IMF Executive Board Concludes 2009 Article IV Consultation with the Kyrgyz RepublicPublic Information Notice (PIN) No. 09/69
May 29, 2009
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On May 22, 2009 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kyrgyz Republic.1
Up to 2008, a favorable external environment and sound economic policies resulted in a steady increase in the pace of economic growth in the Kyrgyz Republic, while inflation remained low. Following periods of political turmoil, economic growth accelerated to 8½ percent in 2007 and non-gold growth reached 9 percent that year. Poverty rates fell to 35 percent, from 54 percent in 2002, while extreme poverty dropped from 23 percent to 7 percent. Inflation remained close to 5 percent, until it started to surge in late 2007.
Over the last year and a half, adverse external developments have led to a deterioration in economic conditions. Initially, the Kyrgyz economy was hit by the rise in international commodity prices that caused a sharp increase in Kyrgyz inflation, to over 30 percent by mid-2008, and a worsening of the external position. When the international economic tide turned in the second half of 2008 and the global economic and financial crisis spread to the region, the Kyrgyz economy was badly hit as well. In addition, long-standing energy sector problems combined with water shortages caused a major shortfall in hydropower capacity and widespread power outages. Overall growth remained strong in 2008, reaching 7.6 percent on account of a strong recovery in gold production, but the global and regional slowdown started to affect economic activity outside the gold sector, with non-gold growth falling to 5.4 percent. The global crisis is hurting the Kyrgyz economy mainly through trade and remittance channels. Russia and Kazakhstan remain key trading partners and the main source of remittances. With these countries in recession, Kyrgyz growth is expected to almost come to a halt in 2009, before recovering modestly in 2010.
The Kyrgyz authorities’ economic policies for 2009, together with large donor support, will help mitigate the impact of the crisis on the Kyrgyz economy. Sizable assistance received from Russia allows fiscal policy to accommodate the large shortfall in government revenues expected this year, while creating room for an increase in capital and social spending. The resulting fiscal easing will provide a strong boost to the economy and help to avoid a recession. The assistance will more than cover the balance of payments and fiscal needs that were emerging for 2009. Accordingly, the authorities are planning to use this money in a medium-term fiscal framework.
The National Bank of the Kyrgyz Republic (NBKR) continues to aim its policies at further reducing inflation and maintaining financial sector stability. Inflation has come down sharply to 13.6 percent in March 2009, as world commodity prices have eased, and is expected to slow further to about 10 percent by year-end. The NBKR has allowed continued exchange rate flexibility to absorb the large external shocks and limit foreign exchange reserve losses. Notwithstanding some signs of stress, including an increase in non-performing loans and a loss of deposits, the banking sector has thus far weathered the crisis well.
Although the current emphasis of the authorities’ policies is on addressing the impact of the external shocks, they continue to advance their broader structural reform agenda to ensure strong growth over the medium term. Considerable progress was made in the last two years in improving the business environment, earning the Kyrgyz Republic a ranking as one of the top ten reformers in last year’s World Bank Doing Business Survey. The authorities are continuing with their efforts to strengthen public financial management, reduce the administrative burden on businesses, including in the areas of taxation and trade, and fight corruption.
Executive Board Assessment
Executive Directors noted that the Kyrgyz Republic is being adversely affected by the global economic crisis spreading to the region, primarily through trade and remittances, spilling over to domestic demand, and creating a revenue shortfall and larger balance of payments needs. As a result, growth in the Kyrgyz Republic is likely to come to a halt this year, with considerable downside risks associated with a possibly more protracted recession, a worsening of financial sector difficulties in the region, and uncertainties surrounding the upcoming elections. Looking ahead, Directors were encouraged by the authorities’ commitment to sound economic policies and their readiness to take additional measures if needed to ensure macroeconomic stability.
Directors commended the authorities on their prompt response to the crisis including a strong performance under the ESF arrangement. They agreed with the Kyrgyz authorities’ emphasis on managing the spillover from the global crisis, aiming to support growth, safeguard external and financial stability, and mitigate the impact on the poor. Directors welcomed the large financial support provided by the Russian Federation and the authorities’ commitment to use this support in a medium-term budget framework.
Directors noted that the larger donor support will permit fiscal stimulus to sustain economic activity, by compensating for a revenue shortfall, while still leaving room to increase capital and social spending. Directors particularly welcomed the authorities’ plans to raise the level and improve the targeting of social benefits, with the help of the World Bank and the European Union. Looking forward, they encouraged the authorities to press ahead with fiscal reforms, including strengthening public financial management, further revising the tax system, including a partial reversal of the recent VAT rate reduction and eliminating VAT exemptions on imports, and strengthening revenue administration. These measures will be crucial to ensure fiscal sustainability over the medium term, when donor support may decline.
Directors noted the updated debt sustainability analysis, which continues to place the Kyrgyz Republic at a moderate risk of debt distress. They underscored the need to maintain a prudent debt strategy, and supported the authorities’ decision to abstain from issuing guarantees for commercial projects, including in the energy sector.
Directors concurred with the central bank’s monetary policy aimed at further reducing inflation, while maintaining a flexible exchange rate regime. They noted the staff’s assessment that the real effective exchange rate is broadly in line with fundamentals. In the short term, Directors saw limited scope for monetary easing to help support economic growth, given depreciation pressures and the persistence of high core inflation. Looking ahead, they considered that the pace of any gradual easing would depend on lower inflation and the easing of exchange rate pressures. Directors welcomed the decision to increase the central bank’s capital, thereby strengthening its independence.
Directors observed that banks have been resilient to the global financial turmoil. They were encouraged by the authorities’ readiness to deal with any financial sector problems, including by providing emergency liquidity support and injecting capital into systemic banks if needed. Directors also welcomed the early introduction of the deposit insurance scheme, which would help improve confidence in the banking system. The authorities should continue to monitor banks closely, as banks’ asset quality is likely to worsen further as the economy slowed.