## 1kgzea2019002

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---

### Background and Key Findings
- Private investment: about 9 percent of GDP in 2015-17.
- Growth performance:
  - Kyrgyz Republic averaged 4 percent growth over the last two decades.
  - Comparison: 6.5 percent in other CCA countries and 5.3 percent in EMDEs.
- Income per capita and forecast scenarios:
  - Current GDP per capita: $1,268.
  - Middle-income GDP per capita benchmark: $2,370.
  - Baseline forecast without reforms: 3.8 percent on average over 2020-23 — at this rate it would take 23 years to reach $2,370 GDP per capita.
  - Faster growth with reforms: 4.8 percent — would shorten the income gap by 5 years relative to the baseline forecast.
- Business formalization:
  - New formal business entry is a major challenge; many micro and small enterprises remain informal to avoid onerous regulations and minimize interactions with tax authorities.
- Comparative trends:
  - Private investment ratios were only slightly below CCA oil importers and EMDEs in 2000-10, but are now about half of those in EMDEs.
  - Contribution of private investment to growth has shrunk.

### Growth Diagnostic Methodology (Hausmann–Velasco–Rodrik decision tree)
- Decision tree classifies short-run binding constraints into:
  - High cost of finance, or
  - Low private return to investment.
- If low private returns, causes include:
  - Low social (economic) returns, or
  - Large gap between social and private returns (low private appropriability).
- If high cost of finance, causes include:
  - Absence of or high cost of international finance, or
  - High local finance.
- Analysis uses cross-country comparisons to identify which branches best characterize the Kyrgyz Republic.

### Private Sector Growth Constraints — Human Capital and Labor Market
Findings
- Education:
  - Average years of schooling: 12.5 years.
  - Learning-adjusted years of school: 8.4 years.
  - World Bank Human Capital Index: a child born today in the Kyrgyz Republic will be 58 percent as productive as if receiving full health and complete education.
- Education spending and efficiency:
  - Spending skewed towards primary and secondary; spending on tertiary is disproportionately less.
  - Most education spending is on wages: 70 percent.
  - Investment in education is very small relative to wage spending.
- Labor market and wages:
  - Nominal wages relatively low; wage growth has exceeded productivity growth in industry and services (National Statistical Committee).
  - Real effective exchange rate: appreciated (+15 percent over the past three years).
  - Women labor participation has become relatively low.
- Labor market efficiency weaknesses (WEF Global Competitiveness Index): reliance on professional management, hiring and firing practices, redundancy costs, cooperation in labor-employer relations, and active labor policies need improvement.

Policy implications / recommended actions
- Improve predictability of the wage bill and avoid ad-hoc wage increases.
- Better align teacher pay to productivity or performance evaluations.
- Consolidate support staff in education to increase efficiency.
- Strengthen active labor policies and flexibility in hiring/firing.

### Private Sector Growth Constraints — Infrastructure
Findings
- Infrastructure quality remains weak despite investments; country ranks relatively low on roads, rail, and air (WEF Global Competitiveness Index).
- Logistics, customs clearance efficiency, timeliness, and shipment costs are obstacles to business.
- Electricity sector specifics:
  - 45 percent of generation capacity in the power sector is beyond its useful life.
  - Lack of maintenance/rehabilitation has undermined reliability and increased risk of breakdowns (example: Bishkek Heat and Power Plant failed in January 2018).
  - Tariffs below cost have deterred private investment.
  - Residential tariffs (representing 53 percent of consumption) are 44 percent below cost recovery.
  - Non-residential electricity tariffs are above cost recovery levels.
  - Distribution losses represent 4 percent of annual sales, contributing to higher costs and outages.

Policy implications / recommended actions
- Reform electricity tariffs toward cost recovery to remove cross-subsidies that deter private investment.
- Increase maintenance and rehabilitation of generation and distribution assets to reduce outages and losses.
- Encourage private investment in the energy sector by improving tariff policy and investment climate for energy rehabilitation.

### Governance — Micro Risks
Findings
- Weak governance increases cost of doing business, reduces appropriability of returns, and impedes revenue mobilization and public goods provision.
- Business environment and corruption indicators:
  - Areas for improvement: respect of the rule of law, control of corruption, government effectiveness (WEF Global Competitiveness Indicators, 2018; EBRD and World Bank Enterprise Surveys, 2016).
  - World Bank Incidence of Graft index: 53.5 percent of firms are expected to give gifts.
  - About 9 percent of firms believe the court system is fair, impartial, and uncorrupted.
  - Licenses are non-automatic and the licensor takes about 30 days to issue or deny a license.
  - Contract enforcement through courts is protracted and costly; relatively high incidence of investor-state disputes taken to international arbitration.
- Specific issues: informal payments to secure government contracts, obtain construction permits, import licenses or operating licenses; repeated disputes and renegotiations with a large foreign investor have harmed the business environment.

Policy implications / recommended actions
- Strengthen rule of law, judicial capacity, and impartiality to improve contract enforcement.
- Reduce opportunities for informal payments and graft through procurement and licensing reforms.
- Improve government effectiveness to bolster investor confidence and private sector investment.

*Source: IMF staff summary from "CONSTRAINTS TO PRIVATE INVESTMENT AND ECONOMIC GROWTH IN THE KYRGYZ REPUBLIC" (May 21, 2019).*

### Tax system and administration
- Tax regimes:
  - Formal regime: corporate income tax of 10 percent.
  - Simplified regime: sales tax of 4 and 6 percent for cash payment (2 and 3 percent for non-cash payment) depending on sector.
  - Patent regime: flat payment for individual entrepreneurs in 83 types of activities.
- Despite simple rates, Kyrgyz Republic ranks low in Doing Business “Paying Taxes” due to number of tax payments per year, time to make payments, low usage of e-filing, cumbersome VAT practices, and high share of firms expecting informal payments to tax inspectors (World Bank and IFC, Investment Climate, 2015).
- Government plans for electronic filing of tax payments offer opportunities to reduce administrative cost of filing.

### Governance — Macro risks and fiscal position
- Fiscal outcomes and public debt:
  - Fiscal deficit in 2018 was reduced to 1.3 percent of GDP (from 4.6 percent of GDP in 2017).
  - Public debt: 56 percent of GDP and largely denominated in foreign currency.
- Composition and efficiency of spending:
  - Spending tilted towards wages, subsidies, and untargeted social benefits.
  - Efficiency of spending and public investment is low.
  - Subsidies aggravate fiscal imbalances, crowd out priority public spending, and depress private investment, including in the energy sector.

### Cost of finance and financial sector constraints
- Savings and credit:
  - Domestic savings: fell from 25 percent of GDP in 2011-14 to 22 percent in 2015-17; remain higher compared to CCA oil importers and EMDEs, and only lower than in CCA oil exporters.
  - Lending-deposit spreads are among the highest in the CCA and much higher compared to upper middle-income countries and the world.
- Bank market structure and operating environment:
  - Market concentration: 3 largest banks hold about 70 percent of the market.
  - Low bank diversification and high operating costs contribute to high spreads.
  - Barriers to cheaper financing: limited medium-term funding for banks; prudential barriers for banks and institutional investors to invest in local currency corporate bonds; lack of foreign exchange hedging instruments; inability to mobilize credit claims; absence of local rating infrastructure.
- Bank performance and firm access:
  - Banks' non-interest expense is high relative to gross income.
  - Collateral requirements often exceed loan value.
  - Firms with a bank loan/line of credit remain limited.

### Electricity sector overview and economic potential
- Resource endowment and generation:
  - Around 90 percent of electricity generated from hydropower over the last decade.
  - Annual average production: 12–13 terawatt hour (TWh).
  - Less than 10 percent of hydropower potential exploited.
  - International Hydropower Association estimates hydropower potential at 140–170 TWh annually.
- Sector policy and outcomes:
  - Policy emphasis on universal access and low tariff has led to supply and demand side weaknesses.
  - Cross-country comparison (2014 data): transmission and distribution losses among largest; high monetary cost and required days/procedures to obtain electricity; significant share of firms experiencing outages and high reported lost value.
  - Share of firms identifying electricity as a major constraint stands around the 75th percentile in the sample.
- Performance index and macro linkages:
  - Composite electricity sector performance index places Kyrgyz Republic in the bottom half with deterioration over time.
  - Panel estimation: closing 10 percent of the gap with the median country could raise per capita GDP the following year by 1.1 percent.
- Reform implications:
  - Address below-cost tariffs causing dire financial conditions and chronic under-maintenance.
  - Successful reforms usually accompanied by comprehensive strategy, information campaign, enhanced governance of regulatory bodies and energy companies, and mitigation measures to protect the poor and vulnerable.

### Challenges and diagnostics: demand, supply, and assets
- Deteriorating productivity of ageing capital limits ability to meet fast-growing domestic demand and rising winter residential demand.
- Seasonal shortages frequent despite annual generation generally covering domestic consumption; World Bank estimates winter supply shortage widening from 581 gigawatt hours in 2015 to almost 900 gigawatt hours in 2030 under existing capacity.
- Households not connected to district heating use electricity for heating, increasing winter demand.
- Low residential tariffs provide inadequate incentive for conservation; households consume more electricity on average than peers in similar weather conditions.
- Generation plateaued at early 2000s levels.
- Around 45 percent of available capacity beyond useful life of 25 years, including Toktogul HPP (about 30 percent of total Kyrgyz power system) and Bishkek CHP.
- Transmission and distribution decay results in high technical losses: 17 percent of 2016 total generation.
- New investment and rehabilitation have occurred with donor support but gradually; underspending on maintenance could accelerate capital decay.

### Financial situation and fiscal implications
- Residential tariffs highly subsidized; over half of electricity users (mostly residential customers with monthly usage below 700 kWh) pay tariffs too low to cover cost of service.
- For 81 percent of residential consumption, tariffs cover only 40 percent of cost of service.
- Domestic electricity segment ran a chronic deficit amounting to over KGS 2.4 billion in 2017 (0.4 percent of GDP).
- Technical and commercial losses (including unpaid bills) contributed but together accounted for only 20 percent of the deficit during 2007–12.
- Export revenue has temporarily narrowed deficits in favorable years (e.g., 2017) but exports are expected to decline.
- Sector debt reached almost 20 percent of GDP (32 percent of overall public debt) in 2016.
- Loan repayments projected to pick up and exceed one percent of GDP on average during 2019–23 and will likely be assumed by the budget.
- Total subsidy to electricity, district heating, and hot water estimated at 3 percent of GDP (IMF, 2017).

### Cost of service versus revenue by customer class, 2017 (selected figures preserved)
- Percent of Consumption by customer class: 52.9% | 11.9% | 29.5% | 5.4% | 0.4% | 100%
- Tariff (KGS per kWh) by class: 0.77 | 2.16 | 2.24 | 0.77 | 0.088 | 1.37 | 1.57
- Consumption (billion kWh) total: 10.0 | 1.2
- Revenue (billion KGS) total: 13.7 | 11.9
- Cost of Service (CoS, KGS per kWh) by class: 1.75 | 1.75 | 1.55 | 1.33 | 1.75 | 1.67
- Full Cost of Service (billion KGS) total: 16.1
- Difference between CoS and Revenue (billion KGS) total: -2.40 | 1.9 (memo: Deficit percent of 2017 GDP: -0.43 | 0.34)

(Note: table rows preserved as presented in source; classes include Exports, Domestic Consumption, Residential, Non-Residential, Pumping Stations, Other, Total.)

### Distributional and social considerations: affordability and willingness to pay
- Energy subsidies are regressive: almost half of subsidies to electricity, district heating, and hot water go to the 30 percent richest households; bottom 30 percent receive barely 20 percent.
- Poverty and vulnerability:
  - 25 percent of the population is poor (per capita income less than $2.5 per day in 2015).
  - Another 70 percent vulnerable (per capita income less than $10 per day).
- Social safety net: the only means-tested social benefit was abolished in 2017 and replaced by universal child benefits; existing programs largely aim at categories without explicit income requirement.
- Public priorities (World Bank survey, 2017): high electricity prices 21%, government efforts to stop corruption and stealing 20%, electricity cutoffs 18%, quality of service 15%, consumer service quality 13%, quality of public information about the sector 13%.
- Consumer willingness to pay constrained by unsatisfactory service, repeated cutoffs (including winter), poor quality, and perceived corruption.

### Reform roadmap: recommended actions and sequencing
- Holistic reforms addressing supply, demand, governance, and social protection simultaneously.
  - Supply-side actions:
    - Continue cooperating with development partners to rehabilitate existing assets and enhance productivity.
    - Improve transmission and distribution to reduce technical losses and mitigate seasonal shortages.
    - Create a business environment attractive to private investors by achieving tariffs that cover full cost recovery (operational expenditures and full capital costs) and by ensuring good governance and policy certainty.
    - Develop alternative energy sources beyond hydroelectricity to diversify generation and strengthen energy security.
  - Demand-side and social actions:
    - Improve energy efficiency of residential and public buildings and upgrade heating systems to reduce winter shortages.
    - Enhance customer service quality and simplify access procedures.
    - Strengthen and redesign the social safety net to protect poor and vulnerable households.
- Tariff strategy and communication:
  - Make tariff increases the cornerstone of sector development to restore financial viability given projected decline in exports and rising debt repayments.
  - Elaborate and implement a new medium-term tariff strategy so electricity companies, users, and the regulator have a clear, predictable plan.
  - Communicate sector challenges and government strategy, explaining structural losses, consequences, and combined measures (gradual residential tariff increases, cost reductions, governance strengthening).
  - Disclose the amount and distributional impact of electricity sector subsidies (including transfers for investment and implicit transfers from below-cost tariffs).
  - Prepare targeted mitigation measures for the poor (e.g., cash transfers), identify vulnerable groups and calibrate to available fiscal space; move toward income-related transfers from category-based assistance.
  - Gradually increase tariffs to achieve full cost recovery, potentially by lowering social tariff consumption threshold and increasing residential tariffs; calibrate adjustments to sector financial needs and households’ ability to pay, implementing changes gradually and predictably.

### International lessons and implementation cautions (Box 1)
- Common successful reform features:
  - Clear long-term objectives from the onset.
  - Ex-ante impact assessment on revenue distribution and mitigation measures for the poor.
  - Active consultations with stakeholders and public communication campaigns.
  - Depoliticized tariff-setting (independent regulator).
- Country case highlights:
  - Armenia: deployed meters, enforced cutting power to non-payers, more than doubled tariffs during 1995–99, abolished lifeline tariff, strengthened targeted social programs, set up independent regulator in 1997.
  - Brazil: privatized distribution, unbundled tariffs, conditional cash transfers, rural access programs including free rural power (2003).
  - Kenya: raised tariffs achieving cost recovery by 2008, introduced automatic pricing formula, maintained transparency, lifeline of 50 kWh/month and aid for connection fees.
  - Philippines: sizable tariff increase about 30 percent during 2004–05, gradual privatization, well-functioning wholesale markets, depoliticized tariff setting.
  - Turkey: unbundling, privatization, wholesale market, cost-based pricing with automatic adjustment in early 2008 and multiple increases during 2008–09.
  - Uganda: significant tariff increases in 2012, explicit subsidy 1.1 percent of GDP in 2011, maintained lifeline below 15 kWh/month.
- Common reform measures and mitigation instruments:
  - Revenue and collection: deploy meters, shift bill payments to banks/post offices, strict enforcement (cutting power to non-payers).
  - Tariff policy: increase tariffs to cost-recovery, adopt cost-based pricing mechanisms and automatic formulas, establish independent regulators, unbundle tariffs.
  - Privatization and market reforms: privatize distribution first, implement wholesale markets.
  - Social mitigation and targeting: replace universal lifelines with targeted social programs; lifelines where retained include 50 kWh/month (Kenya) and 15 kWh/month (Uganda); use conditional cash transfers, targeted low tariffs, assistance for connection fees, rural electrification programs.
- Outcomes and lessons:
  - Improved revenue collection and enforcement, combined with clear communication, can raise collection rates and public acceptance.
  - Tariff reforms paired with targeted social protection protect the poor while restoring sector financial viability.
  - Independent regulators and automatic pricing formulas depoliticize tariff setting.
  - Privatization and private participation, when coupled with tariff reform and regulation, improve efficiency and attract investment.
  - Timing and accompanying measures (service improvements, rural access expansion, social safety nets) are crucial to reduce political resistance.

*Source: IMF and World Bank staff analysis as presented in the chapter "6. The potential of the electricity sector to boost growth and welfare is hampered by a few inter-connected challenges."*

### 1.    Private Investment and Business Climate _______________________________________________ 4

### 1.    Private Investment and Business Climate

### Background and Key Findings
- Private investment has been relatively low: about 9 percent of GDP in 2015-17.
- Growth performance has been subpar: growth has averaged 4 percent over the last two decades, compared to 6.5 percent in other CCA countries and 5.3 percent in EMDEs.
- Income per capita dynamics and forecasts:
  - Current GDP per capita: $1,268.
  - Middle-income GDP per capita benchmark: $2,370.
  - Forecast growth scenario without reforms: 3.8 percent on average over 2020-23 — at this rate it would take 23 years to reach $2,370 GDP per capita.
  - Faster growth scenario with reforms: 4.8 percent — would shorten the income gap by 5 years relative to the baseline forecast.
- Business formalization and entry:
  - New formal business entry is a major challenge, especially to open a small formal business or to convert an informal micro/small business into a formal, growing firm.
  - Many micro and small enterprises remain informal to avoid onerous regulations and minimize interactions with tax authorities.
- Comparative trends:
  - Private investment ratios in the Kyrgyz Republic were only slightly below those in the CCA oil importers and EMDEs in 2000-10, but are now about half of those in EMDEs.
  - The contribution of private investment to growth has shrunk (see decomposition of real GDP growth).

### Growth Diagnostic Methodology (Hausmann–Velasco–Rodrik decision tree)
- The decision tree identifies the most binding short-run constraints to growth by classifying causes into:
  - High cost of finance, or
  - Low private return to investment.
- If low private returns, causes are:
  - Low social (economic) returns, or
  - Large gap between social and private returns (low private appropriability).
- If high cost of finance, causes are:
  - Absence of or high cost of international finance, or
  - High local finance.
- The analysis uses cross-country comparisons to diagnose which branches best characterize the Kyrgyz Republic.

### Private Sector Growth Constraints — Human Capital and Labor Market
Findings
- Education quantity and quality:
  - Average years of schooling: 12.5 years.
  - Learning-adjusted years of school: 8.4 years.
  - World Bank Human Capital Index: a child born today in the Kyrgyz Republic will be 58 percent as productive as if receiving full health and complete education.
- Education spending and efficiency:
  - Spending is skewed towards primary and secondary; spending on tertiary education is disproportionately less.
  - Most education spending is on wages: 70 percent.
  - Investment in education is very small relative to wage spending.
- Labor market and wages:
  - Nominal wages are relatively low, but wage growth has exceeded productivity growth in industry and services (National Statistical Committee).
  - Real effective exchange rate: appreciated (+15 percent over the past three years).
  - Women labor participation has become relatively low.
- Labor market efficiency weaknesses (WEF Global Competitiveness Index):
  - Reliance on professional management, hiring and firing practices, redundancy costs, cooperation in labor-employer relations, and active labor policies are areas needing improvement.

Policy implications / recommended actions (as described in source)
- Improve predictability of the wage bill and avoid ad-hoc wage increases.
- Better align teacher pay to productivity or performance evaluations.
- Consolidate support staff in education to increase efficiency.
- Strengthen active labor policies and flexibility in hiring/firing to improve labor market efficiency.

### Private Sector Growth Constraints — Infrastructure
Findings
- Infrastructure quality remains weak despite investments:
  - Country ranks relatively low on roads, rail, and air infrastructure in the WEF Global Competitiveness Index.
  - Logistics quality, customs clearance efficiency, timeliness, and shipment costs are obstacles to business.
- Electricity sector specifics:
  - 45 percent of generation capacity in the power sector is beyond its useful life.
  - Lack of maintenance/rehabilitation has undermined reliability and increased risk of breakdowns (example: Bishkek Heat and Power Plant failed in January 2018).
  - Tariffs below cost have deterred private investment.
  - Residential tariffs (representing 53 percent of consumption) are 44 percent below cost recovery.
  - Non-residential electricity tariffs are above cost recovery levels.
  - Distribution losses represent 4 percent of annual sales, contributing to higher costs and outages for the private sector.

Policy implications / recommended actions (as described in source)
- Reform electricity tariffs toward cost recovery to remove cross-subsidies that deter private investment.
- Increase maintenance and rehabilitation of generation and distribution assets to reduce outages and losses.
- Encourage private investment in the energy sector by improving tariff policy and investment climate for energy rehabilitation.

### Governance — Micro Risks
Findings
- Weak governance undermines growth by increasing cost of doing business, reducing appropriability of returns, and impeding revenue mobilization and public goods provision.
- Business environment indicators and corruption:
  - Areas for improvement: respect of the rule of law, control of corruption, and overall government effectiveness (WEF Global Competitiveness Indicators, 2018; EBRD and World Bank Enterprise Surveys, 2016).
  - World Bank Incidence of Graft index: 53.5 percent of firms are expected to give gifts.
  - Only about 9 percent of firms believe that the court system is fair, impartial, and uncorrupted.
  - Doing Business and WTO: licenses are non-automatic and the licensor takes about 30 days to issue or deny a license.
  - Contract enforcement through the courts is protracted and costly; relatively high incidence of investor-state disputes taken to international arbitration indicates lack of trust in domestic judicial process.
- Specific business-government relations issues:
  - Companies and private businesses are frequently requested to make informal payments to secure government contracts, obtain construction permits, import licenses or operating licenses.
  - Relations between the government and the largest foreign investor have involved perpetual contract renegotiations, lawsuits, prosecution of expatriate staff and withdrawal of licenses (Press, July and November 2018), harming the business environment.

Policy implications / recommended actions (as described in source)
- Strengthen rule of law, judicial capacity, and impartiality to improve contract enforcement.
- Reduce opportunities for informal payments and graft through procurement and licensing reforms.
- Improve government effectiveness to bolster investor confidence and private sector investment.

*Source: IMF staff summary from "CONSTRAINTS TO PRIVATE INVESTMENT AND ECONOMIC GROWTH IN THE KYRGYZ REPUBLIC" (May 21, 2019).*

### 10.      Tax rates are light, but tax regulations and administration are heavy. The tax system is

### 1kgzea2019002 - 10.      Tax rates are light, but tax regulations and administration are heavy. The tax system is

### Tax system and administration
- The tax system comprises:
  - a formal regime with a corporate income tax of 10 percent;
  - a simplified regime with a sales tax of 4 and 6 percent for cash payment (2 and 3 percent for non-cash payment) depending on the sector of activity;
  - a patent regime with a flat payment for individual entrepreneurs in 83 types of activities.
- Despite the simplicity of tax rates, the Kyrgyz Republic ranks low in the Doing Business “Paying Taxes” indicator because of:
  - number of tax payments per year and time it takes to make tax payments;
  - low usage of e-filing and cumbersome practices on VAT returns;
  - a high share of firms expecting to have to make informal payments to tax inspectors (World Bank and IFC, Investment Climate, 2015).
- Government plans for electronic filing of tax payments offer opportunities to reduce the administrative cost of filing for taxpayers.

### Governance — Macro risks and fiscal position
- Fiscal outcomes and public debt:
  - Fiscal deficit in 2018 was reduced to 1.3 percent of GDP (from 4.6 percent of GDP in 2017).
  - Public debt is on the high side at 56 percent of GDP and is largely denominated in foreign currency, exposing the country to foreign exchange risk.
- Composition and efficiency of spending:
  - Spending is tilted towards wages, subsidies, and untargeted social benefits.
  - Efficiency of spending and of public investment is low.
  - Subsidies aggravate fiscal imbalances, crowd out priority public spending, and depress private investment, including in the energy sector.

### Cost of finance and financial sector constraints
- Savings and credit:
  - Domestic savings fell from 25 percent of GDP in 2011-14 to 22 percent in 2015-17, but remain higher compared to CCA oil importers and EMDEs, and only lower than in CCA oil exporters.
  - Lending-deposit spreads are among the highest in the CCA and much higher compared to upper middle-income countries and the world.
- Bank market structure and operating environment:
  - Market concentration: 3 largest banks hold about 70 percent of the market.
  - Low bank diversification (low non-interest income) and high operating costs contribute to high spreads.
  - Barriers limiting cheaper financing include: limited medium-term funding for banks; prudential barriers for banks and institutional investors to invest in local currency corporate bonds; lack of foreign exchange hedging instruments; inability to mobilize credit claims between banks, private investors, and central bank; absence of local rating infrastructure.
- Bank performance and firm access:
  - Banks' non-interest expense is high relative to gross income (figures shown in source charts).
  - Collateral requirements often exceed loan value (figures shown in source charts).
  - Firms with a bank loan/line of credit remain limited (figures shown in source charts).

### Electricity sector overview and economic potential
- Resource endowment and current generation:
  - Around 90 percent of electricity has been generated from hydropower over the last decade.
  - Annual average production equal to 12–13 terawatt hour (TWh).
  - Less than 10 percent of the country’s hydropower potential has been exploited.
  - International Hydropower Association estimates hydropower potential at 140–170 TWh annually.
- Sector policy and outcomes:
  - Policy emphasis on universal access and low tariff has led to supply and demand side weaknesses, affecting quality and quantity of service.
  - Cross-country comparison (2014 data) shows: transmission and distribution losses among the largest; high monetary cost and required days/procedures to obtain electricity; significant share of firms experiencing outages and high reported lost value.
  - The share of firms identifying electricity as a major constraint in the Kyrgyz Republic stands around the 75th percentile in the sample.
- Performance index and macro linkages:
  - A composite index of electricity sector performance places the Kyrgyz Republic in the bottom half among countries considered, with deterioration over time driven by worsening transmission and distribution losses and stalled generation and consumption per capita.
  - Panel estimation linking the composite electricity performance index to per capita GDP finds a significantly positive coefficient (with a one-year lag). For the Kyrgyz Republic, closing 10 percent of the gap with the median country could raise per capita GDP the following year by 1.1 percent.
- Reform implications:
  - Reforms should address below-cost tariffs that have caused dire financial conditions for energy firms and chronic under-maintenance and under-investment.
  - Successful reforms are usually accompanied by a comprehensive strategy and information campaign, enhanced governance of regulatory bodies and energy companies, and mitigation measures to protect the poor and vulnerable.

*Source: IMF staff compilation from the Kyrgyz Republic country report content provided.*

### 6.      The potential of the electricity sector to boost growth and welfare is hampered by a

### 1kgzea2019002 - 6.      The potential of the electricity sector to boost growth and welfare is hampered by a

### Challenges and diagnostics: demand, supply, and assets
- Productivity of ageing capital is deteriorating, limiting ability to meet fast-growing domestic demand and rising residential demand during winter heating seasons.
- Seasonal shortages are frequent despite annual generation generally covering domestic consumption; World Bank estimates winter supply shortage widening from 581 gigawatt hours in 2015 to almost 900 gigawatt hours in 2030 under existing capacity.
- Households not connected to district heating or hot water increasingly use electricity for heating, contributing to surging winter demand.
- Low residential tariffs provide inadequate incentive for conservation; Kyrgyz households consume more electricity on average than peers in countries with similar weather conditions.
- Electricity generation has plateaued at early 2000s levels.
- Around 45 percent of available capacity is beyond the useful life of 25 years, including Toktogul HPP (generation capacity about 30 percent of the total Kyrgyz power system) and the Bishkek CHP, both vital for winter supply.
- Transmission and distribution network decay results in high technical losses: 17 percent of 2016 total generation.
- New investment and rehabilitation have occurred with donor support but only gradually given the sector’s weak financial situation; underspending on maintenance could accelerate capital decay.

### Financial situation and fiscal implications
- Residential tariffs are highly subsidized; over half of electricity users—mostly residential customers with monthly usage below 700 kWh—pay tariffs that are too low to cover cost of service.
- For 81 percent of residential consumption, tariffs cover only 40 percent of the cost of service.
- Domestic electricity segment ran a chronic deficit amounting to over KGS 2.4 billion in 2017 (0.4 percent of GDP).
- Technical and commercial losses (including unpaid bills) contributed but together accounted for only 20 percent of the deficit during 2007–12.
- Export revenue has temporarily narrowed deficits in favorable years (e.g., 2017) but exports are expected to decline going forward.
- Sector debt reached almost 20 percent of GDP (32 percent of overall public debt) in 2016.
- Loan repayments are projected to pick up and exceed one percent of GDP on average during 2019–23 and will likely be assumed by the budget.
- Total subsidy to electricity, district heating, and hot water estimated at 3 percent of GDP (IMF, 2017).

### Cost of service versus revenue by customer class, 2017 (selected figures preserved)
- Percent of Consumption by customer class: 52.9% | 11.9% | 29.5% | 5.4% | 0.4% | 100%
- Tariff (KGS per kWh) by class: 0.77 | 2.16 | 2.24 | 0.77 | 0.088 | 1.37 | 1.57
- Consumption (billion kWh) total: 10.0 | 1.2
- Revenue (billion KGS) total: 13.7 | 11.9
- Cost of Service (CoS, KGS per kWh) by class: 1.75 | 1.75 | 1.55 | 1.33 | 1.75 | 1.67
- Full Cost of Service (billion KGS) total: 16.1
- Difference between CoS and Revenue (billion KGS) total: -2.40 | 1.9 (memo: Deficit percent of 2017 GDP: -0.43 | 0.34)

(Note: Table rows preserved as presented in source; classes include Exports, Domestic Consumption, Residential, Non-Residential, Pumping Stations, Other, Total.)

### Distributional and social considerations: affordability and willingness to pay
- Energy subsidies are regressive: almost half of subsidies to electricity, district heating, and hot water go to the 30 percent richest households; bottom 30 percent receive barely 20 percent.
- Per capita income is low: 25 percent of the population is poor (per capita income less than $2.5 per day in 2015); another 70 percent vulnerable (per capita income less than $10 per day).
- The social safety net offers few instruments to mitigate tariff increases; the only means-tested social benefit was abolished in 2017 and replaced by universal child benefits; existing social assistance programs largely aim at categories without explicit income requirement.
- Public priorities identified in a World Bank survey (2017): high electricity prices 21%, government efforts to stop corruption and stealing 20%, electricity cutoffs 18%, quality of service 15%, consumer service quality 13%, quality of public information about the sector 13%.
- Consumer willingness to pay for higher tariffs is constrained by unsatisfactory service, repeated cutoffs including during winter, problematic quality, and perceived corruption.

### Reform roadmap: recommended actions and sequencing
- Adopt a holistic reform approach addressing supply, demand, governance, and social protection simultaneously.
  - Supply-side actions:
    - Continue cooperating with development partners to rehabilitate existing assets and enhance productivity.
    - Improve transmission and distribution to reduce technical losses and mitigate seasonal shortages.
    - Create a business environment attractive to private investors by achieving tariffs that cover full cost recovery (operational expenditures and full capital costs), and by ensuring good governance and policy certainty.
    - Develop alternative energy sources beyond hydroelectricity to diversify generation and strengthen energy security.
  - Demand-side and social actions:
    - Improve energy efficiency of residential and public buildings and upgrade heating systems to reduce winter shortages.
    - Enhance customer service quality and simplify access procedures.
    - Strengthen and redesign the social safety net to protect poor and vulnerable households.
- Tariff strategy and communication:
  - Make tariff increases the cornerstone of sector development to restore financial viability given projected decline in exports and rising debt repayments.
  - Elaborate and implement a new medium-term tariff strategy so electricity companies, users, and the regulator have a clear, predictable plan.
  - Communicate sector challenges and the government’s strategy, explaining structural losses, consequences, and combined measures (gradual residential tariff increases, cost reductions, governance strengthening).
  - Disclose the amount and distributional impact of electricity sector subsidies (including transfers for investment and implicit transfers from below-cost tariffs).
  - Prepare targeted mitigation measures for the poor (e.g., cash transfers), identifying vulnerable groups and calibrating to available fiscal space; move toward income-related transfers from category-based assistance.
  - Gradually increase tariffs to achieve full cost recovery, potentially by lowering social tariff consumption threshold and increasing residential tariffs; calibrate adjustments to sector financial needs and households’ ability to pay, implementing changes gradually and predictably.

### International lessons and implementation cautions
- Successful reform episodes elsewhere share:
  - Clear long-term objectives from the onset.
  - Ex-ante impact assessment on revenue distribution and mitigation measures for the poor.
  - Active consultations with stakeholders and public communication campaigns to foster support.
  - Depoliticized tariff-setting (allocation to an independent regulator) to avoid reform reversals.
- These features should inform the Kyrgyz authorities’ reform strategy despite political and social sensitivity.

*Source: IMF and World Bank staff analysis as presented in the chapter "6. The potential of the electricity sector to boost growth and welfare is hampered by a few inter-connected challenges."*

### Box 1. International Experiences on Reforming Electricity Subsidies

### Box 1. International Experiences on Reforming Electricity Subsidies

### Country case studies
- Armenia
  - Sector suffered from large implicit consumer subsidies and low collection rates before reforms.
  - Relied on direct budgetary loans, state guarantees, and arrears to tax authorities.
  - Reforms since the mid-1990s: deployed meters, implemented payment of utility bills through banks and post offices, strictly enforced cutting power to customers who did not pay.
  - Communication campaign emphasized linkage between paying utility bills and more reliable service.
  - Authorities more than doubled tariffs, including the residential tariffs, over 1995–99 to reach cost-recovery level.
  - Abolished the lifeline tariff and strengthened targeted social programs to shield the poor.
  - Set up an independent regulator in 1997 with legal mandate to ensure tariffs fully cover medium-term costs, including depreciation, debt service, and other capital costs.
  - Tariff increases in the 1990s effectively eliminated the bulk of subsidies; a further increase was needed in 2009 to reflect higher price of gas supplied by Russia.
  - Result: restored financial viability and improved efficiency thanks to private sector participation.

- Brazil
  - Launched ambitious privatization program of the electricity sector in the 1990s to address large deficit, high external debt, and severe under-investment caused by suppressed tariffs.
  - Privatization began with distribution companies to stabilize upstream transmission and generation.
  - Liberalized and unbundled tariffs into generation, transmission and distribution segments to enhance price transparency.
  - Implemented conditional cash transfer programs and targeted low tariff for poor families as mitigation.
  - Enhanced rural access to electricity, including a program to provide free power to rural areas in 2003.

- Kenya
  - Reforms from the mid-1990s to maintain financial sustainability and attract investment.
  - Starting in 2005, authorities raised electricity tariffs and achieved cost recovery by 2008.
  - Coupled tariff reform with measures to improve technical and administrative efficiency, expand access, improve service quality, and establish a sound regulatory framework.
  - Introduced an automatic pricing formula linking tariffs to long-term marginal costs and other factors such as exchange rate.
  - Maintained transparency by regularly updating prices on the regulator’s website.
  - Mitigation measures included a lifeline supply of 50 kWh per month, financial assistance to cover connection fees, and a rural electrification program.

- Philippines
  - Reforms began in the early 2000s; initial limited regulator capacity and lengthy privatization led to deterioration in financial conditions.
  - A sizable tariff increase (about 30 percent) was implemented during 2004–05 as part of fiscal consolidation messaging.
  - Gradual privatization reduced government budget exposure to the energy sector.
  - Implemented well-functioning wholesale electricity markets over time.
  - Depoliticized tariff setting as the regulator became more capable; largely eliminated cross-subsidization except for a lifeline for poor families and small subsidies for remote regions.

- Turkey
  - Sequence of reforms since the 1980s to transition from state-dominated to market-oriented economy.
  - Focused on unbundling vertically integrated state-owned companies, promoting privatization, and introducing a wholesale electricity market.
  - Adopted cost-based pricing mechanism in early 2008 to allow automatic tariff adjustment to costs and implemented multiple price increases during 2008–09.
  - Economic growth, improving living standards, and a well-functioning social safety net softened resistance to tariff reform.

- Uganda
  - Implemented significant electricity tariff increases in 2012 driven by government determination and effective stakeholder communications.
  - Government argued limited fiscal space to continue subsidizing electricity; explicit subsidy amounted to 1.1 percent of GDP in 2011.
  - Emphasized that subsidies accrued disproportionately to the rich and that removing them would be pro-poor.
  - Maintained a lifeline tariff for monthly consumption below 15 kWh.

### Common reform measures and mitigation instruments
- Revenue and collection improvements
  - Deploy meters and shift bill payments to banks and post offices to reduce cash-related corruption risks.
  - Strict enforcement (e.g., cutting power to non-payers) to raise collection rates.
- Tariff policy and regulation
  - Increase tariffs toward cost-recovery levels; adopt cost-based pricing mechanisms and automatic adjustment formulas linked to long-term marginal costs and exchange rates.
  - Establish independent regulators with legal mandates to ensure tariffs cover medium-term costs, including depreciation, debt service, and other capital costs.
  - Unbundle tariffs into generation, transmission, and distribution to enhance transparency.
- Privatization and market reforms
  - Privatize distribution first to stabilize the sector and attract private investment.
  - Implement wholesale electricity markets to reduce government exposure and depoliticize tariff setting.
- Social mitigation and targeting
  - Replace universal lifeline tariffs susceptible to misuse with strengthened targeted social programs.
  - Where lifelines retained, examples include 50 kWh per month (Kenya) and monthly consumption below 15 kWh (Uganda).
  - Use conditional cash transfers, targeted low tariffs for poor families, financial assistance for connection fees, rural electrification programs, and free rural power programs (Brazil, 2003) to garner public support.

### Outcomes and lessons
- Revenue collection and enforcement measures combined with clear communication can significantly increase collection rates and public acceptance of higher tariffs.
- Tariff reforms paired with targeted social protection protect the poor while restoring sector financial viability.
- Establishing independent regulators and automatic pricing formulas helps depoliticize tariff setting and link prices to costs.
- Privatization and private sector participation, when coupled with tariff reform and regulatory frameworks, improve efficiency and attract investment.
- Timing and accompanying measures (service improvements, rural access expansion, social safety nets) are crucial to reduce political resistance.

*Source: Box 1. International Experiences on Reforming Electricity Subsidies.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1kgzea2019002.pdf_