Kyrgyz Republic—Supplementary Memorandum of Economic Policies and Technical Memorandum of Understanding
Bishkek, Kyrgyz Republic
June 11, 2004

The following item is a Letter of Intent of the government of Kyrgyz Republic, which describes the policies that Kyrgyz Republic intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Kyrgyz Republic, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Rodrigo de Rato
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. de Rato,

1. This Supplementary Memorandum of Economic Policies (SMEP) updates our Memorandum of Economic Policies (MEP) dated December 15, 2003, which describes the economic policies supported by the International Monetary Fund under a three-year Poverty Reduction and Growth Facility (PRGF) arrangement. The SMEP supplements the policies detailed in the MEP for the period April-September 2004, as well as earlier memoranda under the current IMF arrangement. These policies are consistent with our National Poverty Reduction Strategy (NPRS), presented to the IMF and World Bank in December 2002, and the NPRS Progress Report presented concurrent with this memorandum. We request completion of the fifth review under the PRGF arrangement and modification of the quantitative performance criteria applicable to disbursement of the seventh loan.

I. Performance Under the Program

2. The strong macroeconomic performance of last year, when growth reached nearly 7 percent, has continued into early 2004. Growth helped to reduce the official poverty rate to 41 percent in 2003, from 48 percent in 2001. This year, our tentative estimates indicate that real GDP increased 5.7 percent in January-March (year-on-year). The price pressures that resulted from wheat and gasoline supply disruptions and led inflation to increase abruptly in late 2003 have abated. Despite strong domestic demand, higher gold production and prices helped to reduce the current account deficit in 2003 to under 3 percent of GDP.

Macroeconomic policies

3. All end-March performance criteria were observed. Tax collections in October-March exceeded the cumulative target by som 600 million despite lagging implementation of the agricultural VAT and the real property tax. Payroll tax collections exceeded the target by about som 200 million. The state government fiscal deficit for the period was met by a small margin. There were no central government expenditure arrears, Social Fund pension arrears, or Social Fund arrears to the Medical Insurance Fund, as defined in the program. We have not contracted or guaranteed nonconcessional external debt nor accumulated new external payment arrears.

4. We have issued no decrees or approved legislation that would result in unbudgeted expenditures. We have granted no wage increases, other than the 15 percent increase effective April 1, 2004, for teachers, nurses, and doctors, which was indicated in our December 2003 MEP. Also in line with the MEP, the base pension was raised from som 200 to som 222.6 on January 1, 2004, and the average monthly pension was increased by an additional 5 percent on April 1, 2004.

5. Monetary conditions have been appropriately tight and remonetization has continued. The National Bank of the Kyrgyz Republic (NBKR) purchased $28 million from the foreign exchange market during October 2003-March 2004 and the adjusted end-March program floor for net international reserves (NIR) was exceeded by 11 percent of reserve money. The NBKR's net domestic assets (NDA) remained below the adjusted end-March program ceiling by 3 percent of reserve money as the NBKR reduced its foreign exchange market intervention and increased its sales of NBKR bills. Reserve money at end-March exceeded the indicative ceiling by 8 percent. Broad money has continued to expand rapidly—by 33 percent in the year ending March 2004—and private sector credit grew 35 percent during this period.

Structural conditionality

6. We met one end-March structural benchmark and most components of the other. The 2005-07 Medium-Term Fiscal Framework (MTFF) approved and published in March has served as the basis for the update of our NPRS and for our PRGF-supported program. The MTFF is based on quantified policy plans in key line ministries. Regarding the tax policy package described in paragraph 21 of the MEP: (i) the increase of the general VAT threshold from som 300,000 to som 500,000 (the level applied in agriculture) took effect April 1, unifying the VAT threshold throughout the tax system, (ii) we reviewed the current list of VAT exemptions on goods and, as a result, intend to propose to parliament that the new Tax Code contain no VAT exemptions beyond normal international practices, and (iii) a draft law was submitted to parliament in December 2003 to ensure the effective zero-rating of service exports and to define the place of supply consistent with best international practice. We postponed the small business tax reform component in order to undertake this in parallel with the revision of the Tax Code later this year (see below). With effect from April 1, 2004, voluntary patent tax rates were increased on average 45 percent.

7. The 2003 electricity sector quasi-fiscal deficit (QFD) was som 9,240 million (11.1 percent of GDP), compared to the program indicative target of som 9,645 million. This was achieved mainly because energy efficiency improved and the som appreciated against the U.S. dollar (the program's cost recovery tariff is set at 2.3 U.S. cents per KwH).

8. A tender was issued for the sale of Kyrgyz Telecom in November 2003. Negotiations with the winner of the tender took place over several months but were eventually unsuccessful because of differences regarding the investor's medium-term tariff intentions and the payment schedule. We continue negotiating with other tender participants. The privatization of Kairat Bank is proceeding, following the issuance of a tender in November 2003. Final sale of the bank is expected during the third quarter of 2004.

Banking sector reforms

9. Our 2004 banking sector reform program has progressed largely according to schedule. Regarding bank supervision, the new bank supervisory manual adopted by the NBKR in December 2003 is now in effect. Technical assistance from the IMF's Legal Department helped us to identify existing impediments to the effective implementation of our banking legislation. These impediments include conflicts between banking and other legislation and weaknesses in the enforcement and judicial review processes. Beginning with their 2003 accounts, banks are submitting their financial statements in accordance with IAS. Currently under consideration in parliament, amendments to the Law on Banks and Banking Activities would consolidate supervision of banks and bank holding companies and eliminate the 15 percent maximum ownership threshold for financial institutions on bank capital. We are working with parliament on adoption of the revised Anti-Money Laundering Law (reflecting the June 2003 recommendations of the Financial Action Task Force (FATF)) and amendments to the Law on Audits and the Banking Law.

Governance

10. Governance reforms have proceeded. Medium-term quantitative policy frameworks were prepared for the Ministries of Education, Health, and Agriculture and underlie the March 2004 Medium-Term Fiscal Framework (MTFF). A review of the reorganization of the ministries and regulatory agencies with significant economic responsibilities was prepared, reflecting earlier functional analysis reports of these entities. This review contributed to reorganization of government ministries in early 2004 and the establishment of the Ministry of Economic Development and Trade. Its charter is expected to be finalized by end-May. The Permanent Secretary institution is included in the Civil Service Law now before parliament. Regarding agriculture, the National Agricultural Policy Document and Rural Development Strategy will be submitted to the Economic Policy Council (EPC) in June. We have also reorganized the Ministry of Labor and Social Protection as required by our EU Food Security Program.

11. The National Integrity Council approved its work plan in January 2004 and prepared a draft Governance Reform Strategy paper, which was discussed in May at a council meeting chaired by the President. The presidential decree on the NIC structure will be updated to reflect recent changes in its composition.

12. The Economic Deregulation Concept paper was approved by the President in February 2004. A draft law has been prepared requiring that changes to business legislation, regulations, and rates be open to 60 day public consultation and take effect no sooner than 3 months after enactment. A program to reform the "special means" payments and other mandatory non-tax payments related to business operations is expected to be approved by June 2004. Specific steps toward improving the legal framework for business include the adoption by parliament of the Law on the Fundamentals of Technical Regulation in April 2004 and preparation of amendments to the laws on the Procedures for Business Audits and the Law on Licensing, which are expected to be submitted to parliament in June. We have reviewed the court fee system and intend to reduce fees to 3 percent of par value of collateral by end-June. Under our program with the Asian Development Bank, we have taken important steps regarding corporate governance, including requiring enterprises listed on the Kyrgyz Stock Exchange to apply IAS 2001 to their 2004 financial accounts, and submitting to parliament new laws on national standards for asset valuation and on collateral.

External sector policies

13. We have not imposed any seasonal tariffs or non-tariff barriers. Our m.f.n. import duties were modified slightly with effect from March 2004 in order to meet our WTO commitments. Overall, our average import tariff was reduced from 5.4 to 5.1 percent, while the maximum tariff remains at 15 percent. The third-year consolidation period for our external debt was approved by the Paris Club in April 2004. Bilateral negotiations with the Kuwait Fund on debt rescheduling according to our 2002 Paris Club terms have failed, but all other agreements have been concluded. An agreement to resolve the dispute related to the 1998 aircraft lease and government guarantee has been signed between the Government and DEBIS company.

II. Program for the Period October 2003-September 2004

Program Objectives, Economic Strategy, and Macroeconomic Framework

14. Nearing the completion of our three-year PRGF-supported economic program, our broad objectives remain much as they were in 2001: (i) further macroeconomic stabilization, (ii) alleviating our external debt situation, and (iii) enhancing future growth by implementing focused structural reforms. Our strategy for achieving these objectives remains as described in the December 2003 MEP.

Revisions to the 2004 macroeconomic framework

15. The 2004 macroeconomic framework in our December 2003 MEP remains broadly appropriate and we have made only minor changes. We now expect real growth in 2004 of 4½ percent and end of period inflation of 4 percent or less. The projected current account deficit of 3.9 percent of GDP is slightly below earlier projections, reflecting the improved balance on non-factor services.

16. We have agreed with the Cameco Corporation, our partner in the Kumtor gold mine, to transfer ownership of the mine to Centerra, a new company to be listed on the Toronto Stock Exchange in June 2004. Through state-owned Kyrgyz Altyn, we would take a one third equity position in Centerra, but would sell down this position at the time of Centerra's initial public offering to 20 percent. The amount of sales receipts will depend on market valuation. For purposes of our financial program, we have assumed the amount of $60 million. The full amount of these receipts will be transferred to a government account in the NBKR, thus increasing its official reserves, to be smoothly used by the budget over the medium-term, beginning in 2005.

17. The following sections specify further our intentions in fiscal, monetary and exchange rate, external, as well as structural policies for the period ending September 2004. To monitor policy implementation under the remainder of the third-year program, we have set out several quantitative and structural performance criteria and benchmarks through end-September 2004 (Tables 1 and 2). Detailed definitions of the quantitative targets appear in the updated Technical Memorandum of Understanding (TMU) (Annex).

Fiscal Policies

18. We have slightly increased our cumulative October 2003-September 2004 state government cash fiscal deficit target to 4,229 million soms and have slightly increased our 2004 nominal deficit target to 4,039 million soms (4.4 percent of GDP). This fiscal deficit target includes social compensation of som 180 million (0.2 percent of GDP) conditional on increased user costs of electricity. Included in this compensation is an additional transfer to the Social Fund of som 63 million.

19. We intend to build on our recent success in improving tax revenues during the remainder of the 2004 program. In particular, we expect state government tax revenues to reach 14.6 percent of GDP in 2004 and have increased our tax revenue target for end-September (performance criterion) by 4 percent to som 13,008 million because of the higher projected tax base. We are redoubling efforts to fully implement the agricultural VAT by tightening administration over VAT registration through scheduled audits, and the real property tax through Parliamentary approval of the regulation on Real Estate Valuation for Taxation Purposes. We will implement a proper self-assessment system for all large taxpayers by end-2004 and will reduce outstanding VAT refunds due to large taxpayers to som 35 million or less by end-September. In addition, by end-June we will assess our VAT refund mechanism and take steps to improve information sharing between the tax and customs authorities in order to expedite VAT refunds while limiting fraudulent claims. Regarding the Social Fund, we now target payroll tax cash collections of 3,777 million soms for October 2003-September 2004, 2 percent above the original target. For 2004, Social Fund payroll tax collections should reach 4.6 percent of GDP.

20. State government expenditures would be held to 23.4 percent of GDP. This would allow for total expenditures to grow by 1.3 percent in real terms. Following discussions with the Fund staff, we intend to further raise wages for teachers, nurses, and doctors in October 2004, to bring the cumulative increase for the year to 30 percent, as indicated in our December 2003 MEP. We do not intend to raise any other public sector wages in 2004. We will move away from the categorical bases for determining eligibility for social protection and towards means-tested targeting of social benefits. An action plan and schedule for moving to means-tested targeting will be prepared by the Ministry of Labor and Social Protection by end-September 2004. We will continue to abstain from issuing any decrees or other legislation that would result in unbudgeted expenditures unless offsetting expenditure savings are identified in the same decree or legislation. Accordingly, the recent som 38 million increase in war veteran pensions was offset by reducing the transfer to the Social Fund. We envisage the foreign financing of the public investment program (PIP) to total som 3,212 million in 2004.

21. To consolidate various tax laws into a single piece of legislation and to remove certain inconsistencies, a special task force was appointed to identify and address legal inconsistencies and to ensure the Code covers all spheres of taxation. The task force is receiving valuable input from the public, the private sector, and international consultants in this endeavor. We intend to submit to the Economic Policy Council by end-August 2004 a proposal for a new Tax Code to simplify the small business taxation, taking into account the need to realign, and possibly unify, the VAT and small business tax thresholds, define taxes to be replaced by the small business tax, and eliminate the current voluntary and mandatory patent tax systems (end-August structural benchmark). The small business tax reform package would be considered by parliament together with the Tax Code and the 2005 budget. By end-June we will prepare, for discussion with Fund staff, a scheme that would zero-rate gold exports under the VAT. This principle will be applied in the possible investment agreements with the Jeeroy and Taldy-Bulak gold mine projects. Following a review with staff, we have concluded that no changes to cigarette excises are warranted at this time, but the issue will be revisited in the new Tax Code. Gasoline excise rates will be reduced to better harmonize Kyrgyz excise and sales taxes with those of neighboring countries. We will prepare a specific action plan to curb gasoline and cigarette smuggling by end-September 2004.

Monetary and Exchange Rate Policies

22. Our monetary program is designed to support the targeted 4 percent inflation rate during 2004. The projected increase in money demand this year, reflected in a 8 percent decline in som velocity, would be accommodated by 14 percent som broad money growth. Accounting for a rising money multiplier as a result of more confidence in the banking sector, reserve money is programmed to grow 9 percent. Fiscal consolidation, the expected donor financing, and inflows related to the Kumtor gold mine restructuring should support an increase of NIR by $61 million during April-September and a build-up of government deposits with the central bank. As a result, NDA would decline by som 2185 million during this period. Credit to the private sector is projected to increase by 36 percent during 2004. To provide alternative low-risk investment opportunities for banks, we intend to increase our net sales of government securities during 2004, helping to diversify banks' assets.

23. The NBKR will continue its exchange rate policy of managed floating. It will not intervene on the foreign exchange market except to smooth temporary variations of the nominal exchange rate. The competitiveness of our tradable goods sector remains adequate, in view of the relatively low wage rates as compared to those of key trading partners. Our stabilization strategy rests on maintaining competitiveness by containing inflation, rather than through nominal exchange rate depreciation. In this respect, some nominal appreciation could occur without harming competitiveness.

Structural Policies

24. We will continue our banking sector reform program during the remainder of the third-year program (Box 1). A reputable international firm will finalize by end-June 2004 an external audit of the 2003 financial statements of KAFC and assessment of its loan portfolio (structural benchmark). This will serve as the basis for assessing the viability of KAFC and its future institutional form. No banking license will be issued for KAFC without clear evidence of its viability. SSC's 2003 accounts were audited by a domestic company approved by the World Bank, as budget and scheduling constraints precluded an IAS-based audit by an international reputable firm for SSC's 2003 accounts. This practice will now begin with the 2004 accounts.

25. With IMF Legal Department technical assistance, we have identified legislative amendments and other actions needed to ensure that other legislation is made consistent with banking legislation. We will implement the recommendations of the recent LEG TA mission, as described in Box 1. The NBKR and the Government will continue to adhere strictly to our regulatory response policy, which was developed with IMF technical assistance and was a component of the first-year program under the current PRGF arrangement.

26. In line with IMF staff recommendations, we have concluded that it would be premature to submit to parliament a draft deposit insurance law by June 2004. During the next round of program discussions with IMF staff, we will determine the preconditions for the introduction of the deposit insurance system. These conditions will reflect appropriate financial indicators and other criteria, including criteria for the soundness and stability of the banking system and for individual banks' participation in the DIS.

27. The registration period for depositor compensation has been extended to end-August 2004. The filed claims (currently estimated at som 700 million, or 0.8 percent of GDP) are to be settled with 7-year government bonds to be issued to depositors, as described in our June 2003 SMEP. To reduce domestic debt and to avoid forcing many of the older (and poorest) recipients into selling their bonds in the secondary market at deep discounts, we intend early repurchase of up to som 100 million of these bonds annually, starting in 2005.

28. In the area of governance, we are taking several important steps in mining and related areas in the coming months.

• By end-June, the Government will publicly adopt and begin implementing the principles of the Extractive Industries Transparency Initiative.

• In close cooperation with the World Bank, we will develop and adopt a detailed template for disclosing and reporting to the government the financial data of the mining sector (including Kyrgyz Altyn) (structural benchmark), as specified in Box 2. The first draft report will be submitted to Fund staff by end-September 2004 and be published by end-October.

• We will issue a decree reorganizing mining supervision in line with World Bank recommendations (end-September structural benchmark).

• We will ensure that a reputable international firm completes a risk assurance and control audit of Kyrgyz Altyn, with reference to its 2002 and 2003 accounts (end-September structural benchmark).

29. We will continue to implement the governance reform strategy identified in our December 2003 MEP (Box 3). We will also 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 and, by end-September 2004, we will develop proposals to reorganize the regional structure of the Ministry of Agriculture and all agencies reporting to it, including oblast and rayon subordinated units. Following the completion of the regional agricultural functional reviews in September and November 2004, we will prepare an action plan to transfer part of publicly-financed veterinary and irrigation services to the private sector. We will continue to work with neighboring countries to reach a satisfactory conclusion regarding compensation for our water resources and would welcome the participation of the international financial institutions in this process. Based on our March 2004 MTFF, we will develop, by end-September, quantitative expenditure ceilings for the four key ministries (Health, Education, Agriculture, and Labor and Social Protection), as required by the EU Food Security Program.

30. As agreed earlier, in 2004 we will further reduce the electricity sector quasi-fiscal deficit to som 8,650 million (9.4 percent of GDP). To achieve this indicative target under the program, we will use tariff policy and measures to increase cash collection and reduce losses. Reflecting our commitment under the World Bank CSAC, we plan to raise electricity tariffs as of July 1, 2004. Our mid-year quasi-fiscal deficit target for end-June is som 4,900 million.

III. Program Monitoring

31. 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.

Yours sincerely,

Box 2. Line items required to be reported by Kyrgyzaltyn and other Mining Companies The line items identified in the table below are intended to capture all the significant revenue flows that the Kyrgyz Republic receives from the Mining Sector (i.e. from International and National State-Owned Companies).
REQUIRED TO BE REPORTED BY KYRGYZALTYN AND OTHER MINING COMPANIES
Non-monetary flows	Produced from:	Volume
Production from mining operations (to be reported separately by mine and commodity)
Nature of revenue stream	Received from (state where the revenue stream was received from)	Value (US$ millions)
Taxes on profit and income
Mineral Resources taxes and royalties
Other taxes, such as value added taxes (net), withholding taxes, environmental taxes, property taxes, road taxes, employee social payments, customs duties, fuel and excise taxes, emergency taxes etc (to be reported as separate line items if material)
License fees, rental fees, entry fees and other considerations for licenses/concessions (to be reported separately if material)
Signing bonuses and production bonuses
Dividends paid to Kyrgyz Republic/ Kyrgyzaltyn
Interest/loans paid on behalf of government (or government agency) by mining company/ Kyrgyzaltyn
Other payments made on behalf of government (or government agency) by mining company/Kyrgyzaltyn (nature of payment to be specified. If more than one type payments to be reported as separate line items if material)
Proceeds from long term borrowings and other financial operations received on behalf of government and subsequently paid to government
Lease payments to Kyrgyz Republic
Proceeds from lease activities received on behalf of government and subsequently paid to government
Charitable donations
Contributions to government social funds
Other significant payments, to be specified: ____________________________ ____________________________ ____________________________
REQUIRED TO BE REPORTED BY KYRGYZALTYN ONLY
Nature of revenue stream	Received from (state where the revenue stream was received from)	Value (US$ millions)
Management fees received from mining interests
Proceeds from sale of mining interests/assets (100% basis)
Proceeds from sale of mining interests/assets transferred to government (government % share of total proceeds)
Dividends received from mining companies
Disclosures specific to Kumtor re-structuring
Proceeds from sale of Centerra stock (on 100% basis)
Other proceeds received related to the Kumtor re-structuring
Other payments made related to Kumtor re-structuring

Box 3. Remaining Governance Reform Measures1 Institution building 1. Prepare plan to restructure State Commission for Procurement; amend Public Procurement Law in line with EU directives—end-September, 2004. (WB) Public awareness 2. Draft the National Agricultural Policy Document and Rural Development Strategy for discussion in the EPC—end-June 2004. (IMF) Efficiency of public administration 3. Approve a program to reform the system of mandatory non-tax payments related to business operations, including so-called "special means" payments—end-June 2004. (IMF, WB) 4. Appoint Permanent Secretaries for key ministries and strengthen role of financial officers in line ministries—end-June 2004. (IMF, WB) 5. Prepare and discuss at the EPC a report on improving registration procedures for businesses—end-June 2004. (IMF) 6. Reorganize the organizational structure and management system of the Ministry of Agriculture headquarters according to a December 2002 agreement with the EU Food Security Program—end-September 2004. (IMF) 7. Develop proposals to reorganize the regional structure of the Ministry of Agriculture and all agencies reporting to it, including oblast and rayon subordinated units—end-September 2004. (IMF) Legal system 8. Reduce court fees to 3 percent of par value of collateral—end-June 2004. (IMF) 9. Submit to parliament laws on the following matters: "On the Protection of the Rights of Businesses during Inspections and Auditing," and "On Amendments and Additions to the Law of the Kyrgyz Republic on Licensing."—end-June 2004. (IMF) 10. Prepare and discuss at the EPC a report on improving the Land Code, Urban Development Code, and the law on State Registration of Real Estate Titles and Transactions, with a view toward ensuring safeguards for private property rights and transparency in real estate operations—end-June 2004. (IMF) 11. Submit to parliament an amendment to the Law on Normative Legal Acts requiring that any new bill approved by parliament incorporate all amendments necessary to bring related laws into conformity with the proposed bill—end-September 2004. (IMF) 1Several of the governance measures will be carried out under the World Bank (WB) and Asian Development Bank (ADB) lending operations, as indicated.

Table 1. Kyrgyz Republic: Quantitative Program Targets for April-December 20041 (in millions of soms, unless otherwise indicated; eop)
				2004
				June			September			December
				Indicative			Perfomance			Indicative
				Targets			Criteria			Targets
				Program	Revised Program		Program	Revised Program		Program	Revised Program
I.	Performance criteria
	1.	Floor on net international reserves of the NBKR in convertible currencies (eop stock, in millions of U.S. dollars)		159.4	221.1		162.5	221.7		169.4	240.2
	2.	Ceiling on net domestic assets of the NBKR (eop stock)		1,827	-4		1,926	152		1,671	-562
	3.	Ceiling on cumulative fiscal deficit of the state government		3,118	3,264		4,183	4,229		600	949
	4.	Cumulative floor on state government tax collections in cash		8,966	9,513		12,503	13,008		4,063	3,934
	5.	Ceiling on the stock of central government budget arrears		0	0		0	0		0	0
	6.	Ceiling on the stock of Social Fund pension arrears		0	0		0	0		0	0
	7.	Floor on payroll collections in cash of the Social Fund		2,657	2,863		3,703	3,777		1,081	1,175
	8.	Ceiling on the stock of Social Fund arrears to the Medical Insurance Fund		0	0		0	0		0	0
	9.	Ceiling on contracting or guaranteeing by the state government or NBKR of new nonconcessional external debt of less than one year (in millions of U.S. dollars)		0	0		0	0		0	0
	10.	Ceiling on contracting or guaranteeing by the state government or NBKR of new nonconcessional external debt with a maturity of one year or more (cumulative, in millions of U.S. dollars)		0	0		0	0		0	0
	11.	Ceiling on accumulation of new external payment arrears (in millions of U.S. dollars)		0	0		0	0		0	0
II.	Indicative targets
	1.	Ceiling on reserve money (NBKR liabilities)		9,831	10,689		10,069	10,868		10,128	10,993
	2.	Ceiling on the electricity sector quasi-fiscal deficit (in millions of som)		4,900	4,900		. . .	. . .		8,650	8,650
Sources: Kyrgyz authorities; and Fund staff estimates and projections. 1Performance criteria, benchmarks, and indicative targets are defined in the Supplementary Technical Memorandum of Understanding.

Supplementary Technical Memorandum of Understanding

1. The Kyrgyz Republic's performance during the second half of 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 SMEP define the quantitative performance criteria and indicative targets (Table 1 attached to the SMEP), the structural benchmarks (Table 2 attached to the SMEP), as well as the monitoring requirements.¹

I. Quantitative Targets

2. Quantitative targets (i.e., quantitative benchmarks for end-June 2004, quantitative performance criteria for end-September 2004, and indicative targets for end-December 2004) are defined below and summarized in Table 1 of the SMEP.

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 $161.0 million as of March 31, 2004.

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

Table 1. Floors on NIR of the NBKR in Convertible Currencies1,2
	(In millions of U.S. dollars)
March 31, 2004 (actual)	161.0
June 30, 2004 (indicative target)	221.1
September 30, 2004 (performance criterion)	221.7
December 31, 2004 (indicative target)	240.2
1End-of-period stocks. 2In the event the base value of March 31, 2004 is revised, the program targets will be revised by the same amount.

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 state government budget and cash grants; (ii) upward/downward by 100 percent for any excess/shortfall in cash privatization receipts, and (iii) upward/downward by 100 percent for any excess/shortfall in the proceeds from the sale of the government's Centerra shares. Valued at the program exchange rate, the programmed cash privatization receipts are equivalent to $5.0 million in the fourth quarter of 2004 and the proceeds from the sale of the government's Centerra shares are equivalent to $60.0 million in the second 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 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 $3.5 million on March 31, 2004.

Table 2. Projected Net Foreign Financing and Cash Grants Cumulative from April 1, 2004
	(In millions of U.S. dollars)
June 30, 2004	4.9
September 30, 2004	5.9
December 31, 2004	23.2

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 2,338 million on March 31, 2004.

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

Table 3. Ceilings on the NDA of the NBKR1,2
	(In millions of soms)
March 31, 2004 (actual)	2,338
June 30, 2004 (indicative target)	-4
September 30, 2004 (performance criterion)	152
December 31, 2004 (indicative target)	-562
1End-of-period stocks. 2In the event the base value of March 31, 2004 is revised, the program targets will be revised by the same amount.

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; (ii) downward/upward by 100 percent of the excess/shortfall of cash privatization receipts; and (iii) downward/upward by 100 percent of the excess/shortfall in the proceeds from the sale of the government's Centerra shares, all 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 2003 amounted to som 2,027 million as of March 31, 2004.

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; 2.0 taxes on goods and services; 3.0 specific taxes on services; 4.0 taxes on property; and 5.0 taxes on international trade. Thus defined, cumulative tax collections in cash since October 2003 amounted to som 6,435 million as of March 31, 2004. 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.

Table 5. Floors on Cumulative Tax Collections in Cash1
	(In millions of soms )
June 30, 2004 (indicative target)	9,513
September 30, 2004 (performance criterion)	13,008
December 31, 2004 (indicative target)2	3,934
1Cumulative from October 1, 2003. 2Cumulative from October 1, 2004.

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 March 31, 2004, 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.

Table 6. Stock of Central Government Budget Arrears1,2
	(In millions of soms)
March 31, 2004 (actual)	0
June 30, 2004 (indicative target)	0
September 30, 2004 (performance criterion)	0
December 31, 2004 (indicative target)3	0
1Cumulative from October 1, 2003. 2In the event the base value of September 30, 2003 is revised, the program targets will be revised by the same amount. 3Cumulative from October 1, 2004.

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 March 31, 2004, the stock of thus defined 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.

Table 7. Stock of Social Fund Pension Arrears1,2
	(In millions of soms)
March 31, 2004 (actual)	0
June 30, 2004 (indicative target)	0
September 30, 2004 (performance criterion)	0
December 31, 2004 (indicative target)3	0
1Cumulative from October 1, 2003. 2In the event the base value of September 30, 2003 is revised, the program targets will be revised by the same amount. 3Cumulative from October 1, 2004.

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 2003 amounted to som 1,970 million as of March 31, 2004.

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

Table 8. Floor on Social Fund Payroll Tax Collections in Cash1
	(In millions of soms)
June 30, 2004 (indicative target)	2,863
September 30, 2004 (performance criterion)	3,777
December 31, 2004 (indicative target)2	1,175
1Cumulative from October 1, 2003. 2Cumulative from October 1, 2004.

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. As of March 31, 2004, the stock of thus defined arrears of the Social Fund to the Medical Insurance Fund was zero.

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:

Table 9. Ceiling on the Stock of Social Fund Arrears to the Medical Insurance Fund1,2
	(In millions of soms)
March 31, 2004 (actual)	0
June 30, 2004 (indicative target)	0
September 30, 2004 (performance criterion)	0
December 31, 2004 (indicative target)3	0
1Cumulative from October 1, 2003. 2In the event the base value of September 30, 2003 is revised, the program targets will be revised by the same amount. 3Cumulative from October 1, 2004.

(1)        QFD = Q*MC – R;

(2)        Q = 1/(1 – ℓ)*(∑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);

ℓ 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 9,240 million (or [11.1] percent of GDP) in 2003. The indicative ceiling on the quasi-fiscal deficit in the electricity sector is as follows (Table 10).

Table 10. Ceiling on Quasi-Fiscal Deficit in the Electricity Sector1,2
	(In millions of soms)
December 31, 2003 (actual)	9,240
June 30, 2004 (indicative target)	4,900
December 31, 2004 (indicative target)	8,650
1Annual average. 2In the event the actual 2003 figure is revised, the 2004 ceilings will be revised by the same amount.

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 1 of the SMEP.

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 10,377 million as of March 31, 2004. The indicative program limits are reported in Table 11 below.

Table 11. Ceilings on Reserve Money1
	(In millions of soms)
March 31, 2004 (actual)	10,377
June 30, 2004 (indicative target)	10,689
September 30, 2004 (indicative target)	10,868
December 31, 2004 (indicative target)	10,993
1End-of-period stocks.

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 information:⁴

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.

Table 12. Kyrgyz Republic: Electricity Quasi-Fiscal Deficit
	Period
Production (GWh)1 Losses (GWh) Loss Rate (in percent)2 Consumption (GWh) Tariff ($ct/kWh)3 Cash Collection Rate (in percent) Effective Tariff ($ct/kWh)4     cash effect. rate     total effect. rate Cost Recovery Tariff ($ct/kWh)5 Quasi-Fiscal Deficit     in percent of GDP     in $ millions     in millions of soms
1Generation plus imports minus exports minus normative losses. 2Excess technical and commercial losses as percent of production. 3Average posted tariff, calculated as quotient of total bill and consumption volume. 4Nominal tariff times cash collection rate 5Marginal costs, derived from marginal incremental capital cost.

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.

Table 13. Program Cross Exchange Rates
	Currency Names	National Currency/ US$		US$/ National Currency
SDR		0.6984		1.4318
GBP	UK pound sterling	0.5903		1.6942
DKK	Danish krone	6.3095		0.1585
EUR	Euro	0.8491		1.1778
INR	Indian rupee	45.3200		0.0221
CAD	Canadian dollar	1.3064		0.7655
CNY	Chinese yuan	8.2768		0.1208
KRW	South Korean won	1,185.6000		0.0008
NOK	Norwegian krone	7.0024		0.1428
TRL	Turkish lira	1,489,255.3957		0.0000
SEK	Swedish krona	7.6810		0.1302
CHF	Swiss franc	1.3144		0.7608
JPY	Japanese yen	109.6752		0.0091
AZM	Azerbaijani manat	4,911.0115		0.0002
AMD	Armenian dram	557.1430		0.0018
BYR	Belarusian rubel	2,124.0150		0.0005
KZT	Kazakh tenge	148.1793		0.0067
LVL	Latvian lats	0.5560		1.7986
LTL	Lithuanian litas	2.9176		0.3427
MDL	Moldavian lei	13.3574		0.0749
RUR	Russian ruble	29.9176		0.0334
TJS	Tajik somoni	3.0640		0.3264
UZS	Uzbek sum	976.4458		0.0010
UAH	Ukrainian hryvnia	5.3320		0.1875
EEK	Estonian kroon	13.2854		0.0753
AUD	Australian dollar	0.7046		1.4193
	Gold ($/troy ounce)	384.60