Growth is projected to ease to 6.5% in 2014 from 7.4% last year. Growth this year is being supported primarily by an extraordinarily rapid expansion of construction (over 27% through September). Declining remittances are weighing on the services sector, and there has been a sharp fall in cotton and aluminium exports due to global market developments. Growth is expected to decline in 2015 and beyond due to the adverse external environment – particularly in Russia – and the slow pace of structural reforms, though going forward it will receive some support through the pivot to closer economic ties with China and South Asia. Inflation increased through September on the back of gradually rising costs for food, transport, and utilities, and is expected to remain somewhat elevated in the near term due to the pass through to prices from the depreciation of the somoni.

Strong policy actions and bold structural reforms are needed to steer the economy through the challenges presented by adverse external conditions, and to lay the foundation for higher investment and job-creating growth. These actions include exchange rate and monetary policy adjustment, financial sector reforms, and strengthened reforms of public financial management and state owned enterprises (SOEs).

While the official exchange rate has depreciated by about 7% to date in 2014, the decline in the competitiveness of Tajikistan’s exports, the large spread between the official and cash market exchange rates, the low level of international reserves, and the still deteriorating external environment indicate the need for further adjustment. To help contain inflation, further exchange rate adjustment should be complemented by an increase in the National Bank of Tajikistan’s (NBT) refinance rate, a stop to liquidity lending to banks that do not meet prudential requirements, and no further transfer of government deposits at the NBT into commercial banks. Price controls should be avoided as they will create distortions and delay the adjustment of the economy to new relative prices of domestic and imported goods. Further movement in the somoni – in conjunction with tighter financial conditions – will help support growth by raising the somoni purchasing power of remittances, which are mainly denominated in roubles, are equivalent to nearly 50% of GDP, and are a significant source of household income. Fiscal policy – in particular a temporary increase in targeted social spending – should be used to assist the most vulnerable parts of the population.

Strong actions are needed to safeguard the financial sector. Non-performing loans are rising, are concentrated in the largest banks, and are largely to SOEs and politically-connected borrowers. Some banks are exposed to the rapidly growing construction sector, while residential real estate prices have flattened or are even declining, signalling the need for caution. Banking supervision and regulation should be applied evenly across all banks – and without political interference – to limit forbearance and financial sector risks, and to level the playing field for dynamic and well-managed smaller financial institutions. While the new management team at Agroinvestbank (AIB) has successfully resisted new directed lending in 2014, the government – as the majority shareholder – should lead the restructuring of AIB in line with good international practice. This should include holding delinquent AIB borrowers fully accountable for their debts to AIB and the government, hiring experienced international managers to restructure AIB, and then marketing internationally the restructured bank.

Though medium-term fiscal policy is consistent with debt sustainability, there are substantial risks to the fiscal position that remain to be addressed. These risks largely stem from loss-making SOEs, uncertainty about plans for the Rogun hydropower project (HPP), and weaknesses in the tax system. For SOEs, specific actions to limit fiscal risks and to increase transparency include full enforcement of the new SOE dividends policy, the comprehensive restructuring of Barki Tajik (BT) – possibly under a foreign management contract – to improve collections enforcement and achieve cost recovery, and a requirement for key SOEs (including BT, the Rogun hydropower company, Talco, and Talco Management) to conduct and make available to the public annual IFRS-standard audits. Should financing become available, the massive Rogun HPP – estimated to cost US$5-6 bln, or 55-65% of current GDP – may bring significant long-run benefits to the economy, but debt sustainability would come under strain and the crowding out of other needed fiscal spending and of private sector activity would need to be addressed. In the area of tax administration, the recent decision to establish a formal dispute resolution system for taxpayers will help improve the investment climate, and should be complemented by a move away from revenue targets to a tax collection system that treats all taxpayers fairly and focuses on compliance risk. Looking forward, the possible discovery of commercially recoverable quantities of natural gas in Tajikistan, and expected gas transit fees from new pipelines, would both bring substantial economic benefits, while also creating the need to manage income from hydrocarbons in a transparent manner and for the benefit of future generations.

During its visit, the mission met with senior government officials, members of parliament, the private sector, non-governmental organizations, and development partners. The mission team would like to thank the authorities and other partners for the productive discussions and for their hospitality. The IMF looks forward to continued close cooperation with Tajikistan through policy dialog and technical assistance.