Kyrgyz Republic
2013 Article IV Consultation and Fourth Review Under the Three-Year Arrangement Under the Extended Credit Facility, Request for Waiver of Nonobservance of a Performance Criterion, and Request for Modification of Performance Criteria—Staff Report; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Kyrgyz Republic
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The shift to a parliamentary democracy in 2010 provided an impetus for the Kyrgyz Republic to reform the economy. Despite the recent progress, the Kyrgyz Republic faces significant economic challenges, which will require actions on many fronts. Improving the business climate, governance, and institutions remains a key pillar of sustainable and inclusive growth. Restoring fiscal sustainability will be essential, as the budget has become more dependent on external assistance since the 2009 global and 2010 domestic crises. Tight monetary policy continues to be warranted to keep inflation at bay.

Abstract

The shift to a parliamentary democracy in 2010 provided an impetus for the Kyrgyz Republic to reform the economy. Despite the recent progress, the Kyrgyz Republic faces significant economic challenges, which will require actions on many fronts. Improving the business climate, governance, and institutions remains a key pillar of sustainable and inclusive growth. Restoring fiscal sustainability will be essential, as the budget has become more dependent on external assistance since the 2009 global and 2010 domestic crises. Tight monetary policy continues to be warranted to keep inflation at bay.

Recent Developments and Outlook

A. Context

1. The shift to a parliamentary democracy in 2010 provided an impetus for the Kyrgyz Republic to reform the economy. The Kyrgyz economy is the most open one in the region, and depends heavily on gold exports and remittances. The political turmoil and internal ethnic conflict in 2010 disrupted economic activity. To address the effects of the domestic crisis, the new government increased social outlays, wages, and pensions, leading to fiscal tensions. Nonetheless, the public debt-to-GDP ratio declined, helped by recent debt write-offs.1 The authorities introduced tax policy and tax administration measures to strengthen revenue collection and improved public financial management to increase the efficiency of spending. However, the new political system and frequent changes in government have made some aspects of economic reform more difficult and led to delays, particularly in the financial sector (Box 1).

Kyrgyz Republic: How Much Traction did Previous IMF Advice Receive?

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2. Despite the recent progress, the Kyrgyz Republic faces significant economic challenges. The key near-term challenge is to maintain macroeconomic stability and to put the financial sector on a sound footing. The authorities agreed that key medium-term challenges include diversifying the economy away from gold, reducing dependence on remittances and external support, and creating a business environment conducive to private sector-led growth.

3. Meeting the challenges will require actions on many fronts. Fiscal consolidation is critical to ensure sustainability of public finances, keep debt on a declining path, and support the central bank’s efforts to curb inflation. In this context, it is essential to maintain and strengthen central bank independence, which recently has come under pressure. Moving ahead with reforms in the banking sector and improving the business environment will be key to strengthening the role of the private sector. Enhancing the provision of high-quality public services and addressing corruption are essential elements of a successful development agenda. The government will also need to address the remaining ethnic tensions and actively participate in the regional dialogue on the development of the hydro-power sector.

B. Recent Developments

4. The political situation has stabilized but remains fragile. The three-party coalition government formed after the breakup of the previous coalition in August 2012 has managed to maintain a relatively stable political environment. Nevertheless, the political situation remains fragile as some members of parliament continue to voice their disagreement with the government’s reform agenda.

5. The economic situation deteriorated in 2012 (Figure 1). Gold production dropped by 40 percent owing to disruptions at Kumtor, the largest gold mine. Solid growth in other sectors, fueled by remittances inflows, cushioned the drop in overall output to -0.9 percent. The current account deficit increased substantially, mainly due to the decline in gold exports and an increase in imports of inputs for ongoing energy infrastructure projects. Official assistance and remittances, which have the strongest impact on the exchange rate, mitigated depreciation pressures. The capital and financial accounts have been volatile, primarily because of upward revisions to private external debt, sizable debt relief, and short-term flows related to mining activity. Inflation increased to 7.5 percent by end-2012, owing to rising international food prices in the summer.

Figure 1.
Figure 1.

Kyrgyz Republic: Recent Economic Developments, 2010–12

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff estimates.

6. Notwithstanding adverse economic conditions, fiscal policy remained prudent. The 2012 fiscal deficit was 5.4 percent of GDP and below the targeted 6 percent of GDP, although somewhat higher than in 2011 owing to the expenditure carryover. The revenue-smoothing arrangement with Kumtor and buoyant customs revenue in the first nine months of 2012 offset the shortfall in gold-related revenue. However, growth in customs revenue decelerated in late 2012. The government curtailed some nonpriority expenditure to accommodate lower-than-budgeted external financing on account of delays in the implementation of structural measures agreed with donors. Unexpected external grants in late 2012 led to a better-than-projected fiscal outturn.

7. Despite lowering the policy rate, the central bank continued to mop up excess liquidity, although not consistently throughout 2012. The National Bank of the Kyrgyz Republic (NBKR) reduced the policy rate in several steps to 2.6 percent, in response to negative economic growth and moderate inflation. The shift in monetary policy has not affected the average lending rate in the banking system. Toward end-2012, however, sterilization efforts were not sufficient to offset strong growth in foreign inflows. As a result, reserve money increased by more than expected. Growth in private credit was strong on account of buoyant demand across most sectors and a one-off factor (a micro-finance institution became a bank in November 2012).

8. The banking sector has remained generally stable (Text Table 1). Nonperforming loans continued to fall during 2012, while provisioning increased. Capital adequacy and liquidity of the banking system remained sufficient, while profitability increased. However, dollarization, even though on a declining trend, is still high.

Text Table 1.

Kyrgyz Republic: Selected Financial Soundness Indicators, 2009–12

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Source: NBKR.

AUB is excluded from October 2010.

In March 2011, some NPLs were transferred from Zalkar bank to the old AUB and left the system.

C. Program Implementation

9. The program has been broadly on track, albeit with some slippages. All end-December 2012 QPC and all but one structural benchmarks were met (Tables 13 and 14). The structural benchmark on the sale of Zalkar was met with a delay in early May. The end-December 2012 indicative targets on state government tax collections and reserve money were also missed. The continuous QPC on the ceiling on contracting or guaranteeing of new nonconcessional external debt was missed in early 2013.2 The law on anti-money laundering and countering the financing of terrorism (AML/CFT) and the relevant provisions of the Criminal Code were submitted to parliament in December 2012. The revised SSC sales strategy was approved by the government in February 2013. A government resolution on the procedures for submission of budgets of the next 10 largest state-owned enterprises (SOEs) to the government was adopted at end-March 2013 (LOI ¶7). The authorities are requesting a waiver of nonobservance of the continuous QPC based on corrective actions being taken. The authorities are making progress toward meeting the structural benchmarks scheduled for the coming months.

Table 1.

Kyrgyz Republic: Selected Social and Economic Indicators, 2010–18

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

General government comprises State Government and Social Fund finances. State government comprises central and local governments.

Calculated at end-period exchange rates.

Twelve-month GDP over end-period broad money.

Interest rate on three-month treasury bills.

Table 2.

Kyrgyz Republic: Balance of Payments, 2010–18

(In millions of U.S. dollars)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Projected budget support is included in the financing gap.

The capital account in 2012 includes debt write-offs.

Includes return of KRDF investments abroad.

Net short-term flows in 2012 partially reflect capital inflows to domestic enterprises.

Public and publicly-guaranteed debt.

Net of rescheduling.

Valued at end-period exchange rates. The discrepancy between the difference in year-end stocks and the change in reserves under financing is caused by movements in prices and exchange rates.

Table 3.

Kyrgyz Republic: NBKR Accounts, 2010–13

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Contribution is defined as change of asset stock relative to previous end-year reserve money stock (in percent).

Table 4.

Kyrgyz Republic: Monetary Survey, 2010–13

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Contribution is defined as change of asset stock relative to previous end-year broad money stock (in percent).

Twelve-month GDP over end-period broad money.

Table 5.

Kyrgyz Republic: General Government Finances, 2010–15

(In millions of soms, unless indicated otherwise)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

In 2009, the road, emergency and retail taxes have been abolished, the VAT tax rate reduced from 20 to 12 percent, and a new turnover tax introduced. Median turnover tax rate was reduced from 2.5 percent to 2 percent from January 1, 2010.

Table 6.

Kyrgyz Republic: General Government Finances, 2010–15

(In percent of GDP)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Yearly GDP ratios are as a percent of annual GDP. Quarterly GDP ratios are as a percent of quarterly GDP.

In 2009, the road, emergency and retail taxes have been abolished, the VAT tax rate reduced from 20 to 12 percent, and a new turnover tax introduced. Median turnover tax rate was reduced from 2.5 percent to 2 percent from January 1, 2010.

Table 7.

Kyrgyz Republic: State Government Finances, 2010–15

(In millions of soms, unless indicated otherwise)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

In 2009, the road, emergency and retail taxes have been abolished, the VAT tax rate reduced from 20 to 12 percent, and a new turnover tax introduced. Median turnover tax rate was reduced from 2.5 percent to 2 percent from January 1, 2010.

Table 8.

Kyrgyz Republic: State Government Finances, 2010–15

(In percent of GDP)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

In 2009, the road, emergency and retail taxes have been abolished, the VAT tax rate reduced from 20 to 12 percent, and a new turnover tax introduced. Median turnover tax rate was reduced from 2.5 percent to 2 percent from January 1, 2010.

Table 9.

Kyrgyz Republic: Social Fund Operations, 2010–15

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Sources: Kyrgyz authorities and IMF staff estimates and projections.
Table 10.

Kyrgyz Republic: General Government Operations, GFSM 2001 Presentation, 2010–15

(In millions of soms, unless indicated otherwise)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Program grants in 2012 include debt forgiveness by Russia (US$188.9 million), Turkey (US$49.7 million), and Germany (US$8.5 million).

Table 11.

Kyrgyz Republic: Proposed Reviews and Disbursements Under the Extended Credit Facility Arrangement

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Source: International Monetary Fund.
Table 12.

Kyrgyz Republic: Indicators of Capacity to Repay the Fund, 2013–18 1/

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Sources: IMF staff estimates and projections.

Assumes seven semi-annual disbursements under the ECF facility of 75 percent of quota (SDR 66.6 million) starting in June 2011. Projections of interest payments incorporate the temporary interest relief initiative and interest rate structure under the new architecture of LIC facilities and financing.

Total external public debt service includes IMF repurchases and repayments.

Table 13.

Kyrgyz Republic: Quantitative Performance Criteria and Indicative Targets Under the Extended Credit Facility Arrangement, December 2011–December 2012

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

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

As defined in the TMU.

Cumulative from the beginning of the year.

External debt contracted or guaranteed with a grant element less than 35 percent. The limit is cumulative from end-December 2010 to end-Septemer 2012 and tied to energy infrastructure projects only.

Table 14.

Kyrgyz Republic: Structural Benchmarks Under the Extended Credit Facility Arrangement, 2012–13

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D. Outlook and Risks

Outlook

10. With prudent macroeconomic policies and continued structural reforms, the medium-term outlook is broadly favorable (Text Table 2). Nongold growth this year is expected to be lower than in 2012 because of the negative impact on the investment climate from the ongoing government dispute with Kumtor. With the expected recovery in the gold sector, overall growth is, however, expected to be strong (Box 2). Going forward, staff projects that growth will stabilize at 5 percent, supported by continued remittances inflows, strong private credit growth, and structural reforms leading to a better business environment. In the absence of renewed supply shocks, inflation is expected to remain in single digits. The current account deficit in 2013 is expected to decline, primarily owing to the recovery in gold production. The authorities’ development strategy envisages somewhat more optimistic economic growth over the medium term—7 percent—based on accelerated reforms, in combination with strengthened security, political stability, and increasing energy independence. External public debt remains unchanged at a moderate risk of debt distress (Country Report No. 12/139).

Text Table 2.

Kyrgyz Republic: Medium-Term Outlook, 2008–18

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Sources: Kyrgyz authorities and IMF staff calcualtions.

Kyrgyz Republic: Gold Production in the Kumtor Mine

Geological factors—an unexpected shift of ice and waste into the central pit of the Kumtor mine in early 2012—resulted in a drop in gold production by 40 percent in 2012. The decline was stronger than expected because of additional complications with the bedrock and a lower gold content in the ore. As a result Centerra, Kumtor’s parent company, lowered medium-term gold production projections. While half of the 2013 production is expected to fall to the last quarter, Centerra announced that 2013 will be the last year with back-loaded production as the mine continues to build up stock piles.

uA01fig01

Gold Production at Kumtor Mine

(In thousands of ounces)

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Centerea Gold Inc. and IMF staff calculations.

Going forward, production is expected to stabilize at 650 thousand ounces per year. As a result of the ice block removal from the central pit, gold reserves in the mine are expected to be higher, extending the life of the mine by four years to 2026.

Risks

11. Political fragility, the narrow structure of the economy, and exogenous shocks are the main risks for the Kyrgyz economy in the near and medium terms (Box 3). The political transformation into a nascent parliamentary democracy entails risks of political instability. Political turmoil could lead to uncertainty and disruption in policy implementation. The security situation in Afghanistan could also deteriorate after the NATO troop withdrawal in 2014, and this could in turn spill over to neighboring countries, including the Kyrgyz Republic. A key potential economic shock is that a slowdown in global growth could spill over to the Kyrgyz economy via lower remittances and weaker external demand from Russia and Kazakhstan. The economy also remains vulnerable to global oil and food price shocks which could raise imports and inflation, and could also be hit by further disruptions in gold production and lower gold prices. These shocks would aggravate external vulnerabilities by putting pressure on international reserves.

12. The authorities broadly agreed with the staff’s assessment of risks. They agreed that rebuilding policy buffers and reducing vulnerabilities through fiscal consolidation and continued exchange rate flexibility are key to mitigate these risks. They also agreed to tighten monetary policy as needed to prevent second-round effects of increases in international food and fuel prices on inflation. Moreover, structural reforms geared toward improving the effectiveness of fiscal and monetary policies are expected to help mitigate vulnerabilities.

Kyrgyz Republic: Risk Assessment Matrix 1/

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The RAM shows events that could alter materially the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline. The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with authorities.

Program Discussions: Near-Term Issues—Maintaining Spending Restraint and Accelerating Financial Sector Reforms

A. Fiscal Policy

13. Tax revenue in 2013 is expected to be lower than previously targeted (Tables 5 and 6). The authorities agreed that import-related revenue, in particular VAT on imports, is expected to be lower than projected earlier, mainly because of lower fuel imports anticipated this year.3 With lower projected gold production, the associated tax revenue in 2013 will not reach budgeted levels. Moreover, production is now expected to be back-loaded, implying that a larger portion of Kumtor’s tax payments will take place in January 2014. The authorities also noted that a larger-than-expected amount of the 2012 advance tax payments by Kumtor will have to be repaid this year.

uA01fig02

Gold Exports and Gold-Related Tax Revenues*

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff estimates.* 2013–15 are based on the latest WEO gold price projections and output projections from the major gold-mining company. Tax revenue projections assume the continuation of the current gold taxation regime.

14. Despite these new developments, the authorities are committed to achieving the 2013 fiscal deficit target (relative to GDP) agreed during the third review (LOI ¶5). Noting that total spending would need to be lower by 1 percent of GDP compared to levels agreed during the third review, the authorities were still determined to maintain the agreed fiscal consolidation path by cutting nonpriority spending (Text Table 3).4 Staff agreed with this position, given that social and domestic capital spending would be preserved. The deficit would be mostly financed by external sources. The authorities also intend to temporarily draw down government deposits, which had increased in late 2012 owing to grants from Russia and the ADB. The authorities noted that they do not expect sizable privatization receipts this year because of political constraints that prevent the sale of large state-owned entities.

Text Table 3.

Kyrgyz Republic: Fiscal Deviations 1/

(In percent of GDP)

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Sources: Kyrgyz authorities and IMF staff calculations.

Change in the fiscal indicators relative to the third review.

15. The ongoing dispute with Centerra, Kumtor’s parent company, entails risks to the budget in 2013 and beyond. The government noted that the annual revenue loss on account of the special tax regime agreed with Kumtor in 2009 is 1.5 percent of GDP (in 2011, Kumtor’s tax payments amounted to 2.1 percent of GDP).5 According to Centerra, Kumtor operates under a valid agreement approved by the then government and parliament and therefore the tax regime cannot be revised. Parliament requested to resolve the dispute before end-June through cancellation of the special tax treatment agreement for Kumtor. Staff urged the authorities to resolve the dispute in a constructive manner, noting that failure to do so could lead to significant costs and pressures on the budget. The authorities agreed with staff’s assessment of the risks and emphasized that they would work with Centerra on a constructive resolution of the dispute (LOI ¶14).

16. The authorities are strengthening the role of the ministry of finance in core areas of tax policy. Following the recent return of the tax policy function to the ministry of finance, the authorities will now create a new, adequately staffed tax policy department in the ministry of finance (LOI ¶7, structural benchmark). This department will become the focal point on all tax policy-related matters. The government expects comprehensive technical assistance from the IMF in this area. The authorities have also expressed interest in receiving technical assistance from the IMF that would help identify key challenges in tax administration and provide recommendations regarding future priorities and options for reforms.

17. Better monitoring the largest state-owned enterprises (SOEs) will help limit potential fiscal costs. The coverage of the reporting requirements for the 10 largest SOEs was expanded to 20. The expansion of the list should also help mobilize additional revenues through improved monitoring. To prevent the 10 largest SOEs, which are part of the public sector, from contracting nonconcessional loans, as happened recently and led to the nonobservance of the continuous performance criterion, the authorities will issue a government resolution requiring these SOEs to provide all information on their borrowing plans and debt service obligations (LOI ¶7). The government, as the owner of these SOEs, has the power to stop any nonconcessional external borrowing.

18. Reforms in public financial management (PFM) are continuing. The government has recently updated the action plan on PFM reforms. As part of this plan, the government has drafted a law on public procurement that is expected to be submitted to parliament for approval in June. This law is expected to enhance the transparency and efficiency of public spending. The authorities will issue a regulation on expanding the coverage of the commitment register to include local budgets and special means. The ministry of finance will also develop and approve regulations on accounting and financial reporting using the unified chart of accounts on the basis of international norms (structural benchmarks). The authorities expect that these measures will enhance control over public spending. They are also working with parliament to ensure that the new Budget Code is in line with recent IMF technical assistance advice and the WB recommendations (LOI ¶8).

19. The government continues to improve debt management and to reduce the debt service burden on the budget. The authorities acknowledged that transforming the government securities market into a deep and liquid market requires time (LOI ¶6). Staff proposed to improve the operational infrastructure for the primary market of government securities at the NBKR to develop the domestic debt market. Staff commended the authorities for the discontinuation of direct sales of government securities. The government is looking forward to the upcoming Financial Stability Assessment Program that will assist in identifying reform options to deepen the domestic debt market. The authorities agreed that debt sustainability should be the guiding principle in assessing the financing arrangements of any large-scale infrastructure investments.6

B. Monetary Policy

20. Keeping the policy rate low could lead to further increases in reserve money, thereby putting additional pressure on core inflation. During the first three months of 2013, reserve money growth continued to rise. Staff noted that if this continues, there is a risk of overheating as the negative output gap gradually disappears. Staff therefore advised the NBKR to mop up excess liquidity and contain reserve money growth, and consistent with this, to raise the policy rate gradually to ensure it is positive in real terms (staff also advised the authorities to take steps to improve the monetary transmission mechanism; see bellow ¶33). While the authorities concurred that core inflation remains high and needs to come down to single digits, they were reluctant to commit to raising the policy rate because headline inflation was still at comfortable levels. However, the NBKR also agreed to remain vigilant and tighten monetary policy as needed to prevent second-round effects of potential increases in international food and fuel prices, while being mindful of other risks (LOI ¶9).

21. Staff stressed that strengthening the NBKRs operational independence is instrumental in raining in inflationary pressures. The authorities concurred that lending to the economy in support of growth would increase inflation and severely endanger macroeconomic stability. Staff also noted that NBKR lending would lead to market distortions, moral hazard, and, most importantly the NBKR’s exposure to vested interests.

uA01fig03

NBKR Notes and Reserve Money Growth

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff calculations.
uA01fig04

Interest Rates and Credit to Private Sector /1

(In percent)

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

1/ Strong private credit growth in November-December 2012 was because of a one-off factor (a micro-finance institution became a bank and its loan portfolio was integrated in the consolidated balance sheet of banks).Sources: Kyrgyz authorities and IMF staff calculations.

C. Financial Sector Policies

22. After repeated attempts to resolve Zalkar have failed, the authorities managed to sell the bank in May.

  • Zalkar was established in late 2010 as the “good bank” following the failure of Asia Universal Bank (AUB), the largest bank at that time. The government became the owner of Zalkar, but committed to selling the bank to complete the resolution process that had started with the split of AUB. Zalkar is currently the ninth largest commercial bank in the Kyrgyz Republic and not systemically important. Nonetheless, Zalkar’s sale is important to strengthen the NBKR’s credibility in resolving problem banks and to improve investor confidence in the financial sector.

  • The last auction, originally planned for December 2012, was postponed to end-January 2013 to allow potential buyers additional time for due diligence. Notwithstanding the extra time, the auction was unsuccessful.

  • The authorities saw liquidation of Zalkar as very difficult in the current political situation and stepped up their efforts to sell the bank to complete its resolution. ITB holding, one of the shareholders of ITB bank of Russia signed a contract to buy 90 percent of the shares of Zalkar on May 3, 2013. A direct sale transaction was registered in the Kyrgyz Stock Exchange on the same day. The NBKR confirmed that the buyer was deemed fit and proper. The bank was not immediately recapitalized. However, the buyer committed to meet capital requirements during the five months following the election of a new board of directors scheduled for mid June. Staff noted that it will be essential that recapitalization is completed as planned and Zalkar’s operations are closely supervised.

23. The NBKR has advanced the work on the Banking Code. The draft Banking Code that the NBKR prepared with the assistance of the resident legal advisor and TA from the Fund was submitted to the government in early April. The NBKR highly valued IMF assistance in this regard. Staff urged the authorities to resist calls to dilute key features of the draft Banking Code when sending it to parliament. In particular, the scope of judicial review of the NBRK’s actions should be limited and legal protection of the NBKR’s staff enhanced. Furthermore, compulsory bank liquidation should be an out-of-court procedure and the NBKR’s governance should be further enhanced by strengthening internal audit procedures and extending the term of engagement of the NBKR’s external auditors.

24. Staff stressed the importance of swift enactment of amendments to the AML/CFT Law and to the relevant provisions of the Criminal Code, and the Payment System Law. If these amendments are not enacted swiftly, the Financial Action Task Force (FATF) may move the Kyrgyz Republic from the list of jurisdictions under monitoring (gray list) to the list of jurisdictions with strategic AML/CFT deficiencies (black list) that have not made sufficient progress in addressing these deficiencies. It is important to preserve key provisions related to the criminalization of money laundering and financing of terrorism, the definition of suspicious transactions, customer due diligence, the supervisory framework and the status of the State Financial Intelligence Service Unit in line with TA recommendations. The authorities agreed to increase the communication with parliament to ensure that the amendments to the AML/CFT legal framework and the payment system law are adopted swiftly and in line with Fund technical assistance (LOI ¶13).

D. Other Program Issues

25. Program design and modification of performance criteria. The review schedule and timing of disbursements is outlined in Table 11. Revised and new quantitative performance criteria (QPC), indicative targets, are proposed for June, September, and December 2013, and March and June 2014 (LOI Table 1). The authorities are requesting an upward modification of the QPC on the NBKR’s net international reserves for end-June 2013, mostly reflecting higher-than-expected reserve accumulation in 2012, with the subsequent modification of the QPC on the NBKR’s net domestic assets. The authorities are also requesting a downward modification of the QPC on general government overall deficit target for end-June 2013 to reflect the changed profile of external grants. The authorities are requesting a waiver of nonobservance of the continuous PC on the ceiling on contracting or guaranteeing of new nonconcessional debt by public sector based on corrective actions being taken. The structural conditionality—existing and proposed—is summarized in Table 14 and LOI Table 2.

26. Program monitoring will continue to be performed on a semi-annual basis. The fifth review will be based on continuous and end-June 2013 QPC and the sixth review on continuous and end-December 2013 QPC. Structural conditionality will focus on macro-critical areas, particularly strengthening the tax policy function and public expenditure management, which is essential to support fiscal consolidation efforts (LOI Tables 1 and 2).

27. Financing. Donors and the Fund are expected to fill the estimated balance of payments gap in 2013–14 (Text Table 4). In 2013, the authorities are more cautious in projecting donor support, given the disbursement delays in the past. The authorities requested that the fifth and sixth disbursements under the ECF arrangement be directed to the budget.

Text Table 4.

Kyrgyz Republic: Balance of Payment Financing Gaps, 2013–15

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Budget support loan from Turkey.

Article IV Discussions: Achieving Sustainable and Inclusive Growth

28. Discussions centered on policies needed to secure sustainable and inclusive private sector-led growth over the medium term. The authorities agreed that reducing the reliance on external aid and ensuring medium-term fiscal sustainability is essential for macroeconomic stability. They also acknowledged that creating a well-functioning financial sector is needed to support private sector-led growth. Finally, the government agreed that work on improving the regulatory burden on businesses should continue. Traction of previous IMF advice has been broadly satisfactory (Box 1).

A. Promoting Fiscal Sustainability

29. Restoring fiscal sustainability will be essential in the medium term. The authorities recognized that the budget has become more dependent on external assistance since 2009, when the global crisis hit, and 2010, the year of the internal crisis. They also agreed that creating a sound and predictable revenue base and reducing the dependency on external assistance will play a pivotal role in reducing the structural deficit (defined as the nongold structural deficit excluding grants, see Box 4).7 This would help achieve debt sustainability, the key anchor of fiscal policy, with public debt declining to 42 percent by 2018 (see Annex I in Country Report No. 12/139). At about 50 percent of GDP, the Kyrgyz Republic’s public debt is among the highest in the region. Staff noted that with no significant correlation between growth and tax policy, and low fiscal multipliers in small open economies such as the Kyrgyz Republic, fiscal consolidation is not expected to be a significant drag on growth. Staff agreed with the authorities that while cutting inefficient spending is not expected to harm growth, employment and social objectives will need to be safeguarded.

30. The authorities agreed that embarking on a sustainable medium-term fiscal path will require tax policy measures (see Selected Issues Note “Tax Policy in the Kyrgyz Republic”). In particular, staff emphasized measures such as removing tax exemptions and raising rates for import-related taxes. In addition, gradually phasing out the turnover (sales) tax would remove distortions. As an offsetting measure for losses from removing the turnover tax, staff suggested a moderate VAT rate increase. The authorities agreed that some tax policy measures are needed, in particular those related to removing some of existing tax exemptions and raising the excise rates. However, the authorities noted that phasing out the turnover tax and raising the VAT rate would result in an uneven distribution of the tax burden on VAT payers. The authorities argued that they need to conduct a comprehensive analysis of the revenue cost from the current tax policy setting. Staff supported this view and noted that the proposed tax policy measures would help prepare the budget for the loss in nontax revenue from the expected closure of the U.S. transit center at the Manas airport in 2014.

Kyrgyz Republic: Computing Structural Fiscal Balances

The nongold structural balance excluding grants (the structural balance) shows gradual fiscal consolidation that should be maintained going forward.1 In 2009, the structural deficit reached about 12 percent of GDP. Since then, the authorities have been gradually reducing the structural deficit but the dependence on external grants remains strong at 3 percent of GDP on average in 2010–12. While the conventional deficit measure points toward some fiscal expansion in 2012 and 2013, the structural balance shows a negative fiscal impulse, which is similar to the fiscal impulse from the nongold primary structural deficit excluding grants. The cyclically adjusted deficit in 2013, however, indicates a positive fiscal impulse, but this is largely explained by the recovery in the gold sector. To bring the deficit to a sustainable level, the authorities will need to reduce the structural balance to 5 percent of GDP by 2017, implying annual consolidation of 1 percent of GDP. With a structural deficit of 5 percent of GDP, the unadjusted deficit would fall to 1.5 percent of GDP. At this level, with strengthened revenue collection and streamlined expenditure, dependence on external assistance would be lower—grants would decline to 1 percent of GDP by 2017.

Kyrgyz Republic: Fiscal Impulse, 2005–17

(In percent of GDP)

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Sources: Kyrgyz authorities and IMF staff estimates.
uA01fig05

Fiscal Balance, 2005–17

(In percent of GDP)

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff calculations.
uA01fig06

External Assistance and Deficit, 2005–17

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff calculations.
1 Potential GDP was estimated using the Hodrick-Prescott filter. Using the aggregated approach (IMF, 2011) general government revenues and expenditures were adjusted for cyclical changes using commonly assumed elasticities of one for revenues and zero for expenditures. The nongold structural balance was derived by excluding gold-related revenues from total revenues and using cyclically adjusted nongold GDP. No adjustment was made for asset prices (real estate and equities) given their limited association with tax receipts (lack of asset prices data is another constraint). The results should be interpreted with caution, however, as the quality of the estimate of potential output is constrained by the short span of the series.

31. More fiscal space is needed for priority spending. Although the authorities have made progress in achieving the Millennium Development Goals, more work is needed (Table 15). Health, education, and infrastructure remain underfunded, leading to diminishing capacity to generate growth. Notwithstanding increases in spending on social assistance programs in 2012 and a projected rise in 2013 (the cumulative increase in 2011–13 would be 60 percent), it remains low. In addition, security-related spending may have to increase following the withdrawal of NATO troops from Afghanistan. Staff stressed that streamlining expenditures will need to advance forcefully, in particular cuts in inefficient spending, and civil service and public procurement reforms would yield fiscal savings. The authorities agreed that ensuring financial sustainability of the pension system in the medium term and more reforms to beef up social protection and education are needed. Staff also advised to improve targeting of social protection measures to ensure that the most vulnerable segments of the population are reached. A Programmatic Expenditure Review conducted by the World Bank should help the authorities to address these challenges.

Table 15.

Kyrgyz Republic: Millennium Development Goals

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Source: World Development Indicators. Note: Figures in italics refer to periods other than those specified.

B. Supporting Financial Deepening While Maintaining Financial Stability

32. The authorities agreed that creating a deeper financial sector will be critical to generate savings and support private sector-led growth. Staff noted that shallow financial markets remain an impediment for growth. The interest rate channel remains impaired, with the policy rate having little or no impact on lending rates and inflation (see Selected Issues Note “Transmission Channels of Monetary Policy in the Kyrgyz Republic”). The authorities acknowledged that underdeveloped capital markets and weak confidence discourage banks to invest excess liquidity and to de-dollarize.

uA01fig07

Selected Monetary and Banking Indicators

(In percent)

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Sources: Kyrgyz authorities and IMF staff calculations.

33. Staff’s recommendations to strengthen the operational framework for monetary policy received cautious support at the central bank. The NBKR agreed in principle with the staff’s advice—based on recent TA and examples from other countries that have been in a similar position—to introduce the policy rate as an instrument that will signal the monetary stance to the economy and will serve as an operational target for open market operations, instead of the discount rate currently used. However, the NBKR indicated that more analysis and time is needed to review the role, function, and mechanism for setting the policy rate, as well as the role of other instruments necessary to create a corridor around the new policy rate. The NBKR will develop a model with the help of the IMF and EBRD to improve inflation forecasting. The NBKR agreed to further improve its communication about the macroeconomic outlook and forecast through more regular and frequent press briefings, expert and discussion forums, and publishing notes and articles.

C. Strengthening Balance of Payments Stability

34. The real effective exchange rate (REER) is broadly in line with fundamentals (see Selected Issues Note “Exchange Rate Assessment and Reserve Adequacy in the Kyrgyz Republic”). The REER has not changed materially since the previous assessment conducted in mid-2011. Current estimates indicate a small undervaluation of 2.1 percent on average (Text Table 5). Although the current account deficit widened substantially, the nominal exchange rate depreciated by 2 percent in 2012, mainly supported by strong capital inflows from official assistance.8 With the NBKR intervening in the exchange market only in early 2012, the volume of net foreign exchange sales was substantially lower than in 2011. Staff and the NBKR shared the view that maintaining exchange rate flexibility has been crucial for the Kyrgyz Republic to absorb shocks during the crisis and that this practice should continue. The authorities broadly agreed with the staff assessment of the exchange rate.9

Text Table 5.

Kyrgyz Republic: Econometric Assessments of the Real Exchange Rate Disequilibrium 1/

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Positive numbers indicate an overvaluation. Staff estimates using CGER toolkit.

35. However, continuous current account deficits remain a concern for balance of payment stability (see Selected Issues Note “Exchange Rate Assessment and Reserve Adequacy in the Kyrgyz Republic”). The large deficit reflects insufficient national savings relative to investments supported by sizable official external resources. While supporting investment is needed for growth, the accompanying wide current account deficit increases external vulnerabilities. The assessment of foreign reserve adequacy shows that the current level of reserves may not be sufficiently resilient to external shocks or further disruptions in gold production. If the recent drop in the gold price (by US$200 per ounce) lasts throughout 2013, the current account deficit would widen by 1 percent of GDP and foreign reserves would decline by 0.2 months of imports. To reduce such vulnerabilities, raising private and public savings are key. Financial sector reform is expected to support this. Staff projects a gradual decline of the current account deficit on account of these factors, which would be supported by greater diversification of exports and continued fiscal consolidation.

uA01fig08

Selected Reserve Adequacy Indicators-Baseline

Citation: IMF Staff Country Reports 2013, 175; 10.5089/9781475536386.002.A001

Source: IMF Staff calculations.

D. Improving Competitiveness Through Structural Reforms

36. Staff argued that despite improvements in the business climate legislation, implementation is lagging behind (see Selected Issues Note “Business Environment and Governance”). Weak economic governance and a high level of perceived corruption are still seen as key hurdles to the development of the Kyrgyz economy. The authorities agreed that creating a level playing field for all businesses and more decisive business environment and governance reforms are needed to boost medium- and long-term growth, promote diversification, increase FDI, and raise employment. The government is also committed to resolve the dispute with Centerra constructively to ensure that it does not lead to disruptions in gold production and hurt the overall investment climate. It agreed that a stable and predictable investment climate with proper contract enforcement, strengthened property rights, less red tape, and addressing corruption are essential for attracting investment and spurring private sector-led growth.

37. Staff emphasized the importance of strengthening transparency and accountability in the energy sector. Below cost-recovery electricity tariffs, weak governance, and a poor regulatory framework render the energy sector financially unviable and unattractive for investment. Energy sector finances suffer from a long overdue need to raise domestic electricity tariffs, which the government finds difficult to implement on the back of political economy considerations. To date, poor management of the sector has led to asset dilapidation. The quasi-fiscal deficit in the energy sector, estimated at around 3 percent of GDP, is unsustainable with the current tariffs at below cost recovery levels.

38. The staff reiterated that the State Development Bank (SDB) will have to operate in line with principles of good governance and transparency (see Selected Issues Note “Best Practices for Establishing Development Banks”). The authorities are drafting the regulations of the State Development Bank (SDB) in line with the law approved by parliament. The government agreed that all SDB regulations need to be consistent with international best practices and principles of good governance and transparency. The authorities reiterated their commitment to cooperate closely with IMF staff and the other donors on the SDB charter (LOI ¶15).

39. The full effect of possible accession to the Kazakhstan-Russia-Belarus Customs Union (CU) is unclear at this stage and will depend on the outcome of negotiations. This year, the authorities intend to develop a road map for joining the CU. The road map will define the legal and technical framework of accession compliant with WTO requirements. Accession to the CU is expected to secure the current concessional terms for oil products imported from the CU countries, mainly Russia. External tariffs for non-CU countries could increase, reducing the Kyrgyz Republic’s attractiveness for Chinese imports for re-export to other CIS countries. The authorities noted that over time, accession could enable the Kyrgyz Republic to take advantage of increased regional trade, which could boost investment in the country. Staff advised the authorities to carefully examine the challenges as well as the benefits of accession to the CU. The authorities have commissioned an in-depth study on the impact of CU accession.10

Staff Appraisal

40. The Kyrgyz economy is recovering well after contracting in 2012, but vulnerabilities remain. The disruption in production in the largest gold-mining company took a heavy toll on the economy, resulting in a negative overall growth rate and a higher current account deficit. GDP in 2013 is expected to grow by 7.4 percent, and inflation should settle at around 7 percent. Persistent current account deficits remain a concern for balance of payments stability. However, beginning in 2013 the current account deficit is projected to decline mainly on the back of higher export earnings and robust growth of remittances. A slowdown of growth in the main trade partners, Russia and Kazakhstan, or disruptions in gold production and lower-than-expected gold prices, pose risks.

41. Improving the business climate, governance, and institutions remains a key pillar of sustainable and inclusive growth. A stable and predictable investment climate and addressing perceived corruption will be essential for attracting more investment. Evenhanded and consistent application of the existing business legislation would improve business confidence and foster high and sustainable private sector-led growth. The authorities’ continued commitment to cooperate with staff on the setup of the SDB is welcome and will help ensure that the SDB is established in line with the commitments under the ECF arrangement and does not jeopardize macro-financial stability.

42. Restoring fiscal sustainability will be essential, as the budget has become more dependent on external assistance since the 2009 global and 2010 domestic crises. In the near term, fiscal consolidation is expected to be achieved through nonpriority expenditure restraint, PFM reforms, and further strengthening tax administration. Over the medium term, creating a sound and predictable revenue base and reducing the dependency on external assistance will play a pivotal role in reducing the structural deficit. The recent move of the tax policy function back to the ministry of finance is welcome as it should help shield tax policy decisions from political considerations and pave the way for better revenue performance in the future. The authorities are also mindful of the need to create fiscal space for priority spending, such as health, education, and infrastructure accompanied with the improvement in the quality of spending. The planned work on pension reform will be instrumental to make the pension system more equitable and affordable and financially viable in the future.

43. Tight monetary policy continues to be warranted to keep inflation at bay. The central bank needs to stand ready to mop up excess liquidity through NBKR notes and gradually increase the policy rate to better signal the monetary stance to the market. The NBKR needs to effectively use the recent IMF TA findings and recommendations to overhaul its current monetary policy framework, notwithstanding its limited means to impact economic activity and inflation. This will lay the ground work for a more sophisticated monetary policy framework that will enable the NBKR to exercise better control over inflation. It is crucial that the NBKR continues resisting pressures to lend in support of the economic growth.

44. The financial system is broadly stable, but vulnerabilities remain. Although it took longer than anticipated, the sale of Zalkar is welcome and should help boost confidence in the financial sector. However, it will be essential that the bank is in full compliance with capital requirements by end-2013. Disposing of the remaining 10 percent of the bank’s shares would reaffirm the government’s commitment to strengthen financial sector stability. The banking code, once approved, will constitute a milestone toward restoring confidence in the banking system, leveling the playing field and setting the stage for higher private savings. It will also strengthen the NBKRs independence in dealing with problem banks. It is essential that the key features of the Code are preserved during the parliamentary approval process. In particular, compulsory bank liquidation should be an out-of-court procedure and the NBKR’s autonomy and governance should be further enhanced. Timely enactment of the amendments to the AML/CFT Law (customer due diligence, supervisory framework, and the Financial Intelligence Unit) and to the relevant provisions of the Criminal Code, and the Payment System Law will be necessary to avoid the very strong possibility that the Kyrgyz Republic is placed on the FATF AML/CFT strategic deficiencies black list.

45. Staff recommends completion of the fourth review and approval of the request for a waiver of nonobservance of the continuous PC on the ceiling on contracting or guaranteeing of new nonconcessional debt by the public sector based on corrective actions being taken. Staff also recommends approval of the request for modification of the performance criteria for end-June 2013, and establishment of new performance criteria for end-December 2013. The modified performance criteria and policies for the remainder of 2013 are appropriate to achieve the program’s objectives.

46. The staff recommends that the next Article IV consultation with the Kyrgyz Republic be held in accordance with the Board Decision No. 14747-(10/96), adopted September 28, 2010 (as amended), on Article IV consultation cycles.

Appendix I. Letter of Intent

May 20, 2013

Ms. Christine Lagarde

Managing Director

International Monetary Fund

700 19th street, N.W.

Washington, DC, 20431

USA

Dear Ms. Lagarde:

The third review of our economic and financial program, supported by an arrangement under the Extended Credit Facility (ECF), was completed by the IMF Executive Board on December 3, 2012. We are grateful to the IMF for its continued support of our economic reform program.

The ECF arrangement continues to play a critical role in our efforts to maintain macroeconomic stability and promote sustainable and inclusive growth in a low inflation environment. The program has been fundamental in stabilizing the Kyrgyz economy and in consolidating much-needed financial support from donors following the 2010 events. While the economy rebounded strongly in 2011, 2012 turned out to be a challenging year. The political environment has been stable since a new cabinet took over in September 2012, but the disruption in gold production in the largest gold-mining company took a heavy toll on the economy with negative overall growth and a higher current account deficit.

Notwithstanding these challenges, the program remains broadly on track and the government is committed to the reform path under the ECF arrangement. For the fourth review of the ECF-supported program, all performance criteria, except one continuous performance criterion, and all but one of the structural benchmarks were met. However, indicative targets on reserve money and state government tax collections were missed. Structural reforms continued in line with our commitments in the Letter of Intent (LOI) and the Memorandum of Economic and Financial Policies (MEFP) dated June 2, 2011 and the LOIs dated November 17, 2011; April 12, 2012; and November 14, 2012. The government has submitted the anti-money laundering and countering the financing of terrorism (AML/CFT) law and the relevant provisions of the Criminal Code to parliament in December 2012. We have revised the privatization strategy of the Settlement and Savings Company to ensure the disposal of a majority government stake and adopted it on February 27, 2013. We have made significant progress in drafting the new Banking Code with the help of the IMF resident legal advisor and submitted the Code to the government in March 2013. We adopted a government resolution on the procedures for submission of budgets of the next 10 largest state-owned enterprises (SOEs) to be approved and monitored by the government. Regrettably, we were not able to sell Zalkar Bank within the timeframe under the ECF arrangement. However, we managed to sell Zalkar Bank to a fit and proper buyer in early May. The “Electrical Stations”—one of the 10 largest SOEs—signed a nonconcessional loan agreement with the Eurasian Development Bank, in the amount of US$30 million on February 21, 2013, leading to the nonobservance of the continuous quantitative performance criterion on the contracting of new nonconcessional external debt.

In view of the broadly successful implementation of the program to date and our continued commitment to the program, we request completion of the fourth review under the ECF-supported program, and a waiver for missing the continuous quantitative performance criterion on the ceiling on contracting or guaranteeing of new nonconcessional external debt based on corrective actions being taken. We request the fifth disbursement under the ECF arrangement in the amount of SDR 9.514 million (US$14 million). We ask that the fifth and sixth disbursements under the ECF arrangement be channeled to the budget. Moreover, we request the modification of the end-June 2013 quantitative performance criteria to reflect the changed macroeconomic outlook. The government believes that the economic and financial policies set forth in our LOI and MEFP of June 2, 2011, LOIs of November 17, 2011; April 12, 2012; and November 14, 2012, supplemented with this LOI and the modified quantitative performance criteria and updated structural benchmarks (Tables 1 and 2, respectively) are adequate to meet the objectives of the ECF arrangement. During the period of the ECF arrangement, the Kyrgyz government will continue to maintain a policy dialogue with the Fund and stands ready to take additional measures as needed. We will consult with Fund staff on such measures and in advance of revisions contained in the MEFP dated June 2, 2011, LOIs of November 17, 2011; April 12, 2012; and November 14, 2012 and this updated LOI in accordance with Fund policies.

Table 1.

Kyrgyz Republic: Quantitative Performance Criteria and Indicative Targets Under the Extended Credit Facility, September 2012–June 2014

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

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

As defined in the TMU.

Cumulative from the beginning of the year.

The continous QPC was missed in February 2013.

Table 2.

Kyrgyz Republic: Structural Benchmarks under the Extended Credit Facility, 2012–13

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As in the past, the government of the Kyrgyz Republic agrees to publish this letter and other ECF-related documents circulated to the IMF Executive Board on the IMF website.

I. Policies for the Remainder of the Year and Beyond

1. The policies and commitments set out in the LOI and MEFP dated June 2, 2011, the LOIs dated November 17, 2011; April 12, 2012; and November 14, 2012, remain valid and are updated with this LOI.

2. Maintaining macroeconomic stability remains the cornerstone of our program.

  • Growth in 2013 is expected to rebound on the account of the recovery in the gold production and continued strong performance in the nongold sector. We expect growth to be 7 percent on average over the next three years, before stabilizing at 5 percent thereafter.

  • Twelve-month inflation dropped slightly over the first three months of 2013 mainly because of a continued decline in food prices. We will continue to keep monetary conditions tight to maintain inflation in single digits in 2013 and beyond.

  • The current account deficit is projected to decline in 2013, mainly reflecting the recovery in gold exports. We anticipate that the current account deficit will continue to decline over the medium term.

  • Fiscal consolidation is expected to continue in line with the path set out under the ECF arrangement. The fiscal deficit is projected at 5.3 percent in 2013 and expected to decline to 2.6 percent by 2015.

  • Public debt in percent of GDP is projected to remain on its downward path in the medium term.

3. We are mindful of the risks to our medium-term projections. A deterioration of global economic conditions could spill over to the Kyrgyz economy through reduced external demand and lower remittances from Russia and Kazakhstan. Moreover, a sustained increase in international food and fuel prices could put pressure on inflation and exacerbate external vulnerabilities.

A. Fiscal Policy

4. Because of shortfalls in revenues and external financing in 2012, we cut nonpriority outlays, while safeguarding critical social expenditures. Lower gold production has led to a decline in gold-related revenues. Delays in implementing structural measures agreed with the World Bank added to revenue and financing shortfalls. The revenue-smoothing arrangement, which we negotiated with the Kumtor gold company, and buoyant customs revenues throughout the first nine months of 2012 have partially offset the shortfall in revenues. However, growth in customs revenues decelerated in late 2012. Owing to the decline in the overall resource envelope, we reduced spending on goods and services and capital projects while maintaining social outlays. At the same time, the implementation of foreign-financed energy infrastructure projects was faster than expected. In late 2012, we received external grants that led to a better-than-anticipated overall fiscal deficit—5.4 percent of GDP compared to 6 percent of GDP projected earlier.

5. We continue to place strong emphasis on fiscal consolidation in 2013 and the medium term. The government is basing the 2013 budget on conservative revenue forecasts, nonpriority expenditure restraint, and social considerations. The overall fiscal deficit is expected to decline to 5.3 percent of GDP, in line with our commitment to consolidate the fiscal position.

  • We do not expect the exceptionally strong growth in customs revenues to continue in 2013. Therefore, tax revenues are no longer anticipated to reach budgeted levels. Nontax revenues in percent of GDP are also expected to decline because of the reform to regularize government provided fee-based services.

  • We are continuing our efforts to strengthen tax administration and to reduce noncompliance, including with the support from the IMF. We are implementing a formal compliance improvement plan for several sectors that pose a significant revenue compliance risk. Technical assistance from the IMF would help us identify key challenges in tax administration and provide us with recommendations regarding future priorities and options for reforms.

  • The government remains committed to reducing the overall wage bill in percent of GDP. Savings generated by the ongoing civil service reform will allow us to increase wages in segments of the public sector. The ongoing public procurement reform, including the pending introduction of e-procurement, will also generate fiscal savings by reducing outlays on goods and services.

  • We will ensure that the pension increase in 2013 continues to be tied to the changes in the minimum subsistence level. We intend to submit the draft pension reform concept note to parliament in October. This concept note will propose various options for making the pension system more equitable and affordable, but will also discuss ways to ensure financial sustainability of the pension system.

6. We continue to improve debt management and to reduce the debt service burden on the budget. The medium-term debt management strategy, adopted as part of conditionality under the ECF arrangement, will be updated this year. We acknowledge that transforming the government securities market into a deep and liquid market will take time. To develop the domestic debt market, we are improving the operational infrastructure for the primary market of government securities at the National Bank of the Kyrgyz Republic (NBKR), which will remain the government agent for conducting primary auctions and the central depository for all government securities. We discontinued direct sales of government securities by the ministry of finance and will ensure that the sales take place only at organized auctions. The upcoming Financial Stability Assessment Program will assist us in identifying reform options to deepen the domestic debt market.

7. We are strengthening the role of the ministry of finance in core aspects of fiscal policy. We returned the tax policy function to the ministry of finance and will create a new, adequately staffed, department on tax policy in the ministry of finance (structural benchmark). This department will become the focal point on all tax policy-related matters. The government expects comprehensive technical assistance from the IMF in this area. We expanded the coverage of the reporting requirements for the 10 largest state-owned enterprises (SOEs) to 20. The expansion of the list should help mobilize additional revenues and limit potential fiscal costs through improved monitoring. We will ensure that all reports from these SOEs are shared regularly with the ministry of finance. To prevent the 10 largest SOEs, which are part of the public sector, from contracting nonconcessional loans, which recently led to nonobservance of the continuous performance criterion, we will issue a government resolution requiring these SOEs to provide all information on their borrowing plans and debt service. With this information, the ministry of finance can prevent the SOEs from contracting nonconcessional loans or incurring external arrears.

8. We continue our work on public financial management (PFM) reform and will work with parliament to ensure that the new Budget Code is in line with recent IMF technical assistance advice. The government has recently updated the action plan on PFM reforms. As part of this plan, we have developed a draft law on public procurement, which we will submit to parliament for approval in June. This law is expected to enhance the transparency and efficiency of public spending. We will issue a regulation on expanding the coverage of the commitment register to include local budgets and special means. The ministry of finance will also develop and approve regulations on accounting and financial reporting using the unified chart of accounts on the basis of international norms (structural benchmarks). We expect that these measures will enhance control over public spending.

B. Monetary, Exchange Rate, and Financial Sector Policies

9. The NBKR will maintain a tight monetary policy stance to keep inflation in single digits in 2013 and beyond. Core inflation remains stubbornly high and the expected recovery in economic activity this year may add to inflationary pressures. We will respond to these pressures by further tightening monetary policy. However, declining international food and fuel prices are expected to partly offset the pressures. We acknowledge that second-round effects of unexpected external price shocks will require further policy actions. The NBKR will maintain its policy of intervening in the foreign exchange market only to smooth excessive volatility and ensure orderly market conditions.

10. We plan to strengthen the operational framework for monetary policy in order to improve transmission channels. We welcome suggestions of the recent IMF technical assistance mission in inflation modeling and monetary tools. We will review the role, function, and mechanism for setting the policy rate to better signal the monetary stance to the economy, as well as the role of other instruments necessary to create a corridor around the new policy rate. To better withdraw excess liquidity, we will conduct timely and sufficient OMOs and reassess the maturity of notes used for OMOs. The potential adverse impact on NBKR profits will not be a constraint to the implementation of monetary policy. The NBKR and the ministry of finance will continue the close cooperation to facilitate liquidity management. We will further improve the NBKR’s communication about the macroeconomic outlook and the NBKR’s forecast through more regular and frequent press briefings, expert and discussion forums, and publishing notes and articles. We will develop a model with the help of the IMF and EBRD during this year to improve inflation forecasting and better understand economic relationships in our country.

11. We plan to improve reserve management in line with IMF technical assistance recommendations. The NBKR will develop a comprehensive strategic asset allocation framework and will continue to develop the investment policy further. We intend to review governance procedures and the role of different committees, as well as the risk management framework related to the reserve management activities. We will provide adequate resources (IT, staffing, training, and support from other units) to support the reserve management function in the NBKR.

12. Our financial sector remains broadly sound. Banks are well capitalized and liquid, and nonperforming loans continue to decline. Deposits and loans have also increased. We continue our efforts to address remaining vulnerabilities in the banking sector:

  • The government has intensified its efforts to sell Zalkar Bank to a fit and proper buyer. In early May, we managed to sell 90 percent of Zalkar’s shares to one of the shareholders of ITB bank of Russia (ITB holding). We will ensure that the bank is in full compliance with capital requirements by end-December 2013.

  • We will send the Banking Code to parliament by end-September 2013, in line with our commitments under the ECF arrangement. We will ensure to communicate to parliament the major benefits of the new code so that it is approved in line with IMF TA advice.

13. We will work with parliament to ensure that the amendments to the AML/CFT legal framework and the payment system law are adopted swiftly and in line with Fund technical assistance. The Fund technical assistance missions discussed with us the draft provisions of the Criminal Code (on the criminalization of money laundering and financing of terrorism, and confiscation), the Terrorist Assets Freezing Regulations, and the AML/CFT Law (customer due diligence, supervisory framework, and the Financial Intelligence Unit) that were altered during the parliamentary committee review process. We will urge parliament to bring the relevant provisions of these legislations and the provisions on identification of suspicious transactions and on State Financial Intelligence Service in line with IMF TA advice. We will also urge parliament to adopt and publish the AML/CFT law together with the payment system law swiftly. Timely action would help avoid that the Financial Action Task Force places the Kyrgyz Republic on its black list in June 2013.

C. Structural Policies

14. We recognize the need to further improve the business environment, a key pillar of sustainable and inclusive growth. We acknowledged that weak governance is still seen as one of the key impediments to the development of our economy. We will put all our efforts toward a constructive resolution of the dispute with Centerra to ensure that it does not lead to disruptions in gold production. A stable and predictable investment climate with proper contract enforcement, strengthened property rights, less red tape, and addressing corruption are essential for attracting investment and spurring private sector-led growth.

15. We will continue close cooperation with IMF staff and other donors on the set-up and operations of the state development bank (SDB). We are also studying successful examples of development banks in other countries and will reflect on their experience. The government will ensure that all regulations of the SDB currently being drafted are consistent with international best practice and principles of good governance and transparency. All public resources to the SDB will be channeled through the budget.

D. Program Monitoring

16. The ECF-supported program will continue to be monitored through quantitative performance criteria, indicative targets, and structural benchmarks. Quantitative performance criteria and indicative targets for March 2013, June 2013, September 2013, December 2013, March 2014, and June 2014 and continuous performance criteria are set out in Table 1 and structural benchmarks are set out in Table 2. Program reviews will continue to be conducted semi-annually, based on end-June and end-December test dates. The fifth and sixth reviews are expected to take place on or after November 15, 2013, and on or after April 30, 2014, respectively. The understandings between the Kyrgyz authorities and IMF staff regarding the quantitative performance criteria and structural benchmarks described in this LOI and reporting requirements are further specified in the Technical Memorandum of Understanding as updated in the attached.

Sincerely yours,

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Attachment I. Revised Technical Memorandum of Understanding

May 20, 2013

I. Introduction

1. This memorandum defines the quantitative performance criteria, indicative targets and adjustors, and establishes the content and frequency of the data to be provided to IMF staff for program monitoring related to the economic program supported by an arrangement under the Extended Credit Facility (ECF). The indicators presented in Table 1 of the Letter of Intent dated May 20, 2013 reflect the understandings on quantitative performance criteria reached between the authorities of the Kyrgyz Republic and staff of the IMF.

Table 1a.

Kyrgyz Republic: Ten largest SOEs

(Included in the public sector)

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Table 1b.

Kyrgyz Republic: Other SOEs

(To be monitored, not included in the public sector)

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II. Quantitative Performance Criteria

A. Definitions and Concepts

2. Test dates. Quantitative performance criteria are set semi-annually starting June 30, 2011 through December 31, 2013, and are to be met at the end of each period.

3. National Bank of the Kyrgyz Republic (NBKR). The NBKR is the central bank of the country and is responsible for the formulation and implementation of monetary policy, bank supervision, and the payment system. For the purpose of the program, the NBKR includes all its central and regional offices.

4. Public sector. For the purpose of the program, the public sector comprises the general government, the NBKR, the 10 largest nonfinancial public enterprises (enterprises and agencies in which the government owns more than 50 percent of the shares, but which are not consolidated in the budget, as listed in Table 1a), and any other newly created public development institution. The State budget comprises central and local government budgets. The general government budget includes the State and Social Fund budgets.

5. Foreign-financed Public Investment Program (PIP) loans and grants. The foreign financed PIP is a program of investments in infrastructure and social sectors agreed by the general government of the Kyrgyz Republic and its donors (including but not limited to international financial organizations). The PIP is fully financed by related grants and loans.

6. Program loans and grants are loans and grants received by the general government for direct budget support from external donors and not related to PIP financing.

7. The stock of external payment arrears for program monitoring purposes is defined as the end-of-period amount of external debt service due and not paid within the grace period specified in the relevant debt contract, including contractual and late interest. For arrears to exist, a creditor must claim payment of amounts due and not paid. Amounts in dispute are not considered arrears. Arrears for which a clearance framework/rescheduling or restructuring has been agreed with the creditor are not considered arrears for program monitoring purposes. Program arrears would include any debt service due under such agreements that has not been paid.

8. Concessional and nonconcessional debt. Concessional debt is defined as debt with a grant element equivalent of 35 percent or more. The grant element of a debt is the difference between the present value (PV) of the debt and its nominal value, expressed as a percentage of the nominal value of the debt. The PV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the Organization for Economic Cooperation Development (OECD). For debt with a maturity of at least 15 years, the ten-year-average CIRR will be used to calculate the PV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. To both the ten-year and six-month averages, the same margins for differing repayment periods as those used by the OECD need to be added (0.75 percent for repayment periods of less than 15 years, 1 percent for 15 to 19 years, 1.15 percent for 20 to 29 years, and 1.25 percent for 30 years or more). The debt refers also to commitments contracted or guaranteed and for which value has not been received. The calculation of concessionality will take into account all aspects of the loan agreement, including maturity, grace period, payment schedule, upfront commissions, and management fees. The calculation is performed by the authorities and verified by the IMF staff based on the data provided by the authorities.

9. Valuation changes (program exchange rates). For program monitoring, U.S. dollar-denominated components of the NBKR’s balance sheets will be valued at the program exchange rates. The program exchange rate of the KGS to the U.S. dollar is set at the end-2010 exchange rate of KGS 47.0992 = US$1. The corresponding cross exchange rates and program gold price for the duration of the program are provided in Table 2.

Table 2.

Kyrgyz Republic: Program Cross Exchange Rates and Gold Price

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B. Quantitative Performance Criteria
Floor on net international reserves of the NBKR in convertible currencies1
Definitions

10. Net international reserves (NIR) of the NBKR. The floor on NIR will be calculated as the difference between total international reserve assets and total international reserve liabilities of the NBKR in convertible currencies. Total international reserve assets of the NBKR are defined as the NBKR holdings of monetary gold, holdings of SDRs, reserve position in the IMF, and any holdings of convertible foreign currencies in cash or with foreign banks, and debt instruments issued by nonresidents that are liquid. Accrued interest on deposits, loans, and debt securities are included in reserve assets and liabilities, correspondingly. Reserve assets pledged as collateral or otherwise encumbered, capital subscriptions in foreign financial institutions, and illiquid assets of the NBKR are excluded. Also excluded are net forward positions, defined as the difference between the face value of foreign-currency denominated NBKR off-balance sheet claims on nonresidents and foreign currency obligations to both residents and nonresidents. Total international reserve liabilities of the NBKR in convertible currencies are defined as the sum of Kyrgyz Republic’s outstanding liabilities to the IMF and other convertible currency liabilities to nonresidents with an original maturity of up to and including one year. NIR is not affected when foreign assets are received by the NBKR through foreign currency swaps with resident financial institutions. Total international reserves and NIR decline with the provision of foreign assets by the NBKR through foreign currency swaps with resident financial institutions.2 For program monitoring purposes, total international reserve assets and liabilities will be valued at the program exchange rates as described in paragraph 9. Thus calculated, the stock of net international reserves in convertible currencies amounted to US$1,819 million on December 31, 2012.

11. Net foreign assets (NFA) of the NBKR. NFA consist of net international reserve assets plus other net foreign assets, including the medium- and long-term foreign obligations of the NBKR, other net claims on CIS countries, reserve assets pledged as collateral or otherwise encumbered, capital subscriptions in foreign financial institutions, and illiquid assets. For program monitoring purposes, other NFA will also be valued at program exchange rates.

Adjustors

12. The floor on NIR will be adjusted upward/downward to the full extent of any excess/shortfall in program grants and program loans, as given in Table 3 and upward/downward to the full extent that amortization and interest payments of public external debt is less/more than the amortization and interest payments given in Table 3.

Table 3.

Kyrgyz Republic: Projected Budget Support, PIP, and Amortization

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Cumulative disbursements since the beginning of the year.

Ceiling on the net domestic assets of the NBKR
Definitions

13. Net domestic assets of the NBKR (NDA) are defined as reserve money of the NBKR (defined below), minus NFA as defined above. Items in foreign currencies will be valued at program exchange rates.

14. Thus defined, NDA consist of: (a) net claims to the general government from the NBKR; (b) net claims to other depositary corporations by the NBKR; (c) net claims on other financial corporations; and (d) all other net assets of the NBKR (other items net). Thus defined, the stock of NDA amounted to minus KGS 16,271 million on December 31, 2012.

Adjustors

15. The ceiling on NDA will be adjusted downward/upward to the full extent of any excess/shortfall in program grants and program loans, as given in Table 3 and downward/upward to the full extent that amortization and interest payments of public external debt is less/more than the amortization and interest payments given in Table 3.

Ceiling on the cumulative overall cash deficit of the general government
Definitions

16. The overall cash deficit of the general government will be measured from the financing side (below the line) at current exchange rates and will be defined as the sum of:

  • a) the change in the stock of net claims of the domestic banking system and nonfinancial institutions and households on the general government. The change in the stock of net claims of the domestic banking system on the general government is defined as the change in the stock of the banking system claims on the general government, less the change in the stock of all deposits of the general government with the banking system. The claims of the banking system on the general government include: bank loans to the general government; any securities issued by the general government and held by domestic banks, with the exception of those issued in relation with bank rescue operations; and overdrafts on the current accounts of the general government with banks;

  • b) the change in the stock of net claims of foreign governments, banking systems, and nonfinancial institutions and households on the general government;

  • c) net privatization receipts, i.e. any new sales net of purchases of shares;

  • d) net foreign loans disbursed to the general government for budgetary support; and

  • e) net foreign loans disbursed to the general government for PIP financing.

17. The quantitative performance criteria for the fiscal balance are calculated on the projected exchange rate. Reporting and adjustments, as defined above, will be made using current exchange rates.

Adjustors

18. The ceiling on the cumulative overall cash deficit of the general government will be adjusted downward to the full extent of any excess in program grants, as given in Table 3. The ceiling on the cumulative overall cash deficit of the general government will be adjusted downward to the full extent of any shortfall in program loans, as given in Table 3 and upward/downward to the full extent that PIP loans are more/less than PIP loans given in Table 3.

Ceiling on contracting or guaranteeing of new nonconcessional external debt and accumulation of new external payment arrears by the public sector (continuous quantitative performance criteria)
Definitions

19. Debt. In connection with the contracting or guaranteeing of short-, medium-, and long-term external debt by any entity of the public sector, for program purposes, the definition of debt is set out in Executive Board Decision No. 6230–(79/140, Point 9, as revised on August 31, 2009 (Decision No. 14416–(09/91)) and reads as follows:

  • a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

    • i. loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

    • ii. suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until sometime after the date on which the goods are delivered or services are provided; and

    • iii. leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

  • b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

20. For program purposes, external debt is defined based on the residency of the creditor.

21. External debt ceilings apply to the contracting or guaranteeing by the public sector (as defined in section II. A., paragraph 4) of nonconcessional external debt, i.e. external debt with grant element of less than 35 percent (see section II. A., paragraph 7), except normal short-term import-related credits and NBKR international reserve liabilities.

22. Exclusions from the external debt limits. Disbursements by the IMF are excluded from the ceilings on external debt. Also excluded from external debt ceilings is the contracting or guaranteeing of new external debt that constitutes a rescheduling or refinancing of existing external debt on the terms more favorable to the debtor.

23. Guarantees. For program purposes, the guarantee of a debt arises from any explicit legal obligation of the public sector to service a debt in the event of nonpayment by the debtor (involving payments in cash or in kind), or from any implicit legal or contractual obligation of the public sector to finance partially or in full a shortfall incurred by the debtor.

24. New external payments arrears. The ceiling on accumulation of new external payments arrears is a continuous quantitative performance criterion.

C. Indicative Targets
Ceiling on reserve money

25. Reserve money is defined as the NBKR’s national currency liabilities to the economy, which includes currency issued and liabilities to other depositary corporations.

Cumulative floor on state government tax collections

26. Tax collections in cash correspond to the line “Tax Receipts” in the Treasury Report and comprise the following categories: tax on income and profits; taxes on goods and services; specific taxes on services; turnover taxes; taxes on property; taxes on international trade; and other taxes. Tax collections include collections of tax arrears but exclude tax offsets.

Cumulative floor on state government spending on targeted social assistance

27. Targeted social assistance spending comprises state government spending on Unified Monthly Benefit (UMB) and Monthly Social Benefit (MSB) programs.

III. Reporting Requirements Under the Arrangement

28. The government and the NBKR will provide the IMF with the necessary economic and financial statistical data to monitor economic developments and the quantitative targets (see Table 4). In particular, the government and the NBKR will provide the following specific information.3

Table 4.

Kyrgyz Republic: Reporting Requirements/Frequency Under the Arrangement

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A. The Balance Sheet of the NBKR

29. The NBKR will provide to the IMF its analytical balance sheet on a daily basis. The information provided will clearly identify the following items in the definitions specified above: the gross foreign assets and liabilities of the NBKR, decomposed by currency and instrument for the assets and by currency and creditor for the liabilities (decomposition provided on a monthly basis); the net foreign assets of the NBKR; the net international reserves of the NBKR; medium-and long-term liabilities; the net domestic assets of the NBKR; net credit from the NBKR to the general government, disaggregated by state government and the KRDF; net credit from the NBKR to commercial banks; net claims to other financial corporations; other items net; and reserve money. The balance sheet will be provided using both actual and program exchange rates. The above information will be provided to the IMF Resident Representative and/or transmitted by e-mail to the IMF.

B. Monetary Survey

30. Monthly banking system data, in the form of monetary surveys of the banking sector and other depository corporations, will be reported to the IMF by the NBKR within 16 days of the end of the month. The information provided will clearly identify the following items: net foreign assets and net domestic assets of the banking system, medium- and long-term liabilities, net credit from the banking system to the general government disaggregated by the state government, the social fund and the KRDF, net claims to the rest of the economy, other items net, and broad money. The monetary survey will be provided using both program and actual exchange rates.

31. The NBKR will provide monthly data to the IMF within seven days after the end of the month on the amount of holdings of treasury bills, treasury bonds and other securities issued by the state government, differentiated by the following categories of holders: the NBKR; resident banks; resident nonbanks (including separately the social fund and deposit insurance fund); and nonresidents. The information will be provided in both the book (nominal) value and the actual value, where applicable.

C. International Reserves and Key Financial Indicators

32. The NBKR will provide detailed monthly data within 20 days from the end of the month on the composition of both its gross and net international reserves in convertible currencies and holdings of monetary gold. These data will be provided at two alternative sets of the exchange rates and the gold price: first, at those used to derive the NFA position in the NBKR accounts; and second, at those specified in the program (see Section I). The NBKR will also provide data on net foreign financing flows, including disbursements of program loans and grants, amortization, interest payments on external debt, interest income on reserves, other direct foreign currency payments by the government and the NBKR. In addition, weekly reports should be sent to the IMF on (a) nominal exchange rates (including the official and interbank exchange rates), foreign exchange interbank market turnover, and the volume of NBKR foreign exchange sales and purchases in the domestic interbank market and with other parties, on a daily basis; and (b) treasury bill yields and the amount of treasury bill sales and redemptions on a weekly basis every Monday. On the twenty-fifth day of the month following the reference month, the NBKR will provide indicators of financial soundness of the banking system, including the ratios of regulatory capital to risk-weighted assets, nonperforming loans to total loans, and return on equity, as well as data on bank deposit and lending rates by maturity.

D. External Debt

33. The ministry of finance, together with the NBKR, will provide monthly information on the disbursements, principal and interest payment—both actual and falling due—on contracting and guaranteeing of medium- and long-term external loans by the state government, nonfinancial public enterprises, and the NBKR; and any stock of outstanding arrears on external debt service payments within 21 days of the end of each month. In addition, the ministry of finance will report the total amount of outstanding government guarantees and external arrears on a monthly basis. While the NBKR will provide the debt service payment data on private debt, the ministry of finance will provide data on debt service on public and publicly guaranteed loans.

E. Budgetary and Extra Budgetary Data

34. In addition to the monthly treasury report, the Social Fund will report monthly on its operations. This information will be provided to the Fund staff within 26 days from the end of each reference month. The ministry of finance will also provide monthly reports on the disbursements and use under the public investment program and budgetary grants with a one-month time lag.

F. Balance of Payments Data

35. The NBKR will provide current account and capital account data, including data on foreign trade, services, official and private transfers, foreign investment, and disbursements of public and private loans, on a quarterly basis, with at most a three-month lag. The NBKR will also provide monthly foreign trade data with a two-month lag.

G. Other General Economic Information

36. The National Statistics Committee will notify the IMF of the monthly Consumer Price Index by category by the fifteenth business day of the following month, and convey monthly GDP estimates within 30 days of the end of each month.

1

See IMF Country Report No. 12/329.

2

The Electric Power Station, which is part of the public sector, signed a credit line with the Eurasian Development Bank for a total amount of US$30 million (0.5 percent of GDP). The loan does not have a material impact on the debt outlook.

3

With the recent agreement on Russia’s duty free exports of oil products to Tajikistan, Kyrgyz fuel imports are expected to be lower on account of lower fuel re-exports to Tajikistan.

4

Because the loan from Turkey (US$90 million over 2013–15) was reclassified from a PIP loan to a budget support loan (based on a recent agreement between the Kyrgyz and Turkish governments), foreign-financed capital investment is projected to decline with a corresponding increase in current spending in 2013–14.

5

Under the 2009 agreement, Kumtor pays 13 percent of gross revenue. If Kumtor were to operate under the common tax regime, it would pay income tax (11 percent at the current gold price), royalty (5 percent), sales tax (2 percent), and a tax on maintaining infrastructure (2 percent).

6

No new information is available on these projects. A company to conduct the feasibility study was selected recently. The results are expected later this year.

7

The fiscal impulse from the nongold primary structural deficit excluding grants is similar to the one from the nongold overall structural deficit excluding grants.

8

Balance of payments data remains deficient and subject to uncertainties. The authorities are addressing these deficiencies with the help of IMF TA.

9

The Kyrgyz Republic maintains a Multiple Currency Practice (MCP), which predates the ECF arrangement. The official rate may differ by more than 2 percent from market rates because it is based on the average transaction weighted rate of the preceding day. In practice, this has never happened. New trading software in the foreign exchange market, which is being tested currently, is expected to eliminate the existing segmentation of the foreign exchange market and remove the MCP.

10

The European Bank for Reconstruction and Development highlights in its “Transition Report 2012: Integration across Borders” that the CU could bring benefits, but also costs and risks to its member countries. The report emphasizes that at this early stage, assessing potential costs and benefits for CU members more thoroughly is premature.

1

Convertible currencies are defined as currencies that are freely usable for settlements of international transactions.

2

In case of a foreign currency swap that involves receipt of foreign currency by the NBKR and transfer of local currency to a resident financial institution, total international reserves increase, NIR is unchanged, and net claims on domestic banks in soms increase. In case of a foreign currency swap that involves transfer of foreign currency by the NBKR and receipt of local currency from a resident financial institution, total international assets and NIR decline, while the NBKR net claims on resident banks remain unchanged.

3

Any correction or revisions to data previously reported should be clearly indicated and documented along with the reasons for the revision.

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Kyrgyz Republic: 2013 Article IV Consultation and Fourth Review Under the Three-Year Arrangement Under the Extended Credit Facility, Request for Waiver of Nonobservance of a Performance Criterion, and Request for Modification of Performance Criteria—Staff Report; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Kyrgyz Republic
Author:
International Monetary Fund. Middle East and Central Asia Dept.