Kyrgyz Republic: Third Review Under the Three-Year Arrangement Under the Extended Credit Facility, and Request for Modification of Performance Criteria—Debt Sustainability Analysis Update

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,

Due to the appreciation of the som and re-prioritization of public investment projects, the outlook for debt sustainability in the Kyrgyz Republic has improved significantly. External public debt is expected to decline to 60.7 percent of GDP in 2016 from 64.6 percent in the previous year, and the DSA assesses the Kyrgyz Republic to remain at moderate risk of debt distress. However, the debt outlook remains vulnerable, in particular to a sizeable exchange rate depreciation or scaling-up of public investment, which could tilt the assessment to high risk of debt distress. In order to avoid this adverse development, the authorities need to remain cautious when contracting and guaranteeing new debt and continue fiscal consolidation.1

Underlying Assumptions

1. The current DSA takes into account the revised macroeconomic assumptions compared to the second review. Based on economic developments in the first nine months of the year, 2016 economic growth is now expected to be weaker than at the time of the second review. Due to weak imports driven by sluggish economic activity and the scaling back of public investment projects, the current account deficit will decline further. Following the steady appreciation of the Kyrgyz som in the beginning of the year, the exchange rate has stabilized in recent months and most likely will remain stronger than expected in the medium-term. The postponement of some of the externally financed public investment projects resulted in an improved fiscal balance (including on-lending) in 2016, but some deterioration in the medium-term.

Selected Indicators

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Including onlending

Sources: Authorities data and IMF staff calculations.

External Dsa

2. The debt outlook has improved, but remains vulnerable to external and domestic shocks. Driven by the som appreciation and the postponement of some public investment projects by the authorities, external public and publicly guaranteed debt2 is projected to decrease to 60.7 percent of GDP in 2016, compared to 64.6 percent in 2015. The 2016 external debt ratio had been revised down by 9.5 percentage points from the previous DSA due to the stronger than anticipated exchange rate and the authorities’ decision to re-prioritize some externally financed public investment projects. The external debt-to-GDP ratio is also revised down over the medium term, mainly on the account of the stronger exchange rate projection, which is only partly offset by the weaker GDP forecast. External PPG-debt is now expected to level off at around 64 percent in 2018 and gradually decline afterwards.

A03ufig1

Contribution to Debt Increase from the Second to the Third Review

(In percent)

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A003

Sources: National authorities; and IMF staff calculations.

3. The Kyrgyz Republic remains at moderate risk of debt distress, but it is no longer considered a borderline case. Public and publicly guaranteed external debt is estimated to remain well-below 36 percent of GDP and remittances in present value (PV) terms under baseline conditions over the projection period. Other indicators of debt sustainability also remain below their indicative thresholds and suggest, in particular, limited liquidity risks.

4. The external PPG debt outlook remains vulnerable to large external shocks, in particular to a falloff in exports, and sizeable depreciation of the exchange rate. The PV of the debt to GDP plus remittances ratio rises above the relevant indicative thresholds over the medium term under five of the six stress tests (one standard deviation shock to exports, the most severe of these scenarios, and net debt creating flows, U.S. dollar GDP deflator below historical average, a combined shock, and a 30 percent exchange rate shock (see Table 2). The breach of threshold under the export shock is large and protracted (figure AII.1, panel b), and sufficient to assess the country’s external risk of debt distress as moderate.

Table 1.

Kyrgyz Republic: External Debt Sustainability Framework, Baseline Scenario, 2016–361/

(In percent of GDP; unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - p(1+g)]/(1+g+p + gp) times previous period debt ratio, wth r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2.

Kyrgyz Republic: Indicators of Public and Publicly-Guaranteed External Debt Under Alternative Scenarios, 2016-361/

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is by 2 percentage points higher than in the baseline., while grace and maturity periods are the same as in the baseline.

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assu an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

5. While externally financed public investments are necessary to close the country’s sizeable infrastructure gap, a massive scaling-up of public investments could undermine debt sustainability. As indicated by the adverse fiscal scenario in Annex I, under the assumption of: (i) an 0.7 multiplier of public investments (reflecting Kyrgyz’s low public investment efficiency) and (ii) a 1 percent increase in the cost of new public borrowing (due to the increased reliance on Chinese loans), a 4 percentage point permanent increase in the public investment to GDP ratio would result in a non-stabilizing external debt path3. This finding underlines the risks associated with a debt-financed investment-based growth model in the Kyrgyz Republic and the need for ensuring prioritiziation and sufficient profitability of public investment projects.

Public Dsa

6. The public debt outlook has also improved significantly compared to the previous DSA, mainly driven by the factors affecting external debt. Public debt (external plus domestic) is expected to reach 62.1 percent of GDP in 2016, a 3 percentage points drop compared to 2015. Total public debt is expected to be manageable in the medium and long term, but remains highly sensitive to shocks that reduce real GDP growth or failure to reduce the primary deficit over the medium term. Liquidity risks associated with the servicing of public debt are expected to increase in the years ahead and reach 30 percent of revenues by 3036. This is due to the rising share of domestic debt in total public debt, which is serviced at higher domestic interest rates. Rising liquidity risks underline the importance of continued fiscal consolidation.

Comparison of Debt Ratio

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Sources: Authorities data and IMF staff calculations.

Conclusion

7. The authorities need to remain cautious when contracting and guaranteeing new debt, and should resume fiscal consolidation. In 2017, the primary fiscal deficit is expected to be 2.5 percentage points higher than the debt-stabilizing level, resulting in an increase in the public debt ratio. While necessary to fill the large infrastructure gap, externally financed public investments, could undermine debt sustainability. In this context, further efforts are needed to strengthen public debt and public investment management, in order to ensure that potential gains from externally financed public investment projects are fully realized.

Figure 1.
Figure 1.

Kyrgyz Republic: Indicators of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2016–36 /1

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2026. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock
Figure 2.
Figure 2.

Kyrgyz Republic: Probability of Debt Distress of Public and Publicly Guaranteed External Debt Under Alternative Scenarios, 2016–36 /1

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2026. In figure b. it corresponds to a Exports shock; in c. to a Exports shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock
Table 3.

Kyrgyz Republic: Public Sector Debt Sustainability Framework, Baseline Scenario, 2013-36

(In percent of GDP; unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Figure 3.
Figure 3.

Kyrgyz Republic: Indicators of Public Debt Under Alternative Scenarios, 2016-2036 1/

Citation: IMF Staff Country Reports 2017, 143; 10.5089/9781484302880.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2026.2/ Revenues are defined inclusive of grants.
Table 4.

Kyrgyz Republic: Sensitivity Analysis for Key Indicators of Public Debt 2016–2036

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.