Mission Concluding Statement 

The Kyrgyz Republic: Staff Concluding Statement of the 2017Article IV and Fourth Review under the ECF Visit

April 18, 2017

An International Monetary Fund (IMF) team led by Edward Gemayel, visited Bishkek from April 5-18, 2017 to conduct the fourth review under the Extended Credit Facility (ECF) and hold the 2017 Article IV Consultation. The mission met with Prime Minister Jeenbekov, Speaker of Parliament Tursunbekov, Minister of Finance Kasymaliev, Minister of Economy Kozhoshev, Chairman of the National Bank Abdygulov, other senior officials, and representatives of the private sector, civil society, and the diplomatic community. Discussions centered on policies necessary to consolidate the nascent economic recovery including: (i) maintaining the course of fiscal consolidation, particularly efforts to improve tax administration and reform public wages; (ii) maintaining two-way exchange rate flexibility; (iii) improving safeguards against banking sector vulnerabilities including the adoption of the anti-money laundering and counter financing of terrorism (AML/CFT) law and ensuring a level playing field for all players; and (iv) carrying out structural reforms to promote diversified and inclusive growth.

Outlook and risks

1. The prospects of a recovery following the recent crisis are improving with good indicators across the region, but without additional effort to shore up economic stability and structural reforms growth could fall short of aspirations. As domestic and external demand continue to recover, growth for 2017 is expected to reach 3.5 percent and continue to expand into the medium term. The recovery should push inflation up to the National Bank of the Kyrgyz Republic (NBKR) range of 5-7 percent and cause the external balance to widen to about 13 percent in 2017 before gradually narrowing over the medium term.

2. Regional factors will continue to shape the main risks for the economy. Weaker growth prospects in Russia through another oil price shock or the reorientation of the Chinese economy away from investment could negatively impact the economy, through remittances, trade, and foreign investment. Spending pressures rising towards the second half of the year could undermine fiscal consolidation. Conversely, faster growth in Russia and deeper economic ties with China could have a positive impact on growth prospects.

3. Progress has been made toward completing the fourth review, but additional efforts will be needed. All end-December 2016 quantitative performance criteria were met. Except for tax revenues, all indicative targets were met. All end December 2016 structural benchmarks were met. One 2017Q1 structural benchmark was missed, namely the liquidation of banks under DEBRA due to protracted litigation. Despite significant progress, further efforts will be needed to complete the fourth review, including strong commitment to the program’s targets on wages and the overall fiscal deficit for 2017. The team will remain in close contact with the authorities in the coming weeks.

Fiscal policy

4. As the economic recovery takes hold, fiscal consolidation is essential to rebuild buffers to protect against future shocks and maintain macro-economic stability. Therefore, the overall fiscal deficit for 2017 should meet the program target of 3 percent of GDP. However, expected spending pressures during the second half of the year could widen the deficit. Enhancing permanent revenues—by implementing identified new measures, eliminating tax exemptions (especially the VAT on flour), refraining from granting new ones, and improving tax administration—is a key pillar of fiscal policy. Improving public expenditure efficiency, particularly through reforming public sector wages to reach the agreed target of 8.8 percent of GDP by 2018, is another. Public financial management reforms should continue, particularly work on financial management information systems, adopting a credible transparent and enforceable fiscal rule, and realizing the full benefits of the recently adopted procurement law.

5. Maintaining public debt at a sustainable level in the medium term will require further consolidation and reform efforts. In this context, it is essential to continue to improve the management of both domestically and externally financed public investments and refrain from non-concessional borrowing. Closer coordination between the Ministry of Finance and the State Property Fund is essential to mitigate risks stemming from state owned enterprises (SOEs), starting with a full assessment of SOEs’ assets and liabilities.

Monetary, exchange rate, and financial sector policy

6. To achieve the main policy goal of ensuring price stability, it is necessary to maintain two-way exchange rate flexibility and enhance interest rate channel traction. The NBKR should continue to intervene only to mitigate excessive volatility. Further efforts to improve monetary policy forecasting, develop the interbank market and enhance the forward-looking component of communication are key to strengthening monetary policy transmission.

7. Further strengthening supervision and regulation and maintaining a level playing field among all players are essential to safeguard the financial sector against vulnerabilities. Transition to risk-based supervision, continuing work on improving the framework for asset classification and provisioning in line with international practice, and the establishment of a robust crisis preparedness framework are important steps in this context. The NBKR should continue to pursue its primary objective of maintaining price stability and ensuring a level playing field and equal treatment for all market players and supervised entities.

Structural reforms

8. To achieve the long-term vision of sustainable growth and shared prosperity, structural reforms are necessary to overcome skills, infrastructure, and capital gaps and diversify the economy. Achieving the “Smart Nation/Taza Koom” vision with its emphasis on human development, knowledge, and information technologies will require further investment in health and education and improvement of the efficiency of spending in these areas. It is essential to remove market distortions and liberalize energy tariffs to open the way for much-needed private sector investment. Trade and competition policies need to be developed to take fuller advantage of membership in the Eurasian Economic Union (EEU) and the Generalized Scheme of Preferences Plus (GSP+).

9. Improving the business climate and governance, and continuing the fight against corruption are key to unleashing private sector-led growth. Specific measures aimed at eliminating regulatory and governance related obstacles to doing business are needed to bring the non-observed economy out of the shadows and harness the energy of private enterprise for growth. In this context, further work is necessary to reduce tax evasion and opportunities for abuse and enhance regulatory predictability and transparency.

The team thanks the authorities and other counterparts for their warm welcome, cooperation, and candid and constructive discussions during the visit, and reaffirms the IMF’s support to the government’s efforts to implement their economic reform program.