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p. 14 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia Kazakhstan Kyrgyz Republic Tajikistan and Turkmenistan Uzbekistan Mongolia People’s Republic of China Southeast Asia South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia : Central Asian Republics, Azerbaijan, and Mongolia

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Kyrgyz Republic

Economic growth improved in 2000 despite extensive crop damage. Foreign trade recovered, price and exchange rate stability were in large measure restored, and a modest fiscal consolidation was achieved. However, in the immediate future, a heavy external debt repayment burden threatens to hamper the stabilization process.

Recent Trends and Prospects

The economy appears to be recovering from the adverse impact of the 1998 Russian crisis. In 2000, GDP growth accelerated to 5.0 percent, from 3.7 percent in 1999. The agriculture sector performed well during the first half of 2000 with 9.6 percent growth. But early snowfall in the latter half of the year caused extensive crop damage to an estimated 12.2 percent of the cropped area. This resulted in lower agricultural growth of 3.9 percent for the year compared with 8.2 percent in 1999. Industry recorded 6.0 percent expansion, led by power generation, light manufacturing, and chemical industries. Strong export demand for leather products, and a revival of cotton processing and pharmaceutical units contributed to the improvement of light manufacturing and chemical industry output. The construction sector expanded by 5.9 percent in 2000, aided by externally funded public investments.

The Government followed a tight monetary policy in 2000 in an attempt to achieve low inflation and stabilize the exchange rate: broad money grew by 12.3 percent in 2000, while exchange rate stability was restored to a degree—the som depreciated by 18.2 percent against the dollar in 2000. Interest rates also declined. To improve the central bank's ability to pursue monetary policy effectively and fairly independently of the Government's debt operations, "Notes of the National Bank" were introduced in June 2000. These will have shorter maturities and larger face values than treasury bills and are expected to reduce fluctuations in the expansion of the money supply.

Inflationary pressure abated significantly in 2000, with an average annual price increase of 18.7 percent against 35.9 percent in 1999. This was the result of a relatively stable som and strong farm output growth in the first half of the year despite increases in the administered prices of utilities, communications, and social services (especially health care), as well as a rise in food prices in October.

Although the official rate of unemployment in 2000 increased only marginally to 3.1 percent from 2.9 percent in 1999, the main issue is that the quality of employment is deteriorating due to regressive changes in occupational structure. The decline of the industry sector after independence in 1991 led to a substantial shift in workforce composition: the share of agriculture in the total workforce rose from 33 percent in 1990 to 47.3 percent in 1995. This movement from (relatively) high-wage sectors to low-wage agriculture drove down real wages and impoverished many people. The process was briefly reversed by economic revival during 1995–1997, resulting in an improvement in average real wages, but the growth in nonfarm employment was still too weak to raise real minimum wages and reduce poverty. Since 1998, the migration of labor to agriculture has reemerged, raising the share of the workforce in agriculture to 51.6 percent in 1999. The significant fall in real wages and an increase in food prices in 1998 sharply pushed up the poverty ratio by about 12 percentage points to 63.9 percent. Further food price rises and erosion in real wages marginally raised the poverty incidence to 64.1 percent in 1999. Preliminary trends for 2000 indicate a continued fall in real wages, suggesting a further deterioration in the poverty situation.

The fiscal deficit is estimated to have fallen from 12.0 percent of GDP in 1999 to 9.4 percent in 2000, but this may not be enough to meet official targets. Fiscal consolidation is being hampered by lower than expected tax revenues and the reduced scope for public expenditure cuts. In part, this was because the Parliament elected in March 2000 failed to approve the Government's efforts to raise additional resources through a comprehensive revision of the commodity tax code. Neither did Parliament approve the proposed increases in land tax rates to raise additional resources from the undertaxed agriculture sector. It did, however, enact a law to tax profits earned in free economic zones if these profits are invested outside the zones.

With significant erosion in the real incomes of government staff since 1997, in some cases to below the poverty line, the Government was compelled to implement a 20 percent increase in nominal wages and pensions in August 2000. Yet even this failed to fully offset the erosion in real wages.

Foreign trade improved. Aided by a substantial depreciation of the som in 1999, exports rose by 9.1 percent in 2000 while imports grew by only 1.4 percent. Exports of electricity, nonprecious metals, machinery, and chemicals were the principal contributors to export growth. The trade deficit fell sharply to $50.1 million in 2000, from $84.3 million in 1999.

The Government brought down tariff rates significantly in 2000, reflecting its commitment to World Trade Organization (WTO) requirements. The new structure is expected to yield an average tariff of 5.2 percent. The central bank's international reserves shrank in November 2000 to $256.7 million and are expected to have fallen further to around $250 million by the end of 2000, mainly due to foreign debt service.

Issues in Economic Management

The Kyrgyz Republic has made solid progress in overcoming transition problems, yet several tasks are unfinished, clouding considerably the country's medium-term prospects. The economy has the potential to grow faster than the 5.0 percent attained in 2000 if the Government achieves a sustainable level of internal balance and if financial sector reforms are implemented properly. Although the fiscal situation improved in 2000, it remains fragile. The Government needs to pay greater attention to raising additional tax and nontax revenues to service its debt while maintaining the necessary public expenditure levels. High external debt and the bunching of debt-service payments over the next five years will make macroeconomic management difficult in the absence of strong measures to restore the internal balance. Generation of adequate budgetary savings is the only way to maintain the current level of public investment, which is imperative to sustain economic growth and maintain a minimum level of social services.

The Kumtor gold mine, on which exports and the economy depend heavily, will gradually lose its importance ahead of its scheduled closing in about seven years. The economy will have to diversify its export base in terms of both commodities and markets to offset the impending fall in gold exports. If it does not, declining exports and the heavy debt repayment burden will put considerable pressure on the balance of payments. In short, medium-term growth prospects depend on (i) how fast and effectively the Government can implement broad-based economic and financial reforms and (ii) how it can handle the spikes in debt service through effective management of public sector resources.

The agriculture sector has shown considerable dynamism, driven mainly by the 62,000 private farms created since 1995. These farms, which now account for about 49 percent of the cropped area, are over 20 percent more productive than state farms, and produce profitable cash crops. Yet their output is still far below potential because current levels of productivity are low. Several institutional, social, and economic factors are preventing them from realizing their potential, including excessive regulation of agro-based industry, irrational taxation, obsolete technology in farm-based industry, poor input supply policies, and inadequate promotional support. However, by lifting the ban on the sale and purchase of land and authorizing the establishment of registry offices, Parliament has recently taken a critical step to improving farm productivity and prospects.

Though the Government has privatized over 60 percent of enterprises in manufacturing, the private sector faces an uncertain future in an unfriendly policy framework. A radical improvement in the business environment, and strong support from the Government, are needed to promote entrepreneurs. In particular, the weak financial sector and underdeveloped legal and regulatory institutions are major constraints to rapid private enterprise growth. The restructuring of public enterprises, which will help improve the fiscal situation and general business environment, has been slow but is expected to pick up in the near future.

The economy has a high debt burden, which presents serious risks to macroeconomic management in the short to medium term. Total external debt stood at $1.37 billion (129 percent of GDP) at the end of 1999, rising to $1.41 billion at the end of the first quarter of 2000 (see Figure 2.4). Of this, 69.8 percent (in net present value terms) was concessionary, supplied mostly by multilateral agencies. Persistently high fiscal deficits in excess of 9 percent of GDP since 1993, a shortage of domestic savings to finance public debt, and a sharp devaluation of the som contributed to the sudden increase in outstanding debt. In 1999, debt service absorbed 18 percent of government revenues and amounted to 2.8 percent of GDP. The debt-service burden will increase substantially in the years to 2005 because practically all nonconcessionary debt must be repaid and the grace periods for many concessionary loans will end. About 38 percent of government revenue in 2001 is expected to be used for servicing debt; this figure is projected to remain well above 20 percent in the medium term. Rescheduling of bilateral debt will be required in the coming years to smooth out spikes in repayment burdens. The nonconcessionary loans are principally from the Russian Federation and Turkey, and include some guaranteed by the Government on commercial terms for the Kumtor gold mine. Bilateral talks are under way to reschedule repayments of the nonconcessionary debt. The Government is reviewing its $675 million externally funded public investment program, which is unsustainable at current levels, so as to classify projects on the basis of their social and economic impacts. After classification, public investment in these projects will be reprioritized.

The Government needs to take radical decisions to improve its fiscal consolidation efforts through additional mobilization of tax and nontax revenues to restore fiscal balance. There is scope for raising these revenues with better administration and base broadening since the revenue-to-GDP ratio is low. Pursuit of public sector reforms, particularly in the energy, telecommunications, and transport sectors, is needed to better price the output from these sectors to generate additional internal resources for investment.

Policy and Development Issues

The Kyrgyz Republic is a small open economy, with exports amounting to about 40 percent of GDP, and has made rapid progress in trade liberalization. It joined WTO in December 1998, the first of the former Soviet republics to do so. The present tariff structure is simple: it has four groups with an average rate of 5.2 percent and a maximum rate of 20 percent. Nontariff barriers are few, mainly in the form of quantitative restrictions on and licenses for sumptuary goods, such as alcohol and tobacco, and sensitive items, such as military goods, explosives, and poisonous substances. Export licenses are required for several products. Subsidies are not provided for exports except, to a limited extent, for the units in the free economic zones. The economy is yet to reap the full benefits of WTO market access arrangements as four out of its six largest trading partners are non-WTO members and three of them are neighbors. These three neighbors have also applied for WTO membership and their accession could ease some of the country's current bilateral trade difficulties with them. Pursuance of good subregional trading relationships and finding new trading partners, which inevitably happens with a lag, could provide new opportunities for substantial improvement in foreign trade. In accordance with WTO membership conditions, the Kyrgyz Republic will have to align its economic policies and standards of governance with international benchmarks to help create a vibrant market economy.

As in most other transition economies, the financial sector and capital markets are still at an early stage of development. The economy has a very low level of financial intermediation. Even at its best, in 1998, the ratio of bank deposits to GDP was low at 6.3 percent; it fell further to 5.4 percent in 1999, reflecting much weaker public confidence in the banking sector after the Russian crisis. This can be compared with figures of 43–99 percent for some countries in Southeast Asia in 1999.

The first round of financial sector reforms began in 1996 and introduced the Basle Committee of Banking Supervision norms for capital adequacy, prudential income recognition, risk exposure, and transparency. The bank supervision capacity of the central bank was also enhanced. While these reforms established a solid regulatory framework, they did not adequately address the inherent weakness of the banking system. Efforts are under way both to reform the banking system by addressing larger corporate governance and restructuring issues as well as legal reforms, and to strengthen the regulatory capacity of the central bank.

However, restructuring of banks and the introduction of stringent entry and regulatory norms are complex processes fraught with political difficulties and financial constraints. The country has 23 licensed commercial banks with an average asset size of $4 million; this is too many banks for a population of 4.7 million. The proliferation of small banks has been due to lax entry norms. Besides significantly increasing the central bank's supervisory burden, this has led to fragmentation of capacity and uneconomic scales of operation. Consequently, the banks work on wide interest rate spreads. Lending rates are high and profit margins thin. High interest rates also increase the risk of default. Poor corporate governance has compounded these problems. At present, six banks, which hold 24 percent of bank deposits, are insolvent, and the finances of the remaining profit-making banks are weak.

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