Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 59071-KG

INTERNATIONAL DEVELOPMENT ASSOCIATION

PROGRAM DOCUMENT FOR A

PROPOSED CREDIT IN THE AMOUNT OF SDR 10.40 MILLION

(US$16.50 MILLION EQUIVALENT)

AND A

PROPOSED GRANT IN THE AMOUNT OF SDR 8.50 MILLION

(US$13.50 MILLION EQUIVALENT)

TO THE KYRGYZ REPUBLIC

FOR AN

ECONOMIC RECOVERY SUPPORT OPERATION

June 30, 2011

Poverty Reduction and Economic Management South Caucasus and Central Asia Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

  

KYRGYZ REPUBLIC – GOVERNMENT FISCAL YEAR

January 1 – December 31

CURRENCY EQUIVALENTS (Exchange Rate Effective as of June 30 2011)

Currency Unit = Kyrgyz Som (KGS)

US$1.00 = 45.2840 (KGS)

Weights and Measures Metric System

ABBREVIATION AND ACRONYMS

AAA Analytic and Advisory Activities ACF Anti Crisis Fund ADB Asian Development Bank AUB AsiaUniversalBank CAD Current Account Deficit CAR Capital Adequacy Requirements CAREC Central Asia Regional Economic Co-

operation CAS Country Assistance Strategy

CBEM Capacity Building for Economic Management

CEM Country Economic Memorandum CoA Chamber of Accounts CRT Cost Recovery Tariff DPA Deposit Protection Agency DSA Debt Sustainability Analysis

EBRD European Bank for Reconstruction and Development

EC European Commission ECA Europe and Central Asia ECF Extended Credit Facility EEMAP Energy Emergency Mitigation Action

Plan EI-TAF Extractive Industries Technical Advisory

Facility EITI Extractive Industries Transparency

Initiative EREC Economic Reform to Enhance

Competitiveness ERSO Economic Recovery Support Operation ESTI Energy Sector Transparency Initiative ESW Economic and Sector Work EU European Union FAO Food and Agricultural Organization FDI Foreign Direct Investment FIRST Financial Sector Reform and

Strengthening FSAP Financial Sector Assessment Program FX Foreign Exchange GDP Gross Domestic Product

GFS Government Finance Statistics GMI Guaranteed Minimum Income GNI Gross National Income GSAC Governance Structural Adjustment

Credit GTAC Governance Technical Assistance Credit GIZ German Agency for International

Cooperation ICR Implementation Completion Report IDA International Development Association IDB Islamic Development Bank IDPs Internally Displaced Persons IFC International Finance Corporation IFIs International Financial Institutions ILO International Labor Organization IMF International Monetary Fund ISN Interim Strategy Note JCSS Joint Country Support Strategy JEA Joint Economic Assessment JICA Japan International Cooperation Agency KfW Germany Development Bank KGS Kyrgyz Republic Som KICB Kyrgyz Investment and Credit Bank LDP Letter of Development Policy LTU Large Taxpayer Unit MDGs Millennium Development Goals MDTF Multi Donor Trust Fund MFN Most Favored Nation MFO Microfinance Organization MLSD Ministry of Labor and Social

Development MOF Ministry of Finance MSB Monthly Social Benefits MSME Micro, Small and Medium Enterprises MTBF Medium Term Budget Framework MTS Medium Term Strategy NBKR National Bank of the Kyrgyz Republic NPL Non Performing Loans OHCHR Office of the High Commissioner for

Human Rights

  

OSCE Organization for Security and Co-operation in Europe

PAs Performance Agreements PEFA Public Expenditure and Financial

Accountability PER Public Expenditure Review PFM Public Financial Management PSIA Poverty and Social Impact Analysis RCF Rapid Credit Facility REER Real Effective Exchange Rate REMAP Regional Energy Markets Assistance

Program ROE Return on Equity ROSC Report on the Observance of Standards

and Codes RTBET Reducing Technical Barriers for

Entrepreneurship and Trade SC Supervisory Council SDR Special Drawing Rights SIDA Swedish International Development

Cooperation Agency

SME Small and Medium Enterprise SOE State Owned Enterprise SSC Settlements and Savings Company TF Trust Fund UK DfID UK Department for International

Development UN United Nations UNDP United Nations Development Program UNHCR UN High Commissioner for Refugees UNICEF UN Children’s Fund

UNIFEM United Nations Development Fund for Women

USAID United States Agency for International Development

VAT Value Added Tax WB World Bank WFP World Food Program WHO World Health Organization WTO World Trade Organization

Vice President: Country Director:

Sector Director Sector Manager:

Country Manager Task Team Leader:

Philippe H. Le Houerou Motoo Konishi` Yvonne Tsikata Kazi M. Matin Alexander Kremer Afsaneh Sedghi

 

  

  

KYRGYZ REPUBLIC

ECONOMIC RECOVERY SUPPORT OPERATION

TABLE OF CONTENTS

PROGRAM SUMMARY ....................................................................................................................................... i 

I.  INTRODUCTION ................................................................................................................................... 1 

II.  COUNTRY CONTEXT .......................................................................................................................... 3 A.  Political Background ............................................................................................................... 3 B.  Recent Economic Developments ............................................................................................. 4 C.  Medium Term Outlook and Debt Sustainability ...................................................................... 8 

III.  GOVERNMENT STRATEGY ............................................................................................................. 15 A.  Post-Conflict Recovery .......................................................................................................... 16 B.  Economic Reforms ................................................................................................................ 17 

IV.  BANK SUPPORT TO THE GOVERNMENT PROGRAM ............................................................. 22 A.  Links to Proposed Interim Strategy Note (ISN) and Earlier Country Partnership

Strategy/JCSS ........................................................................................................................ 22 B.  Consultations ......................................................................................................................... 24 C.  Collaboration with the IMF and Other Donors ...................................................................... 24 D.  Relationship to Other Bank Operations ................................................................................. 25 E.  Lessons Learned .................................................................................................................... 26 F.  Analytical Underpinnings ...................................................................................................... 27 

V.  THE PROPOSED ECONOMIC RECOVERY SUPPORT OPERATION ...................................... 28 A.  Theme I: Strengthened Governance in Management of Public Assets and Revenues ......... 28 B.  Theme II: Safeguarding Social Protection and Supporting Conflict-Affected Population .... 36 

VI.  OPERATIONAL IMPLEMENTATION ............................................................................................ 38 A.  Poverty and Social Impact Analysis ...................................................................................... 38 B.  Environmental Aspects .......................................................................................................... 39 C.  Implementation, Monitoring, and Evaluation ........................................................................ 40 D.  Fiduciary Aspects .................................................................................................................. 40 E.  Disbursement and Auditing ................................................................................................... 42 F.  Risks and Risk Mitigation ..................................................................................................... 43 

TABLES

Table 1: Crisis Related Expenditures in 2010 (% of GDP)...................................................................................... 5 Table 2: Kyrgyz Republic: Selected Economic Indicators, 2008–2014 ................................................................ 12 Table 3: Balance of Payments Developments and Projections 2010-2014 (in $ million) ...................................... 14 Table 4: Public Debt and Debt Service, 2009-16: ................................................................................................. 15 Table 5:Government Program-ISN-ERSO Linkages ............................................................................................. 24 Table 6: Link with Donors’ Activities ................................................................................................................... 26 Table 7: ERSO and AAA ....................................................................................................................................... 27 

  

BOXES

Box 1: Food Prices in ECA .................................................................................................................................... 10 Box 2: Governance: Challenges & Efforts to Improve .......................................................................................... 19 

FIGURE

Figure 1: Recent Headline and Core Inflation Developments ................................................................................. 9 

ANNEXES

Annex 1: Letter of Development Policy ................................................................................................................ 45 Annex 2: Proposed Matrix of Policy Actions and Expected Outcomes ................................................................. 56 Annex 3: Note on Fund Relations .......................................................................................................................... 61 Annex 4: Kyrgyz Republic – Joint Debt Sustainability Analysis under the Debt Sustainability Framework for

Low Income Countries .......................................................................................................................... 64 Annex 5: Country at a Glance ................................................................................................................................ 78 

Map of Kyrgyz Republic: KYR33430

The proposed Economic Recovery Support Operation (ERSO) was prepared by an IDA team consisting of Sarah Babirye, Aibek Baibagysh Uulu, Bakyt Dubashov, Saumya Mitra, Orhan Niksic, Svetlana Proskurovska, Sarosh Sattar, Afsaneh Sedghi (Task Team Leader), Ekaterine Vashakmadze (ECSPE); Mirlan Aldayarov, Marat Iskakov, Sunil Kumar Khosla, (ECSS2); Damodaran Krishnamurti (ECSS2); Brett Coleman, Nurlanbek Tynaev (ECSF2); Anastassia Alexandrova (ECSH3); Jyldyz Abdyrakhmanova, Alexandra Pugachevsky (SEGOM); Vsevolod Payevskiy (CEUIC), Yuling Zhou (ECSO2); John Ogallo (ECSO3); Joseph Formoso (CTRFC); Kenneth Mwenda (LEGEM); Naresha Duraiswamy (ECSSD); Asel Almanbetova, Jyldyz Beknazarova, Nurgul Irsalieva, and Yulia Massenkoff (ECCKG). The team benefited from the guidance of Motoo Konishi, Mehrnaz Teymourian, Alexander Kremer, Yvonne Tsikata, and Kazi Mahbub-Al Matin.

i  

PROGRAM SUMMARY

KYRGYZ REPUBLIC

ECONOMIC RECOVERY SUPPORT OPERATION

Recipient Kyrgyz Republic Implementing Agency

Ministry of Finance

Financing Data IDA Credit (55%) of 40 years to maturity including a 10-year grace period and IDA Grant (45%). Operation Type Development Policy Operation (DPO) Main Policy Areas (i) Governance, (ii) Safeguarding social protection. Key Outcome Indicators

Ministry of Finance’s control over all capital spending restored and maintained. Energy sector finances are managed in more transparent manner and the sector performance has

not deteriorated. Comprehensive information available to fully assess fiscal stance over the medium term (PEFA

indicator PI-7). Privatization implemented in an open and transparent manner in line with best practice. Targeted social support provides adequate living standards for the poor and conflict affected

population. Central bank better equipped to monitor the banking sector, address vulnerabilities in a timely

manner, and resolve troubled banks efficiently. Program Development Objective(s) and Contribution to CAS

(i) Strengthened governance in the management of public assets and revenues through maintaining Ministry of Finance’s control over all capital spending by abolishment of the off-budget development fund and asserting stronger budget control, enhancing transparency in privatization process, establishing proper accounting and improving operational performance in the energy sector, and maintaining financial sector stability; and (ii) Safeguarding social spending by ensuring essential social protection spending, and re-establishing livelihoods and providing social compensation for the conflict-affected population and businesses. The proposed operation is rooted in the Bank’s assistance strategy as outlined in the Joint Country Support Strategy (JCSS 2007-2010) and the Interim Strategy Note (ISN). The JCSS Progress Report (October 2009) envisaged budget support lending. An ISN covering August 2011 to June 2013 Bank strategy is to be discussed by the Board of Executive Directors jointly with this operation in August 2011. The ISN provides the background and context for the Bank’s intervention through a single tranche budget support operation in 2011 to help the government protect its high priority expenditures in light of its continued recovery and reconciliation challenges and envisages the resumption of support for long-term economic development.

Risks and Risk Mitigation

Continuation or even intensification of social strife in the south of the country, in light of the Presidential election towards the end of the year, remains a major source of internal risk that could jeopardize political stability in the country. The external risks stem from continued border closures with Uzbekistan, with severe disruptive effect on production and trade. Keeping open the channels for trade flows as well as ensuring a smooth, uninterrupted operation of the common electricity grid that links these three countries are important contributors to stabilization. Economic risks arise from weaker economic growth than projected and high inflation driven by rising food and energy prices, which would result in greater fiscal pressures and a possible threat to maintaining essential social expenditures, particularly if the anticipated donor financial support does not materialize. These risks would be addressed during the medium term engagement planned by the World Bank and other Kyrgyz Republic development partners through a combination of decisive and sufficient external financing of the budget to ensure implementation of the reconstruction and recovery program over the medium term and by continued prudent fiscal management. The authorities have identified clear priorities in public spending and have successfully protected the essential. Clearly, not all risks of the complexity and gravity that are faced by the Kyrgyz Republic are amenable to mitigation through an operation such as the ERSO.

Operation ID P125425

 

 

1  

IDA PROGRAM DOCUMENT FOR A PROPOSED ECONOMIC RECOVERY SUPPORT OPERATION

TO KYRGYZ REPUBLIC

I. INTRODUCTION

1. The document describes a program of policy actions taken by Government of Kyrgyz Republic to promote economic recovery that are supported by the proposed Economic Recovery Support Operation (ERSO) in the amount of US$ 30 million. The actions taken are aimed at stabilizing the economy, strengthening governance and safeguarding social spending in the face of fiscal pressures arising from the impact of political and civil conflict during April and June 2010.1

2. Prior to the conflict, the country had a track record of macroeconomic stability, economic growth and poverty reduction. Between 2003 and 2008, GDP growth averaged 5.7 percent a year and the share of population in poverty fell from 50 percent to 31.7 percent. The government maintained a relatively stable macroeconomic environment in the face of several internal and external shocks. As the only Central Asian member of the WTO, the country put in place a liberal trade and investment regime, but progress in implementing structural reforms in general and in improving transparency of government operations in particular was weak or absent as evidenced by World Economic Forum’s Global Competitiveness Report, Transparency International’s Corruption Perception Index and other authoritative assessments. The global crisis in 2009 reduced growth to 2.9 percent, but this performance was better than most due, in part, to a bumper harvest and the strong fiscal stimulus.

3. The political and civil conflict resulted in an economic contraction of 1.4 percent in 2010 and worsened the near term growth prospects and the fiscal situation. The protests in Bishkek and other cities (April 2010) and the internal clashes in the south (June 2010) took their toll in life and property, and temporarily displaced 400,000 people at its peak. The conflict disrupted trade flows, agricultural production, construction and tourism, strained public finances to meet conflict-related expenditures and inflicted large losses on the banking sector. In addition, increases in world food and fuel prices put more pressure on public sector wages and social assistance programs.

4. The post-conflict governments have taken actions to ensure social and political stability. The interim government (April-December 2010) shifted from a presidential system to parliamentary democracy and reversed what were perceived as severe governance failures of the pre-conflict regime. The elected government that succeeded the interim government in December 2010 is expected to contribute to political stability, post-conflict healing and private sector confidence. It has announced its intention to formulate a medium term development strategy, including reforms in such key areas as governance, social assistance and private sector development, and has requested development partners to provide technical support for its preparation and financial support for its implementation. This augurs well for the continuity of policies supported by the proposed operation, over the medium term.

                                                            1 Throughout the document, reference is to the US dollar.

 

2  

5. The proposed ERSO supports policy actions implemented between April 2010 and June 2011 aimed at stabilizing the economy, strengthening governance and safeguarding social protection. These areas are rooted in the governments near term priorities and medium term vision, and are likely to be critical for improving private sector confidence and reviving the economy. On governance, the policy actions will support the government’s efforts in addressing some of the key governance failures of the previous regime and in addition make modest advances in several parts of the agenda for greater transparency and accountability. On social protection, the actions aim not only to safeguard benefits for the poor but also provide, temporarily, social assistance to the conflict-affected population. The ERSO could be followed by a programmatic series of multi-year development policy operations provided the authorities stay the course on fiscal consolidation, ensure macroeconomic stability, and implement medium term structural reforms centering on governance and other relevant areas in line with their medium term development strategy currently being prepared.

6. Specifically the two pillars of the proposed ERSO are:

Strengthening governance and transparency in the management of public assets and revenues. The authorities have taken measures to re-assert ministerial control over capital spending and have tightened standards and enhanced transparency on the management of the budget and public assets – all areas of weakness under the previous administration. Thus, public investment choices and financing are now integrated with the national budget, and the off-budget Development Fund has been abolished in support of transparency and good governance. Critically, first steps have been taken towards establishing greater transparency over energy sector operations. Efforts to raise transparency standards in mining have resulted in the country’s achieving full compliance with the norms of the Extractive Industries Transparency Initiative (EITI). Measures taken to ensure financial stability allowed the NBKR to provide timely response to manage the financial stress within a major bank and prevent contagion.

Safeguarding social protection and supporting conflict affected population. The authorities have raised the level of general social benefits and reformed the eligibility criteria to improve targeting. They and have also provided additional support for conflict-affected families and businesses. Moreover, livelihoods and housing for such families are being supported. Social protection spending directed at post-conflict needs was rights-based in nature and now has to be incorporated within a targeted means-based system.

7. The development partners have been providing timely and well coordinated support to the Kyrgyz Republic. Following the conflict in 2010 the multilateral development partners prepared a Joint Economic Assessment (JEA) that assessed the impact, analyzed the financing needs over 2010-12 and provided the basis for a donor conference in July 2010 that pledged $1.1 billion2 in financial support. As a result, the budget for 2010 was adequately financed by donors and the financing need for 2011 budget is expected to be met by IDA, the IMF, the EU, the Asian Development Bank (ADB), and the Anti-Crisis Fund of the Eurasian Development Bank.

                                                            2 Throughout the document, reference is to the US dollar.

 

3  

The Bank also provided an Emergency Recovery Project (ERP), an additional financing project and restructured existing projects in 2010 to support the government’s emergency program. In June 2011, the Fund board approved a three- year program under the Extended Credit Facility (ECF) in the amount of $106 million.

8. The proposed operation is in line with the Bank’s assistance strategy as outlined in the proposed Interim Strategy Note (ISN)3 that covers fiscal years 2012 and 2013. The ISN will be discussed by the Board of Executive Directors jointly with this operation in August 2011. The pillars of the interim strategy – economic stabilization, improved governance, and social stabilization – are the areas of policy focus in the ERSO.

II. COUNTRY CONTEXT

A. POLITICAL BACKGROUND

9. Since independence in 1991, the Kyrgyz Republic has advanced towards the creation of a liberal market economy. The aim was to promote sustained economic growth and reduce poverty and seek international integration through trade and investment. The country has met with some success in fostering openness, but has struggled to embed lasting democracy and civic freedom. In the three year period to April 2010, the president took specific measures to concentrate power in his own administrative apparatus, which resulted in the weakening of authority of the national assembly ministries. Thus, checks and balances were removed, consultation over policies and accountability greatly reduced, and governance standards lowered.

10. In April 2010, anti-government demonstrations took place in various cities. This was directed at centralization of power within the presidency, economic decisions taken without public consultation and a strong perception of corruption as evidenced by the Transparency International Corruption Perception Index, particularly related to evidence of diversion of assets and revenues of the energy and telecommunications sectors. The protests culminated in riots in Bishkek and several other cities, resulting in a crackdown by the government. The president was subsequently removed from office and an interim administration, headed by a coalition of opposition political and civic leaders, came to power.

11. In June 2010, civil clashes took place over three days, particularly in the southern cities of Jalalabad and Osh. These two cities and some neighboring areas erupted in a spasm of internal clashes. It was officially reported that over 300 persons were killed, over 2500 injured, nearly 400,000 temporarily displaced, and significant material damage to property occurred.

12. The interim government put into effect a new constitution that shifted the balance of executive power from a presidential system to a parliamentary one. The elections of October 2010 were conducted on the basis of the new constitution; international observers characterized the conduct of the general elections as substantially fair and proper. The elected

                                                            3 A Joint Country Support Strategy (JCSS) guided Bank’s program over 2008-10. It was an early example of a partnership of seven bilateral and multilateral donors: the Asian Development Bank, the European Commission, the IMF, United Nations agencies and the World Bank, together with the governments of Germany, Switzerland and the United Kingdom.

 

4  

government that took office in December 2010 is a three party coalition, which has a comfortable majority in parliament, and is committed to macroeconomic stability and market-oriented reforms. But security conditions are fragile, social tensions continue to run high in the south and peace remains vulnerable. The presidential elections are due later this year.

B. RECENT ECONOMIC DEVELOPMENTS

13. The Kyrgyz Republic is one of the two least developed economies in Central Asia (next only to Tajikistan). Its GNI per capita is equivalent to $880 in 2010. Around 51 percent of value added in the economy is generated in the services sector and 28 percent in industry. The production of gold in the Kumtor mine (Centerra Gold) amounts to as much as 7 percent of GDP. Agriculture sector contributes 21 percent of value added and nearly half of total employment. With nearly two thirds of its population in rural areas, Kyrgyz Republic is still a largely rural economy, characterized by subsistence agriculture and low-value-added services.

14. Kyrgyz Republic has adopted liberal economic policies and enjoyed strong growth coupled with macroeconomic stability in the years preceding the global economic crisis. It joined WTO as early as 1998 with around 5 percent Most Favored Nation (MFN) tariff, and it has a very liberal trade regime compared to the rest of the CIS countries. The privatization process is also largely completed save the telecommunications and energy sectors. Prior to the crisis, between 2006 and 2008, the Kyrgyz economy grew at the average rate of 6 percent per annum, largely driven by an expansion in construction and services sectors. Inflation was kept in check by prudent monetary policy and the external public debt burden dropped to 41 percent of GDP by 2008 from as much as 100 percent in 2002.4

15. Economic performance deteriorated significantly during the global crisis, but a recession was avoided largely due to a large fiscal stimulus. As external demand, remittances and capital inflows dropped due to the global crisis, the authorities responded by relaxing fiscal and monetary policies. On the revenue side, the key measure was the reduction in the rate of VAT from 20 percent to 12 percent; public expenditures were stepped up sharply from 29 percent of GDP in 2008 to 36 percent in 2009 across the board, but more heavily on the side of current expenditures largely through increases in pensions and public sector wages. The overall fiscal accounts moved from a balance in 2008 to a deficit equivalent to 3.5 percent of GDP in 2009. Economic growth dropped from 7.6 percent to 2.9 percent of GDP in 2009, but a recession was successfully averted.

16. Poverty reduction in recent years was impressive. The incidence of overall poverty fell from 40 percent in 2006 to 32 percent in 2009, and extreme poverty from 9 percent to 3 percent. Although the incidence of poverty is still much higher in rural areas (37 versus 22 percent in 2009), the rate of reduction in rural areas was faster. The drop of extreme poverty in rural areas from 11 to 3 percent during this period was particularly impressive as it is now similar to urban areas. Strong economic growth coupled with rising inflow of worker remittances contributed to this decline in poverty although the slowdown in growth and the sharp decline in remittances in 2009 reduced the speed of poverty reduction.

                                                            4 Paris Club debt was restructured two times during this period, first in 2002 and then in 2005.

 

5  

Economic, Social, and Poverty Impact of the 2010 Upheavals

17. In 2010, the political disturbances in April and the outburst of civil conflict in June dealt a large shock to the economy and caused a recession. The events led to loss of life and injuries to persons, damage to infrastructure, the destruction of private and public property, and a weakening of confidence within the private sector. Economic activity was disrupted, particularly in the south of the country; the financial sector was severely stressed, trade and services adversely affected by weak security and several key border closures. Consequently in 2010, the economy contracted by 1.4 percent. While investment activity dropped in many sectors, particularly in construction, total private investment to GDP increased by 1.4 percentage points, due to large investments in the Kumtor gold mine by Centerra Gold, which amounted to around 3.3 percent of GDP or 17 percent of total private investment. The current account went from 0.7 percent surplus to 2.1 percent deficit. New fiscal pressures emerged and the deficit5 widened.

18. The crises-related and to a lesser extent other policy measures led to an increase in government expenditures from 36.1 to 38.1 percent of GDP and a worsening of its composition. Attempting to deal with the immediate impact of the crisis and address the issues that were thought to have caused it, the authorities decided to step up several categories of public expenditures. However, because of various constraints on implementation capacity the expenditures directly related to the crises amounted to 1.7 rather than the originally projected 4.5 percent of GDP (Table1). Prior to political disturbances, the Social Fund expenditures were increased by as much as 2.4 percent of GDP as a result of pension increases intended to offset the earlier rise of utility tariffs. . The pensions remained in place even though the tariff increases were reversed following the 2010 events. Non-pension social expenditures were steady for several years at around 1.6 percent of GDP, but increased in 2010 to 2.6 percent.6 Overall, current expenditures increased by 3.8 percentage points of GDP.

Table 1: Crisis Related Expenditures in 2010 (% of GDP)

Actual Salary increases (law-enforcement agencies and other) 0.7 One-off payments for the victims of April events 0.1 Security related expenditures 0.2 Rehabilitation of government offices damaged during April events 0.2 Elections related expenditures 0.1 Rehabilitation costs in the south (private housing and public infrastructure) 0.3 Compensations for the victims of April and June events 0.1 Social infrastructure projects throughout the country 0.0 Commercial bank recapitalization/losses 0.0 TOTAL 1.7

Source: Kyrgyz authorities and IMF staff estimates.

                                                            5 Throughout the document, fiscal deficit refers to the deficit of the general government, unless otherwise stated. 6However, relatively well-targeted non-categorical social benefits have remained steady at around 0.7 percent, which is low and results in low coverage.

 

6  

19. Tax revenues performed surprisingly well, but grants dropped compared to 2009. Tax revenues rose counter-cyclically by 1 percentage point of GDP for four reasons:

(i) The base for levying fuel taxes increased sharply because of the Russian-imposed export duty on fuels.7

(ii) The depreciation of the som combined with inelastic demand for imports led to higher import-related revenues, particularly VAT receipts.

(iii) High gold price and the prepayment of taxes by the major gold mining company.

(iv) Administrative measures led to exceptional performance of income tax and Social Fund contribution revenues. Grants, however, were reduced by 2.1 percentage points, following a steep increase in 2009, when Russia alone provided $160 million of economic crisis-related grant assistance to Kyrgyz Republic. In sum, revenues and grants dropped around 0.4 percentage points.

20. The deficit increased, but turned out lower than it had been anticipated. The deficit increased from 3.6 percent of GDP in 2009 to 6.5 percent. However, it turned out significantly lower than 12 percent, which was predicted in the 2010 post-crisis Joint Economic Assessment because of stronger than expected revenue and output performance, cautious approach to spending, and lower than planned capital spending due to capacity constraints.

21. External public debt increased faster than GDP for the second year in a row and reached an estimated 57.3 percent of GDP in 2010. Debt increase in both 2009 and 2010 was not only caused by public sector foreign borrowing to meet the financing gap related to the budget deficit and non-budgetary public investments, it was also driven by som depreciation against the dollar of 26 percent over the period, as most of the debt is dollar denominated.

22. The failure of the largest bank, where serious governance failures and strong evidence of corruption were found, threatened the stability of the Kyrgyz financial sector.8 Seven banks faced serious problems in 2010 and were placed under NBKR administration. Among the seven, one was systemically important: AsiaUniversalBank (AUB) which accounted for a significant share of the banking assets and deposits. The AUB was a good example of the failures of governance and transparency of that era. It saw a fall in mostly non-resident deposits from 50 percent of total to 20 percent between March and June 2010. It also became obvious that a large share of AUB’s assets, invested through asset management companies abroad, was by and large unrecoverable. Of the other six banks, which were placed under central bank’s administration along with AUB, one has been removed; of the remaining five, one is under conservation, while the other four are still under temporary administration. However, these banks are small and will not affect the overall health of the financial system. Primarily because of problems at AUB, the health of the financial sector deteriorated substantially between December 2009 and June 2010: net total capital/risk-weighted assets dropped from 33 percent to

                                                            7 Russia resumed the supply of duty-free fuels in early 2011. 8 Given lack of transparency that existed in the AUB’s operations, the authorities have discovered problems with data accuracy in AUB as a result of its audit. As such, the accuracy of the financial sector data is under review by NBKR.

 

7  

25 percent; liquidity ratio dropped from 87 to 76 percent; the share of non-performing loans increased from 8 to 14 percent. Thus a profitable banking system quickly became a loss making one, as return on assets went from 2 percent to -10 percent.

23. The actions taken by the authorities helped prevent contagion to other important banks and the rest of the financial sector has started to recover. Following the intervention in AUB, the rest of the banking sector stabilized: the capital adequacy ratio remained at 2008 level of around 31 percent at the end of 2010; the liquidity ratio was 73 percent and the excess reserves at 51 percent (up from 30% in December 2008). The remaining banks also remained profitable at the end of 2010. However, non-performing loans increased to 16 percent (5.3% end 2008). Finally, although all banks temporarily suspended lending in the south, overall credit to the private sector as a share of GDP remained roughly the same at 26 billion som or 13 percent of GDP.

24. The fiscal relaxation and financial sector measures provided stimulus to economic activity and employment. Outlays on essential repairs and rehabilitation to infrastructure and the capital stock strengthened the supply base of the economy and in particular led to improvements in the reliability of energy supply that is vital to continued economic growth and maintenance of social peace. Stepped up public expenditures for reconstruction in the south also helped restore disrupted livelihoods. Confidence in the financial sector has not been lost and companies have been able to borrow. Without these measures, the economic effects would have undoubtedly been worse, as important sectors like construction, tourism, and trade all suffered significant losses due to physical clashes, lack of confidence and border closures.

25. Nonetheless, the 2010 events have had a serious social and poverty impact. The conflict in the south created social tensions that left a residue of bewilderment and fear that is typical of post-conflict situations. At its peak, an estimated 75,000 refugees fled to neighboring Uzbekistan and an added 300,000 were temporarily internally displaced within the southern oblasts of the Kyrgyz Republic. While the refugees and internally displaced have returned to their homes and their immediate needs have been addressed, efforts are still needed to complete long term housing reconstruction and repairs, livelihoods-restoration and social services programs. There was a large-scale destruction of public and private property, especially housing and commercial enterprises. The JEA estimated private housing costs related to the destruction and damage at $105 million. For commercial and public property, the estimate is $240 million. Other physical damage relates to destruction of power transmission, as well as gas and heating distribution systems in the south. These items are estimated at $145 million. Thus, total physical damages amount to $490 million or the equivalent of 13 percent of GDP. The associated need for housing, livelihood support, social reconciliation and peace-building continue to be critical priorities.

26. After years of steady reduction, poverty increased by 2 percentage points as a result of the 2010 events. The closure of the border with Kazakhstan for six weeks, the restrictions on trade imposed by the Kazak authorities as well as the persistent closure of the Uzbek border, have affected border trade carried out by communities with a high incidence of poverty. Farming was disrupted by delays in supply of inputs, especially during the sowing season in the north of the country, as well as sustained drop in bank lending and cut-off of credit to the south, leading to a 3 per cent drop in the agriculture output. Finally, the sectors that bore the brunt of

 

8  

the disruptions and the growth slowdown, construction (-23% drop in output) and tourism, are labor-intensive sectors. The tourism sector has been badly hit by the April and June events and the perception of lack of security. In particular, tourism has all but dried up in the important region of Issykul, with highly significant losses in income and employment. On the other hand, the reversal in April 2010 of the energy tariff increases that came into effect at the beginning of the year had a positive impact on poverty; it bolstered household incomes, especially of the urban poor, with the effect being much more muted for the rural poor who though dependent on electricity are not beneficiaries of the district heating and hot water systems. Moreover, the earlier rise in tariffs was accompanied by increases in public sector wages, pensions, social allowances for privileged groups, and targeted cash transfers for the poor, but these have not been reversed. According to latest data9, poverty and extreme poverty reached 33.7 percent and 5.3 percent in 2010, respectively.

C. MEDIUM TERM OUTLOOK AND DEBT SUSTAINABILITY

27. Economic growth is expected to average 6 percent over the next four years if the political situation stabilizes and security improves. With relatively strong quarter one performance, we project real GDP growth of 6 percent in 2011 and for three years thereafter. The growth will be driven by the recovery in agriculture, trade, and other services, as well as a significant increase in gold production enabled by recent and planned investments in the Kumtor mine, which currently accounts for 7 percent of GDP. Strong growth of private remittances, which is expected to reach around 16 percent in 2011, based on first quarter data, and to continue thereafter, together with the planned fiscal stimulus, will provide support to demand for goods and services. In 2011, private investment is expected to remain unchanged at around 19 percent of GDP, but higher government investment spending by 1.5 percentage points is expected to be a stronger driver of growth. As of 2012, growth will be primarily driven by investment and output increases in the private sector, including agriculture, mining, manufacturing, and service sectors, and not least $450 million of investments planned in the energy sector, which alone would add 1 percent to GDP growth for 4-5 years starting in 2012.

28. Growth will be supported through a number of important reforms. First, privatization presents significant potential for increasing FDI and productivity. The authorities have committed to privatizing telecommunication companies, the Zalkar Bank (a spin off from the AUB), and a number of resorts that could drive private investment in the tourism industry. Second, reforms and activities to attract investment in the energy sector are also part of the government’s plans and already ongoing discussions with China are expected to result in the financing of $450 million for the Datka-Kemin transmission line connecting power generating capacity in the south of the country to consumers in the north. In addition, the Ministry of Energy is taking a number of initiatives to increase profitability, improve transparency, and attract investments in this high-potential sector (particularly hydro), but deep-seated reforms in regulation and pricing will be needed if private capital is to be attracted. Third, a number of activities have been initiated to support access to credit for the private sector (more details below). Finally, other reforms to improve the business environment are also currently discussed in the context of recently commenced work on a medium term development strategy, the first draft of which is expected in June this year. These reforms are expected to generate significant                                                             9 Kyrgyz Republic, National Statistics Committee, June 2011.

 

9  

new investments across a relatively wide range of private sector activities, including mining, agriculture, manufacturing, and service sectors.

Figure 1: Recent Headline and Core Inflation Developments

Source: Kyrgyz government

29. Inflation is expected to moderate, but remains a concern. Following a sharp rise in 2010 to 19 percent, almost entirely driven by international food and fuel price increases (see chart above), inflation is projected to decline to 12-13 percent range in 2011, assuming international commodity prices stabilize. The increase in domestic prices would moderate with more stability and security, especially in the south. However, high inflation in the first quarter may result in higher inflation expectations, which poses a challenge for monetary policy. Thus, the authorities have already started tightening monetary policy by raising the policy rate by almost 500 basis points and the sale of NBKR notes, as well as by increasing the reserve requirement in February by 1 percentage point. Monetary policy will be tightened further if needed. By 2012, inflation is expected to drop to a range of 7-8 percent, but uncertainty is significant with risks on the upside.

30. To support growth and complete the reconstruction process in the south, the authorities will continue their fiscal stimulus in 2011, but undertake significant consolidation from 2012 onwards (see Table 2). The fiscal expansion will enable the authorities to carry out increases of wages in health and education sectors where average wages are close to minimum consumption level, and complete reconstruction in conflict-affected areas in the south, which was not completed in 2010 as originally planned. The stimulus will be followed by a sharp fiscal consolidation, particularly in current spending. Capital expenditures (including net-lending) will remain high, at around 7 percent until 2015 because of the expected investments in the energy sector to be financed by China.

 

10  

Box 1: Food Prices in ECA

The fiscal stimulus will, in addition to promoting growth, support social safety nets in the face of higher food and energy prices. The planned fiscal stimulus, in addition to supporting growth, will provide support to social safety nets and poverty reduction. Specifically, the authorities plan to increase the threshold for the means tested unified monthly benefit by 19 percent as of July 2011 to offset coverage erosion and purchasing power of monthly benefit payments due to recent inflation. Furthermore, the increase in salaries for teachers, health sector employees, and technical level civil servants, starting in May 2011, is also expected to improve the social safety nets within their families. Currently, average salary of $84 and $89 for education and health sector employees, respectively, are just above the minimum consumption level of $75, while those of technical level staff are significantly below $75. Finally, the reconstruction activities in conflict affected areas in the south will have a positive effect on social safety and poverty. The increase in social spending is particularly important given the 25 percent increase in food prices in Kyrgyz Republic in 2010, the impact of which on poverty has not been measured, but has no doubt been negative.

Food Price Inflation in ECA (end-period % change)

Source: WB ECA PREM

31. Public expenditures are projected to increase from 38 percent to 42 percent of GDP in 2011. About three-quarters of the expected expenditure growth is attributable to the government’s plan to increase salaries in health, education and social sectors by up to 250 percent. Capital expenditures are set to increase by 1.5 percentage points, primarily as a result of reconstruction activities in the south and a small increase in pension expenditures. On the other hand, the government will cut non-essential spending on goods and services by 1 percentage point of GDP.

32. Revenues are also expected to increase, but more modestly and the deficit will widen to 7.7 percent in 2011. With economic recovery, non-grant revenues are expected to increase 1.4 percentage points; grant revenues will increase by an equal amount. Based on the above expenditure and revenue projections, the deficit is set to widen from 6.5 to 7.7 percent.

33. The authorities aim to bring the fiscal position back on a sustainable path in the medium term. They recognize the necessity to undertake significant fiscal consolidation from 2012 onwards. Specifically, the reconstruction program in the south is expected to be

 

11  

largely over in 2011, which would reduce capital expenditures by 1.4 percentage points of GDP in 2012. The wage bill in 2012 will be contained through a nominal freeze and planned civil service reform, with only limited pay increases granted thereafter. By 2014, the wage bill will be reduced by around 1 percentage point, expenditures on goods and services by 1.5 percentage points, and capital expenditures on non-energy-projects by 2.6 percentage points of GDP.

34. Reforms to improve efficiency and ensure fiscal sustainability will need to be carried out in the social sector, including pensions. Pension expenditures have increased significantly in recent years due to government decisions to ensure a certain level of consumption capacity for the retired population and are expected to amount to just below 9 percent of GDP in 2011. As the revenues from social contributions are projected to drop by 0.7 percentage points, the government plans to restrain the growth of pensions as a share of GDP, but the exact mechanism is not clear yet. As transfers from the government budget to the pension fund have been on the rise in recent years (2 percentage points increase between 2008 and 2010), a clear reform path will need to be developed to ensure not only fiscal sustainability over the medium term, but also long-term sustainability of the pension system.

35. On the revenue side, several policy and administrative measures will be implemented to increase tax revenues to by around 1.5 percentage points by 2014. These measures will broaden the tax base and reduce or eliminate a number of tax exemptions. For instance, weight-based customs valuation will be replaced by value-based, excise taxes on tobacco and alcohol will be reformed and the number of exemptions for VAT and turnover taxes will be reduced. As a result of the expenditure and revenue measures discussed above, and in spite of the expected significant reduction in grants, the non-energy-projects deficit will drop to 4.4 percent in 2014 (Table 2).

36. The financing for 2011 fiscal deficit has been identified, and a contingency plan has been prepared in case of a shortfall. The 2011 budget foresees financing from a mixture of external sources amounting to 5.4 percent of GDP (Table 2) and 2.3 percent in domestic financing (1.6 percent from privatization proceeds, -0.1 percent NBKR, and 0.9 commercial banks). Foreign financing is expected from the ACF, EU, ADB, IMF, WB, and bilateral donors, primarily Turkey. Financing from the ACF, could be as large as 2 percent of GDP, but its timing is not yet certain. The government plans to generate 1.5 percent of GDP in financing by privatizing Kyrgyztelecom. A contingency plan has been developed, should there be a financing or revenue shortfall. Although not part of the planned budget financing, the government intends to sell its 49 percent stake in the mobile phone operator MegaCom, estimated at $200 million. If it becomes necessary, the government will consider a supplementary budget proposing cuts in non-essential current and capital expenditures. Finally, the government has committed to save 75 percent of the dividend payment by Centerra Gold, as well as any other windfall revenues. These measures will be sufficient to finance the deficit in case some planned sources of financing fail to materialize in time.

 

12  

Table 2: Kyrgyz Republic: Selected Economic Indicators, 2008–2014

2008 2009 2010 2011 2012 2013 2014

Act. Prel. Prel. Proj. Nominal GDP (in billions of soms) 188.0 201.2 212.2 250.5 286.0 320.1 360.5 Nominal GDP (in millions of U.S. dollars) 5,131 4,683 4,615 5,187 5,695 6,187 6,766 Real GDP (growth in percent) 7.6 2.9 -1.4 6.0 6.0 6.0 5.8 Non-gold real GDP (growth in percent) 5.4 3.4 -2.1 5.8 6.1 6.1 5.9 GDP per capita (in U.S. dollars) 972 880 863 960 1,044 1,123 1,216 Consumer prices (12-month percent change, eop) 20.1 0.0 18.9 13.0 8.0 7.5 7.1 Consumer prices (12-month percent change, average) 24.5 6.8 7.8 20.0 8.7 7.5 7.5 Investment and savings (in percent of GDP)

Investment 20.3 23.0 24.9 26.5 26.0 26.0 26.5 Public 4.1 5.0 5.6 7.1 5.7 5.4 4.5 Private 16.2 17.9 19.3 19.4 20.3 20.6 22.0

Savings 12.3 23.6 22.7 17.7 17.9 19.9 21.1 Public 5.1 3.8 -0.4 -0.2 -0.5 -0.2 0.1 Private 7.2 19.8 23.2 17.8 18.4 20.1 21.0

Savings-investment balance -8.1 0.7 -2.1 -8.9 -8.2 -6.2 -5.4 General government finances (in percent of GDP) 1/

Total revenue and grants 29.9 32.1 31.7 34.5 32.3 31.6 31.2 of which: Tax revenue 23.0 22.2 23.2 24.0 25.0 25.3 25.4

Grants 1.9 5.1 2.9 4.3 2.1 1.1 0.7 Total expenditure (including net lending) 29.2 36.1 38.1 42.2 39.4 38.5 38.0

of which: Current expenditure 24.8 28.4 32.2 34.6 32.8 31.8 31.1 of which: wage bill 6.5 7.3 8.0 11.1 11.0 10.8 10.3 of which: Social Fund expenditures 6.0 6.6 9.0 9.2 9.2 9.2 9.1

Capital expenditure 4.1 5.0 5.6 7.1 5.7 5.4 4.5 Net lending 0.3 0.1 0.3 0.5 0.9 1.3 2.4

Overall fiscal balance 0.0 -3.5 -6.5 -7.7 -7.1 -6.9 -6.8 Overall fiscal balance w/o energy infrastructure

projects 0.0 -3.5 -6.5 -7.7 -6.2 -5.6 -4.4 Total financing 0.0 3.5 6.5 7.7 7.1 6.9 6.8

External financing 0.4 7.4 3.2 5.4 3.7 3.9 3.8 Domestic financing 2/ -0.4 -3.8 3.2 0.8 2.1 1.9 2.0 Privatization 0.0 -0.1 0.1 1.6 1.3 1.1 1.0

Banking sector Reserve money (percent change, eop) 11.3 18.3 18.4 16.4 17.0 17.3 18.1 Broad money (percent change, eop) 12.6 17.9 21.1 15.7 16.2 19.7 20.5 Credit to private sector (percent change, eop) 26.4 -2.8 6.3 18.4 18.0 26.1 21.0 Credit to private sector (in percent of GDP) 14.4 12.9 13.0 13.0 13.5 15.2 16.3

External sector Current account balance (in percent of GDP) -8.1 0.7 -2.1 -8.9 -8.2 -6.2 -5.4 Export of goods and services (million USD) 3,037 2,695 2,529 3,133 3,407 3,684 4,221

Export growth (percent change) 35.4 -11.3 -6.2 23.9 8.7 8.1 14.6 Import of goods and services (million USD) 4,747 3,683 3,904 4,955 5,402 5,764 6,395

Import growth (percent change) 47.5 -22.4 6.0 26.9 9.0 6.7 10.9 Gross International reserves (million USD) 1,222 1,584 1,716 1,862 1,888 2,040 2,240 Gross reserves (months of next year imports, eop) 4.0 4.9 4.2 4.1 3.9 3.8 3.8 External public debt outstanding (in percent of GDP) 41.2 52.8 57.3 51.2 50.5 50.7 50.2 External public debt service-to-export ratio (in percent) 2.4 3.2 3.6 2.9 2.5 2.4 2.3

Memorandum item Exchange rate (soms per U.S. dollar, average) 36.6 42.9 46.0 ... ... ... ...

Sources: Kyrgyz authorities; and Fund staff estimates and projections. 1/ General government comprises State Government, Social Fund and Development Fund (starting from September 2009) finances. State government comprises central and local governments. 2/ Includes KRDF investments abroad, (-2.4) percent of GDP in 2009 and 2.8 percent of GDP in 2010.

 

13  

37. In the financial sector, reforms will continue to support bank resolution, enhanced supervision, and other activities aimed at securing its stability and easier access to credit. With outstanding loans amounting to around 12 percent of GDP, the banking sector is relatively small. However, its stability needs to be restored following the 2010 shakeup and significant increase in NPLs. Several aspects of the banking system will undergo reform. First, the recent crisis has exposed weaknesses in the bank resolution framework and the authorities are now taking steps to strengthen it with measures to prevent undue court interference and to improve the clarity of triggers for intervention. Second, efforts are underway to strengthen bank supervision which will have to be intensified, particularly in case of systemically important banks. Third, a number of legislative reforms will be carried out to strengthen independence, accountability, and technical capacity of NBKR through amendments to the Law on NBKR and the introduction of a new banking code.10 Finally, measures are being taken to strengthen the deposit protection system. Several of these measures will be directly supported through this operation and others will be supported by the IMF through the three-year ECF.

38. The current exchange rate policy of managed float has served the country well and will be continued into the future. The flexible exchange rate policy has enabled the authorities to manage significant internal and external shocks in recent years, while they have been able to smoothen the exchange rate shocks. The evolution of real exchange rate has been in line with fundamentals and does not pose an issue for the growth of exports. Therefore, inflation management in combination with flexible exchange rate policy, with interventions only to smoothen shocks, remains appropriate.

39. Driven by demand recovery and high international commodity prices, the current account deficit will widen in 2011, but is expected to slowly narrow thereafter. Net exports are likely to make a slightly negative contribution to growth in 2011, as import growth is expected to outweigh that of exports by 7 percentage points. The planned fiscal expansion coupled with high international commodity prices and new investments in the Kumtor mine will be the primary driver of import growth in 2011, projected at 31 percent. Consequently, the current account deficit is expected to widen significantly to 8.9 percent in 2011, but will start narrowing thereafter, as export growth is projected to pick-up. However, planned large-scale investments in the energy sector with substantial import component will prevent a faster reduction in CAD.

40. Most of Kyrgyz’s public debt is external and highly concessional. Virtually all external debt is contracted on concessional terms with average interest rate equal to 1.3 percent of the debt stock. Of the total external debt, 66 percent is owed to IFIs and 33 percent to bilateral creditors.

                                                            10 The new banking code will ensure that only constitutional laws will supersede the banking laws, it will strengthen NBKR powers related to early intervention and banking supervision, it will limit the scope of judicial review for actions taken by NBKR and provide legal protection for its staff and agents, and secure adequate protection of shareholders and creditors in the banking sector.

 

14  

Table 3: Balance of Payments Developments and Projections 2010-2014 (in $ million)

2010 2011 2012 2013 2014 Prel. Proj. Current account balance 1/ -98 -461 -466 -381 -366

Current Transfers (net) 1/ 1391 1,559 1,780 1,994 2,314 Of which: Private 1313 1,550 1,782 1,996 2,315

Capital Account 10 289 -1 -21 -46 Financial account 318 67 362 457 555

Commercial banks -4 -10 15 15 15 Medium- and long-term loans, net 74 -141 107 182 257

Disbursement 1/ 219 210 253 306 380 Of which: Loan financed PIP 158 151 138 146 122 Of which: Energy and other investments financed by

China and Eurasec 0 0 50 79 160 Amortization -145 -351 -146 -124 -123

Foreign direct investment 234 219 240 260 283 Portfolio investment 103 0 0 0 0 Other (including SDR allocation) 0 0 0 0 0

Net short-term flows -79 0 0 0 0 Errors and omissions -127 0 0 0 0 Overall balance 102 -104 -105 55 143 Financing -102 104 105 -55 -143

Net international reserves -102 -167 -44 -173 -218 Gross official reserves (–, increase) -112 -146 -26 -152 -200 IMF (net) 10 -21 -18 -21 -17

Exceptional Financing (including arrears) 0 0 0 0 0 Financing gap 1/ 0 271 149 118 75

Memorandum: Current account balance (in percent of GDP) -2.1 -8.9 -8.2 -6.2 -5.4 FX Reserves (months of next year’s imports, eop) 4.2 4.1 3.9 3.8 3.8 Source: IMF 1/ Budget support loans and grants are included in the financing gap. For 2011, they are sufficient to cover the gap.

41. Under the baseline scenario, external public debt will start falling over the medium term. The government intends to prepare a new medium-term debt management strategy covering 2012-2014. The key elements of the new strategy are to maintain the share of grant financing to GDP at the same high level and to pursue the planned fiscal adjustment. In particular, the authorities will seek concessional terms for $208 million for the power sector loan from China and possibly another $240 million for related projects, but in a few years time; the grant element of these loans is expected to be 35 percent. The authorities have also been active in pursuing debt write-offs and have reached preliminary agreement with Turkey on the write-off of a $49.5 million debt, which is expected to become effective in late 2011. Discussions are also ongoing on debt relief of about $194 million owed to Russia. Under the baseline scenario, which assumes GDP, export, and deficit targets shown in Table 2, as well as grant element of public borrowing of 34 percent and nominal interest of around 1 percent, external public debt will be on a declining trajectory (Table 4) with a small exception of 2013, when significant borrowing for energy sector projects is expected to take place.11

                                                            11 Recent negotiations with the Chinese have resulted in an increase in the grace period and hence in the grant element of planned foreign borrowings from China to 35 percent.

 

15  

42. The Joint Bank-Fund debt sustainability analysis conducted in 2011 shows that public sector debt is sustainable with moderate risk of debt distress. Under the baseline scenario, as discussed, as well a scenario where key variables are kept at their historical averages, present value of debt is on a downward trajectory. Stress tests show indicative thresholds for debt level would be exceeded under certain shocks. PV of external debt-to-GDP ratio would exceed the indicative risk threshold of 40 percent in the medium term under shocks to a) export growth, b) increase in borrowing by 10 percent in 2012 and 2013, and c) a shock that would combine lower GDP and export growth, currency depreciation, and increased borrowing in 2012-2013. The indicative threshold for PV of debt-to-revenue ratio would be breached under the last two scenarios, but the PV of debt-exports ratio would not be breached under any scenario. Debt service to revenue ratio is the most sensitive to an increase in borrowing in 2012-2013 by about 10 percent and the combined shock mentioned above, both of which would increase debt service to revenue ratio from 5 under the baseline scenario to 8 in 2014. Importantly, debt service thresholds would not be breached under any of these scenarios. In sum, sustained growth, fiscal consolidation, and prudent debt management/borrowing strategy remain essential for debt sustainability.

Table 4: Public Debt and Debt Service, 2009-16:

2009 2010 2011 2012 2013 2014 2015 2016

Total public debt (in % of GDP) 56.6 61.2 55.4 55.5 56.9 57.6 57.3 57.1

External debt outstanding (in % of GDP) 52.8 57.3 51.2 50.5 50.7 50.2 49.6 49.0

PV of external debt-to-GDP ratio (in %) n/a 34.2 33.8 33.4 33.9 34.1 34.1 34.1

PV of external debt-to-exports ratio (in %) n/a 62.3 55.9 55.8 56.9 54.7 52.6 50.5

PV of external debt-to-revenue ratio (in %) n/a 118.6 111.7 110.0 110.8 111.0 105.2 104.4

External debt service-to-export ratio (in %) 3.2 3.6 2.9 2.5 2.4 2.3 2.2 2.3

External debt service-to-revenue ratio (in %) 6.7 6.9 5.7 5.0 4.7 4.8 4.4 4.8

Source: IMF & WB Joint DSA Analysis conducted in H1 2011.

43. The macroeconomic policy framework is adequate for the proposed ERSO. The risks – political, social, and economic – and the implementation challenges are discussed in the final section of this document. The policy framework will support economic activity in 2011 and thereafter lead to fiscal consolidation. An impressive beginning with governance reforms has been made. Measures to safeguard social spending will create the conditions for stability and social reconciliation.

III. GOVERNMENT STRATEGY

44. The post-April government concentrated on strengthening security across the land and in particular, reasserting central control over the entire country following the clashes in the south in June. Rebuilding trust in the government and confidence in public institutions was a high priority, as was embarking on social reconciliation. The social agenda required the government to strengthen protection for the conflict-affected and aid the restoration of livelihoods. The main economic challenges required the government to stem the downward spiral in economic output and employment through a fiscal stimulus, prevent a possible crisis in the financial system, and at the same time to continue market-oriented reforms to bolster private

 

16  

investment. A firm grasp over macroeconomic policies was maintained and the authorities obtained rapid, large-scale donor assistance to finance budget and investment needs.

A. POST-CONFLICT RECOVERY

Response to the Crisis

45. Protecting essential social expenditures was given top priority. In view of the anticipated fall in tax revenues in line with the contraction of the economy, the authorities took prompt action to define a new category of essential expenditures which includes wages of public sector workers, pensions, social protection transfers, expenditures on health and education, and capital expenditures related to rehabilitation and reconstruction of the conflict-affected areas.

46. Addressing the needs of the internally displaced and the vulnerable was seen as urgent. The government responded to the June events by establishing a Commission for the Assessment of Damages to address restoration of livelihoods, the reconstruction of housing and commercial enterprises, as well as the restoration of markets to provide critical support to the economy and create jobs. Current priorities are being established through an open process of wide participation and a strategy for reconciliation in the south is being drawn up. Focus will be on the recovery of businesses and agriculture, rehabilitation of basic and vocational education, provision of cash transfers for vulnerable groups, generation of employment through labor-intensive public works, initiation of inter-community reconciliation, and establishment of psycho-social support for victims of clashes.12

47. The authorities took important commitments and actions to enable safe return of the displaced. The government announced its commitment to provide full choice to displaced individuals and families in the design of housing solutions for them and not to resort to involuntary resettlement of any affected individual or family. The clashes and its aftermath revealed the weakness of the state and its lack of control over the security apparatus and the local administration. A precondition for stability and recovery is therefore the reestablishment of an impartial security regime capable of protecting all citizens.

Priorities in 2011

48. The new government developed a one-year plan of actions highlighting its priorities in 2011, and is currently formulating the 2012-2014 Medium Term Development Strategy (MTDS) with technical support from the development partners. The main focus of the strategy is to restore political and macro-economic stability, and to address the stress factors that brought out the internal conflict of June 2010.13 Strengthening governance and reducing corruption is the overarching theme of the government reform agenda.

                                                            12 For example, returnees while rebuilding their homes and/or businesses, people who lost employment, elderly / pensioners, female headed households, and people dependent on seasonal labor. 13 Key drivers of instability are believed to include (i) poverty and socioeconomic disparity; (ii) disputes over farm land, irrigation water and commercial assets triggered by the high population density; (iii) harsh border regime with disputed boundaries and several territorial enclaves; (iv) the trade in narcotics; (v) youth unemployment; and (vi) an ineffective administrative and security system.

 

17  

49. To address the social reconciliation issues, a new Department on Ethnic Development Issues, Religious Policy and Public Relations has been established at the President’s Administration which is currently working on a Concept of Ethnic Development and Integration of Kyrgyz Republic to be presented to the Parliament. An early draft of the Concept recommends an increased emphasis on a shared national identity, integration of the population, increased inter-regional links, the protection of different ethnic identities, equal employment opportunity for all regardless of ethnicity, non-discrimination, the need for a multi-cultural and multi-lingual curriculum, reform of the educational curriculum, and support from the Office of the OSCE High Commissioner on National Minorities.

B. ECONOMIC REFORMS

50. The strategy for recovery and sustained growth was based on the recognition that the post-conflict shocks to business confidence would lead to falling private sector investment and, thus, to a sharp decline in the rate of economic growth. Falling domestic demand would affect fiscal revenues, reducing the capacity of the state to undertake vital expenditures, including additional outlays on social spending. The authorities saw the need to undertake additional public expenditures as a bridge to the period when private confidence is substantially restored through:

a combination of external financing for the budget and some counter-cyclical fiscal policy, implying a relaxation of the original fiscal deficit targets, so as to finance additional current expenditures, largely associated with the events;

external support for essential reconstruction and rehabilitation needs to be undertaken largely by the public sector to substitute for the private demand shortfalls, and to safeguard production and employment; and

external support for key priorities in the revival of private sector growth and financial support for the banking sector.

51. The elected government that took office in December 2010 represents a continuity of central objectives. Its program places macroeconomic stability and a reduction of the fiscal deficit over the medium term, as core priorities. Sustained growth would require reforms to contain the expansion of public expenditures on pensions and the wage bill and to attract investment and innovation. These reforms would aim to improve management of public enterprises, energy and infrastructure services, and the business climate. The government will need to raise budget revenues through tax and customs policy and administration reforms. In several areas, policy work conducted in the past will provide guidance and impetus to reforms; in others (such as pensions and some aspects of the governance agenda, regulatory reforms) fresh policy thinking will be required.

 

18  

Governance

52. The interim government took immediate steps upon coming into office in April 2010 to improve governance. The goal was to create conditions for higher standards in public accountability, enforcement of control over budget expenditures, and the management of public assets. The government confirmed that governance will continue to be a major focus of reforms over the medium term, with particular emphasis on the energy and the mining sectors.

53. The new authorities decided to adopt a parliamentary system of government to replace the presidential one in light of the experience of abuse of presidential powers. The constitution was amended to this effect later in the year following a popular referendum. A cabinet system of government headed by a prime minister answerable to parliament and with the powers of the president greatly attenuated is an innovation for the country. This constitutional change was motivated by a widely-felt need to disperse executive power and bolster accountability to parliament. It was also driven by the need to widen consultation and debate within parliament, engage with the public at large, and allow a range of opinions within government to be expressed and evaluated before executive decisions were taken. The Parliament is already beginning to hold the government to account; the budget committee in particular subjected the 2011 budget to a close scrutiny and successfully enacted amendments to it.

54. To make a parliamentary democracy work, institutions have to be built and governance practices re-engineered including the strengthening of local government as well. The responsibilities of local self-governing bodies and revenue-raising authorities were rolled back in recent years. Now opportunities exist to strengthen citizens’ participation in local planning and decision making.

55. The government is committed to following principals of budget transparency. The MoF publishes approved budget laws, revised budget laws, changes to budget laws, mid-term budget framework, and monthly and annual budget execution reports on its website (www.minfin.kg). The website of the Treasury (www.kazna.gov.kg) has detailed execution reports with the breakdown by republican and local budgets, reports on nonfinancial assets and liabilities, cash flows, sources of financing budget deficit, and annual consolidated financial statement. The Parliament’s website (www.kenesh.kg) also has links to submitted draft laws, draft laws under consideration, approved and refused draft laws. This is expected to continue.

56. In fact, the new Parliament has introduced budget hearings prior to budget approvals. The budget committees involved civil society organizations, professional associations, mass media (including press and television, which broadcasted budget hearings), ministries, and independent experts. As a result the degree of openness practiced during the 2011 budget approval process was unprecedented.

 

19  

Box 2: Governance: Challenges & Efforts to Improve

There are substantial governance challenges facing the Kyrgyz Republic, especially as the country recovers from recent conflict. The country compares poorly with other countries of the region on accountability, control of corruption, government effectiveness and regulatory quality according to the World Bank Governance indicators, and is in lowest quintile of Transparency International’s Corruption Perception Index as of 2010 ( ranked 164th out of 178). In the World Economic Forum’s Global Competitiveness Index for 2010-2011, the average rating for institutions in Kyrgyz Republic is 113 out of 139 countries, but only 132 out of 139 with respect to the question on irregular payments and bribes. Improving transparency and accountability and reducing corruption remain important for achieving strong growth and poverty reduction.

Efforts to meet the challenges have progressed gradually with occasional slippages. The government has been taking actions to increase transparency and accountability in public finance management as well as in energy and mining sectors. There have been reductions in restrictions on starting businesses thereby reducing bureaucratic discretion, but earlier perceptions about the country continue to inhibit private investment. Specifically, in respect of public finance management, the government publishes the proposed budget, the approved budget and the executed budget. This year, the government has reversed the previous regime’s arrangement of keeping a significant share of public investment expenditures outside the budget process, strengthened the medium term budget framework, and took steps to improve monitoring and regular reporting of budget execution.

The authorities continue to take steps to improve governance within mining and energy sectors. The Kyrgyz Republic joined the Extractive Industries Transparency Initiative (EITI) and a recent EITI assessment found it fully “EITI Compliant” and gave an award for “Successful implementation under challenging circumstances.” In the energy sector the authorities have taken steps to improve transparency and governance through the Fuel Energy Sector Transparency Initiative whereby its receipts and expenditures are monitored frequently and will be available to the public.

The country has a liberal trade regime and has made progress in opening up the business environment. It is the only Central Asian country to be a WTO member and is among the best in Central Asia in Doing Business, ranking 44th out of 183 countries in 2011.

57. The government has committed to enhancing transparency and accountability in the country, starting with four areas that are significant for the economy. These four areas include public financial management, privatization and state-asset management, mining as well as energy. These actions comprise of reversing inappropriate actions taken by previous regime as well as actions to take the country forward in improving governance. The abolition of the Central Agency for Development, Investments and Innovations (CADII) created by the former regime reduced centralization of power that CADII was meant to implement as all policy and investment decisions and management of borrowings were concentrated in one body that the former President operated without public scrutiny. The Development Fund was also put in liquidation. In addition, privatizations completed under the previous regime covering the two electricity distribution companies, Severelectro and Vostokelectro, and the telecommunications company Kyrgyztelecom, were cancelled when the new government found clear evidence of procedural breaches.14 The governments’ agenda also included actions to strengthen transparency and accountability in mining and energy sectors. The Energy Sector Transparency Initiative (ESTI) has already been adopted and the mining sector has already become compliant with the internationally recognized Extractive Industries Transparency Initiative (EITI) and their continued implementation is expected increase transparency and accountability in areas that are economically significant (for more details see section V).                                                             14. These privatizations were carried out in early 2010 and assessed to fall short of international good practice as it allowed privatization of state assets by auctioning/bidding but without an established pre-specified minimum reservation price and without proper valuation of assets of these companies.

 

20  

58. The authorities have taken systematic actions to avert the impact of the global crisis on the Kyrgyz financial system. Over the course of 2008-10, the authorities implemented various crisis contingency measures:

(i) launched a deposit protection system in August 2008 that became effective in November 2009;

(ii) the National Bank of the Kyrgyz Republic (NBKR) required banks to prepare anti-crisis contingency plans starting in October 2008, and banks increased liquidity, tightened lending standards, and increased provisioning;

(iii) the government and NBKR issued a joint resolution in December 2008 on Measures for the Rehabilitation of Banks of Systemic Importance that identified the roles of the NBKR and the MoF and allowed for capital injections into systemic banks through the budget;

(iv) NBKR set up emergency liquidity support for banks by establishing the Specialized Banks Refinancing Fund in January 2009;

(v) NBKR required banks to perform stress tests;

(vi) NBKR increased the number of its targeted bank inspections, and required all banks to send a weekly report on their liabilities and expected outflows; and

(vii) NBKR lowered the discount rate from 14.4 percent in January 2009 to 1.6 percent in November 2009 to facilitate lending.

59. The April and June 2010 events led to substantial financial instability, revealing deficiencies in the governance and supervision of the banking system. Prompt interventions were required by the interim government to restore stability and improve governance in the banking sector. There is evidence that the banking sector was the main channel that was used by the previous regime to channel funds out of the country, including fraudulent schemes at AUB. NBKR introduced temporary administration in AUB, the large insolvent bank, and six other banks (two of which later returned to normal operations) and direct supervision in 12 banks (which was later withdrawn from eight of these banks) to stem the fraud and transfers. AUB was nationalized in August, put under liquidation and then restructured into a new bank named Zalkar Bank on December 24, 2010 which is currently undergoing a thorough review of its assets and liabilities. In the absence of a sound bank resolution legal framework, the intervention in AUB has engulfed the authorities in a complicated legal process and has absorbed much of the capacity of NBKR. In the meantime, NBKR has prepared and initiated implementation of special bank supervision strategies for problem banks and issued an instruction to its supervision committee to enhance its supervisory response mechanism by end-August 2011. These actions should enable NBKR to better monitor and preempt similar potential risks in the future.

Social Protection

60. A significant reform of the social protection system was initiated at end-2009 with the aim of expanding the recipients’ choice through the provision of cash instead of notional (but

 

21  

often unavailable) or badly targeted benefits, simplifying administration (cash privileges as compared to in-kind privileges), and mitigating the effects of energy and heating tariff increases on vulnerable households. Moreover, the reforms would improve transparency of public spending. Specifically, the reform process is aimed at:

Monetization of in-kind benefits. Categorical benefits that were mainly provided in-kind, through direct payment of costs to the providers, are either cashed out or abolished.

Elimination of certain categories of (poorly targeted) categorical benefits. Of the previous 39 groups of beneficiaries receiving over 40 in-kind benefits, 25 beneficiary groups are still eligible for assistance in the form of cash benefits, but no in-kind benefits remain.

Improving targeting of the current transfer systems to reach the poor and reducing the leakages to non-poor. Specifically, the Guaranteed Minimum Income (GMI), which determines the eligibility threshold for the means-tested monthly benefits for poor families with children (previously known as UMB), was raised significantly. Eligibility remains limited to households with children, which fits the country’s poverty profile well. Monthly benefits for poor families with children were instrumental in helping respond to the global food crisis.

Providing increased payments to vulnerable households to soften the impact of the price increase. In January 2010, electricity tariffs were raised by 56 percent and 114 percent for industrial and household consumers, respectively, and increases of 186 and 110 percent were put into effect for hot water and district heating in urban areas. Specifically, the monthly social benefits (MSB) are transformed into flat-rate benefits no longer related to the GMI and increased from an average 524 som to 1,000 to 2,000 som per month. MSB remains rights-based rather than needs-based, but the beneficiary categories (e.g. children with special needs, people with different degrees of disability, old age people not entitled to any pensions fall into high vulnerability groups. In addition, the government established top-up payments to low wage public sector workers and low pension recipients, and indexed military pensions.

61. The social benefits established earlier to cope with higher electricity tariffs were preserved. Although the interim government rolled back both the rise in household electricity tariffs (fully) and the rise in industrial tariffs (substantially) in light of heavy social pressure following the April events, the rise in benefits was not reversed. During 2010, changes in the eligibility criteria for the monthly benefits for poor families with children were put into effect so as to direct the benefit towards low income families with children; as such families were most vulnerable to poverty. The elected government adheres to the reform principles above.

 

22  

IV. BANK SUPPORT TO THE GOVERNMENT PROGRAM

A. LINKS TO PROPOSED INTERIM STRATEGY NOTE (ISN) AND EARLIER COUNTRY

PARTNERSHIP STRATEGY/JCSS15

62. The proposed policy based lending (ERSO) is envisaged in the proposed Interim Strategy Note (ISN) and in the earlier Joint Country Support Strategy Progress Report (2007-08). This is in response to the impact of events of April and June 2010, whereas earlier it was to be mainly in response to the 2008/2009 food-fuel price hike and the global crisis, both requiring financial support to the budget from its development partners, including the Bank.

63. As part of this response, the Asian Development Bank, the IMF, and the World Bank in partnership with other IFIs16 prepared a Joint Economic Assessment (JEA) of the impact of the April and June events. The JEA identified the need for external support in three major areas:

Essential public expenditures and services. With emergency expenditure needs rising, the budget would have to address these while maintaining other spending in line with authorities’ regular spending plans.

Social needs. The resettlement and integration of the internally displaced and the needs associated with other affected populations has put an unsustainable burden on fiscal resources. Through support for housing, livelihoods, social protection and other social programs identified in the JEA, donors can make an important contribution to economic and social recovery.

Critical investments. The JEA found that needs associated with destroyed private commercial and public buildings were closely tied to recovery prospects. Moreover, critical needs in energy and transport exist and if financed would make a large contribution to reconciliation and building peace. Financing need for such investments would be needed as a bridge to the period when the private sector resumes investing and enhance the economic security of the country by strengthening energy and transport.

64. The JEA formed the basis for a donor conference, co-chaired by the government and the Bank, on July 27, 2010 in Bishkek during which donors pledged $1.1 billion over a three year program for reconciliation, recovery, and reconstruction.

                                                            15 The Joint Country Support Strategy for the Kyrgyz Republic (JCSS), 2007-2010 was one of the first in the World Bank Group. The eight development partners constituting the JCSS were the Asian Development Bank, Swiss Cooperation, UK Department for International Development (DFID), United Nations, World Bank Group, European Commission, Government of Germany, and the IMF. The JCSS supported the Kyrgyz Country Development Strategy (PRSP equivalent). 16 The Eurasian Development Bank, the European Bank for Reconstruction and Development, the European Commission, the International Finance Corporation, and the United Nations.

 

23  

65. As its contribution to the JEA-based donor effort, the Bank pledged $80 million in IDA support in fiscal year 2011. It rapidly prepared an Emergency Recovery Project (ERP)17 in the amount of $70 million so as to provide urgently needed funds into the economy in the interests of maintaining essential social expenditures, and to restore and ensure continuous provision of basic energy services for the affected areas of the south. The credit supported economic output and employment by generating local works and ensuring adequate heating during the winter. Additional financing in the amount of $10 million was provided for the National Road Rehabilitation (Osh-Batken-Isfana) project with the objective of improving access through expansion of secondary roads to the conflict affected areas in the south. This project supported the recovery of livelihoods in agriculture and the rural areas, and enhanced employment opportunities. It is estimated to create 5500 person-weeks of employment for unskilled workers.

66. In late 2010, the Kyrgyz Republic obtained a special allocation of IDA-15 funds in the amount of $56 million. These funds, to be committed in the current fiscal year, are devoted to additional financing for a health swap project ($24 million), focusing on access to health services in conflict-affected areas, additional financing for an irrigation project ($15 million), additional financing for a disaster hazard mitigation project for clean-up of uranium tailings in the mining sector ($1 million), and additional financing for the roads project ($16 million). The proposed budget support operation is designed as a single tranche operation aimed at supporting actions in policy areas identified by the new government as priorities. It will lay the ground for implementing a medium term reform program that would be supported by another Development Policy Operation that could either be another stand-alone operation or the first in a series of programmatic Development Policy Operations from fiscal 2012 onwards.

67. The ERSO is being presented to the Board together with the Interim Strategy Note that covers the period August 2011 to June 2013. As explained in the ISN, the focus of the IDA assistance effort will be on countervailing the major stress factors that underlay the conflicts of 2010 and on building institutional capacity to strengthen governance and public management. The ERSO -- together with a possible series of programmatic development policy loans -- will ensure adequate financing for the budget (taking into account the contributions of other donors) so that essential spending, especially in the social sphere, is protected, and support is provided for economic stabilization over the medium term. Greater economic and social stability will contribute to the prospects for social peace. The new government has emphasized that it saw the Bank playing a key role as an advisor and financier of its post-conflict recovery and reconciliation program as well as long term investment needs. The Interim Strategy Note defines the proposed IDA program.

                                                            17 This was an investment operation prepared under operational policy guidelines on rapid response to crises (OP 8.00), with a retroactive element of $35 million that financed past budget expenditures and hence had the character of being fast disbursing budget support. The remainder financed energy repairs, rehabilitation and investments.

 

24  

 Table 5:Government Program-ISN-ERSO Linkages

GOVERNMENT GOALS

ISN PILLARS ECONOMIC RECOVERY SUPPORT OPERATION GOALS

Post-conflict economic recovery, macroeconomic stability, fiscal and budget sustainability.

Economic stabilization for economic recovery, reconstruction and growth.

Maintenance of macroeconomic stability, fiscal sustainability, and debt management.

Governance reforms and transparency of public assets management, with the emphasis on public financial management and energy and mining sectors.

Improving governance, effective public administration and reducing corruption.

Assert budget control over all capital spending, strengthened transparency in privatization process and in mining sector, increased transparency/better accounting in energy sector operations, stabilizing the banking system and strengthening the legal and regulatory frameworks for bank resolution and supervision.

Sustained peace-building and post-conflict social stabilization with the emphasis on improvement of basic state and social services.

Social stabilization, through social services, community infrastructure, and employment.

An efficient and equitable safety net system, better targeted social support providing adequate living standards for the poor and for conflict-affected population.

B. CONSULTATIONS

68. A number of meetings were held with various stakeholders, including civil society, government and donors during February and March 2011 to describe the economic program being supported by the ERSO as a part of overall consultations on the Interim Strategy. The subjects that received the most attention were governance and energy sector reforms -- and civic society organizations in particular looked for firm monitoring of the budget and accountability for all budget spending. Bank staff explained the role stakeholders could play in the development of the official medium term development strategy (MTDS). The process of consultations will be deepened in the course of the preparation of DPO series, and active mechanisms for participation in the formulation and implementation of the MTDS will be used.

C. COLLABORATION WITH THE IMF AND OTHER DONORS

69. The World Bank has been collaborating closely with the IMF and other donors to support the Kyrgyz Republic’s reform agenda. This collaboration has been particularly active through the process of preparation and update of the Joint Country Support Strategy (JCSS) led by the World Bank jointly with seven development partners; Asian Development Bank (ADB), European Commission (EC), the German government, IMF, Swiss Cooperation, UK DfID, and United Nations agencies. In addition, the World Bank collaborates with DfID, the EC, the Swiss Cooperation, and Swedish International Development Cooperation Agency (SIDA) through a multi donor trust fund (MDTF) established to support the reform agenda on Public Financial Management (PFM). The World Bank and the IMF have also been coordinating their respective interventions in the banking sector, with the IMF providing a resident advisor to NBKR while the World Bank has provided technical assistance in complementary areas of bank resolution,

 

25  

prompt remedial actions, and problem bank action plans. In addition, the World Bank and the IMF collaborate on regular conduct of the Joint Debt Sustainability Analysis (DSA).

70. The World Bank and the Fund took the lead amongst donors to ensure adequate funding for the budget in 2010. The IMF Rapid Credit Facility (RCF) approved in August 2010 provided $34 million in support of the 2010 budget. These resources have helped Kyrgyz government maintain its macroeconomic stability while mitigating the impact of crisis in 2010.

71. A three-year program with the Fund under the extended credit facility (ECF) in the amount of $106 million was approved in June 2011. It supports fiscal consolidation over the medium term, with Fund resources to be used as needed for budget support. Budget financing from the ADB of $40 million approved in December 2010 was disbursed in March 2011. Support to the 2011 budget is also expected from the Anti Crisis Fund (ACF) of the Eurasian Development Bank in the amount of around $106 million and the European Union in the amount of €32 million in grants.

D. RELATIONSHIP TO OTHER BANK OPERATIONS

72. The reforms supported under this operation will add to effectiveness of several on-going projects in the Kyrgyz Republic:

73. The Capacity Building for Economic Management (CBEM) Project is assisting the government in establishing and institutionalizing an efficient and effective framework for formulating and implementing sustainable economic policies as well as in enhancing the capacity of public institutions responsible for the development and implementation of such policies to formulate and carry out the policies. There are strong synergies with areas of reform under the budget support operation: macroeconomic policy coordination, regulatory environment, fiscal policy and capacity and institution building in various public agencies.

74. The Payments & Banking System Modernization Project is developing a modern integrated national payments system that is accepted and used by the commercial banks and their clients. This is providing basic infrastructure that is essential for the development of a modern banking system that will increase the efficiency of payment services and facilitate the growth of financial intermediation, areas which will strengthen the implementation of the banking and financial sector reforms supported by the budget support operation.

75. The Governance Technical Assistance Project is strengthening institutional capacity to implement the measures under the program outlined in the GSAC Program Document and to assist with Treasury modernization. The public finance management reforms supported by this operation are advancing the implementation of the Governance TA project by supporting full operation of the Treasury Management Information System.

 

26  

Table 6: Link with Donors’ Activities

ERSO POLICY AREAS DONORS’ ACTIVITIESMacroeconomic and fiscal policy framework supports sustained growth with low inflation. Fiscal and external debt indicators improve with the risk of debt distress falling to minimal

IMF Rapid Crisis Facility (RCF) ADB: Crisis Support program, Economic Policy TA EC: SPSP in Social Policy and PFM Swiss: Government Securities Market Development Project (impl. IMF-effective management of public debt)

Enhance transparency over management of public assets

EC: SPSP in SP and PFM, SPSP TA in MoF, CB in PFM MDTF Swiss: PEFA, CB in PFM MDTF DfID: CB in PFM MDTF DfiD : EITI MDTF

Strengthened public finance management

EC: SPSP in SP and PFM, SPSP TA in MoF, CB in PFM MDTF Swiss: PEFA, CB in PFM MDTF DfID: CB in PFM MDTF

Establish proper accounting in energy sector operations

KfW: Advanced measures Severelectro Loan and TA, Loss reduction in energy sector Loan and TA Swiss: Naryn electricity losses reduction project, At-Bashy hydro power plant rehabilitation project EC: Technical audit of oil and gas pipelines project, regional projects in gas and water management sectors USAID: Kyrgyz Energy Advisory Services USAID: Regional Energy Markets Assistance Program (REMAP-II) 9/2009 — 9/2012

Maintaining financial sector stability.

ADB: Banking Sector and Capital Market Development Program and TA, Rural Livelihood Development Project KfW: KICB, Mortgage Financing, SME Credit line Swiss: SME Financing Facility, Anti-Money Laundering and Counter Terrorism Financing project (impl. IMF) GTZ: Promotion of Microfinance in CA Project IMF TA

Re-establish livelihoods and provide social compensation Safeguarding essential social protection spending

EC: SPSP in SP and PFM, SPSP TA in MLSD KfW: SP measures to compensate tariff increases UN: Poverty reduction program, Child protection system reforms UN: ILO regional projects and AAA FAO: Supply to vulnerable populations under the initiative on Soaring Food Prices JICA: Inclusion of the Persons with Disabilities into Society

USAID: Energy Analysis and Social Protection

E. LESSONS LEARNED

76. The operation was designed as a single stand-alone budget support to address the needs of the budget in 2011 in an environment that economic recovery and social reconciliation and peace building efforts have taken the center stage. Nonetheless, the formulation of the proposed program draws on the lessons learned from the implementation and mid-term review of the CAS/JCSS and the ICR of the GSAC project, both of which reflect the generally weak governance environment in the Kyrgyz Republic.

 

27  

77. Ownership is a key lesson. The preparation of the proposed budget support operation has involved working closely with the most senior levels of the new government in trying to build a program that is aligned to the government priorities in the area of recovery and reconciliation strategy. The operation focuses on areas which are of priority to the government.

78. The design of this operation also builds on the lessons from the ICR of GSAC in avoiding complex structures which strain the reform commitment and implementation ability of the government. This operation has built a program which is solid yet not complex. Moreover, the government’s implementation capacity and supporting TA are important elements for a successful implementation of the reform program. The team has assessed the TA needs across pillars of the reform program and has built in TA support through some of the ongoing projects and TAs (e.g. GTAC and PFM MDTF, Financial Sector Reform and Strengthening (FIRST) TA projects for NBFI and for Deposit Protection Agency capacity buildings, Health SWAP, Social Protection), and plans to seek additional TA possibilities. Donor coordination related to the provision of technical assistance in support of achieving the objectives of the program will be an important determinant of its success. The JCSS has succeeded in stimulating donor partnership and in presenting a joint approach to reform to the government.

F. ANALYTICAL UNDERPINNINGS

79. The preparation of this operation has been supported by recent economic and sector work.

Table 7: ERSO and AAA

ERSO REFORM AREAS AAA (ESW, TA) Macroeconomic and fiscal policy framework supports sustained growth with low inflation. Fiscal and external debt indicators improve with the risk of debt distress falling to minimal.

CEM Follow Up (2008) Kyrgyz Republic Programmatic PER (2007, 2008, 2009) Kyrgyz Republic Poverty Update (2007, 2010) Pension Policy Note (2009) Debt Sustainability Analysis (2009, 2010, 2011) Joint Economic Assessment (2010)

Strengthened governance in management of public assets and revenues

Corporate Governance ROSC Assessment (2010) ICR ROSC Update (2009) Building Local Self-Government Capacity (2008) Multi donor trust fund on PFM (2009) Public Expenditure and Financial Accountability (PEFA) (2009) Energy Dialogue and Technical Assistance (2006) JEA (2010)

Maintaining financial sector stability.

Financial Sector Monitoring (2010, 2011) FIRST TA: Pre-privatization Advice – Aiyl Bank (2011) FSAP Follow Up TA (2006, 2007, 2009) FIRST TA: Kyrgyz Republic NBFI Capacity Building Project (2010) FIRST TA : Deposit Protection Agency Capacity Building (2010) JEA (2010) FIRST TA: Strengthening Bank Supervision and Regulation (2010)

Nurturing post-conflict recovery; safeguarding social protection

Social Protection TF (2009) Programmatic Social Protection Strategy (2008) Programmatic Kyrgyz Republic Social Protection Notes (2008) Poverty Analysis Notes (2011) Poverty and Social Impact Analysis (PSIA) (2011) JEA (2010)

 

28  

80. The JEA, prepared in July 2010, has provided the main platform for the Bank activities in the Kyrgyz Republic, including the preparation of the ERSO program. As a multi sector report, the JEA addressed post crisis needs of the country and relied heavily on the existing and ongoing AAA and TA work in the energy, financial and social protection sectors.

81. Recent AAA in the financial sector underpins the ERSO program. An early assessment under the Financial Sector Monitoring study in 2009 highlighted the vulnerabilities in the banking sector, including the high concentration of deposits in AUB. It noted deficiencies in the supervisory response mechanism and recommended an assessment of the adequacy of NBKR’s contingency plans and crisis management framework to ensure that they were comprehensive, with clearly defined roles and responsibilities of the various stakeholders, including NBKR, MoF, and DPA. The study also noted deficiencies in the bank resolution framework, which allowed bankrupt banks to linger for years unresolved and recommended further strengthening of the legal framework for bank resolution. A comprehensive vulnerability assessment was completed in March 2010 before the crisis of April 2010, which identified many of the risks that subsequently materialized.18 In response to the crisis, the World Bank quickly mobilized additional TA to strengthen the Deposit Protection Agency’s capacity in case of deposit payouts in failed banks, to identify vulnerable banks and to develop bank-specific action plans, to enhance the legal framework for bank resolution, and to strengthen NBKR’s supervisory response mechanism. In these activities, the World Bank has been coordinating closely with the IMF to avoid duplication of efforts and to ensure that all critical issues were being addressed.

V. THE PROPOSED ECONOMIC RECOVERY SUPPORT OPERATION

82. The proposed operation supports Kyrgyz Republic’s post-conflict recovery and the transition to medium term growth and poverty reduction. Following the political and civil strife of mid 2010, the country met the immediate challenges of security and reconstruction, and now faces the task of recovering from economic contraction. The government has placed a strong emphasis on combining limited fiscal expansion with reforms to strengthen governance and safeguard social protection. The proposed operation supports the budget and implementation of government’s reforms (between April 2010 and May 2011) and thus provides a bridge to medium term policy actions that the government plans to take once its medium term strategy is adopted. There are twelve prior actions that the proposed operation supports; all of which have already been implemented.

A. THEME I: STRENGTHENED GOVERNANCE IN MANAGEMENT OF PUBLIC ASSETS AND REVENUES

83. Strengthening transparency and accountability in the public sector, is supported by the operation. The newly elected government is committed to improving governance as a means of restoring confidence of the people and the private sector. Thus implementing actions to increase transparency and accountability comprise this component of the operation. The activities relate to the areas of public investment, privatization, and mining and energy. Given

                                                            18 See Banking Sector Vulnerability Assessment: Kyrgyz Republic, June 2010 (final draft).

 

29  

significant weaknesses in governance in the Kyrgyz Republic, the actions supported by the operation are a bridge to a larger program of reforms that will feature prominently in the government’s medium term development strategy that is under preparation.

84. The ousted government had centralized power in a new agency, established a Development Fund (DF) outside the budget and privatized state enterprises in ways that indicated weaknesses in process. This was part of a general trend under the previous regime when the role of parliament was reduced, consultations on policies limited, and overall transparency and accountability of government actions reduced. The Central Agency for Development, Investment, and Innovation, (CADII), was made responsible for decisions on public investment, policy/strategy formulation, the mobilization of external finance and the coordination of policy implementation, thereby disempowering the ministries. A Development Fund (DF) was also set up to hold and allocate incoming external finance to investment projects outside the budgetary process as well as to place its liquid balances into instruments of less than investment quality in an opaque manner. Several large SOEs were privatized without a due competitive process thereby increasing opportunities for corruption. There is strong evidence that connected lending also grew rapidly during that period, especially in AUB, resulting in a rapid increase in non-performing loans thereafter.

85. The new government abolished the off-budget DF, re-established budgetary accountability for public investments and adopted better norms, standards and processes for privatization and state asset management. The responsibility for the development of the public investment program, the choice of projects, and the management of public capital spending will be firmly in the hands of the MoF. The DF has been put in liquidation and its holdings placed in a special account in the central bank. An international auditor has been identified to conduct a financial audit of the DF. The government intends not to establish any extra-budgetary funds. All capital spending will form part of the budget and submitted to the Parliament on a consolidated basis.

86. In both these areas there is a significant medium term agenda for reforms to improve governance. In public finance management, despite progress in selected areas, the system still has some substantial weaknesses to overcome. In respect of privatizations and management of state enterprises, the State Property Committee has been elevated to a ministry and is constitutionally responsible for the management of government shares in state owned enterprises. The proposed ERSO supports the following prior actions:

The Development Fund that was designed to hold and allocate incoming external finance to investment projects outside the budgetary process has been placed under liquidation pursuant to Interim Government Ordinance Number 31, dated April 30, 2010, and the audit of said Development Fund by an external auditor appointed by the Recipient has commenced.

The following Resolutions of the Recipient have been passed to establish improved asset management norms and practices for the Ministry of State Property: (i) Resolution Number 178 of the Government of the Kyrgyz Republic, dated August 27, 2010; and (ii) Resolution Number 309 of the Government of the Kyrgyz Republic,

 

30  

dated December 8, 2010; and (iii) Resolution Number 104 of the Government of the Kyrgyz Republic, dated March 14, 2011.

87. Mining sector. Improved management and transparency of the country’s mining sector is required, to avoid allocations of mining titles in an arbitrary manner. Non-transparency also inhibits international investment. Despite excellent mining potential, the Kyrgyz Republic has been unable to move beyond a one-operator country for the last 15 years. A number of investors, despite having exploration or production licenses, are unable to access the mineral deposits because of social unrest and opposition by the local communities. Implementation of the Extractive Industries Transparency Initiative (EITI) which covers the full publication and verification of company payments and government revenues from oil, gas, and mining, has somewhat helped to increase transparency and accountability. EITI implementation will have to be followed by increased outreach in remote parts of the country, beyond Bishkek and Issyk Kul.

88. The interim and newly elected governments reaffirmed their commitment to the standards of transparency contained in EITI. The country has recently taken steps to complete EITI compliance with the global standard against 20 criteria and a special prize for “achieving remarkable progress in implementing the EITI in difficult circumstances” was presented to President Roza Otunbaeva at the 5th Global EITI Conference in Paris on March 2-3, 2011. The authorities plan to continue implementing EITI beyond the period of the proposed operation, with technical assistance from the World Bank.

89. The government has also focused on improving the management of mineral resources in line with international best practices. Social aspects of mining are receiving more attention because of a challenging situation in the regions that has at times blocked access to the mining sites. The new government is determined to implement a transparent system in line with high international standards for mining tenders. The World Bank is currently working with the authorities to put in place a system for mineral tenders that will meet international mining sector best practices and attract new investment to the sector.

90. The proposed ERSO supports the following prior action:

The Recipient has achieved compliance with the Extractive Industries Transparency Initiative’s (EITI) global standards for improved transparency in the oil, gas and mining sectors as evidenced by the declaration made by EITI at the March 2011 Global EITI Conference.

91. As a result, Kyrgyz Republic is now one of the 11 countries having the status of EITI Compliant. The number of mining enterprises that provide EITI reports that are subject to independent reconciliation has increased from 25 to 46. These reports, which reflect the companies’ financial flows from mining activities, have been available to public and provide a mechanism to implement the principles of transparency and public participation in monitoring.

92. Energy sector. This sector, overwhelmingly public, accounts for 4 percent of GDP and 16 percent of the industrial production, and its performance is critical for the performance of the Kyrgyz economy. The sector has a significant potential for export that is unrealized. Other advantages of the power sector are relatively low cost of power generation, reliance on clean

 

31  

sources of energy, and the near universal access to power supply. However, the sector is hobbled by extremely weak governance, equivocal regulatory environment, and lack of transparency in its operations and its accounts. Large commercial losses, coupled with evidence of significant theft of power by vested interests and unrecorded exports under the previous regime are some examples of key governance problems. Persistently weak governance led to significant deterioration of the energy assets, poor sector performance, and inadequate financial viability. The current authorities have taken major steps to initiate a process of improved governance and transparency in the sector.

93. Transparent management of electricity revenues is important to the public whose life and work depend on reliable supply of electricity. The full cooperation of the public is also needed to make the sector financially viable. There is a very low degree of trust in the energy sector among the local population, foreign financiers and other investors. The authorities recognize that reforms in the energy sector are central to removing a key structural impediment to growth; and that with energy reforms under way and given the low cost of energy production, Kyrgyz Republic would be highly competitive for investment in the sector, and more broadly in the economy. There is also a clear understanding of the need for an integrated approach towards reform in the sector including specific policies to reduce losses and measures to enhance transparency of accounts for electricity companies. The government has already taken a number of important steps to improve the sector’s management. The main focus is currently given to improved governance of the sector both from points of increasing transparency and accountability as well as improving the state regulation. The following actions have been taken:

94. First, the authorities established a Supervisory Council at the Ministry of Energy in mid-2010 to raise standards of disclosure and transparency in the sector. Half of the membership of the council consists of representatives of the civil society. The council exercises surveillance over the sector. Major actions by energy companies, e.g., tariff changes, exports, new investments are to be disclosed to the council and agreed, with the major objective of making all developments transparent.

95. Second, in mid-2010, the authorities established special escrow accounts at power generating and transmission companies where all export receipts are to be deposited. These funds are then allocated for specific purposes such as the purchase of fuel for winter heat and power generation. The use of proceeds from the escrow accounts is to be monitored by representatives of the Supervisory Council. Clear rules and procedures for managing the cash collected on these special escrow accounts are established through the Ministry of Energy.

96. Third, the authorities have introduced Performance Agreements as a new performance management and accountability tool. These agreements are signed between the state regulator and the energy companies. This is a first attempt of the state in ensuring accountability of the companies’ management. The performance agreements establish clear responsibilities and obligations of the companies’ management in improving the companies’ performance and achieving the agreed targets. Indicators have been established for measuring improved performance by companies.

97. Going forward, the authorities need to develop longer-term policy and investment measures to improve the energy sector’s governance and performance. The government

 

32  

realizes that the key to strengthened governance is establishing proper mechanisms for reporting and accountability of the sector entities – generation, transmission, and distribution companies. As licensed natural monopolies, the power sector entities should have a regular reporting requirement to the state authorized body in charge of sector regulation; as joint stock companies the power sector entities are required to undergo annual financial audits under the Kyrgyz Republic laws. Given the weaknesses in governance and related deficiencies in the internal control systems of these entities, it is essential that the financial audits be conducted by independent and reputable audit firms. Further, the authorized regulatory body should disclose and publish the key technical and financial data about the sector’s performance.

98. The authorities need to take further actions to improve the regulatory function of the state. While the introduction of Performance Agreements is a very welcome step, these agreements need to be further strengthened to clarify the system of incentives and penalties. To properly carry out the sector regulation, there is a major need to establish adequate metering and data acquisition system to enhance the sector accountability and strengthen internal controls. At a minimum, the metering needs to be improved to validate power inflows at commercial nodes of the network, from generation plants to transmission company, wholesalers and large consumers, with special attention to exports and imports and from distribution companies to end users. Additionally, a Metering Protocol needs to be established to stipulate clear rules and procedures for the collection of power flow data for planning and billing purposes. Once the metering and related accountability and transparency issues are addressed at the wholesale level, the metering system can be rolled down to the distribution segment.19

99. There is a need to increase predictability of the revenue streams and establish clear rules to manage centralized escrow accounts at the Settlements and Savings Company (SSC). These accounts hold the proceeds of utility payments made by consumers, and these proceeds are then allocated across the entities by the Ministry of Energy. The reformed rules must be totally transparent and incorporate objective criteria that would incentivize greater efficiency. As part of the reformed rules, the following will need to be considered: (i) the escrow accounts remain blocked for sector entities till the bills of outside suppliers (including suppliers of natural gas) are settled; (ii) the entities are rewarded for good performance, i.e. the entity that performs better (lower losses, higher collections) get larger share of the collected cash.

100. Improving financial viability by reducing losses, improving collection rates, and rationalizing the pricing system is critical over the medium term. Both the level and the structure of the power sector tariffs have to fundamentally change to ensure that tariffs reflect the true cost of supply that incentives are in place for sector entities for efficient operation and end-users for energy savings. Also, while the subsidies in the power sector can be maintained as a matter of policy choice, any subsidies maintained should be compensated from the state budget. Given the lack of reliable information about sector costs and the severe under-valuation of assets in the sector (no asset revaluation has been carried out and the assets are carried at their historical cost) an in-depth tariff study is needed to reveal the structure and level of costs in the sector. The government has set up a commission (jointly with parliament) to study the optimal way of

                                                            19 Development of a metering program including installation of automated metering and data acquisition system for the wholesale electricity transactions as well as the supervisory control and data acquisition system (SCADA) is being supported by the ADB Power Sector Improvement Project.

 

33  

raising tariffs. A policy of gradual increases over the medium term with protection for the vulnerable and clear communication will be a part of the Medium Term Development Strategy.20

101. The authorities need to take urgent steps to ensure energy security including a strategy to meet winter energy needs and a power export plan. Given that both base and peak loads in the Kyrgyz Republic are covered by hydro-generation year-round, developing a base-load thermal capacity to address the issue of the winter deficit is important. Furthermore, given that the country has summer surpluses, the power sector has significant potential for export of power even without major investments in generation. Such exports could compensate for imports of gas and coal and ensure timely payments to avoid supply disruptions and improve the country’s trade balance. Finally, the country’s authorities need to address the existing inadequate transmission capacity to supply both southern and northern territories that increases dependence on neighboring countries and electricity wheeling costs. The country is heavily dependent on the Soviet-era regional water and power network, also involving Kazakhstan, Uzbekistan, and Tajikistan. Power was supplied to southern and northern Kyrgyz Republic through the regional grid. However, neighboring countries are moving toward national energy self-sufficiency. The Kyrgyz energy sector with constrained funding is much behind.

102. The proposed ERSO supports the following prior actions:

The Kyrgyz Republic has adopted the Energy Sector Transparency Initiative (ESTI) pursuant to Presidential Decree Number 49, dated July 20, 2010, and the following measures have been carried out: (a) the Supervisory Council (SC) of the Ministry of Energy, comprising representatives of the Government of the Kyrgyz Republic, power companies and civil society, has been established to supervise ESTI implementation; (b) the SC has adopted internal regulations for its governance; and (c) a transparent and rules-based mechanism for managing and monitoring financial flows, particularly, electricity export proceeds in the escrow account, has been established.

Performance Agreements that include indicators pertaining to losses and the collection of revenue in the energy sector have been signed and are in effect between the Energy Regulatory Authority and the energy companies.

103. These measures for increased transparency and accountability are only initial steps in a medium term agenda to restore public trust and to operate in the public interest. Setting up the Supervisory Council has established a basis for dialogue between the government, energy professionals, and the civil society that is expected, in a longer term, to help build trust and lay a foundation for further reforms in the sector. Increased transparency and improved management of power export proceeds are expected to help partially address the issue of winter deficit through timely payments for the critically needed fuel (coal, mazout, gas) for winter heat generation. The transparent and rules-based mechanism for monitoring and managing financial flows, especially electricity export proceeds instituted by way of opening escrow accounts at the power plants and the Kyrgyz National Electricity Grid companies will enable the power export

                                                            20 The USAID Regional Energy Security, Efficiency and Trade (RESET) project in Central Asia is conducting a management diagnostic study of the main energy companies in the Kyrgyz Republic which involves a separate Cost of Electricity Review expected to be finalized by end-2011.

 

34  

proceeds and its use to be accounted for and managed transparently. The Ministry of Energy is expected to submit to the government and to the Supervisory Council (which have representation from civil society) under the Ministry of Energy, quarterly reports on balances of and use of funds from the escrow accounts for their recommendation. Finally, the introduction of the Performance Agreement has helped to restore the accountability of the energy companies by clarifying the responsibilities of the companies, setting clear indicators and targets for the energy companies that would, ultimately, lead to improved operational performance of the energy sector reflected in reduced losses and improved collections.

104. Financial Sector: Establishing a clear framework under which actions can be taken to maintain financial sector stability is a key requirement for economic recovery. Reforms supported jointly by the IMF and the World Bank to establish such a framework so that banks and their customers have clarity in terms of the rules under which the banks operate and address banking system distress, are important. . The cumulative effects of the 2009 crisis and 2010 conflict highlighted the relevance of these reforms to avoid a full-blown banking crisis and contagion, as well as to promote orderly resolution of problems.

105. The authorities have taken bold measures to restore stability and avoid contagion. They have implemented temporary administration in seven banks, direct supervision in twelve banks, and nationalization of the AUB followed by its liquidation and restructuring into the new Zalkar Bank. The NBKR has intensified supervision and in some cases suspended certain bank operations when needed. These efforts, however, have stretched the NBKR’s capacity. Supervising the still-fragile banking sector will continue to be highly demanding for the foreseeable future.

106. Improving legislative frameworks to address problem banks and establish an effective deposit protection system are important for stability and development. The NBKR plans to redefine the role of the Supervision Committee, introduce a revised supervisory response mechanism, and prepare and initiate the implementation of action plans and bank-specific supervision strategies with respect to each of the problem banks in early 2011. The government will re-establish the independent status for the Deposit Protection Agency (DPA) with an appropriate supervisory board providing oversight, thus paving the way to improve governance in the deposit protection system through clarified roles, responsibilities, and accountability of DPA, NBKR, and the government. Amendments to the Law on the Protection of Individuals’ Deposits will, inter alia, ensure that deposit protection will be available for depositors in all banks, including those that violate prudential norms.

107. In the medium term, continued reforms to strengthen frameworks for bank resolution, supervision, contingency planning and regulation will be needed. The crisis simulation protocol has to be strengthened. The deposit protection system will be strengthened to ensure prompt payment on a level playing field of protected deposits in banks under liquidation. The authorities realize the importance of protecting access to finance during periods of economic stress, as well as the crucial role that both banks and non-bank financial institutions play. As noted above, the microfinance industry came under pressure as its main source of currency swaps, the AUB, was required to suspend operations. NBKR stepped in to roll over the existing stock of such swaps and offered guarantees to other commercial banks offering swaps to MFOs. It lowered capital requirements on MFOs, inter alia by permitting deposits placed by

 

35  

MFOs in banks that were used for hedging to be subtracted from the asset base of the MFO, as well as allowing risk-based classification of assets. Moreover, MFOs’ provisioning requirements for loans secured with a group guarantee were reduced.

108. There will have to be measures to strengthen the legal and institutional frameworks for microfinance lenders and parts of the non-bank financial sector. NBKR will revisit minimum capital requirements for existing and newly entering banks with the aim to strengthen competition. Reforms to modernize the secured transactions system (i.e., use of collateral to secure loans) will be undertaken to re-invigorate bank credit for enterprises and households. Reforms in the Kyrgyz Republic Post Office will be undertaken to expand its provision of financial services. Both Aiyl Bank and the Finance Company for the Support and Development of Credit Unions will be privatized to enhance their governance structure, enlarge their range of products and services, and increase their access to commercial funding sources.

109. The proposed ERSO will support the following prior actions:

The National Bank of the Kyrgyz Republic (NBKR), as the banking supervisory authority, has restructured the financially distressed OJSC AsiaUniversalBank (AUB) into a new entity, the Zalkar Bank, and has introduced direct supervision and temporary administration procedures for the rehabilitation of financially distressed banks.

NBKR has issued Directive Number 30, dated May 26, 2011, for improving supervisory response mechanisms to identify shortcomings in, and initiate prompt preventive and corrective action to, financially distressed banks in the Kyrgyz Republic.

The Deposit Protection Agency has been reconstituted as an independent legal entity by Government Resolution Number 269, dated May 31, 2011.

110. These actions will strengthen governance, enhance stability, and increase access to finance. For example, by managing the insolvency of a major bank and preventing contagion to the rest of the financial system by introducing temporary administration or direct supervision in vulnerable banks, NBKR helped to restore stability and confidence in the banking sector. By initiating the implementation of action plans and bank-specific supervision strategies to strengthen problem banks, NBKR has helped to restore financial health in some banks while initiating resolution of other banks. When the bank supervisory response mechanism for identifying critical shortcomings in banks and initiating prompt responses is adopted, NBKR will be better equipped to supervise the banking sector, address vulnerabilities in a timely manner, and resolve troubled banks efficiently. By issuing a decision reestablishing DPA’s independence, DPA’s legal status will be clear, paving the way for needed reforms to strengthen the deposit protection system. Finally, by improving the CAR calculation for MFOs, MFOs will need to set aside less capital, thus freeing up more resources to increase access to financial services and enhance competition in the financial sector.

 

36  

B. THEME II: SAFEGUARDING SOCIAL PROTECTION AND SUPPORTING CONFLICT-AFFECTED POPULATION

111. Safeguarding social assistance to the poor and to conflict affected families in the face of fiscal pressures and improving targeting is a priority. This component seeks to maintain real benefits of targeted programs and to rationalize the less well targeted ones. In addition, it supports the provision of social assistance temporarily to conflict affected families because of their heightened vulnerability and disruption in livelihoods.

112. The 2010 conflicts and economic downturn have caused new challenges to poverty alleviation and heightened the need to strengthen targeted social assistance. The poor in Kyrgyz Republic had been hit by a series of shocks: the food crisis in 2007-08, the global energy price increases in 2008-09, the continuing global economic and financial crisis, and now in 2010-2011 by political upheaval and instability affecting the entire economy and labor markets as well as by recent food price inflation. The June events disrupted livelihoods by loss of life, displacement, loss of employment, large-scale disruption of markets and economic activities. Prior to the onset of crisis in 2010, poverty incidence was around 32 percent (2009 data); and the most recent data reported by the National Statistics Agency indicates an increase to 33.7 percent.

113. Social assistance provided by the government that is targeted to the poor was far from adequate to cover the vulnerable population. While the means-tested monthly benefits to poor families with children was instrumental in helping respond to the global food crisis, this was largely due to rapid donor assistance channeled through increases in the program to help smooth consumption for poor households with children. When this emergency support faded, the Government retained the responsibility to strengthen this monthly benefit so that it is a meaningful tool to protect the poor in the face of shocks, including the current food price inflation and future crises.

114. The current social safety net system consists of two targeted benefits (MSB & monthly benefits to poor families with children (previously known as Unified Monthly Benefit - UMB21) and a number of rights-based in kind benefits. The MSB with 65,000 recipients, is a cash income-replacement program that is categorically targeted (but not means-tested) to disadvantaged groups, including children with disability up to 18 years of age and other categories of people with disabilities, orphaned children, mothers of large families22, as well as elderly who have reached pension age but do not qualify for pensions from the state pension insurance system. The monthly benefits to poor families with children is a targeted cash allowance program that is means-tested and has been provided to low income families with children to bring the household low income to the level of Guaranteed Minimum Income (GMI) considered as minimum for basic needs. It is well targeted, with over 70 percent of funds going to the lowest two quintiles and 54 percent to the first quintile.

                                                            21 The program is targeted to families with children from 1.5 to 16 years of age (or up to 23 years of age when still studying). The monthly benefits to poor families with children also includes payment of a fixed birth grant and an increased allowance for children from birth to 3 years of age, who are considered to be particularly vulnerable to poverty. 22 Mothers of 7 or more children.

 

37  

115. Both the amount of the monthly benefits to poor families with children and its coverage of the poor are low. The benefit covers the gap between the GMI (recently raised to 310 som per capita) and the household per capita income and fluctuates around 120 – 150 som ($2.7-$3.3) per capita in an average recipient household. This amount is far from sufficient to cover the basic needs of poor families. Coverage of the poor is also low, as only 8.7 percent of the population participates in the program (too low given the high level of poverty). More will have to be done over the medium term to improve targeting given limited fiscal envelope and high poverty.

116. The authorities have taken measures to prevent the erosion of monthly benefits to poor families with children in the face of inflation. Given the relationship between the GMI and the monthly benefit, the authorities raised the GMI by 10 percent in mid-2010 so as to preserve the value of the benefit in real terms. However, with rising inflation in the rest of the year, there has been a significant erosion of the monthly benefits. The government has then committed to raising the GMI from mid-2011 by 19 percent and to significantly raise the MSB targeted to children with special needs. The government revised the eligibility criteria for the monthly benefits to poor families with children to tilt it more sharply towards families with children taking the view that poverty was concentrated in such households. Also imputed income from certain assets such as livestock and agriculture land was revised to reflect reality more closely.

117. The authorities have also taken actions to reduce the number of poorly targeted categorical benefits, but much more remains to be done. The number of poorly targeted categorical benefits was reduced from 39 to 25. The remaining 25 categories are non renewable and are expected to be extinct in several years. In addition, the monetization of benefits has taken place with the transformation of the major categorical benefits to direct payments in cash. However, more will need to be done in the future to move away from a system that is still partially rights based to one that will be predominantly needs based.

118. In the post-conflict period, the government provided significant support to the affected people. Social assistance package in the form of cash compensations, support to re-establish livelihoods, efforts towards recovery of private businesses and to stimulate investment and trade were provided by the authorities in the conflict affected areas. Suffered businesses were granted exemptions from profit tax, sales tax, immovable property tax and land tax, and reduced payments of patent tax, unified tax and payments under tax contracts. To further stimulate employment, businesses in the south were granted lower payments towards social fund contributions. The re-establishment of essential infrastructure and utility services such as public transport in Jalalabad and Osh and electricity repair has also helped significantly to raise output.

119. The proposed ERSO supports the following prior actions:

In its respective national budgets for 2010 and 2011, and pursuant to Resolutions Number 131 of July 20, 2010, and Number 134 of April 4, 2011, respectively, the Recipient has increased the Guaranteed Minimum Income (GMI) by ten percent (10%) during the mid-2010 to mid-2011 period, and by 19 percent (19%) from mid 2011 onwards, in order to maintain the value of Monthly Benefits for the Low Income Families with Children in real terms.

 

38  

Pursuant to Presidential Decree Number 795, dated December 22, 2009, On Providing Monetary Compensation to Selected Categories of Citizens in Connection with Changing Energy Prices, in-kind social benefits that would have been provided to beneficiaries have been monetized as direct cash payments to be made to beneficiaries, with the number of rights-based categories of said beneficiaries reduced from thirty-nine (39) to twenty-five (25).

Pursuant to Interim Government Decree Number 124, dated August 24, 2010, additional monthly social benefits for families affected by the national crisis of 2010 have been introduced.

120. These prior actions will contribute to improved targeting and increasing the level of assistance for the most vulnerable categories of the population, as well as towards addressing the immediate social and poverty needs caused by the 2010 conflicts. The increase in GMI will help offset the negative income effects of recent food price inflation on the poor segments of the population. The monetization of benefits and reduction in the number of categorical benefits increase efficiency of government’s efforts to tackle poverty and provide social safety nets, given very scarce public resources. The additional monthly social benefits introduced as compensation to families affected by the 2010 events will reduce the poverty and social impact on beneficiary families. They will also contribute to the efforts to restore livelihoods and build an enduring peace.

121. Over the medium term, a comprehensive reform of the social safety net is required for reasons of efficiency and sharper targeting. It also would prevent actions to contradict the main policy principles. Having a strategy is needed to address the gap in development of social services for the poor and the vulnerable. It would also mean that the government makes a consolidated policy statement for social protection to the general public and the donor community, who can direct their efforts around the proposed pillars.

VI. OPERATIONAL IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACT ANALYSIS

122. The core policy actions under the operation’s Theme I will have a positive social impact. These measures address reforms in the category of “strengthening governance in management of public assets and revenues”. The specific proposed reforms improve (i) capital budget management, transparency in privatization process, and asset management; (ii) transparency of the energy sector operations; and (iii) financial sector stability. These reforms have a positive social impact as they signal greater accountability of the government to the population and its commitment to greater transparency in the use of public funds.

123. The first of the three policy actions under Theme II is expected to have a positive impact in reducing poverty. The first policy action is raising the Gross Minimum Income (GMI) by 10 percent which has two beneficial consequences. First, it allows a greater number of poor families with children to be eligible for the monthly benefits to poor families with children; this is particularly important at a time where the number of recipient households has been falling.

 

39  

Second, it serves to increase the nominal value of this monthly benefit such that the real value remains constant. The in depth poverty and social impact analysis report prepared for this project showed that the increase in the GMI and the subsequent impact on the program of monthly benefits to poor families with children would have a positive impact on reducing both poverty and extreme poverty.

124. The second policy action in this area pertains to monetizing in-kind benefits and will have a positive social impact by improving transparency and degree of usage of social transfers. Benefits were monetized for selected groups (about 38 individual categories) such as war veterans and disabled persons. The monetization resulted in a net gain for the recipient groups (poor and non-poor) because their choice was no longer limited to particular goods or services provided through the in-kind programs. Although, persons living at high elevations were cut from the program, reducing the total number of beneficiaries by 83 percent, they were eligible to apply for the monthly benefits to poor families with children. These changes in the program led to both transparency and predictability of these expenditures in the budget but also a de facto increase in income for the remaining beneficiaries. However, this greater transparency has had a cost. Expenditures on social transfers have increased by 140 million KGS between 2008 and 2009 due to the monetization and have created greater fiscal pressure. Second, because only 29 percent of these benefits go to those in the poorest quintile of the population, in aggregate non-poor beneficiaries have benefited even more than the poor.

125. The policy matrix also includes the objective of re-establishing livelihoods and providing social compensation to the south, with expected positive poverty and social impact. The first policy action is the provision of additional monthly social benefits to conflict-affected families. The poverty and social impact of these actions were positive since they were likely to have prevented many of the conflicted-impacted households from falling below the poverty line, especially since the majority of victims were working age males.

126. This operation is expected to have an overall positive impact on poverty through its support for achieving fiscal sustainability and growth and also its protection of key social sector expenditures, especially in social protection. In the Kyrgyz Republic, economic growth has gone hand in hand with poverty reduction. The elasticity over the period 2006 – 2009 has been 1.13 percent indicating that an increase in growth has led to an even greater fall in poverty. Thus, with the added actions on reforming the safety net, especially raising the cash transfers to those living in extreme poverty, the poverty impact of growth is likely to sharpen.

B. ENVIRONMENTAL ASPECTS

127. The specific policies supported by the operation are not likely to have significant effects on Kyrgyz Republic environment and natural resources. The measures contemplated under the ERSO operation are intended primarily to ensure growth, stability and fiscal prudence, and to support the government in strengthening governance in management of public assets and public finances, promoting private sector development, and nurturing post-conflict recovery and safeguarding social protection. No negative effects on the environment can be foreseen from these measures.

 

40  

C. IMPLEMENTATION, MONITORING, AND EVALUATION

128. The MoF which has the responsibility of coordinating donors’ activities and all external assistance to Kyrgyz Republic will be the World Bank counterpart on the ERSO implementation, as well as on the management and coordination of implementation of the proposed policy measures among various ministries and agencies. Other key counterparts will include the Ministry of Economic Regulation, Ministry of Energy, Ministry of State Property, Ministry of Natural Resources, Ministry of Labor and Social Protection, State Directorate for Rebuilding and Reconstruction of Osh and Jalalabad, and National Bank of the Kyrgyz Republic.

D. FIDUCIARY ASPECTS

129. Accounting, recording and reporting. Kyrgyz Republic has reasonably strong systems of accounting, recording and reporting. Computerisation of treasury functions now enables regional treasuries to agree expenditure details with the local transit banks daily before submitting details to the central treasury which then agrees the total with the National Bank. Revenue details are also received by regional treasuries which pass information to local tax offices to enable them to update taxpayers’ accounts. There are established arrangements for monthly and quarterly reconciliations between budgetary organisations’ records and those of the central treasury that leads, each quarter, to reports to the President, the Parliament and the Prime Minister. Although the arrangements are cumbersome and probably do not resolve all data errors they are the only possible arrangements in the absence of a fully integrated system.

130. The introduction of a GFS 2001 compliant chart of accounts in 2007 has improved the level of information available on a quarterly basis. No reports are made available to line ministries or other bodies, neither are reports produced on resources received by local delivery units. Annually a cash-based budget execution report, in respect of the previous financial year, is produced by the government for submission to the Parliament by the middle of May. This report is the nearest there is to financial statements, and, though it includes extensive information on revenues and expenditures, in accordance with GFS 2001, it does not include accounting policies. The huge amount of numerical data it does contain is not supported by any useful summaries or commentary that would assist in their interpretation.

131. National accounting and reporting standards for the public sector are not fully developed yet. However, the government issued a resolution in July 2009 on reforming accounting and reporting in the public sector with the aim of introducing Cash-basis IPSAS in the public sector. This was followed by a government Resolution in December 2009 on the introduction of unified accounting software in budget organizations. These measures, if fully implemented, will go a long way in improving accounting and reporting in the public sector.

132. Public sector auditing. Public sector auditing is performed by the Chamber of Accounts (CoA), the equivalent of supreme audit institution (SAI) in the country. The Chamber of Accounts is responsible for auditing the budget execution report, prepared by the MoF by mid-May, and submitting its findings to the Parliament. No audit opinion is given; instead a report of errors and violations is produced which is laid before the Parliament in September or October following the year of account. The absence of a set of financial statements prepared in accordance with internationally recognised accounting standards represents a limitation on what

 

41  

the Chamber can do. Its audit of revenues and expenditure each year is not complete with only the consolidated statement of the MoF audited annually; the policy in relation to other financial statements is not transparent. In addition to work on the annual budget execution report, the Chamber undertakes audits of budget organisations, but does not separate reporting on its work on the financial statements from compliance and the efficient use of resources.

133. The World Bank is supporting the Chamber of Accounts, through an IDF grant aimed at supporting capacity building activities, including development of appropriate audit methodology. It is expected that sustained technical assistance will enable the Chamber of Accounts to develop sustainable capacity to conduct audits in accordance with international standards. Capacity strengthening of the Chamber of Accounts is running in parallel to the efforts being made to develop financial reports in the public sector that can be subject to audit resulting into expression of audit opinion.

134. The National Bank of the Kyrgyz Republic (NBKR) has been audited regularly by reputed international audit firms. The 2010 audit of the consolidated financial statements was conducted by Grant Thornton (Armenia), who issued unqualified opinion on the financial statements. Previous audited financial statements have also been unqualified with no major issues raised in the management letter. A safeguards assessment of the NBKR is in progress and will be completed before the end-2011. The last safeguards assessment was completed in 2009. The authorities have updated the February 6, 2010 memorandum of understanding between the ministry of finance and the NKBR on the management of foreign exchange reserves, including those for budgetary support.

135. Public procurement. Public procurement has gone through some reform through revisions introduced in the Public Procurement Law to bring it in line with international standards; introducing principles and stages of an efficient procurement process, and defining the mandate and authority of the State Procurement Agency. However, this agency, which was established as an independent public procurement oversight body, was abolished in October 2009 as a part of the government reorganization which took place under previous government. Instead, a new Department on Public Procurement Methodology has been established under MoF while the procurement supervision function was not assigned to any organization. In addition, the National Procurement Training Center has been taken over by a private ownership and the range of procurement training has been gradually decreasing.

136. As such, budget entities have become solely responsible for the procurement process, with no regular oversight from other government bodies. Random external audits are conducted by the Chamber of Accounts once every two years. This decision seriously undermines a system of checks and balances in public procurement and creates a responsibility gap for assuring the quality of public procurement, especially given that the public sector internal audit is weak. This heightens corruption risks in procurement.

137. The MoF has improved its website to bring more transparency to the procurement system. The procuring entities can place their procurement plans, bidding opportunities and contract award results on this website. However, the process for redressing tender violations remains unclear. Given that public procurement carries a risk of high corruption, appropriate oversight and transparency will need to be established as a priority. The MoF recognizes this

 

42  

priority, but its capacity and current legal basis are the main constraints for immediate improvements. The MoF Public Procurement Unit includes only five staff, whose major responsibility concerns methodology of public procurement. Recently, the unit began to request the minutes of tender commission meetings in an attempt to check accuracy of the tender process; however, the unit’s capacity clearly is not sufficient to do this promptly and with acceptable quality. The unit also drafted a new public procurement law that is intended to re-establish appropriate procurement oversight. The process of approving the draft law will take quite some time. Even once approved, there will be a need for extensive capacity and institution building.

138. The treasury is developing a database of contracts, but there is an institutional gap in monitoring the adherence to procurement rules. The Chamber of Accounts reviews procurement process only during the regular assessment of budget organizations once every two years. The government had noted that the supervision function in procurement had been reportedly a source of administrative corruption. The provisional government will need to establish the procurement oversight function to foster credible state institutions and to develop mechanism of dispute resolution and handling of complaints to reduce corruption in procurement.

139. The World Bank maintains dialogue with the government on public procurement reform. The government has actively participated in the Regional Public Procurement Forum.23 The World Bank would provide more assistance through the on-going PFM project to facilitate further reform, institutional development and capacity building in public procurement.

E. DISBURSEMENT AND AUDITING

140. The Recipient is the Kyrgyz Republic. The credit and grant proceeds would be made available to the Recipient upon the effectiveness of the Financing Agreement between the World Bank and the Kyrgyz Republic.

141. Disbursement. The Recipient will submit a withdrawal application to the International Development Association (IDA). Upon receipt of the withdrawal application IDA will disburse the amount in (one tranche) into a foreign currency deposit account that forms part of the country’s official foreign exchange reserve and is opened for the purpose in the National Bank of Kyrgyz Republic (the Central Bank). This account is available for budget financing and will be managed by and subject to the control of the MoF. The Recipient will report to the World Bank on the amount deposited in the foreign currency account and confirm its availability to finance budget expenditures, within 30 days of receiving such funds. If, after depositing funds in this deposit account, the proceeds of the credit and/or grant are used for ineligible purposes as defined in the Financing Agreement, the World Bank will require the Recipient to either: (i) return that amount to the account for use for eligible purposes; or (ii) refund the amount directly

                                                            23 The Regional Public Procurement Forum, an annual event initiated by the Bank in 2005, provides a platform for public procurement officials from Central Asia and neighboring countries to share knowledge and learning, exchange views and experiences, and discuss policy issues in public procurement reforms. Countries from other regions (such as Korea, Singapore, Brazil) as well as relevant international organizations were also invited to share experiences and good practices. The Government of Kyrgyz Republic has actively participated in the Forum including hosting two of them.

 

43  

to the World Bank, in which case the World Bank will cancel an equivalent un-disbursed amount of the credit.

142. The administration and accounting of the credit will be the responsibility of the MoF. The proceeds of the credit and grant deposited at the Treasury account with NBKR will be converted into local currency to cover budget expenditures or will be used for refinancing foreign debt repayments. The MoF will be responsible for the credit and grant administration and for preparing the withdrawal application, and maintaining the withdrawal application as required. The MoF, with the assistance of NBKR, will maintain records of all transactions under the credit in accordance with sound accounting practices.

143. No additional fiduciary arrangements will be required. The World Bank will not require an audit of the designated account but will require the government to provide confirmation to the World Bank in the form of an official letter from the MoF on the amounts deposited into the foreign currency account within 30 days of receiving the funds.

144. The closing date of the proposed operation will be June 30, 2012.

F. RISKS AND RISK MITIGATION

Risks

145. Political risks. The country is still going through a peace and state building process. The main political risk relates to the viability of the constitution, with some political parties hankering for a return to a presidential system. A poorly managed political transition following the late 2011 presidential elections and the constitution of a new government thereafter could increase domestic instability and exacerbate regional fragility. Power sharing between the executive and legislative branches is still to be properly defined, and the give and take of coalition government is still to be fully internalized. Continued geographical polarization of the country on ethnic lines or along a religious/secular divide are risk factors.

146. Social risks. A major source of internal risk arises from the continuation or even the intensification of social strife in the south of the country that led to clashes and massive loss of life in mid-June. Social tensions reflect competition for resources and are exacerbated by the links between entrenched criminality (itself based on the lucrative drug transit trade in the south), and rent-seeking political structures. Parts of the south are effectively out of the control of the central authorities. Security forces, which like the civilian administration in the south are largely mono-ethnic, continue with low-level harassment and extortion of minorities.

147. A continuation of social tensions will damage economic activity and lead to higher reconstruction and recovery needs. It will also be a source of political instability and could poison the climate for the efficient absorption of donor financial support.

148. Risk of macroeconomic and financial instability. As a small, open, and landlocked economy, the country remains highly vulnerable to economic destabilization through external shocks – prices, foreign demand, interest rates and capital flows. In addition, the current high inflation and the need for fiscal consolidation whilst safeguarding essential social spending pose

 

44  

risks to economic stability. Banking sector risks have diminished, but bank supervision needs to be vigilant and the financial sector reforms are urgent. Although donors have pledged sufficient support through the JEA and other channels, failure to deliver on external financing, particularly budget support, is a risk – the consequences of which would be destabilizing for the economy.

149. External risks. The external risks stem from border closures with Uzbekistan. The border with Uzbekistan continues to be closed or is open on occasions but with severe limitations. Such border closures have a severely disruptive effect on production and trade as well as local small-scale border trade, and lead to impoverishment of border communities. Keeping open the channels for trade flows as well as ensuring a smooth, uninterrupted operation of the common electricity grid with Kazakhstan and Uzbekistan that links these three countries are important contributors to stabilization. Progress with the difficult agenda on regional cooperation on energy and water sharing is essential in the interests of common prosperity.

150. Risks related to institutional capacity and governance. Severe shortcomings in capacity at all governmental levels, partly the result of political changes and rapid staff turnover, bedevil prospects for efficient program implementation. As noted, governance weaknesses and potential corruption also constitute dangers to the proper use of public funds. In the event of delays and difficulties in forming an effective coalition government following elections in late 2011, governance problems could well multiply during the power vacuum. The buildup of human capital and knowledge in the public services is a major focus of donor assistance in central government, the line ministries and the financial sector with large trust funds being used for public financial management, governance, central bank supervision and surveillance of the financial industry, standards in mining and health. Governance will be the major focus of the development policy series.

Mitigating Risks

151. Clearly, not all risks of the complexity and gravity that are faced by the Kyrgyz Republic are amenable to mitigation through an operation such as the ERSO. Nevertheless, the ERSO, together with the interventions of other development partners, can make an important contribution. Macroeconomic risks could be mitigated through a combination of fiscal prudence and adherence to the medium term fiscal consolidation plan without any slippage as well as sufficient external financing of the budget and of the recovery program over the medium term. The authorities have identified clear priorities in public spending and have successfully protected the essential. The authorities have shown flexibility in responding to the social tensions in the south by combining dialogue with law enforcement measures, but clearly they have been stretched to their capacity and beyond. The neighbors can play a significant confidence-building role by announcing their determination to open borders or to keep them open and to ensure reliable transmission of electricity.

152. A comprehensive and well integrated approach to promoting reconciliation, recovery and reconstruction is important to mitigating the potentially dangerous social risks prevalent today. A social reconciliation program is being developed and needs to be implemented with vigor. The implementation of measures over a period of years will have to be handled with sensitivity and skill.

 

45  

Annex 1: Letter of Development Policy

 

46  

 

47  

 

48  

 

49  

 

50  

 

51  

 

52  

 

53  

 

54  

 

55  

 

56  

Annex 2: Proposed Matrix of Policy Actions24 and Expected Outcomes

OBJECTIVES

. ERSO POLICY ACTIONS

EXPECTED OUTCOMES MEDIUM-TERM POLICIES AND

OUTCOMES (Beyond ERSO) INDICATORS BASELINE25 TARGET

Theme 1: Strengthened governance in management of public assets and revenues Assert budget control and transparency over management of public assets and revenues.

The Development Fund that was designed to hold and allocate incoming external finance to investment projects outside the budgetary process has been placed under liquidation pursuant to Interim Government Ordinance Number 31, dated April 30, 2010, and the audit of said Development Fund by an external auditor appointed by the Recipient has commenced.

The following Resolutions of the Recipient have been passed to establish improved asset management norms and practices for the Ministry of State Property: (i) Resolution Number 178 of the Government of the Kyrgyz Republic, dated August 27, 2010; (ii) Resolution Number 309 of the Government of the Kyrgyz Republic, dated December 8, 2010;, and (iii) Resolution Number 104 of the Government of the Kyrgyz Republic, dated March 14, 2011.

The Recipient has achieved compliance with the Extractive Industries Transparency Initiative’s

Comprehensive information available to fully assess fiscal stance over the medium term (PEFA indicator PI-7.)

Transparent rules-based privatization process.

Continued publication of EITI report to inform the public at large.

MoF exercises no budgetary control over capital spending.

Privatizations process lacks transparency.

25 extractive companies provide EITI reports that are subject to an

2011 budget submitted to parliament on a fully consolidated basis (current and capital).

Privatizations implemented in line with best practice.

46 extractive companies provide EITI reports that are subject to an

MoF total control over all capital spending maintained. No fund operational outside the budget.

Private sector participation in production and utilities sectors enhanced

Dissemination of EITI to regions as a motivating factor for transparency for extractive

                                                            24 ERSO policy actions comprising of actions taken between April 2010 and end-May 2011 constitute the prior actions for the operation. 25 Refers to pre-April 2010 period.

 

57  

OBJECTIVES

. ERSO POLICY ACTIONS

EXPECTED OUTCOMES MEDIUM-TERM POLICIES AND

OUTCOMES (Beyond ERSO) INDICATORS BASELINE25 TARGET

(EITI) global standards for improved transparency in the oil, gas and mining sectors as evidenced by the declaration made by EITI at the March 2011 Global EITI Conference..

independent reconciliation.

independent reconciliation.

companies whose reports are subject to an independent reconciliation.

Establish proper transparency and accounting practices in energy sector operations.

The Kyrgyz Republic has adopted the Energy Sector Transparency Initiative (ESTI) pursuant to Presidential Decree Number 49, dated July 20, 2010, and the following measures have been carried out: (a) the Supervisory Council (SC) of the Ministry of Energy, comprising representatives of the Government of the Kyrgyz Republic, power companies and civil society, has been established to supervise ESTI implementation; (b) the SC has adopted internal regulations for its governance; and (c) a transparent and rules-based mechanism for managing and monitoring financial flows, particularly, electricity export proceeds in the escrow account, has been established. Performance Agreements that include indicators pertaining to losses and the collection of revenue in the energy sector have been signed and are in effect between the Energy Regulatory Authority and the energy companies.

Degree of transparent participatory process in strategic decision making in the energy sector. Escrow accounts at the Power Plants and the Kyrgyz National Electricity Grid companies are established. Tools to monitor sector performance and improve performance accountability.

Decisions in the energy sector are made in non-transparent and non-inclusive manner. There is no existing mechanism of public involvement. Power export proceeds are not used transparently and no rules exist on managing these proceeds. No regulatory/ accountability tool is currently in use by the regulator.

All the strategic decisions in the sector incorporate public feedback through the Supervisory Council and in other forms. The level of stakeholders’ confidence in transparent management and reporting of the sector increases. Power export proceeds are accounted for and used transparently and escrow accounts balances and use of funds is reported on quarterly basis. Regulatory/accountability tools to monitor the sector performance are designed and followed.

Improve the sector reporting arrangements through: (a) regulations on reporting and audit obligations of sector entities and (b) reporting and publication of performance indicators and audit reports. Ensure public access to companies’ performance reports and plans for new investment projects. Ensure transparent use of funds from power export and timely payments for fuel supply or other approved usage. Develop sustainable power export and revenue usage plan. Develop an implementation strategy to improve the operational performance of energy companies including measures, such as (i) the metering and data acquisition plan.

 

58  

OBJECTIVES

. ERSO POLICY ACTIONS

EXPECTED OUTCOMES MEDIUM-TERM POLICIES AND

OUTCOMES (Beyond ERSO) INDICATORS BASELINE25 TARGET

Losses (percentage of kWh generated). Collection rate per kWh delivered to the internal market. Transparent revenue sharing mechanism.

29.3% (end-2009). KGS. 0.81 (end-2009). No regulation in place on revenue sharing mechanism among generation, transmission, and distribution sub-sectors.

26% (end-2011). KGS.94 (end-2011). Revenue sharing regulation developed and adopted with clear and transparent criteria.

(ii) steps to ensure commercial discipline for the non-paying/ defaulting consumers. (iii) further develop PAs with improved incentives and disincentives system. Develop transparent, rules-based principles of revenue sharing between generation, transmission, and distribution sub-sectors and approval through government Resolution.

Maintaining financial sector stability.

The National Bank of the Kyrgyz Republic (NBKR), as the banking supervisory authority, has restructured the financially distressed OJSC AsiaUniversalBank (AUB) into a new entity, the Zalkar Bank, and has introduced direct supervision and temporary administration procedures for the rehabilitation of financially distressed banks. NBKR has issued Directive Number 30, dated May 26, 2011, for improving supervisory response mechanisms to identify shortcomings in, and initiate prompt preventive and corrective action to, financially distressed banks in the Kyrgyz Republic.

AUB resolution. Banks’ adherence to prudential norms, including capital, and NBKR’s supervisory response (timeliness and appropriateness).

Major bank moved rapidly into insolvency following the events of April 2010, including rapid deposit withdrawals and asset deterioration. Other banks also lost deposits and had deteriorating assets. Several banks fragile, failing to meet norms, and NBKR supervisory response mechanism lacks key good practice to ensure timely and adequate response to

Major bank nationalized and restructured through a “good bank, bad bank” split. Other banks put under conservatorship, temporary administration, or direct supervision. Stability and confidence in the banking sector partly restored. NBKR equipped to supervise the banking sector, address vulnerabilities in a timely manner, and resolve troubled banks efficiently.

AUB liquidated, and Zalkar Bank audited and ultimately privatized to a strong institutional investor. Continued policy and institutional reforms to strengthen frameworks for bank resolution and supervisory response mechanism, regulation, supervision, stress testing and contingency planning.

 

59  

OBJECTIVES

. ERSO POLICY ACTIONS

EXPECTED OUTCOMES MEDIUM-TERM POLICIES AND

OUTCOMES (Beyond ERSO) INDICATORS BASELINE25 TARGET

The Deposit Protection Agency has been reconstituted as an independent legal entity by Government Resolution Number 269, dated May 31, 2011.

Capacity of DPA to conduct a payout in case of a bank liquidation

fragility in banks (e.g., early warning system, triggered responses). Independent DPA legal status unclear (independent by law, under MoF by decree), blocking necessary legal and institutional reforms.

DPA’s legal status will be clear, paving the way for needed reforms to strengthen the deposit protection system.

Strengthen the deposit protection system by (a) introducing an effective mechanism for exchange of information on troubled banks between the DPA and NBKR; (b) developing efficient payout procedures; and (c) improving the current reporting system for banks and ensuring reporting accuracy on an ongoing basis.

Theme II: Safeguarding Social Protection and Supporting Conflict-Affected population Safeguarding essential social protection spending.

In its respective national budgets for 2010 and 2011, the Recipient has increased the Guaranteed Minimum Income (GMI) by ten percent (10%) during the mid-2010 to mid-2011 period, and by 19 percent (19%) from mid 2011 onwards, in order to maintain the value of Monthly Benefits for the Low Income Families with Children in real terms. Pursuant to Presidential Decree Number 795, dated December 22, 2009, On Providing Monetary Compensation to Selected Categories of Citizens in

Average monthly benefit for poor families with children per beneficiary household. Number of rights-based categories of benefits.

Monthly benefit of less than 100 som based on GMI of 240 som per capita per month (as of January 2010). 39 right-based ‘privileged’ categories of the population.

Monthly benefit of 200 som based on GMI of 370 som per capita per month (as of July 1, 2011). 25 rights-based categories of benefit recipients remaining.

A comprehensive reform of social safety net to be designed and implemented. The reform shall be based on core pillars: (1) sharper targeting of social assistance benefits, (2) building a coherent family and child protection policy, (3) development of inclusive, flexible and needs-based social care services. No introduction of any new categorical (rights-based) benefits.

 

60  

OBJECTIVES

. ERSO POLICY ACTIONS

EXPECTED OUTCOMES MEDIUM-TERM POLICIES AND

OUTCOMES (Beyond ERSO) INDICATORS BASELINE25 TARGET

Re-establish livelihoods and provide social compensation in the south.

Connection with Changing Energy Prices, in-kind social benefits that would have been provided to beneficiaries have been monetized as direct cash payments to be made to beneficiaries, with the number of rights-based categories of said beneficiaries reduced from thirty-nine (39) to twenty-five (25). Pursuant to the Interim Government Decree Number 124, dated August 24, 2010, additional monthly social benefits for families affected by the national crisis of 2010 have been introduced.

Payment of social allowances to help conflict-affected families.

No social allowances paid to conflict affected families.

Conflict-affected families granted benefits to cope with the consequences of the conflict.

Delink social support to affected families from the GMI, and fix it at the current monetary level to prevent rights-based benefits rising relative to means-tested benefits targeted to the poor. Introduce local economic development schemes, active labor market programs, self-employment assistance.

  

61  

Annex 3: Note on Fund Relations

 

Public Information Notice (PIN) No. 11/80 FOR IMMEDIATE RELEASE June 23, 2011 IMF Executive Board Concludes 2011 Article IV Consultation with Kyrgyz

Republic

On June 20, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Kyrgyz Republic.26

Background

The Kyrgyz Republic is recovering from a deep political crisis last year. In April 2010, a popular uprising toppled the previous regime and internal ethnic conflict in June 2010 exacerbated the already difficult political situation. The subsequent constitutional referendum and parliamentary elections in October 2010 have helped to stabilize the political situation and put the economy on a path of recovery, though the political situation remains fragile with presidential elections scheduled for later this year.

The fallout from the domestic crisis has posed significant challenges. Border closures, especially with Kazakhstan, hampered Kyrgyz companies and households involved in trade. The security situation led to the lowest tourist arrivals in almost a decade. Interruptions in the spring farming season and problems in harvesting and marketing have led to losses in agricultural production. Rising global food and fuel prices have posed additional challenges. The banking sector also suffered from diminished depositor confidence and the economic effects from events in the south. Subsequently, the economy contracted by 1.4 percent and inflation rose to nearly 20 percent in 2010. To counter rising inflation, monetary policy was tightened toward the end of 2010. Early signs of recovery have started to appear this year, with the economy growing by 3.2 percent in the first four months of 2011.

On the back of political and macroeconomic stability, the Kyrgyz economy is expected to grow by 6 percent in the medium term with positive spillovers from its larger partners in the Region.

                                                            26 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

International Monetary Fund 700 19th Street, NW Washington, D. C. 20431 USA

  

62  

Agriculture, tourism, mining and textile production will be important drivers of growth. Strong export oriented growth and fiscal consolidation will help to reduce the current account deficit in the medium term. Official development assistance, while slowing, will remain an important source of financing the current account deficit and will help to maintain an adequate reserves level.

Executive Board Assessment

Executive Directors noted that the economy is recovering from a deep political crisis, which disrupted activity and negatively affected near-term growth prospects. Directors commended the authorities for their efforts to restore macroeconomic stability and acknowledged the timely and coordinated assistance by the international community, which helped prevent the economy from falling into a deeper recession. Directors noted that the recovery remains fragile and a steadfast implementation of prudent policies and structural reforms are crucial to improving growth prospects.

Directors acknowledged the importance of supporting the nascent recovery, but underscored that fiscal consolidation is needed to rebuild policy buffers, reduce vulnerabilities, and promote inclusive growth over the medium term. In this context, Directors welcomed the revenue and expenditure measures prepared by the authorities, and encouraged them to follow through with contingency plans, possibly based on reductions in low-priority spending, if risks to the fiscal position materialized.

Directors noted the risks and governance issues associated with extra-budgetary funds and underscored the importance of channeling all public finances through the budget. They welcomed the authorities’ decision to liquidate the Special Bank Refinancing Fund and their efforts to increase the transparency of public finances through improved reporting and monitoring of large state-owned enterprises. They also encouraged the authorities to strengthen the existing targeted social assistance system, with the support of key development partners.

Directors expressed concerns on continued high inflation, and welcomed the central bank’s timely tightening of monetary policy in response to growing inflationary pressures. Most Directors agreed with the need for further policy tightening if inflation fails to decline in the period ahead. Directors noted the staff assessment that the exchange rate is broadly in line with fundamentals and highlighted that exchange rate flexibility has served the Kyrgyz Republic well.

Directors noted that developments in the banking sector have exposed shortcomings in the bank resolution framework and the central bank’s de facto lack of supervisory independence. They encouraged the authorities to take decisive action to resolve problem banks and restore confidence in the financial system, and welcomed the selection of an external auditor for Zalkar Bank. Directors stressed the need to reform the legal framework for early intervention and resolution of problem banks, and highlighted the need for enhanced supervisory vigilance and increased capital buffers for the largest state-owned bank.

Directors endorsed the authorities’ structural reform agenda, emphasizing that steadfast implementation is critical to the success of the economic program. They welcomed plans to improve the business environment, which is key to supporting private sector-led growth, and stressed that energy sector reform would create an important driver for growth in the medium

  

63  

term. Directors also welcomed the ongoing efforts to increase transparency and efficiency of the largest energy companies, with assistance from key development partners.

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.

Kyrgyz Republic: Selected Economic Indicators, 2008–11 2008 2009 2010 2011

Act. Act. Prel. Proj.

Real GDP (growth in percent) 7.6 2.9 -1.4 6.0 Nongold real GDP (growth in percent) 5.4 3.4 -2.1 5.8 Consumer prices (12-month percent change, eop) 20.1 0.0 18.9 13.0 Consumer prices (12-month percent change, average) 24.5 6.8 7.8 20.0

General government finances (in percent of GDP) 1/ Total revenue and grants 29.9 32.1 31.7 34.6 Of which: Tax revenue 23.0 22.2 23.2 24.0 Total expenditure (including net lending) 29.2 36.1 38.1 42.3 Of which: Current expenditure 24.8 28.4 32.2 34.9 Capital expenditure 4.1 5.0 5.6 6.9 Overall fiscal balance 0.0 -3.5 -6.5 -7.6 Primary balance excluding grants -1.1 -7.8 -8.6 -10.6

Banking sector Reserve money (percent change, eop) 11.3 18.9 18.4 16.4 Broad money (percent change, eop) 12.6 20.9 21.1 15.7 Credit to private sector (percent change, eop) 26.4 -2.8 6.3 18.0 Credit to private sector (in percent of GDP) 14.2 12.9 13.0 13.0

External sector Current account balance (in percent of GDP) -8.1 0.7 -2.1 -8.7 Export growth (percent change) 35.4 -11.3 -6.2 23.9 Import growth (percent change) 47.5 -22.4 6.0 26.7 Gross International reserves (in millions of U.S. dollars) 1,222 1,584 1,716 1,862 Gross reserves (months of next year imports, eop) 4.0 4.9 4.2 4.1 External public debt outstanding (in percent of GDP) 41.2 52.8 57.3 51.0 Sources: Kyrgyz authorities and IMF staff estimates and projections. 1/ General government comprises State Government, Social Fund and Development Fund (starting from September 2009) finances. State government comprises central and local governments.

  

64  

Annex 4: Kyrgyz Republic – Joint Debt Sustainability Analysis under the Debt Sustainability Framework for Low Income Countries

Based on the joint IMF-World Bank Low-Income Country Debt Sustainability Framework, the Kyrgyz Republic is assessed to remain at a moderate risk of debt distress.27. Stress tests suggest that the country is still vulnerable, particularly to a combination of exogenous shocks. Further improvement of the debt outlook will depend on maintaining sound macroeconomic policies, including fiscal consolidation and prudent borrowing, as well as ensuring continued concessional financing to support the country’s large development needs.

I. BACKGROUND

The Kyrgyz Republic’s nominal stock of public and publicly guaranteed (PPG) external debt declined from about 100 percent of GDP in 2003 to 41 percent in 2008. This decline was mainly the result of acceleration in the pace of economic growth and a nominal appreciation of the domestic currency, but also reflected firm fiscal discipline and Paris Club support.

The Kyrgyz Republic had two debt restructuring agreements with the Paris Club. The first was in December 2002 under Houston terms and provided for flow rescheduling in three phases. The second was in March 2005, under the Evian approach. The Kyrgyz authorities indicated in early 2007 that they did not wish to avail themselves of the HIPC initiative, but subsequently expressed interest in the MDRI.

Since end-2008, the nominal stock of PPG external debt has increased, reaching 57 percent of GDP at end-2010. The increase in this ratio largely reflects the decline in nominal (dollar) GDP in 2009 and 2010 as a result of the international financial crisis and domestic political instability which negatively impact real growth, but also reflects an uptick in external borrowing to finance infrastructure development and crisis-related fiscal deficits. The present value (PV) of PPG external debt was equivalent to $1.5 billion (34 percent of GDP) at end-2010, of which 66 percent is owed to international financial institutions (IFIs), and the remaining 34 percent to bilateral creditors. At end-2010, indebtedness indicators were estimated to be below the applicable HIPC Initiative thresholds, while income levels were estimated to be above the IMF MDRI thresholds.

II. UNDERLYING DSA ASSUMPTIONS

The macroeconomic assumptions reflect the framework underlying the ECF-supported program and World Bank and IMF staff projections through 2031. They have been updated to incorporate recent developments and changes to the medium-term outlook, but long-term assumptions are broadly similar to the framework used in the last DSA. The data on the stock of external debt at end-2010 and debt payment schedule were provided by the Kyrgyz authorities, except for the data on the World Bank and Asian Development Bank debt, which were provided directly by the two institutions.

                                                            27 This DSA has been produced jointly by Fund and Bank staffs, in consultation with Asian Development Bank and the Kyrgyz authorities. The fiscal year for the Kyrgyz Republic is January 1–December 31. The risk rating would not change with the inclusion of remittances (Figure 2).

  

65  

The framework assumes implementation of sound macroeconomic policies—including fiscal consolidation and prudent public debt management—as a basis for sustaining growth. Near- and medium-term growth would be underpinned by recovery from the shocks of 2009 and 2010, including a rebound in agricultural production and tourism, and would be supported by infrastructure investments and strong mining production. Long-term growth will be generated by firm implementation of structural reforms to remove impediments to private investment, stimulate economic diversification, and improve the business climate, including increased financial stability and deepened financial intermediation. The energy sector, which has large potential, is also envisioned to add positively to growth in the long run. The framework features average medium-term GDP growth of around 6 percent per year and average long-term growth over 2017–31 of about 5 percent, as in the previous DSA.

The main updates relative to the last DSA reflect new information regarding the authorities’ infrastructure development plans and debt relief. Specifically, energy-related investments have been delayed, partly because of the domestic political unrest in 2010. The Kyrgyz government is still in discussions with the Chinese authorities to finance and assist in the construction of substations and transmission lines linking to the south.28 The latest information indicates total investments in this area to be about $450 million (compared to $550 million in the previous DSA), including $208 million likely to be disbursed over the next two to three years. These investments would be financed with loans from China and are expected to contain a grant element slightly less than 35 percent, but not less than 30 percent. This borrowing would be accommodated in the ECF-supported program under a tied, nonzero, nonconcessional debt limit in the equivalent amount. In April 2011, the authorities reached an agreement with Turkey for a debt write-off in the amount of about $49.5 million, which is likely to be effected in 2011.

Planned energy sector investments will ensure smooth supply of electricity within the country and contribute to economic growth. During the construction period (2012–16), the energy infrastructure projects are estimated to contribute around a quarter of a percentage point to GDP growth annually.29 The electricity transmission lines, when built, will reduce system overloading and increase the self-sufficiency of supply. The impact on exports and long-term growth from the energy projects would be more significant if new large electricity generation facilities are built.30

The authorities have also explored the possibility of investing in transportation infrastructure around a main tourist destination (Lake Issyk-Kul). Borrowings in this area could total approximately $600 million and be financed on terms similar to those of the energy infrastructure projects. Given the uncertain growth effects and the possibility of a significantly worse debt outlook

                                                            28 These energy infrastructure projects will expand the potential for exporting electricity, improve reliability of the transmission system and ensure smooth supply of electricity to remote parts of the country. Neighboring Uzbekistan has been threatening repeatedly to withdraw from the regional power grid that would leave the southern part of the Kyrgyz Republic without electricity, given that the only way to supply electricity to the south is through the Uzbek electricity grid. 29 The contribution to economic growth will come from increased domestic spending, which is not likely to be significant, as only around 10 percent of the disbursed financing from China will be spent domestically (the rest will be used to purchase imported equipment and labor). 30 Kambarata-II (hydropower) was put in operation in 2010, but does not generate substantial volumes of electricity. Its contributions to exports and growth are therefore limited. Kambarata-I is a much larger project, but remains highly uncertain and therefore excluded from this DSA, as from previous DSAs.  

  

66  

(Text Figure 1), the authorities have decided not to pursue this investment further at this stage. Consequently, this borrowing is not included in the baseline DSA projections.

Note: Issyk-kul road disbursements are assumed totake place over three years starting in 2012.

0

10

20

30

40

50

60

2011 2016 2021 2026 2031

Text Figure 1. Kyrgyz Republic: Issyk-kul Road Scenario

Issyk-kul road borrowing would breach PV of debt-to-GDP threshold

Baseline

Box 1. Kyrgyz Republic: Baseline Macroeconomic Assumptions

Real GDP growth is projected to average about 6 percent over the medium term, underpinned by economic recovery from the shocks of 2009 and 2010, including a rebound in agricultural production and tourism and in line with strong recent growth in the main trading partners. Growth in the medium term would also be supported by infrastructure investments and strong mining production. Long-term growth would be generated by firm implementation of structural reforms to remove impediments to private investment, stimulate economic diversification, and improve the business climate, and is broadly in line with the historical average and with assumptions in the previous DSA.

After two successive years of contraction, exports would rebound somewhat in 2011, in line with developments in the mining and tourism sectors, and reflecting strong growth in the main trading partners. In the medium term, export growth will decelerate as the Kyrgyz Republic joins the Russia-Kazakhstan-Belarus customs union and transit trade declines. Import growth in 2011 would be strong, consistent with growth projections and reflecting the high price of crude oil. In the medium term, import growth will also decelerate with the loss of transit trade, but the high import content of energy infrastructure projects will keep dampen the deceleration somewhat. In the long-term, import growth would be in line with assumptions in the previous DSA, averaging around 6½ percent. As a result of these trends, the current account deficit would increase in 2011, but gradually improve, averaging about 5 percent of GDP in the long term.

With the exception of the energy infrastructure borrowing from China, medium-term public borrowing is assumed to be on highly concessional terms. Over the longer DSA horizon, concessionality of new external public borrowing would gradually decline from around 38 percent in 2011 to around 20 percent by 2031, as more borrowing is assumed to be contracted at less concessional terms from bilateral and commercial creditors.

In line with the programmed fiscal consolidation, government revenues are projected to increase from about 30 percent of GDP in 2011 to about 32 percent by 2016 and remain broadly stable at that level through 2031. After a wage-related increase in 2011, noninterest current expenditure would increase temporarily to about 33 percent of GDP before declining to about 30 percent of GDP by 2016. As a result, the primary fiscal deficit would deteriorate to 6.4 percent of GDP in 2011, but gradually improve to 2.4 percent of GDP by 2016. Fiscal consolidation and appropriately tight monetary policy will also help to maintain (GDP deflator) inflation at an average of around 7 percent over the medium term.

2011 2012 2013 2014 2015 2016

2010 DSA Proj. Actual 2010 DSA Proj. 2011 DSA Proj.

Real GDP growth (in percent) ‐3.5 ‐1.4 6.0 6.0 6.0 5.8 5.8 5.7 5.0 5.1

Growth of exports of G&S (US dollar terms, in percent) 1.9 ‐6.2 23.9 8.7 8.1 14.6 12.5 12.1 6.1 6.3

Growth of imports of G&S (US dollar terms, in percent) 12.2 6.0 26.9 9.0 6.7 10.9 10.3 10.0 5.7 6.7

Primary deficit (percent of GDP) 10.9 5.5 6.4 6.2 6.0 5.9 3.3 2.4 ‐1.1 2.2

GDP deflator in US dollar terms (change in percent) 0.7 ‐0.1 6.0 3.6 2.5 3.4 2.3 1.7 1.9 2.0

Source: Country authorities and staff projections.

2010 Long‐term average

2011 DSA Proj.

Text Table 1. Underlying DSA Assumptions

  

67  

III. EXTERNAL DEBT SUSTAINABILITY ANALYSIS

A. Baseline

The baseline scenario points to a cautiously favorable improvement in the external debt outlook over time. At end-2010, the PV of debt-to-exports and the PV of debt-to-revenue ratios, at 62 and 119 percent respectively, were well below their policy-based indicative thresholds.31 Only the PV of PPG debt-to-GDP ratio, at 34 percent in 2010, is close to its relevant threshold of 40 percent. This latter ratio then remains broadly stable through the medium term as energy-related disbursements offset growth gains, before returning to a sustainable path underpinned by solid growth, fiscal consolidation, and prudent debt management.

Debt service is expected to remain manageable throughout the DSA horizon. This reflects the high concessionality of both the outstanding multilateral debt and the assumed new borrowing over the medium term. The PPG debt service ratio would decline slightly from 3.6 percent of exports in 2010 to 2.9 percent in 2011 following debt relief from Russia and Turkey, and remain broadly at that level through the medium and long term.32

B. Alternative Scenarios and Stress Tests Stress tests and alternative scenarios show that the Kyrgyz Republic’s external debt is vulnerable to large shocks or substantially less favorable assumptions. The PV of the external debt-to-GDP ratio and the PV of the external debt-to-revenue rise above the relevant indicative thresholds under some tests. The PV of debt-to-GDP ratio rises above the indicative threshold of 40 percent in the medium term (or even over the longer term) when (i) export value growth is at historical average minus one standard deviation in 2012−13; (ii) the net non-debt creating inflows over 2012−13 are one standard deviation below their historical average; and (iii) under a shock over 2012−13 combining lower GDP and export growth, a decline in the US dollar GDP deflator, and lower net non-debt creating inflows. The ratio of PV of debt-to-revenue would also approach the relevant indicative threshold of 250 percent in the medium term under the last two conditions. However, the PV of debt-to-exports ratio is robust and does not breach its threshold under various tests. Debt service ratios also prove resilient, staying below their indicative threshold levels under various tests. The historical scenario—where key macro variables evolve according to their historic averages—points to a more benign external debt outlook than the baseline scenario. However, an alternative scenario that assumes no fiscal consolidation in the medium term, financed by external borrowing, results in an unsustainable debt outlook, with the PV of debt-to-GDP following an upward trend (Text Figure 2).

                                                            31 The Kyrgyz Republic is rated as a medium performer based on the World Bank’s Country Performance and Institutional Assessment Index for low income countries. The relevant policy-dependent thresholds for countries in this category are 40 percent for the PV of the debt-to-GDP ratio, 150 percent for the PV of debt-to-exports ratio, 250 percent for the PV of debt-to-revenue ratio, 20 percent of the debt service-to-exports ratio, and 30 percent of the debt service-to-revenue ratio. 32 Under the debt-for-equity swap agreement signed between the previous Kyrgyz administration and the Russian authorities in 2009, the Russian side agreed to relinquish claims on the Kyrgyz Republic in the amount of US$193.5 million in exchange for a 100 percent stake in two state-owned companies in the Kyrgyz Republic. However, in early 2010, despite the Kyrgyz Republic appearing to have fulfilled all its obligations, the Russian side called in question the implementation of the agreement and declared the outstanding debt disputed. Since then the parties have been in close consultations to resolve this issue and a settlement is expected in 2011, as also assumed in the previous DSA.

  

68  

0

5

10

15

20

25

30

35

40

45

2011 2016 2021 2026 2031

Text Figure 2. PV of Debt to GDP with No Fiscal Consolidation

BaselineMedium‐term fiscal deficit unchanged from 2011

IV. PUBLIC DEBT SUSTAINABILITY ANALYSIS

A. Baseline

Domestic debt is projected to increase and will play a more important role in financing the budget deficit in the medium and long term. Domestic debt accounted for around 3 percent of total public debt at end-2010. However, by 2031, domestic debt is projected to reach about 9 percent of total public debt as domestic financial markets deepen.

The Kyrgyz Republic’s public debt outlook is projected to be manageable in the medium and long term. Under the baseline scenario, the PV of public debt to GDP ratio would increase slightly in the medium term from about 38 percent of GDP at end-2010 to a maximum of about 42 percent of GDP in 2016 following disbursements for energy-sector infrastructure. It would then decline gradually to about 37 percent by 2031 reflecting fiscal consolidation.

B. Alternative Scenarios and Stress Tests

Alternative scenarios and stress tests show that Kyrgyz Republic’s public debt remains highly sensitive to shocks that reduce real GDP growth and result in unsustainable debt burden trajectories. The standard sensitivity analysis based on the historical variation of key parameters, including real GDP growth and exchange rate, shows that debt ratios would rise considerably in the long run. Under stress tests and scenarios, the PV debt-to-GDP ratio in 2031 could increase to about 80 percent under the permanent real GDP growth shock scenario and the fixed (at 2011 level) primary deficit scenario. In addition, debt burden trajectories are ever increasing if the long run growth rate turns out 0.8 percentage points below the current estimate.

V. DEBT DISTRESS CLASSIFICATION AND CONCLUSIONS

Based on the projected external debt burden indicators, the Kyrgyz Republic is assessed to be at moderate risk of debt distress. All PV-based external debt indicators in the baseline are projected to stay below their indicative thresholds over the DSA horizon. Moreover, the debt service burden would remain well below the thresholds, reflecting the high concessionality of the external debt. Nevertheless, alternative scenarios and stress tests show that the external public debt indicators could approach or breach the thresholds if the Kyrgyz Republic were to experience large adverse exogenous shocks or relax its prudent debt management policy. This conclusion is consistent with the last DSA. When adding domestic debt to the analysis, total public sector debt seems manageable in light of the dynamics of the domestic debt stock. This said, debt burden trajectories are highly sensitive to real GDP shocks and a somewhat smaller long run real growth rate.

  

69  

Low-concessionality loans from bilateral and commercial creditors to finance large public investment projects continue to pose a risk to the debt outlook. Staff recognizes that the Kyrgyz Republic has large developmental needs, but considers paramount to lock in the recent progress towards achieving and maintaining debt sustainability. Even if loans have a grant element of at least 35 percent, it would be important to ensure that the underlying projects are viable and that market risks, including exchange rate risk, are accounted for, so as to avoid the buildup of an unsustainable debt burden. Similarly, it would remain important for the government to seek highly concessional loans, including in the energy sector.

The authorities broadly concurred with this analysis. They are highly concerned about maintaining debt sustainability and will remain vigilant on the debt outlook. Indeed, given the uncertain growth benefits and negative debt impact of the potential Issyk-kul road borrowing, the authorities do not plan to pursue that project further at this point. Looking forward, the authorities intend to make every effort to contract only concessional loans.

  

70  

Sources: Country authorities; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a Non-debt flows shock; in c. to a Non-debt flows shock; in d. to a Non-debt flows shock; in e. to a Non-debt flows shock and in figure f. to a Non-debt flows shock

Figure 1. Kyrgyz Republic: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios, 2011-2031 1/

-5

0

5

10

15

20

25

30

35

2011 2016 2021 2026 2031

Baseline Historical scenario Most extreme shock 1/ Threshold

f.Debt service-to-revenue ratio

0

5

10

15

20

25

30

35

40

45

0

1

2

3

4

5

6

7

2011 2016 2021 2026 2031Rate of Debt Accumulation

Grant-equivalent financing (% of GDP)

Grant element of new borrowing (% right scale)

a . Debt Accumulation

-40

-20

0

20

40

60

80

2011 2016 2021 2026 2031

b.PV of debt-to GDP ratio

100

-50

0

50

100

150

200

2011 2016 2021 2026 2031

c.PV of debt-to-exports ratio

-150

-100

-50

0

50

100

150

200

250

300

2011 2016 2021 2026 2031

d.PV of debt-to-revenue ratio

-5

0

5

10

15

20

25

2011 2016 2021 2026 2031

e.Debt service-to-exports ratio

 

  

71  

Sources: Country authorities; and staff estimates and projections.

Figure 2. Kyrgyz Republic: Indicators of Public and Publicly Guaranteed External Debt under Alternatives Scenarios Including Remittances, 2011-2031

1/ The most extreme stress test is the test that yields the highest ratio in 2021. In figure b. it corresponds to a Non-debt flows shock; in c. to a Non-debt flows shock; in d. to a Non-debt flows shock; in e. to a Non-debt flows shock and in figure f. to a Non-debt flows shock

-5

0

5

10

15

20

25

30

35

2011 2016 2021 2026 2031

Baseline Historical scenario Most extreme shock 1/ Threshold

f.Debt service-to-revenue ratio

0

5

10

15

20

25

30

35

40

45

0

1

2

3

4

5

6

7

2011 2016 2021 2026 2031Rate of Debt Accumulation

Grant-equivalent financing (% of GDP)

Grant element of new borrowing (% right scale)

a . Debt Accumulation

-40

-20

0

20

40

60

80

2011 2016 2021 2026 2031

b.PV of debt-to-GDP+remittances ratio

-100

-50

0

50

100

150

2011 2016 2021 2026 2031

c.PV of debt-to-exports+remittances ratio

-150

-100

-50

0

50

100

150

200

250

300

2011 2016 2021 2026 2031

d.PV of debt-to-revenue ratio

-5

0

5

10

15

20

2011 2016 2021 2026 2031

e.Debt service-to-exports+remittances ratio

 

  

72  

Sources: Country authorit ies; and staff estimates and projections.

1/ The most extreme stress test is the test that yields the highest ratio in 2021. 2/ Revenues are defined inclusive of grants.

Figure 3. Kyrgyz Republic: Indicators of Public Debt Under Alternative Scenarios, 2011-2031 1/

0

50

100

150

200

250

300

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031

PV of Debt-to-Revenue Ratio 2/

0

10

20

30

40

50

60

70

80

90

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031

Baseline Fix Primary Balance Most extreme shock Growth Historical scenario

PV of Debt-to-GDP Ratio

0

5

10

15

20

25

2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031

Debt Service-to-Revenue Ratio 2/

  

73  

Estimate

2008 2009 2010Average 5/

Standard Deviation 2011 2012 2013 2014 2015 2016

2011-16 Average 2021 2031

2017-31 Average

Public sector debt 1/ 45.1 56.6 61.2 55.4 55.5 56.9 57.6 57.3 57.1 51.4 45.9o/w foreign-currency denominated 42.2 53.8 58.2 52.0 51.2 51.3 50.8 50.0 49.5 43.2 37.3

Change in public sector debt -14.6 11.5 4.6 -5.8 0.2 1.4 0.7 -0.2 -0.3 -0.8 -0.2Identified debt-creating flows -9.9 5.4 6.0 -1.4 0.2 1.2 0.6 -0.6 -1.0 -0.5 -0.2

Primary deficit -1.4 3.0 5.5 2.3 1.9 6.3 6.2 6.0 5.7 3.1 2.4 4.9 2.2 2.1 2.2

Revenue and grants 29.9 32.1 31.7 34.5 32.5 31.7 31.4 33.7 33.9 34.0 33.9of which: grants 1.8 5.1 2.9 4.3 2.1 1.1 0.7 1.3 1.2 1.0 0.7

Primary (noninterest) expenditure 28.5 35.1 37.2 40.8 38.6 37.7 37.1 36.8 36.3 36.3 36.0Automatic debt dynamics -8.7 2.4 1.6 -6.1 -4.6 -3.7 -4.1 -3.7 -3.3 -2.7 -2.3

Contribution from interest rate/growth differential -5.1 -0.9 1.3 -3.3 -3.2 -3.4 -3.4 -3.5 -3.5 -2.7 -2.3of which: contribution from average real interest rate -0.9 0.4 0.5 0.2 -0.1 -0.2 -0.3 -0.4 -0.4 -0.3 -0.1of which: contribution from real GDP growth -4.2 -1.3 0.8 -3.5 -3.1 -3.2 -3.1 -3.2 -3.1 -2.4 -2.2

Contribution from real exchange rate depreciation -3.5 3.3 0.3 -2.8 -1.4 -0.2 -0.7 -0.1 0.1 ... ...Other identified debt-creating flows 0.1 0.0 -1.0 -1.6 -1.3 -1.1 -1.0 -0.1 -0.1 0.0 0.0

Privatization receipts (negative) 0.1 0.0 -1.0 -1.6 -1.3 -1.1 -1.0 -0.1 -0.1 0.0 0.0Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Residual, including asset changes -4.7 6.1 -1.4 -4.4 -0.1 0.1 0.1 0.4 0.7 -0.3 0.0

Other Sustainability Indicators

PV of public sector debt 32.5 37.6 38.1 38.0 38.4 40.1 41.4 41.9 42.1 39.1 36.8

o/w foreign-currency denominated 29.6 34.7 35.1 34.6 34.0 34.5 34.7 34.6 34.6 30.9 28.2

o/w external 28.5 33.7 34.2 33.8 33.4 33.9 34.1 34.1 34.1 30.6 28.0

PV of contingent liabilities (not included in public sector debt) ... ... ... ... ... ... ... ... ... ... ...

Gross financing need 2/ 1.4 6.6 9.1 10.7 10.5 10.8 12.0 8.5 8.1 8.2 7.0PV of public sector debt-to-revenue and grants ratio (in percent) 108.8 116.9 120.1 110.1 118.3 126.4 131.8 124.2 124.2 114.9 108.5PV of public sector debt-to-revenue ratio (in percent) 115.9 138.9 132.2 125.6 126.7 131.2 134.8 129.2 129.0 118.4 111.0

o/w external 3/ 101.8 124.7 118.6 111.7 110.0 110.8 111.0 105.2 104.4 92.8 84.6Debt service-to-revenue and grants ratio (in percent) 4/ 5.5 7.1 7.1 8.8 8.1 8.2 10.8 7.2 7.2 8.0 11.3

Debt service-to-revenue ratio (in percent) 4/ 5.9 8.5 7.8 10.0 8.7 8.5 11.0 7.4 7.4 8.3 11.5Primary deficit that stabilizes the debt-to-GDP ratio 13.2 -8.5 0.9 12.1 6.0 4.6 5.0 3.3 2.7 3.0 2.3

Key macroeconomic and fiscal assumptions

Real GDP growth (in percent) 7.6 2.9 -1.4 4.0 3.7 6.0 6.0 6.0 5.8 5.8 5.7 5.9 4.7 5.1 5.1

Average nominal interest rate on forex debt (in percent) 0.9 1.2 1.1 1.3 0.4 0.7 0.7 0.8 0.8 0.9 1.0 0.8 1.2 1.7 1.3

Average real interest rate on domestic debt (in percent) -7.8 10.4 5.5 0.1 5.5 5.0 9.6 7.4 3.8 1.7 1.5 4.9 0.1 0.1 0.1

Real exchange rate depreciation (in percent, + indicates depreciation) -6.9 8.1 0.6 -5.7 7.0 -5.1 ... ... ... ... ... ... ... ... ...Inflation rate (GDP deflator, in percent) 23.2 4.0 6.9 8.4 6.3 11.4 7.7 5.5 6.5 5.3 4.8 6.9 4.0 4.0 4.1

Growth of real primary spending (deflated by GDP deflator, in percent) 0.0 0.3 0.0 0.1 0.1 0.2 0.0 0.0 0.0 0.0 0.0 0.1 0.0 0.1 0.1

Grant element of new external borrowing (in percent) ... ... ... … … 38.5 37.5 36.4 32.9 33.9 34.2 35.6 32.3 19.7 ...

Sources: Country authorities; and staff estimates and projections.1/ [Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.]

2/ 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.

3/ Revenues excluding grants.

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

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

Table 1a.Kyrgyz Republic: Public Sector Debt Sustainability Framework, Baseline Scenario, 2008-2031(In percent of GDP, unless otherwise indicated)

Actual Projections

 

  

74  

Table 2a.Kyrgyz Republic: Sensitivity Analysis for Key Indicators of Public Debt 2011-2031

2011 2012 2013 2014 2015 2016 2021 2031

Baseline 38 38 40 41 42 42 39 37

A. Alternative scenarios

A1. Real GDP growth and primary balance are at historical averages 38 36 35 35 35 36 36 38A2. Primary balance is unchanged from 2011 38 39 41 42 45 49 60 79A3. Permanently lower GDP growth 1/ 38 39 41 44 45 47 53 80

B. Bound tests

B1. Real GDP growth is at historical average minus one standard deviations in 2012-2013 38 42 49 53 57 60 69 84B2. Primary balance is at historical average minus one standard deviations in 2012-2013 38 37 37 39 39 40 37 36B3. Combination of B1-B2 using one half standard deviation shocks 38 37 38 42 44 47 53 64B4. One-time 30 percent real depreciation in 2012 38 52 52 52 52 52 46 43B5. 10 percent of GDP increase in other debt-creating flows in 2012 38 47 48 49 49 49 44 40

Baseline 110 118 126 132 124 124 115 109

A. Alternative scenarios

A1. Real GDP growth and primary balance are at historical averages 110 111 112 110 105 107 104 111A2. Primary balance is unchanged from 2011 110 119 128 135 134 143 175 232A3. Permanently lower GDP growth 1/ 110 120 130 138 134 137 154 236

B. Bound tests

B1. Real GDP growth is at historical average minus one standard deviations in 2012-2013 110 129 155 169 167 175 201 246B2. Primary balance is at historical average minus one standard deviations in 2012-2013 110 114 117 123 116 117 109 105B3. Combination of B1-B2 using one half standard deviation shocks 110 115 120 133 131 137 155 189B4. One-time 30 percent real depreciation in 2012 110 160 165 167 154 152 136 127B5. 10 percent of GDP increase in other debt-creating flows in 2012 110 143 151 155 145 144 130 118

Baseline 9 8 8 11 7 7 8 11

A. Alternative scenarios

A1. Real GDP growth and primary balance are at historical averages 7 8 8 11 7 7 7 12A2. Primary balance is unchanged from 2011 7 8 8 11 7 8 10 19A3. Permanently lower GDP growth 1/ 7 8 8 11 8 8 10 19

B. Bound tests

B1. Real GDP growth is at historical average minus one standard deviations in 2012-2013 7 8 9 12 9 9 12 21B2. Primary balance is at historical average minus one standard deviations in 2012-2013 7 8 8 10 7 7 7 11B3. Combination of B1-B2 using one half standard deviation shocks 7 8 8 11 8 8 9 16B4. One-time 30 percent real depreciation in 2012 7 9 10 13 9 10 11 16B5. 10 percent of GDP increase in other debt-creating flows in 2012 7 8 9 12 8 8 9 12

Sources: Country authorities; and staff estimates and projections.1/ Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.2/ Revenues are defined inclusive of grants.

PV of Debt-to-GDP Ratio

Projections

PV of Debt-to-Revenue Ratio 2/

Debt Service-to-Revenue Ratio 2/

  

75  

Historical 0 StandardAverage 0 Deviation 2011-2016 2017-2031

2008 2009 2010 2011 2012 2013 2014 2015 2016 Average 2021 2031 Average

External debt (nominal) 1/ 45.1 58.2 68.3 61.3 58.8 58.3 57.7 57.0 56.3 51.5 55.0o/w public and publicly guaranteed (PPG) 41.2 52.8 57.3 51.2 50.5 50.7 50.2 49.6 49.0 42.9 37.1

Change in external debt -15.1 13.1 10.2 -7.0 -2.5 -0.5 -0.6 -0.7 -0.6 -0.4 1.1Identified net debt-creating flows -12.7 -0.4 -2.1 1.0 0.6 -1.3 -1.9 -2.5 -2.4 -0.2 3.0

Non-interest current account deficit 7.5 -1.6 1.3 -0.4 4.0 7.8 7.3 5.3 4.6 3.9 3.8 5.1 7.9 6.7Deficit in balance of goods and services 33.3 21.1 29.8 35.1 35.0 33.6 32.1 31.5 30.9 31.3 32.5

Exports 59.2 57.5 54.8 60.4 59.8 59.5 62.4 64.9 67.6 62.6 60.2Imports 92.5 78.6 84.6 95.5 94.8 93.2 94.5 96.3 98.5 94.0 92.7

Net current transfers (negative = inflow) -28.8 -25.8 -30.1 -19.1 9.8 -30.1 -31.3 -32.2 -34.2 -32.9 -32.7 -27.9 -26.4 -27.0o/w official -0.9 -4.2 -1.7 -0.2 0.0 0.0 0.0 0.0 0.0 -0.4 -0.2

Other current account flows (negative = net inflow) 2.9 3.1 1.7 2.8 3.5 3.9 6.7 5.3 5.6 1.6 1.7Net FDI (negative = inflow) -5.2 -4.0 -5.1 -3.6 2.4 -4.2 -4.2 -4.2 -4.2 -4.2 -4.0 -3.8 -3.2 -3.5Endogenous debt dynamics 2/ -15.0 5.3 1.6 -2.6 -2.4 -2.4 -2.3 -2.3 -2.2 -1.5 -1.6

Contribution from nominal interest rate 0.6 0.9 0.8 1.0 0.9 0.9 0.8 0.8 0.8 0.8 0.9Contribution from real GDP growth -3.4 -1.4 0.8 -3.6 -3.4 -3.3 -3.1 -3.1 -3.0 -2.3 -2.6Contribution from price and exchange rate changes -12.2 5.7 0.1 … … … … … … … …

Residual (3-4) 3/ -2.5 13.5 12.3 -8.0 -3.2 0.9 1.2 1.8 1.8 -0.2 -1.9o/w exceptional financing -0.1 0.0 0.0 -4.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0

PV of external debt 4/ ... ... 45.2 43.9 41.7 41.5 41.6 41.5 41.4 39.2 45.9In percent of exports ... ... 82.5 72.7 69.6 69.8 66.6 64.0 61.2 62.6 76.2

PV of PPG external debt ... ... 34.2 33.8 33.4 33.9 34.1 34.1 34.1 30.6 28.0In percent of exports ... ... 62.3 55.9 55.8 56.9 54.7 52.6 50.5 48.9 46.6In percent of government revenues ... ... 118.6 111.7 110.0 110.8 111.0 105.2 104.4 92.8 84.6

Debt service-to-exports ratio (in percent) 3.6 7.1 8.1 6.1 6.4 5.5 4.6 4.5 4.8 7.2 15.2PPG debt service-to-exports ratio (in percent) 2.5 3.2 3.6 2.9 2.5 2.4 2.3 2.2 2.3 3.2 3.8PPG debt service-to-revenue ratio (in percent) 5.2 6.7 6.9 5.7 5.0 4.7 4.8 4.4 4.8 6.1 6.9Total gross financing need (Billions of U.S. dollars) 0.2 -0.1 0.0 0.4 0.4 0.3 0.2 0.2 0.2 0.6 3.0Non-interest current account deficit that stabilizes debt ratio 22.6 -14.7 -8.8 14.9 9.8 5.7 5.3 4.7 4.4 5.4 6.8

Key macroeconomic assumptions

Real GDP growth (in percent) 7.6 2.9 -1.4 4.0 3.7 6.0 6.0 6.0 5.8 5.8 5.7 5.9 4.7 5.1 5.1GDP deflator in US dollar terms (change in percent) 25.4 -11.3 -0.1 9.2 10.6 6.0 3.6 2.5 3.4 2.3 1.7 3.2 2.0 2.0 2.0Effective interest rate (percent) 5/ 1.3 1.9 1.3 1.6 0.4 1.7 1.7 1.7 1.5 1.5 1.6 1.6 1.7 1.9 1.8Growth of exports of G&S (US dollar terms, in percent) 35.4 -11.3 -6.2 17.8 21.5 23.9 8.7 8.1 14.6 12.5 12.1 13.3 7.7 6.5 6.3Growth of imports of G&S (US dollar terms, in percent) 47.5 -22.4 6.0 22.2 25.7 26.9 9.0 6.7 10.9 10.3 10.0 12.3 7.0 7.6 6.7Grant element of new public sector borrowing (in percent) ... ... ... ... ... 38.5 37.5 36.4 32.9 33.9 34.2 35.6 32.3 19.7 28.9Government revenues (excluding grants, in percent of GDP) 28.0 27.1 28.8 30.2 30.3 30.6 30.7 32.4 32.7 33.0 33.1 32.8Aid flows (in Billions of US dollars) 7/ 0.1 0.6 0.3 0.4 0.3 0.3 0.2 0.2 0.3 0.3 0.4

o/w Grants 0.1 0.2 0.1 0.2 0.1 0.1 0.0 0.1 0.1 0.1 0.2o/w Concessional loans 0.0 0.4 0.1 0.2 0.2 0.2 0.2 0.1 0.2 0.2 0.3

Grant-equivalent financing (in percent of GDP) 8/ ... ... ... 6.6 4.0 3.1 2.3 2.7 2.6 2.1 1.5 1.9Grant-equivalent financing (in percent of external financing) 8/ ... ... ... 63.5 56.1 47.9 41.3 49.8 49.5 47.8 33.0 43.7

Memorandum items:Nominal GDP (Billions of US dollars) 5.1 4.7 4.6 5.2 5.7 6.2 6.8 7.3 7.9 11.2 22.1Nominal dollar GDP growth 34.8 -8.7 -1.4 12.4 9.8 8.6 9.4 8.2 7.5 9.3 6.8 7.1 7.1PV of PPG external debt (in Billions of US dollars) 1.5 1.7 1.9 2.1 2.3 2.5 2.6 3.4 6.1(PVt-PVt-1)/GDPt-1 (in percent) 3.7 3.1 3.4 3.4 2.8 2.5 3.2 1.6 1.9 1.7Gross remittances (Billions of US dollars) 1.4 1.0 1.3 1.5 1.8 2.0 2.3 2.4 2.6 3.1 5.8PV of PPG external debt (in percent of GDP + remittances) ... ... 26.6 26.0 25.4 25.6 25.4 25.7 25.7 24.0 22.2PV of PPG external debt (in percent of exports + remittances) ... ... 41.0 37.4 36.6 36.9 35.3 34.9 34.0 34.0 32.5Debt service of PPG external debt (in percent of exports + remittances) ... ... 2.4 1.9 1.7 1.6 1.5 1.4 1.6 2.2 2.6

Sources: Country authorities; and staff estimates and projections. 01/ Includes both public and private sector external debt.2/ Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms. 3/ 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.Also includes the effect of the financing gap, which is assumed to create debt, but does not enter the current or financial account.4/ Assumes that PV of private sector debt is equivalent to its face value.5/ Current-year interest payments divided by previous period debt stock. 6/ Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability. 7/ Defined as grants, concessional loans, and debt relief.8/ 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).

Actual

Table 3a.: External Debt Sustainability Framework, Baseline Scenario, 2008-2031 1/(In percent of GDP, unless otherwise indicated)

Projections

  

76  

2011 2012 2013 2014 2015 2016 2021 2031

Baseline 34 33 34 34 34 34 31 28

A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 34 27 22 19 16 13 -1 -33A2. New public sector loans on less favorable terms in 2011-2031 2 34 34 36 37 38 39 40 45

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 34 35 37 38 38 38 34 31B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 34 38 48 47 47 46 40 31B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 34 35 36 37 37 37 33 30B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 34 52 71 69 67 66 55 36B5. Combination of B1-B4 using one-half standard deviation shocks 34 50 69 67 66 64 54 37B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 34 46 47 47 47 47 43 39

Baseline 56 56 57 55 53 50 49 47

A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 56 44 38 31 25 20 -1 -55A2. New public sector loans on less favorable terms in 2011-2031 2 56 57 60 59 59 58 63 75

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 56 55 56 54 52 50 48 46B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 56 72 102 96 91 86 81 66B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 56 55 56 54 52 50 48 46B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 56 86 119 110 104 98 88 61B5. Combination of B1-B4 using one-half standard deviation shocks 56 82 111 104 98 92 84 60B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 56 55 56 54 52 50 48 46

Baseline 112 110 111 111 105 104 93 85

A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 112 88 74 63 50 41 -3 -100A2. New public sector loans on less favorable terms in 2011-2031 2 112 112 117 121 117 119 120 136

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 112 115 122 122 116 115 103 94B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 112 125 156 153 144 141 121 94B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 112 114 119 120 113 113 101 92B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 112 170 231 224 207 202 167 110B5. Combination of B1-B4 using one-half standard deviation shocks 112 164 224 218 202 197 165 112B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 112 153 154 154 146 145 129 118

PV of debt-to-exports ratio

PV of debt-to-revenue ratio

Table 3b.Kyrgyz Republic: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031(In percent)

PV of debt-to GDP ratio

Projections

 

  

77  

 

Baseline 3 3 2 2 2 2 3 4

A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 3 2 2 2 1 1 1 -1A2. New public sector loans on less favorable terms in 2011-2031 2 3 3 2 3 2 3 4 5

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 3 3 2 2 2 2 3 4B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 3 3 3 4 3 4 6 6B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 3 3 2 2 2 2 3 4B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 3 3 3 4 3 3 6 6B5. Combination of B1-B4 using one-half standard deviation shocks 3 3 3 4 3 3 6 5B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 3 3 2 2 2 2 3 4

Baseline 6 5 5 5 4 5 6 7

A. Alternative Scenarios

A1. Key variables at their historical averages in 2011-2031 1/ 6 5 4 4 3 3 2 -2A2. New public sector loans on less favorable terms in 2011-2031 2 6 5 5 5 5 6 7 9

B. Bound Tests

B1. Real GDP growth at historical average minus one standard deviation in 2012-2013 6 5 5 5 5 5 7 8B2. Export value growth at historical average minus one standard deviation in 2012-2013 3/ 6 5 5 6 5 6 8 8B3. US dollar GDP deflator at historical average minus one standard deviation in 2012-2013 6 5 5 5 5 5 7 8B4. Net non-debt creating flows at historical average minus one standard deviation in 2012-2013 4/ 6 5 6 8 7 7 12 10B5. Combination of B1-B4 using one-half standard deviation shocks 6 5 6 8 7 7 12 10B6. One-time 30 percent nominal depreciation relative to the baseline in 2012 5/ 6 7 7 7 6 7 9 10

Memorandum item:Grant element assumed on residual financing (i.e., financing required above baseline) 6/ 25 25 25 25 25 25 25 25

Sources: Country authorities; and staff estimates and projections.

1/ 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. 2/ 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.3/ 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 (implicitlyan offsetting adjustment in import levels). 4/ Includes official and private transfers and FDI.5/ Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.6/ 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.

Debt service-to-revenue ratio

Debt service-to-exports ratio

Table 3b.Kyrgyz Republic: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2011-2031 (continued)(In percent)

 

 

  

78  

Annex 5: Country at a Glance

Europe &Key Development Indicators Kyrgyz Central Low

Republic Asia income(2010)

Population, mid-year (millions) 5.5 404 846Surface area (thousand sq. km) 200 23,549 17,838Population growth (%) 1.1 0.3 2.2Urban population (% of total population) 35 64 29

GNI (Atlas method, US$ billions) 4.7 2,746 431GNI per capita (Atlas method, US$) 880 6,793 509GNI per capita (PPP, international $) 2,200 12,609 1,220

GDP growth (%) -1.4 -5.8 4.6GDP per capita growth (%) -2.4 -6.1 2.4

(most recent estimate, 2004–2010)

Poverty headcount ratio at $1.25 a day (PPP, %) <2 4 ..Poverty headcount ratio at $2.00 a day (PPP, %) 29 9 ..Life expectancy at birth (years) 68 70 57Infant mortality (per 1,000 live births) 27 19 76Child malnutrition (% of children under 5) 6 .. 28

Adult literacy, male (% of ages 15 and older) 100 99 69Adult literacy, female (% of ages 15 and older) 99 97 55Gross primary enrollment, male (% of age group) 102 100 107Gross primary enrollment, female (% of age group) 101 98 100

Access to an improved water source (% of population) 86 95 64Access to improved sanitation facilities (% of population) 24 89 35

Net Aid Flows 1980 1990 2000 2010 a

(US$ millions)Net ODA and official aid .. 24 215 315Top 3 donors (in 2008): United States .. 1 25 52 European Union Institutions .. 0 15 29 Germany .. 0 5 24

Aid (% of GNI) .. 1.0 16.7 7.0Aid per capita (US$) .. 5 44 58

Long-Term Economic T rends

Consumer prices (annual % change) .. 1208.8 18.7 8.0GDP implicit deflator (annual % change) .. 7.9 27.2 6.9

Exchange rate (annual average, local per US$) .. 0.0 47.7 46.0Terms of trade index (2000 = 100) .. 112 100 80

1980–90 1990–2000 2000–10

Population, mid-year (millions) 3.6 4.4 4.9 5.5 1.9 1.1 1.1GDP (US$ millions) .. 2,674 1,370 4,617 .. -4.1 4.4

Agriculture .. 34.2 36.7 20.7 .. 1.5 0.0Industry .. 35.8 31.4 28.0 .. -10.3 1.1 Manufacturing .. 27.7 19.5 17.8 .. -7.5 -0.6Services .. 30.0 31.9 51.3 .. -4.9 9.6

Household final consumption expenditure .. 71.1 65.7 84.0 .. -6.5 8.1General gov't final consumption expenditure .. 25.0 20.0 19.0 .. -8.8 1.0Gross capital formation .. 24.2 20.0 28.4 .. -3.9 9.1

Exports of goods and services .. 29.2 41.8 57.7 .. -1.6 5.9Imports of goods and services .. 49.6 47.6 89.2 .. -8.2 11.4Gross savings .. 3.8 14.7 23.7

Note: Figures in italics are for years other than those specified. 2010 data are preliminary. Group data are for 2009. .. indicates data are not available.a. Aid data are for 2009.

Development Economics, Development Data Group (DECDG).

(average annual growth %)

(% of GDP)

6 4 2 0 2 4 6

0-4

15-19

30-34

45-49

60-64

75-79

percent of total population

Age distribution, 2009

Male Female

0

10

20

30

40

50

60

70

80

1990 1995 2000 2009

Kyrgyz Republic Europe & Central Asia

Under-5 mortality rate (per 1,000)

-25

-20

-15

-10

-5

0

5

10

15

95 05

GDP GDP per capita

Growth of GDP and GDP per capita (%)

  

79  

Balance of Payments and Trade 2000 2010

(US$ millions)Total merchandise exports (fob) 511 1,837Total merchandise imports (cif) 559 3,354Net trade in goods and services -81 -1,614

Current account balance -75 -98 as a % of GDP -5.5 -2.1

Workers' remittances and compensation of employees (receipts) 9 1,398

Reserves, including gold 263 1,719

Central Government Finance

(% of GDP)Current revenue (including grants) 18.5 31.3 Tax revenue 15.1 23.2Current expenditure 20.8 32.2

Technology and Infrastructure 2000 2009Overall surplus/deficit -9.6 -6.5

Paved roads (% of total) 91.1 ..Highest marginal tax rate (%) Fixed line and mobile phone Individual .. .. subscribers (per 100 people) 8 94 Corporate .. .. High technology exports

(% of manufactured exports) 17.7 5.0

External Debt and Resource FlowsEnvironment

(US$ millions)Total debt outstanding and disbursed 1,717 3,163 Agricultural land (% of land area) 56 56Total debt service 190 199 Forest area (% of land area) 5.3 5.3Debt relief (HIPC, MDRI) – – Terrestrial protected areas (% of land area) .. ..

Total debt (% of GDP) 125.4 68.5 Freshwater resources per capita (cu. meters) 9,803 9,351Total debt service (% of exports) 30.0 5.1 Freshwater withdrawal (billion cubic meters) 10.1 ..

Foreign direct investment (net inflows) -2 234 CO2 emissions per capita (mt) 0.94 1.2

Portfolio equity (net inflows) 0 103GDP per unit of energy use (2005 PPP $ per kg of oil equivalent) 3.1 3.8

Energy use per capita (kg of oil equivalent) 489 542

W orld Bank Group portfolio 2000 2009

(US$ millions)

IBRD Total debt outstanding and disbursed 0 0 Disbursements 0 0 Principal repayments 0 0 Interest payments 0 0

IDA Total debt outstanding and disbursed 379 656 Disbursements 34 8

Private Sector Development 2000 2010 Total debt service 3 17

Time required to start a business (days) – 10 IFC (fiscal year)Cost to start a business (% of GNI per capita) – 3.7 Total disbursed and outstanding portfolio 31 18Time required to register property (days) – 5 of which IFC own account 31 18

Disbursements for IFC own account 0 6Ranked as a major constraint to business 2000 2010 Portfolio sales, prepayments and (% of managers surveyed who agreed) repayments for IFC own account 5 3 Tax administration .. 33.7 Access to/cost of financing .. 32.7 MIGA

Gross exposure 75 11Stock market capitalization (% of GDP) 0.3 1.7 New guarantees 0 6Bank capital to asset ratio (%) .. ..

Note: Figures in italics are for years other than those specified. 2010 data are preliminary. 5/23/11.. indicates data are not available. – indicates observation is not applicable.

Development Economics, Development Data Group (DECDG).

0 25 50 75 100

Control of corruption

Rule of law

Regulatory quality

Political stability

Voice and accountability

Country's percentile rank (0-100)higher values imply better ratings

2009

2000

Governance indicators, 2000 and 2009

Source: Kaufmann-Kraay-Mastruzzi, World Bank

IBRD, 0IDA, 649

IMF, 177

Other multi-lateral, 640Bilateral, 1,149

Private, 548Short-term, 0

Composition of total external debt, 2010

US$ millions

TT ii aa nn SS hh aa nn

KK uu nn gg ee yy -- AA ll aa tt aa uu MM tt ss ..

Peak PobedyPeak Pobedy7439 m7439 m

B AB AT K E NT K E N

TTA L A SA L A S

J A L A L - A B A DJ A L A L - A B A D

C H U I C H U I

I S S Y K - K U L I S S Y K - K U L

O S H O S H

N A RN A R Y NY N

SulyuktaSulyukta

Kyzyl-KiyaKyzyl-Kiya

Tash-KumyrTash-Kumyr

Kara-Kul Kara-Kul

At-BashyAt-Bashy

KirovKirovKara-BaltaKara-Balta Tokmok Tokmok

ChaekChaek

Barskaun Barskaun

Kara-Say Kara-Say

Sary-TashSary-Tash

Daraut-Daraut-KorganKorgan

Gul'chaGul'cha

ToktogulToktogul

TunukTunuk

TyupTyup

EnilchekEnilchek

ShyirakShyirak

OshOsh

Jalal-AbadJalal-Abad

BatkenBatken

NarNarynyn

TTalasalasKarakolKarakol

B AT K E N

TA L A S

J A L A L - A B A D

C H U I

I S S Y K - K U L

O S H

N A R Y N

BISHKEKBISHKEK

Sulyukta

Kyzyl-Kiya

Tash-Kumyr

Kara-Kul

At-Bashy

KirovKara-Balta Tokmok

Balykchi

Chaek

Cholpon-Ata

Barskaun

Kara-Say

Sary-Tash

Daraut-Korgan

Gul'cha

Toktogul

Tunuk

Tyup

Enilchek

Shyirak

Osh

Jalal-Abad

Batken

Naryn

TalasKarakol

BISHKEK

T A J I K I S T A N

UZBEKISTAN

C H I N A

K A Z A K H S T A N

Chatkal

Chu

Naryn

Aksay

Kyzyl Suu

Kurshab

Lake Issyk-Kul

ToktogulReservoir

Lake Sonkul

LakeCharyi-Kel'

To Panfilov

To UshtobeTo

Burylbaytal

To Shymkent

To Tashkent

To Bukhoro

To Murghab

To Hotan

T i a n S h a n

K u n g e y - A l a t a u M t s .

Peak Pobedy7439 m

72E 74E 76E 78E 80E

70E 72E 74E 76E

78E 80E

44N

42N42N

40N40N

KYRGYZREPUBLIC

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 25 50 75

0 25 50 75 Miles

100 Kilometers

IBRD 33430

SEPTEMBER 2004

KYRGYZ REPUBLICSELECTED CITIES AND TOWNS

OBLAST CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

OBLAST BOUNDARIES

INTERNATIONAL BOUNDARIES