Kyrgyz Republic: Third Review Under the Three-Year Arrangement Under the Extended Credit Facility, and Request for Modification of Performance Criteria
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
02 Jun 2017
eISBN:
9781484302880
Language:
English
Keywords:
ISCR; CR; Kyrgyz authorities; real GDP; Kyrgyzstan; exchange rate; government decree; core inflation; authorities datum; state government; Credit; Loans; Monetary base
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Third Review Under the Three-Year Arrangement Under the Extended Credit Facility,

Abstract

Third Review Under the Three-Year Arrangement Under the Extended Credit Facility,

Context and Recent Developments

1. The Kyrgyz economy continues to face headwinds, despite some positive developments. The regional economic recovery remains weak with negative output gaps, subdued consumption and low investment, which is limiting the Kyrgyz Republic’s domestic and external demand, and thereby constraining growth prospects. Notwithstanding these headwinds, remittances have picked up and pressures on the som have subsided. However, with regional economies expected to grow at a slower pace for longer, the Kyrgyz economy is expected to remain on a lower-growth trajectory with limited fiscal space, calling for policy adjustments.

Figure 1.
Figure 1.

Kyrgyz Republic: Consumption and Poverty

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

2. Despite a modest recovery, growth remains weak. For the first nine months of 2016, overall and non-gold growth grew by 2 percent and 3.1 percent y-o-y respectively. Consumption was boosted in the run-up to the September Nomad Games. Among sectors, trade, construction and agriculture contributed most to growth.

Figure 2.
Figure 2.

Kyrgyz Republic: Growth

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

3. While overall inflation is negative, core inflation is in the middle of the NBKR’s 5–7 percent target range. Subdued growth, appreciating som, and declining domestic food prices—due to a good agriculture harvest and limited exports to the EEU on account of non-tariff barriers—are the key downward drivers of inflation, which turned negative in September (-0.3 percent y-o-y). Core inflation, however, remains at about 6 percent.

Figure 3.
Figure 3.

Kyrgyz Republic: Inflation

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

4. The NBKR gradually lowered its policy rate as inflationary and exchange rate pressures declined. By end-September, the policy rate was cut by 400 basis points to 6 percent. The som appreciated by about 9.5 percent against the U.S. dollar over the first 10 months reflecting tight market liquidity, an appreciating ruble, and recovering remittances. This allowed the NBKR to purchase in net terms about US$61 million. At the same time, reserve money picked up, as a result of the NBKR’s unsterilized FX purchases. Despite monetary policy relaxation, interest rate on som-denominated loans remains high.

A01ufig1

Policy Rate, Inflation, and Depreciation

(In percent)

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

Source: NBKR data.
Figure 4.
Figure 4.

Kyrgyz Republic: Monetary Developments

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

5. Fiscal performance during 2016: H1 was in line with the program, with the deficit limited to 2.5 percent of GDP. Taxes, exceeded projections mostly due to higher-than-expected customs revenue following the introduction of new measures, especially on strengthening customs’ payments and collection (LOI, Attachment I). Current expenditures were slightly higher than expected. On the other hand, capital expenditures were lower due to delays in some domestically financed projects.

6. After rapid increases in previous years, the external debt to GDP ratio declined slightly during the first eight months. This was mainly driven by the appreciation of the som, but a rephasing of externally financed public investment projects also helped to contain the pace of debt accumulation.

Text table 1.

Kyrgyz Republic 2016H1 Budget Execution

(In percent of GDP)

article image
Sources: Kyrgyz authorities and IMF staff estimates.

7. With remittances recovering and trade slowing down, the current account deficit remained largely unchanged. Inflow of remittances picked up in US$ and RUB terms, as Kyrgyz citizens benefit from easier access to EEU labor markets, but is still well below pre-crisis levels. However, trade continues to lag due to weak gold exports and trade diversion. Exports have dropped by 12 percent y-o-y by end-August, while imports declined by 7.6 percent over the same period, mainly driven by lower energy imports and weak domestic demand. Strong inflows on the financial account, namely FDIs related to the Russia Kyrgyz Development Fund (RKDF) and capital and commercial banks’ flows partly driven by the appreciation of the som, resulted in an increase in the level of reserves. The REER and NEER appreciated by 4.2 and 10.5 percent, respectively, over the first nine months.

A01ufig2

Public External Debt

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

* stock of debt as of end-August 2016Sources: Authorities data and IMF staff calcualtions.
Figure 5.
Figure 5.

Kyrgyz Republic: Exchange Rates and Remittances

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

8. Despite strong capital buffers and falling dollarization, the banking sector remains vulnerable. Overall credit to the private sector contracted by 2 percent during the first three quarters as a result of the economic slowdown. Despite robust growth in som denominated loans (21 percent), the demand for dollar-denominated loans substantially fell (21 percent). The macro-prudential measures introduced since mid-2015 resulted in a drop in deposit and loan dollarization to 54 and 43 percent, respectively. The loan portfolio continued to deteriorate, largely due to the weak economic environment, with NPLs at 9.0 percent, loans under watch over 24 percent, and continued high incidence of loan restructuring and prolonging. Capital adequacy is high and all banks have met the new capital requirements of som 400 million.

A01ufig3

Credit Growth

(In percent; year-on-year)

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

Sources: NBKR data and IMF staff calculations.
Figure 6.
Figure 6.

Kyrgyz Republic: Financial Sector Trends

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

9. Program performance was broadly satisfactory. All end-June quantitative performance criteria (QPCs) and indicative targets (ITs) were met. Two structural benchmarks (SBs) have not been met, namely the review of subsidies due to capacity constraints, and the publication of the Banking Law in the Official Gazette. To move forward with the review of subsidies, the authorities have asked for IMF technical assistance. As to the Banking Law, which was adopted by Parliament on November 30 with key provisions diluted (¶27), the authorities have committed to take remedial measures by agreeing to introduce amendments to the Law.

10. The political environment remains fluid. There were sporadic protests in the spring, the dispute with Centerra continues,1 some former officials were arrested on criminal charges, and there have been frequent personnel changes at key positions. Disagreement over the recently proposed constitutional amendments led to the collapse of the ruling coalition in October and the resignation of the cabinet. A new government was subsequently formed with the outgoing prime minister and ministers of finance and economy retaining their posts. The authorities are focused on December’s constitutional referendum and the presidential elections next year, which, in staff’s views, could detract from the reform agenda.

Outlook and Risks

11. While the near-term outlook has worsened, medium-term prospects should improve. Non-gold growth is now projected at 2.4 percent in 2016, which represents a sharp weakening of economic activity compared with historical rates observed before the crisis, and will remain on a lower trajectory over the near term. Slowdown in the credit growth will also have a drag on growth. Reaching potential growth of 5 percent over the medium term will be contingent on the adoption of appropriate policies and the recovery of trading partners’ growth. Inflation in 2016 is expected to be lower than previously projected, and will gradually pick up over the near term as economic activity starts to recover. The current account deficit will narrow this year due to the rescheduling of PIPs, before widening in 2017/18, and will gradually moderate thereafter as remittances recover and public investment tempers.

Figure 7.
Figure 7.

Kyrgyz Republic: Growth Projections and Historic Trends

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

12. Downside risks continue to dominate the economic landscape. Near-term risks continue to stem from regional developments due to possibly lower-than-projected commodity prices and/or slower-than-anticipated growth in key trading partners, particularly in Russia and Kazakhstan, which could exacerbate financial and fiscal vulnerabilities, and delay economic recovery (Annex I). Full positive effects of the EEU accession are still to be realized, reflecting a weak economic activity within the union, lack of full compliance with EEU regulations, and trade diversion. Escalation of already difficult discussions with Centerra over the Kumtor mine poses a risk to the economy and weighs on the business climate (Annex II). Domestically, the President’s proposed constitutional amendments are exacerbating political tensions in the run up to next year’s presidential elections and will, in staff’s views, preoccupy politicians and policy makers for the coming few months. Upside risks include the strengthening of economic ties with China (Annex III), the projects financed by the RKDF, and a larger than expected impact from EEU membership.

13. The authorities broadly agreed with staff views on the outlook and risks. Their growth projections are more optimistic than staff’s forecast, reflecting their expectation of a faster recovery in the region and higher growth dividend of intensive public investments. They also agreed on the risks in the financial sector, as well as mounting debt vulnerabilities. Regarding the EEU, the authorities indicated that they are still adjusting to the new rules and requirements.

Program Issues

A. Resuming Fiscal Consolidation

14. Spending pressures during 2016: H2 risk jeopardizing the end-year fiscal targets. Tax revenues will be slightly below projections, due to the recently introduced VAT exemption on the import of grains and the sale of flour. However, non-tax revenues should exceed projections due to higher than expected dividends from SOEs and the NBKR. Expenditures, on the other hand, are under pressure. Goods and services and domestically financed capital expenditures are expected to exceed the second review projections, by 1.3 and 2 percentage points of GDP, respectively. This is the result of (i) the country hosting three international events during the second half of the year, incurring higher spending than budgeted (1 percentage point of GDP);2 (ii) larger-than-expected spending of revenue collected in 2015 by public agencies but not spent (1.2 percentage points of GDP); and (iii) building law enforcement housing and schools (1.1 percentage points of GDP). Overall, absent any corrective measures, the headline deficit could exceed 7 percent of GDP.

Text table 2.

2016 Budget Comparison

(In percent of GDP)

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

Mineral fees are now classified under other revenue. They were previously classified under taxes.

Including grants in-kind from EEU accession.

15. Despite the above anticipated slippages, the authorities remain committed to a deficit target of 4.5 percent of GDP for 2016. To meet this target, they will seek to implement the tax policy and administration measures identified at the time of the second review (LOI, Attachment I). However, some of these measures necessitate legislation and may only be implemented next year. As a result, only about half of them will be implemented this year (0.5 percentage point of GDP). On the expenditure side, they will resort to rephasing foreign financed capital expenditures to close the gap and reach the deficit target.

16. Although the draft 2017 budget submitted to Parliament features a looser-than-programmed fiscal stance, the authorities agreed to reduce the deficit to sustainable levels. The government initially submitted to Parliament a draft budget featuring a deficit of 4.7 percent of GDP compared to a commitment at the time of the second review of 2.4 percent of GDP, arguing an improvement in the overall debt outlook and a weak economic environment. Staff pointed out that notwithstanding the improved debt position, debt sustainability remains a concern and thus growth-friendly consolidation efforts should continue. In the end, the authorities and staff agreed to relax the deficit for 2017 to 3 percent of GDP (LOI, ¶11). To achieve this target, the authorities agreed to: (i) implement all the fiscal measures identified at the time of second review; (ii) reduce the wage bill; (iii) bring down goods and services to the 2015 level in percent of GDP through an across-the-board cut in non-priority spending; and (iv) refrain from populist measures in the run-up to next year’s presidential election. Even with the slightly looser target, the cyclically-adjusted balance would still significantly improve by 1.7 percentage points of GDP.

17. In addition to the identified measures, and to bolster their credibility, the authorities also committed to the following:

  • a. On the revenue side, reviewing natural resources taxation and reversing the VAT exemption on the import of grains and the sale of flour.

  • b. On the expenditure side, streamlining subsidies once the ongoing review is completed (LOI, ¶11), (SB, July 2017), improving the targeting of social benefits, and refraining from potential quasi-fiscal activities that may have budgetary implications.

  • c. On tax administration, strengthening the State Tax Services (STS) to smooth the transition to the EEU and to gradually expanding the functions to the STS. Efforts will continue to reduce the size of the informal economy and limit corruption by introducing cash registries and encouraging e-filing for individual and corporate taxes.

18. taff urged the authorities to pursue the action plan to reform public sector wages and to commence a gradual reduction of the wage bill. The objective under the action plan is to rationalize staffing and to reduce the wage bill by 1.4 percentage points of GDP, to reach a wage bill of 8.7 percent of GDP by 2018 (LOI, ¶11), in line with Fund’s TA recommendation. The authorities have started to implement the action plan in 2016: Q4 and plan to reduce the wage bill by 0.4 and 1 percentage point of GDP in 2017 and 2018, respectively. Staff would have preferred a more evenly balanced reduction of the wage bill over the next two years. The authorities recognized that the reduction in 2018 is ambitious, but argued that with presidential elections taking place in 2017, it would be very difficult to commit to additional cuts. However, to strengthen the credibility of their action plan, they committed to identify specific quantitative measures that would allow them to reach the targeted reduction—(SB, May 2017).

Text Table 3.

Effort to Reduce the Wage Bill by 2018

(In percent of GDP)

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

from the teachers’ salary increase

19. Strengthening public financial management remains a top priority (LOI, ¶23). The authorities will (i) revisit the budgetary process with the objective of enhancing cooperation among the ministry of finance (MoF), the ministry of economy (MoE), and the prime minister’s office; (ii) develop a fiscal rule, which will include limits on external debt and the fiscal balance (Annex IV); (iii) continue working on the implementation of the financial management information system (FMIS) to improve expenditure monitoring and oversight of budget operations—signing the FMIS’ terms of reference was postponed by three months at the donor’s request (SB new deadline, May 2017); (iv) sign the contract with the IT provider (SB, September 2017); (v) continue to pursue accounting reforms to improve reporting and transparency; and (vi) work on including fiscal risks into their budget framework.

B. Preserving Debt Sustainability

20. Whereas the debt outlook has improved, it remains vulnerable to external and domestic shocks. Driven by the som appreciation and the rescheduling of some public investment projects, external public and publicly guaranteed debt is projected to drop to 60.7 percent of GDP in 2016, compared to 64.6 percent in 2015. According to the latest DSA, external debt remains at a moderate risk of debt distress, and is no longer considered a high-moderate borderline case. Nonetheless, vulnerabilities to large external shocks persist, in particular to a sizable depreciation of the exchange rate and/or to a massive scaling-up of public investments. Furthermore, public investment projects, if not profitable, would not increase the country’s future capacity to repay its debt, which combined with the potentially higher costs of borrowing, could push debt to an unsustainable path (Annex V).

Figure 8.
Figure 8.

Kyrgyz Republic: Contribution to the Revision of External Debt

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

Sources: Authorities data and IMF staff calculations.

21. While the authorities welcomed the results of the recent DSA, they acknowledged the elevated debt vulnerabilities. They indicated to staff that they are committed to (i) pursuing fiscal consolidation efforts over the medium term; (ii) refraining from non-concessional borrowing; (iii) improving debt monitoring; (iv) minimizing fiscal risk stemming from SOEs; (v) ensuring sufficient profitability of public investment projects; and (vi) enhancing the efficiency of public sector investments by implementing the PIMA recommendations. Regarding the latter, a government decree was issued to clarify the respective roles of the MoE and MoF in the decision-making process. In this context, staff encouraged the authorities to expeditiously update the PIP guidelines.

C. Balancing Monetary and Exchange Rate Policies

22. A neutral monetary stance at this juncture is appropriate. Staff and the authorities agreed that the key causes of low inflation are exogenous and thus do not see any merit for further relaxation. They also concurred that given monetary policy’s lagged effect on key economic variables, the current level of the policy rate at 5.5 percent is adequate, as it balances the need for policy relaxation stemming from the recent drop in headline inflation, moderation in credit growth, exchange rate appreciation, and weaker growth prospects. The NBKR pointed out that it stands ready to fine-tune its policy in line with emerging market pressures (LOI, ¶13).

23. Enhancing the monetary transmission mechanism remains a priority for the NBKR (Annex VI). Staff and the authorities agreed to (i) gradually narrow the corridor around the policy rate and make it more symmetric; (ii) improve coordination between the NBKR, MoF, and the RKDF to facilitate liquidity forecasting; and (iii) enhance the forward-looking component of the NBKR’s communication policy. Once the policy rate traction becomes more effective, the NBKR aims to gradually transition to inflation targeting (LOI, ¶14).

24. The NBKR reiterated its commitment to allow the exchange rate to be market determined with limited intervention. It considered that the appreciating trend of the som since the beginning of the year reflected market forces. Staff underscored the importance of striking a careful balance in the NBKR’s foreign exchange intervention policy between financial sector stability and external competitiveness without any government interference in its decision-making process (LOI, ¶15). Staff also emphasized the importance of a two-way intervention policy.

25. The authorities are committed to maintain reserves at, adequate level given the economy’s vulnerability to shocks and high dollarization. After overvaluation in previous years, the significant depreciation of the somvis-à-vis the U.S. dollar brought the real effective exchange rate broadly in line with fundamentals by end-2015. However, the nominal exchange rate appreciation since the beginning of this year has partly offset the gains in competitiveness. Reserve coverage is adequate and provides a cushion in case of an unexpected drop in remittances or exchange rate pressures.

D. Safeguarding Financial Stability

26. The authorities are taking additional efforts to mitigate the elevated financial risks. While the recent appreciation of the som has contained banking sector risks, key vulnerabilities continue to stem from high dollarization and credit risk due to the economic slowdown. In addition to regularly conducting stress tests, the NBKR agreed to improve monitoring of the non-performing loan portfolio. In this context, they are collecting additional data on individual NPLs and improving regulations for classification of assets (LOI, ¶16). Staff urged the NBKR to ensure adequate provisioning for NPLs. Moreover, the authorities have established a high-level Financial Stability Council, and developed a Crisis Preparedness Framework (LOI, ¶18). They are also finalizing the strategic plan for supervision and have completed the risk-based supervision of five banks (LOI, ¶17).

Text Table 4.

Estimated Exchange Rate Misalignment: Comparison Between Reviews 1/

article image
Sources: Authorities data and IMF staff calculations.

Positive numbers indicate overvaluation

Figure 9.
Figure 9.

Kyrgyz Republic: Financial Sector Stability

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

The Banking Law, which was passed on November 30 with key provisions missing or diluted, still brings several improvements over the status quo and provides a basis for further work to enhance the banking sector regulatory framework. The draft law was in Parliament for almost three years, facing opposition from vested interests and from those with concerns that the law would contradict the spirit of the constitution.3 In the end, Parliament’s approval of the Law necessitated compromises which weakened some key provisions, namely (i) limitations to the scope of judicial review of decisions taken by the NBKR with respect to license revocation and bank resolution; (ii) the autonomy of the NBKR by introducing provisions that permit the NBKR to grant loans to non-supervised institutions; (iii) the framework for early intervention and resolution of problem banks; and (iv) the NBKR’s Board composition, which should comprise a majority of non-executive members. Following the adoption of the Law by Parliament on September 28, the Office of the President returned it to Parliament requesting the introduction of some amendments to (i) clarify some provisions and address some discrepancies in the Law;4 and (ii) return to the status quo with respect to the NBKR’s budget preparation and Board members’ remuneration.5 The current version brings several improvements over the existing framework as it (i) reduces the duplication, overlaps, and contradictions prevalent under the existing patchwork of laws and regulations; (ii) introduces the concept of protection of consumer rights; (iii) streamlines and clarifies the process of issuing and withdrawing banking licenses and strengthens the NBKR role in this process; (iv) strengthens corporate governance requirements for banks and stiffens the penalty regimes for violators; (v) protects NBKR staff from legal prosecution in the conduct of their duties; and (vi) repeals the law on bank conservation (one of the five laws to be replaced by the new Law), which removes the legal basis for Debt Enterprise Bank Resolution Agency (DEBRA)—a long-standing program objective.

27. Staff would have preferred the adoption of the Banking Law with all key provisions included and without the recent amendments proposed by the Office of the President. However, the authorities pointed out that attempts to re-introduce some of the key provisions in the current Law before its enactment could have resulted in a protracted process. As to the Office of the President’s amendments, particularly those that could infringe on the NBKR’s independence, they indicated that existing legislation has been in effect for about two decades under three very different administrations and has never been used to influence the NBKR’s decision-making process. Staff and the authorities agreed that since near-term banking sector vulnerabilities were contained as a result of the various measures introduced by the NBKR since the beginning of the program,6 that there was merit in cementing the gains achieved so far while continuing to pursue further strengthening of the Law.

28. Accordingly, to address the shortcomings of the new Banking Law, the authorities agreed to seek its amendment, but cautioned that it will take time (LOI, ¶19). Staff and the authorities agreed that the amendments will be prepared by April (SB), and submitted to Parliament in July (SB), after the Law comes into force—six months after its enactment— and taking into account political economy considerations. The authorities underscored their commitment to exerting their best efforts to amend the Law, but also pointed out that some parliamentarians may continue to object to some of the amendments such as the limitation of judicial review.7

29. The liquidation of the banks under DEBRA is underway. The court has already ordered the liquidation of “Bishkek”, “Adil”, “Kurulush” and “Mercury” banks.8 The authorities and staff agreed on the importance of a timely liquidation of all the remaining banks under DEBRA’s management.

E. Advancing Structural Reforms

30. The authorities recognized that improving the business climate is essential for diversifying the economy and improving the economy’s competitiveness within the EEU. The country’s 2017 Doing Business ranking remained largely unchanged, and it continues to lag behind its’ peers in key areas. The authorities and staff agreed that bold reforms are needed in several areas, including financial inclusion, trading across borders, the insolvency regime, access to electricity, and contract enforcement. These productivity-boosting reforms, in conjunction with the large infrastructure investment program currently undertaken, will help the Kyrgyz Republic improve its competitiveness, particularly within the EEU. 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.

Figure 10.
Figure 10.

Kyrgyz Republic: Doing Business and Competitiveness

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

31. Staff underscored the need to address governance issues to improve the economy’s efficiency. 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. Staff encouraged the authorities to address the remaining shortcomings of the draft law, particularly by bringing the framework for preventing officials to launder the proceeds from corruption in line with the FATF standard. Staff cautioned the authorities against amending the recently enacted procurement law, and warned that the suspension of the e-procurement system would be a step backward.

Figure 11.
Figure 11.

Kyrgyz Republic: Governance and Corruption

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A001

F. Program Modalities

32. Program design and modification of performance criteria. Revised QPCs for December 2016 and new QPCs for June and December 2017—on the floor on NIR, ceiling on NDA, ceiling on cumulative overall 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, non-concessional borrowing and a new IT on introduction of new or extension of the existing tax exemptions—are proposed (LOI, Table 1) to reflect the revised 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.

Table 1.

Kyrgyz Republic: Selected Economic Indicators, 2014-21

article image
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.

As of end-Septemebr 2016.

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)

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

Includes IMF and identified budget support.

Includes return of RKDF 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.

33. Financing needs for 2016 and 2017 are covered. The IMF, along with multilateral and bilateral partners, is expected to cover the country’s financing gap for this year and 2017. Despite the downside risk to the outlook, the Kyrgyz Republic’s capacity to repay the Fund is expected to remain adequate.

34. An updated safeguards assessment was completed in October 2015. The assessment concluded, inter alia, that legal amendments were needed to strengthen governance and autonomy at the central bank. The timely passage of the necessary amendments to the Banking Law will strengthen the independence of the NBKR.

Text Table 5.

Kyrgyz Republic: Balance of Payments Financing, 2016–18

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

Staff Appraisal

35. The subdued external environment facing the Kyrgyz Republic calls for a continued strong policy response. The Kyrgyz economy continues to adjust to large and persistent external shocks, particularly the slump in oil prices, depressed economic conditions in Russia, and economic slowdown in China, which have amplified domestic vulnerabilities. At the same time, large external borrowing has significantly increased debt levels, and the som depreciation in previous years, while recently reversed, has elevated financial and debt vulnerabilities. Absent a more decisive implementation of macro policies and reforms, growth will remain sluggish and below potential.

36. Fiscal consolidation and improvement of the public investment framework are necessary to ensure public debt sustainability. The large slippage in non-priority outlays this year is unfortunate, and reaching the budget deficit target will necessitate cuts in much-needed investment. Reliance on grants, one-off revenues, and ad hoc expenditure cuts to keep fiscal deficits within program targets should not be substitutes for permanent measures. Going forward, growth-friendly consolidation efforts should be pursued through boosting tax revenues, reducing the wage bill, streamlining goods and services, and improving the public investment framework. Prudence should be exercised when selecting new infrastructure projects, and contracting and guarantying new public debt. Strengthening coordination among various government agencies to ensure an efficient budget process will be critical. Adopting a fiscal rule will be essential to guide fiscal policy-making over the medium term.

37. A neutral monetary stance is warranted in the current deflationary environment, while efforts should continue to enhance the transmission mechanism and maintain a flexible exchange rate policy. The som’s appreciation in conjunction with low food prices are likely to keep inflation low. The NBKR should continue to monitor developments and inflationary expectations carefully and adjust monetary policy as needed. Moreover, the NBKR should intensify its work on improving the monetary transmission mechanism before transitioning to inflation targeting. The NBKR’s commitment to a flexible exchange rate policy is welcome. A two-way FX intervention policy is critical to strike a careful balance between financial sector stability and external competitiveness.

38. Continued efforts are needed to strengthen the resilience of the financial sector. While staff regrets the dilution of some key provisions of the Banking Law during the parliamentary deliberations as well as the recent Office of the President’s amendments, the Law still brings several improvements over the status quo. A stronger commitment by the authorities will be needed to swiftly reintroduce the key provisions that were diluted; these would represent a critical enhancement to the law that would put it at par with international best practices, and will help preserve financial sector stability, particularly in the current difficult economic environment. 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. Finalizing the liquidation of all the banks under DEBRA and winding down DEBRA’s activities are important measures to enhance confidence in the banking sector.

39. Bold structural reforms are necessary to improve the economy’s competitiveness. Improving the business climate, addressing infrastructure bottlenecks, fostering financial inclusion and tackling corruption are necessary to unlock the economy’s potential, boost long-term growth, and lift people out of poverty. Speeding up PFM reforms will improve public sector efficiency and accountability. 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.

40. The program continues to face significant external and domestic risks, but the authorities’ policy commitments provide adequate safeguards. A further drop in oil prices, and/or slower-than-anticipated growth in key trading partners could delay the recovery. Political resistance to reforms, as well as populist polices in the run up to next year’s presidential elections, could reverse the reform process, and heighten fiscal and financial vulnerabilities. Continued dialogue with the Fund is essential for the success of the program, along with the commitment to adjust policies as needed to achieve the program’s objectives.

41. Staff supports completing the third review of the authorities’ program under the ECF arrangement. Staff supports the authorities’ request to modify the end-December 2016 and set new end-March, end-June, end-September, and end-December 2017 QPCs and ITs. The policies outlined in the attached LOI are adequate to achieve the program’s goals.

Table 3.

Kyrgyz Republic: NBKR Accounts, 2014-17

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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, 2014–17

article image
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’s lending via banks - expected to mostly materilize in Q4 2016.

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.