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p. 47 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia : Central Asia

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Kyrgyz Republic

Economic performance was robust due to favorable external conditions and prudent macroeconomic management, though excessive dependence on gold production, a high debt burden, and low levels of saving and investment threaten sustainable economic growth. Such growth requires diversification of exports, implementation of reforms to improve the business environment, restructuring of external debt, and fiscal consolidation.

Macroeconomic assessment of 2004

Belying expectations, GDP grew very rapidly in 2004, by 7.1%, underpinned by strong external demand and prudent macroeconomic policies. Agriculture, aided by favorable weather conditions and an improved external environment, expanded by 4.1%. Despite a setback to gold production, which has a 45% weight in industrial production, the industry sector grew by 3.5% as non-gold industrial output jumped by 6.7%, reflecting strong gains in electricity generation, food processing, chemicals, transport equipment, and coal. Of greatest importance, however, was the services sector. With a 32% share in GDP, it saw a large 11.7% expansion. A combination of higher tourist arrivals, buoyant foreign trade, and the introduction of a lump-sum tax (the “patent system”) on small businesses, which brought some of their activities into the registered sector, contributed to this strong performance. Gross domestic investment, having fallen from 17.6% of GDP in 2002 to 16.2% in 2003, may have recovered to 19.0% in 2004, despite an estimated decline in the externally assisted public investment program. This suggests a welcome pickup in private investment. Gross domestic saving is also expected to improve.

Broad-based growth in non-gold output (at about 5% annually since 2000), low inflation, increased real wages, and a decline in income inequalities contributed to an overall improvement in living standards. The incidence of poverty fell from 55.3% in 1999 to around 41% in 2003, and preliminary estimates indicate a further decline to about 39% in 2004 (Figure 2.23). Nevertheless, poverty is still a major problem, especially in rural areas where some three quarters of the poor live.

The Government is estimated to have met the 2004 budget deficit target of 4.3% of GDP, an improvement on the 5.1% deficit recorded in 2003. Fiscal consolidation was achieved by an increase in tax revenues and cuts in nonsalary current and capital expenditures. Better tax administration and the measures taken to widen the tax net improved revenue performance. The external debt burden is large but falling, from 102% of GDP at end-2003 to an estimated 92% of GDP 12 months later. Since 91% of the external debt is public, it is an important determinant of fiscal sustainability.

High demand for money has sustained a substantial monetary expansion in recent years without causing inflation. Broad money grew by 32.0% in 2004 on top of a 33.5% increase in 2003. The growing coverage of credit unions in rural areas and improved availability of microcredit have propelled the rapid monetization process. Weighted average interest rates fell marginally, but remained high at 24.6% for domestic currency loans and 19.2% for foreign currency loans. The entry of a number of foreign banks, which now own about half of banking assets, seems to be rekindling public confidence in the banking sector. The level of financial intermediation remains low, however. Consumer price inflation was 4.0%, associated largely with higher prices of energy, food, and public services.

Preliminary data indicate strong growth in foreign trade in 2004. Merchandise exports expanded by 23.8%, with a significant contribution from non-gold exports. Increased demand in the rapidly growing economies of Kazakhstan and the Russian Federation accelerated exports of a wide range of goods. Merchandise imports were up by 24.6%, reflecting strong consumer demand. The trade gap widened to $171 million and, though private remittances accelerated, the current account deficit is estimated to have reached $115 million, or 5.2% of GDP. Net FDI inflows grew to about $122 million during the year. Together, FDI inflows, government portfolio sales, and official aid covered the deficit and helped raise gross international reserves to $565 million, providing about 7 months of merchandise import cover. The Government maintains a managed floating rate regime. The som appreciated against the dollar by 5.1% in nominal terms during the year but this seems not to have affected competitiveness.

Macroeconomic policy developments

Structural reforms in 2004 focused on two areas--strengthening governance in both public and private sectors to create a conducive business climate, and improving public resource management.

Corruption, poor governance, and a weak judicial system have emerged as major impediments to private sector-led, pro-poor economic growth. A new national anticorruption strategy was adopted and the UN Convention against Corruption was ratified by Parliament in 2004. All government officials are now mandated to declare their income and wealth. A three-member council was constituted in September 2004 to manage and regulate the civil service as a prelude to comprehensive civil service reform. In addition, a Law on Fundamentals of Technical Regulation was introduced to make public consultation compulsory before any new business-related law or regulation is introduced, or existing ones amended. This will minimize the risk of introducing conflicting and excessive regulatory measures. The Law on Joint-Stock Companies was further amended in 2004 to align it with international best practices and to remove contradictions with the legislation governing banking regulation. The Government took further steps to implement international accounting standards in large joint-stock companies. Parliament also enacted the Bank Insolvency Law for expeditious liquidation of problem banks. The Law on Pledge was approved in January 2004 to bring it into line with international norms. This law is expected to protect creditors’ rights; it should also help bring down interest rates as debtor behavior becomes more disciplined.

The Government has continued its efforts to broaden the tax base and improve tax administration. The customs code was revised and simplified to bring it in line with WTO requirements and the revised Kyoto convention, and came into effect on 1 January 2005. The Government has also improved coordination between the customs administration and the state tax inspectorate, and prepared a comprehensive plan to modernize the former. In addition, the tax code is being revised to simplify taxation, rationalize the rate structure, and make the tax system investment friendly without sacrificing revenue. The new tax code is likely to be adopted in 2005.

The Paris Club of creditors provided debt relief to the Government in March 2005 in the form of cancellation of 50% of credits given on commercial terms (about $124 million) and rescheduling repayment of the remaining balance of such credits over 23 years with a 7-year grace period. The repayment of bilateral official development assistance of about $306 million has been rescheduled over 40 years, with a 13-year grace period. Even after receiving debt relief on concessional terms in 2005, debt parameters are likely to remain above the World Bank’s Heavily Indebted Poor Countries threshold until 2008, and the debt situation will remain vulnerable to external shocks. Continued focus on fiscal consolidation is critical for fiscal sustainability and for providing adequate resources for social services and public investment.

The Government made progress in privatizing key public sector enterprises. The Kairat Bank was privatized, leaving only one bank in the public sector. Efforts to privatize KyrgyzTelecom to a consortium of German companies hit a roadblock after Parliament raised questions about the process. Reforms in the electricity sector, which generates a huge quasi-fiscal deficit (11% of GDP in 2003), made little headway over the year. The Kumtor Gold Mining Company was, in effect, privatized, with the Government swapping its two-thirds stake in the company for a one-third stake in Centerra Gold Inc., a newly formed holding company listed on the Toronto Stock Exchange. Subsequently, the Government sold a part of its stake in Centerra Gold Inc. and deposited the proceeds of $86 million--earmarked for poverty reduction projects--in its account at the National Bank of the Kyrgyz Republic.

Outlook for 2005-2007 and medium-term trends

The medium-term outlook for the country, though positive, is subject to several risks, especially to higher oil prices and lower gold prices on the economic side. On the political side, the March 2005 uprising and apparent change of government appear to be related mainly to governance issues rather than to economic policy. However, it will take some time to assess the full impact of these events on the economic outlook.

For the ADO 2005 projections, GDP growth is expected to decelerate to 5.0% in 2005, reflecting depletion and continued decline in gold production at the Kumtor gold mine. This could be offset to some extent in 2006-2007 if production begins as scheduled at the Jerui and Taldy-Bulak mines. The start of operations there will increase gross domestic investment to over 22% of GDP and widen the current account deficit to close to 6.0% of GDP in 2005. Inflation is targeted at 4.6% for the year and is projected to moderate to 4.0% in 2006 and 2007. The 2005 fiscal deficit target was fixed at the same level as in 2004, at 4.3% of GDP; thereafter it is projected to fall, to 3.7% of GDP by 2007.

Diversification and expansion of non-gold industrial activity--especially export-oriented areas--fiscal consolidation, implementation of structural reforms, and pursuit of sound macroeconomic policies are crucial to achieving sustainable growth. The country needs to align its production and exports with the evolving demand in neighboring countries, particularly PRC, Kazakhstan, and Russian Federation. In this context, agriculture--including high-value crops, agroprocessing, and animal husbandry--light industry, and tourism have considerable untapped potential if better technologies are introduced. Proactive pursuit of subregional cooperation in the areas of trade, transport, and transit is needed to ease transit problems and costs.

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