Kyrgyz Republic strategy overview

Full strategy  (0.3Mb) Approved 12  Jun 2007

Стратегия для Киргизской Республики  (0.9Mb)

The Kyrgyz Republic is committed to and is making progress towards the implementation of the principles of multi-party democracy, pluralism and market economics referred to in Article 1 of the Agreement Establishing the Bank. The political upheaval in March 2005 resulted in a change of power and presidential elections, which took place in summer 2005 and marked tangible progress towards meeting international standards for democratic elections. In terms of political pluralism, the Kyrgyz Republic, with many functioning political parties, a relatively free media and a network of active civil society organisations, continues to feature well in the regional context.

Nevertheless serious problems remain. Poverty, unemployment, deep-seated corruption and nepotism, which were major driving forces behind the 2005 “Tulip Revolution”, still exist. Local entrepreneurs still complain of bribery, bureaucracy and burdensome taxes, while foreign investors are concerned about political and legal instability. Organised crime is also a spectre on the political and economic scene, including instances of criminal elements attempting to exert undue influence on the Government. Those problems triggered a political crisis in November 2006, which was resolved in a peaceful and negotiated manner and led to an agreement, reflected in the country’s new Constitution. However, the Constitution has been amended again at the end of December, reversing changes that had limited the President’s authority. The December reversal, combined with the termination of the Kyrgyz President’s political alliance with Feliks Kulov and the latter’s joining the ranks of opposition, led to a new wave of protests in April 2007 with protesters demanding early presidential elections and constitutional reforms restoring a parliamentary form of governance.

Macroeconomic environment

The authorities managed to retain prudent macroeconomic policies throughout the Strategy period, despite the political upheaval in March 2005, presidential elections and the November 2006 political crisis. Although growth for 2005 registered a small decline (0.2 per cent), the country continued to restrain the fiscal deficit and reduce external public debt – albeit from a very high level. The trade deficit increased in part due to lower output from Kumtor Mining Company (KMC) and significant imports of equipment at the mine have been financed by remittances, foreign direct investments (FDI) and funding from donors including debt forgiveness under the Paris Club. The economy grew by 2.7 per cent in 2006 primarily driven by the service sector, while growth in agriculture, which still accounts for 30 per cent of GDP, remained sluggish. The Kyrgyz Republic has made progress in reducing poverty as the official poverty rate declined from 50 per cent in 2003 to 44 per cent in 2005.

Investment climate

Notwithstanding these positive macroeconomic developments, the country continues to be at risk to exogenous and internal shocks. Therefore, the country should take care to protect existing investments and create an attractive environment for new investments; unfortunately, recent political and legislative instability has raised questions about the overall investment climate. The country also continues to deal with a high debt burden - public external debt to GDP (at end 2006) remained at 69 per cent and debt service is projected at about 3.5 per cent of GDP (approximately USD 100 million) per year in the Strategy period. While in April 2006 the country was found to be eligible for debt relief under the enhanced heavily indebted poor countries (HIPC) initiative, the Kyrgyz authorities decided against participation in February 2007.

Transition progress

Progress on key transition measures has been insufficient, primarily due to lack of government implementation. The investment and business climate, as recorded in the 2005 EBRD/World Bank Business Environment and Enterprise Performance Survey and the World Bank’s Doing Business Survey 2006, leaves scope for significant improvement. Small positive steps - a new pledge law; ratification of the UN Convention against Corruption; and strengthened supervision in the National Bank – do not make up for overall poor progress on structural reforms. In the past few years, there has been practically no progress on infrastructure reforms - in transport, energy and telecoms - where state-owned entities continue to deplete government resources.

Key challenges

Therefore, in the forthcoming period, the key challenge remains to further build an environment to foster a sustainable private sector which can contribute to growth and further poverty alleviation, in line with the country’s development strategy for 2007–2010. The Government’s key goals must be: (i) to further improve the investment climate and avoid actions which threaten existing investments; (ii) to take concrete measures to tackle corruption, improve the court systems and lessen bureaucracy; (iii) to increase transparency and corporate governance of enterprises (particularly in the state sector); (iv) to improve tendering and licensing procedures, particularly in the natural resources sector (v) to improve tariff regulations, particularly in the power sector, in order to attract private investment; and (vi) to facilitate the deepening of the financial sector by avoiding unnecessary interference while further strengthening the regulatory independence and remit of the regulator.

The Bank will support the Kyrgyz Republic in the following priority areas to address the above mentioned transition challenges. Among donors and international financial institutions, the Bank is uniquely placed to support private sector development; its projects and assistance have a significant demonstration impact despite relatively modest volumes. The Early Transition Countries Initiative has opened new opportunities for the Bank to reach a wider range of clients, thus widening its overall impact.

Fostering the private sector 

Development of private businesses remains the Bank’s key operational objective. Direct financing will be targeted to agribusiness, textile, property and tourism, consumer services, as well as natural resources should there be opportunities with credible investors, thus contributing to diversify the economy and expand external trade. Through these activities, the Bank also will promote energy efficiency measures in private sector enterprises.

Given the importance of agriculture (30 per cent of GDP), the Bank will strengthen efforts to reach this sector and ETCI products should help widen opportunities with smaller foreign and local investors. For example, the Bank has financed smaller agribusiness companies via the MSEFF as well as the new Direct Lending Facility and Medium-sized Co-Financing Facility.

The Bank will continue to expand its successful programme to finance micro and small enterprises through financial intermediaries. In the past two years, the Bank has increased its focus on facilitating financial access to rural borrowers, and in 2006 began working with Aiyl Bank, the country’s largest provider of agricultural finance. The Bank has increased the number of commercial bank partners. From a sectoral perspective, by working with an array of financial institutions, the Bank would like to increase competition, which will increase lending volume, reduce interest rates and lengthen tenors for borrowers.

The Bank has successfully financed regional cross-border investments involving investors from Russia, Kazakhstan and the Kyrgyz Republic. Given rapid growth in the region, the Bank expects to be able to support other regional investors coming to the Kyrgyz market from CIS countries, as well as from countries such as Turkey, Korea and China.

Strengthening the financial sector

The Bank’s impact on the financial system is significant, with exposures to nine financial institutions accompanied by substantial technical assistance.  Overall, the sector has strengthened due to continuing capital increases, growing depositor confidence and increased competition. The Bank has supported the sector by developing a stronger pledge law and enhancing the operation of the credit bureau. Moreover, the Kyrgyz Republic has been at the forefront of the Bank’s efforts to work with non-bank microfinance institutions.

The Bank will be focusing on strengthening (in terms of capital, corporate governance and general competitiveness) its partner financial institutions.  In the forthcoming period, the Bank could participate in capital increases and where appropriate support consolidations between banks and non-bank institutions. The Bank also considers supporting the conversion of NBMFIs into deposit-taking institutions.

As the Government intends to privatise Aiyl Bank and the Savings and Settlement Company, which would further strengthen the overall quality of the financial sector, the Bank will seek how best to support this initiative.  Also the Bank will seek ways to develop new products which reduce financial institutions’ foreign exchange risks. As a first step, the Bank has developed a guarantee facility product which enables NBMFIs to raise local currency funding more competitively.

As the Bank is at or near prudent lending levels with a number of partners, it will work with donors to share risks as a means of leveraging Bank financing.  At the same time, the Bank will work with the NBKR on bank supervision issues to strengthen the sector and hope to find additional partners. The Bank will maintain a close dialogue with other donors to ensure targeted assistance for the sector more generally. Such assistance in the coming period could include further support on bank supervision, development of deposit insurance system, implementation of the new anti-money laundering law and further support for the credit bureau.

Support for critical infrastructure

The Bank’s direct financing of infrastructure has been limited due to the country’s restricted capacity for external borrowing and also due to inability to proceed with key reforms. For example, efforts to finance the energy sector are most likely possible only after tariff reforms and willingness to allow commercial (private) management. In light of its high debt burden, the Government must continue to avoid significant new state borrowings, and it is expected that new sovereign loans will continue to be limited to those with a 45 per cent grant element. 

Therefore, the Bank will continue to seek non-sovereign infrastructure projects. These could include financing for privatisations (telecoms) or concessions (power, roads, gas pipelines). Where possible, projects may be regional in nature. Considering the level of the country’s sovereign indebtedness, the Bank’s ability to finance sovereign guaranteed projects in the strategy period will be limited, particularly if there is not access to a stable and predictable source of co-financing grants. 

Policy dialogue

The Bank is a key counterpart to the Government and provides advice on private sector development and the investment climate. Following the 2005 political changes, the Bank has retained its dialogue with the new authorities as well as civil society. Building on success of the International Business Council, the Bank has proposed to work with the President and Prime Minister to form a new advisory council which will bring attention to key barriers to private sector development. Considering recent discussions of potential nationalisation of an existing high-profile investment, it remains extremely important to maintain policy dialogue regarding the investment climate and its impact on long-term development. Other key TC projects include ongoing training for judges and a legal reform programme to address obstacles to investment.

The Bank worked with other donors to harmonise approaches to improve the business environment, this included support for the first joint country strategy developed by the World Bank, Asian Development Bank, United Nations Development Programme and key bilateral donors. The Bank will continue to coordinate with other IFIs, donors and the business community. The Bank’s Environmental Policy and Public Information Policy will apply to all projects developed in the Kyrgyz Republic.