large government deposits placed with the NBT (about 6.5 percent of GDP at end-October), the practice of earmarking a large share of deposits for specific ministries leaves limited flexibility to manage financial resources within the Treasury Single Account (TSA). Increasing the efficiency of cash management and expanding market-based domestic issuance would provide greater scope to mitigate shortfalls in external financing during the year.

9. Comprehensive governance and transparency reforms are key to reducing fiscal risks from the SOE sector. The recent steps to approve a Fiscal Risk Management Strategy and publish a Fiscal Risk Statement are well-placed and should be followed by steps to improve monitoring and management of SOE fiscal risks, including collecting data in line with IFRS requirements and audit, developing a comprehensive SOE ownership and oversight policy, and improving corporate governance and management performance. Borrowing by SOEs should be carefully considered and included within the government’s overall medium-term debt envelope and strategy.

10. Decisive efforts are needed to advance reforms to improve the financial viability of the electricity sector. This takes on increased urgency in the context of ongoing investments in electricity generation . Recent electricity tariff increases for households and the state-owned aluminum company are important steps (the first tariff adjustment since 2019) but need to be accompanied by a comprehensive reform of the electricity tariff structure with a time-bound plan to reach cost recovery. Sustained efforts to restructure Barki Tojik’s debt remain a critical priority to reduce the cash deficit in the electricity sector, in addition to efforts to reduce technical, commercial, and collection losses, improve governance, and address Barki Tojik’s arrears to suppliers, commercial debt and liabilities to other public entities. In addition, the move to unbundle Barki Tojik into separate generation, transmission and distribution units needs to be supported by implementation of a rules-based distribution of revenues among the three entities for the new financial model of the sector to become fully operational.

Monetary , Exchange Rate and Financial Sector Policies

11. Inflation remains well-contained, but the NBT should stand ready to tighten the monetary policy stance if inflationary pressures emerge. The monetary stance remains relatively tight despite the reduction in the policy rate in October, with real interest rates close to 8 percent (using realized inflation). Nevertheless, monetary aggregates have increased sharply due to strong financial inflows. This appears to partly reflect stronger demand for somoni, but the NBT should stand ready to tighten the monetary stance if needed to prevent a de-anchoring of inflation expectations. Quantitative measures such as raising the reserve requirement and sterilizing inflows through NBT bill and ruble auctions can help absorb excess liquidity.

12. A transition to inflation-targeting will require sustained efforts to improve monetary policy transmission. Implementation of the required reserve averaging mechanism would help strengthen the application of reserve money targeting as an interim policy anchor, while strengthening the liquidity forecasting framework and supporting deeper interbank and government debt markets will enhance liquidity management and monetary policy transmission. Implementation of the roadmap provided by the National Financial Inclusion Strategy for 2022-26 will help increase the level of financial intermediation and improve access to finance. Enactment of the amendments to the NBT Law recommended by the 2021 Safeguards Assessment is important to strengthen the NBT’s operational autonomy and governance.

13. Exchange rate flexibility should remain an important part of the policy toolkit to absorb external shocks. The somoni demonstrated more flexibility in 2022 as it has broadly tracked the volatility of the ruble. Reduced FX pressures and greater exchange rate flexibility have helped keep the official and parallel rates relatively aligned, but the NBT should remain vigilant to any reemergence of FX pressures in 2023. Steps to modernize FX markets, including by moving to price-based FX auctions, improving transparency on FX market transactions, and executing public-sector transactions at prevailing market rates, would help improve FX management and could facilitate the elimination of the exchange restriction and multiple currency practices.

14. Financial soundness indicators continue to improve as the resolution of two large banks in 2021 has helped clean up legacy loans in the banking system. The capital adequacy ratio strengthened to 24.4 percent at end-October 2022 as non-performing loans declined to 11.9 percent of total loans, while strong fee and commission income has supported profitability. Credit concentrations and foreign currency lending remain on a downward trend, albeit from relatively high initial levels. Credit growth has picked up this year, driven by consumer loans to households in domestic currency, with claims on the private sector increasing by 15 percent (year-on-year) in October.

15. Emerging risks call for further strengthening of financial supervision and regulation and strong safety nets. The resolution of two formally systemic banks should be completed in a timely and transparent manner, with full disclosure of associated costs. Despite progress, legacy NPLs remain high at some banks while the war in Ukraine is posing new risks. Therefore, strengthening supervision, regulation, macroprudential analysis, and financial safety nets in line with the recommendations of the recent IMF Financial Sector Stability Review is essential to improve the banking system’s resilience to shocks and risk monitoring. In this context, the broadening of deposit insurance coverage to SMEs and NGOs is welcome but should be backed by strong Deposit Insurance Fund buffers. Sanctions on Russia can accelerate de-risking by foreign banks, calling for strong AML-CFT safeguards and diversification of correspondent banking relationships. In this regard, the government approval of the draft AML/CFT law is a welcome step towards stronger AML-CFT standards.

Structural Reforms

16. A transition to more market-oriented resource allocation will be needed to unlock the economy’s full potential and support more inclusive growth. Accelerating progress on structural reforms to reduce the state footprint in the economy and transition to market-based principles would help foster entrepreneurship, promote competition, and expand private sector development. Good governance can have a transformative impact on investment, creating space for the private sector to become an engine of growth. The new Law on Public Procurement to expand coverage of SOEs, and the new Permit System Law and the amendments to the Law on Inspections of Business Entities’ Activity are welcome steps in this direction. Sustained implementation of this legislation will be essential to ensure that statutory changes achieve meaningful results in the business climate. Market-based reforms should be complemented by expanded social safety nets to ensure vulnerable populations are adequately protected.

17. Reducing climate-related vulnerabilities would open new opportunities for more sustainable growth. Tajikistan’s climate and economy are especially vulnerable to climate change, and climate reforms are key to realizing the economy’s long-term potential and limiting the environmental impact of accelerated industrialization. The Green Development Strategy for 2023-37 provides a roadmap for greening of the economy and achieving mitigation and adaptation goals. Adaptation measures are critical to strengthen the resilience of climate-prone sectors and promote sustainable and inclusive growth. The strategy should be supported by strong policy and institutional frameworks that help create fiscal space for climate reforms, improve access to climate funding, and ensure adequate human capital and social protection.

The mission would like to thank the Tajik authorities for their hospitality and close collaboration and express its appreciation for the candid and insightful discussions. The IMF team stands ready to engage with the authorities on their interest in a Fund program and support their commitment to advancing their structural reform agenda.