Kyrgyz Republic—Letter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Bishkek, December 15, 2003

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Mr. Horst Köhler
Managing Director
International Monetary Fund
700 19th Street, N.W.
Washington, D.C. 20431

Dear Mr. Köhler:

The Kyrgyz authorities held discussions with Fund staff in October–November 2003 for the fourth review under the PRGF arrangement. Based on these discussions, the attached Third-Year Memorandum of Economic Policies (MEP) reviews economic developments and policy implementation through September 2003, updates the macroeconomic framework, and discusses the financial policies and structural reform program for the third-year program (October 1, 2003–September 30, 2004). It supplements our earlier MEPs and supplementary MEPs under the current PRGF arrangement. It also proposes quantitative performance criteria for end-March and end-September 2004 as well as structural benchmarks for the period through September 2004.

All performance criteria for end-September 2003 were met, except that on the fiscal deficit. This target was exceeded by a small margin because a grant was not received as programmed, and we request a waiver of nonobservance regarding this deviation.

We consent to publication by the Fund of the MEP and the staff’s report.

The Government and the NBKR believe that the policies set forth in the attached Memorandum of Economic Policies (MEP) are adequate to achieve the objectives of the economic program, but they will take any further measures that may become appropriate for this purpose. The Kyrgyz Republic will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEP, in accordance with the Fund’s policies on such consultation.

Yours sincerely,

Memorandum of Economic and Financial Policies
For the Period October 1, 2003–September 30, 2004

I. INTRODUCTION

1. This Memorandum of Economic Policies (MEP) sets forth our economic objectives and policies for the period October 1, 2003–September 30, 2004—the third year of the economic program supported by the International Monetary Fund (IMF) under the Poverty Reduction and Growth Facility (PRGF). These objectives and policies are an integral part of our medium term strategy for poverty reduction, as described in the National Poverty Reduction Strategy (NPRS) paper of December 9, 2002. This third-year memorandum supplements previous memoranda, including the first-year MEP dated November 16, 2001 and supplemented on June 13, 2002, as well as the second-year MEP dated January 31, 2003 and supplemented on June 30, 2003.

II. PERFORMANCE UNDER THE PROGRAM

2. The Kyrgyz economy has returned to the targeted medium term growth path in 2003. Following zero growth in 2002, real GDP grew by 5.1 percent in the first nine months of 2003—led by the recovery of gold production—and we expect a broadly similar growth rate for the year as a whole. The 12-month consumer price inflation was 3.9 percent in October 2003, and we foresee a broadly similar rate of inflation at the end of the year. The current account deficit in the first nine months of 2003 (4.0 percent of GDP) was somewhat higher than projected earlier because of depressed energy exports and higher imports from CIS countries. The annual current account deficit is expected to decline to 3.5 percent because of higher gold prices and the recovery of gold production.

3. Poverty has declined further. According to our statistics, 44 percent of our population were poor at end-2002, 8 percentage points less than at end-2000. At the same time, however, poverty remains too high and poverty reduction remains our first priority.

4. We will reduce the fiscal deficit to 4.9 percent of GDP in 2003—an improvement of about 0.5 percentage point of GDP compared to 2002. The central government fiscal deficit target for end-September 2003 was exceeded by 0.2 percent of GDP because of a smaller-than-programmed European Union (EU) grant and natural disasters in the south of the country earlier in the year (Table 1). We believe that this deviation was minor and temporary, and it does not undermine program objectives. Therefore, we request a waiver of this performance criterion under the PRGF arrangement.

5. The targets for tax collection were met, and there were no budgetary arrears as monitored under the program. Social spending (i.e., health, education, and social benefits) has increased relative to GDP—from 12.1 percent in 2001 to a projected 13.8 percent in 2003. Regarding tax policy, we have modified the cigarette excise tax to eliminate the differential excise rates between domestically-produced and imported products (structural benchmark at end-September). We have also made progress in implementing the VAT to large-scale agriculture and publishing valuation guidelines for the real property tax. However, local authorities will still need some time to finalize their property tax procedures and start collection. Regarding tax administration, we have reduced tax arrears by som 270 million since January 1, 2003 and transferred 40 large taxpayers to the newly restructured Large Taxpayers Unit (LTU), as committed under the program.

6. Monetary conditions have been appropriately tight and remonetization has continued. The National Bank of the Kyrgyz Republic (NBKR) purchased $19 million from the foreign exchange market during April-September 2003 and the adjusted end-September program floor for net international reserves (NIR) was exceeded by 9 percent of reserve money. Part of the foreign exchange inflow was sterilized through accumulation of government deposits in the central bank as well as through the NBKR’s active use of open market operations. As a result, its net domestic assets (NDA) remained below the adjusted end-September program ceiling by 2 percent of reserve money. Som broad money has continued to expand rapidly although the growth rate dropped from 34 percent during 2002 to an annualized rate of 23 percent during the first nine months of 2003.

7. Banking reforms have advanced. We have carried out most measures under the 2003-05 reform program. To meet the program’s structural benchmark at end-September 2003, amendments to the Law on Audits and the Law on Banks and Banking Activities have been submitted to parliament to strengthen commercial bank auditing. Progress in divesting Kairat Bank has, however, been slower than expected. The further delay in issuing the privatization tender (structural benchmark at end-September) was due to the prolonged process of hiring foreign privatization advisors and largely beyond our control. We now expect the tender to be issued by end-November 2003 and have already made a public announcement to that effect. Our work on developing strategies for the other two state-owned financial institutions (Savings and Settlement Corporation, SSC, and Kyrgyz Agriculture Finance Corporation, KAFC) is ongoing.

8. We have fulfilled about half of the measures under the governance agenda agreed in 2002. Among other measures, a corruption survey has been published and the National Integrity Council has begun its work. In addition, fiscal bulletins and a Medium Term Fiscal Framework (MTFF) have been made public. Also, functional reviews of several ministries have been completed. In addition, the legal appeal system has been simplified and extrajudicial arbitration is now possible.

9. The electricity sector quasi-fiscal deficit (QFD) amounted to 6.3 percent of annual GDP in January–June 2003, slightly more than half the program’s indicative target for the year as a whole (11.7 percent). However, improving cash collection and reducing losses during the remainder of the year should keep the electricity sector QFD below the program ceiling for end-2003. We expect to complete the sale of KyrgyzTelekom by end-2003.

10. We have now completed our discussions on bilateral debt rescheduling agreements as committed under our Paris Club agreement. The agreements with China and Uzbekistan were signed in July 2003; those with India and Pakistan in November. Negotiations with the Kuwait Fund have, however, been unsuccessful.

III. PROGRAM FOR THE PERIOD OCTOBER 2003–SEPTEMBER 2004

Program Objectives, Economic Strategy, and Macroeconomic Framework

11. The Kyrgyz economy has been developing broadly as targeted under our three-year economic program supported by the IMF. We have streamlined the externally financed Public Investment Program (PIP), and the fiscal adjustment has helped maintaining domestic savings while the use of foreign financing has declined. These developments are consistent with our external debt reduction strategy. With tight fiscal policies in the coming years, further increases in public savings and maintaining the level of private savings are projected. The total investment ratio is projected to reach 19½ percent of GDP in 2007. Achieving this level requires a 4 percentage points of GDP increase in private investment. About half of this increase is expected from foreign direct investment (FDI), including investments in our gold deposits.

12. The strategy for achieving our macroeconomic objectives remains largely unchanged. The growth strategy will continue to focus on strengthening structural policies, including in the energy sector, where reductions in the electricity sector QFD are needed in order to avoid undermining our stabilization efforts. For both FDI and domestic investment it is critical that the investment climate improves, which calls for strong policies to improve governance, reduce corruption, and continue financial sector reforms. The major macroeconomic constraint—the high external debt—will require continued fiscal consolidation to be achieved through more efficient revenue mobilization and some decline in the expenditure-to-GDP ratio. Export diversification is needed to offset the impact of the declining trend in gold production. This will require prudent monetary and fiscal policies to contain wage inflation. This, with our ambitious structural reform agenda should improve productivity and should ensure adequate cost competitiveness in the medium term.

13. Overcoming the challenges imposed by the debt overhang and dependence on a few export commodities is especially important because of the restrictive trading environment in our neighboring countries. In this respect, we expect that the accession process to the World Trade Organization (WTO) under way for Russia and Kazakhstan will help in the medium term. Meanwhile, we call on the International Financial Institutions to assist us in seeking agreements with neighboring countries to facilitate trade and reduce trade restrictions.

14. The fragile fiscal position and high debt level severely limit our scope for financing social spending through higher fiscal deficits. Thus, poverty reduction must rely largely on economic growth, more effective service delivery, strengthened spending priorities, donor grants, and better targeting of social benefits. While protecting social spending to provide room for reducing distortionary production taxes, we will continue to improve tax collection, including through efficient implementation of the new agricultural VAT, property taxation, and the restructured LTU.

15. We recognize that fiscal discipline is the main challenge for the third annual program to avoid triggering macroeconomic imbalances. Failure would undermine the prospects for the Paris Club debt relief needed for debt sustainability and for covering the projected balance of payments financing gap in the second half of the decade.

16. We have revised the macroeconomic framework for 2004 and now expect real GDP growth to slow to 4.1 percent because of the decline in gold production. This forecast includes growth of 5–6 percent of non-gold industrial production and agriculture. The 12-month rate of inflation is projected at 3.8 percent, reflecting partly the implementation of the agricultural VAT and higher administered prices. Although gold exports are projected to decline, a recovery in energy exports and buoyant demand from Russia and Kazakhstan are expected to lead to a small increase in overall exports. Imports would grow faster, however, with expanding domestic demand driven by investment, including through construction of a new gold mine. The current account deficit would be higher, at 4.2 percent of GDP, with the reserve coverage rising to 5.0 months of imports.

17. The following sections specify further our intentions in fiscal, monetary and exchange rate, external, as well as structural policies for the period October 1, 2003–September 30, 2004.

Fiscal Policies

18. We will cut expenditures by som 495 million (0.6 percent of GDP) in the last quarter of 2003 to keep the fiscal program on track. The measures include: (1) postponing the wage increases for the military and security services, the national guard, and the military prosecutors to January 1, 2004 (som 35 million)—the delay will be compensated in the 2004 budget; (2) reducing budget transfers to various government agencies (som 60 million); (3) postponing capital repair (som 30 million); (4) reducing planned travel expenditures (som 40 million); (5) cutting planned purchases of equipment (som 70 million); (6) reducing expenditures on public utilities (som 50 million) and transportation (som 20 million); (7) cutting spending on other goods and services (som 130 million); and (8) postponing domestically financed capital expenditures (som 60 million). We will take additional measures to meet the 2003 fiscal deficit target of 4.9 percent of GDP, if the need arises. All government agencies will have to start acting immediately to implement this package.

19. We intend to reduce the fiscal (cash) deficit further from a projected 4.9 percent of GDP in 2003 to 4.4 percent in 2004. This consolidation stems from both the mobilization of additional tax revenues (equivalent to 0.5 percent of GDP) and the rationalization of expenditures (equivalent to 0.1 percent of GDP). The increase in the state government tax ratio will require prompt implementation of the recent tax legislation on the agricultural VAT and the property tax. Expenditure discipline is especially important in the non-priority sectors and for new investment projects. We recognize that passage by parliament of the 2004 State and Social Fund budget laws consistent with this memorandum will be a prior action for completion of the fourth review under the PRGF arrangement.

20. The extension of the VAT to direct sales of large agricultural producers will expand the tax base in 2004. The additional revenue collection is estimated to be equivalent to 0.3 percent of GDP, and more in later years. Our fiscal program also assumes that all local authorities will have in place their property tax legislations in January 2004, increasing our annual revenues forecast by 0.1 percent of GDP. This estimate takes into account revenue losses from repealing several local taxes (such as the resort and hotel taxes) to gradually make the property tax the primary revenue tool of local governments, thereby improving the efficiency of revenue collection.

21. Effective April 1, 2004, we will introduce (as a structural benchmark) a package of tax policy measures that will improve the efficiency of the revenue system and lower administration costs. These measures include: (1) aligning the general VAT threshold more closely to international practice and unifying it with that applied to agriculture (raising it from som 300,000 to som 500,000); (2) restructuring the current small business tax to be more consistent with the new VAT threshold—it will apply to small businesses below the threshold instead of the profit tax, VAT, road tax, and emergency tax; (3) reviewing the current list of VAT exemptions to ensure that goods sold for final consumption are not inappropriately exempt from VAT; and (4) zero rating exports of services and defining the place of supply consistent with best international practices. Regarding the patent tax system, we will reduce the scope of voluntary patent taxes, including by increasing the tax amounts for voluntary patent taxes by 25 percent on average to provide incentive to register under the small business tax scheme. We will not expand the existing application of the mandatory patent tax beyond what has been agreed in previous MEPs.

22. Tax administration will benefit from strengthening further the LTU. In particular, we will start operating a separate enforcement unit under the LTU in January 2004. A proper self-assessment system will be made operational for 30 percent of large taxpayers in April 2004 and for all of them in January 2005. The criteria for selecting large taxpayers will be published by January 1, 2004. In addition, we will reduce the stock of outstanding VAT refunds due to large taxpayers (som 69 million) by 50 percent by end-September 2004. No new net arrears will be accumulated beginning October 1, 2003, and all refunds will be in cash (no offsets or in-kind payments).

23. We project 2004 total expenditures (excluding net lending) to remain below 2003 levels measured in percent of GDP. Most importantly, the increase in the wage bill (including Social Fund contributions) will be confined to a 15-percent increase for teachers, nurses, and doctors on April 1, 2004. A further increase is scheduled for October 1, 2004 in order to bring the overall increase during the year to 30 percent assuming that resources are available. This will be discussed with the IMF staff during the fifth review mission in May 2004. The rationalization of public sector employment could create room for increasing other public sector wages in 2004. The annual pension bill will rise by 7 percent as a result of increasing the monthly base pension from som 200 to som 222.6 on January 1, 2004, and the average monthly pension by 9 percent on April 1, 2004. The envelope also includes som 1,128 million in state budget transfers to the Social Fund (excluding the package of social compensation for higher electricity user costs described below). Consistent with the medium term strategy of containing borrowing under the PIP, the externally financed PIP will be further streamlined from a projected 3.7 percent of GDP in 2003 to 3.6 percent (som 3,212 million) in 2004.

24. The proposed fiscal program includes social compensation of 0.2 percent of GDP conditional on rising user costs of electricity. This package includes a som 15 increase in the Unified Monthly Benefit (net of the base increase) and a som 10 increase in specific monthly tariff compensation for pensioners. In addition, we are going to utilize the existing compensation mechanism, such as discounted tariffs for selected groups and a flat subsidy to low income households, while understanding these measures need to be streamlined in the future. The additional transfer to the Social Fund needed for this compensation package is som 63 million.

25. To tighten expenditure control, we will refrain from issuing any decrees or other legislation that would result in unbudgeted expenditures unless offsetting expenditure savings have been identified in the same decree or legislation. This policy will be made effective immediately. A new Medium Term Fiscal Framework (MTFF) for 2005-2007 based on key line ministries’ quantified medium-term policy plans will be approved and published by the Economic Policy Council (EPC) by end-March 2004 (a structural benchmark).

26. The coverage of fiscal performance criteria under the program will remain unchanged. They include cash tax collections of the state and Social Fund budgets, the cash deficit of the state budget, and avoidance of budgetary arrears in wages, pensions, categorical grants, mandatory transfers to the Social Fund, energy bills to the former KyrgyzEnergo distribution companies, allowances to poor families, and Social Fund transfers to the Medical Insurance Fund.

Monetary and Exchange Rate Policies

27. Our monetary program is designed to keep inflation below 4 percent. The expected increase in money demand, reflected in a 9-percent decline in som velocity, would be accommodated by 20-percent som broad money growth during the program period. Accounting for a rising money multiplier with more confidence in the banking sector, reserve money is programmed to grow by 16 percent during the program period. The NBKR stands ready to use open market operations to slow the expansion of monetary aggregates in case we perceive any sign of rekindling inflation. Fiscal consolidation and the expected donor financing should support an increase of NIR by $32.8 million during the program period. The expected surplus in the primary fiscal balance (excluding the foreign financed component of the PIP) should reduce NDA by som 42 million.

28. The NBKR will continue its exchange rate policy of managed floating. It will intervene on the foreign exchange market only to smooth temporary variations of the nominal exchange rate and to strengthen the official foreign reserve position. In our medium term strategy, we believe that the tradable goods sector’s competitiveness is better served by containing price and wage inflation rather than by a nominal exchange rate depreciation.

External Sector Policies

29. We will maintain a free trade and exchange regime. In particular, we continue to apply under the third year program the continuous performance criterion on not imposing or intensifying restrictions on payments and transfers for current international transactions, introducing multiple currency practices, or concluding bilateral payments agreements that are inconsistent with the IMF’s Article VIII. We will also refrain from imposing new or intensifying existing import restrictions for balance of payments reasons, such as seasonal tariffs or non-tariff barriers on agricultural and other imports and honor our commitments under regional trade agreements. We will address trade restrictions in the region through regional initiatives, the WTO, and in the context of the CIS-7 initiative. In particular, we will continue our discussions with Uzbekistan and propose to Kazakhstan negotiations on harmonizing investment regulations and non-tariff barriers in transit transportation. We will further promote free regional trade on our part by simplifying our transit transportation policies as well as customs procedures. More generally, we will review regional trade arrangements to identify overlaps and regularize our trade agreements. We will also publish a database of legislation and regulations governing foreign trade. As part of our efforts to diversify the export base of the Kyrgyz economy, we will develop a market based export promotion strategy for discussion with the IMF staff.

Structural Policies

30. We will continue our 2003-05 banking sector reform program during the third year of the PRGF arrangement (Box 1). While the privatization of Kairat Bank, now expected in mid-2004, should proceed smoothly, a reputable international firm will finalize by end-June 2004 an external audit of the 2003 financial statements of KAFC as well as an assessment of its loan portfolio. On this basis, we will assess the operational sustainability and financial viability of KAFC and develop options for its future institutional reform. Meanwhile, no banking license will be issued for KAFC. An IAS-based audit by an international reputable firm will be conducted for the SSC by end-June 2004. We will also continue strengthening bank supervision both through strengthening banking legislation and improving the efficiency of the bank inspection process. In particular, by end-March 2004, we will identify amendments to existing legislation needed to ensure that banking regulation is not undermined by legal inconsistencies. We will also propose to parliament amendments to the Law on Banks and Banking Activities concerning consolidated supervision of banks and bank holdings, in line with the Basle Core Principles for Effective Banking Supervision. In this context, the 15-percent maximum ownership threshold for financial institutions on bank capital would be lifted. Furthermore, the NBKR will adopt by end-January 2004 the new supervisory manual. Regarding deposit insurance, we will draft a concept paper by end-March 2004 that will identify the required funding of the scheme and other necessary prerequisites for its introduction in the medium term. We will adopt several measures aimed at improving corporate governance within banks, including through increasing the accountability of employees of banks and other financial institutions. Finally, the NBKR will continue modernizing the payments system with assistance from the World Bank.

31. Regarding the compensation of depositors for their lost savings, we will issue by end-November 2003 a third government resolution that will regulate the compensation (up to
som 10,000) of the individual depositors of the three failed commercial banks, with the maturity and interest rate mentioned in the June 2003 supplementary MEP. The bonds will be negotiable to provide an opportunity for those depositors who prefer cash to sell them in the market. The NBKR will, however, not make a market for these securities nor purchase them on its own account.

32. The fact that several governance indicators place the Kyrgyz Republic behind the more advanced reformers among the CIS countries, including Russia, requires strong action by the government (Box 2). The government will concentrate on fiscal transparency and improving its internal organization. Under the third year program, the National Integrity Council (NIC) has begun its work. In the coming months, the NIC will elaborate a strategy to reform the system of governance to respond to medium- and long-term development priorities set in the National Poverty Reduction Strategy paper and in the Comprehensive Development Framework (CDF). Furthermore, we will reorganize by end-September 2004 the structure and management system of the Ministry of Agriculture headquarters according to a December 2002 agreement with the EU Food Security Program. By end-September 2004, we will also develop proposals to reorganize the regional structure of the Ministry of Agriculture and all agencies reporting to it, including oblast and rayon subordinated units. The other remaining governance agenda will be carried out under the World Bank and Asian Development Bank (ADB) lending operations.

33. We will reduce the electricity sector quasi-fiscal deficit by som 995 million (2 percentage points of GDP) in 2004. To achieve this indicative target under the program, we will use tariff policy and measures to increase cash collection and reduce losses. The targets for end-June and end-December 2004 are set at som 4,900 million and som 8,650 million, respectively.

IV. PROGRAM MONITORING

34. To monitor policy implementation under the third-year program, we have set out several quantitative and structural performance criteria and benchmarks for end-March as well as end-September 2004 (Tables 2 and 4). We understand that there may be an opportunity to update the quantitative performance criteria and indicative targets for end-September in the context of the fifth review, which we expect to be completed by end-June 2004. Detailed definitions of the quantitative targets appear in the Technical Memorandum of Understanding (TMU) (Annex 1).

35. The Government and the NBKR believe that the policies set forth in this memorandum are adequate to achieve the objectives of the economic program, but they will take any further measures that may become appropriate for this purpose. The Kyrgyz Republic will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEP, in accordance with the Fund’s policies on such consultation.

Box 1. Banking Sector Reform Program for 2004 Bank supervision and regulatory framework 1. Submit to parliament amendments to the Law on Banks and Banking Activities concerning consolidated supervision of banks and bank holdings, including the elimination the 15 percent maximum ownership threshold for financial institutions on bank capital—by end-December 2003. (IMF) 2. Adoption by the NBKR of the new supervisory manual—by end-January 2004. (IMF) 3. Identify amendments to existing legislation to ensure that banking legislation is not undermined by legal inconsistencies—by end-March 2004. (IMF) 4. Submit to parliament amendments to the AML/CFT law to reflect the June 2003 recommendations by the Financial Action Task Force on Money Laundering (FATF)—by end-March 2004. (IMF) 5. Prepare, in close coordination with the IMF, a concept paper on deposit insurance that will identify the required funding of the scheme and the other necessary prerequisites for its introduction in the medium term—by end-March 2004. (IMF) 6. Submit to parliament amendments to the Bank Secrecy Law and the Law on Banks and Banking Activity to eliminate inconsistencies with the Basle Principles regarding bank secrecy. In particular, allow the disclosure of confidential information to foreign banking supervision agencies based on bilateral agreements—by end-September 2004. (IMF) 7. Submit to parliament amendments to the Code of Administrative Liability and the Law on Banks and Banking Activity to increase monetary fines levied against employees of banks and financial institutions that are licensed and regulated by the NBKR—by end-September 2004. (IMF) 8. Ensure compliance with NBKR requirement to raise, by end-2005, minimum own capital to som 60 million. (IMF) 9. Require banks to produce their 2003 and subsequent financial statements in accordance with IAS. (IMF, WB) State-owned banks 1. Issue a privatization tender for Kairat Bank—by end-November 2003. (WB) 2. Conduct an IAS-based audit by an international reputable firm for the SSC—by end-June 2004. (IMF, WB)3. Complete external audit of the 2003 financial statements of KAFC as well as the assessment of its loan portfolio, both conducted by a reputable international firm—by end-June 2004. (IMF, WB)

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ANNEX 1

TECHNICAL MEMORANDUM OF UNDERSTANDING

1. The Kyrgyz Republic’s performance under the third-year PRGF-supported program will be assessed by the IMF on the basis of the observance of quantitative performance criteria and structural benchmarks. This annex and the tables attached to the MEP define the quantitative performance criteria and indicative targets (Table 2 attached to the MEP), the structural benchmarks (Table 3 attached to the MEP), as well as the monitoring requirements¹.

I. QUANTITATIVE TARGETS

2. Quantitative targets (i.e., quantitative benchmarks for end-December 2003, quantitative performance criteria for end-March and end-September 2004, and indicative targets for end-June and end-December 2004) are defined below and summarized in Table 2 of the MEP. The performance criteria for end-September 2004 and indicative targets for end-June and end-December 2004 can be updated in the context of the fifth review.

Floor on net international reserves of the NBKR in convertible currency

3. The program contains a floor on the stock of net international reserves of the NBKR in convertible currencies. This floor will be calculated as the difference between total gross international reserves in convertible currencies at the NBKR and total international reserve liabilities of the NBKR in convertible currencies.

4. Total gross international reserves of the NBKR shall be defined as the NBKR holdings of monetary gold, holdings of SDRs, any reserve position in the IMF, and any holdings of convertible currencies in cash, debt instruments (including accrued interest) or with foreign banks. Amounts pledged as collateral or in swaps or otherwise blocked, capital subscriptions in foreign financial institutions, and non-liquid assets of the NBKR are excluded. Excluded are net forward positions, defined as the difference between the face value of foreign currency denominated NBKR off-balance sheet claims on non-residents and foreign currency obligations to both residents and non-residents. In addition, net claims on other BRO countries are excluded from the ceiling. For program monitoring purposes, gross international reserves shall be valued at a fixed program exchange rate of som 44 per U.S. dollar ($) and $1.4318 per SDR. Official gold holdings shall be valued at $384.6 per troy ounce. Program cross exchange rates are listed in Table 13 below.

5. Total international reserve liabilities of the NBKR in convertible currencies shall be defined as outstanding liabilities to the IMF and other convertible currency liabilities of the NBKR to non-residents with an original maturity of up to and including one year. For program monitoring purposes, total international reserve liabilities shall be valued at the program exchange rates. Thus calculated, the stock of net international reserves in convertible currencies amounted to $129.7 million as of September 30, 2003.

6. The program floors on the NIR of the NBKR in convertible currencies are reported in Table 1 below.

7. The floor on net international reserves of the NBKR will be adjusted: (i) upward/downward by 100 percent for any excess/shortfall in net foreign financing of the sate government budget and cash grants; and (ii) upward/downward by 100 percent for any excess/shortfall in cash privatization receipts. Valued at the program exchange rate, the programmed cash privatization receipts are equivalent to $2.75 million in the fourth quarter of 2003 and $1.75 million in the fourth quarter of 2004. The adjustment for shortfalls in adjustors (i) and (ii) is to be limited to $15 million each, valued at the program exchange rate. In the case of a release of the NBKR’s pledged foreign reserves, the NIR floor will be adjusted upward/downward by 100 percent for any excess/shortfall in the net effect of the releases and related amortization payments. The programmed net effect is $0.36 million in the fourth quarter of 2003 and the first and second quarter of 2004, and $0.12 in the third quarter of 2004.

8. ‘Net foreign financing and cash grants’ is defined as balance of payment support loans plus cash grants to the state government budget plus any changes in the balance of unused PIP funds held in the NBKR minus amortization payments by the Ministry of Finance and NBKR (excluding repayments to the Fund). This definition applies to the adjustors to NIR and NDA. The programmed cumulative net foreign financing is as follows (Table 2). The balance of unused PIP funds was equivalent to $0.033 million on September 30, 2003.

Ceiling on the net domestic assets of the NBKR

9. Net domestic assets of the NBKR are defined as reserve money of the NBKR (defined below) minus the NBKR’s net foreign assets² minus the medium- and long-term NBKR obligations (MLT) minus the counterpart of the loan by the Eximbank of Turkey minus the counterpart of the EBRD and IDA enterprise loans (see equation 1 below).

(1) NDA=RM—NFA—MLT—Turkish Loan—EBRD-IDA Enterprise Loan

10. Thus defined, the NBKR’s net domestic assets consist of: (a) gross credit to the general government from the NBKR minus deposits of the general government with the NBKR minus the counterpart of the loan by the Eximbank of Turkey; (b) gross credit to domestic banks by the NBKR minus the counterpart of the EBRD and IDA enterprise loans; and (c) all other net assets of the NBKR (other items net). Thus defined, the stock of the NBKR’s net domestic assets amounted to som 1,968 million on September 30, 2003.

11. The program ceilings on the NDA of the NBKR are reported in Table 3 below.

12. The ceiling on net domestic assets of the NBKR will be adjusted: (i) downward/upward by 100 percent of the excess/shortfall in net foreign financing of the state government budget and cash grants; and (ii) downward/upward by 100 percent of the excess/shortfall of cash privatization receipts, both programmed as described above. The adjustment for shortfalls in adjustors (i) and (ii) is to be limited to $15 million each, valued at the program exchange rate, excluding the amortization payments for the release of the NBKR’s pledged foreign reserves.

Ceiling on the cumulative fiscal deficit of the state government

13. The ceiling on the state government fiscal deficit is defined as the negative sum of: (i) the change in the stock of net claims of the domestic banking system and nonfinancial institutions—including state-owned enterprises and public companies—and households on the state government; (ii) the change in the stock of net claims of the foreign banking system and nonfinancial institutions and households on the state government; (iii) net privatization receipts; (iv) net foreign loans disbursed to the state government for budgetary support; (v) net foreign loans disbursed to the state government for project financing; and (vi) rescheduling of bilateral debt (principal and interest payments), following the Paris Club agreement. The fiscal balance will be measured at the program exchange rates, excluding valuation gains and losses on all foreign currency denominated assets and liabilities arising from exchange rate fluctuations. Thus defined, the cumulative fiscal deficit of the state government since October 2002 amounted to som 4,572 million as of September 30, 2003.

14. The change in the stock of net claims of the domestic and foreign banking systems on the state government is defined as the change in the stock of claims of these banking systems on the state government less the change in the stock of all deposits of the state government with these banking systems. The claims of these banking systems on the state government include: (i) bank loans to state government; (ii) securities or bills issued by the state government held by banks with the exception of those issued in relation with bank rescue operations; and (iii) overdrafts on the current accounts of the state government with banks.

15. The program ceilings on the cumulative fiscal deficit of the state government are reported in Table 4 below.

Cumulative floor on state government tax collections in cash

16. Tax collections in cash correspond to the line “IV. Tax Receipts” in the Treasury Report and comprise the following categories: 1.0 taxes on income and profits; 4.0 taxes on property; 5.1 VAT on domestic and imported products; 5.1.1.0 retail sales tax; 5.2 excises on domestic and imported products; 5.4 specific taxes on services; 5.5 taxes on use of goods and services; 5.6 taxes on use of natural resources; 6.0 taxes on international trade; 7.0 other taxes. Thus defined, cumulative tax collections in cash since October 2002 amounted to som 11,442 million as of September 30, 2003. Cumulative tax collections in cash include collections of tax arrears but exclude tax offsets.

17. The program floors for the cumulative tax collection in cash are reported in Table 5 below.

Ceiling on the stock of central government budget arrears

18. For the purposes of the program, central government budget arrears are defined as an overdue payment obligation of the Republican budget arising since the start of the three-year program period (October 1, 2001) and related to: (i) wages; (ii) Social Fund payroll contributions; (iii) mandatory transfers to the Social Fund; (iv) categorical grants; (v) payments of electricity bills; and (vi) allowances for poor families. A payment is defined to be overdue if it remains unpaid after its due date for (iii) and (iv); for 30 days after its due date for (i) and (ii); for 60 days after its due date for (v); and for 40 days after its due date for (vi). As of September 30, 2003, the stock of thus defined central government budgetary arrears was zero.

19. The program ceilings on the stock of central government budget arrears are reported in Table 6 below. No new arrears will be accumulated by the central government.

Ceiling on the stock of Social Fund pension arrears

20. A pension payment by the Social Fund is defined as overdue if it has come due since the start of the three-year program period (October 1, 2001) and remains unpaid for 30 days or more after its due date. As of September 30, 2003, the stock of pension arrears was zero.

21. The program ceilings on the stock of Social Fund pension arrears are reported in Table 7 below. No new pension arrears will be accumulated.

Floor on the Social Fund payroll tax collections in cash

22. Payroll tax collections in cash correspond to the total contributions collected by the Social Fund from both employers and employees for a given period. Thus defined, social fund payroll tax collections in cash since October 2002 amounted to som 3,602 million as of September 30, 2003.

23. The program floors for the Social Fund tax collections in cash are reported in Table 8 below.

Ceiling on the stock of Social Fund arrears to the Medical Insurance Fund

24. Social Fund arrears to the Medical Insurance Fund are defined as overdue transfer obligations of the former to the latter as defined by law and refer to arrears incurred starting January 1, 2002. A transfer is defined to be overdue if the value date of any transfer obligation is more than 5 business days after the due date. Thus defined, total arrears of the Social Fund to the Medical Insurance Fund amounted to soms 10 million on September 30, 2003.

25. The program ceiling on the stock of Social Fund arrears to the Medical Insurance Fund are reported in Table 9 below. No new arrears will be accumulated to the Medical Insurance Fund.

Ceiling on the quasi-fiscal deficit of the electricity sector

26. The quasi-fiscal deficit (QFD) of the electricity sector is defined as cost of production minus cash revenues:

(1) QFD=Q*MC — R;

(2) Q = 1/(1-)*( Ci);

(3) R = ( Ci) * T * Ccash,

where:

Q is the domestic supply (generation plus import minus export) minus normative losses;

MC is the marginal cost of production required for efficient supply of Q;

R is the total cash revenue;

Ci is the sum of consumption by all end-users (households, industry, agriculture, budgetary institutions, and other);

is the annual average loss rate of excessive (i.e., above normative) technical and commercial losses in percent of Q;

T is the annual weighted average of posted (or nominal) tariffs for end-users; and

Ccash is the ratio of annual average cash collections to total billing to end-users.

27. For the purposes of the program, the marginal cost is equal to U.S. cents 2.3 per kilowatt hour, and normative losses (including own use) are defined as 15 percent of domestic supply. Total billing of end-users is defined as consumption times the posted nominal tariff. The cash collection component is the amount of bills paid in cash to the energy companies, and excludes any form of cash-to-cash settlements, off-sets, barters, or other non-cash payments. Thus defined, the QFD in the electricity sector amounted to som 9,024 million (or 12.0 percent of GDP) in 2002. The indicative ceiling on the quasi-fiscal deficit in the electricity sector is as follows (Table 10).

Ceilings on contracting or guaranteeing of new external debt by the state government of the Kyrgyz Republic or the NBKR or any other agency acting on behalf of the state government

28. In connection with the contracting or guaranteeing of external debt by the state government of the Kyrgyz Republic, the NBKR, or any other agency acting on behalf of the state government of the Kyrgyz Republic, ‘debt’ is understood to have the meaning set out in point 9 of the Guidelines on Performance Criteria with respect to External Debt in Fund arrangements (Decision No. 12274-00/85, dated August 24, 2000)³.

29. External debt ceilings apply to (i) the contracting or guaranteeing of short term external debt (i.e. external debt with an original maturity of less than one year, except normal import-related credits and NBKR reserve liabilities); and to (ii) contracting or guaranteeing of nonconcessional medium- and long-term external debt (i.e., external debt with an original maturity of one year or more). Disbursements by the Fund from the PRGF Trust are excluded from the ceilings on external debt. Also excluded from these external debt ceilings is the contracting or guaranteeing of new external debt that constitutes a rescheduling or refinancing of existing external debt at terms more favorable to the debtor. The limit on the contracting or guaranteeing of short-term external debt is zero on a continuous basis throughout the period of the arrangement. The limit on the contracting or guaranteeing of medium- and long-term external debt is zero as specified in Table 2 of the MEP.

30. For program purposes, a debt is considered concessional if the grant element is at least 45 percent, calculated by using currency specific discount rates based on the Commercial Interest Reference Rates (CIRRs) published by the OECD. A lower grant element will be considered only for new debt committed to replace old debt originally contracted at less favorable terms. The average of the CIRRs over the last 10 years will be used for debts with a maturity of at least 15 years and the average CIRR of the preceding six months will be used for shorter maturities.

Ceiling on new external payments arrears

31. For the purposes of the program, external payments arrears will consist of all debt-service obligations (i.e., payments of principal or interest) arising in respect of any debt contracted or guaranteed or assumed by the state government of the Kyrgyz Republic, or the NBKR, or any agency acting on behalf of the state government of the Kyrgyz Republic since the Kyrgyz Republic’s independence, including, without limitations, unpaid penalties. interest charges or judicially awarded damages associated with these arrears owed by the state government of the Kyrgyz Republic, or the NBKR, or any agency acting on behalf of the state government of the Kyrgyz Republic, on imports received subsequent to independence. The ceiling on new external payments arrears shall apply on a continuous basis throughout the period of the arrangement. It shall not apply to external payments arrears arising from external debt being renegotiated with external creditors, including Paris Club creditors; and more specifically, to external payments arrears in respect of which a creditor has agreed that no payment needs to be made pending negotiations.

Ceiling on reserve money

32. For the purposes of the program, reserve money consists of currency issued by the NBKR and balances on commercial banks’ correspondent accounts with the NBKR. The stock of reserve money amounted to som 8,672 million as of September 30, 2003. The indicative program limits are reported in Table 11 below.

II. REPORTING REQUIREMENTS UNDER THE PROGRAM

33. The government and the NBKR will provide the Fund with the necessary economic and financial statistical data to monitor economic developments and the quantitative targets. In particular, the government and the NBKR will provide the following specific information⁴:

The balance sheet of the NBKR

34. The NBKR will provide to the Fund its balance sheet every Monday. The information provided will clearly identify the following items in the definitions specified above: the gross foreign assets and liabilities of the NBKR, decomposed by currency and instrument for the assets and by currency and creditor for the liabilities; the net foreign assets of the NBKR; the net international reserves of the NBKR; medium- and long-term liabilities; the net domestic assets of the NBKR; net credit from the NBKR to the general government; net credit from the NBKR to commercial banks; the balance of unused PIP funds held in the NBKR; other items net; and reserve money. The balance sheet will be provided valued at the actual exchange rate as well as according to the valuation applied under the program, as specified in Section I. The above information will be provided to the IMF Resident Representative and/or transmitted by e-mail to the Fund.

Monetary survey

35. Monthly banking system data, in the form of a monetary survey, will be reported to the Fund by the NBKR within 14 days of the end of the month. The information provided will clearly identify the following items: net foreign assets and net domestic assets of the banking system, medium- and long-term liabilities, net credit from the banking system to the general government, financing provided to the rest of the economy, other items net, and broad money. The monetary survey will be provided valued at the actual exchange rate as well as according to the valuation applied under the program, as specified in Section I.

36. The NBKR will provide monthly data to the Fund within seven days after the end of the month on the amount of holdings of treasury bills, GKOs, state obligations, state bonds, and other securities issued by the state government, differentiated by the following categories of holders: the NBKR, resident banks, resident nonbanks, and nonresidents. The information will be provided in both the book (nominal) value and the actual value, where applicable.

International reserves and key financial indicators

37. The NBKR will provide detailed monthly data within 14 days from the end of the month on the composition of both its gross and net international reserves in convertible currencies and holdings of monetary gold. These data will be provided at two alternative sets of the exchange rates and the gold price: first, at those used to derive the NFA position in the NBKR accounts; second, at those specified in the program (Section I). In addition, weekly reports should be sent to the Fund every Monday on: (a) exchange rates (including the official and interbank exchange rates), foreign exchange interbank market turnover, and the volume of NBKR foreign exchange sales and purchases in the interbank market and with other parties; and (b) treasury bill yields and the amount of treasury bill sales and redemptions. On the 25th day of the month following the reference month, the NBKR will provide indicators of financial soundness of the banking system, including the ratios of regulatory capital to risk-weighted assets, non-performing loans to total loans, and return on equity, as well as data on bank deposit and lending rates by maturity.

Banking system data

38. The NBKR will provide detailed bank-by-bank data within 14 days of the end of the month on commercial banks’ compliance with: (a) prudential requirements; and (b) reserve requirements, as well as any penalties, sanctions and other administrative actions imposed on banks.

External debt

39. The Ministry of Finance, together with the NBKR, will provide monthly information on the disbursements, principal and interest payment—both actual and falling due; on contracting and guaranteeing of medium- and long-term external loans by the state government and the NBKR; and any stock of outstanding arrears on external debt service payments within 21 days of the end of each month. In addition, the Ministry of Finance will also report the total amount of outstanding government guarantees and external arrears on a monthly basis. While the NBKR will provide the debt service payment data on private debt, the Ministry of Finance will provide data on debt service on public and publicly guaranteed loans.

Budgetary and extrabudgetary data

40. In addition to the monthly treasury report, the Ministry of Finance and the Social Fund will report monthly on all their recorded expenditure arrears, in particular on those defined above in this TMU. This information will be provided to the Fund staff within 26 days from the end of each reference month. The Ministry of Finance will also provide monthly reports on the disbursements and use under the public investment program and budgetary grants with a one-month time lag.

41. The State Energy Agency, in consultation with the Ministry of Finance and the World Bank, will submit to Fund staff in March and September 2004 their semi-annual report on the QFD in the electricity sector according to the format specified in Table 12 below.

Balance of payments data

42. The NBKR will provide current account and capital account data, including data on foreign trade, services, official and private transfers, foreign investment, and disbursements of public and private loans, on a quarterly basis, with at most a two-month lag. The NBKR will also provide monthly foreign trade data with a two-month lag.

Other general economic information

43. The National Statistics Committee will notify the Fund of the monthly Consumer Price Index by category by the 5th business day of the following month, and convey quarterly GDP estimates within two months of the end of each quarter.

¹ Central government and Republican government are synonymous in this memorandum. State government comprises central and local governments. General government comprises state government and Social Fund finances.
² The NBKR’s net foreign assets consist of net international reserves, as defined in this TMU, plus other foreign assets plus the net claims on other BRO countries.
³ Debt is understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows: (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements); (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

Under the above definition of debt, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
⁴ Any correction or revisions to the data previously reported should be clearly indicated and documented as to the reasons for revision.