Draft for Consultation. Not for Quotation

Kyrgyz Republic

Agricultural Policy Update

Overview

June 2011

ECSSD

Europe and Central Asia Region

Document of the World Bank

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CURRENCY AND EQUIVALENT UNITS

(as of June 30th

Currency Unit

2011)

= Som

US$ = 46.5 Som

1 Som = 0.022 US$

ABBREVIATIONS AND ACRONYMS

AO Aiyl Okmotu ABMP Agri Business and Marketing Project AISP Agricultural Investments and Services Project ASSP Agricultural Services Support Project CDS Comprehensive Development Strategy CET Common External Tariff CPMP Community Pasture Management Plan CRI Crop Research Institute CSU WUA Central Support Unit FCSCU Financial Company for Savings and Credit Unions GDP Gross Domestic Product ISF International Seed Federation ISTA International Seed Testing Association KAMIS Kyrgyz Agricultural Market Information Service KSAP Kyrgyz Swiss Agricultural Project LRF Land Reallocation Fund LPRI Livestock and Pasture Research Institute LSGB Local Self Government Body MAWRPI Ministry of Agriculture, Water Resources and Processing Industry MFO Microfinance Organization MOA Ministry of Agriculture MOF Ministry of Finance MOM Management Operation and Maintenance MTBF Medium Term Budget Framework MTBS Medium Term Development Strategy NACSF National Association of Community Seed Funds NBKR National Bank of the Kyrgyz Republic OIP On Farm Irrigation OECD Organization for Economic Cooperation and Development

PAR Portfolio at Risk PC Pasture Committee PD Pasture Department PUU Pasture User Union PUG Pasture User Group RAS Rural Advisory Service RSI Republican Seeds Inspectorate SCVT State Commission on Variety Testing SCWRLI State Committee for Water Resources and Land Improvement SDC Swiss Development Cooperation Office SVD State Veterinary Department SWA State Water Agency (proposed) UPOV Union for Protection of Plant Varieties VRI Veterinary Research Institute WUA Water User Association

Vice President : Philippe H. Le Houerou Country Director : Motoo Konishi

Sector Director : Peter Thomson Sector Manager : Dina Umali-Deininger

Task Leader : Peter Goodman

ACKNOWLEDGEMENTS

The Report was prepared by a team of Bank staff and consultants led by Peter Goodman (Senor Agriculture Specialist) and comprising Brett Coleman (Senior Financial Specialist), David Burton (Consultant- Irrigation), Garry Christensen (Consultant- Agricultural Sector), Jos Haynes (Consultant- Price Stabilization), Michael Turner (FAO Consultant- Seeds), Umit Ukaeva (Consultant- Agricultural Sector). The peer reviewers were Stephen Mink (Lead Economist, AFTSN), Marc Sadler (Senior Agriculture Economist, ARD) and David Sedik (Senior Agricultural Policy Officer, Regional Office for Europe and Central Asia, FAO). The Country Manager was Alexander Kremer and the Sector Manager was Dina Umali-Deininger.

The team is indebted to the government, donors, other agencies private businesses which provided valuable information and advice including the Ministry of Agriculture and its departments, the Ministry of Finance, the Agri-Food Corporation, the National Bank of Kyrgyzstan, GosRegister, the Delegation of the European Commission, the World Food Programme, the Kyrgyz Market Information Service (KAMIS) the Association of Agribusinessmen in Kyrgyzstan, the Rural Advisory Services, banks and microfinance organizations, farmers and agribusinesses.

Contents A. INTRODUCTION ...................................................................................................................................... 1B. STRATEGIC OBJECTIVES ........................................................................................................................ 2C. POLICY AND INVESTMENT OUTCOMES: SECTOR PERFORMANCE ....................................................... 2D. ASSESSMENT OF THE POLICY & PUBLIC INVESTMENT FRAMEWORK ................................................ 41. PUBLIC EXPENDITURE TRENDS .............................................................................................................. 42. FOOD SECURITY POLICY - EMERGENCIES, SHORT-TERM SHOCKS, & LONG-TERM FOOD INSECURITY. . 63. THE LAND MARKET ............................................................................................................................... 84. AGRICULTURAL FINANCE ...................................................................................................................... 95. IRRIGATION AND DRAINAGE ................................................................................................................ 106. MECHANISATION ................................................................................................................................. 127. SEEDS AND INPUT SUPPLY ................................................................................................................... 128. RURAL ADVISORY SERVICES AND RESEARCH .................................................................................... 139. PASTURE MANAGEMENT ..................................................................................................................... 1410. VETERINARY SERVICES ..................................................................................................................... 1511. AGROPROCESSING AND THE BUSINESS ENVIRONMENT ..................................................................... 16

E. CONCLUSIONS ...................................................................................................................................... 17

LIST OF FIGURES FIGURE 1 REAL ANNUAL GROWTH ................................................................................................................................. 2FIGURE 2 SELECTED CROP YIELD TRENDS ..................................................................................................................... 3FIGURE 3 TRADE TRENDS FOR AGRICULTURAL AND THE FOOD INDUSTRY PRODUCTS .................................................. 4FIGURE 4 COMPOSITION OF RECURRENT PUBLIC EXPENDITURE ON AGRICULTURE 2009 BY FUNCTIONAL CATEGORY . 5FIGURE 5 TRENDS IN FOOD INSECURITY ......................................................................................................................... 7

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I. INTRODUCTION

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Kyrgyzstan has been considered one of the most advanced countries in Central Asia in terms of agricultural reform. Following a period of decline after independence, the sector expanded rapidly between 1996 and 1999 and moderately up until 2005, in response to land privatization and a program of fundamental reforms, which provided improved access to credit, irrigation, advisory and other services. Growth since the 2005 crisis has been low and erratic. This along with concerns over how to respond to the 2008 food price crises, fuelled debate over an appropriate policy response and consequently after 2008, there was a shift in policy towards greater government involvement in markets.

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This Policy Note examines the policy and investment framework between 2003 and 2010, resulting sector performance and the priorities for future development. It draws attention to the need to refocus on completing the fundamental reforms and investments on which Kyrgyzstan’s early successes were built. These include further development of land market, building rural finance markets, further public investment and institutional development in the irrigation sector, encouraging greater private investment in the seeds sector and machinery services, public-private partnerships for advisory service provision, completion of ongoing reforms in pasture management, development of veterinary services and improving the business environment for private investment in agroprocessing.

The Policy Note discusses the government’s approach to achieving greater

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food security, which centres around food self-sufficiency and discusses why this is not the best route to raising low rural incomes - the root cause of food insecurity. The report discusses some of the policies conceived after the food price crisis, including intervention in output markets, and argues that these are likely to be unaffordable, ineffective and will divert limited resources away from more important reforms.

The Policy Note describes possible approaches to development of the sector, including minimal government intervention in markets, promoting responsibility for management of natural resources with communities, facilitating user contributions to infrastructure investments and the cost of services and provision of public services through private providers. These were the foundation of many of Kyrgyzstan’s earlier successes but also respond to the new imperatives brought about by the 2010 political crisis, including the renewed urgency for growth and stability in the agricultural sector to rebuild rural communities, fiscal discipline to address the budget deficit and improved governance to restore confidence in government.

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II. STRATEGIC OBJECTIVES

5. The government’s strategic objectives for the sector have lacked clarity and consistency over time but have broadly included four main themes: food provision; food market stability; competitiveness and trade; environmental preservation and food safety. The strategic statements after the 2007/08 food crisis, emphasize food self-sufficiency as an approach to food provision. This reveals a narrow interpretation of the nature of the food security threat in Kyrgyzstan, which is one of persistently low rural incomes, partly due to low agricultural productivity - rather than low availability of food

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III. POLICY AND INVESTMENT OUTCOMES: SECTOR PERFORMANCE

The strategic objectives could more usefully emphasize the need to: a) raise rural incomes; b) protect vulnerable consumers from price and supply shocks; c) increase agricultural profitability and reduce risk; d) protect consumers from public health risks; e) arrest environmental degradation and loss of biodiversity. Arguably, the first objective - raising rural incomes - should be part of a broader rural development strategy and the second - protecting vulnerable consumers - should be part of a food security strategy rather than an agricultural development strategy.

7. The policy and investment framework between 2003 and 2009 translated into only modest growth but may have prevented a decline in output given that the country has experienced in a series of climatic, economic and political shocks during this period, including the political revolution of 2005 , the global financial and economic crises, sporadic droughts in 2007 and 2008 and the ethnic conflict of 2010. Real GDP growth in the agricultural sector has been erratic and low averaging 2.27% per annum between 2003 and 2010. This contrasts with the wider economy, which grew at an average rate of 5.06% per annum during this period (Figure 1

Figure 1 Real Annual Growth

) which meant that agriculture’s contribution to GDP declined. Labor productivity declined sharply in 2005 but has recovered and grown, despite low agricultural growth, as labor migrated out of the sector.

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8. Although crop areas and livestock numbers have increased, productivity has remained low. Areas of grains, fodder crops (principally lucerne) and vegetables increased but yields were fairly static (for vegetables and potatoes) or declined (for grain crops) (Figure 2). Similarly, cattle and sheep numbers have increased but yields and other indicators of livestock productivity, such calving rate, have changed very little. There are multiple causes of low productivity and opportunities for growth - Although growing agricultural lending suggests rising investment in agriculture, this has primarily been directed towards the purchase of livestock. While there has been substantial public investment in irrigation and drainage, the majority of the system has still to be rehabilitated. A range of other factors, described in further detail in subsequent sections of the Policy Note, have constrained productivity, including low use of certified seed and fertilizers, limited investment in machinery, moderate use of advisory services, inadequate veterinary services, degradation of pastures, poor winter feeding, weak marketing infrastructure and institutions and a poor business environment for investment in agribusiness. There are major opportunities for sector growth by address these basic constraints.

Figure 2 Selected Crop Yield Trends

9. The sector has faced strong competition on the domestic market, particularly for

processed food products, but has managed to improve its position in some regional export markets. The net trade deficit in agricultural and food products increased consistently between 2003 and 2008 as agricultural imports, particularly processed food imports, grew to meet rising domestic demand (Figure 3). The main areas of export growth have been fruit and vegetable exports to Russia (although vegetable exports to Kazakhstan declined by a similar volume) and milk and dairy products to Kazakhstan. The main areas of import growth were in wheat and flour from Kazakhstan, fruit from China and dairy products from Russia. There are opportunities to further expand exports, including to the growing Russian, Kazakh markets, and to substitute the imports in fresh and processed foods, including those from China, by increasing productivity, raising the consistency of quality and improving food safety.

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Figure 3 Trade Trends for Agricultural and the Food Industry Products 1

10. Modest agricultural sector performance has not impeded the decline in rural poverty, which fell sharply during this period. As labor migrated out of agriculture after 2005, agricultural labor productivity and wages increased, along with non farm employment. Public transfers also increased. Consequently, rural poverty has declined significantly, despite low and erratic growth the agricultural sector. There were however strong regional differences. Although rural poverty declined from 57% to 37% between 2003 and 2008, rural poverty remained unchanged in many high altitude regions that are highly dependant on agriculture.

IV. ASSESSMENT OF THE POLICY & PUBLIC INVESTMENT FRAMEWORK

A. PUBLIC EXPENDITURE TRENDS

11. Overall, real spending on agriculture declined by about one fifth during this period, in line with the declining contribution of agriculture to GDP.

12. Recurrent spending: The composition of the recurrent budget remained fairly constant between 2003 and 2009, with irrigation and animal health accounting for the majority of spending (Figure 4). This is consistent with the importance of these subsectors in Kyrgyzstan. Although real recurrent expenditure increased slightly during this period, recurrent funding of the irrigation system and veterinary services was inadequate, underlining the importance of improving the efficiency of service delivery and increasing user contributions to the cost of these services, particularly given the recent surge in the budget deficit. Transfers, in terms of subsidized credit and inputs, were not an important feature of public spending, in line with governments’ predominantly free market approach up until 2008.

1 NSC include re-export trade in exports since 2008 giving an inconsistent trend. Re-export is not included in this figure.

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Figure 4 Composition of Recurrent Public Expenditure on Agriculture 2009 by Functional Category

13. Investment Spending: There was a noticeable shift in the composition of investment spending, following the food security law of 2008 towards greater government involvement in private markets. Specifically, this included the allocation of public funds to AFC to fund commercial activities and ad hoc market intervention activities. Given the dire need for investment in basic rural infrastructure and public services for the sector and the ineffectiveness of market intervention in addressing the root causes of long-term food insecurity, this represents poor prioritization of public spending. The Public Investment Program (PIP) for agriculture has fallen since 2005 in real terms and the projected decline in the PIP for agriculture after 2010 is a concern - in particular the projected decline in spending on irrigation and drainage rehabilitation.

14. The high budget deficit resulting from the recovery program in the South, further heightens the need for greater fiscal discipline, through better prioritization of spending focusing on fundamental public services and rural infrastructure, more efficient public services and increased user contributions to the cost of investments and service provision.

15. The following sections examine the food security concerns that triggered the shift in spending after 2008 and the priorities for reform and investment in land markets, credit markets and agricultural services.

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B. FOOD SECURITY POLICY - EMERGENCIES, SHORT-TERM PRICE SHOCKS AND LONG-TERM FOOD INSECURITY.

16. The World Food Summit Plan of Action states that “food security exists when all people, at all times, have physical and economic access to sufficient, safe and nutritious food to meet their dietary needs and food preferences for an active and healthy life”. Food security therefore involves ensuring availability of food at national and regional level, access to food (ability to purchase food), and proper utilization of food. In Kyrgyzstan, the food security debate has focused excessively on threats to food availability, specifically the threat of interruptions of supplies imported from Kazakhstan. Arguably, low household incomes and low capacity to purchase food is a much more greater threat to food security in Kyrgyzstan and should be the main focus of food security policy.

Definition of Food Security

17. Overall food insecurity remained high and relatively constant between 2006 and 2009. The World Food Program (WFP) assessed trends in food insecurity based on 2006-2009 Kyrgyz Integrated Household Survey data. The WFP methodology for estimating food insecurity categorizes households as either food secure, moderately food insecure or severely food insecure, based on consumption expenditure (a measure of poverty) and calorific food intake

Food Security Status

2. In 2009, approximately one-third of households were food insecure with 19-22% facing severe food insecurity and 12-15% facing moderate food insecurity. Rural households exhibited much higher levels of food insecurity than urban households but severe food insecurity in rural areas declined significantly from 27% in 2006 to around 23% in 20093

. There is no evidence that there was a significant increase in either severe or moderate food insecurity as a result of the 2008 food crisis - indeed between 2007 and 2009, overall food insecurity declined. There were large differences between the extent of food insecurity in the oblasts, which broadly fall into two groups: the most food insecure (Batken, Issyk-Kul and Naryn oblasts); and the least food insecure (Talas, Jalalabad, Osh, Chui Oblasts and Bishkek city).

2 Standard food consumption requirement is assumed to be 2100 kcal/person/day. The detailed methodology is shown in Text Box 2 of the main report. 3 Third quarter data each year

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Figure 5 Trends in Food Insecurity

Source: WFP Second Update on The Food Security and Nutrition Situation in The Kyrgyz Republic, April 2010

18. In response to the Food Crisis, the 2008 government adopted a more interventionist approach to agricultural policy. The 2008 Food Security Law embodied the 2008 government’s approach to addressing food insecurity - it provided a basis for: a) food security monitoring and information; b) food distribution measures - ensuring an adequate stock of food reserves under the State Material Reserve and distribution of food to vulnerable groups; c) price and trade intervention measures - including price ceilings on essential food items, limits on output traders’ profit margins, restrictions on fuel prices and regulation on food imports and exports; and d) establishment of the Food Security Council - an advisory body, the executive body of which is the Ministry of Agriculture. The Law also provided the foundation of establishment of AFC, which among other things, was given a remit to buy and sell in the market, in an attempt to influence domestic prices. In practice, the extent of market intervention has been small but the debate on an appropriate food security policy is ongoing.

Food Security Policy

19. Food security policy should encompass a broad set of measures to address: a) emergency threats to food imports ; b) protection of vulnerable groups from short-term price shocks; c) low incomes, which are the cause of long-term of food insecurity:

• Emergency Food Insecurity: It is prudent to maintain a sufficient food reserve to prepare for emergencies, even though the threat of a total cessation of all food supplies for a long period due to border closure is small in practice.

• Short Term Price Shocks: Short-term price shocks can be best dealt with by maximizing traders’ price responsiveness and by protecting vulnerable households through social safety-nets. Short-term price shocks temporarily increase the number of households that become food insecure. The level of price instability in Kyrgyzstan is not unusually high and is largely driven by

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international markets. Trade is an important means of reducing price instability so the aim here should be to maximize price responsiveness by increasing competition between traders, removing any remaining barriers to trade and diversifying sources of imports. Market-based risk management tools (specifically warehouse receipts in the case of Kyrgyzstan), could contribute to reduced instability. Caps on food prices or traders’ margins would reduce responsiveness and discourage trade. Price stabilization would not be possible without border tariffs and subsidies, which would undermine international trading relationships, create an enormous and unpredictable burden on the agricultural budget and is likely to be ineffective. Vulnerable groups can be protected by temporarily extending social safety nets during price shocks.

• Long-term Food Insecurity: Food security policy should focus on reducing long-term food insecurity. The fundamental cause of long-term food insecurity is low incomes not low availability of food at national level. A food self-sufficiency policy based on increasing the area of cereals does nothing to address this cause and would make some farmers, who would otherwise grow more profitable crops, worse off. Important means of reducing the long-term vulnerability of rural households to food insecurity include: a) improving these households’ access to the land reallocation fund and pastures; b) developing intensive agriculture to provide rural jobs; and c) generating non-farm employment to provide rural jobs and stimulate migration from the farming sector.

20. The remainder of the report examines long-term influences on agricultural productivity, including the land market, the rural finance market, irrigation and drainage, mechanization, seeds, advisory services and research, pasture management, veterinary services, agroprocessing, the business environment and international trade.

C. THE LAND MARKET

21. Land privatization is largely complete and many restrictions on the market have now been removed. There is an efficient land registry and an active land lease market. Early land market reforms resulted in a rapid decline in poverty and provided the foundation for other sector reforms. A free land market is an important foundation for the rural finance market and eases migration from the farm to the non farm sector. However, the restriction that “ownership of agriculture land shares may only be exchanged for other land plots and shares within the same aiyl okmotu”, reduces the potential number of buyers and land sales and limits the use of land as collateral.

22. The objectives of maintaining a Land Reallocation Fund (LRF) under public ownership were to provide land for expansion of settlements, to provide land for leasing at preferential rates to vulnerable groups and to provide a pool of land for allocation to those unable to claim their land share at the time of privatization. The extent to which LRF leasing by Local Self Government Bodies (LSGB) is transparent and meets its poverty targeting objectives deserves further examination - the

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preferential access of cooperatives to the LRF appears to contradict the poverty reduction objective. The rationale for maintaining the LRF under public ownership so long after privatization should also be reviewed.

D. AGRICULTURAL FINANCE

23. Kyrgyzstan has achieved a great deal in increasing the provision of credit to agriculture, from both Aiyl Bank and Microfinance Organizations (MFOs), albeit with a very high concentration of livestock in the portfolio. Lending is now slowly diversifying into crops and agribusiness.

24. Aiyl Bank’s portfolio grew substantially between 2003 and 2009. Although recognizing that Aiyl Bank has had access to low cost donor finance, its profitability and portfolio quality are nevertheless impressive for a Bank with such a high concentration of risk in agriculture. Aiyl Bank’s license has expanded to allow 30% of lending to be used for non-agricultural purposes and to allow limited deposit taking up to 25% of its capital. Further reducing the limits on deposit taking by Aiyl Bank would help to address its current liquidity problem and make it a more attractive proposition for investors. Privatization would also bring much needed capital and expertise in agricultural lending.

25. MFO’s grew rapidly between 2003 and 2009. Much of the growth has been in agriculture, which now represents 41% of their portfolio and in long-term lending (12-36 months) which now represents 47% of MFO portfolios. The high quality of MFO loan portfolios (average portfolio at risk of 1.33% for the five largest MFOs in 2009) demonstrates their ability to manage agricultural loans and their potential to further expand agricultural lending.

26. The growth of Aiyl Bank has been based on its ability to make lending decisions, largely free from government interference and the development of its skills in agricultural lending. The growth of the MFO sector has been based on a competitive market, free market interest rates and professionalization of the MFO sector through more stringent prudential and licensing requirements.

27. Kyrgyzstan should build on the principles of its successes in developing the rural finance sector to date, address the fundamental constraints in the market which lead to high interest rates and refrain from any future measures that artificially influence interest rates or lending decisions. A successful strategy for the future should focus on the following:

a. encouraging competition and new entrants by: i) providing equal access to all financial institutions to preferential funds; ii) refraining from imposing interest caps which would severely undermine the profitability of financial institutions and deter new entrants into the market; iii) reforming policies, such as capital adequacy requirements, which discriminate against MFOs; iv) and improving the transparency of bank licensing.

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b. improving financial institutions’ access to funds by: i) extending the deposit licence of Aiyl Bank and MFOs that meet the required criteria for deposit taking or support their transformation into Banks; ii) privatizing Aiyl Bank which will bring with it new capital and access to international financial markets.

c. reduce lending risks and lending costs by: i) addressing the fundamental causes of high production and marketing risks, such as unreliable irrigation, poor animal health and nutrition and the array of other production constraints discussed throughout this report, which increase lenders risks’ and interest rates; ii) improving lenders’ access to information by expanding the credit bureau network; iii) reforming articles in the law which limit the useful of land as collateral; iv) improving skills in agricultural lending; v) reducing requirements for registration of collateral for small loans; vi) developing post offices as rural payment agencies for financial institutions.

E. IRRIGATION AND DRAINAGE

28. The irrigation system serves about 1.04 million ha of land or 80% of the total cultivated area. The State Committee for water Resources and Land Improvement (SCWRLI) is responsible for management, operation and maintenance of the river system and most higher-order off-farm infrastructure. Water users manage the lower order on-farm systems through Water Users Associations (WUA), traditional communities or individually. WUA development started in 1997 and by 2010, 474 WUA were managing on-farm systems serving 72 percent of the total irrigated area.

Structure of the Irrigation System

29. The WUA Support Units under the SCWRLI have made considerable progress in the developing the institutional capacity of the WUA, with more than half of them having developed operation and maintenance plans and fully paid their irrigation service fees to SCWRLI and about a quarter of them having rehabilitation and recurrent financing plans in place.

WUA Development

30. The steady increase in water charges paid by water users to the WUA is a further indicator of the success of the WUA formation and support program. Over the period 2001-2010 payments increased from 2.74 tien/m3 to 6.65 tien/m3.

31. WUAs have started to cooperate and form Water Councils (40 now serving 250,000 ha) to represent WUA interests, WUA Federations (35 serving 200,000 ha) to take over management of their off-farm infrastructure from SCWRLI and a National Union of WUAs.

32. The government has yet to fully implement the water code which provides a foundation for separating the functions of water regulation and water delivery. Water

Implementing the water code

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resources management functions are not performed, or done so in a very fragmented way by a number of different agencies. Functions of water resources management should be placed under a new State Water Authority (SWA), which would fund its operations from issuing licenses to organizations abstracting water, primarily SCWRLI. SCWRLI would remain responsible for irrigation water delivery.

33. The river and main irrigation systems (termed off-farm systems), which deliver water to the on-farm systems, are mainly managed by the SCWRLI. These systems are increasingly being transferred to WUA and WUA Federations, which significantly reduces the burden on public spending. There are several scenarios for future management of off-farm systems under which 30% - 50% of the off-farm infrastructure would remain under SCWRLI control. This would significantly reduce the burden on the under-funded SCWRLI budget. The government will need to invest in training and technical support to ensure that the WUA Federations have the required skills in asset management to take on this role. This underlines the importance of providing sufficient funding for the WUA Support Units.

Rationalizing institutional arrangements for off-farm systems

34. It is critical that Parliament releases control over the setting of the level of the SCWRLI Irrigation Service Fee (ISF) to WUA, currently 3 tien/m3, so that SCWRLI can raise sufficient funds for operation and maintenance of the off-farm system. An estimate of a realistic figure to sustain the off-farm systems is some 3-4 time greater at 15 tien/m3. Farm budgets show that this is affordable to farmers.

Rationalizing SCWRLI finances

35. The economic and social rationale for subsidizing pumped irrigation schemes deserves further analysis. Irrigation and drainage expenditure, represents 50%-60% of total public expenditure on agriculture. About one-third of this expenditure is for electricity for pumping stations and canal and pumping station maintenance serving only some 55,000 ha.

36. Approximately 56 percent of the off-farm systems and 75 percent of the independent/on-farm systems remains to be rehabilitated, which would cost in the region of US$ 348 million. Rehabilitation projects financed by the Word Bank, Asian Development Bank and government have gone some way towards alleviating the situation but investment over many more years will be required to complete this work.

Rehabilitation

37. At present there is no overall strategy and plan for rehabilitation of these systems - it is somewhat ad hoc as funds become available. There is a need for a thorough review of which systems need to be retained by government, which should be handed over to water users, WUAs and Federations of WUAs, and which need to be abandoned. This

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should be followed by preparation of a strategy and action plan for sustaining the systems over time.

F. MECHANISATION

38. The current state of machinery in Kyrgyzstan is a legacy of low investment since the time of privatization. Machinery imports have been low except for sporadic injections funded by the Japanese and Chinese governments. Kyrgyzstan now has the lowest level of mechanization in ECA. Low investment is the result of farmers adjusting to a) poor access to finance; b) changes on the relative price of machinery and agricultural labor; and c) an increase in high value labor intensive crop since independence.

39. Previous governments’ have attempted to address low levels of mechanization by directly supplying machinery. While these schemes provided a short-term boost to the availability of machinery, they have done little to help promote the development of viable machinery import distribution, repair and spare part businesses. Such programs create disincentives to the establishment of dealerships because they reduce demand for machinery supplied by dealers and create uncertainty about the level of supply in any year.

G. SEEDS AND INPUT SUPPLY

40. Kyrgyzstan led the way in adopting legislation that complies with international standards; it is ISTA accredited (for seed certification and testing) and has been admitted as a member of various OECD Seed Schemes since 2005 (a requirement for export to many countries). Kyrgyzstan also has a Plant Variety Protection Law in place, which is also entirely compliant with international standards. However, legislative progress has not translated into the development of a functional commercial seeds supply chain, either in terms of breeding, multiplication, domestic use of certified seed or export.

41. There are insufficient resources and skills for domestic breeding and no incentives for international breeders to invest in Kyrgyzstan. This is because the royalty system is not functional, there are insufficient local skills in variety maintenance and few well established local breeders to act as local partners for foreign investors.

42. The State Commission for Variety Testing lacks resources to conduct proper field testing for seed testing and certification, although it is well equipped and skilled.

43. There is need to encourage new entrants into seed multiplication, a market characterized by often poorly managed and unstable cooperatives. These are encouraged to remain in seeds production because of the preferential tax treatment offered to seeds farms. However, the lack of transparency in acquiring a license, preferential tax treatment of existing seed farms, illegal imports of seed, as well as

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MOA procurement and distribution of seed, are all disincentives for new entrants and reduce incentives for seed farms to aggressively market their seed to farmers.

44. Community Seed Funds are addressing demand side weaknesses by increasing farmers’ knowledge of the potential benefits of using certified seed and creating reliable clients for seeds farms.

H. RURAL ADVISORY SERVICES AND RESEARCH

45. The Rural Advisory Service (RAS) and its predecessor organizations were established and mainly funded by donors between 1998 and 2008. The 2006 SDC/ IFAD joint review of the rural advisory service, a membership organization, revealed that membership of RAS offered few benefits, the Oblast and Raion councils which governed RAS, did not play a useful role and that clients (farmers) had insufficient involvement in determining the services provided.

46. Consequently, a transition strategy was put in place to reduce dependence on donor funding and make the system more client driven. This involved the reorganization of the RAS into an independent non-membership service provider and exposure of RAS to competition. It also involved a transition from donor procurement to community-based procurement of advisory services by Farmer Koshuuns (FK), membership organizations established in each AO to procure advisory services for farmers. In parallel, the MOA capacity to procure public advisory services was to be developed.

47. It is too early to assess the willingness of FKs to pay for services. Evidence from the SDC funded Land to Market Development Project demonstrates a high farmer and agribusiness willingness to pay for advisory services, when provided as part of a wider supply chain support program. About 30-40% of the FK are now stable and show positive signs of increasing their contributions to the costs of services. More service providers are now involved in service provision and RAS is trying to diversify its sources of income, given its increasing independence from donor programs. There has been little progress in securing government funding and developing a mandate for public services, which will be important given that the less wealthy farmers may not be willing to pay for services.

48. There is clearly a need for an agricultural research review to help develop long-term costed research programs and capacity building programs for these organizations or consider how they could be reorganized. There are four key research institutes the Crop Research Institute (CRI), the Livestock and Pasture Research Institute (LPRI), the Kyrgyz Irrigation Research Institute (KIRI) and the Veterinary Research Institute (VRI). Total spending in agricultural research in 2009 was 6.7 million som or 0.02% of agricultural GDP.

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I. PASTURE MANAGEMENT

49. In the past, the responsibility for pastures was fragmented between Oblast Administrations responsible for summer pastures, and the Raion Administrations responsible for spring/ autumn pastures and Local Self-Government Bodies (LSGB) in each Aiyl Okmotu responsible for winter pastures. This led to disruption of seasonal grazing routes, a lack of transparency in pasture allocation, inequitable access to pastures and insufficient investment in infrastructure to maintain access to pastures. The Pasture Law provided the legal basis for transfer of authority for pastures to LSGBs and delegation of authority for management from LSGB to community based Pasture User Unions in each Aiyl Okmotu , each represented by their executive body - the Pasture Committee (PC).

50. The Pasture Law reconnects management of all summer, spring/ autumn and winter pastures, provides more equitable and transparent allocation of pasture rights. It is expected to considerably increase pasture use fee revenues and tax revenues. Allocation of user rights in the form of a headage-based pasture tickets and development of PC skills in pasture assessment will allow stocking rates to be better aligned with pasture carry capacity.

51. The immediate priorities are to: a) implement pasture boundary demarcation, ensuring that all disputes are dealt with thoroughly through the established dispute resolution procedures; b) monitor and continue to build PC governance to ensure that they represent the interests of all its members; c) provide the PC with the skills they need in pasture assessment and improvement to manage the pastures professionally; d) establish skills in the pasture department, the LPRI and the rural advisory services to support the technical aspects of pasture management; e) establish contractual arrangements between private vets and PCs to implement vaccination and other disease control measures; e) finalize the arrangements for taxation of PCs to ensure an affordable and fair contribution of pasture users to government revenues; f) establish the legal and institutional framework for secondary user rights; g) reform the legal framework for inter-governmental agreement on pastures and ensure proper consultation with PCs; h) complete alignment of other laws with the pasture law.

52. A challenge for the future will be to extend these management arrangements to the leskhoz pastures and establish arrangements for secondary use rights. There are several options for applying the principles of the pasture law to the leskhoz pasture. An attractive option would be for the leskhoz to lease their entire pasture to the PC on a multi-year lease and the PC would management these pastures along with their main pastures – this is probably the most feasible option and would have the advantage of managing the entire pasture area as a single system.

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J. VETERINARY SERVICES

53. Given the dominant role of livestock in the agricultural sector, a dysfunctional state veterinary service is one of the most important remaining constraints to improved agricultural productivity, access to regional and international export markets. Zoonotic diseases including brucellosis, echinococcosis, rabies and anthrax, are serious threats to human health and Kyrgyzstan has some of the highest rates of these diseases in the world.

54. Strategy for Development of Veterinary Services: The 2007 OIE Performance of Veterinary Service (PVS) evaluation judged that the veterinary services in Kyrgyzstan had the lowest levels of conformity to OIE standards for most critical competences such as infrastructure, staffing, education, epidemiological surveillance and diagnosis, and disease control and eradication. The 2008 Strategy for Development of Veterinary Services, developed with the assistance of the OIE and the EU, aims to: a) develop private veterinary services and contract them for public services; b) license vets through a veterinary chamber; c) develop national animal disease control strategies; d) build epidemiologically sound disease surveillance capacity; e) develop a National Animal Disease Information System (Kyrgyzvet); f) build laboratory capacity; g) develop rapid response capacity; h) raise public awareness of zoonotic and transboundary diseases; i) establish proper border sanitary control measures; j) control vaccine and veterinary drug quality; and k) control animal movement and improve inspection at markets.

55. Vet Law: The Vet Law is being amended to enable implementation of the strategy but the current draft is lacking in several respects, specifically: a) the law does not clearly distinguish between state and private veterinarians; b) the role of the Veterinary Chamber is not outlined; and c) no distinction is made between veterinarians and veterinary para-professionals.

56. Veterinary Chamber: A veterinary chamber has recently been established but the Law on licensing will need to be amended before it can license vets. Until such time as the Law on licensing is revised, the Veterinary Chamber will provide recommendations on the licensing of veterinarians to SVD, which is currently responsible for licensing.

57. Vaccine importation: SVD has been the focus of government’s concerns regarding potential corruption in the public sector. The transfer of responsibility for procurement of vaccines to a small number of regulated and licensed wholesalers would help to remove this burden from SVD.

58. Private vet contracts with PCs: Establishing contracts for vaccination between private vets and pasture committees will help to establish private vets, ease management of vaccination programs and reduce potential accusations of SVD corruption related to these contracts.

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59. Laboratory Capacity: Insufficient or inconsistent recurrent budgets and staffing of laboratories means that further investment in laboratories would not be viable until this problem is addressed. This issue has undermined the usefulness of substantial previous investments in equipment and training for public laboratories. There is a need to consolidate and rationalize the national network of laboratories for improved efficiency and sustainability.

60. Compensation Fund: The government plans to establish an Animal Disease Control and Compensation Fund (ADCCF) which will allow test and slaughter programs to be implemented much more successfully. The Fund would compensate farmers for the loss of income resulting from the compulsory slaughter of animals, encourage reporting of infected animals and provide revenue to fund animal disease control. International experience indicates that such a Fund should be autonomous from government, supervised by a joint public private sector board and be replenished through compulsory farmer fees and government contributions.

61. Animal Insurance: The development of compulsory animal insurance is not currently feasible in Kyrgyzstan, particularly one which insures against a wide range of causes of death. A draft law on animal insurance is under consideration but international experience suggests that it would not be feasible to implement such a scheme while the disease risk in Kyrgyzstan is so high or prior to establishment of an operational compensation fund. The very high level of risk of animal disease in the absence of proper disease control programs and proper feeding in Kyrgyzstan, means that premiums would be extremely high and unaffordable to farmers. The draft law is vague in terms of the causes of death which it would cover, lacks sufficient actuarial analysis and is not based on an estimate of the potential risks and farmer premiums or public funding, which would be required to cover those risks.

K. AGROPROCESSING AND THE BUSINESS ENVIRONMENT

62. Kyrgyzstan has not been able to fully exploit the growing domestic demand for processed foods as incomes have risen and to compete with imports, particularly from Russia and Kazakhstan. Growth in agro-processing has been constrained by many of the same factors which constrain investment in the economy as a whole; these include political instability, a weak business environment, inadequate transport and energy infrastructure, informal constraints to cross-border trade, and a lack of knowledge, skills and investment in new technology. Erratic supply from farmers both in terms of quantity and quality further inhibits the development of processing.

63. The fruit and vegetable agro processing sector, which is dominated by a large number of small and medium processors has not shown signs of growth and consolidation. Small enterprises are often unable to supply clients with the flexibility that a larger processors can or to provide the minimum quantities required by buyers, making it difficult for them to secure more contracts in Russia.

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64. Dairy processing, particularly in Northern Kyrgyzstan has expanded to take advantage of Kyrgyzstan’s vast pasture resources and proximity to the expanding Kazakh market but there is potential for much further expansion. Processors face three key difficulties in securing sufficient and consistent quality milk supplies: a) the imbalance between summer and winter supplies; b) difficulties in arranging communal collection points with adequate cooling and simple testing facilities and; c) low inconsistent quality and lack of certification that cows are free of brucellosis.

65. Kyrgyzstan is expected to join Russia, Kazakhstan and Belarus in the customs union in 2011. The extent to which Kyrgyzstan’s agricultural sector benefits from the customs unions will depend on: a) its ability to respond to the requirements of the evolving Russian and Kazakh markets in terms of quality and sanitary standards; and b) its ability to respond to higher prices resulting from higher import duties on fruit, vegetable and meat imports from China. If it is not able to respond, consumers will be hurt by higher prices of foods imported from non customs union members without any benefits to producers.

V. CONCLUSIONS

66. This Policy Note describes priorities for policy and public investment reforms needed to help Kyrgyzstan increase agricultural productivity, exploit potential opportunities on both domestic and export markets and contribute to improved rural incomes and food security. In summary, food security, policy should refocus on raising the incomes of the most food insecure households, rather than focusing on food self-sufficiency as means of addressing long-term food insecurity. Market intervention is likely to be ineffective and expensive as a means of addressing short-term price shocks. There is a need to prepare for emergency threats to food insecurity through national reserves. Removing remaining restriction on the land market will help structural transformation by allowing farmers to enter and exit the sector more easily and will increase the usefulness of land as a source of collateral. Improved administration of the land reallocation fund will make access to land more equitable. Encouraging further competition in the banking and MFO sectors and reducing lenders risks will help stimulate private investment. Completing institutional reform in the irrigation sector and further investments in rehabilitation is a long-term program which will be critical in a country where agriculture is driven by irrigation. Providing incentives for private investment in machinery might be more effective than direct distribution of machinery by government. The legal framework for the seeds market has been established but commercialization will require development of skilled local partners for breeding, selection and maintenance, a functional royalty system and the cessation of government distribution of seed. The rural advisory services are now operating independently but some public funding will be required for the foreseeable future. The ongoing establishment of professional private veterinary services to implement improved animal disease control strategies under

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public contracts is an urgent priority, to protect public health and secure access to regional markets for dairy and meat products. The pasture reforms have the potential to significantly raise productivity and provide more equitable access to one of Kyrgyzstan most important resources. Until many of these basic production constraints are addressed, it will be difficult for the agroprocessing sector to grow. Raising food safety standards, easing the environment for doing business and improving rural infrastructure will also be important foundations for private investment in agroprocessing.

67. The proposed approaches to implementing these reforms are summarized in Table A. These proposed approaches contribute to four important pillars for development – growth, stability, fiscal discipline and improved governance. These pillars are particularly relevant in the aftermath of the 2010 crisis in the South. The proposed approaches to development contribute to:

• Growth by: i) investing in public services and infrastructure which increase agricultural productivity; ii) promoting investment and competition in the provision of private agricultural services and trade (such as seeds and machinery provision) ; iii) improving private sector access to finance; iv) promoting foreign investment; v) creating an improved, lower risk, environment for private business to operate in.

• Stability by: i) preparing for emergency threats to food supply; ii) reducing short-term supply shocks by maximizing traders’ responsiveness to prices and providing social safety-nets to reduce the vulnerability of the most affected households to short-term supply shocks; iii) reducing farmers’ long-term vulnerability to climatic and disease related shocks by investing in public services and infrastructure which reduce production variability; iv) reducing the most vulnerable households’ exposure to international price shocks by providing social safety-nets and improving their access to agricultural assets which help them cope with such shocks.

• Fiscal Discipline by: i) identifying savings from more efficient public service provision; ii) increasing tax revenues from agriculture; iii) increasing user contributions to services; iv) transferring some infrastructure and subsequent responsibility for maintenance from the public sector to the private sector; v) ceasing government involvement in private markets; vi) ensuring competitive and transparent procurement of public services from private service providers where possible to improve efficiency of services.

• Improved Governance and Conflict Resolution by: i) reducing government provision of in-kind credit or private goods under preferential programs, which created opportunities for corruption; ii) transferring responsibility for public procurement to licensed private sector operators (e.g. vaccines); iii) transferring responsibility for management of natural resources, the allocation of which by state organizations, created opportunities for corruption, to community-based

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organizations; iv) encouraging the involvement of community based organizations in resolution of disputes related to natural resource allocation; and v) reducing vulnerability to supply and price shocks which exacerbate social tensions. These proposed approaches are not new to Kyrgyzstan, indeed the success of its reform program between 1995 and 2005 was built on a number of fundamental principles which mirror the proposed approaches, including:

• private sector led growth, with minimal government interference in private markets;

• a free trade regime to exploit Kyrgyzstan’s comparative advantages; • placing responsibility for management of natural resources with communities; • promoting transparent and inclusive governance at the community level; • improving fiscal sustainability by increasing user contributions to services; • improved the efficiency of public services through private sector contracts.

68. In summary, Kyrgyzstan would benefit by refocus on completing the long-term program of fundamental reforms on which some of Kyrgyzstan’s past successes have been based and steer away from some of the more interventionist approaches which emerged after the 2008 food price crisis which are likely to be ineffective and unaffordable.

69. Detailed recommendations from this Policy note are summarized in the main report.

70. This policy note is intended to inform the discussion on agricultural strategy and policy reform but is not a strategic plan. The government is currently preparing its medium term development strategy for the sector. Such a strategic plan should ideally include the following:

Strategic Planning

• Domestic and international contextual issues. • Set of quantifiable objectives. • Constraints that affect the achievement of the objectives. • A statement of the role of government and the private sector. • Identification and justification of government programs. • A framework for prioritizing programs. • The results of the prioritization exercise of programs. • Key performance indicators

71. The Strategic Plan should be supported by an Action Plan and Investment Plan. These

would help the government to operationalize its approach to addressing many of the challenges discussed in this Policy Note.

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Table A. Summary of Proposed Approach to Agricultural Sector Development

Approach (See Table 24 in the main policy note for detailed recommendations) 1. Public Expenditure 1.1 Improve public expenditure planning, monitoring and evaluation. 1.2 Create savings by ceasing public intervention in private markets. 1.3 Create savings through more efficient recurrent spending and better governance (reduced corruption). 1.4 Increase public revenues from agriculture. 1.5 Increase User Contributions to Services. 2. Food Security Policy 2.1 Design Emergency Measures focusing on: i) ensuring adequate national food reserves. 2.2 Design Short-Term Price Shocks Policies focusing on: i) increasing trader price responsiveness; ii) not pursuing market intervention; iii) market based risk management instruments; iv) flexible social safety nets for vulnerable HH. 2.3 Design Long Term Food Insecurity Policy focusing on: i) identification and monitoring of food insecure households; ii) increasing farm incomes and reducing risks; iii) improving vulnerable HH access to land; iii) increasing non-farm incomes; iv) refraining from food self –sufficiency targets; v) providing social safety nets. 3. Land Market 3.1 Remove remaining restrictions on the land market. 3.2 Review management of the Land Reallocation Fund. 4. Rural Finance 4.1 Encourage competition and new entrants into the rural finance market and refrain from government intervention in the credit market. 4.2 Improve financial institutions access to funds . 4.3 Reduce lending risks and lending costs. 5. Irrigation and Drainage 5.1 Invest in WUA Development. 5.2 Implement the Water Code . 5.3 Complete the transfer of some off-farm systems to WUA and WUA Federations. 5.4 Rationalize SCWRLI financing. 5.5 Prepare an irrigation rehabilitation plan.

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6. Mechanization 6.1 Provide incentives to machinery dealers and producers. 6.2 Improve access to finance and insurance for machinery. 6.3 Ensure the provision of maintenance services by dealerships. 6.4 Provide information to farmers on machinery.

7. Seeds 7.1 Invest in publicly funded breeding and selection or provide incentives to private breeders. 7.2 Improve incentives for international breeders to invest in Kyrgyzstan. 7.3 Increase funding for SCVT testing and certification. 7.4 Encourage new entrants and competition in seed multiplication and seeds distribution. 7.5 Improve access to regionally and internationally available varieties. 7.6 Increase demand for high quality seed. 8. Advisory Services and Research 8.1 Continue to implement the strategy for development of a financially sustainable, competitive and client driven advisory services. 8.2 Invest in improving skills in agricultural extension. 8.3 Prepare arrangements for public funding of advisory services. 8.4 Prepare costed research programs. 9. Pasture Management 9.1 Complete pasture boundary demarcation 9.2 Build technical capacity for pasture management 9.3 Establish legal framework and capacity in PC for determination and distribution of pasture use fees, animal health fee and pasture taxes. 9.4 Establish legal framework for punitive measures against non compliant PCs 9.5 Establish transparent arrangements for international leasing of pastures 9.6 Establish arrangements for national pasture management 9.7 Establish arrangements for redistribution of unwanted pastures 9.8 Improve management of leskhoz pastures

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10. Veterinary Services 10.1 Reform the veterinary law to support the provision of public and private services through licensed private vets. 10.2 Reform the law on licensing to allow licensing of private vets. 10. 3 Establish an animal compensation fund. 10. 4 Endorse and implement national animal disease control strategies, including animal disease information system (Kyrgyzvet). 10. 5 Increase farmers’ contributions to animal disease control programs. 10. 6 Transfer responsibility for vaccine importation to licensed importers. 10.7 Cease plans for compulsory animal insurance. 10. 8 Ensure adequate recurrent funding and staffing of veterinary laboratories.