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10 The Integration of Low-Income CIS-7 Countries into the World Trading System

Author(s):
Sarosh Sattar, and Clinton Shiells
Published Date:
April 2004
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Author(s)
Constantine Michalopoulos*

More effective integration into the world trading system is part of the transition from central planning to markets. Based on market forces, international trade promotes more efficient resource allocation and increased productivity and growth—necessary conditions for sustainable poverty alleviation. The low-income CIS-7 countries started the transition with different resource endowments but with similar protectionist policies that isolated their economies from the rest of the world and created large distortions in prices and resource allocation.

In the decade since independence, the CIS-7 countries have introduced market-oriented reforms, including trade reforms. Many have established very liberal trade policy regimes, and three—Georgia, the Kyrgyz Republic, and Moldova—have become members of the World Trade Organization (WTO). Yet, their overall trade performance lags by comparison with other CIS and Central and Eastern European countries. So far, international trade has failed to provide the boost to productivity, growth, and poverty reduction that had been anticipated.

This study looks at why and outlines a strategy to enable the CIS-7 countries to obtain greater benefits from international trade. The strategy includes a mix of domestic policy reform and regional cooperation, and the focus is as much on issues of trade policy as on other aspects of domestic market reform and capacity building. Frequently, the most important reforms would strengthen trade-related capacity and reduce unnecessary constraints. In many areas, the international community can play a supporting role.

Economic Context and Trade Performance

All of the CIS-7 countries are among the poorest countries in the CIS and need to take urgent steps to stimulate growth and reduce poverty. All face similar challenges in improving governance, maintaining macroeconomic stability, addressing debt issues, improving the climate for private investment, and providing adequate health and education services to their people. In terms of their positioning in international trade, however, six of the seven countries are very similar, but Uzbekistan is different.

Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, and Tajikistan are small in both population and aggregate GDP, ranging from Moldova, at 3.6 million people and a GDP of $1 billion, to Azerbaijan, at 8.0 million people and a GDP of $5 billion. For such small economies, trade is a large component of GDP and an important determinant of growth in income and output. These six countries have further similarities.

  • All have relatively liberal formal trade regimes.
  • With the exception of the Kyrgyz Republic, all have been involved in some kind of conflict, either international or domestic (see Chapter 8), which adversely affects normal international trade relationships.
  • With the exception of Georgia, they are landlocked countries (although Azerbaijan is on the inland Caspian Sea), which means that their trade depends on transit through third countries and raises the issue of collaboration on points related to transport.

Uzbekistan, however, is a much larger country, with 25 million people and a GDP of close to $8 billion. It has a very protected trade regime; it has not had any significant conflicts, with the exception of its border skirmishes with Afghanistan; and, though also landlocked, it has had fewer problems of transshipment than many of the others.

The three Caucasus countries—Armenia, Azerbaijan, and Georgia—are a distinct group whose trade links have been severely distorted by the Armenia-Azerbaijan conflict. Their other regional trade partners are primarily Iran, Russia, and Turkey. The three Central Asian countries—the Kyrgyz Republic, Tajikistan, and Uzbekistan—have trade links with each other as well as with Kazakhstan. Their trade links outside the immediate region are with Russia and China. Moldova, not truly part of any distinct regional group, has ties both to the Balkans and to other CIS countries, primarily Russia and Ukraine. There are few actual trade links among the three groups and limited natural potential for trade. Russia is the most important regional trading partner common to all seven countries.

General Trends in Trade Performance

The export performance of the CIS-7 countries in the second half of the 1990s was weak. There has been little change in the composition of exports. Major new export products have tended to be in capital-intensive extractive industries, which hold little promise for increasing employment and reducing poverty. There has been a major reorientation of trade away from the CIS countries and toward developed economies, especially the European Union, but Russia continues to be the largest trading partner for almost all the CIS-7 countries.

There are also important trade links among the countries in Central Asia, but much less so in the Caucasus, mainly because of the Armenia-Azerbaijan conflict. As a consequence, there is clearly a basis for increased regional trade in both groups of countries: in Central Asia, to intensify what already exists and in the Caucasus, to develop natural trading partnerships if a political solution to the conflict is found. Moldova has regional partners in both the CIS and the Balkans, with the Balkans holding greater promise as trading partners.

Changes in Trade

The poor quality of the trade data for the CIS-7 countries, especially Azerbaijan, Georgia, Moldova, Tajikistan, and Uzbekistan, makes precise determinations about international trade difficult. There is a large amount of unregistered merchandise trade, misrepresentation of customs invoices, and other weaknesses in the operations of customs, resulting in significant discrepancies between data based on customs declarations and data derived from financial statistics, and between official statistics based on country reports and data derived from trade partners’ data.1

Given these substantial caveats, information on the export and import of goods and services in the CIS-7 for 1995–2000 suggests that merchandise exports declined in absolute terms in Armenia (through 1999), Moldova, and Uzbekistan, and grew in the other countries (Table 10.1). Growth was substantial in Azerbaijan and Georgia, and modest to negligible in the Kyrgyz Republic and Tajikistan. In Azerbaijan, growth was based on a large increase in oil exports. Georgia’s growth may not all be real: exports increased about 30 percent in 2000, in part due to a rebound in the Russian market, but appear not to have been sustained in 2001. Changes in the method of calculation throughout the period, and a possible decline in underreporting shed some doubt on the reliability of these findings and the sustainability of this export performance.

Table 10.1.Average Annual Growth of Exports and Imports, 1995–2000(In percent)
ItemArmenia1AzerbaijanGeorgia2Kyrgyz RepublicMoldovaTajikistan3UzbekistanTotal
Merchandise exports-2.324.96.84.6-8.40.9-3.31.9
Service exports47.28.61.39.72.4n.a.11.88.7
Total6.322.05.05.0-6.32.3-1.92.7
Merchandise imports1.79.3-5.8-1.1-0.7-3.6-5.5-1.5
Service imports39.79.7-4.8-5.20.9n.a.0.53.3
Total6.19.4-5.6-2.2-0.4-1.8-4.6-0.6

1999 data are used instead of 2000.

1997 data are used instead of 1995.

Growth in services is not calculated due to lack of 1995 data. It is taken to be zero in calculating total growth, in services.

1999 data are used instead of 2000.

1997 data are used instead of 1995.

Growth in services is not calculated due to lack of 1995 data. It is taken to be zero in calculating total growth, in services.

In countries for which Russia is an important market (Armenia, Moldova, Tajikistan, and Uzbekistan) the sharp contraction of the Russian market in 1998 led to a decline in exports from which they have not fully recovered. Merchandise exports for Moldova and Uzbekistan were lower in 2000 than they had been five years earlier.

Overall for the CIS-7 countries, the growth of merchandise exports averaged 1.9 percent a year, compared with 4.9 percent for Russia, 5.7 percent for the rest of the CIS, and almost double that for the Baltics (Table 10.2). This performance is worse than that of the least-developed countries, a group of 49 low-income developing countries for which the international community has planned measures to enhance their trade prospects.

Table 10.2.Annual Average Growth of Exports and Imports of CIS-7 and Selected Countries and Country Groups, 1995–2000(In percent)
ItemCIS-7Russian FederationOther CIS1Baltic CountriesCzech RepublicHungaryPolandSlovakia
Merchandise exports1.94.95.710.36.214.57.56.7
Service exports8.7-1.89.012.60.03.8-0.5-1.2
Total2.74.36.210.94.911.95.35.2
Merchandise imports-1.5-6.41.39.95.012.412.67.7
Service imports3.3-3.019.214.22.14.44.7-0.4
Total-0.6-5.63.310.54.511.111.16.5
Source: IMF international Financial Statistics.

Belarus, Kazakhstan, and Ukraine, Turkmenistan is not included because trade data are not available.

Source: IMF international Financial Statistics.

Belarus, Kazakhstan, and Ukraine, Turkmenistan is not included because trade data are not available.

Imports also declined after 1995 in all countries except Armenia and Azerbaijan. In Azerbaijan, increased imports reflect the large inflows of foreign direct investment. The decline in the other countries reflects both the decrease in exports, the leveling-off of foreign official flows, and the inability to attract substantial amounts of private capital.

Trade in services is growing in importance in transition economies, which had stifled growth of the sector under central planning. The limited information available suggests significant growth in exports and imports of commercial services for most countries, albeit from very low levels (see Table 10.1).

Direction of Trade

Since 1995, all the CIS-7 countries except Tajikistan have reoriented their exports away from CIS markets and primarily toward the markets of developed countries. By 2000, 62 percent of total CIS-7 exports were going to non-CIS countries, up from 47 percent in 1995 (Table 10.3). Imports have followed a similar but weaker trend.

Table 10.3.Geographical Composition of Merchandise Trade, 1995–2000
ArmeniaAzerbaijanGeorgiaThe Kyrgyz

Republic
MoldovaTajikistanUzbekistanTotal
1995199919952000199520001995200019952000199520001995200019952000
Exports
Total CIS48243913634173416349344955535339
Neighboring
countries115842010191911818131111129
Russia2515186312124134837133330282822
Other CIS214144111030934341514138
Non-CIS52766187375927593751665145474761
European Union2236176052112341220462822202233
Other developed
countries2116635607215995647
Other countries in
the region31111356232419175102687
Other191431757148711111316161314
Imports
Total CIS48203432403269546836597052395338
Neighboring
countries1923115102014331831298101511
Russia19161321121327243317171630142517
Other CIS2021810139221612112614141311
Non-CIS52806668606831463264413048614762
European Union1534131916242121426261719231723
Other developed
countries2181531741521533110611711
Other countries
in the region32931132115771113021289
Other172219191814211362241122261519
Source: IMF, Direction of Trade Statistics Yearbook, various issues.

For South Caucasus countries this includes Armenia, Azerbaijan, and Georgia; for Moldova it includes Ukraine and Belarus; and for Central Asia it includes Ike Kyrgyz Republic, Tajikistan, and Uzbekistan.

Canada, United States, Japan, Switzerland, Norway, and Australia.

Defined as China for Central Asian countries; Iran and Turkey for South Caucasus countries; member countries of the Stability Pact for South Eastern Europe (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Romania, and FR Yugoslavia) for Moldova.

Source: IMF, Direction of Trade Statistics Yearbook, various issues.

For South Caucasus countries this includes Armenia, Azerbaijan, and Georgia; for Moldova it includes Ukraine and Belarus; and for Central Asia it includes Ike Kyrgyz Republic, Tajikistan, and Uzbekistan.

Canada, United States, Japan, Switzerland, Norway, and Australia.

Defined as China for Central Asian countries; Iran and Turkey for South Caucasus countries; member countries of the Stability Pact for South Eastern Europe (Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR Macedonia, Romania, and FR Yugoslavia) for Moldova.

Among non-CIS trading partners, the European Union has emerged as the most important, accounting for 33 percent of exports and 23 percent of imports. Turkey is also emerging as an important supplier to the region. While Russia’s share of trade with the CIS-7 countries is declining, it is still the largest single market and source of imports for all but Azerbaijan.

Regional trade, i.e., trade among the three Central Asian countries or among the three Caucasus countries, is far more important for the former group than for the latter. In the Central Asian countries, regional trade accounts for 13 percent of total exports and 14 percent of imports. Adding Kazakhstan to the group brings regional trade to almost 20 percent of the four countries’ total trade. Trade among the Caucasus countries accounts for 5 percent of exports and 4 percent of imports. Greatly reducing the total is the almost complete absence of trade between Armenia and Azerbaijan. Moldova’s regional trade partners include Belarus and Ukraine in the CIS, and Romania and some of the Balkan countries. Trade with both sets of regional partners is declining, while that with the European Union is rising (see Table 10.3).

Composition of Merchandise Trade

Exports

Available data on the product composition of merchandise trade suggest little change in the basic structure of exports of the CIS-7 countries during 1995–2000, with two exceptions. Azerbaijan became even more dependent on oil exports, which reached 85 percent of exports in 2000 and was up from 69 percent in 1995. The Kyrgyz Republic has increased its exports of gold, which account for about 40 percent of exports. In both cases, especially for the Kyrgyz Republic, known reserves will run out in a few years, giving the countries a limited horizon during which to develop a more diversified export structure. For the rest of the CIS-7 countries, traditional commodities account for the overwhelming proportion of exports (see Box 10.1).

While a few sectors have shown some promise, such as prepared foodstuffs in Armenia and textiles in Moldova, the increased dependence on capital-intensive extractive industries is likely to provide little direct stimulus to employment or increased incomes for the poor. Developing country experience suggests that raw material and primary product exporters have fared worse in recent periods, in terms of both export and GNP growth, than more diversified exporters. The challenge is to use the increased foreign exchange and tax revenues from the expansion of resource-based exports to spur development of other sectors and to assist the poor.

Despite an abundance of labor—much of it highly educated and unemployed—labor-intensive exports did not grow during 1995–2000 in most of the CIS-7 countries, with Armenia as an exception. Several factors help to explain why. Overall economic restructuring has been slow, labor-intensive activities have been heavily taxed, governments have continued to intervene in business activities, and access to developed country markets for labor-intensive exports was less favorable for the CIS-7 countries than for their competitors. The net effect has been that the export sector has not contributed to poverty reduction as it did in successful Asian exporters like China. This makes the challenge of reducing poverty in these countries even greater.

Imports

Imports tend to be more diversified, and their composition varies from country to country. In most, machinery and transport equipment account for a significant share of imports. Armenia, Georgia, the Kyrgyz Republic, and Moldova are heavily dependent on imports of oil and oil products. The three Caucasus countries import large amounts of food, and some countries import products that are subsequently reexported, such as diamonds (Armenia) and aluminum (Tajikistan).

Trade Policy

In exploring why export performance has been weak, the first place to look is trade policy—both the policies of trade partners, which affect market access, and the CIS-7 countries’ own trade and exchange rate policies, which affect incentives to produce for the domestic market or for export.

Box 10.1.Major Export Developments

Armenia. Imported diamonds are processed, polished, and subsequently reexported to Belgium, accounting for a third of exports. Metal scrap (old equipment and parts from deactivated Soviet-era industry) and prepared foodstuffs are other important exports. There are also electricity swaps with Iran.

Azerbaijan. The dominance of oil exports is increasing, reaching an estimated 90 percent of total exports in the first three quarters of 2001. Cotton, previously an important export crop, has virtually collapsed, accounting for only 1–2 percent of exports.

Georgia. Metal scrap (again from Soviet-era factories) and timber are important exports, the value of which is probably underestimated because export restrictions have forced trade in these products underground. Exports of wine, almost exclusively to CIS markets, are important and rising. Sales of other traditional exports, such as tea, have declined in value. Metal scrap is the only new substantial export product.

Kyrgyz Republic. Gold is by far the most important export product. Electricity exports to Kazakhstan and Uzbekistan are the second most important, although volatile, export (they are bartered for natural gas and coal). Cotton and tobacco account for about 10 percent of merchandise export earnings, and manufactured products destined for the Russian defense industry account for a declining portion. Once-important wool and textile exports have virtually disappeared.

Moldova. Agricultural products, mainly foodstuffs and wine destined for CIS markets (especially Russia), are the main exports. A new development is the increase in textile exports, based on subcontracting by foreign firms. Moldova’s agricultural export base is at a disadvantage in EU markets because it faces heavy competition from established EU exporters and substantial protection. A further handicap is the inability to raise the food quality to meet EU standards. Transdnestria has substantial heavy industry, with total exports perhaps as high as 70 percent of those of Moldova. The largest exporter is probably Moldova Metallurgical Works, an efficient producer and exporter worldwide, owned by a Russian company registered in the United States.

Tajikistan. The main export product is aluminum, based on imported alumina and the heavy use of subsidized electricity generated by hydropower, a major resource of Tajikistan. The Soviet-era Tadaz aluminum plant accounts for 55 percent of exports and 29 percent of imports. It could not survive, however, without the heavy electricity subsidy. Other important exports are electric power and cotton fiber. No new export has been developed in recent years.

Uzbekistan. Gold, energy (oil and natural gas), and cotton fiber appear to be the main exports, although details are not readily available. Cotton fiber, the traditional export, seems to have been declining in importance in recent years. It is not clear what, if any, new export lines outside the resource-intensive sectors have been developed.

Market Access

Market access in the two major markets for CIS-7 products, the CIS and the non-CIS developed countries, does not seem to have been a major constraint in the expansion of exports during 1995–2000. Most of the CIS-7 countries have enjoyed preferential treatment in the CIS based on a number of free trade agreements. Despite some uncertainties, the problems of accessing the CIS markets have had less to do with formal trade barriers and more to do with the lack of transparency and weaknesses in the operation of market institutions, a problem that has plagued all CIS countries.

All of the CIS-7 countries enjoy most-favored-nation trade status in major non-CIS markets. Developed countries have extended most-favored-nation status on a voluntary basis while the CIS countries apply to the WTO. Those that have become WTO members (Armenia, Georgia, the Kyrgyz Republic, and Moldova) enjoy contractually guaranteed, unconditional, permanent most-favored-nation treatment from other members. Minerals and fuels, which constitute a significant portion of CIS-7 exports, are typically subject to very low, if any, tariffs in developed countries and virtually no quantitative restrictions.

The CIS-7 countries also benefit from the Generalized System of Preferences (GSP) operated by developed countries. However, GSP focuses on manufactured products and excludes common CIS-7 exports, such as textiles and clothing as well as sensitive temperate-climate agricultural products (such as wine), which are heavily protected. Indeed, preferences under the GSP put the CIS-7 countries on the lowest rung of the EU preference ladder, behind the least-developed countries; the African, Caribbean, and Pacific countries; the Balkans and other Central and Eastern European countries; and the Mediterranean countries. On balance, however, it is unclear whether these issues have played a significant role in limiting exports, especially of agricultural products, which, in Moldova’s case, are also constrained by quality and standards problems.

Finally, the CIS countries have been characterized as nonmarket economies by the developed countries, including the United States and the European Union and, as such, have been subjected to antidumping actions more frequently and to procedures that are even less transparent and more arbitrary than the antidumping procedures applied to other countries. The European Union has also used the nonmarket designation to impose selective safeguards and quantitative restraints on imports from the CIS countries. Most of these restraints and antidumping actions have been directed at iron and steel and nonferrous metal exports from Russia and Ukraine.2 A few of these actions have affected exports from Transdnestria and Tajikistan. Overall, however, antidumping actions have not been a major constraint on CIS-7 exports to developed country markets.

Countries’ Own Trade and Exchange Rate Policies

Armenia, Georgia, the Kyrgyz Republic, and Moldova are WTO members, while Azerbaijan, Tajikistan, and Uzbekistan are at the early stages of accession. All except Uzbekistan have adopted relatively liberal trade policies, although countries still protect certain products. As a consequence, the formal trade regime is not a significant source of inefficiency. Except for Uzbekistan, none of the countries uses foreign exchange restrictions to control imports. Armenia, Georgia, the Kyrgyz Republic, and Moldova have met IMF Article VIII standards for exchange rates.

On a scale of one to ten, with ten the most restrictive, the IMF rates the overall trade policy stance of the six CIS countries, excluding Uzbekistan, as either one or two (Table 10.4). It rates Uzbekistan as a nine. Uzbekistan has a more restrictive tariff regime than the other countries, but the greatest distortions result from foreign exchange controls and state trading in major exports such as gold and cotton. Import contracts have to be registered in advance with the Ministry of Foreign Economic Relations. While the stated purpose is the protection of state interests and the interests of Uzbek enterprises, the protection of consumers against poor quality goods, rationalization of import flows, and the prevention of unwarranted outflows of international reserves, the actual purpose is to contain the balance of payments deficit and avoid depreciation of the official exchange rate.

Table 10.4.Trade Regimes
Tariffs
CountrySimple average

(percent)
Number of bands

(percentage rate)
Nontariff

Barriers
IMF Trade Policy

Stance Rating1
Armenia42 (0–10)Minimal1
Azerbaijan104 (0–15)Minimal2
Georgia113 (0–12)Minimal2
Kyrgyz Republic55 (0–20)Minimal1
Moldova76 (0–15)Minimal1
Tajikistan86 (5–30)Minimal1
Uzbekistan195 (max 100)Extensive9
Source: IMF.

The scale is 1 to 10, with 10 the most restrictive.

Source: IMF.

The scale is 1 to 10, with 10 the most restrictive.

Simple average tariffs range from a low of 5 percent in the Kyrgyz Republic to a high of 11 percent in Georgia and Tajikistan. Weighted-average tariffs tend to be lower still. The maximum tariff in most cases is 15–20 percent, although both Azerbaijan and Tajikistan have a few higher tariffs. Also, most countries have adopted relatively simple tariff structures with few tariff bands. The CIS-7 countries that are members of the WTO have eliminated nontariff barriers, except those related to health, safety, security, and environmental protection. Azerbaijan and Tajikistan also appear to have no significant formal nontariff barriers.

Uzbekistan’s average tariff in 2000 was relatively high at about 19 percent, and its maximum tariff was 100 percent (on used cars for which the maximum tariff in other sectors was 30 percent). Tariffs are changed frequently—six revisions in six years—and there are numerous exemptions (about 180). Tariffs are thus neither the main device for controlling imports nor a significant source of revenue. The main import control mechanism is the allocation of foreign exchange based on the degree of essentiality of the import. The import controls are coupled with a system of government procurement of cotton, which taxes producers by paying them substantially less than world prices, and state monopolies on exports of cotton, minerals, and precious metals.

Other than in Uzbekistan, there are also few controls on exports. Azerbaijan and Georgia ban exports of scrap metal, and Georgia and Moldova have licensing requirements or other controls on exports of some natural resource-based products, such as timber. None of these controls appears to affect the overall level of exports. In some cases, they just drive the exports underground. Tariffs on certain inputs, however, may put some exporters at a disadvantage because systems for import tax (and value-added tax) rebates for exporters are subject to delays and inefficiencies.

While all CIS-7 countries except Uzbekistan have liberal exchange rate regimes, appreciation of the real exchange rate and fluctuating real rates have adversely affected competitiveness and the development of new export industries in some countries. The Russian crisis in 1998 forced a number of other countries, such as the Kyrgyz Republic and Moldova, to devalue after a period of real exchange rate appreciation. In others, such as Armenia and Georgia, the overall real exchange rate appears to have remained relatively constant during 1995–2000, although the Armenian dram has continued to appreciate relative to the Russian ruble since 1998, which has contributed to the decline in the competitiveness of Armenian products in that market. In Azerbaijan, rapidly expanding oil exports have been accompanied by a depreciation of the exchange rate since 1997, thus apparently avoiding the Dutch disease phenomenon, which impedes the development of new export products and reduces the competitiveness of others.

In summary, formal trade policy measures do not appear to be an important factor undermining efficiency and export expansion in the CIS-7 countries, except for Uzbekistan. For several of the countries, however, maintaining real exchange rate stability has been a challenge, in part because of significant exchange rate changes in some of their major markets, such as Russia and Turkey. In Uzbekistan, improvements in trade and exchange rate policies would make a significant contribution to more effective integration in the world trading system. In the other six countries, however, trade and foreign exchange policies are not behind the lackluster trade performance.

Regional Cooperation in Trade and Related Issues

The CIS countries participate in a large number of regional cooperation agreements having a potential impact on trade. In most cases, implementation lags far behind the ambitious formal commitments. Some of the agreements, such as the CIS Free Trade area, are CIS-wide, while others, such as the Eurasian Economic Community—comprised of Belarus, Kazakhstan, the Kyrgyz Republic, Russia, and Tajikistan—involve smaller groups of CIS countries. Still others, such as the Central Asian Cooperation Organization—comprising Kazakhstan, the Kyrgyz Republic, Tajikistan, and Uzbekistan—have had a regional focus. One agreement, the Transport Corridor Europe-Caucasus-Asia (TRACECA), is a project to develop a transit corridor between Central Asia and the Caucasus that would include all the CIS-7 countries.

Most of these arrangements aim to stimulate trade among the CIS countries through trade preferences. Their effectiveness is in doubt, in part because they have not been fully implemented. But even those that have been at least partly implemented have failed to arrest the relative decline in intra-CIS trade.

The CIS Free Trade Agreement

This agreement involves a series of bilateral agreements between participating countries, each with different product coverage and rules of implementation, resulting in a complex network of agreements where coverage and rules change frequently and the impact is difficult to evaluate. Operating an effective free trade agreement requires implementing rules of origin, which are the responsibility of customs authorities. Given the extreme weakness in the customs institutions in all the countries, porous borders, and the complex character of the agreements, the payment of actual tariffs paid on any product to any authority in intra-CIS trade is a very chancy thing and has little to do with the formal agreements signed by the trading countries.

The Eurasian Economic Community

This is a free trade area in practice and is expected to become a customs union with a common external tariff by 2005. Its main driving force has been the desire of traditional exporters to Russia to maintain their preferences and links to the industrial structures in the other countries. Russia expects the other countries to move to its tariff, but progress in achieving this goal has been uneven: according to the most recent information available, tariffs have been harmonized on 95 percent of the items in the schedules for Russia and Belarus, 85 percent in the schedules for Russia and Kazakhstan, 60 percent in the schedules for Russia and Tajikistan, but only 14 percent in the schedules for Russia and the Kyrgyz Republic.

Moving to the much higher Russian tariff will result in substantial trade diversion and will tend to tie the other economies to the old technology of the Russian industrial structures. On the other hand, if these countries maintain a free trade agreement with Russia and with each other, they would enjoy the benefits of access to the Russian market without incurring the high costs of trade diversion that would result from a customs union with Russia that adopts the higher Russian tariff.

Participation in the Eurasian agreement and regional preferential trade arrangements has led to some confusion regarding their implications for WTO membership. A few years ago, countries in Central Asia were discussing the two options as though they were mutually exclusive alternatives: either become a WTO member or join the Eurasian Economic Community. In fact, when a country applies for WTO membership, it can be a member of any number of regional preferential arrangements, as long as they are compatible with WTO provisions regarding such arrangements, which is typically not difficult to achieve.

Members of the Eurasian Economic Community agreed to apply to join the WTO individually, which means they recognized that the Eurasian Economic Community is not a customs union (which requires a common external tariff) but a free trade area where each member has its own tariff structure on imports from the rest of the world. This was clearly understood during the accession negotiations of the Kyrgyz Republic, the first member of the Eurasian agreement to become a WTO member. The Kyrgyz Republic accepted legal commitments to bind its tariffs in the WTO at levels significantly lower than those applied by Russia—the levels that are to be applied by the yet-to-be formed Eurasian customs union.

The Eurasian Economic Community can play an important role in areas beyond trade preferences. For example, it has worked on cooperation in customs activities, an area in which regional efforts are especially appropriate. Russia and Kazakhstan’s participation in these efforts is critical because they are major markets for the CIS-7 countries and key transit routes for several of them.

The Central Asian Cooperation Organization

This organization is intended to address economic and security cooperation issues. Its economic objectives include the creation of free trade zones in the most important sectors of the economy, improvement of transport infrastructure, and more efficient use of the water resources of transborder rivers and water basins. So far, the organization has served as a vehicle for multilateral discussions of regional issues and as a forum for regular meetings of the presidents of the four member countries.

The Transport Corridor Europe-Caucasus-Asia (TRACECA)

TRACECA is supported by the European Commission and aims to establish a transportation corridor linking Central Asia and Europe through the Caucasus. In addition to providing good quality infrastructure (roads and ports), the project seeks to facilitate trade through simplified customs procedures. Implementation has been slow, complicated by the growing number of participants and the political conflicts involving some of them.3

Moldova

This country deserves separate mention because it has one foot in each of two regions: it has bilateral preferential arrangements with Russia and Ukraine (and is apparently interested in becoming a member of the Eurasian customs union) and also has signed the Memorandum of Understanding on Trade Liberalization of the Stability Pact, committing it to participate in bilateral free trade agreements with the other seven Balkan countries, which are signatories. Moldova can continue its free trade agreements with other CIS countries, but clearly it cannot be a member of a customs union with Russia and others in the CIS—which would require a common external tariff—while entering into free trade agreements with the Balkan countries.

The small CIS economies are likely to benefit most from open, transparent trade regimes. Free trade agreements that cover substantially all trade (with few product exceptions) among themselves and between themselves and Russia may be useful in providing access to markets. This means, however, that the complex and perplexing system of trade preferences that now exists should either be made to work better, by developing transparent rules and a common, limited list of exemptions, or abandoned altogether because it is mainly a source of inefficiency and corruption. But if the overall trade regime is liberal, even free trade agreements that cover substantially all products are unlikely to provide a major stimulus to foreign trade.

Analysis of the potential expansion of trade among the Caucasus countries, in the event that they reestablish normal trading relations, suggests that their mutual trade would expand by a few percentage points even without the establishment of any preferential trade regimes.4 While the major increase in trade is likely to occur between Armenia and Turkey, all countries should benefit from the overall economic growth that normalization of relations would bring about. Some regional agreements, in particular in Central Asia, could be used as forums for discussion and collaboration on issues such as transport, customs procedures, and the like that could be very important in promoting trade.

Trade-Related Capacity and Institutions

Since neither formal trade policies (except in Uzbekistan) nor market access conditions in the main trading partner countries appears to explain the lagging export performance of the CIS-7, other factors must be involved. Effective integration into the world trading system requires the support of a variety of institutions and policies. The availability of low-cost, high-quality services is a critical determinant of export competitiveness. Weak trade-related institutions (in customs and tax administration, the banking system, and marketing and standards organizations), lack of infrastructure, and poor governance likely play a role. None of the CIS-7 countries scores more than two of a possible four points in the most recent European Bank for Reconstruction and Development rating of competition policy and governance and enterprise restructuring.

Bureaucratic, institutional, and infrastructure constraints to trade would have to be addressed before trade could expand and the CIS-7 countries could reap substantial economic benefits from normalized political relationships. A fundamental problem, not limited to international trade, is an economic interventionist attitude by governments. This attitude is pervasive in nearly all aspects of market activity, but it has an especially stultifying effect on international trade and has been identified as a key constraint in export development in all the CIS-7 countries.

Customs

The problems faced by the customs services in all seven countries are well known.5 Customs services are only a few years old and have not had much time to develop expertise. Salaries are low, and customs officers lack the resources of a modern customs service, including fully computerized communications and data systems. They also are expected to administer a complex, and frequently changing, set of rules and regulations. In Georgia and Moldova particularly, but in other countries as well, customs officers are not able to control large parts of the border. The physical infrastructure is also weak and probably would not be able to cope with significant increases in trade.

These difficulties are compounded by internal management problems. Georgia has had frequent changes in the top customs administrator. Azerbaijan has problems of coordination and communication among the different agencies involved in the clearance of imported merchandise. In Azerbaijan and the Kyrgyz Republic, approvals by standards and health agencies take a long time, and rules are sometimes enforced capriciously. Dispute settlement procedures are lengthy and nontransparent, driving many to resort to bribes. In the Kyrgyz Republic, approvals are needed from agencies located in different parts of the country. Better coordination among the customs authorities in each of the two main regions is also needed.

Many of the CIS-7 countries have been reforming their customs administration, though more needs to be done. Some of the problems are political, requiring political will or international cooperation to resolve them. Some of the problems require additional resources to support ongoing reforms. The key reforms needed relate to internal organization of the customs authority, staffing and remuneration, performance management and accountability, modernization of operational procedures, internal and external control and audit procedures, physical infrastructure, and approval procedures for standards and health organizations.

Taxes

The tax system and tax administration are important impediments to exports in many CIS-7 countries. While tariffs are not high, there is often a cascading of tariffs. Also, a value-added tax (VAT) of around 20 percent is charged on all imports. Tariffs and VAT paid on imports used in export production need to be promptly refunded or credited; this rarely happens. As a consequence, export competitiveness is impaired. In the Kyrgyz Republic, the failure to refund tariffs and VAT is estimated to have raised total costs by 9 percent for 44 firms surveyed in 2000.6

Another problem in several CIS-7 countries is high payroll taxes, 39 percent in the Kyrgyz Republic. These taxes diminish the competitiveness of exports and undermine an important comparative advantage of these countries, their large supply of educated and qualified labor.

Banking and Finance

Financial institutions in the CIS-7 countries do not appear capable of financing trade flows. Financial markets are poorly developed; letters of credit, bills of exchange, and other modern payment instruments are unavailable. And while payments between traders in the Central Asian countries can be cleared through settlement accounts in commercial banks of neighboring countries, governments levy taxes on these accounts, and international clearing is tightly controlled.

Exporters have almost no access to domestic credit. This is part of a general problem of credit availability for small and medium-sized enterprises because the banks see other easier, more profitable investment opportunities and because establishing creditworthiness is difficult. As a consequence, credit has to be provided on the importing side, which is easier to do when selling to developed countries than to other CIS countries.

While trade finance is important, improving it should be part of an overall strengthening of the commercial banking system. International experience suggests that directed credit lines specifically designed for short-term trade finance do not have a lasting impact outside the context of a strong banking sector. And there are very few product lines in these countries that require longer-term export credits. Promoting the entry of foreign banks, with their international contacts, could help develop the banking system as well as provide trade finance.

Marketing and Standards

Exporters have to rely on their own resources to market their products because marketing institutions do not exist. For traditional raw material exports (cotton in Uzbekistan or aluminum in Tajikistan), this is not a problem. Difficulties arise in introducing a new product line. Marketing is easier when the export is based on a joint venture with an international partner that has established commercial links abroad. But there are few joint ventures in these economies. These should be encouraged along with the development of domestic marketing organizations.

While little information exists about the operational effectiveness of standards organizations in the CIS-7, there is a general impression that these organizations are weak. On the import side, they tend to delay shipments, sometimes extensively. On the export side, they are unable to provide the information exporters need to meet the requirements in export markets. These organizations have to replace Soviet-era standards with standards that are compatible with modern international trade. This is a requirement for countries joining the WTO. Assistance to these organizations typically has been offered by donors in connection with WTO accession, but there is a continuing need for strengthening these institutions even after WTO accession.

Transport and Transit

Transport costs are a major determinant of competitiveness. In all the CIS-7 countries transport infrastructure is a significant impediment to expanded trade. The substantial investment in transport infrastructure during the Soviet era was designed to service trade flows within the former Soviet Union. After independence, demand for transport services declined along with economic activity. Since then, infrastructure has been poorly maintained, and no new infrastructure has been added to meet the needs of changing trade patterns. Reform of transport sector management and financing has also been slow.

Roads are in generally poor condition, the trucking fleet is aging and not being renewed, railway rolling stock is antiquated, airfreight services are very limited, and general freight charges are highly subsidized, with transport enterprises—often publicly owned—in poor financial condition.

Road funds and railway companies operating in the CIS-7 countries are in need of substantial institutional strengthening and increased investment in maintenance and repair. Demand and supply for various transport services need to be reassessed in light of emerging patterns of economic activity and international trade. Support for these efforts, such as that provided by the Asian Development Bank, should be an important component of the efforts to strengthen the integration of these economies into world trade.

Transit problems differ for the two CIS-7 groups of Central Asia and the Caucasus, while Moldova appears to face no serious transit problems other than those endemic to a landlocked country. In Central Asia, transit problems are concentrated in the Kyrgyz Republic and Tajikistan, largely in road transport. All Central Asian railways use the same rolling stock, track standards, and rulebooks, and there appears to be good cooperation among the rail authorities in the three countries. In the Caucasus, the problems derive from the Armenia-Azerbaijan conflict and the Turkish blockade of Armenia.

  • Kyrgyz Republic: The destination of many exports is Russia and the European Union. Road transport costs are typically 10–15 percent of total costs. About a third of this is fuel costs, and the rest is official and unofficial fees and payments at various points in transit countries.7 Transporters also complain that axle weight limitations are set differently and biased against their trucks, and that slight deviations above weight limitations incur disproportionate penalties, forcing them to carry inefficiently small loads.
  • Tajikistan: About 80 percent of Tajikistan’s exports are routed through Uzbekistan, in part because of the topography and in part because Tajikistan’s northern and southern rail networks, which carry most of the exports, are not connected. Uzbekistan depends on transit through Tajikistan for access to the Ferghana Valley. Cooperation appears better on rail than on road traffic. Tajik drivers complain that border fees are higher for exports than for imports and that complex customs regulations leave considerable room for harassment and bribery.8
  • Armenia: Transport costs account for about 10 percent of the total value of merchandise in Armenia. Also, Armenia has been affected by the Turkish blockade, forcing it to reroute its trade through Georgia. It is estimated that lifting the Turkish blockade would halve trucking costs between Armenia and Turkey. There would also be substantial savings if Turkish ports were used for transshipments of sea freight. Opening the direct link between Armenian and Turkish road systems would also increase the availability, predictability, and reliability of shipping services.
  • Azerbaijan and Georgia: Azerbaijan’s transport costs would decrease less as a result of opening the road between Armenia and Turkey, while Georgia would lose transit fees if the blockade on Armenia were lifted. But all countries would gain from the increased trade and growth that would result from normalization of political relations.9

Telecommunications

An efficient telecommunications sector is important to the long-term integration of the CIS-7 countries into the world economy. All the CIS-7 members inherited an extensive but low-quality fixed telephone network. Since independence, the countries have adopted a variety of regulatory regimes and have made varying progress in modernizing and privatizing their telecommunications sector.

  • Tajikistan has made the least progress. The government controls the fixed-line operator monopoly as well as the broadcasting enterprise, which in turn owns shares in the only cellular, tracking, and paging operators companies. Non-transparent and noncompetitive licensing further increases investor risk and constrains entry into new services, such as the Internet. Infrastructure is outdated and managed inefficiently, and the sector is in a precarious financial position. The structure of tariffs penalizes exporters, with high international tariffs subsidizing low local tariffs.10
  • The Kyrgyz Republic has a sounder regulatory environment, with an established independent regulator. The financial viability of the public sector telecommunications entities is in doubt, however, making the chances of finding an international investor rather slim.
  • The Uzbekistan telecommunications sector has benefited from Japanese and Korean investments (with EBRD participation). The government is trying to privatize the fixed telephone network and rebuild the licenses for the seven existing mobile operators.
  • The three Caucasus countries have adopted different regulatory regimes, but telecommunications sector development has been constrained by a common set of regulatory bottlenecks. Chief among these are noncompetitive and inconsistent licensing: lack of clear build-out obligations in license agreements; interconnection and revenue-sharing problems among operators; unbalanced tariffs; and a lack of capacity to manage scarce resources, such as numbering or frequencies. Underdeveloped telephone infrastructure, especially low digitalization, hampers Internet connectivity and data transmission, while the high cost of leased lines and international connectivity is a heavy burden for exporters.11 Foreign interest in these markets is dampened in part by conditions affecting the telecommunications industry globally. While there is growth potential, especially in mobile communications, the three markets are small individually. They need to form a single market to interest foreign investors, which would require making mutually inconsistent regulatory networks more compatible.

Priorities for action depend on the state of development in each of these markets. In Tajikistan the priority is to develop a comprehensive restructuring strategy. This would require separating the operational, regulatory, and policymaking functions of the public sector, establishing a transparent licensing system for infrastructure and service providers, revising existing licenses, and developing a regulatory network. A key short-term priority is to rehabilitate and increase the efficiency of the fixed telephony system, with a view to privatizing it.

In the Kyrgyz Republic and Uzbekistan, the priority is to find a strategic foreign investor to privatize the public telecommunications and fixed telephony system. If this fails, the governments may need to consider alternatives, such as performance-based management contracts with foreign firms.

In the Caucasus, the priorities are to update the legal and regulatory frameworks, especially licensing arrangements that restrict market entry, and to reduce the remaining obstacles to privatization. Efforts are needed to create a regional market for telecommunications services, including common regulatory frameworks and the establishment of a regional Internet exchange point. A breakthrough is also needed on the political side in the Armenia-Azerbaijan conflict.

Elements of a Strategy for Better Integration

In developing a strategy for better integration into the world economy, the CIS-7 countries need to consider policies they can pursue individually and policies that require regional cooperation, often relating to arrangements for strengthening trade capacity and reducing constraints. In many of these efforts the international community can play an important supportive and complementary role.

Actions by the CIS-7

Trade Policy

  • Countries that are members of the WTO need to take advantage of ongoing multilateral trade negotiations to further liberalize their trade policies on a multilateral, reciprocal basis within the WTO framework.
  • Countries that are not members of the WTO need to redouble their efforts toward accession, which would contribute to their integration in the international trading system by strengthening their market institutions, establishing clear and transparent rules for the conduct of trade, and creating an opportunity to lock in liberal trade regimes. This would also enhance and secure market access for their products and provide access to a dispute settlement mechanism that would contribute to better trade relations with neighbors and other trade partners.
  • Uzbekistan urgently needs to review its trade policy, with a view to eliminating nontariff barriers and export policies that discriminate against cotton producers.
  • All CIS-7 countries need to establish efficient ways of providing refunds or credits to exporters for tariffs and other taxes, especially VAT, paid on imported inputs.

Trade-related Institutions

  • Maintaining macroeconomic stability is crucial. Inflation and overvalued exchange rates can be extremely damaging to export prospects, as can policies that result in large fluctuations in the real exchange rate.
  • The numerous approvals, permits, and other clearances required of importers and exporters need to be reduced and procedures need to be streamlined.
  • Customs and trade-related institutions dealing with technical standards and sanitary and phytosanitary regulations need to be strengthened. This may require the assistance of the international community and the cooperation of regional trading partners, including Kazakhstan and Russia, which are important both as markets and as transit routes for many of the CIS-7 countries.
  • Banking and finance, and tax design and administration need to be reformed as part of the transition to a market economy. The reforms should take into account the needs of the trading community so as to ensure, for example, that exporters are not disadvantaged through the imposition of export or payroll taxes and that the banking system has incentives to provide trade finance.
  • Strengthening the transport and telecommunications sectors should receive high priority. These sectors are important to overall development and to increasing competitiveness and participation in international trade.
  • Regional cooperation will be necessary for many of these actions to succeed and for reduction of the external constraints that impede trade.
  • Bilateral trade preferences should be streamlined by developing common rules and a small, standard list of exemptions or should be abandoned altogether. The small CIS-7 countries would probably be better off maintaining low protection on a most-favored-nation basis. But maintaining free trade agreements that cover substantially all trade could also be beneficial, especially by contributing to broader regional cooperation.
  • Maintaining access to the Russian market is especially important to many CIS-7 countries. A free trade agreement with Russia, if it covered substantially all trade, could be beneficial; but a customs union with Russia, based on Russia’s higher protective tariff, should be avoided.
  • In the future, priority should be given to other regional cooperation efforts that hold greater promise for enhancing trade relations, such as collaboration among the countries in Central Asia and, separately, among the countries in the Caucasus. In Central Asia, cooperative arrangements need to include Kazakhstan because of its strong links with the other economies. TRACECA, the transport project linking the two sets of countries, should be pursued in tandem with strengthening cooperation within each group. Moldova’s trade future is likely to be better served through closer links with its Balkan partners than with the CIS countries.
  • In Central Asia, a number of institutions already in place could be used for regional cooperation on a range of issues. These institutions need to be significantly strengthened, however. Even in the Caucasus, despite the Armenia-Azerbaijan conflict, it may be possible to explore ways to enhance collaboration on technical issues, such as standards and telecommunications.
  • Regional cooperation efforts are especially needed on customs arrangements and border crossings and in the development of a common policy on transit fees, rules, and procedures, especially for road transport. Central Asian institutions, such as the Central Asian Cooperation Organization, already have a mandate to do this. Countries need to use them to reach agreements in these areas.
  • For meeting WTO commitments, it would be more efficient to have one regional standards authority in Central Asia than to have several separate ones. Similarly, there are potential benefits from the establishment of Central Asian regional institutions on phytosanitary regulations and intellectual property rights. The same holds true for the three Caucasus countries.
  • Enhanced regional cooperation on transportation, telecommunications, water, and electricity generation in Central Asia and the Caucasus would also promote international trade. Political independence has not reduced these countries’ economic interdependence, and cooperation in dealing with common problems continues to be a priority. But cooperation based on formulas developed under the Soviet system needs to be reviewed, and new economic relations need to be forged based on market principles. The telecommunications sector needs to be modernized, based especially on foreign direct investment and reduced public sector involvement. New technologies offer new opportunities for regional cooperation.

Actions by the International Community

Trade-related Policies

  • Developed countries should identify products of interest to the CIS-7 countries for export that are protected by high tariffs or nontariff barriers, with a view to reducing these barriers in the context of the ongoing WTO multilateral trade negotiations.
  • Developed countries should review their trade preference schemes, with a view to improving the preferences offered to the CIS-7 countries. Most of these countries are as poor as the least-developed countries and the Balkan countries, to which various developed countries have offered especially deep and broad preferences in recent periods, and which face limitations just as severe on their capacity to trade.
  • CIS-7 countries that become members of the WTO should no longer be considered nonmarket economies in possible antidumping or safeguard actions.

Assistance Priorities

  • Strengthening the trade-related capacity of the CIS-7 countries should have high priority in assistance programs. This means, in particular, continuing support for strengthening of customs and tax administration and broadening support for the establishment of standards and other trade-related institutions.
  • Trade-related assistance should not be terminated once countries become members of the WTO.
  • The private sector should have the primary role in strengthening transport and telecommunications, but countries should be assisted in elaborating sectoral and regional strategies in these areas.
  • The development of institutions that would foster regional cooperation in Central Asia and the Caucasus should be supported by technical and financial assistance, as should activities that have a true regional dimension.
References

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    MichalopoulosConstantine2001Developing Countries in the WTO. (New York: Palgrave Macmillan).

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*This chapter is based in part on interviews conducted by Wojciech Paczynski (in the Caucasus and Moldova) and Carolina Revenco (in Central Asia) in early 2002, Their contributions are gratefully acknowledged. The author also thanks Carolina Revenco for assistance in preparing the database, statistical analysis, and tables used in the study and her comments on the Moldovan economy: Martin Reiser and David Cooper of the European Bank for Reconstruction and Development for inputs on telecommunications issues in Central Asia; Ataman Aksoy, Nina Budina, and Evegeny Polyakov of the World Bank and Marco Pani, Clinton Shiells, and Thomas Richardson of the International Monetary Fund for comments on earlier drafts; Armanda Carcani of the World Bank for assistance with processing and formatting; and Saumya Mitra of the World Bank for overall direction and support.
1Uzbekistan does not formally report, or readily share, trade data; for what it does report, it uses a unique product and country classification that is different from that employed in standard international classifications. The analysis in this study uses international Monetary Fund International Financial Statistics data in the discussion of overall trends; the United Nations Statistics Division Direction of Trade Statistics data in the analysis of the geographical orientation or trade; and COM-TRADE data, which are based on national statistics, in the discussion or the product composition of merchandise trade.
3See World Bank (2001c) for a description of other regional issues and organizations.
5This section summarizes the findings of various studies by governments or donors. The problems in Tajikistan and Uzbekistan have not been extensively studied, so there are far fewer references to these countries. This should not be interpreted to mean that they face fewer problems.

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