Financial Crisis Could Make Bad Situation Worse

UNCLAS SECTION 01 OF 05 DUSHANBE 000046 SENSITIVE SIPDIS DEPARTMENT FOR SCA/CEN E.O. 12958: N/A TAGS: EFIN EAID ECON ETRD PGOV TI SUBJECT: Financial Crisis Could Make Bad Situation Worse Ref A: 08 State 134905 Ref B: 08 Dushanbe 1348 Ref C: 08 Dushanbe 1470 Ref D: 08 Dushanbe 1256 Ref E: 08 Dushanbe 1502 Ref F: 08 Dushanbe 1518 Ref G: 08 Dushanbe 1572 Ref H: 09 Dushanbe 21 ¶1. (SBU) Summary: This cable responds to ref A, seeking information on the effects of the world financial crisis. The crisis is likely to affect Tajikistan via three routes: falling prices for its two largest exports, cotton and aluminum; declining remittances from Tajik migrant workers in Russia; and a slackening in domestic sectors, such as construction and services, that depend on revenue from the first two areas. The isolation of Tajikistan's banking system and the primitiveness of its financial sector will insulate it from some direct effects. The government response has been mixed; some officials acknowledge the potential severity of the crisis while others say the country's isolation will protect it. Much assistance to Tajikistan, including ours, is currently focused on helping the country recover from the effects of last year's terrible winter. Donors agree that difficulties arising from the financial crisis, particularly falling remittances, could be devastating for the country. End summary. ¶2. (U) This cable is organized as follows: -- For the effects of the financial crisis on the Tajik economy, see paragraphs 3-14. -- For the government's response and impact on the budget, see paragraphs 15-17. -- For the response of international financial institutions and other donors, see paragraphs 18-19. -- For the impact on USG assistance, see paragraphs 20-24. Tajikistan's Poverty Means Few Direct Effects... ¶3. (U) While the world financial crisis is likely to have a significant bearing on Tajikistan's economy, most of its effects will be indirect (ref B). According to Luc Moers, the resident representative of the International Monetary Fund in Dushanbe, as a result of the isolation of Tajikistan's banking system and the primitiveness of its financial sector the crisis will have few "first-order" effects here. Jamshed Yusupov, deputy director of the National Bank of Tajikistan, concurred, noting that the low level of investment and savings in Tajikistan's banks mean that few people would be affected even if there was turmoil in the banking sector. Furthermore, 99% of existing deposits are in somoni-denominated accounts, insulating account-holders somewhat from currency fluctuations or speculation resulting from financial market turmoil. The banking system itself is relatively safe too, he said, since foreign ownership in Tajikistan's dozen private banks amounts to only some 37%, which is rather low by international standards. ¶4. (U) Tajikistan's poverty "saves" it in another way: since it has only two major exports, cotton and aluminum, its economy is more insulated from falling world commodity prices. And falling aluminum prices -- which have tumbled to well under half their high-water mark this summer -- will have very little direct effect (refs C and E). The Talco aluminum company, Tajikistan's largest industrial concern, operates under a tolling arrangement according to which it is paid a fixed price to process aluminum; profits and losses, are absorbed by an offshore company based in the British Virgin Islands. Qabsorbed by an offshore company based in the British Virgin Islands. For the most part this arrangement has been criticized, not only for the opacity of the offshore company's finances -- the profits of which purportedly end up in the pockets of the country's political leadership -- but also because Tajikistan's state budget receives very little from taxation of Talco's operations. Although Talco has announced a 10% cut in output and tons of aluminum are rumored to be warehoused for want of buyers, this will have limited effect on the Tajik economy. As one government official said, "We can't be hurt from the loss of something we never had." ...But Cotton Sector not In Cotton ¶5. (U) There are already indications, however, that the 40% drop in world cotton prices is having negative effects here. The State Statistics Committee reports that over the first eleven months of 2008, Tajikistan exported 73,800 tons of cotton fiber, worth $97.4 million, making it the world's fourth-largest exporter of raw DUSHANBE 00000046 002 OF 005 cotton. According to official statistics, cotton exports account for 3.7% of Tajikistan's total GDP and 12% of its agricultural production (in value added). Recent news reports have stated that cotton farmers, who had to borrow money to plant their crops, are facing grave difficulties paying back those loans because their harvests aren't fetching enough on the world market. Banks, in turn, are now highly reluctant to lend to farmers for future operations. Farmers and cotton investors have been given three more months to pay back loans, but donors doubt that world prices will increase during that time. The government's solution for the long term, to develop a domestic cotton processing industry that will allow it to export value-added finished products, if it ever gets off the ground, will do little to aid farmers in the immediate term. ¶6. (U) Given the nature of the cotton industry in Tajikistan, the financial crisis may make a difficult situation worse. The sector is notoriously corrupt, with reports of government-enforced quotas being met by forced labor, all for the benefit of wealthy investors tied to the ruling elite (ref D). Last year the National Bank admitted that it had made unauthorized loan guarantees to fund cotton production (refs C and E). Against this backdrop, banks' reported reluctance to provide new loans to cotton farmers may not mean much. According to embassy sources, smaller cotton farmers never got many loans in the first place, while larger operations were issued government-backed loans even when it was proscribed. The government of Tajikistan recently announced that would make 180 million somoni ($52 million) available for general agricultural loans in 2009. Donors have pressed the government to make sure that some of this money will fund crops other than cotton. Lost Remittances and Other "Second-Order" Effects Could Be Significant ¶7. (U) While the direct effects of the financial crisis are expected to be minimal, Tajikistan may be particularly vulnerably to second-order effects. Without a doubt the biggest of these will be the reduction of remittances due to cutbacks in construction and a slowing economy in Russia, where as many as a million Tajiks work. Over the course of 2008, $2.67 billion was sent back to Tajikistan, equal to 50% of the country's GDP, indicating that Tajikistan is more dependent on remittances than any other country in the world. But the rate of remittance growth has been falling. Over the first nine months of the year, remittances averaged 75% higher than the previous year. The numbers for October through December were still higher than 2007, but gains were more modest: 18% in October, 1% in November, and 9% in December. (The numbers have been dropping in absolute numbers as well, but this is typical for this time of year.) Despite December's surprising uptick, few here doubt that the country faces leaner months ahead (ref F). ¶8. (U) The lower remittance income will, first and foremost, hurt Tajik families that depend on them for survival. According to several experts here, it was only through remittances -- or loans taken out against prospective remittances -- that many Tajiks made it through last year's disastrous winter, with its record low Qit through last year's disastrous winter, with its record low temperatures and skyrocketing prices for food and fuel. Not only will there be less money, but workers returning from Russia will also mean more mouths to feed. ¶9. (SBU) The decline in remittances will have other effects as well. Stocks of foreign currency could decline because of the drop in dollars coming from Russia. There are already signs that dollars are harder to come by, although the reasons for this remain unclear. The few ATMs around town, including one in the Embassy, are "temporarily" not providing dollars. The Embassy's cashier said he suspected the shortage was not linked to the crisis but that the government was tightening the flow of dollars to insure that major holiday season purchases were made in somoni. He said there were similar shortages in past years. ¶10. (U) According to the IMF's Moers, an additional second-order effect from the financial crisis may be the loss of liquidity in some banks connected with the trade credit system. Tajik traders may have difficulty taking out (and repaying) loans from some Russian and Kazakh banks that help finance the purchase of goods abroad for sale here. Moers said that although the government has expressed some concern about this, a recent IMF survey revealed that only some 1% of trading loans were provided by Kazakh and Russian banks, indicating that the trading system was relatively safe. Nevertheless, a number of banks have recently stopped issuing loans DUSHANBE 00000046 003 OF 005 to ordinary citizens. A contact at Amonatbank said the main reason is the banks' concern that returning labor migrants from Russia, who make up the majority of the potential borrowers, simply do not have the means to repay the loans. He said that banks chose to cut off lending entirely rather than add to the many existing bad debts (Ref G). According to other sources banks have faced a 25% drop in deposits in recent months as customers have pulled their money out. Banks have responded by advertising increased rates on deposits. Third-Order Effects ¶11. (U) The economic fallout from the financial crisis described above may lead to further indirect problems. Lower remittances will reduce spending on the local market which will force a contraction in domestic enterprises. Similarly, according to Moers, falling aluminum prices will have some effect on the economy because the small group of people who profit from Talco will have less income to spend domestically. This will impact the construction sector particularly, since wealth is invested mainly in real estate in Tajikistan. But sectors as diverse as the service industry, food, and transport may be affected. ¶12. (U) At the same time that remittance income is falling, the cost of living is rising for many Tajik families. In addition to higher food prices, the government has recently increased electricity prices by 25% to 1.7 cents per KWh. Although rates remain well below world averages -- and indeed below the recommendations of several international financial institutions that are concerned that government subsidization of such low prices leads to waste and inadequate revenues -- the increase will still be difficult for poorer Tajiks to afford. The government chose not to raise the rates for Tajikistan's largest electricity consumer, however. Talco will continue to pay 2008 prices, which will place a larger burden of the payments on the general population. Complicating Factors ¶13. (U) The economic problems associated with the world financial crisis may be compounded by Tajikistan's perennial winter power difficulties (ref H). Although the country reportedly possesses four percent of the world's potential for hydroelectric power generation, its capacity is greatly reduced due to decreased water flow during winter. Longstanding political difficulties with Uzbekistan, with which it shares the existing Soviet power grid, make it difficult for the Tajik government to import energy. Although in principal an agreement exists whereby Tajikistan trades its summer surplus for winter imports, in practice the Uzbek government routinely has been slow to honor it. Tajikistan will ultimately escape this cyclical problem by building transmission lines to its other neighbors and by improving relations with Tashkent, but for now, its citizens are short of winter electricity for heating, cooking, and conducting normal business (ref G). ¶14. (U) One bright spot has been declining fuel prices. Over the past two months the cost of a liter of gasoline has fallen from 3.80 somoni ($1.12) to as low as 2 somoni ($0.58). This will reduce the cost of agricultural production. Regarding the price of other inputs, including food, the critical period will come in early Qinputs, including food, the critical period will come in early spring, when many labor migrants typically return to Russia to look for new work. Tajikistan must import 90% of its food supplies, and its large trade deficit is financed by remittances, which fund well over half of the imports of food and other primary items. If jobs are unavailable in Russia, it could have a profound effect on imports. The Government Response ¶15. (SBU) Tajikistan's government is ill-equipped to handle a full-blown financial crisis if it does emerge. Apart from the country's extreme poverty, small budget, and lack of administrative capacity, top bureaucrats generally have proved unwilling to reduce corruption or adopt reforms that might curb personal profits to benefit the country as a whole. Without a governmental safety net, the population's traditional means of dealing with economic difficulties, such as last winter's emergency, has been to send family members to work abroad; if the financial crisis strikes at this source of income, the population has very little to fall back on. ¶16. (SBU) So far the government has provided mixed messages about the financial crisis. On the one hand, some officials have stressed DUSHANBE 00000046 004 OF 005 that Tajikistan's relative financial isolation will insulate it from the most serious potential problems, such as bank failures and the loss of savings. On the other hand, many officials recognize the seriousness of the danger posed by the loss of remittances. In concrete terms the government has done little so far to prepare for the crisis. In December the government distributed to members of the Donor Coordination Council an unsigned and vague appeal for financial assistance to deal with the crisis. (Although the document was dated November 17, no one had seen the appeal before December.) Some donors had the impression the government was using the crisis as an opportunity to fish for funds. In early December the government announced the creation of a commission comprised of officials, academics, and representatives of financial institutions to study and prepare for the crisis, but as of yet the commission has not had any visibility. Earlier, the Tajik government announced the formation of a state agency to help Tajik workers find employment abroad, in part by certifying their qualifications; the vast majority of Tajiks continue to find work through their own contacts, however, in part because most of them are unskilled workers for whom credentials are not an issue. ¶17. (SBU) Most of Tajikistan's government revenues come from VAT, income taxes, and customs fees. If trade and the retail sector slow as a result of the financial crisis, government revenue could fall. To some extent this will be mitigated by the fact that the country's economy is largely in the shadows, and few on the state payroll actually depend on the government for their wellbeing. The government's ability to make agricultural loans may be affected, although it is likely that loans to cotton farmers and investors will be the last to be scotched under any financial difficulties. Tajikistan's 2009 budget is $1.65 billion (6.1 billion somoni), which comes out to approximately $235 per capita. The International Response ¶18. (SBU) There are no indications that funding for government operations from other sources are failing to materialize. Tajikistan has issued no government bonds (although there are plans to float a bond issue later this year),and according to the IMF the government has taken out no commercial loans. According to discussions with international financial institutions here, revenue from donors has shown no sign of drying up and may actually increase due to the crisis. As a result of the misreporting scandal at the National Bank, the IMF is currently providing no financial assistance to Tajikistan (ref E). Future funding will depend on the results of an assessment due in February. Resident representative Luc Moers said that the government's response to the IMF's demands in the wake of the scandal had been positive, and he was optimistic that Tajikistan would qualify for renewed funding. He added that the IMF would seek to expedite assistance if the financial crisis warranted it. ¶19. (SBU) Chiara Bronchi of the World Bank said a team from the Bank would come to Dushanbe this month to negotiate with the government on future funding. Assistance from both the Bank and the European Community was conditional on a positive response to the IMF QCommunity was conditional on a positive response to the IMF requirements. Depending on the IMF's assessment of the macroeconomic situation, the Bank might recommend that the government apply for fast track assistance that was recently approved by the World Bank's board of directors. This would allow the country to frontload some resources to better respond to the crisis. Both Bronchi and Moers emphasized that Tajikistan's extreme poverty and the damage done during last year's difficult winter made the country very vulnerable to external factors, especially declines in remittances. Bronchi said that until structural reforms are completed, particularly the development of the private and financial sectors necessary to share risks and resources, Tajikistan would remain particularly vulnerable. Impact of the Crisis on USG Activities ¶20. (U) The financial crisis has not directly affected most USG assistance to Tajikistan, although it has the potential to greatly expand the country's needs. A sizable portion of USAID's activity last year was directed at addressing issues affecting or affected by last year's difficult winter, including agriculture and trade reform. That last year's winter was not even more disastrous for Tajikistan's population was due to record remittance flows from relatives working abroad. This year, declining remittances combined with another difficult winter could add up to a true humanitarian disaster. USAID has programmed about $6.3 million for pre-winter DUSHANBE 00000046 005 OF 005 and winter assistance to help vulnerable Tajiks deal with poor harvests and increasing prices. The assistance includes one-off cash transfers, distribution of quality winter wheat seed, and food distribution through local and regional procurements. In addition, the mission garnered a $5.8 million Single Year Assistance Program through Food for Peace for a one-time food delivery in the spring of ¶2009. The multi-year Food for Peace program, which includes humanitarian as well as development assistance, had already been scheduled to end in 2008, a decision made before last winter's crisis. We have been trying to get the program renewed, but without success. ¶21. (SBU) The financial crisis appears to be directly affecting a USAID program to attract funding for agricultural loans. In September 2007, USAID signed a Development Credit Authority (DCA) with Agroinvest Bank in which the bank would attract $5 million from foreign investors for such loans. The DCA would guarantee $2.5 million, or 50% of the foreign investment. Agroinvest was to attract the full $5 million by June 2008 and complete loan disbursements by December, but it was unable to find any investors. USAID amended the DCA agreement to extend the dates of funds acquisition to December 2008 and loan disbursement to February 2009. However, the bank was again unable to attract the foreign capital. USAID is currently considering terminating the DCA agreement and exploring the possibility of a new DCA with another bank. Given the credit crunch around the world, the decline in remittances, and Tajikistan's bad reputation stemming from last year's IMF report, it is unlikely that this program will be viable in the near future. ¶22. (U) USAID is providing assistance in several other sectors that may be affected by the financial crisis. The Economic Reforms to Enhance Competitiveness (EREC) Project is intended to create a sustainable foundation for competitive private sector development and stimulate investment. EREC's objective is to strengthen the institutional capacity of the Ministry of Finance, Tax Committee, and National Bank of Tajikistan, to improve tax policy and tax administration practices as well as the preparation and execution of the budget, and to strengthen the banking sector. A strained national budget and a financial system burdened by bad loans and decreased deposits may make it difficult to make meaningful changes in the financial sector. ¶23. (U) One small but cumbersome effect of the financial crisis is the increased reporting by microfinance organizations to the National Bank. The USAID-funded Association of Microfinance Organizations of Tajikistan reports that reporting that used to be quarterly must now be submitted monthly, while what used to be monthly reports are now required every ten days. This places a significant burden on the microfinance organizations as the reports are large and require significant preparation time. The National Bank changed the reporting cycle to monitor (and possibly control) microfinance organizations' liquidity and cash flows. ¶24. (U) The financial crisis is not likely to directly impact programs administered by other USG agencies. The country may see a rise in property crimes, however, if a large number of displaced or Qrise in property crimes, however, if a large number of displaced or unemployed workers return home. Difficult economic conditions could lead to increased drug use and related crimes. These potential effects could lead to greater needs for law enforcement and anti-narcotics assistance. Comment ¶25. (SBU) Although the financial crisis is unlikely to affect Tajikistan directly through its rudimentary financial sector, most observers here expect that its indirect effects will be significant: that the Tajik economy will slow, and more households will be more vulnerable. A shrinking economy will add to Tajikistan's perennial problems securing adequate and affordable food and power for its citizens, which are compounded by its isolation and the endemic corruption of its leaders. While the government has consolidated power to the point that large-scale political destabilization is unlikely, it cannot be ruled out. Of immediate concern is ensuring that Tajikistan's vulnerable inhabitants -- who number over half the population -- receive adequate food this winter. In this respect the country desperately needs all of the assistance it can get. End comment.