Regions and Countries

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Country Strategy and Program Update 2005-2006: Kyrgyz Republic

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I. Current Development Issues and Trends

A. Recent Political and Social Developments

1. The amendment to the Kyrgyz Constitution following a referendum in February 2003, resulted in measures to reform the electoral process and further decentralize political power. Parliamentary and presidential elections are due in February and October 2005, respectively. The election code was amended after consultations with political parties and civil society. These amendments aim to make the election commission more independent, give more powers and responsibilities to local governments in supervising elections, allow voters to elect all members of Parliament directly, and eliminate the practice of political parties nominating some of them. However, some domestic and international agencies and groups believe that the amendments favor the Government. Decentralization is a key objective of the Comprehensive Development Framework (CDF) and National Poverty Reduction Strategy (NPRS). The Law on the Fiscal and Economic Basis of Local Self-Government has been promulgated to further institutionalize and strengthen the decentralization process.

2. Although high poverty continues to be a serious matter, considerable progress has been made in combating it. The headcount index of absolute poverty declined from 44.4% in 2002 to 40.8% in 2003 due to a 14.0% increase in average real wages, improved agriculture production, and price stability. Other social indicators also generally improved, particularly in child and maternal mortality and improvement of access to safe drinking water. Appendix 1, Table A1.1, indicates the country’s progress in achieving the Millennium Development Goals and Targets.

B. Economic Assessment and Outlook

3. The economy rebounded in 2003 after remaining stagnant in 2002. Gross domestic product (GDP) grew at 6.7% as gold production recovered. Non-gold industrial output also grew by about 8.5%, aided by electricity generation, food processing, chemicals, and nonmetallic products. Bad weather restricted agriculture growth to 3.8%. Sales to foreign military bases, deregulation of the economy, and a rise in tourism helped the service sector grow by 5.8%. Gross domestic investment fell marginally in 2002 to 17.6%. Preliminary trends in foreign direct investment, and the high growth in bank credit to the commercial sector indicate a possible rise in private investment in 2003 compared to 2002. The Government will continue to cut public investment as part of the debt reduction strategy; public investment fell from 4.7% of GDP in 2002 to 3.6% in 2003. GDP grew by 6.7% during the first 4 months of 2004, prompting the Government to revise GDP growth projection for 2004 upward to 4.5%.

4. The fiscal deficit fell by 0.4 percentage points to 5.0% of GDP in 2003. The deficit, however, was higher than targeted due to the unanticipated spending on disaster relief and emergency rehabilitation. Total tax and nontax revenues increased by 0.8 percentage points to 18.7% of GDP due to better tax collection efforts. The value added tax was introduced on large farms in April 2003. Property tax legislation was approved and is likely to be introduced in 2004 after agreements on valuation and exemption limits. Excise duties on petroleum fuels were cut by 50%, resulting in a sharp fall in smuggling and a rise in revenue. Despite good revenue efforts, Public Investment Program (PIP) spending fell significantly. The debt-servicing burden eased as the Government negotiated successfully with almost all bilateral creditors following the Paris Club understandings reached in March 2002. The Government successfully completed the third year of implementation of the ongoing Poverty Reduction and Growth Facility (PRGF) of the International Monetary Fund (IMF), which will end in September 2004. Broad money supply expanded by 33.5%, largely due to an increase in foreign exchange reserves. Remonetization of the economy and the consequent rise in demand for the som absorbed this money supply without causing high inflation. The annual average consumer price inflation was 3%. The trade gap widened in 2003 to $82.7 million, and imports grew at 21.9% as the strong som made imports of consumer goods cheaper, and excise tax reforms reduced smuggling of oil products. Preliminary estimates indicate that the current account deficit fell to about 1.6% of GDP.

5. GDP is expected to grow at over 4.5% during the next 2 years. The fiscal deficit is targeted to reduce to 4.4% of GDP in 2004, and to about 3.5% by 2006. Achieving GDP growth of 5% or more, which is necessary for speedy poverty reduction, will require (i) debt restructuring to ease the fiscal burden of external debt; (ii) improvement in public resource management; (iii) expeditious implementation of structural reform, particularly in the financial sector, energy sector, civil service, and judiciary; (iv) easing of trade barriers to diversify exports; and (v) a favorable external environment.

6. The Government has developed a program to implement structural reforms in many of the above areas. The medium-term challenge, therefore, will be to achieve sustainable growth while pursuing further fiscal consolidation without burdening vulnerable groups. This will require immediate focus on four areas: reducing quasi-fiscal deficits in the energy sector, implementing tax reforms, improving the effectiveness of public spending, and improving the environment for private sector-led economic growth.

C. Implications for Country Strategy and Program

7. The new Country Strategy and Program (CSP) for the Kyrgyz Republic was endorsed by the Board in November 2003. The CSP’s focused approach and thrusts remain valid as no significant economic and political developments affected them. However, the following factors need to be recognized. Achieving the Government’s development goals of fostering private sector led growth and reducing poverty depend on progress in key structural reforms and, more important, addressing the several challenges affecting private sector functioning. The run-up to the 2005 parliamentary and presidential elections may dampen momentum in this direction. However, a favorable outcome at the Paris Club negotiations in 2005, following a successful conclusion of the PRGF, is likely to see an easing of the fiscal situation and constraints on the PIP, allowing the Government to deepen public investments, particularly in the social sectors.

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