Press Release No. 01/49

Press Release: IMF Approves In Principle Three-Year, US$93 Million PRGF Arrangement for the Kyrgyz Republic

November 30, 2001

The Executive Board of the International Monetary Fund (IMF) today approved in principle a three-year arrangement under the Poverty Reduction and Growth Facility (PRGF) for the Kyrgyz Republic for SDR 73.4 million (about US$93 million) to support the government's 2001-04 economic program.

A final decision by the Executive Board is pending discussion of the Kyrgyz Republic's Interim Poverty Reduction Strategy Paper (I-PRSP), entitled Interim National Strategy for Poverty Reduction (I-NSPR), by the World Bank's Executive Board, which is expected on December 4, 2001. The final decision will enable the immediate release of a first loan under the PRGF arrangement of SDR 11.7 million (about US$15 million).

After the Executive Board's discussion on the Kyrgyz Republic, Eduardo Aninat, Deputy Managing Director and Acting Chairman, said:

"The Fund commends the Kyrgyz Republic's recent achievements in macroeconomic stabilization, and the authorities' renewed commitment to strengthen the foundations for economic growth and poverty reduction through sustained fiscal adjustment and structural reform is encouraging. The recent approval by parliament of a prudent 2002 budget represents an important step forward. The new tax policy measures should now be implemented promptly, and a sustained effort will be needed to strengthen tax administration and revenue performance over the medium term. Regarding expenditure management, apart from ensuring timely payment of wages and social benefits, it is particularly important that the Ministry of Finance, in close cooperation with line ministries and international donors, continues to streamline the Public Investment Program while raising the efficiency of public investment.

"The program's monetary policy is appropriately tight to support further gains in lowering inflation and instilling confidence in the som. In late June, the National Bank took an important step towards strengthening the banking system by liquidating four insolvent banks, thereby demonstrating clearly that violations of prudential banking regulations will not be tolerated. Reform efforts to improve confidence in the banking sector will need to be continued, and the new Regulatory Response Policy, which enhances the enforcement powers of the bank supervision authorities, is especially welcome in this respect.

"The authorities' comprehensive external debt strategy shows their determination to tackle the problem of the country's debt burden, but success hinges critically on a strong fiscal adjustment. It will also be crucial to accelerate privatization and devote such proceeds to reducing the stock of external debt, and to contract new loans only at highly concessional terms. Concerted efforts by external creditors will also be required to achieve external debt sustainability in the longer term.

"An Economic Policy Council has recently been established to help upgrade the country's economic policy making capacity and improve governance. The Fund looks forward to further steps to reduce impediments to private sector development, enhance the transparency in the management of public finances, and simplify tax and custom administration regulations.

"The National Strategy for Poverty Reduction has benefited from a broad-based participatory process. Over the next twelve months, the challenge is to finalize the poverty reduction strategy by carefully assessing the cost of alternative policies, setting spending priorities in the context of a medium-term fiscal framework, and defining in more detail key policies in the area of social policy and public administration reform," Mr. Aninat said.

ANNEX

Recent Economic Developments

In 2001, macroeconomic performance in the Kyrgyz Republic continued to improve. Real GDP growth accelerated to 6.7 percent in the first nine months of 2001, compared with 5 percent in the same period in 2000. Growth has been driven by agriculture, mining, trade, and construction. Twelve-month inflation dropped to 5.2 percent in September 2001 in part reflecting an appreciation of the nominal exchange rate vis-à-vis the U.S. dollar. However, as Kyrgyz dollar wages are low, the Kyrgyz cost of competitiveness has remained satisfactory.

Fiscal performance has improved. In the first half of 2001, the state government's annualized overall fiscal deficit declined to 4.6 percent of GDP, mainly owing to lower public investments. Monetary conditions remained tight in the first half of 2001. In the third quarter, the National Bank of the Kyrgyz Republic (NBKR) bought significant amounts of foreign exchange in the market to strengthen its foreign reserve position. Nevertheless, despite the increase in reserve money, the nominal effective exchange rate remained stable, or even appreciated, suggesting that the demand for money has strengthened. Nominal and real interest rates have also declined.

On structural reforms, progress has been made in several areas, particularly in the banking sector and in government administration.

Program Summary

The proposed economic program for 2001-04 has three pillars: further macroeconomic stabilization, a credible external debt strategy, and more focused structural reforms. Output is projected to increase by 4.5 percent in 2002, and inflation is targeted to decline to 6 percent during 2002 from the 7 percent projected for 2001. The central bank's gross foreign reserves are expected to increase to 3.9 months of imports at end-December due to bunching of balance of payments support in the last quarter of 2001, before declining to 3.8 months of imports by the end of the first-year program. These short-term targets incorporate the estimated impact of the recent downturn in the world economy and the September 11 tragedy.

Over the next three years, real GDP is projected to grow by 4.5 percent per annum, below the rates seen in more advanced transition economies. At this stage, the medium-term projections are based on the assumption that the conflict in Afghanistan does not have a major adverse effects in the Kyrgyz economy, as about 80 percent of its foreign trade is with countries outside the sensitive region. The anticipated acceleration in productivity growth reflects, in addition to the catch-up in the utilization rate of labor and capital, the expected impact of the structural reforms to be implemented under the program. The economy's gross investment ratio is projected to remain unchanged at 16 percent of GDP despite the projected streamlining of the Public Investment Program (PIP). Government investment is expected to fall to 4.8 percent of GDP by 2004 from 8.5 percent in 2000. The authorities believe that the decline in public investment will be compensated by higher private investment.

On the fiscal side, the program aims at strong adjustment to promote macroeconomic stability and to address the external debt problem. The authorities intend to restructure the Ministry of Finance to strengthen its control over the implementation of the budget and fiscal policy. This will entail initiating the next stage of the treasury reform and further measures to improve tax administration. A broader tax reform will include new revenue measures in the 2002 budget to raise the tax-to-GDP ratio in the medium term.

A tight monetary policy is critical for further reducing inflation and the required balance of payments adjustment. The economy remains highly dollarized and a tight supply of money serves well for strengthening confidence in the local currency. On exchange rate policy, the NBKR agreed that a flexible regime is currently the most appropriate. Interventions in the foreign exchange market will be directed only at the accumulation of reserves and smoothing temporary market fluctuations.

The external current account deficit is projected to decline to 6-6.5 percent of GDP in 2001 and 2002 from 8 percent in 2000. In 2002, the volume of exports is projected to increase by 2.6 percent, mainly because gold exports are projected to decline. As the PIP will be further streamlined, imports are projected to grow only by 3.5 percent. The surplus in the capital account is expected to narrow significantly in 2001 as disbursements of project and program loans decline before stabilizing at around 2 percent of GDP in 2002.

The government plans to amend its comprehensive external debt strategy and intends to request rescheduling of the Kyrgyz Republic's bilateral debts from the Paris Club and private creditors on Naples terms; ensure comparability of treatment of creditors, as typically required by the Paris Club if repaying debt early; and take further measures to improve the country's external debt management capacity.

Structural reforms will focus on areas that are macrorelevant and critical for the success of the program. Priority is given to four areas: banking sector reform, privatization of the four strategic enterprises, reduction of the energy sector's quasi-fiscal deficit, and improving governance.

The Poverty Reduction Process

The I-NSPR sets out the main elements of the three-year approach to broader structural reform and poverty reduction consistent with the economic program supported by the Fund under the PRGF. In addition, it outlines reform initiatives in the areas of infrastructure, agriculture, small and medium-size enterprise development, and social protection. The authorities intend to develop a full-fledged NSPR in the second half of 2002.

The Kyrgyz Republic joined the IMF on May 8, 1992. Its quota¹ is SDR 88.8 million (about US$113 million), and its outstanding use of IMF resources totaled SDR 134 million (about US$170 million) as of October 31, 2001.