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p. 38 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia Azerbaijan Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan The Pacific III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia : Central Asia

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Kyrgyz Republic

A contraction in the economy, stemming from an accident at the country's largest gold mine, exposed the narrow economic base and vulnerability of the economy to external and domestic shocks. Consequently, medium-term prospects depend largely on rapid diversification of the domestic production base and exports. Debt relief from Paris Club members has provided some additional resources and time to carry out the necessary structural reforms.

Macronomic Assessment

GDP is estimated to have fallen by 0.5% in 2002, as against 5.3% growth in 2001. This is mainly due to a 26% drop in gold production caused by an accident at the Kumtor gold mine in July—the mine contributed 9% of GDP and 40% of industrial output in 2001. Industry declined by 11.2% during 2002 on account of the steep fall in gold production and a downturn in electricity generation, which resulted from low export demand. However, a few sectors showed a strong turnaround: textiles, glass, leather products, and food processing. Late sowing due to adverse weather conditions delayed the agricultural harvest and affected crop yields, but sector output is expected to have risen by 3.3%, somewhat below the target of 4.0%. The services sector is estimated to have grown by about 4.2%. The output of hotels and restaurants rose by 28.5% and retail trade by 8.2%, mainly because of the foreign troops now based in the country and higher numbers of tourist arrivals.

Gross domestic capital formation declined from 20% of GDP in 2000 to about 18% of GDP in 2001 due to a fall in the Public Investment Program (PIP) as a result of budgetary pressure. This trend appears to have continued in 2002 and PIP disbursements are expected to fall short of target by over 10%, which might reduce the overall capital formation rate in 2002 to about 17% of GDP.

The incidence of poverty fell from 52% in 2000 to 47.6% in 2001. Despite the economic contraction in 2002, the potential impact on poverty is likely to be limited because of a 10.5% increase in average monthly wages in the year to September 2002, coupled with low inflation and continued growth in the agriculture sector, which employs about half the workforce. The level of unemployment is not officially available; however, it was likely little changed from the 7.8% estimate for 2001.

In 2002, the estimated fiscal deficit of 5.9% of GDP, higher than the target of 5.1%, is attributed to the fall in GDP and the consequent loss of revenues. The Government succeeded in eliminating pension arrears, and in reducing arrears in counterpart financing of externally assisted projects and payments to the medical insurance fund. The debt service burden eased with the decision of Paris Club members in March 2002 to reschedule repayments due between December 2001 and December 2004. They also agreed to consider providing more enduring long-term debt relief in the form of concessional stock treatment if the ongoing IMF-supported Poverty Reduction and Growth Facility (PRGF) is successfully implemented (Figure 2.21).

Broad money expanded by 34.1% in 2002, mainly due to the rise of foreign assets held by the central bank. This rapid expansion did not, however, cause a rise in inflation, on account both of increased demand for domestic currency spurred by the strong som, and of increased monetization of the economy. Expansion of credit unions in rural areas and improved availability of microcredit contributed significantly to the monetization process. Indeed, inflation continued falling with consumer prices rising by only 2.0% on average for the year (2.3% in the year to end-December 2002). Weighted average interest rates fell slightly during the year but were high at 36.4% for domestic currency loans and 22.7% for foreign currency loans in October 2002. Bank lending rates are very high due to large default risks and problems arising from the difficulties in enforcing claims against collateral.

Foreign trade increased in 2002 for the first time since 1998; it is estimated to have grown by about 14%, aided by a 25.4% increase in imports. The trade deficit is expected to exceed $50 million, as exports grew by only 3.7%. Imports of petroleum products for the foreign troops stationed in the country and strong domestic demand contributed to the surge in imports. Exports of precious metals (which accounted for 47% of total exports in 2001) fell by over 27% and the sale of electricity to neighboring countries declined. This would have caused a considerable drop in exports but for the notable export performance of agriculture and light industry products. The current account deficit for 2002 is expected to widen to 2.0% of GDP, from 2001's level of 1.3%. The inflow of FDI was a meager $1.6 million during the first 11 months. Foreign exchange reserves are sufficient to cover about 7 months of imports.

Policy Developments

The Government undertook several structural reform measures in 2002 to stabilize the economy, raise the quality of public resource management, and improve governance to create an environment in which the private sector can function efficiently. It has successfully implemented the policy benchmarks stipulated for 2002 under the PRGF. A draft of the National Poverty Reduction Strategy, which provides the blueprint for development for 2003-2005, has been prepared and was submitted to donors at the Consultative Group meeting held in October 2002 in Bishkek.

The Government made significant progress in fiscal reforms in 2001 and continued the momentum in 2002. Effective July 2002, it cut the business profit tax rate to 20% for all entities except natural monopolies where the tax cut was deferred until 2003 on revenue considerations. Personal income tax rate slabs (previously from 5% to 30%) were consolidated into two slabs of 10% and 20% to reduce the tax burden and simplify administration. Other revenue measures included removing many VAT exemptions, increasing the retail sales tax rate, and raising the nonagricultural land tax. The rate of employers' contribution to the Social Fund was reduced, aiding both business profitability and lowering employment costs. In an effort to improve revenue administration, the Government decided in September to merge the State Tax Inspectorate, the Customs Committee, the Financial Police, and the revenue-collecting division of the Social Fund into a single independent revenue-collecting organization under the Ministry of Finance. Moreover, it initiated steps to reform and strengthen the customs administration and to create a special unit to monitor and collect taxes from large taxpayers. Energy tariffs were increased by 20% to reduce the quasi-fiscal deficit, and further adjustments will be required. The Government, however, made little progress in privatizing four large SOEs in the electricity, gas, airlines, and telecommunications subsectors.

The primary objectives in the monetary area are to contain inflation and to improve financial intermediation through financial sector reforms. In 2002, the Government submitted amendments to the Law on Licensing of Banks to impart more authority to the central bank to revoke or suspend licenses of delinquent banks and to adjudicate disputes relating to bank liquidation. The central bank has approved a strategy for reforming the banking sector and initiated measures to improve the payments system in the country with a view to encouraging banking system payments rather than cash in settling transactions. The Government is carrying out background work to introduce legal reforms for enforcing creditor rights, quickly resolving business disputes, improving corporate governance in the banking sector, and protecting depositor rights. Other notable structural reform measures include the phased introduction of international accounting standards, preparation of a blueprint and a time-bound implementation plan for judicial reforms, and initiation of steps to facilitate the early implementation of SOE reforms. Many of these measures are expected to be undertaken in 2003.

Outlook for 2003-2004

The Kumtor accident demonstrated the extent of the economy's vulnerability to internal and external shocks. It is difficult to insulate a small economy like that of the Kyrgyz Republic completely from such shocks. However, diversification of domestic production and foreign trade, rapid implementation of structural reforms, and continued pursuit of solid macroeconomic policies are needed to reduce such risks in the medium term. With revival of gold production in early 2003, GDP is expected to grow by about 5% in both 2003 and 2004. The Government intends to reduce the fiscal deficit to 4.7% of GDP in 2003 by mobilizing additional revenues, which will also allow increased spending on social services. According to a recent survey, business confidence is high but business people cited expensive credit, intrusive regulations, and corruption as their most important constraints.

Medium-term economic prospects for maintaining 5% GDP growth will depend on the resolution of two inexorable trends during the next few years: a gradual reduction in foreign funding of the PIP to around 3% of GDP after 2005, and the beginning of a decline in gold production at Kumtor. These two developments underscore the immediate need for enhancing private investment, identifying new sources of production and exports to compensate for the fall in gold output, and raising domestic resources for maintaining the required levels of public investment. These can be accomplished only with further progress in financial sector reforms, improvement in governance, implementation of legal reforms, and removal of remaining impediments to private business.

The rescheduling of debt service payments by the Paris Club creditors and the promise to provide further debt relief through stock treatment in 2004-2005 have provided an opportunity and appropriate environment for the Government to pursue these goals. However, it will need to secure domestic resources and external grants to fund increasingly more of the PIP.

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