Uzbekistan Towards 2030: Transition to the Resource-efficient Growth Model DRAFT

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1 This Policy Brief is prepared by the Center for Economic Research within the joint initiative of the United Nations Development Programme in Uzbekistan and the World Bank on developing Strategy of structural reforms in Uzbekistan for the period of 2030 Vision Uzbekistan Uzbekistan Towards 2030: Transition to the Resource-efficient Growth Model Center for Economic Research Shota Rustaveli Str., Tupik 1/5 Tashkent , Uzbekistan Tel: , /57/58/59; Fax: The publication reflects opinions and views of the working group, which may not coincide with the official point of view of the Center for Economic Research or UNDP. Tashkent 2015 UNDP Country Office in Uzbekistan 41/3 Mirabad street, Tashkent , Uzbekistan Tel: , ; Fax:

2 Contribution of natural capital to generation of economic growth is much higher in Uzbekistan compared to the upper middle income countries By 2030 Uzbekistan needs to join the group of upper-middle income countries, maintain annual growth rates at 8% and implement structural transformation of the economy by increasing the share of manufacturing industry from 9% to 22%, and the share of services from 45% to 55%. At the same time, the population is estimated to reach 37 million by Faster industrialization, population and income growth will significantly increase the need of the economy for resources and at the same time will augment negative manmade impact on the landscape, generating threats for biodiversity conservation. The key challenge in implementation of the long-term strategy is linked to the resource scarcity and risks of natural resource depletion needed for current and future generations. Will the existing model of resource use enable to achieve strategy objectives? According to the findings of the international assessment of the natural wealth of Uzbekistan, today the indicator of adjusted net savings, which takes into account depletion of resources and environmental degradation, has a negative value, while the net and gross saving values are positive. This means that the country is experiencing net loss of its stock of natural resources. This is closely linked to the prohibitively high resource intensive current model of economic growth, where the ratio of return on natural capital to the return of intangible capital in Uzbekistan is 0.56, compared to in the upper-middle income countries. This corresponds to over 6.5 times difference. Figure 1. Adjusted Net Savings in Uzbekistan have negative value the country will experience net loss of its reserves (% of GNP, 2010) 2

3 Table 1. Ratio of the Return on Natural Capital to the Return of Intangible Capital in Uzbekistan is 6.5 times as high as in the Upper-middle Income Countries (impact of 1% growth of assets on economic growth). Uzbekistan Upper-middle Income Economies Human capital Intangible capital Production capital Natural capital Expected economic growth 4-6% 8-10% If the current resourceintensive model of development is retained, the deficit of energy resources will account for 65.4% by 2030 Today, natural capital plays a much greater role in generating the economic growth compared to intangible capital. During the first years of transition the period characterised by low and moderate rates of economic growth - and in the context of inefficient development institutions, this growth model enabled the country to generate resources in order to boost the development of backbone industries and agriculture in a relatively short period. As transformation processes accelerate, reliance on the current model of economic growth will lead to a much greater rate of resource depletion. Failure to revisit the current model of the natural resource use will result in the loss of more than half of country s natural resource base by Firstly, if resource efficient strategies are not implemented the deficit of energy resources could grow sharply by 2030, thus limiting the opportunities to achieve long-term development goals. Demand for energy will continue to grow by 6.88% annually between due to the following reasons: Higher incomes will impact the structure of energy use by the population: greater use of air conditioners, computers, washing machines. In addition, increasing rates of urbanization in rural areas will spur greater energy use in the agrarian sector of the economy; Greater emphasis on processing local raw materials and commodities, primarily natural gas, cotton, silk, leather, fruits and vegetables, will increase energy consumption in the manufacturing sector; Adherence with the social rights will require measures to address the current hidden deficit (5.82% in 2013) by eliminating current under-consumption of energy. Secondly, given projected growth of population and the changing age structure (with increasing number of adult population), as well as higher incomes that has implications on volumes and demand for foodstuffs, there is high probability of deficit for certain goods. For example, with the current model of land and water resource management, the deficit of grain will be at 21.2%, meat at 48%, milk at 41%, sugar at 30%, and fruits at 23.6% respectively. 3

4 Figure 2. Under the current model of land and water resource management, the food deficit will grow, the quality of soil will deteriorate, and stocks of water will decline. Growth of food deficit will be caused by the limited land and water resources, as well as the projected climate change, which will increase the irrigation norms by 5-10% by 2030, leading to greater shortages of water for irrigation. Projected resource deficit indicates that production capacity by itself can not enable to achieve macroeconomic, social and transformational objectives towards The transition to the resource-efficient development model is essential. With the current model of land and water management, the deficit of grain will be at 21.2%, meat at 48%, fruit at 23.6% in 2030 Transition to the Resource-efficient Model in the Energy sector: Focus on the Fast-track There are two viable options of transition to the resource-efficient model: Option 1 phased: increase in extraction of energy resources by 1% before 2020, and by 2% after 2020, while reducing energy intensity down to 40% by In this case almost half of the deficit will be covered by expansion the production of energy resources and by increase in energy efficiency. 1% of the deficit can be covered by renewables and other unconventional sources of energy (0.6% by solar energy, 0.4% by biogas and other unconventional sources). Implementation of these strategies will provide opportunity to ensure economic growth at 5% per annum. In order to maintain 8% growth, this deficit needs to be covered by imports of energy resources (oil, electricity), which may turn the country into the net importer of energy resources. 4

5 Option 2 fast-track: growth in extraction of energy resources by 1-2% until 2020 and by 2-3% after 2020, combined with reduction of energy intensity by 2.3-fold until This option implies maximum use of the capacity both for producing energy resources and enhancing energy efficiency, thereby generating 5.5% surplus. Despite the surplus, renewables and unconventional sources of energy need to be developed (0.6% by solar energy, 0.4% by biogas, shale oil and other unconventional sources of energy) in order to diversify the structure of energy balance and generate multiplier effects for development of technologies, as well as generate demand in the adjacent sectors. According to this model, imports of liquid hydrocarbons will amount to 2% by Implementation of these strategies envisages: To ensure rapid economic growth and implement structural reforms towards 2030 without aggravating the resource scarcities and ecological risks, the resource efficient pattern of development needs to be introduced 1. Enhancing energy efficiency of the economy While in the phased model the timeline for implementation of energy efficiency measures may be extended for entire period until 2030, in the fasttrack model, it is necessary that the following key activities are completed in the first five years: 1. Complete phaseout of incandescent bulbs, replacement of outdated heating boilers in all sectors of the economy, including the households; replacement of all pumps into energy-efficient ones across-the-board, and launch of programs for energy-efficient buildings (refurbishment of existing buildings and construction of new ones). 2. Improve transparency systems to track financial and physical flows in the fuel and energy companies (ERP systems, electronic trading, transparency, IFRS reporting). 3. Change in the entire system of fee collection from the users of energy resources: introduction of online system of monitoring and billing for household users (implementation of modern technologies for smart metering of electricity). Improvements are also necessary in payment systems for agricultural producers (while ensuring that this does not negativley impact agricultural producers). 4. Introduction of modern technologies to monitor losses of hydrocarbon resources during transportation along long-distance and distribution networks (SCADA), and completion of the new power distribution networks and transformers by 2020; The charts below shows envisaged investments and returns on aforementioned measures: 5

6 Figure 3. Investments and Returns on Energy Efficiency Measures Energy conservation curves indicate the cost of energy generation in USD per kwh (bars, units of measurement on the left axis) and energy use after introduction of new technologies (curve and the data on the right axis indicate the fuel and energy costs as a percentage of current use of energy)) for each of proposed areas of energy efficiency or introduction of renewable energy sources. Presenting this combination of data in one chart enables to prioritize actions depending on the cost of energy generation and returns expected from energy efficiency. Prioritizing activities based on the curves helps to split the implementation of these measures by phases. 2. Solar energy should become the key driver for development of the energy sector by It s share in the national energy balance should increase at least to 6% with the following rationale in mind: 1) The country has significant solar energy potential. According to the expert assessments, potential of renewable sources of energy in Uzbekistan is about 51 billion t.o.e., technical potential is million t.o.e., which is 3.1 times as high as the current annual production of primary energy resources. 2) Development of solar energy may have multiplier effects on the economy and may significantly encourage demand in the satellite sectors, generate demand for labor, and thus, trigger acceleration of transformation processes. Estimates show that the total direct and indirect benefits (Level 1 multiplier effects generating demand in other sectors) will add up to USD 3.5 billion in 16 years, whereas the Level 2 multiplier effects (effects generated by higher consumption in the solar energy and related sectors) will add up to USD 0.87 billion, while the effects of natural gas savings will be USD 2.9 billion. In total, annual net benefits will total USD million. 6

7 3. Institutitional changes will play a key role in identifying comprehensive and coordinated solutions to implement aforementioned objectives. a) Once the monitoring systems of production, transportation and consumption are in place, emphasis should be placed on creation of corporations, which, while remaining in state ownership, will be co-managed by national and foreign managers with broad spectrum of responsibilities and oversight to ensure effective asset management. It is expected that such regulatory mechanisms will facilitate optimal business solutions and enhance the effectiveness of the sector in general. In addition, in order to enhance the operational effectiveness of the sector, it will be important to introduce reforms that would separate business functions from regulatory functions. This would free energy companies from a number of redundant functions and responsibilities and strengthen the decision making power of the boards of directors. Hence, it is proposed to set up one regulatory body the Ministry of Energy - and leave companies to explicitly focus on business operations. Maximum use of energy efficiency capacity will reduce energy consumption by 2.3 times and ensure the proficit of 5.5% in the energy balance by 2030 b) Following the universal introduction of monitoring and fee payment systems and a successful split between business and regulatory functions in the sector, attention can be placed on attracting private financing through implementation of independent energy projects (IEPs), which can be regulated based on agreements. The government can start implementing a number of IEPs to assess the market and project norms for broader engagement of private capital in future. For example, international competitive biddings for concessional agreements based on the principles construction management - transfer or construction ownership - management can raise private investments without having to introduce radical changes in the form of asset privatization. Gradual privatization of the system for energy distribution to end users can start post 2020, including, more gradually, privatization of transmission lines. In the presence of appropriate institutions this can facilitate greater efficiency of companies and, at the same time, enable them to generate investments for the sector. c) There is a need to introduce adequate incentives to ensure the use of efficient energy and a widescale use of renewable sources by gradualy increasing tariffs. Currently, in order to maintain competitiveness of companies in a number of sectors and to enable companies to fulfil social tasks, Uzbekistan is continuing the policy of low tariffs for natural gas in the domestic market. Inter alia, the price of natural gas for domestic users is nearly 1/4th of the export price. It appears expedient to gradually reduce the difference between prices for domestic consumers and export prices by raising domestic tariffs. At the same time, transformation costs need to be minimized: mechanisms to ensure affordability of energy for low-income groups (preferential tariffs) must be designed. 7

8 Resource efficiency in Land and Water Sectors: Focus on Intensification of Agriculture The following are suggested measures to introduce improvements in agricultural infrastructure and to transition to intensive methods of land and water use: Transformation of cropping pattern based on the country s comparative advantage will generate extra benefit of 4.8 bln. USD 1. Land Improvement Measures A) Altering cropping patterns and production structure of food crops with the focus on the products where Uzbekistan has a comparative advantage. Abolishing cultivation of cotton and grain on low-yield lands will enable to significantly enhance average crop yields, harvest and exports, margins for farmers, and radically improve the system of mutual settlements in the economy. Hence, if the cultivation of grains is reduced by 42,000 hectares on rainfed lands and instead this land is used for cultivating fruits, the average yield of fruits could be increased from 10 to 20 tons per hectare during Similarly, if cultivation of cotton on low-yield lands is reduced by 60,000 hectares in favor of vegetable crops, the average yield would increase from 30 to 48 tons per hectare, while implementing intensive methods of horticulture. Total gain for the economy can amount to USD 4.8 billion. Given the prospects of job creation related to processing of agricultural food crops, additional 133,600 jobs will be created. Table 2. Focus on Comparative Advantages will Produce Total Gain of USD 4.8 billion Vegetable VS Cotton Fruits VS Wheat Changes in the acreage of farmlands, thousand hectares Change in the yields, tons per hectare Changes in output, thousand tons Changes in production costs, billion soums Changes in export earnings (import costs), USD million Additional investments, USD million Change in employment Total Gain, USD million Creation of new jobs, in thousands b) Agronomic and Agrotechnical Measures and Introduction of Modern Agrotechnologies Technical measures include land rehabilitation and amelioration. The land area in need of rehabilitation is 1,550,000 hectares, whereas 782,000 hectares are in need of soil amelioration. Agronomical and cultural activites (building up organic matter in the soil, balanced plant nutrition, silvicultural reclamation) are required on all irrigated lands. 8

9 Introduction of the soil laser-levelling system can increase efficiency of production by 15-22% In order to increase yields in plant production and productivity in livestock farming, it is essential to create incentives for introduction and use of modern agrotechnologies. It would also be appropriate to introduce the system of laser-leveling, as a result of which mechanization costs can be reduced by 14%, use of labor by 23%, water use by 30%, irrigation costs (electricity, pumps) by 27%, respectively, and yield (of wheat) can increase by 400 kg per hectare. In general, profitability will go up from 15% to 22% in the first year, and up to 37% in the second year. Expansion of biodiversity and further diversification of agricultural food production are important in increasing efficiency in the use of resources and in gaining higher yield without negative impact on the ecosystems and consequently on the well-being of future generations. In this context, in addition to the conventional crops, it is appropriate to consider prospects of growing unconventional crops (e.g. pistachios). Creation of industrial pistachio plantations can be an effective alternative to the existing system of land use in the piedmont raindfed lands. For instance, according to the results of pilot projects, cultivation of pistachios in the piedmont rainfed lands is 50-time as profitable as cultivating wheat on these lands, whereas cattle grazing for the entire period accounts for merely 4.5% of the profit of cultivating pistachios during the same period. As a result of these measures, the area of lands with salination levels above the average will be reduced from 804,000 to 172,000 hectares in % of irrigated lands will be covered by amelioration measures by 2030 and the rating for land productivity will go up to good and high on 93% of irrigated lands. This will create favorable environment for the higher yield of crops and their overall harvest volumes. With projected yield growth, it is critical to create an effective system of food storage for agricultural produce harvested nationally. This implies significant upscaling of the refrigeration capacity up to 5.8 million cubic meters of cold storage by 2025 (compared to 1.14 million cubic meters in 2013). Total gains of increasing food storage capacity amounts to USD 2,095 billion. Furthermore, establishment of local manufacturing of refrigerators will generate spillover effects to other sectors in the amount of USD 2.4 billion. In addition, higher yields enable scaling up processing of foodstuffs for up to 30% in case of meat (currently at 6.9%); 50% in case of milk (11%); 30% in case of fruit and vegetable products (13.3%) and 35% in case of grapes (15%). With additional investments of USD 4.3 billion, return on processing will be USD 600 million, which will enable creation of additional 67,275 jobs both in the food processing industry and related sectors. 2. Efficient Use of Water Resources a) Significant expansion of water-efficient irrigation methods by 2030 include drip irrigation systems in the area of 100,000 hectares and creation of intensive farming zones in areas of piedmont and mountainous zones where the 9

10 soil is not affected by salinization. Set up of drip-irrigation on 100,000 hectares requires investments in the amount of USD million. This will enable to reduce the use of mineral fertilizers by 30% thus contributing to the reduced food production costs, and help address the issue of soil degradation. At the same time, yield of crops is estimated to increase by 40%. b) Enhancing efficiency of irrigation systems up to 0.74 and maintaining sustainable use and maintenance of irrigation and drainage infrastructure. It is important to re-use collector and drainage waters for irrigation by mixing with irrigation water and alternating freshwater-return water - freshwater scheme. Transition to the intensive methods of water use will enable reduction in total demand for irrigation water by Figure 4. Intensification will enable to improve the quality of soil and eliminate the deficit of water resources by 2030 Drip irrigation will boost the crop yield by 40% and decrease the consumption of fertilizers by 30% Planned range of measures in the framework of intensive water use will enable to cover the deficit of water resources for irrigation already by Institutional measures. According to the estimates, aforementioned measures for development of infrastructure and intensification of land and water use require major investments. Capacity development of institutions will be crucial in order to: a) ensure effectiveness of investments; b) support farmers in developing financial sustainability in order to generate additional resources for investments. Based on this, following areas of institutional reforms are proposed: (A) Reforming institutions and optimizing the size of farms in the agricultural sector. According to the estimates, reaching economies of scale requires the following parameters: the size of livestock farms need to be increased at least up to 1,000 heads, vegetable farms up to 85 hectares, and fruitgrowing farms up to 40 hectares. Increasing the size of farms will facilitate 10

11 higher effectiveness of food production. For example, optimization of land size will increase the productivity of livestock farms by 35%. Large farms will possess major administrative and financial resources and can become drivers of reforms. It is also important to create conditions for concentration of capital and support the establishment of modern agroindustrial complex, enhance effectiveness of procurement systems, as well as systems of distribution and processing. To benefit from the economies of scale the size of livestock farms need to be increased at least up to 1000 heads b) Promoting greater independence for farmers, by reducing government intervention and creating incentives for long-term investments Firstly, long-term strategy needs to envisage greater independence of farmers in decision-making related to land use. It is important to create more opportunities for crop rotation in order to improve soil quality and significantly enhance yields. Transfering farmland to those, who can use it effectively is an important and still underutilised measure in agricultural productivity. Such redistribution works best on market terms through bankruptcy, liquidation, and sublease. Moving forward, wider use of these mechanisms will be essential. Security and transparency in the system of land use (inter alia, lease agreements) is extremely important for long-term investments into improvement of soil quality. Secondly, the relationship between companies and Uzpakhtasanoat Association calls for re-assessment and revision. A farmer needs to know the basics on the output of cotton fiber, seeds, lint as well as humidity and infestation of each batch of cotton he/she delivers. Such transparency and objectivity may open up hidden reserves and strong incentives for farmers, which will lead to improved quality of produce and opportunities for additional profit margin, which can, in turn, be invested into land. B) Introduction of the mechanism of partial compensation of water supply costs for agricultural producers. Introduction of the system of fees for water supply services in Uzbekistan in the context of growing deficit of water resources and limited government funding for rehabilitation and maintenance of waterworks addresses two major goals: (i) Reducing government expenditures for maintenance of water supply infrastructure, primarily on-farm irrigation and melioration system, and enabling greater financial sustainability of water sector in the long-run; (ii) Forming an integrated system for stimulating rational use of water in agriculture on a national scale. It is notable that introduction of water supply service fee will be feasible once the financial sustainability of farmers is improved. Center for Economic Research Shota Rustaveli Str., Tupik 1/5 Tashkent , Uzbekistan Tel: , /57/58/59; Fax: The publication reflects opinions and views of the working group, which may not coincide with the official point of view of the Center for Economic Research or UNDP. Tashkent 2015 UNDP Country Office in Uzbekistan 41/3 Mirabad street, Tashkent , Uzbekistan Tel: , ; Fax: