Kyrgyz Republic: Selected Issues and Statistical Appendix

This Selected Issues paper examines figures related to the key policy areas for the Kyrgyz Republic. Specifically, the paper studies the sources of growth, the cost competitiveness of export, and trade restrictions in the region, which are all linked to the achievement of the growth and poverty reduction targets of the National Poverty Reduction Strategy. It addresses the issues of agricultural taxation and fiscal aspects of the environment. The paper also focuses on a specific structural problem in taxation, and analyzes the fiscal aspects of environmental protection.

Abstract

This Selected Issues paper examines figures related to the key policy areas for the Kyrgyz Republic. Specifically, the paper studies the sources of growth, the cost competitiveness of export, and trade restrictions in the region, which are all linked to the achievement of the growth and poverty reduction targets of the National Poverty Reduction Strategy. It addresses the issues of agricultural taxation and fiscal aspects of the environment. The paper also focuses on a specific structural problem in taxation, and analyzes the fiscal aspects of environmental protection.

VI. Macroeconomic Aspects of Resource and Environmental Issues29

83. The Kyrgyz Republic has considerable environmental liabilities from the past which could cause serious problems in the future. At the same time, efficient management of natural resources provides opportunities to sustain economic growth. Good environmental policy is important also to support the country’s broader objectives for better living standards.

A. Mining

84. The mining sector is an important contributor to the Kyrgyz economy, accounting for almost 40 percent of industrial output and 40 percent of exports. However, inadequate environmental protection in this sector poses a significant macroeconomic risk. In particular, the Kumtor gold mine—the largest mine in the country—attracted considerable attention following a spill of cyanide in 1998 which negatively affected tourism in the lake Issyk Kul area. More recently, a large landslide significantly curtailed gold production. Although Kumtor has an environmental management system in place, there are concerns about the mine closure and revegetation plans when it shuts down in 2010 as currently expected. The waste deposits (also called tailings) from mining operations, containing mostly cyanide, are located in a moving permafrost zone close to a river-bed and may pose an environmental hazard to the country, including potentially significant clean-up costs.

85. Audits on the environmental performance of other mining enterprises are either not conducted or not publicly available. However, the nature of the minerals mined and processed (mercury, antimony, uranium) raises concerns about environmental effects. For example, the laxity of environmental controls at the Kara Balta ore refining facilities and the dust and water contamination from wastes of processed uranium are worrisome (Box 1). The regional authorities responsible for environmental monitoring and supervision generally lack resources and training. The existing legislation does not address environmental issues relating to mine closures. Addressing these environmental liabilities is important for privatization prospects, in order to differentiate between the liabilities of the previous owner (state) and the new owner (private).30

Former Uranium Mining Sites

The Kyrgyz Republic was a center for the Soviet Union uranium mining and milling industry from the end of the second World War until the late 1970s. Uranium mines have now been closed, but they have left significant environmental liabilities, with more than 100 million cubic meters of mining waste including radionuclides, heavy metals, cyanides and other toxic substances. The tailings—currently 35—are located throughout the country. They were built many years ago and most incorporate outdated technology with little monitoring. According to a recent World Bank study, there also seems to be a serious underestimation of the environmental risks associated with radioactivity of waste. Many sites are located in flood zones and pose regional threat of radioactive contamination over large areas of the Ferghana valley, the densely populated agricultural and politically sensitive region of Central Asia.

Most tailing dumps already appear unstable, causing concern that the release of radioactive material or of other hazardous waste may occur in rivers in case of collapse or erosion. This would have both long-term health and environmental effects. The risk increases every year, especially during the ‘spring flooding’ season when rainfall coincides with snow melting. Also, the country is located in a moderately seismic zone; floods and earthquakes—especially landslides—could cause serious harm to, or even destruction of tailings. Potential landslides threaten a number of sites (especially the one in Mailuu Suu), which could cause an environmental disaster impacting large areas of Kyrgyzstan, Uzbekistan, and possibly Tajikistan.

A number of studies have focused on the tailings issues especially to evaluate and prepare measures to reduce health risks to the population and to prevent environmental pollution. While in some locations, a few short-term measures could be taken to stabilize impoundments, there are at least 8-10 sites that are threatened by landslides, where tailings security cannot be assured in their present location. Available cost estimates of relocating the highest priority site in Mailuu Suu range from $12 to $25 million per site covering the relocation of the tailings, preparation of a consolidated site and decommissioning of the dam. Cost estimates usually differ depending on whether local or foreign expertise is used. Even decommissioning existing tailing dams is not without risks and alternative sites must be available within a limited distance to minimize leakage and contamination. Temporary remediation of all other sites including annual monitoring costs have been estimated by a World Bank study at around $20-$25 million. The current allocation from the budget for emergency situations is only around $0.3 million. So far the government of Kyrgyz Republic has not been very successful in evoking interest of donors in addressing these problems.

86. There are also outstanding tax policy issues that need to be addressed in the context of sustainable development, including in the mining sector. One issue is the application of the Value Added Tax (VAT). According to the Kyrgyz tax code, exports of gold alloy and refined gold are currently exempt from VAT. At the same time, gold producers who operate under particularly advantageous tax arrangements, do not benefit from the VAT refunding on input costs. The non-refunding, however, has both economic and environmental implications. Since the production costs are increased by the VAT, this reduces the profitability prospects of new investments in gold production and hence may deter new investors. The non-refunding also provides existing producers with an incentive to exploit the richest sources first, often to the detriment of the exploitability of the remaining deposits. A normal international practice would be to zero-rate exports and make input costs refundable.

B. The Role of Environmental Taxes and Charges

87. The growth of cities and towns has brought about several environmental problems, including air and water pollution. Primary sources of air pollution are thermal power stations, factories, and transportation. Urban transport, though still moderate, is a cause for air pollution because of widespread use of low-grade, leaded gasoline, and old vehicles. Also, there is an acute problem of water pollution of rivers and lakes, and contamination of subsurface water. In 2001, most of solid waste (15 million cubic meters), liquid sewage (11.8 million cubic meters), and toxic waste (over 33 million tons in the last 5 years) went untreated. This has serious consequences on water and soil quality, translating into health risks for the population, reduced man-hours of work, as well as reduced agricultural productivity.

88. The fundamental legal and regulatory framework for the environment and natural resources was developed in 1997-2001.31 However, the regulatory institutions and enforcement mechanisms remain weak. For example, the current system of collection of fees for the use of natural services covers all economic entities. This elaborate system has existed since the Soviet era and is based on various presumptive charges on polluting materials and wastes—not on actual measurement of discharges. The polluter-pay principle does not seem to be in effect as charges are very low and offer little incentive to decrease pollution. Over the years, inflation and a deteriorating financial situation of enterprises have further eroded revenue from the system. The amount collected for 2001 was 0.02 percent of GDP. The fees are collected to a Regional Ecological Fund, of which 25 percent is transferred to the National Ecological Fund. About 70-80 percent of the funds is spent on management including staff salaries, and little if any goes for environmental protection. The off-budget nature of these fees makes it difficult to the Ministry of Finance to monitor the revenue and expenditure of these funds.32 As a result, environmental investment has been paralyzed and local priorities are not taken into account.

89. Recognizing the weaknesses of the traditional fee system, many transition economies have opted for more flexible and market-based instruments. They have introduced environmental taxes on energy and transportation, as well as pollution charges. Environmental taxes are considered attractive because of their promise of “double dividend”. In addition to reducing environmental problems, they could increase the overall economic efficiency if these revenues were used to reduce the rates on other, more distortionary taxes. Environmental taxes represent a relatively small, but growing, source of revenue in a number of countries. For example, the Central and Eastern European countries are already using such taxes extensively. Environmental tax revenue, including energy taxes, amount to 7-8 percent of total tax revenues or 2-4 percent of GDP, and there share is increasing. These revenue estimates, excluding the energy taxes, range from 0.1 to 0.8 percent of GDP.

Environmental Taxes in Selected Economies in Transition

(In millions of U.S. dollars)

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Source: IMF FAD database.

90. In the Kyrgyz Republic, an environmental tax presents a good opportunity, especially as the government is reviewing the phasing out of road and emergency taxes. The environmental tax could be a unified production tax or a combination on such taxes as tax on motor vehicles, batteries, lubricating oils, packaging, tires, coal ash and others. The objective could be to increase the environmental tax basis (excluding the energy taxes) so that it would generate adequate revenue for environmental protection and at the same time offset revenue shortfall resulting from phasing out the emergency tax.33 The revenue from such a tax could be earmarked to mitigate critical environmental problems at the local level and the remaining set aside in a ‘natural disasters reserve fund’.34. Over the long-run, more sophisticated forms of environmental tax such as carbon or sulfur taxes directly targeting larger polluters could be considered to complement the regulatory framework (Table VI-1). This would encourage economic entities to take adequate measures for cleaning-up including the adoption of environmentally-friendly technologies.

Table VI-1.

Selected Market Based Instruments and the Scope of their Future Use in the Kyrgyz Republic

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Source: OECD (1999).

C. User fees

91. In addition to scenic Tien Shan mountains and the historic Silk Road, the Kyrgyz Republic has several nature reserves and national parks. The total area protected amounts to 2 million acres (3.9 percent of the country’s territory). These natural habitats provide a number of opportunities for recreation. At present, many of these benefits are not priced, or are priced at very low levels, in effect, there are resource rents to be taxed. The concept that “nature” is a free good (inherited from the Soviet system) has created the expectation of free access to these areas. As a result, these natural preserves are chronically short of funds for conservation and protection. Instituting user fees could generate funds that would help fill this gap.

92. The literature suggests that foreign visitors are willing to pay considerably more than the fees currently charged (or not charged) for visits to developing country natural areas.35 User fees or visitor fees could thus become an important source of income to fund conservation, protection, and visitor impact activities for the protected areas which are currently nothing more than “paper parks.” The number of foreign tourists is steadily increasing in the Kyrgyz Republic: non-CIS tourist arrivals increased from 48,000 in 1995 to 70,000 in 2001. Assuming that half of foreign tourists visit at least one park or protected reserve during their stay and assuming a nominal $20 fee, the amount of revenue collected would be about $0.7 million which is almost seven times the amount currently spent on maintenance of parks and reserves.36 A recent Deutsche Gesellschaft für Technische Zusammenarbeit (GTZ)-Agha Khan study estimates an additional revenue potential of $15-20 million per annum from nature-based tourism.

D. Debt-for-Nature Swaps

93. Debt-for-nature swaps were introduced in a number of countrieş in the 1980s as a tool to increase environment support while reducing external debt. A debt swap (or conversion) is a cancellation of external debt in exchange for the debtor government’s commitment to mobilize domestic resources for an agreed environmental purpose. These are usually environmental projects covering biodiversity conservation, support for and development of the existing nature reserves, reduction of greenhouse gas emissions and of transborder pollution. Such swaps apply to both bilateral and commercial debt. So far there have been 45 swap programs in 17 countries generating approximately $1 billion worth of debt-for-nature swaps.37 Usually an international NGO acts as a mediator in the development of prospective projects.

94. The Kyrgyz Republic, which has one of the highest debt-GDP ratio of any transition economy, also has unique biodiversity assets. These include species of animals and plants in the list of endangered species (including snow leopard, brown bear, Central Asian mountain goat and Marco Polo lamb). However, their numbers are dwindling due to intensive poaching, habitat fragmentation and destruction. The Department of Protected Areas is resource constrained to seriously address any conservation issues. However, there is considerable interest in the international conservation community in protecting these rather unique resources. An option for debt-for-nature swap arrangements is included in the current Paris club agreement of the rescheduling of the Kyrgyz external debt.

APPENDIX I

Kyrgyz Republic: Summary of the Tax Structure as of November 30, 2002

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STATISTICAL APPENDIX

Table 1.

Kyrgyz Republic: Progress in Transition, 1996-2002 1/

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Source; EBRD Transition Report.

Based on the transition indicators produced by the EBRD, Table 2.1, 2002 Transition Report.

EBRD mid-year estimate.

For enterprises, in general a “1” ranking signals little private ownership or progress while a “4+” signals standards and performance typical of advanced industrial economics.

For markets and trade, a “l” ranking signals extreme controls, while “4+” is typical of standards and performance of advanced industrial countries.

For financial institutes, a “1” ranking signals little progress, while “4+” is typical of standards and performance of advanced industrial countries.

This rating is computed as an average of the reform process in telecommunications, electric power, water and waste water, roads and railways.

Table 2.

Kyrgyz Republic: Value Added in the Main Production Sectors, 1996-2002

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Source: National Statistical Committee.

Includes: trade and catering; procurement; supplies; information and computing services; real estate; geological; business services; and others.

Preliminary.

Transport and communication used for production.

Table 3.

Kyrgyz Republic: Industrial Production by Sectors, 1995-2002

(Volume, percentage change)

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Source: National Statistical Committee.

Over same quarter previous year.

For 1995-96 growth rates are given at comparable prices.

Table 4.

Kyrgyz Republic: Output of Selected Industrial and Manufacturing Products, 1995-2002

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Source: National Statistical Committee.
Table 5.

Kyrgyz Republic: Agricultural Production, 1995 - 2001

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Source: National Statistical Committee.
Table 6.

Kyrgyz Republic: Agricultural and Animal Production by Farm Type, 1997-2001

(In thousands of tons)

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Source: National Statistical Commitee.

Includes collective farms.

Weight after processing.

Table 7.

Kyrgyz Republic: Yields of Major Agricultural Commodities, 1995-2001

(100 Kilogram per hectare)

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Source: National Statistical Committee.
Table 8.

Kyrgyz Republic: Consumer and Producer Prices, 1995-2002 1/

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Source: National Statistical Committee.

Changes refer to annual average data.

Consumer price indices ate recounted according to international standards.

Producer price indices are based on 2000.

Table 9.

Kyrgyz Republic: Energy Prices, 1995-2002 1/

(In soms)

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Source: National Statistical Committee.

Producer prices, excluding indirect taxes.

Table 10.

Kyrgyz Republic: Nominal and Real Wages, 1995-2002

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Source: Kyrgyz authorities; and Fund staff estimates.

The December average wage reflects year-end bonus, typically one month’s wage.

Based on the monthly wage statistics.

Based on annual wage statistics with a broader coverage of the sectors than the monthly statistics, particularly with respect to agriculture.

Table 11.

Kyrgyz Republic: Wages by Economic Sector, 1996-2002

(In percent of average wage)

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Source: National Statistical Committee.
Table 12.

Kyrgyz Republic. Labor Market, 1995-2002

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Source: National Statistical Committee.

Includes those employees on forced vacation on the instruction of their employers and those engaged in part-time employment.

Defined as labor force less total employment.

Ratio of officially unemployed to economically active population.

Ratio of total unemployment to economically active population.

Ratio of economically active population to labor force.

Total employment as a percentage of labor force.