Kyrgyz Republic: Staff Report for the 2006 Article IV Consultation, Third Review Under the Poverty Reduction and Growth Facility, and Request for Waiver of Structural Performance Criterion

The Kyrgyz authorities have maintained macroeconomic discipline in recent years, despite a challenging political environment. This 2006 Article IV Consultation highlights that the economic activity is rebounding in 2006, with year-over-year real GDP growth of 3.2 percent through September, after a slight contraction in 2005. Inflation is projected to rise slightly to just below 6 percent during 2006. Remonetization has gathered pace in recent years, but the financial system remains relatively shallow by international standards. Comprehensive financial reforms are under way and are slated to gain momentum under the IMF-supported program.

Abstract

The Kyrgyz authorities have maintained macroeconomic discipline in recent years, despite a challenging political environment. This 2006 Article IV Consultation highlights that the economic activity is rebounding in 2006, with year-over-year real GDP growth of 3.2 percent through September, after a slight contraction in 2005. Inflation is projected to rise slightly to just below 6 percent during 2006. Remonetization has gathered pace in recent years, but the financial system remains relatively shallow by international standards. Comprehensive financial reforms are under way and are slated to gain momentum under the IMF-supported program.

I. Developments Since the late 1990s

1. The shock from the Russian financial crisis of 1998 and the authorities’ weak policy response to it seriously destabilized the Kyrgyz economy in the latter part of the 1990s. The accommodating policy stance avoided a downturn in economic activity, at the expense of stubbornly high inflation and a spike in the fiscal and external current account deficits, financed by a rapid and unsustainable buildup in external public debt. The economic turbulence and lax enforcement of prudential requirements led to a number of bank failures as loan delinquency increased rapidly.

Selected Economic Indicators, 1997–2006

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Sources: Kyrgyz authorities, and Fund staff estimates.

Excluding debts owed by the Kumtor gold mine.

2. From late 2001, however, the government reasserted macroeconomic discipline and established a good track record under successive PRGF-supported programs. Identifying the external debt overhang as a fundamental constraint, the authorities launched a multi-year fiscal adjustment underpinned by improvements in tax administration, prudent spending and a streamlining of the Public Investment Program that had in part driven the debt accumulation, while seeking to create the conditions for a rise in private investment. A firm monetary policy helped reduce inflation and maintain a broadly stable nominal exchange rate.

3. The authorities also introduced market-oriented reforms to enhance prospects for economic and social development, including price and trade liberalization, state enterprise privatization, and elimination of directed subsidized credits. As a consequence, overall economic performance improved, aided by a rapid rebound in activity in Russia and Kazakhstan and soaring international gold prices. Nevertheless, recurrent gaps in implementation of envisaged reforms and festering governance problems weakened the effectiveness and credibility of the Akayev administration, prompting its collapse during the March 2005 Tulip Revolution.

uA01fig01

Economic Performance in the CIS Region in the early 2000s

Citation: IMF Staff Country Reports 2007, 135; 10.5089/9781451821529.002.A001

Source: Country authorities and Fund staff estimates.

II. recent Performance under the program

4. Real GDP grew by 3.5 percent year-on-year during January–August 2006, after a small contraction last year; excluding the Kumtor gold mine, which recently suffered a serious accident, output rose by 6.6 percent during the period. Inflation (5.1 percent in the 12 months ending August) has remained in line with the program. For the year as a whole, the authorities expect to keep inflation below the target of 5.7 percent, but they have scaled back their real GDP growth projection to 4 percent.

uA01fig02

Real GDP Growth and CPI Inflation 2001-07

(In percent)

Citation: IMF Staff Country Reports 2007, 135; 10.5089/9781451821529.002.A001

Sources: Kyrgyz authorities; and Fund staff projections.

Key Projections 2004–07

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Sources: Fund staff estimates and projections.

5. Since early 2006, monetary policy has been conducted in an environment of stronger-than-expected foreign exchange receipts and continued remonetization. Sizable unsterilized intervention has sparked a 40 percent increase in reserve money in the 12 months ending September, well above the program’s indicative limits. Despite this intervention, mirrored in a rise in gross foreign exchange reserves to $690 million by end-September (4 months of projected 2007 imports of goods and services), the som has appreciated by 4.7 percent against the dollar since the beginning of the year; in real effective terms, it has appreciated by nearly 5 percent since end-2004. Private sector credit has grown rapidly in the year-to-date, albeit from a low base. Nonperforming loans have decreased from over 13 percent of total loans at end-2002 to 8½ percent in mid-2006, but their level has remained relatively high and edged up in recent months. The NBKR has gradually increased policy interest rates, which are now positive in real terms.

uA01fig03

Effective Exchange Rate Development, 2003-06

(Index; year 2000=100)

Citation: IMF Staff Country Reports 2007, 135; 10.5089/9781451821529.002.A001

Source : INS dat abase.1/ Against 20 major trading partners. Increase indicates appreciation.
uA01fig04

Net International Reserves and Nominal Exchange Rate, 2004-06

Citation: IMF Staff Country Reports 2007, 135; 10.5089/9781451821529.002.A001

Source: Kyrgyz auhtorities.

6. The external current account deficit has widened over the past two years, to an estimated 11 percent of GDP in 2006, despite a surge in workers’ remittances. The deficit is being financed by a rise in the net capital and financial account balance, resulting in a buildup in gross foreign reserves and a strengthening of the currency. Part of the current account deterioration reflects a revision in the statistical series on shuttle trade, which was mirrored by a large increase in net financial capital inflows including errors and omissions. 1 Imports have increased rapidly, sparked by rising world fuel prices and strong demand for consumer goods and construction materials, buoyed by the recovery in nongold domestic activity. Despite persistently high world gold prices, gold exports have sagged due to a gradual weakening in the grade of the Kumtor mine pit under exploration and a recent accident in that mine. By contrast, nongold exports, which suffered from the political turbulence associated with the March 2005 revolution, have since recovered, driven by rapid growth in Russia and Kazakhstan.

Balance of Payments, 2004–07

(in millions of U.S. dollars)

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

7. The PRGF-supported program remains on track. All end-June quantitative performance criteria (PCs) were met, in some cases by wide margins (Table 1). In particular, the primary fiscal deficit before grants undershot the half-year target by 1 percent of GDP as a result of revenue gains from stricter tax enforcement at customs and robust import growth. Despite a faster-than-expected increase in current expenditure, total spending was in line with the program due to delayed execution of the investment budget. Based on preliminary third quarter data and the thrust of the supplementary budget that will shortly be sent to parliament, the authorities expect to comfortably meet the full-year primary deficit target (3.3 percent of GDP). Strong payroll tax collections allowed the Social Fund to clear old arrears and make nationwide pension payments current, despite a 2 percentage-point payroll tax reduction in January. The half-year indicative limit on the electricity sector’s quasi fiscal deficit (QFD) was met owing to rising cash collections, and the annual limit of 5.9 percent of GDP will also likely be met, aided by the unification of household tariffs in May 2006.

Table 1.

Kyrgyz Republic: Quantitative Program Targets for 2005–06 1/

(In millions of soms, unless otherwise indicated; eop)

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

Definitions are provided in the Technical Memorandum of Understanding.

Targets adjusted for the nondisbursement of the EU food security grant ($4.8 million in Q1), the ADB grant ($7.8 million in Q2), and the EU health sector SWAP grant ($4.0 million in Q2).

New concessional loans during the year.

Table 2.

Kyrgyz Republic: Quantitative Program Targets for 2006–07 1/

(In millions of soms, unless otherwise indicated; eop)

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

Definitions are provided in the Technical Memorandum of Understanding.

New concessional loans during the year.

8. All structural benchmarks through end-September 2006 were also met (Table 3). The authorities are requesting a waiver for nonobservance of the end-June structural PC on transferring shares in the Centerra Canadian mining conglomerate (held by the Kyrgyzaltyn SOE) to the State Property Fund,2 based on a legal finding that the transfer would not be feasible; they noted that an April 21 Kyrgyzaltyn board resolution—prohibiting Centerra share sales without government authorization and specifying that proceeds from any sales should be used in accordance with government guidelines—effectively fulfills the spirit of the missed PC.

Table 3.

Kyrgyz Republic: Structural Conditionality

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Actions labeled with an asterisk are structural performance criteria.

Table 4.

Kyrgyz Republic: Selected Economic Indicators, 2003–11

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

General government comprises state government and social fund finances. State government comprises central and local governments.

Projections are based on program exchange rates specified in the Technical Memorandum of Understanding.

12-month GDP over end-period broad money.

Weighted average interest rate on som-denominated loans.

Gross reserves exclude international reserves of the NBKR that are pledged or blocked.

Excluding obligations of the Kumtor gold mine.

Table 5.

Kyrgyz Republic: Summary of General Government Fiscal Operations, 2004–07

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

Includes payroll tax revenue (contribution to the Social Fund), net of the government contribution to the Social Fund.

Excludes transfer to Social Fund.

Starting in 2006, interest and amortization reflect bilateral agreements signed following March 2005 Paris Club agreement.

Mainly privatization proceeds.

Table 6.

Kyrgyz Republic: General Government Finances, 2004–07

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

Includes payroll tax revenue (contribution to the Social Fund), net of the government contribution to the Social Fund.

Mainly privatization proceeds. Includes som 3,589 million related to the Kumtor mine restructuring for 2004.

Table 7.

Kyrgyz Republic: State Government Finances, 2005–07

(In millions of soms)

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Sources: Kyrgyz authorities; and Fund staff estimates and projections.

In 2005, the VAT and customs revenues were reclassified, leading to lower VAT and higher customs duty collections.

Mainly mineral resource tax and motor vehicle tax.

Excludes transfer to Social Fund (columns for original program include transfer to Social Fund).

Includes carry-forward expenditure from previous fiscal year (som 994 million in 2004, som 945 million in 2005, and som 480 million in 2006).

Mainly privatization proceeds. Includes som 3,589 million related to the Kumtor mine restructuring for 2004.