Kyrgyz Republic: Second Review Under the Three-Year Arrangement Under the Extended Credit Facility, and Request for Modification of Performance Criteria–Press Release; Staff Report; and Statement by the Executive Director for the Kyrgyz Republic
Author: International Monetary Fund. Monetary and Capital Markets Department
Publication Date:
29 Jun 2016
eISBN:
9781475519198
Language:
English
Keywords:
ISCR; CR; Kyrgyz authorities; Kyrgyzstan; exchange rate depreciation; authority; SDR; foreign currency; core inflation; NBKR data; som depreciation; Loans; Credit; Currencies
Download PDF (1,003.3 KB)

External shocks continue to shape both the outlook and policies. A weaker-than-expected external environment is hurting growth, straining the budget, and raising public debt and banking sector vulnerabilities. The authorities' response to shocks has focused on exchange rate flexibility and unorthodox stimulus measures, although the budget deficit in 2015 was well within the program target. For 2016, the authorities are undertaking additional efforts to adhere to the program's fiscal commitments. Financial sector vulnerabilities and risks are high and rising. Slow progress toward passing the Banking Law that aims to introduce a modern bank resolution system and increase the independence of the National Bank of the Kyrgyz Republic remains a concern. The change in the cabinet just six months after the elections underlines the fluidity of the country's political situation.

Abstract

External shocks continue to shape both the outlook and policies. A weaker-than-expected external environment is hurting growth, straining the budget, and raising public debt and banking sector vulnerabilities. The authorities' response to shocks has focused on exchange rate flexibility and unorthodox stimulus measures, although the budget deficit in 2015 was well within the program target. For 2016, the authorities are undertaking additional efforts to adhere to the program's fiscal commitments. Financial sector vulnerabilities and risks are high and rising. Slow progress toward passing the Banking Law that aims to introduce a modern bank resolution system and increase the independence of the National Bank of the Kyrgyz Republic remains a concern. The change in the cabinet just six months after the elections underlines the fluidity of the country's political situation.

Context

1. External shocks continue to hit the Kyrgyz economy hard, with the outlook for regional economic environment weaker than anticipated at the time of the first review. Oil and commodity prices, based on the latest (April 2016) WEO assumptions, are projected to be lower, with weaker growth and currencies in key trading partners such as Russia and Kazakhstan. These developments are depressing trade and remittances, reducing custom revenues, especially from the Eurasian Economic Union (EEU) countries, and harming the business sentiment. Moreover, trade diversion of Chinese goods through Kazakhstan following the EEU accession is creating additional strains on economy.

A01ufig1

Projected 2016 Real Growth

(In year–on-year percent change)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: World Economic Outlook.
A01ufig2

2016 Projections for EEU Imports and Customs Revenue

(In billions of USD)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: Authorities’ data and staff projections.

2. The authorities’ response to the adverse external shocks has been a mix of exchange rate flexibility and, reflecting lack of fiscal space, unorthodox methods to stimulate the economy. Exchange rate flexibility helped the economy to absorb the external shocks. With public external debt surpassing the legal threshold of 60 percent of GDP in 2015, the authorities resorted to policies intended to stimulate demand with minimum direct fiscal impact, including targeted tax measures, a foreign exchange loan conversion program, and the establishment of a State Mortgage Company (SMC).

3. The political environment remains fluid. The prime minister resigned just six months after the elections amid allegations of corruption. The new government, with a new prime minister and minister of transport, was appointed swiftly. No major shifts in economic policies are expected, but populist measures in the run up to next year’s presidential elections cannot be ruled out.

Recent Developments

4. After showing resilience in 2015, the economy is starting to slow down. Real output grew by 3.5 percent in 2015, with nongold growth better than expected at 4.5 percent, helped by construction, trade, and agriculture. However, as a result of a slowdown in energy production, and back-loaded gold production, overall GDP contracted by 4.9 percent in April 2016, whereas nongold GDP was flat.

A01ufig3

Contribution to GDP Growth

(Percentage points)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: National Statistics Committee.
A01ufig4

Growth, 2012–16

(In year-on-year percent change, cumulative beginning of the year)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: National Statistics Committee.

5. While overall inflation has declined steadily, core inflation remains close to double digits. In 2015, inflation declined gradually to 3.4 percent by year-end, well below the National Bank of the Kyrgyz Republic’s (NBKR) target of 7 percent. This largely reflected a moderation in food prices. However, core inflation remained high at 9 percent, reflecting exchange rate pass-through to nonfood and nonfuel items. By March 2016, overall inflation had further dropped to 0.5 percent, while core inflation remained at 8.3 percent.

A01ufig5

Contributions to Inflation

(In year–on–year percent change)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: National Statistics Committee.

6. The current account deficit narrowed to 10.4 percent of GDP in 2015, reflecting temporary factors in the run up to the EEU accession. Expectations of higher import tariffs following EEU accession, initially planned for early 2015, pushed businesses to advance their imports, especially cars, in late 2014, correspondingly reducing imports in 2015. Lower oil prices and delays in high-import content investment programs were also contributing factors. These developments significantly outweighed the fall in remittances (25 percent in dollar terms) and a weaker external demand (Annex I). Imports continued to decline over the first two months of 2016 (30 percent year-on-year), while nongold exports increased (36 percent year-on-year), driven by machinery and footwear. Remittances started to pick up and rose by 6 percent in dollar terms.

A01ufig6

External Sector, 2012–16

(In year-on-year percent change, three-month moving average, USD)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: National Statistics Committee and NBKR data.
A01ufig7

Remittances Inflows, 2014–16

(In percent, cumulative change, year-on-year)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: Authorities data and IMF staff calculations.

7. Monetary policy was kept on a tightening stance during 2015. The NBKR raised its policy rate to 10 percent as market pressures built up. It also allowed the som to depreciate by 29 percent against the U.S. dollar (and by 11 percent in nominal effective terms), while undertaking significant interventions, spending about one-sixth of its reserves. During 2016Q1, lower inflationary expectations allowed the NBKR to lower its policy rate to 8 percent. In addition, the combination of the recent ruble appreciation, tight som liquidity, and an increase in remittances helped the som appreciate by 10 percent, and allowed the NBKR to purchase about US$80 million. Reserves were also boosted by the conversion of nonconvertible currencies to dollars and stood at US$1.7 billion.

A01ufig8

Foreign Exchange Market, 2014–16

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: NBKR data.
A01ufig9

Policy Rate, Inflation, and Depreciation

(In percent)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: NBKR data.

8. The exchange rate flexibility pursued by the NBKR helped mitigate the impact of the external shocks on the domestic economy. The real effective exchange rate (REER) depreciated by some 12 percent in 2015. In the first two months of 2016, the REER appreciated by 4 percent.

9. While fiscal policy in 2015 was designed to support growth in the face of emerging shocks, it ended up being contractionary due to one-off factors. The overall fiscal deficit fell to 1.2 percent of GDP, well below the program’s target of 3.5 percent of GDP. Revenues were better than anticipated due to one-off nontax revenues.1 Tax revenues, on the other hand, underperformed reflecting a weak economic environment, especially in tax-generating sectors (trade and construction), and lower customs duties. The latter reflected lower imports by the Kyrgyz Republic before it joined the EEU in August, and lower imports by the EEU as a whole after August.2 Nonpriority spending—mostly goods and services—was partially postponed to 2016 as budgetary support from the EU and Russia was delayed to the last quarter. Delays in major investment projects financed by China resulted in a significant drop in capital expenditure. In 2016Q1, fiscal performance was better than anticipated, with higher tax and grants revenues and lower current and development expenditures.

A01ufig10

Exchange Rate Developments

(Index: 2010=100)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: Authorities data and IMF staff calculations.

10. Debt vulnerabilities, however, intensified. While delays in major investments contained the increase, the external public debt ratio rose to 64.6 percent of GDP in 2015, 1.6 percentage points above projections at the time of the first review (Annex II), owing to weaker-than-anticipated nominal GDP growth and valuation effects from exchange rate depreciation. With the 60 percent of GDP legal threshold now breached, the authorities are reviewing the debt limit framework and have introduced annual debt limits in the context of the budget process.

A01ufig11

Contribution to Debt Increase from the First to the Second Review

(In percent)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: Authorities data and IMF staff calculations.

11. Vulnerabilities in the banking sector are high and rising, but capital buffers remain comfortable. In 2015, credit growth slowed significantly but remained relatively strong at 17 percent. The som depreciation led to a drop in demand for dollar loans—even before these loans to consumers were banned (Annex III)—and an increase in deposit dollarization. Banks remain well capitalized, with an average capital adequacy ratio of 23.5.3 Nonperforming loans (NPLs), mainly in the real estate and trade sectors, reached 7.1 percent. Loans under watch tripled in 2015,4 to 21.2 percent reflecting the deteriorated economic environment and weaker som. Credit growth slowed to 1 percent (year-on-year) by end-March 2016, mostly due to the contraction of the dollar denominated loan portfolio. However, som credit growth remained strong at 15 percent year-on-year.

A01ufig12

Credit Growth

(In percent; year-on-year)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: NBKR data and IMF staff calculations.
Figure 1.
Figure 1.

Kyrgyz Republic: Financial Sector Trends

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

12. Despite the mixed economic picture, program conditionality has so far been broadly met. All end-December quantitative performance criteria (PCs) and indicative targets (ITs) were met, except for the IT on tax revenues. All but two SBs have been met. The audit of DEBRA and banks under its management was not completed fully, as one of the eight banks still remains to be audited (prior action). The submission of the AML/CFT law to parliament was delayed to early June due, in part, to a protracted consultation process.

Outlook and Risks

13. The near-term outlook has worsened slightly, but with appropriate policies the medium-term prospects should improve. Reflecting a weaker external environment, nongold growth is projected to grow by 2.9 percent in 2016. Projected annual credit growth of 10 percent—mostly spurred by funding from the Russian-Kyrgyz Development Fund (RKDF), which is being largely onlent via commercial banks—is expected to support economic recovery. Inflation is expected to remain low, driven by a further decline in international food and fuel prices and weak domestic demand. The current account deficit will widen again this year as imports will return to normal following last year’s unusual dip ahead of the EEU accession and because of a pickup in the PIP program, but will gradually moderate thereafter as remittances recover and public investment moderates. Over the medium term, growth is expected to slowly recover as trading partner growth rebounds, reaching its potential of 5 percent by 2020. The fiscal and current account deficits are expected to gradually narrow.

14. The outlook is subject to significant downside risks. Near-term risks continue to stem from the external environment, especially developments in Russia, Kazakhstan, and China. Further som depreciation triggered by a weaker external environment could exacerbate the debt and banking sector vulnerabilities. Upside risks include a rebound in oil prices over the medium term, which would stimulate the economy through remittances and external demand, mainly via Russia. Other upside factors include the strengthening of economic ties with China and investments through the US$1 billion RKDF.

15. The authorities broadly agreed with staff views on the outlook and risks. Their near-term growth projections are aligned with staff’s forecast, but more optimistic for the medium term due to expectation of a faster recovery in the region. They agree on the increasing risks in the financial sector, as well as mounting debt vulnerabilities. In addition, they acknowledge that steadfast commitments to program policies and decisive implementation of reforms are necessary to weather the existing shocks and catch up with regional peers.

A01ufig13

Real GDP: Kyrgyz Republic and Peers

(Index: 2000=100)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: World Economic Outlook and IMF staff calculations.
A01ufig14

Real GDP, GDP per Capita, and PPP GDP per Capita, 2000–15

(Index: 2000=100 unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Sources: World Economic Outlook and IMF staff calculations.

Program Issues

A. Resuming fiscal consolidation

16. While the 2016 budget approved by parliament targeted a deficit of 4.5 percent of GDP as programmed, it implied a much larger deficit. Since the budget was prepared, macroeconomic assumptions changed substantially as the exchange rate depreciated and GDP growth was marked down. In addition, the budget’s tax revenue estimates were optimistic, and it included measures that would increase the deficit, such as the phasing out of the sales tax (0.6 percentage point of GDP) and accommodating expenditure carried over from 2015 (0.8 percentage point of GDP). As a result, the budget implied a deficit of 7.1 percent of GDP, 2.6 percentage points of GDP higher than targeted.

Text Table 1.

Kyrgyz Republic: 2016 Budget Deviations and Additional Efforts

article image
Sources: Kyrgyz authorities and IMF staff estimates.

Budget adjusted with staff exchange rate projections, GDP forecast, and expenses from revenues collected in 2015 by public agencies and not spent.

17. The authorities are committed to taking action to reduce the deficit to the targeted level. They concurred with staff that the absence of fiscal space prevents any relaxation of the fiscal target, despite the weaker economic outlook. Accordingly, they identified a comprehensive set of measures—more than two-thirds of which are permanent—which are expected to yield 2.6 percentage points of GDP, with no individual measure yielding more than 0.4 percentage point of GDP. These include: (i) tax revenue measures (strengthening tax administration, introducing new tax measures, and streamlining exemptions), which are expected to yield about 1.2 percentage points of GDP (LOI, ¶12); (ii) nontax revenue measures yielding 0.4 percentage point of GDP; (iii) expenditure measures amounting to 0.6 percentage point of GDP; and (iv) PFM measures equivalent to 0.4 percentage point of GDP. Some of the measures either require legislation, whose passage is uncertain or may yield less than expected. Should any of these measures fall short of their estimated impact, the authorities agreed to cut expenditures by an equivalent amount.

Text Table 2.

Kyrgyz Republic: 2016 Measures to Close 2016 Fiscal Gap

article image
Sources: Authorities data and IMF staff calculations.

18. The authorities and staff agreed that a more efficient and growth-friendly fiscal framework is needed to support fiscal consolidation going forward. While past deficit targets have typically been met, the quality of adjustment was low. To address this, staff noted that on the revenue side this will require identification of permanent measures to build a solid revenue base, while one-off revenues should only be used to reduce the deficit. On the spending side, this will necessitate streamlining nonpriority expenditures, particularly on goods and services, through expenditure reforms rather than ad hoc cuts, while preserving the much-needed social programs. With respect to the development budget, increasing the efficiency of public investment and focusing on priority infrastructure projects will be essential (Annex V). The authorities broadly agreed with staff on the consolidation strategy, but reiterated that investments are needed to close the country’s infrastructure gap.

19. The authorities and staff reaffirmed that fiscal consolidation should continue in 2017–18 to maintain public debt at sustainable levels, reduce external imbalances, and restore private sector confidence. The consolidation efforts during those two years should target a cumulative improvement in the primary balance of 3.7 percent of GDP, of which 1.8 percentage points are needed in 2017. To bolster their credibility, the authorities have developed a menu of measures from which the bulk of the adjustment is expected to come from:

  • a. On the revenue side, they committed to strengthen the customs and VAT administrations, streamline exemptions, raise excise tax rates on alcohol and tobacco and harmonize excise tax rates with EEU countries, introduce excise stamps for domestically produced goods, and introduce a luxury tax on properties. They also intend to review the taxation of natural resources.

  • b. On the expenditure side, they committed to gradually reduce the wage bill (Annex IV), refrain from ad hoc wage increases, and set up a comprehensive register for all public sector employees (SB, March 2017). Additionally, they will undertake a review of subsidies with the objective of streamlining them, improving the targeting of social benefits to avoid duplication (LOI, ¶13), and containing domestically financed capital expenditure. They will also refrain from potential quasi-fiscal activities that may have budgetary implications.

  • c. On tax administration, they will take measures to strengthen the capacity of the State Tax Services (STS) to: (i) overcome the impact of the transition to the EEU by, among other things, increasing inspections and control at the borders; (ii) gradually add additional tax collection functions to the STS; and (iii) reduce the size of the informal sector (LOI, ¶12).

For 2017, the authorities have already committed to about 0.7 percentage point of GDP in permanent measures, namely from (i) tax policy including revisions to the VAT; and (ii) strengthening tax and customs administration, including improving payments through harmonization procedures. The remainder of the measures will be specified in the draft budget for 2017, which will be prepared in the fall.

20. Meeting the medium-term objectives will also require strengthening public investment management (Annex V). To enhance their public investment framework, the authorities undertook an action plan, where they agreed to: (i) modify through a government decree the decision-making process for the selection of public investment projects by formalizing the role of the ministry of economy and ministry of finance (LOI, ¶16) (SB, December 2016); and (ii) introduce a standardized framework for project monitoring of physical and financial performance for all projects exceeding KGS 50 million (SB, June 2017).

21. Strengthening public financial management remains a priority. First and foremost, it is critical to strengthen the budget process through better coordination or consolidation of tasks. Currently, the ministry of finance prepares the budget and is in charge of current spending; the ministry of economy designs tax policies and selects investments projects; and the STS, which reports to the prime minister, acts as the tax collecting agency. The authorities agreed to review the process with the objective of enhancing cooperation among the three agencies. The authorities will also continue working toward the implementation of the financial management information system (LOI, ¶31) with support from the Turkish Cooperation and Coordination Agency (SB, February 2017), which will help to better monitor spending and improve the oversight of the budget operations.

B. Preserving debt sustainability

22. The attached DSA suggests that debt sustainability has further deteriorated compared to the DSA in the November staff report. However, the DSA update suggests that debt remains at a moderate risk of debt distress. The present value of the public and publicly-guaranteed debt to GDP and remittances ratio is expected to exceed 36 percent of GDP in 2016–17, and will remain around 34 percent of GDP thereafter. Acknowledging escalating debt vulnerabilities, the authorities are revising their public investment framework to better manage debt and bring it back to sustainable levels. They also agreed with staff on the need for a more selective public investment process to maximize the long-term impact on growth and prevent the explosive path of the public debt (Annex VI).

C. Fine-tuning monetary and exchange rate policies

23. Monetary policy will continue to focus on containing inflation within the NBKR’s targeted range of 5–7 percent. The NBKR and staff agreed that the policy rate should balance the need for policy relaxation stemming from the recent drop in headline inflation, the moderation in credit growth, and the weaker growth prospects, against potential fiscal and exchange rate pressures. The NBKR indicated that it will continue to adapt its monetary stance to circumstances (LOI, ¶17). Moreover, the NBKR and ministry of finance agreed to continue strengthening their coordination to facilitate liquidity management (LOI, ¶18). In addition, the NBKR will continue to work on enhancing the policy rate’s transmission mechanism (LOI, ¶24).

24. Exchange rate flexibility has helped reduce external imbalances, enhance competitiveness, and prevent a rundown of external buffers. The NBKR stressed the need to balance the objectives of financial sector stability and exchange rate flexibility. At the same time, the NBKR remains committed to: (i) limiting interventions in the foreign exchange market to only smoothing excessive fluctuations; and (ii) introducing new monetary and hedging instruments (LOI, ¶20).

25. Staff and the authorities agreed on the need to rebuild reserves to about four months of imports, given the country’s vulnerability to shocks and the high dollarization. Following its large depreciation in 2015, the real effective exchange rate is assessed to be broadly in line with fundamentals. Although reserves are largely adequate, continued significant intervention or additional external shocks would make reserves drop below desired levels.

Text Table 3.

Kyrgyz Republic: Estimated Exchange Rate Misalignment: Comparison Between Reviews

article image
Sources: Authorities data and IMF staff calculations.

D. Safeguarding financial stability and supporting growth

26. Financial sector risks are high and increasing, particularly foreign currency-induced risks. Key vulnerabilities continue to stem from high dollarization and credit risks due to the economic slowdown and the som volatility. Stress test results continue to indicate increasing vulnerabilities from exchange rate volatility and sectoral concentration. The NBKR emphasized that the introduction of macroprudential measures has helped to contain foreign currency credit growth. It also agreed to closely watch developments in NPLs and bring loan classification in line with international standards, in particular for restructured and extended loans. Staff argued for carefully monitoring FX liquidity, given the significant foreign currency denominated liabilities. The authorities are also committed to developing a strategic plan for robust banking supervision and to expanding the risk-based supervision framework to the entire sector (LOI, ¶22). Moreover, they are establishing a high-level financial stability committee and finalizing a crisis preparedness framework with the assistance from the IMF and World Bank (LOI, ¶23).

A01ufig15

Loan Classification, 2007–16

(In percent of total loan portfolio)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: NBKR data.

27. Staff argued that de-dollarization should be only pursued through market-based measures. The authorities and staff concurred on the need to focus on stabilizing the economy and strengthening central bank credibility. They also agreed that the recent foreign currency loan conversion program should not be expanded beyond its current scope (Annex VII). They also indicated that they will be supervising the SMC should it engage in banking activities (LOI, ¶24). Moreover, the NBKR indicated that it is in the process of signing a memorandum of understanding with the RKDF to exchange the necessary information for the proper conduct of monetary and financial policies.

28. The current challenging economic environment strengthens the case for the immediate passage of the Banking Law. Staff reiterated that the current banking resolution framework is contradictory and inefficient, as it allows shareholders to delay the resolution process indefinitely. It also opens the door for insolvent banks to be resurrected and provides impunity to bank owners at the expense of depositors who are made to wait for years to be compensated. The draft Banking Law, which has been lingering in parliament since 2013, aims to address these issues by strengthening the independence of the central bank and establishing a robust banking resolution framework in line with international best practice. The proposed framework allows for swift resolution of distressed banks to prevent problems in one bank from destabilizing the entire sector. It also allows depositors to be paid out quickly and protects their rights. The authorities noted that delays in the passage of the Banking Law were continuing because clarifications were needed on the constitutionality of key provisions related to the judicial review of the NBKR’s decision. The authorities nevertheless indicated that they will continue to exert their best efforts to ensure its passage by September in a form substantially similar to the draft submitted to parliament in September 2013 (LOI, ¶25).

29. Speedy resolution of all problem banks under DEBRA is essential to enhance confidence in the banking sector. Staff indicated that the situation with DEBRA and the banks under its administration is another manifestation of the shortcomings of the existing bank resolution framework. Delays in the liquidation of these banks, some of which have been under DEBRA since the mid-1990s, undermine the credibility of banking regulations and trust in the system as a whole. The audit of DEBRA and the banks under its management suggests that four have no assets at all. As a result, the authorities proposed, and staff agreed, that as a first step the liquidation procedures for the four banks that have no assets will be initiated by September (SB) (LOI, ¶26). The authorities also committed to proceed with the liquidation of the remaining four banks in the first quarter of 2017. To ensure a smooth and successful liquidation process, staff and the authorities agreed on the need for full cooperation between DEBRA on one side, and the NBKR and ministry of finance, as the largest creditors in some banks, on the other side.

E. Advancing structural reforms

30. The authorities recognized that improving the business climate is essential for diversifying the economy and maximizing the benefits from EEU accession. While the country’s 2016 Doing Business ranking remained largely unchanged, the Kyrgyz Republic continues to lag behind its’ regional peers. The authorities and staff agreed that bold reforms are needed in several areas, including trading across borders, the insolvency regime, access to electricity, and contract enforcement. In addition, reforming the energy sector is important to ensure a better service delivery and to put it on sound economic footing (LOI, ¶30). Staff also underscored the importance of a constructive and fair resolution of the dispute with Centerra, which is critical for maintaining a stable and predictable investment climate.

A01ufig16

Doing Business Elements

(Rank)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: Doing Business database.
A01ufig17

Cross-Country Comparison of Ease of Doing Business

(Rank, 2016)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: Doing Business database.

31. Corruption and the rule of law continue to prevent maximizing the economy’s potential by reducing inefficiency. According to Transparency International, corruption perception remains high, while governance indicators are deteriorating. Staff emphasized, and the authorities agreed, that timely adoption of the AML/CFT law by parliament should contribute to a positive assessment of technical compliance with the FATF standard by the Eurasian Group on Combating Money Laundering and Financing of Terrorism later this year. An AML/CFT legal framework in line with the 2012 FATF standard could complement anti-corruption efforts by assisting in detecting, prosecuting, and deterring instances of corruption. Staff welcomed the recent passage by parliament of the Budget Code, which is expected to enhance budgetary transparency.

A01ufig18

Corruption Perception Index

(Rank, 2015)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: Transparency International data.
A01ufig19

Governance Indicators

(In percentile rank)

Citation: IMF Staff Country Reports 2016, 186; 10.5089/9781475519198.002.A001

Source: Worldwide Governance Indicators.

F. Program modalities

32. Program design and modification of performance criteria. Revised QPCs for June and December 2016—on the floor on NIR, ceiling on NDA, ceiling on cumulative over deficit of the general government, and present value on new external debt contracted or guaranteed and ITs on ceiling on reserve money, cumulative state government tax collections, and nonconcessional borrowing—are proposed (LOI, Table 1) to reflect the weaker macroeconomic outlook. Structural conditionality (LOI Table 2) will focus on macro-critical areas, particular in the financial sector and reforms to support fiscal consolidation. The program will continue to be monitored on a semi-annual basis.

33. Financing needs for the remainder of the year are covered. The IMF, along with multilateral and bilateral partners, is expected to cover the country’s financing gap for the next 12 months. Despite the downside risk to the outlook, the Kyrgyz Republic’s capacity to repay the Fund is expected to remain adequate.

Text Table 4.

Kyrgyz Republic: Financing Needs

article image
Sources: Kyrgyz authorities and IMF staff estimates and projections.

34. An updated safeguards assessment was completed in October 2015. The assessment concluded that legal amendments are needed to strengthen the central bank’s autonomy and governance arrangements. The enactment of the draft Banking Law should address these recommendations. Furthermore, the internal audit mechanism requires strengthening.

Staff Appraisal

35. The Kyrgyz Republic continues to face large and persistent external shocks, requiring a strong policy response. The regional economic slowdown, which is being transmitted primarily through a decline in remittances, a slowdown in trade, and exchange rate pressures, has amplified domestic vulnerabilities. At the same time, large external borrowing has significantly increased debt levels, and the som depreciation has elevated financial and debt vulnerabilities. Given this environment, a more decisive implementation of macro policies and reforms is needed.

36. After showing resilience in 2015, the economy is expected to slow down this year before picking up again over the medium term. Lower oil prices, a weak regional economic environment, and the slowdown in China will all be contributing factors. Over the medium term, growth should gradually pick up, provided prudent macro policies are implemented and structural reforms accelerated.

37. Fiscal consolidation and a sound public investment management framework are critical to maintaining debt on a sustainable path. Reliance on grants and one-off revenues to keep fiscal deficits within program targets are not substitutes for permanent measures to ensure lasting fiscal consolidation. The authorities’ commitment to resume consolidation in 2016 and bring the budget in line with program commitments by implementing additional measures is welcome. Compensating any possible shortfall from these measures by equivalent cuts in expenditures will be critical to meet fiscal targets. Going forward, success will hinge on identifying concrete measures to boost tax revenues over the medium term, reducing the wage bill, streamlining spending on goods and services, and improving the public investment framework. It is also critical to strengthen coordination among various government agencies to ensure an efficient budget process.

38. Public debt has reached worrisome levels and should be contained. Prudence should be exercised when selecting new infrastructure projects, and contracting and guarantying new public debt. Debt is close to moving from medium to high risk of debt distress, which would reduce access to concessional and nonconcessional borrowing. Furthermore, debt should be carefully monitored to avoid contingent liabilities. In addition, the new debt limit legislation, which would allow revisions to the debt limit on an annual basis, increases the risk of undermining its credibility. In this context, the authorities should refrain from frequent revisions to this limit, especially to soften up borrowing constrains.

39. Monetary policy should continue to focus on containing inflation within the NBKR’s target range. The current interest rate level appropriately balances declining inflationary pressures, weakening credit, and GDP growth against rising fiscal and exchange rate pressures. The NBKR should continue to monitor developments and inflation expectations and adjust monetary policy as needed. Efforts to enhance the monetary transmission mechanism should be stepped up by, as a first step, narrowing the corridor around the policy rate and making it more symmetric. Strengthening coordination between the NBKR, ministry of finance, and the RKDF as well as enhancing the forward looking component of the NBKR’s communication policy will be critical in the period ahead.

40. The central bank’s flexible exchange rate policy has served the economy well by acting as a shock absorber. Looking forward, the NBKR should continue to limit interventions only to smooth excessive volatility while allowing the som to move in the line with fundamentals. In this context, given the large current account deficit and the high degree of dollarization, building reserves to about four months of imports would be appropriate. The NBKR should also introduce new monetary and hedging instruments to offset the effect of its FX interventions.

41. High and rising banking sector vulnerabilities call for the immediate passage of the Banking Law, given its macro-criticality to preserve financial sector stability, particularly in the current difficult economic environment. The authorities should exert every effort to ensure the passage of the Law in a form substantially similar to the draft submitted to parliament in September 2013. At the very least, the Law should maintain the original provisions in the areas of: (i) governance and oversight; (ii) judicial review and nonsuspension of the NBKR’s decisions; and (iii) powers of the NBKR in the resolution process.

42. Additional efforts are needed to ensure financial sector stability. The authorities’ efforts to strengthen supervision by developing a strategic plan for banking supervision, improve the quality of prudential regulation, and put in place a crisis preparedness framework are all welcome. The NBKR should also stand ready to introduce additional macro-prudential measures. Moreover, finalizing the liquidation of all the banks under DEBRA and winding down DEBRA’s activities by early 2017 are important measures to enhance confidence in the banking sector. Success will hinge on the full cooperation between DEBRA, NBKR, and ministry of finance.

43. Expanding the economy’s potential will necessitate bold structural reforms. Improving the business climate, addressing the infrastructure bottlenecks and tackling corruption and governance are necessary to enhance broad-based growth and maximize benefits from the EEU. Governance reforms are essential to reduce the corruption perception and unlock the growth potential. Speeding up the PFM reforms will enable the authorities to better monitor spending and increase transparency of the budget’s operations. Simplifying cross border trade, better enforcement of contracts and faster resolution of insolvency will allow the Kyrgyz Republic to have a competitive edge within the EEU.

44. The program continues to face significant risks, but the authorities’ policy commitments provide safeguards and the Kyrgyz Republic’s repayment capacity remains adequate. Regional economic slowdown, volatile exchange rates, and uncertainty about gold production are key risks to the program. Furthermore, political resistance to financial sector reforms, as well as populist polices in the run up to the 2017 presidential elections, could reverse the reform process, undermine macroeconomic and financial sector stability, and increase risk of debt distress. Continued dialogue with the Fund is essential for the success of the program.

45. Staff supports completing the second review of the authorities’ program under the ECF arrangement. Staff supports authorities’ request to modify end-June, end-September, and end-December 2016 QPCs and ITs. The policies outlined in the attached LOI are adequate to achieve the program’s goals.

Table 1.

Kyrgyz Republic: Selected Economic Indicators, 2014–21

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Includes general government and onlending to state owned enetrprises

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.

The US$263 million of reserve assets in nonconvertible currencies were reclassified to other assets at the end-2015 upon the recommendation of the Safeguards Assessment.

Table 2.

Kyrgyz Republic: Balance of Payments 2014–21

(In millions of U.S. dollars)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Includes IMF and identified budget support.

Includes return of KRDF investments abroad.

The US$263 million of reserve assets in non-convertible currencies were reclassified to other assets at the end-2015 upon the recommendation of the Safeguards Assessment.

Projected IMF financing.

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, 2014–16

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

The US$263 million of reserve assets in nonconvertible currencies were reclassified to other assets at the end-2015 upon the recommendation of the Safeguards Assessment.

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

Table 4.

Kyrgyz Republic: Monetary Survey, 2014–16

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

One MFI got banking liscence in March 2015, and another in January 2016. It also includes RKDF lending via banks.

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, 2014–18

(In millions of soms)

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Sources: Kyrgyz authorities and IMF staff estimates and projections.

Including grants in-kind from EEU accession.