AN INSTITUTIONAL ANALYSIS OF THE FINANCIAL SECTOR OF

CENTRAL ASIAN REPUBLICS

Bushra Hamid*

Abstract

The demise of the former Soviet Union left Central Asian Republics with enormous problems, besides other, specifically in the financial sector. Each of the republic started route to transition to global economy with their respective compulsions at the time of independence. The main areas of financial sector reforms are banking and financial system, fiscal management, balance of payments and external sector. The key to reform is coordination process of all the areas of financial sector. It should be well integrated in order to orchestrate the rhythms of a market economy. Analyses of the financial sector of Central Asian Republics, during the transition and adjustment period have been made in the light of institutional theory of economics.

Introduction

Central Asian Republics (CARs) faced the unique conditions following independence, which made their process of transition distinct from others. They have been exposed to the Soviet model of a command economy for a much longer period. There were no memories of capitalism left as in VietNam, China and the European Centrally Planned Economies (CPEs) which were drawn to the centrally planned model later than the CARs and some of which started with market-oriented reforms long before 1990. This made the reform in CARs, more demanding in terms of forming both the institutions and the market attitudes. Secondly, the feature which made the economic reform in CARs more difficult and challenging was the fact that its "standard" tasks were superimposed on the process of building the institutions essential for national economic sovereignty. Thirdly, these countries were not ethnically homogenous. This increased the importance of the assessment of the social impact of the various reform measures in order to maintain the political stability and public support for the reform efforts of the governments. Besides, they also faced problems and conditions that were specific to their position in the Former Soviet Union (FSU). For example, they are landlocked, they don't have a common border with any highly industrialized country, supplies of key traditional export, such as oil, had been falling for some time before the collapse of central planning (Hamid: 2000:8).
CARs got their independence as a windfall and they opted for institutional reform at the time of independence as a compulsion rather than a choice. Given the preceding discussion the objective of this paper is to analyze institutional reform carried out by CARs in the financial sector.  The paper highlights the financial position of CARs at the time of independence followed by early conditions of transition process. Moreover, it presents the current scenario of financial sector of these economies. In addition, financial sector institutional reform process during the transition is analyzed along with a critique and suggestions for future discourse.

CARs in Retrospect

A major outcome of the break-up of the FSU had been the accession of its constituent republics into independent states. The CARs were among the last to opt for independence. With the dissolution of the Union, the five Central Asian Soviet Republics found themselves in somewhat a different situation than other states. In one sense their position changed from that of states of secure, paternalistic, political and economic dependence into the insecure and unpredictable condition of political and social, if not economic independence (McChensney, 1996:3). Some argue that these republics did not win their independence the hard way. Notwithstanding the validity of this argument, these republics faced challenges of transition, from a centrally planned to a liberalized set up for which they were not prepared.

Financial Sector

1. Finance is a multi-dimensional sector and its various components not only interact closely with each other but also are also deeply involved with other sectors. However, in central planning, financial sector was characterized by a banking system in which the central bank dominated the financial sector. The banking sector had evolved out of mono-bank system. Typically, the planned economy had one bank which functioned as a fiscal agent. The lone bank simply provided credit needed by state-owned industrial sector for their production plans and monitored cash used principally to cover labor costs and purchases of manufacturing inputs. The savings bank collected savings deposits from households at low interest rates, which were then placed at the Gosbank (Central Bank). According to the credit plan approved by the planning authorities, the Gosbank set policy guidelines determining the volume and allocation of credit to different sectors (the credit plan), and the volume and allocation of cash issuance (the cash plan). Funds were then passed to the specialized banks (such as the agriculture and industrial banks), which represented different sectors for on lending to individual enterprises. Interest rates had no role in the allocation of funds (World Bank, 1993:19).

Central governments were the major financial intermediaries in the socialist countries, because of their large budgets. The consolidated state budgets accounted on average for roughly 60 percent of the GDP in these countries. One of the key features of socialist economies was the high share of fixed investment in GDP. Many public investments were of poor quality. Investments were oriented towards heavy industry; social infrastructure, consumer durable, agro-industry, housing and services were relatively neglected (Gelb and Gary, 1991:49).
Subsidies to consumers and enterprises typically accounted for a large share of budgetary spending. Consumer subsidies were generally on basic commodities and services. Enterprises received both input-specific subsidies and ad-hoc grants. Export subsides were also common, oriented either to Council for Mutual Economic assistance (CMEA) trade or to convertible currency trade. The benefits of certain subsidies, including those on railway transport and culture, tended to be skewed toward higher-income groups, and the high-priced black market trade that accompanied price control generated its own income differentials. The low cost of energy encouraged over consumption, which led to environmental degradation and over investment in the energy sector. Furthermore, low prices led to long queues, hoarding and forced financial savings that reduced work incentives. Taxes had no independent role in traditional centrally planned economies. The government set prices of inputs and outputs and wage rates. Taxes transferred any surplus to the state. The discretion of authorities to change tax rules at will-- often after profits had been made-- was both a major cause of the soft budget constraint of firms and an important disincentive to improved performance (Gelb and Gray, 1991:49).
In the Socialist system trade policy consisted of the processes and decisions that determined the quantities of various goods and services imported and exported, and the prices at which that trade took place. This involved negotiations with foreign suppliers and buyers, and then central instructions to domestic suppliers of exports to ensure that the trade commitments were fulfilled. Foreign trade in FSU was dominated by a few monopolistic organizations. Autarkic trade patterns emphasized bilateral exchange between the members of the CMEA, with increasingly adverse implications for product quality, as shown, for example by the low prices of Soviet automobiles on Western markets (Roberts Bryan, 1993). There was no direct relationship between Soviet export producers or users of imported inputs and foreign purchasers or suppliers (Corden, 1992:2 also see Aslund 1991 Ch.4:3).
 
CARs in Transit

Following the independence, CARs faced hyper inflation which erased real value of all the indicators of financial sector. The reported figures were not indicative of the value of financial determinants. Therefore, the information provided in this section is in terms of determinants.

a.     Macroeconomic Development
While the financial structure in CARs changed after independence, many of the old features were retained. For example, a two-tier commercial banking system was introduced consisting of the central bank and a few commercial banks that remained state-owned. Government ownership of commercial banks, therefore, facilitated government mandated lending to persist even in the new two-tier system. In addition, the new commercial banks in the two-tier system took on the previous loans of the old monobank.
CARs experienced sharp declines in real GDP and major terms of trade shocks following the breakup of the former Soviet Union. They faced hyperinflation, which eroded the real value of old, non- performing loans [(Borish et.al (1995) 23-26)]. Efforts to contain inflation, by tightening monetary and fiscal policies, exposed underlying weaknesses in the banking sector. However, by the end of 1995, except for Tajikistan and Turkmenistan, other CARs had achieved major declines in inflation and stabilized their exchange rates and banks did not mask the strongly reduced cash flow from their non-performing assets. Also, stabilization of exchange rate led to sharply decreased profits from foreign exchange speculation.
Interest rates remained extremely negative under the new financial structure. Monetary balances declined throughout 1992, owing primarily to high inflation levels and the decline in the level of economic activity (World Bank, 1993). As the interest rates on loans were negative, therefore, interest rate and rediscounting policies were not effective policy instruments. Domestic credit to the banking system behaved erratically in 1992, the value in real terms decreased substantially (World Bank, 1993). The distinction between cash and credit rubles evolved in 1992 as a way to separate the financing of inter-enterprise trade and final goods trade. Because these two types of rubles were not freely convertible, they were in effect parallel currencies. The public had access only to cash rubles, since all wages and pension payments were made in this form. Credit to enterprises was made in the form of credit rubles. However, it declined considerably owing to a conscious effort by the central banks to keep domestic credit policy under control.

Consumer Prices in CARS

 

(Percent change in the period)

	1992	1993	1994	1995
Kazakhstan	2960.9	2169.0	1160.3	60.4
Kyrgyzstan	1257.0	1365.6	87.2	31.5
Tajikistan	367.5	7343.7	1.1	2222.6
Turkmenistan	644.3	9741.6	1328.5	1261.5
Uzbekistan	910.0	884.8	1281.4	116.9

Source: IMF Staff Estimates

Following reform process for more than a decade, the macroeconomic data provides a sketchy picture of CARs. Kazakhstan enjoyed double-digit growth in 2000-01 - 9% or more per year in 2002-05. However, average annual growth rate since 1990 registered a negative trend. Upward pressure on the local currency continued in 2005 due to massive oil-related foreign-exchange inflows. Except for Turkmenistan and Uzbekistan all rest of the countries registered a negative growth rate from the period 1990- 2003. Inflation considerably contained by all the countries during the said period.

Gross Domestic Product (GDP)

	Millions of dollars 2003	Avg % of Growth 1990 – 2003
Kazakhstan	29749	- 0.6
Kyrgyzstan	1737	- 1.5
Tajikistan	1303	- 3.2
Turkmenistan	6010	0.8
Uzbekistan	9949	1.2

Source: World Development Report 2005

External debt of Kazakhstan has severely been increased despite registering a positive current account balance which is largely due to increasing petroleum prices in the international market. Whereas Kyrgyzstan recorded negative current account balances. The GDP ranking of CARs depict a dismal situation. Except for Kazakhstan, percentage of population below the poverty line is alarming. There has been mixed trends in increase in ratio of industrial and agricultural output.

Fiscal Development

Initially the government budgets were under control, however, the sharp increase in energy prices affected the budget by, among other things, increasing the amount of direct subsidies. The fiscal impact of the cessation of transfers from Moscow was significant. Moreover, the impact of the negative terms of trade shock on the reduction in national income was not negligible (Economist Intelligence Unit, 1995). The governments financed the ruble deficit in 1992 by issuing bonds and placing them through auctions throughout the country, by central bank credits and by inter-republican food credits. The governments tried to compensate for the loss in revenue by imposing a new tax structure. However, due to the high inflation rate, and ineffective collection methods, the tax base for most of the taxes was eroded through out 1992.
After the breakup of USSR, most of the social programs continued under the direction of republics, financed through a variety of significant budgetary and off-budgetary funds. Total social expenditures increased in 1992. Because energy prices were subsidized indirectly by price regulation, these indirect subsidies largely did not appear in the narrowly defined fiscal budget. The direct impact was thus smaller. However, the impact on the consolidated budget was much larger, since here the higher oil prices could not be disguised, but appeared on the profit and loss statements of the affected enterprises. Since these enterprises were the property of the state, this loss was actually a loss of the consolidated state budget (World Bank, 1997).

General Government Fiscal Balance in CARS

(in Percent of GDP)

	1994	1995
Kazakstan	-6.8	-2.7
Kyrghyzstan	-7.7	-12.5
Tajikistan	-5.4	-11.9
Turkemanistan	-1.4	-1.6
Uzbekistan	-6.1	-4.1

Source: IMF Staff Estimates

The fiscal developments in CARs by and large had been positive. The observed progress in stabilization in CARs reflected the pursuit of stricter financial policies accompanied with sharp decline in inflation in 1995, as compared to 1994. First, the deficit of the general government was reduced significantly during 1995 to below 6% of GDP in Kazakhstan, and Uzbekistan. In Kyrgyzstan, however, the deficit remained at 12%, largely reflecting a narrowed enterprise tax base; difficulties in collecting taxes due, particularly from the emerging private sector; as well as outlays related to enterprise restructuring. The government deficit remained very high in Tajikistan. Turkmenistan indicated a slight increase in the deficit. (Henrie Lorie, 1997:12)
Further progress to reduce inflation was associated with declining external sector deficits. While, decline in external deficit was registered by Kazakhstan in 1995, in Kyrgyzstan and Uzbekistan, external account deficits were widening. Turkmenistan evidenced positive external account balance. Growth in central bank credit to government measured as a percent of beginning of period based money averaged less than 30 percent in Kazakhstan and Uzbekistan, a remarkable improvement when compared with 1994. In Turkmenistan and Tajikistan, financing of government by the central bank remained a very large source of money supply growth. Kyrgyzstan was forced to rely on substantial money creation to finance its large fiscal deficit. (Index of Economic Freedom 2006).
Growth in central bank credit to government measured as a percent of beginning of period base money averaged less than 30 percent in Kazakhstan and Uzbekistan, a remarkable improvement when compared with 1994. In Turkmenistan and Tajikistan, financing of government by the central bank remained a very large source of money supply growth. Kyrgyzstan was forced to rely on substantial money creation to finance its large fiscal deficit.

Current Account Balances of CARS

 
(As a percent of GDP)

	1994	1995
Kazakstan	-8.0	-2.9
Kyrghyzstan	-11.2	-15.2
Tajikistan	-24.0	0.0
Turkemanistan	5.5	2.5
Uzbekistan	2.0	-0.5

Source: IMF Staff Estimates

According to the data collected by various agencies and independent sources, Kazakhstan's top income tax rate is 20 percent. The top corporate tax rate is 30 percent. Government expenditures as a share of GDP were 23.2 percent in 2003. Kyrgyzstan’s top income tax rate is 20 percent. The top corporate tax rate is also 20 percent, down from the 30 percent reported in the 2005 Index. In 2003, government expenditures as a share of GDP increased by 25 percent. Tajikistan's top income tax rate was cut to 13 percent from 20 percent. The top corporate tax rate was also reduced to 25 percent from 30 percent. In 2003, government expenditures as a share of GDP decreased 19.1 percent. Turkmenistan's top income tax rate is 10 percent, down from the 12 percent reported in the 2005 Index. The top corporate tax rate is 20 percent, down from the 25 percent reported in the 2005 Index. In 2003, government expenditures as a share of GDP increased to 19.4 percent. Uzbekistan's top income tax rate is 30 percent. The top corporate tax rate was cut to 15 percent from the 20 percent reported in the 2005 Index. In 2003, government expenditures as a share of GDP increased to 39.9 percent (Index of Economic Freedom 2006).

Banking Reforms

As the CARs embarked on market reforms during 1991-92, two-tier banking systems emerged with the creation of central banks and the transformation of the specialized banks into nationally autonomous commercial banks. The CARs Central Banks under their respective constitutions were given the status to run monetary and credit system, as was common under the market economy. Except in Turkmenistan and Uzbekistan, Central Banks in the other three republics had broad de facto autonomy to pursue price stability and to formulate and implement monetary policy accordingly. The laws enacted by Tajikistan and Uzbekistan emphasized price stability. However, Bank of Uzbekistan's autonomy was restricted by the need for parliamentary approval for its financing of the government, which had no formal limit. Turkmenistan’s directed credits were subject to presidential decrees (Dalton, 1997:26-29).
In CARs, the banking sector was weak, and commercial banks took no initiatives in payments reform. The central bank typically led the reform agenda. However, the need for cooperation and coordination -- either among banks or between banks and the central bank--- to establish new payments systems was well understood [(Sundararajan et.al. (1997:5)]. Weaknesses in legal framework persisted and frustrated reforms. A particular problem in countries that had introduced electronic clearing systems was lost because customers could not access funds cleared through the system before paper confirmation of the transactions had been processed. These kinds of problems were increased as electronic Large Volume Transfer Systems (LVTS) and security transfer systems were developed. (Destesse and Roberts, 97:125).
Uncertainties about transactors' rights and obligations and their enforcement, also reduced confidence in payment instruments and limited growth in payment services, particularly in the household sector. The enforceability of agreements or the absence of appropriate bankruptcy laws limited the options for designing safe payments systems. For example, in netting systems, the netting agreement had to be recognized in law so when a participant failed, all other participants were bound to pay only their net obligations to the system and not run the risk of being required to pay gross obligations to the failed participant. The country ranking related to central bank reforms depicted that Kazakhstan and Kyrgyzstan made substantial progress, while other three republics have made only limited progress in this area. The major reason behind Kazakhstan and Kyrgyzstan’s progress was the international assistance provided by the IMF and IBRD (Sensenbrenner, 1997:4).
Banking reform has progressed during the last decade albeit at a varying degree and speed. The insolvencies of a wide part of the banking system led the governments to restructure the banking system in three key areas: institutional, operational, and financial. Institutional restructuring seek to improve the environment in which banks operate. The key elements are legal framework, prudential regulations, accounting standards, and banking supervision. One of the major developments that resulted from the institutional structuring is the strengthening of the power of the central bank to supervise and regulate banking institutions (Hagiwara 2006).
Supervision and regulation of banks have, likewise, improved from the earlier period of transition. They have, generally, become more stringent and closer to international standards. Efforts have been made to align the countries’ loan-loss classification, provisioning requirements, and capital adequacy ratio to Bank for International Settlements (BIS) rules, even though considerable regulatory forbearance are still in place. Nevertheless, in some countries, there remain some inconsistencies in Bank Law, as well as overall weakness in general commercial and civil law. For instance, in Kyrgyz Republic, despite extensive central bank power, its decisions can be challenged in ordinary civil court, and the appeals process can be protracted.
Despite enacting a number of laws and prudential regulations, what remains an important task is the continuing training and human resources development both for supervision as well as for the consumption of the commercial banking system. These economies remain in dire need of a bigger pool of trained bankers, knowledgeable bank supervisors, as well as good accountants who appreciate and know the intricacies and risks of banking in market economies (Hagiwara: March 2006). During the transition, less emphasis has been put on the issue of debt restructuring; the urgency was placed on revitalizing banks, and less on recovering bad assets. The following table shows country rankings of the central bank reforms in CARs.

Central Bank Reforms: Country Rankings

	1	2	3	4	5	6	7
Kazakstan	III	III	III	III	II	III	III
Kyrghyzstan	III	III	III	III	III	II	III
Tajikistan	I	I	I	I	I	I	I
Turkemanistan	I	I	II	I	II	I	I
Uzbekistan	I	I	II	I	II	II	1

Source: IMF 1997
I = Limited Progress; II = Moderate Progress; III = Substantial Progress

1.     Monetary Operations and Government Securities Markets
2.     Foreign Exchange Operations and Market
3.     Bank Supervision
4.     Bank Restructuring
5.     Payments System
6.     Central Bank Accounting and Internal Audit

1. Overall Ranking

 According to 2006 Index of Economic Freedom, Kazakhstan's banking system is the most developed in Central Asia, and rapidly moving towards adoption of international banking standards. "All banks have to adopt international banking standards, including the risk-weighted 8% capital-adequacy ratio set by the BIS. ”Kazakhstan has privatized all its banks and the private sector is enjoying healthy competition…. Kazakhstan's banks are really in the business of taking deposits and lending money to individuals and corporations." Foreign capital in the banking sector is capped at 25 percent. Despite having these improvements, the banking sector is far from being able to play any sort of central role in investment financing. Substantial improvements are required to increase the capitalization of the sector, mobilize savings, improve bank supervision and strengthen the legislative framework governing the sector."(Index of Economic Freedom 2006)
Tajikistan's financial sector is dominated by banking, which was composed of 15 commercial banks and the central bank in 2003. "Many banks have a high rate of non-performing loans, and the government still retains a large degree of influence in the lending process. Tajikistan still has barriers to foreign participation in the financial sector, including a ceiling on foreign capital in banks, and years of mistrust of the banking sector, combined with its limited financial instruments, have resulted in most businesses avoiding banks entirely. In Turkmenistan, The state-owned institutions are dominant, with 95% of all loans going to state-owned enterprise. The government retains significant influence over the Central Bank of Turkmenistan, which supervises the banking sector. Commercial banks function more as administrators of public sector financial transactions than independent lenders. The state-owned insurance company is the sole insurer (Index of Economic Freedom 2006).
Uzbekistan's government exercises severe control over most of the financial sector, which is comprised primarily of banks. According to the U.S. Department of Commerce, "the banking system remains the primary conduit for the [government's] directed credits to state-owned enterprises at negative real interest rates. The large portfolio of such credits poses a serious threat to the soundness of the banking system given the financial distress and non-profitability of most of these enterprises." Economist Intelligence Unit reports that deposits are extremely low due to years of negative real interest rates, a weak exchange rate and occasional confiscations of savings. Besides, the government has closed the only viable private bank (Index of Economic Freedom 2006).

Trade and Balance of Payment

After independence, both inter-republican and foreign trade declined in CARs. In inter-republican trade, the governments entered into a system of bilateral trade agreements with FSU countries to ensure that key commodities were available at prices that those countries felt they could afford. The agreement covered petroleum and petroleum-related products, rare metals, cotton and some chemical and metallurgical products. The two key export commodities covered under these bilateral agreements were cotton fiber, which exchanged with Russian oil and petroleum products (Kaminski, 1994).
Two major developments affected foreign trade. First, the world price of cotton deteriorated substantially, creating a negative terms-of-trade shock. In addition, the discount on world-market prices for CARs cotton reflected problems with quality and reliability. This deterioration in the price of cotton implied a loss to the net trade balance that was very high (World Bank, 1993). The second major development in foreign trade was the shift from a commercial rate to a unified exchange rate. The unified exchange rate followed the rate in Russia with a time lag. No significant arbitrage took place owing to various exchange controls. In light of the high total tax rate on exports, a substantial portion of foreign trade was made in the form of barters to avoid the surrender requirement and the income and export taxes. Barter trade comprised about 48% of total foreign trade in 1992. The end results of these factors combined with a decline in real working capital due to a policy of tight credit had been an extremely rapid buildup of inter-enterprise arrears. With regard to their share of the foreign debt of the FSU, the CARs have chosen the so-called zero option proposed by Russia. According to this scheme, each country was to relinquish its claims on the assets of the former Soviet Union to Russia in exchange for Moscow's assuming the liability for that country's share of the Union's foreign debt (World Bank, 1993)
Following the collapse of central planning, both output and import demand in CARs contracted. Therefore, the share of trade with other markets increased dramatically. Trade with countries outside the region as a percentage of total trade was increased in case of Kazakhstan and Kyrgyzstan for which figures are available. China was Kazakhstan's largest non-republic trade partner. Turkmenistan had Eastern Europe as largest trade partner followed by Western Europe, Asia and the USA (Khan, 1994:101). The rapid liberalization of external trade and payments was crucial part of reform in most Central European Countries and Baltic States. However, trade regimes in the CARs were significantly less liberal. Kazakhstan and Kyrgyzstan had shown a sharp rise in trade specifically exports to the countries outside the region in 1992. This was largely due to international financial assistance (Easterley and Stanley, 1994: 4). According to official reports, in 1993 CARs as a whole maintained a significant surplus in their trade with the rest of the world. This surplus was formed by Kazakhstan, Kyrgyzstan and Turkmenistan, with Uzbekistan and Tajikistan registering negative balances. (Ghufran: Unpublished paper). This trend was also confirmed by CARS total trade with OECD countries.
CARs were granted Most Favored Nation (MFN) status, on an exceptional temporary or de facto basis. They were also members of Economic Cooperation Organization (ECO), and given GATT observer status, Partnership and Cooperation Agreement with European Union (EU) and economic union with CIS countries. Kazakhstan, Kyrgyzstan and Uzbekistan also share a single economic space since January 1994. Kazakhstan and Kyrgyzstan accepted Article VIII of the IMF, in 1995, which generally represents the culmination of a process of liberalization of payments for current account transactions. On the other hand, except for Kyrgyzstan, who is member of WTO (Maliszewska: 2005), they are not members of OECD, EU and WTO, which is a pre-requisite to an improved market access. Export controls and licenses were a remnant of centralized trade and their use was a mean of cross-subsidization and, some times, ad-hoc state interventionism to raise revenue. However, the CARs started easing up on these controls in order to boost trade links and exports. For example, Kyrgyzstan scrapped the system of generalized export licensing system in April, 1994 (Krumm, 1994:192). Although foreign direct investment (FDI) into CARs economies had increased since 1991, the flows were relatively very small when compared with other regions and with initial expectations.
Merchandise trade has improved during the transition period. Kazakhstan was the largest exporter and importer of the merchandise during the period, followed by Turkmenistan and Uzbekistan. The other two countries have less success in this area. Except for Uzbekistan, all the countries registered a negative trade balance. Kazakhstan attracted highest level of foreign direct investment (FDI), whereas other countries could not manage any substantial level of FDI. Kyrgyzstan and Tajikistan being the poorest countries received the maximum level of official development assistance (ODA), though considerably less than the other transition economies of Eastern Europe and FSU. External debt of all the countries increased. Domestic credit provided by the banking sector as percentage of GDP was highest in case of Tajikistan followed by Turkmenistan (Index of Economic Freedom 2006).

Trade, Aid, and Finance

	I	II	III	IV	V	VI	VII	VIII
Kazakhstan	12900	8327	- 69	2583	13	17538	80	13.0
Kyrgyzstan	582	717	- 32	5	37	1797	93	11.4
Tajikistan	798	881	- 41	9	27	1153	89	21.3
Turkmenistan	3403	2516	- 74	100	8	---	---	19.1
Uzbekistan	2936	2576	659	65	7	4568	38	---

Source: World Development Report 2005
     
I = Merchandise Trade, Exports, million of dollars, 2003
II = Merchandise Trade, Imports, million of dollars, 2003
III = Current Account Balance, million of dollars, 2003
IV = Foreign Direct Investment, million of dollars, 2002
V = Official Development Assistance, dollars per capita
VI = External Debt. Total million of dollars, 2002
VII = Present Value % of GNI, 2002
VIII = Domestic credit provided by banking sector, % of GDP, 2002

CARs with exception of Turkmenistan have entered a number of Regional Integration Agreements (RIAs) (Maliszewska: 2005). Most of them involve solely the members of the CIS bloc. Except for Tajikistan and Turkmenistan, these countries also signed cooperation agreements with the EU. CARs mainly cooperate with China. However, over the 1995-2001 periods none of the existing RIAs among the CIS countries have been successful in preventing the fall of share of intra-CIS trade in total trade of its members. It seems that the potential benefits of regional cooperation, which is, scale and competition effects and secondly, trade expansion and location of production effects, have not been yet fully appreciated and exploited and these RIAs had very limited effectiveness within the existing arrangements (Maliszewska: 2005).
For the CARs, China constitutes a large partner with whom they might seek greater economic integration. The share of Turkey and Iran in exports of Tajikistan and the Kyrgyz Republic is quite significant (17 percent and 4 percent respectively). However, the trade with China is almost non-existent except for the Kyrgyz Republic. Therefore it seems that trade with China is well below potential. One of the main reasons is that non-tariff barriers and transport costs in trade between Central Asia and China are very high. The opening of the new border crossing between Tajikistan and China would greatly contribute to the exchange of goods between the two countries. At present road transport from China goes via Kazakhstan and Uzbekistan and is performed by Kazakh drivers who ask very high prices for their services (Hagiwara 2006).
The tariff rate reported by the Index of Economic of Freedom 2006, Kazakhstan's average tariff rate in 2004 was 7.9 percent, down from the 10 percent in 2002. Kyrgyzstan’s weighted average tariff rate in 2003 was 4.3 percent, down from the 7.8 percent in 2002. Turkmenistan's weighted average tariff rate in 2002 was 2.9 percent. Uzbekistan's weighted average tariff rate in 2001 was 5.9 percent (Index of Economic Freedom 2006).

CARs in Transit: Institutional Insights and Suggestions

 Institutional approach to development is critical to bring about credible and sustainable change with emphasis on reducing the transaction costs. However, institutional reform of the financial sector is considered as the pivotal sector for transition to a market based economy. Douglas North defined "Institutions as a set of formal and informal rules, and are distinct from the public organizations that emerge to administer and enforce them" (North, 1991:97-112). Thus institutional development can be defined as a move from a less efficient to a more efficient set of rules. The objective of institutional reform can therefore be defined as the "quickest and largest possible reduction of transaction costs". Transaction costs are inversely related to: (a) the efficiency of institutional framework in terms of defining clear property rights and protecting them; and (b) the efficiency of enforcement and organizational arrangements.
The transition to a market economy in CARs is only partially complete. Property rights and the legal system remain weak. The problems that have been identified towards a slow transition in CARs are numerous. Corruption at all level is the worst of the evils. The main reason for corruption is lack of reform and poor salaries with greater power and authority of the concerned officers. Other then that, judiciary is under developed and inefficient. Judges at all levels have extremely poor access to legal reference materials. Legal system, particularly corporate law, is poorly developed and poorly enforced. The judiciary is badly trained and open to bribery. It views itself more as an arm of the executive than as an enforcer of contracts or guardian of fundamental rights. Besides, lack of transparency, non-tariff barriers, poor supervision, a substantial government presence in the financial sector, and inefficient bureaucracy are the main obstacles to economic and financial development in CARs.
CARs lack a transparent legal framework that secures property rights and provides credible and efficient mechanisms for enforcement of contracts, which is a pre-condition for creating an enabling environment for market economy. The fundamentals for a sound market economy are clear property rights and the commercial accountability of enterprise governance. This is particularly so in the case of financial and banking sectors where the managers are managing resources and funds of others and where their imprudence will not only cause loss to the depositors but also can shatter the business confidence. The environment of trust and confidence is to be developed by a legal framework defining the parameters of various institutions. Legal codes and enforcement mechanisms, and the payments, accounting, auditing, and bank supervision and regulation systems are not developed enough to support a market economy.
The main indicators of development, that is, human development index, rate of population below the poverty line are alarming in CARs. On the average, half the population of these republics lives below the poverty line, whereas, human development index is medium. According to Douglas North, incidence of poverty can be reduced by building institutions, both public and private which should complement and connect with each other. This can be done by creating incentives for people to invest their skills and organize efficient markets. Such incentives are embodied in institutions. Markets work if they have rules, enforcement mechanism, and organizations promoting market transactions. Extremely diverse, these institutions transmit information, enforce property rights and contracts, and manage degree of competition. In doing so, they give the people opportunity and incentives to engage in fruitful market activity. To ensure effective institutions, they should be designed to compliment what exists in terms of other supporting institutions, human capabilities and available technologies. The success of state in providing laws and performance of judiciary and police reflects how citizens and investors perceive the state as respecting property rights.
Access to financial services and the sophistication of financial markets reflects how institutions reflect the property rights of borrowers and lenders. High level of corruption reflects the type of incentives that exist for politicians and civil servants to pursue their self interest over public good. Institutions that are effective in achieving their goals in industrial countries can have quite different outcomes in developing countries, which have fewer complementary institutions, weaker administrative capacity, higher per capita costs, lower human capital level, different technology and different levels and perception of corruption. Therefore, CARs need to provide for indigenous mechanism to overcome its existing institutional deficiencies.
It has become obvious, specifically in case of CARs, that, macroeconomic reforms while necessary are not enough to propel these countries along the road to prosperity. It also became evident that economic growth did not matter much to people if hospitals did not have medicine, and that a booming stock market could be highly dangerous if the domestic equivalent of Securities and Exchange Commission is ineffectual. A competitive exchange rate could not do much to bolster exports if inefficiency and corruption paralyzed the ports, and fiscal reform did not matter much if taxes could not be collected. The elimination of restrictions on foreign investment, while indispensable to attract foreign capital, is far from sufficient to make a country internationally competitive in the race to attract long term foreign investment. A reliable justice system, a well educated workforce and an efficient telecommunications infrastructure are some of the additional factors that would give these countries an edge in its effort to attract foreign investors. It became apparent that stronger, more effective institutions are urgently needed to complement macroeconomic policy changes.
The quality of life and human development indicators have gone down, economic and social disparity has been enlarged and economic growth has suffered. The lack of the skilled human resources in the financial sector constrains its development. The main message of this study is that much of what needs to be accomplished in the financial sector of CARs is development, rather than reform. Starting and maintaining the long process of building a sound financial infrastructure should be given highest priority, or the necessary financial services will not be available when the enterprises need them. Given the relatively high educational levels in CARs, strategies that emphasize training and building skills in various aspects of finance the supervision will yield high returns. Extensive training facilities need to be provided for local entrepreneurs on the one hand and for technologists, managers and others specialized personnel on the other. With rapid technological changes, human resource capability also requires constant modification and upgrading. Each republic should develop a training and management institute or similar institutions to make assessment of projected specialized manpower requirements and make arrangements for creating the technical personnel within the required time frame.

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