IMF Finishes 2022 Consultation with Kyrgyz Republic

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the 2022 Article IV consultation^[1]with the Kyrgyz Republic and considered and endorsed the staff appraisal without a meeting on a lapse-of-time basis.[2]

The economy of the Kyrgyz Republic has shown resilience to the spillovers from the war in Ukraine and is estimated to have grown by 5.5 percent in 2022, driven by gold production, trade, transportation, and agriculture. Annual inflation increased to over 15 percent during the year, mainly due to high global food and fuel prices, but core inflation also rose to double digits. The general government deficit, including lending to energy sector state-owned enterprises, is estimated to have widened to 5.2 percent of GDP in 2022 from 0.8 percent the year before, primarily due to a significant increase in public sector salaries and pensions, and public investment, offsetting efforts to strengthen tax administration that have yielded a remarkable improvement in tax revenue of around 6 percentage points of GDP. Imports are estimated to have increased considerably, partly because of higher oil prices, but also due to an increase in transit trade, while gold exports were negligible. The banking system has remained financially healthy, but non-performing loans increased to more than 12 percent of total loans.

Growth in 2023 is expected to ease to 3.5 percent, as the projected global slowdown and the contraction in Russia start to weigh on the Kyrgyz economy. Inflation is expected to decline to about 10 percent by end-2023 and the current account deficit to narrow to more sustainable levels, but the elevated fiscal deficit would result in a moderate build-up of public debt in the medium term. In view of the heightened global uncertainty, policy priorities include restoring macroeconomic buffers to strengthen resilience to future shocks and implementing structural reforms to support higher and more inclusive growth and poverty reduction.

Executive Board Assessment

The Kyrgyz Republic has shown resilience in the face of multiple shocks, but risks are elevated. Unexpected migration of capital and productive labor from Russia have supported activity. However, inflation surged, external and fiscal balances deteriorated, international reserves declined, and poverty increased. Total public debt fell, largely because of high nominal GDP and real appreciation of the exchange rate.

The outlook is subject to heightened uncertainty at a time when macroeconomic buffers have been eroded. The decline in the net inflow of remittances suggests that adverse spillovers from the war in Ukraine are starting to materialize. In addition, high commodity prices, the global slowdown and the tightening of global financial conditions are likely to weigh on output growth. However, policy flexibility is constrained by reduced buffers, while forthcoming concessional external financing is limited. The main challenge for policymakers is to strengthen macroeconomic stability, rebuild policy space for future shocks, mobilize financing for development needs, and raise growth potential by advancing reforms.

Fiscal policy should aim to reduce deficits while creating space for priority spending on infrastructure, health and education, and social protection. The expansionary stance in 2022 would need to be reversed in the coming years to restore fiscal buffers, contain build-up of public debt, and alleviate financing constraints. It is recommended maintaining public debt below 60 percent of GDP in the medium term and reducing it more thereafter. Growth-friendly consolidation can be achieved by reducing tax expenditure, optimizing tax policy, strengthening tax and customs administration, reducing the public sector wage bill, and raising electricity tariffs to reduce energy subsidies. Channeling dividends of the state-owned Kumtor Gold Company to the budget would significantly ease financing constraints. Strengthening social safety nets would support the poverty reduction objective.

Monetary policy should aim at reducing inflation to mid-single digits. This will require a restrictive monetary policy stance and tightening of liquidity. Discontinuing NBKR's purchases of gold would prevent further injection of liquidity while resumption of gold exports is critical for sustainability of the balance of payments. The exchange rate was overvalued by about 5-10 percent in 2021, but the NBKR remains committed to exchange rate flexibility, which provides important cushion against external shocks. Renewed efforts are needed to introduce amendments to the NBKR law to strengthen governance and operational independence of the central bank.

While there has been some progress on governance, important gaps remain, which if properly addressed, could have a transformative impact on investment and growth. Opportunities for corruption can be reduced by strengthening income and asset declarations by public officials and investigating illicit enrichment. Competitive bidding should remain integral part of the public procurement law and should extend to SOEs. Its exclusion would increase risks of corruption and may put at risk access to concessional external financing. A comprehensive SOE ownership and oversight policy would improve SOE governance, while strengthening the AML/CFT framework and improving monitoring of cross-border activities can be a potent tool in deterring corruption.

The Kyrgyz Republic needs its own climate adaptation policy to strengthen resilience. This requires creating fiscal space for additional public spending on green infrastructure, healthcare, education, and social safety nets. Strengthening domestic institutions and governance would be essential to support climate policies. Despite its low carbon footprint, the country should also contribute to global mitigation efforts by reducing pollution, investing in renewables, and raising electricity tariffs.