IMF Concludes Article IV Consultation with Kyrgyz Republic

On September 13, 2000, the Executive Board concluded the Article IV consultation with Kyrgyz Republic.¹

Background

In 1996-97, with the development of the Kumtor gold mine and favorable weather that helped boost agricultural production, the decline in output which characterized the transition to a market economy was quickly reversed. Growth in those years was 7 and 10 percent, respectively, and efforts at stabilization and structural reform were beginning to pay off. Inflation was being brought down and the current-account deficit fell to single digits for the first time since independence in 1991. The Russian crisis in 1998, however, changed this picture, particularly because the authorities were initially slow to adopt an appropriate policy response.

The som experienced a sharp depreciation of about 30 percent in dollar terms between end-August and end-December 1998 and inflation jumped. Domestic problems were further exacerbated by deteriorating trade relations between the Kyrgyz Republic and Kazakhstan and Uzbekistan, the country's most important CIS trading partners outside of Russia. The economic situation remained very difficult in the first part of 1999, even though inflation appeared to slow and the exchange rate began to stabilize. These developments reflected, in part, the difficult steps that the authorities adopted, albeit somewhat late, toward the end of 1998 to deal with the situation. Nonetheless, a crisis emerged in the banking system, leading to a decline in confidence, a further slide in the som (partially related to the introduction of a floating exchange rate in Kazakhstan), and a pickup in inflation. Over the course of 1999, the som depreciated from som 29.4 per dollar to 45.3 and inflation (cumulatively) amounted to nearly 40 percent. Real GDP growth in that year registered 3.6 percent, being driven almost entirely by buoyant agricultural production. Over the first half of 2000, economic activity rebounded, with GDP growth estimated at around 7.4 percent, compared with a year earlier, and inflation was reduced to its lowest level for this period since independence. Imports contracted sharply in 1999 which led to an improvement in the current-account deficit of about 4 percentage points, although at more than 16 percent of GDP it is still high.

On the fiscal side, the budget deficit deteriorated, rising more than 2.5 percentage points to 12 percent of GDP in 1999. Additional budgetary arrears were also incurred. The fiscal situation remained difficult in the first part of 2000 and revenues fell short of expectations. Nevertheless, by end-June the revenue picture had improved. With a decline in tax revenues as a share of GDP, the deficit has been primarily financed by borrowing from bilateral creditors and multilateral financial institutions. As a result of the high level of past borrowing and the rapid depreciation of the exchange rate more recently, the stock of external public debt is now more than 110 percent as a share of GDP, and interest payments alone on that debt account for more than 2.5 percent of GDP. The authorities have recently made progress with creditors in rescheduling some debt, however, the situation remains problematic, since the medium-term outlook for the balance of payments has deteriorated . As result of a revised production schedule at the Kumtor gold mine, exports are expected to slow down starting in 2004.(Kumtor accounts for around one-third of exports and 10 percent of GDP.)

Some progress has been made over the past year in the area of structural reform, although the pace of reform has slowed compared with the pre-Russia-crisis period. The key measures pursued included: a comprehensive reform of the pension system; an amendment to the constitution to allow full private ownership of land; changes in the health sector; the issuance of a tender for the privatization of Kyrgyz Telecom; and the adoption of a plan for the restructuring of the financially troubled energy monopoly, KyrgyzEnergo. However, reforms have lagged in the area of public administration reform, privatization of large enterprises, and the application of a rules based legal framework.

Executive Board Assessment

The Executive Directors noted that the Kyrgyz economy faced a difficult year in 1999, including the effects of the Russian crisis as well as trade restrictions by some trading partners. As a result, most macroeconomic indicators worsened. However, policy actions to stabilize the economy together with an improved external environment were beginning to bear fruit, as witnessed by some recent performance, in particular, the pickup in economic activity and relatively low inflation. Directors commended the authorities on recent developments, but urged them to pursue fiscal consolidation, ease the debt burden, and implement further structural reforms.

Directors agreed that the stance of monetary policy has been appropriately tight, and this has contributed to the relative stability of the exchange rate. They recommended that the authorities continue to pursue their present monetary and exchange rate policies. Several Directors noted that the central bank and the government have responded slowly to problems in the banking sector. Nonetheless, they welcomed recent actions in this area, including the adoption of a comprehensive bank restructuring program and urged the authorities to continue on this path to reestablish confidence in the banking system.

While the fiscal situation deteriorated in 1999 and the overall budget deficit rose, Directors noted that progress was made, in particular, in eliminating budgetary arrears. They also noted the authorities' efforts to strengthen public finances so far in 2000 and that achievement of this year's budget deficit target would signify a substantial adjustment. Nonetheless, they expressed concern that revenue performance remains relatively weak. Directors were disappointed that parliament had rejected most of the tax measures that had been envisaged for 2000 to raise revenues relative to GDP. They urged the authorities to make every effort to adopt these and other measures to expand the tax base, and to improve tax administration as soon as possible. These were key issues that needed to be addressed in the 2001 budget, if not before.

Directors commended the authorities for expenditure restraint and urged them to resist spending pressures in the remainder of 2000, especially in the run-up to the presidential elections. While understanding the reasons for the recent wage increase, they regretted that it was not possible to take further compensating revenue measures. Furthermore, given the current fiscal position, Directors stressed the need to carefully consider the composition of expenditures in 2001 and beyond, paying particular attention to the need to alleviate poverty. In this context, they looked forward to the interim Poverty Reduction Strategy Paper (PRSP) expected early next year and a full discussion of these issues in the PRSP.

Directors expressed serious concern about the size of the foreign-financed public investment program (PIP), both because of the high level of external debt and debt service, and the significant future costs for operation and maintenance of these projects. They urged the authorities to improve control over the very ambitious PIP, to engage creditors in a discussion of its appropriate size, and to consider the terms of future borrowing.

Directors also expressed concern about the deterioration in the Kyrgyz Republic's medium-term balance of payments outlook and the worsening of the main external debt indicators. They noted that even with a rescheduling of part of the nonconcessional debt, the debt service burden remains high, especially over the next several years, and there is no clear prospect for finding a sustainable answer to the external debt problem. Directors encouraged the authorities to maintain efforts to bolster the fiscal position, explore ways to further reduce the debt burden, including by improving debt management, severely limiting the contracting of new debt, and by pursuing more vigorous structural reforms to enhance the investment climate and the productive and export base.

Directors regretted the slowdown in structural reforms in 1999, especially with respect to large-scale privatization and the modernization of the legal and regulatory framework. They underscored the importance of regaining structural reform momentum in order to both improve economic performance and to reduce the vulnerability of the Kyrgyz economy to external shocks. In this regard, Directors welcomed the recent progress, albeit on a small scale, in public sector reform and the beginning of restructuring of the energy sector. Nonetheless, they felt that much more should be done to improve the business environment, including through privatization and further simplification of licensing requirements, make further and more substantial public sector reforms, and address shortcomings in the application of business law and corporate governance to create an environment more conducive to private sector-led growth.

Some Directors called for a staff general study of the impact of the Fund's programs in transition economies of that region.