91770 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Kyrgyz Republic Economic Report No.6 Fall 2014 Kyrgyz Republic: Moderating Growth and a Challenging Outlook ________________________________________________________________________________________ Kyrgyz Republic Economic Report No. 6 Fall 2014 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Government Fiscal Year: January 1 – December 31 Currency Equivalents: Exchange Rate Effective as of September 24, 2014 Currency Unit = Kyrgyz Som (KGS) US$1 = 54.30 KGS Weights and Measures: Metric System Abbreviations and Acronyms NBRK National Bank of the Kyrgyz Republic CAD Current Account Deficit FDI Foreign Director Investment ADB Asian Development Bank VAT Value-Added Tax NPLs Non-Performing Loans PSRR Public Sector Reform Roadmap, CU Customs Union HACCP Hazard Analysis Critical Control Point ISO International Organization for Standardization NATO North Atlantic Treaty Organisation WB World Bank EBRD European Bank of Reconstruction And Development EaDB Eurasian Development Bank ii | Kyrgyz Republic: Moderating Growth and a Challenging Outlook Contents Abbreviations and Acronyms ............................................................................................................................................. ii Acknowledgements ............................................................................................................................................................... iv Overview ..................................................................................................................................................................................... 1 A. Recent Political Developments................................................................................................................................. 3 B. Recent Economic Developments ............................................................................................................................. 4 Economic Growth ............................................................................................................................................................... 4 Inflation .................................................................................................................................................................................. 6 Balance of Payments ......................................................................................................................................................... 6 Employment and Labor Markets ................................................................................................................................. 7 Poverty ................................................................................................................................................................................... 9 C. Economic and Structural Policies.......................................................................................................................... 11 Fiscal Policy ........................................................................................................................................................................ 11 Monetary and Exchange Rate Policies ..................................................................................................................... 13 Structural Reforms .......................................................................................................................................................... 14 D. Outlook ............................................................................................................................................................................. 17 Appendix ................................................................................................................................................................................... 21 | iii Kyrgyz Republic: Moderating Growth and a Challenging Outlook List of Tables Figure 1. GDP growth has slowed down markedly … ............................................................................................... 5 Figure 2. … reflecting moderation of economic activity across the board....................................................... 5 Figure 3. Prices have been increasing ............................................................................................................................. 6 Figure 4. The external deficit declined …....................................................................................................................... 7 Figure 5. … as gold exports increased and imports declined ................................................................................ 7 Figure 6. The unemployment rate declined as people moved out of the labor force.................................. 8 Figure 7. The employment structure remained unchanged .................................................................................. 8 Figure 8. Absolute and extreme poverty rates declined slightly in 2013 ........................................................ 9 Figure 9. International Poverty Headcount Ratios .................................................................................................... 9 Figure 10. With divergent moves in urban and rural poverty ............................................................................ 10 Figure 11. The volatility of the som increased in 2014 forcing the NBKR to step up interventions .. 13 Figure 12. Still, the nominal exchange rate depreciation was insufficient to prevent appreciation of the real exchange rate ................................................................................................................................... 13 Figure 13. Money supply growth has moderated .................................................................................................... 14 Figure 14. Some aspects of competitiveness are gradually improving ........................................................... 15 Figure 15. Growth in the region will slow down ...................................................................................................... 17 Figure 16. Commodity prices are expected to weaken .......................................................................................... 17 Figure 17. Growth has been pro-poor but the relationship has weakened in recent years ................... 19 Table Table 1. Selected fiscal Indicators................................................................................................................................... 12 _______________________________ Acknowledgements The World Bank regular economic reports on the Kyrgyz Republic are published every six months. This report was prepared by a team comprising of Evgenij Najdov (Senior Economist) and Bakyt Dubashov (Economist). The report benefited from the guidance of Christos Kostopoulos (Lead Economist), Ivailo Izvorski (Practice Manager, MFM Global Practice), and Jean-Michel Happi (Country Manager). Sarah Babirye (Program Assistant) formatted the report. iv | Kyrgyz Republic: Moderating Growth and a Challenging Outlook Overview Political developments at home and abroad have been prominent this year. Domestically, a new government was formed quickly after one of the coalition parties withdrew the support to Prime Minister Satylbaldiev in March, 2014. The new government, led by Prime Minister Djoomart Otorbayev, represents the same coalition of political parties providing continuity on most policies but also a fresh momentum for reforms in key sectors. The next round of parliamentary elections is scheduled for the autumn 2015. Internationally, the Kyrgyz Republic has made firm commitments towards accession to the Customs Union of Belarus, Kazakhstan and Russia while tensions have appeared in relations with some neighbors. Growth has slowed down significantly and we have revised our projection for real GDP growth to 3 percent for 2014 as a whole from the 4 percent we projected in April. Despite robust government investment and gold exports, economic activity has moderated as the slowdown in Russia, the winding down of operations at the Manas Transit Center and increased tensions in trade relations with neighbors are affecting remittances and non-gold exports. Economic activity has been further affected by the poor agriculture harvest while difficulties expected in ensuring stable energy supply in the winter may add a further drag on activity in the rest of the year. Fast growth rates in credit to the private sector and in construction are leveling off as businesses report a more difficult operating environment. Inflation spiked in mid-2014 reaching 8.5 percent (y-o-y) reflecting the high-pass through of the depreciation of the som earlier in the year. Pressures on the exchange rate re-surfaced in late-August and early-September and despite interventions by the central bank (NBRK), the som depreciated further. Despite slower domestic demand, increases in administered energy prices, further depreciation, and a poor harvest could increase inflation above our projection of around 10 percent for the full year (y-o-y). Hikes in excise tax rates and stepped-up tax enforcement measures helped off-set the impact of slower growth on the budget this year, with the medium-term plan projecting a significant investment-led fiscal expansion. With the latest Budget supplement, the Government is increasing the budget deficit in 2014 to around 5.7 percent of GDP on the account of faster implementation of foreign financed projects. Further increase in the deficit is envisaged in 2015. Keeping fiscal risks manageable may require an adjustment in policies and public expenditure reform. The growth slowdown is likely to reduce imports and together with robust gold exports should narrow the external imbalance. We now project the current account deficit to narrow to around 11 percent of GDP this year from the earlier projection of 15.5 percent of GDP. Increased borrowing and foreign direct investment (FDI) should finance the deficit and allow for some reserve accumulation. The medium-term growth outlook has become more challenging. Even beyond the current geopolitical tensions, projections for the medium-term growth rates of the Russian economy have been cut reflecting capacity constraints and lack of structural reforms. Furthermore, the current slowdown in re-exporting activities which are highly labor-intensive may not to be short-term and may result in job losses going forward. Strong government infrastructure spending and investments in energy, transport and mining would still help generate positive growth rates, but we currently project the economy to grow by 4-4.5 percent a year in the next three years. Overview |1 Kyrgyz Republic: Moderating Growth and a Challenging Outlook With more moderate rates of growth, poverty reduction and gains in shared prosperity are likely to be more difficult going forward. Growth between 2000 and 2013 was pro-poor. However, the link between growth and poverty reduction has weakened in recent years, as price shocks dented purchasing power and contributions from capital-intensive sectors (gold mining, energy investments) have risen. Past experience in the Kyrgyz Republic suggests robust reduction in poverty mostly in years with growth rates in excess of 5 percent, with predominant contribution from domestic demand and non-commodity exports. Ensuring the growth remains inclusive would require a change in the patterns of growth and an overhaul of the social sectors in the Kyrgyz Republic. 2| Overview Kyrgyz Republic: Moderating Growth and a Challenging Outlook A. Recent Political Developments A new government took office in April 2014 as further evidence of the growing capacity for democratic governance in the Kyrgyz Republic. The cabinet of Prime Minister Jantoro Satylbaldiev resigned after the Ata-Meken party decided to withdraw its support following allegations of embezzlements of budget funds by Mr. Satylbaldiev during his tenure as Head of the Agency for restoration of Osh and Djalal-Abad cities in 2010-11. A new government was quickly formed with the appointment of Mr. Djoomart Otorbaev, a first Vice Prime Minister in the previous administration, as Prime Minister. Most of the cabinet ministers were unchanged providing continuity in most policy areas, and a fresh momentum for reforms in key sectors, including energy, governance and business environment. Following the relative calm in the last few months, the political scene is likely to heat up as the new election cycle approaches. With the exception of sporadic road blocks in the south, demanding the release of an opposition leader jailed on charges of fraud and corruption, domestic politics have been relatively calm. Still, political issues are likely to gain prominence as the date for the next parliamentary elections -- currently scheduled for autumn 2015 -- approaches. The Kyrgyz government agreed the road map on accession to the Eurasian Customs Union. The leaders of the Eurasian Customs Union countries met in Astana on May 30, 2014 to agree the road map that contains legislative amendments and infrastructural upgrades for the Kyrgyz Republic to access the Eurasian Customs Union. Following the approval of the road map, the Kyrgyz and Russian governments reached an agreement on a US$200 million grant facility to support the implementation of the road map as well as US$1 billion concessional credit facility to finance development projects in the Kyrgyz Republic. Relations in the region remain tense. Unresolved delimitation of the Kyrgyz Republic and Tajikistan border continues to cause military clashes resulting in the death of soldiers and civilians, damage to infrastructure and disruption of trade relations. Senior government officials have been meeting to de-escalate the situation but an agreement on the disputed border has not yet been reached. Supplies of gas from Uzbekistan remain interrupted reflecting little progress in negotiations between the Uzbek side and Russia’s Gazprom, the new owner of Kyrgyzgas, while Kazakhstan has been strengthening border controls and blocking the delivery of Russian fuel to some traders in the Kyrgyz Republic passing through its territory. Less-than-usual precipitation and water inflows in transboundary river basins is adding to the more tense trade relations and threatening to disrupt the fragile balance. Recent Political Developments |3 Kyrgyz Republic: Moderating Growth and a Challenging Outlook B. Recent Economic Developments Economic Growth Growth moderated to 3.3 percent year-on-year in January-July of 2014 from 10.5 percent in 2013 as a whole, as higher investment and gold exports were off-set by moderate consumption growth, loss of revenues following the closure of the Manas Transit Center and more tense trade relations with neighboring countries. Gold production at the Kumtor mine increased by 15.2 percent year-on-year, down from 52.6 percent a year earlier as the mine returned to normal operations following the disruptions in 2012. The non-gold economy growth was also weaker at 2.6 percent, year-on-year (y-o-y), compared to 5.6 percent a year ago, as declining remittances, modest wage growth and difficulties in trading relations with neighbors affected consumption and exports. While somewhat softer in recent months, investment was robust, supported by strong domestic demand for residential housing and government capital spending. Consumption growth slowed as higher inflation, modest wage growth and declining remittances affected disposable income and consumer sentiment. Consumption growth declined to 5.1 percent (y-o-y) in the first quarter of 2014, down from 6.4 percent in the same period a year ago. 1 Retail trade and tax collection data suggest that the trend has continued since. Slower economic activity and higher inflation kept real wages growth at only 1.4 percent in the first half of the year. At the same time, growth of credit to the private sector, while still remaining strong, moderated in recent months, and government spending on goods and services remained flat. On the other hand, lower growth in Russia as well as the depreciation of the Russian ruble against the US dollar affected remittances which fell by 1.2 percent in the first seven months of this year compared to the same period a year ago. With consumption slowing, investments have been driving growth. Residential housing construction increased by 10.9 percent in the first seven months of 2014, continuing the trend of rapid expansion which began around 2012. A mix of supply (greater availability of construction land; entry of new, including foreign, investors) as well as demand (pent-up demand; stronger economic growth) factors appear to explain the construction boom in recent years. Construction and equipment purchases in the mining sector were up 19.8 percent (y-o-y) and capital spending by the public sector, especially in the energy sector, remained high. While gold exports performed well, weaker external demand, the closure of the Manas Transit Center and a more difficult trade facilitation environment affected exports. Total exports increased by 4.3 percent in the first half of 2014 as the 34.4 percent increase in gold exports off-set the 5.6 percent decline in non-gold exports, mostly due to declining re-exports. 2 Re- export of kerosene declined as the operations of Manas Transit center were winding down. More stringent controls on the Kyrgyz-Kazakh border appear to be significantly affecting trade flows, (both of re-exports but also of exports of Kyrgyz products). Also, border tensions at the Kyrgyz- Tajik border during the first half of the year affected exports (for example, the production at the South cement plant that exports cement to Tajikistan declined). Imports declined by 10 percent as slower consumption growth added to the reduced demand for re-exports. 1Data for the first half of 2014 are not available yet. 2Gold exports growth was driven by an increase in real volumes as gold prices registered a 15 percent decline compared to a year ago. 4| Recent Economic Developments Kyrgyz Republic: Moderating Growth and a Challenging Outlook On the production side, economic activity was marked by stabilizing gold production, a poor harvest and slowing demand for services. Industrial production growth was 8.6 percent (y-o-y) in the first seven months of 2014, down from 12.6 percent a year earlier as gold production at the largest gold mine gradually returned to full capacity operations. Non-Kumtor industry output reached 4.4 percent during January-July of this year (it was negative, -0.1 percent, in the same period of 2013) mainly due to a 13.7 percent growth in food industry, as some of the producers were able to meet Customs Union standards and re-gained market access in Kazakhstan. On the other hand, output in textile and clothing industries declined (-3.8 percent, y-o-y) reflecting continued difficulties to export these products to Russia through the Kazakh border. Higher demand for energy and disruptions in the gas supply from Uzbekistan resulted in an increase of electricity production by 13 percent (y-o-y) but also adding to the risks facing the country as water levels were drawn down to levels that may jeopardize the regular supply of electricity over the upcoming heating season. The late spring and low rainfall have affected agriculture. Agriculture output fell to 1.7 percent in January-July 2014 from 2.1 percent growth in the same period a year ago. This decline was largely due to lower yields of wheat and barley affected by adverse weather conditions. Despite the authorities’ support to farmers providing gasoline and diesel at subsidized prices extending budget loans for purchasing machinery, seeds and fertilizers, the agricultural sector remains weak and more significant reforms are needed. Construction and services registered positive growth although at declining paces. Construction grew by 13 percent (y-o-y) owing mainly to strong demand for residential housing, a slight deceleration compared to a year ago when it registered 18 percent growth. Similarly, the services sector growth moderated to 3 percent (y-o-y) in January-July 2014 from 5 percent (y-o-y) a year ago mainly reflecting somewhat slower growth in the trade and tourism sectors and almost flat output in transport. Figure 1. GDP growth has slowed down Figure 2. … reflecting moderation of economic markedly activity across the board. In percent Contribution by sector, in percentage points 12 100 15 10 80 10 60 8 5 40 6 20 0 4 0 -5 2 -20 0 -10 -40 2008 2009 2010 2011 2012 2013 Jan-Jul 2008 2009 2010 2011 2012 2013 Jan-Jul -2 2014 -60 2014 Agriculture Construction Non-Kumtor real GDP (RHS) Kumtor (RHS) Industry Trade Real GDP (LHS) Transport&communication Other Source: Kyrgyz authorities. Source: Kyrgyz authorities. Recent Economic Developments |5 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Inflation Headline inflation picked up as domestic prices adjusted to the weakened Kyrgyz som against the US dollar and higher imported fuel prices. Annual inflation surged to 8.5 percent in June 2014, its highest level since late 2011 and up from 4 percent in December last year as consumer prices increased responding to the depreciation of the som against the US dollar in the first quarter of 2014. The Kyrgyz Republic shares a number of the characteristics associated with high exchange rate pass-through to consumer prices, including small size, import dependence (close to 60 percent of food is imported) and limited domestic production. In addition, higher prices of oil at refinery plants in Russia since April 2014 put further pressure on domestic fuel prices which increased by close to 20 percent, y-o-y (Figure 3). Figure 3. Prices have been increasing. The increase in core inflation has been In percent, year on year change more muted. Core inflation declined to 7 percent in July 2014 from 9.2 percent a year 20 ago as domestic demand gradually slowed 15 down. It increased slightly most recently, which may be due to second round effects of the 10 higher oil prices. 5 While slowing demand is likely to reduce pressures over prices, a number of factors 0 could increase inflation above the NBKR -5 target of around 7 percent. Price pressures subsided in August as domestic demand slowed while the som recovered some of its value. Headline Food Fuel Core inflation However, the latest depreciation on the som could again reignite pressure over prices. Also, Source: NBKR. the government adopted new mid-term tariff policies for 2014-2017 for hot water, heating and electricity supply envisaging gradual increase in prices starting from the second half of this year. Finally, higher exports of food products to Russia, in response to the retaliatory bans introduced by Russia on countries that have imposed sanctions, are likely to elevate prices in the Kyrgyz Republic. Balance of Payments Lower imports and robust gold exports helped narrow the officially reported current account balance in the first half of 2014. The current account deficit declined to 17.4 percent of GDP in the first six months of 2014 from 29.8 percent a year earlier. Exports rose 4.3 percent (y-o- y) in January-July 2014 as gold exports grew by 34.4 percent accounting for 32 percent of total exports. At the same time, slower economic activity and a disruption in fuel supplies coming through the territory of Kazakhstan led to a 10.4 percent decline in imports in US dollar terms. Consequently, the officially registered trade balance narrowed to 43.2 percent of GDP in the first half of 2014 from 52.8 percent a year earlier. Private transfers in the first seven month of 2014 remained almost flat compared to the same period of 2013, though they have also become more volatile as uncertainty over developments in Russia increased. Transfers cover a large part of the foreign trade deficit and in addition to remittances from the large Kyrgyz diaspora (mostly migrant workers in Russia) also 6| Recent Economic Developments Kyrgyz Republic: Moderating Growth and a Challenging Outlook include unregistered exports of goods and services and other economic transactions. Following a first quarter in which private transfers declined, the inflows recovered in the second quarter as the ruble recovered some of its lost value. However, transfers declined again in July, bringing the total inflows for the first seven months of the year to 1 percent below their level in the same period of 2013. While there is no evidence so far of a return of migrants from Russia, the increased volatility of transfers may reflect greater uncertainty as well as reduced demand for Kyrgyz exports. Figure 4. The external deficit declined Figure 5. … as gold exports increased and imports declined. In percent of GDP In millions, US dollars 0 6,000 -10 -20 4,000 -30 -40 2,000 -50 -60 0 2009 2010 2011 2012 2013 H1 H1 2009 2010 2011 2012 2013 H1 H1 2013 2014 2013 2014 Current account balance Trade balance Export of goods Import of goods Source: NBKR. Source: NBKR. Total capital and financial inflows declined as FDI fell. Smaller reinvested earnings by Kumtor (the largest gold mine) as well as higher outflow based on inter-company transactions resulted in a large decline in FDI to US$64 million in the first half of 2014 from US$223 million in the same period of 2013. Still, debt financing inflows increased, with the government borrowing nearly US$250 million (most of it to finance public investment projects), nearly twice as much compared to a year ago. At the same time, the private sector’s borrowings amounted to almost US$50 million, much higher than compared to a year earlier. Higher debt-creating flows pushed the gross external debt to 93.7 percent of GDP at the end of the first quarter or 2014 (the last date for which official information is available) and it is likely to have increased further since. With net capital and financial inflows exceeding the current account deficit, the NBKR increased reserves to around US$2.2 billion by mid-2014, maintaining the import coverage at around 4 months of imports. Employment and Labor Markets Employment, unemployment and labor force participation all fell in 2013. With growth in 2013 driven by recovery of gold production and capital-intensive investment, creation of jobs was limited. Around 111,000 jobs were created in the Kyrgyz Republic in 2013, 1,500 less than in 2012, but 8,200 less compared to the average for 2007-2009. Furthermore, 95 percent of new jobs were created in the informal sector (sole-proprietors and agriculture). This was insufficient to prevent a decline in employment by 1 percent compared to 2012, bringing down the employment rate to 57.2 percent in 2013, from 58.8 percent in 2012 and 59.3 percent in 2011. Despite a lower number of employed in 2013, the unemployment rate declined as people moved out of the labor force. The participation rate declined sharply in 2013, falling to 62.5 percent, down from 64.2 percent in 2012 and from the high of 65.5 percent of the labor force Recent Economic Developments |7 Kyrgyz Republic: Moderating Growth and a Challenging Outlook recorded in 2006. With the number of people moving out of the economic activity exceeding the reduction in employment, the unemployment rate in 2013 declined to 8.3. The employment structure remains little changed, with agriculture, trade and construction accounting for most of the employees. Out of total employment, 31.7 percent were in agriculture, and 15.9 percent in trade in 2013, up from 30.1 percent and 15.1 percent, respectively, a year earlier. These two sectors created nearly 58 percent of total new jobs in 2013 absorbing most of the youth employment. While the share of employment in construction slightly declined to 10.8 percent in 2013 from 11.3 percent in 2012, it remains the third largest sector in the job market. The construction sector created 4.3 percent of new jobs in 2013. Figure 6. The unemployment rate declined as Figure 7. The employment structure remained people moved out of the labor force. unchanged. (In percent) (Share of total) 70.0 8.8 2013 65.0 8.6 Agriculture Manufacturing 60.0 8.4 Construction Trade 55.0 8.2 Transport 50.0 8.0 Education 2008 2009 2010 2011 2012 2013 Civil service Participation rate (LHS) Employment rate (LHS) Others Unemployment rate (RHS) Source: National Statistics Committee. Source: National Statistics Committee. In the absence of official data, indirect evidence does not suggest major changes in the labor market so far in 2014. The number of officially registered job seekers reported by the Ministry of Labor, Migration and Youth has been stable in recent months, though this appears to be understating the true number of unemployed. Wage growth has been moderate in the first half of 2014 (7.9 percent in nominal terms and only 1.4 percent in real terms) with wages in the public sector growing only slightly faster (1.6 percent real growth) compared to wages in the rest of the economy (1.2 percent real growth). Daily rates for laborers show similar trends suggesting limited changes in demand and supply for labor. 3 Differences in wages across sectors remain the same as a year earlier. According to officially reported wage statistics, the highest wages are paid in the financial sector, transport and communication manufacturing and construction. Relatively lower wages are paid in health and education, sectors dominated by the public sector service providers. Agriculture remains the sector with the lowest remuneration levels. As shown in our March 2014 economic update, wages have been only loosely correlated with productivity improvements in the Kyrgyz Republic, though the limited coverage of the wage statistics may be weakening the relationship. 3 World Food Program collects data on monthly basis on daily rates for hired labor. 8| Recent Economic Developments Kyrgyz Republic: Moderating Growth and a Challenging Outlook Poverty The official poverty rate in the Kyrgyz Republic declined slightly in 2013, reversing the rising trend that began with the crisis in 2009. The absolute poverty rate was 37 percent in 2013, down from 38 percent in 2012 (Figure 9). This means that around 2.14 million people, out of a total population of 5.7 million, lived below the poverty line. 4 Similarly, extreme poverty decreased by 1.6 percentage points to 2.8 percent in 2013. In absolute numbers, about 159 thousand people cannot afford the minimum food basket. With growth in 2014 moderating and largely being driven by capital-intensive investment and gold exports, significant gains in consumption and poverty reduction are unlikely. Figure 8. Absolute and extreme poverty rates Figure 9. International Poverty Headcount Ratios declined slightly in 2013. In percent of population In percent of population 36.8 38.0 37.0 60 40 20 0 4.5 4.4 2.8 -20 2004 2005 2006 2007 2008 2009 2010 2011 2011 2012 2013 GDP growth (annual %) Poverty $1.25 (PPP) per day Absolute Extreme Poverty $2 (PPP) per day Source: National Statistics Committee. Source: World Bank. The earlier convergence in rural and urban poverty rates reversed in 2013 due mainly to a sharp decline in urban poverty. Previous trends since 2004 showed the narrowing gap between rural and urban poverty rates, but in 2013 the gap started to widen again. By 2013, rural poverty increased by 1.8 ppt reaching 41.4 percent of rural population, while urban poverty has declined sharply by 7 ppt leveling at 28.5 percent of urban population. The observed dynamics underlines the great degree of annual volatility of regional level poverty rates—and rural poverty rates may be correlated to low growth in agriculture. The poverty rates based on the extreme poverty line in urban areas has declined from 4.2 percent in 2012 to 1.6 percent in 2013—perhaps in part due to food prices being largely unchanged in 2013. Rural extreme poverty rates show continuation of a declining trend over the years. 4 The poverty line was calculated using the “cost of basic needs” approach in 2011 and subsequently inflated to account for food and non-food price changes in 2012 and 2013. Thus, the poverty lines are in nominal KGS. Recent Economic Developments |9 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Figure 10. Urban and rural poverty trends diverged In percent of population Absolute poverty Extreme poverty 40.4 39.6 41.4 5.7 4.5 35.4 3.3 30.7 28.5 4.2 1.6 2.6 2011 2012 2013 2011 2012 2013 Urban Rural Urban Rural Source: National Statistics Committee. Source: National Statistics Committee. The poverty gap declined during 2012 and 2013 further confirming the reduction in extreme poverty. The poverty gap ratio measures how far the poor’s consumption per capita lies below the poverty threshold, an alternative measure of the severity of poverty. The reported poverty gap and poverty severity index (i.e., the squared poverty gap) narrowed by 0.7 and 0.4 percentage points, respectively, in 2012-2013 indicating that inequality among the poor and depth of poverty are on a decreasing trend. Poverty gaps for food poverty approaches zero. 10| Recent Economic Developments Kyrgyz Republic: Moderating Growth and a Challenging Outlook C. Economic and Structural Policies Fiscal Policy The economic slowdown is adversely affecting tax revenues, while higher capital spending will increase the deficit. The fiscal deficit widened to 3.1 percent of GDP in January-July 2014 from 1 percent a year earlier. The increase is due to higher capital spending financed by foreign loans as lower tax revenues due to slower growth were off-set by more generous donor support and non-tax revenues. The authorities are currently amending the 2014 Budget to increase the deficit by 1.3 percentage points of GDP to around 5.7 percent of GDP on the account of faster implementation of foreign financed projects. Greater donor support and larger non-tax revenues helped offset the impact of slower growth on tax revenues. Total revenues increased to almost 40 percent of GDP in the first half of 2014, largely due to a 2.2 percent increase in non-tax revenues. Grants increased by 0.3 percent of GDP reflecting support from multilateral agencies and bilateral partners (Russia). On the other hand, tax revenues remained little changed as excises were hiked and revenue mobilization efforts were stepped-up. Tax revenues were 27.8 percent of GDP in January-July 2014 compared to 27.9 percent a year earlier. Value-added tax (VAT) on imports and customs duties declined by 0.1 percentage points and 0.4 percentage points of GDP, respectively while corporate income tax declined by 1.4 ppt due to a slowdown of economic activities. However, higher production at the Kumtor gold mine resulted in an increase in its gross income tax payments by 0.1 ppt to 1.3 percent of GDP, and excise tax revenues increased by 0.5 ppt to 1.6 percent of GDP due to higher rates for tobacco and fuel. In addition, in response to the revenue shortfall, the authorities strengthened tax administration to meet the tax targets, including through more stringent controls and through taking measures against businesses with tax arrears. As a result, according to the tax authorities, the tax collection gap was reduced to around KGS1.1 billion as of the end of June 2014. Total spending soared to 43 percent of GDP in January-July 2014 from 38.7 percent in the same period a year ago mainly due to public investment projects. This sharp increase mainly reflects foreign-financed projects, including the Datka-Kemin power transmission line (providing a direct connection between the north and south of the country), modernization of the Bishkek thermal plant and the alternative South-North road which are strategically important for energy and communication inter-connectedness of the country. More intensive works in these projects led to an increase in public investment to 7.7 percent of GDP in the first seven months of this year, up from 2.9 percent of GDP in the same period of 2013. At the same time, current expenditures slightly fell as a higher wage bill and social spending were off-set by lower purchases of goods and services. Current spending declined to 33.8 percent of GDP in January-July 2014, down from 34 percent in the same period a year ago. Higher wages to parts of the public sector (law enforcement bodies, judiciary) as well as larger pension spending resulted in a 0.3 percentage point of GDP increase in expenditures; however, at the same time, the government cut spending on goods and services to 8.2 percent of GDP from 8.6 percent a year earlier. Economic and Structural Policies |11 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Table 1. Selected fiscal Indicators (In percent of GDP) Jan-Jul 2013 Jan-Jul 2014* Total revenues and grants 37.7 39.9 Total revenues 34.9 36.7 Current revenues 34.7 36.6 Tax revenues 27.9 27.8 Non-tax revenues 6.8 8.8 Capital revenues 0.2 0.1 Grants 2.8 3.1 Total expenditure (inc. net lending) 38.7 43.0 Current expenditure 34.0 33.8 Wage 9.4 9.5 Transfer and subsidies 4.1 4.0 Social Fund expenditures 10.9 11.1 Interest 0.9 1.0 Purchase of other goods and services 8.8 8.2 Capital expenditure 5.1 9.6 Domestically finaced 1.4 1.4 PIP loans financed 2.9 7.7 PIP grants finaced 0.8 0.5 Net lending -0.4 -0.4 Overall balance -1.0 -3.1 Financing 1.0 3.1 External 3.7 8.0 Domestic -2.7 -4.9 Source: Ministry of Finance. *Preliminary. The deficit in the first seven months of 2014 was over-financed resulting in further build-up of government deposits, but also government debt. Disbursements on foreign credits during the first seven months of 2014 totaled KGS14.9 billion, exceeding the financing needs of the budget (the deficit was around KGS7 billion) and increasing government’s net claims on the NBKR to around KGS17.7 billion, or 4.5 percent of GDP. However, it also led to a faster build-up of public debt which at the end of the first half of 2014 reached 52.2 percent of GDP, up 5 percentage points of GDP compared to the same period in 2013. Structural reforms remain imperative for medium fiscal sustainability and improved public services. While the strong performance of 2013 and increased donor support in 2014 improved slightly fiscal buffers, the underlying weaknesses of the budget remain and will re-surface as economic activity slows down. The 2015-2017 fiscal framework envisages a strong investment stimulus bringing the deficit to 7.3 percent of GDP in 2015 before returning to a path of gradual reduction to 4 percent of GDP by 2017. The deficit levels may actually be higher given the optimistic assumptions on growth and on the ability of the authorities to control current spending. With the new election cycle during this period additional spending pressures may emerge from current spending. Therefore, the initiation of the public expenditure reforms is becoming critical as their implementation will take time. There are a number of areas where expenditures could be brought down and outcomes of public spending improved e.g. better targeting of social welfare programs, more efficient spending in education and health, pension reforms. Furthermore, in the absence of reforms and gradual introduction of cost-recovery pricing in infrastructure sectors, one-off interventions in infrastructure will have only a temporary and limited impact. 12| Economic and Structural Policies Kyrgyz Republic: Moderating Growth and a Challenging Outlook Monetary and Exchange Rate Policies The authorities are balancing slowing growth with rapid credit expansion, increased pressures over the som and higher inflation. 5 In an effort to balance competing objectives, the NBKR opted for a moderate, 50 basis points (bps), increase in its main policy rate in July 2014, bringing the discount rate to 6.5 percent. These increases appear to have had a limited impact on monetary conditions, reflecting to a large extent the degree of dollarization, low monetization and preference for cash holdings. The NBKR continues to pursue a floating exchange rate regime with interventions aimed at smoothening large fluctuations in the value of the som. Following a sharp depreciation of the Russian ruble and devaluation of the Kazakh tenge in early February 2014, the som came under pressure forcing the NBKR to intervene on the foreign exchange market. By end-April 2014 and following the sale of around US$195 million, or around 9 percent of the country’s international reserves, during the first four months of 2014 the som stabilized at a level around 10 percent below its value against the US dollar at the end of 2013. Transfers from Russia and the value of the Russian ruble recovered in the second quarter of 2014 bringing some stability to the foreign exchange market and as of end-June 2014 the som regained almost half of the value it lost in the early months of 2014. However, the foreign exchange market came under pressure again in the second half of August and early September, most likely reflecting worsening expectations from the Ukraine’s crisis and economic sanctions on Russia, with the NBKR making a sale of additional US$100 million. Higher inflation in Kyrgyz Republic than in its main trading partners led to a 3 percent real appreciation in the first seven months of 2014. Despite some loss of reserves recently, the level of reserves remains adequate. Gross official reserves stood at around US$2.2 million at end-August 2014, as the NBKR interventions on the foreign exchange market were off-set by increased official foreign inflows. The current level of reserves exceeds three months of imports and almost fully covers broad money supply. Figure 11. The volatility of the som increased in Figure 12. Still, the nominal exchange rate 2014 forcing the NBKR to step up interventions. depreciation was insufficient to prevent appreciation of the real exchange rate. (Central bank interventions in US$ million, exchange rate (Index, 2000 = 100) in KGS per 1 US$) 20 56 118 10 54 116 0 52 114 -10 50 112 110 -20 48 108 -30 46 106 -40 44 104 Central bank purchases (mln. USD, LHS) Central bank sales (mln. USD, LHS) Real effective exchange rate Som/USD exchange rate (RHS) Nominal effective exchange rate Source: NBKR. Source: NBKR. 5 Starting from early 2014, the National Bank of the Kyrgyz Republic moved to a new operational framework for monetary policy, using the interest rate to achieve its goal of price stability, rather than targeting monetary aggregates. Economic and Structural Policies |13 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Credit growth has slowed somewhat this year. After peaking at 45.8 percent (y-o-y) in March, credit growth slowed to 39.2 percent (y-o-y) by July 2014 but it is still faster than the 35.4 percent growth (y-o-y) a year ago. Lending rates of commercial banks declined during 2014, despite the higher interest rates of NBKR, and may have fueled demand for credit. Figure 13. Money supply growth has moderated. While financial sector indicators remain (In percent, y-o-y) robust, a sharper slowdown may test its resilience. Despite the recent moderation in 50 the growth of credit to the private sector, the 40 loan-deposit ratio in the banking sector 30 reached almost 1 at end-June 2014, up from 20 around 0.8 at the end of 2013. At the 10 same time, the capital adequacy ratio, at 22.1, remains well above prescribed levels 0 and profitability indicators (return on assets of 2.4 and return on equity of 16.0) are sound and non-performing loans (NPLs) declined to Reserve money Broad money 4.6 percent. Still, only around 60 percent of Credit to private sector NPLs are provisioned for and the decline in Source: NBKR. NPLs may be due to the young profile of the portfolio given the rapid growth rate of credits. In addition, liquidity in the system has declined reflecting developments in the monetary base and slower growth of deposits. Structural Reforms With a more challenging external outlook over the medium-term, continued progress in structural reforms that increase competitiveness will be critical to sustain growth. The 2014-2015 Global Competitiveness report ranked the Kyrgyz Republic at 108th place globally, noting weaknesses across the entire range of competitiveness pillars, including innovation (ranked 132nd), institutions (124th), business sophistication (119th), and infrastructure (115th). Still, this represents an improvement from 121st a year earlier, confirming that the government’s efforts in recent years to improve the infrastructure and functioning of institutions are starting to show some results. The government has made public sector reform a priority. In May 2014, the authorities adopted the Public Sector Reform Roadmap (PSRR), a document summarizing the governance- related priorities of the government in seven areas: i) anti-corruption, ii) judicial reform, iii) public administration reform, iv) civil service reform, v) public financial management reform, vi) energy sector and vii) mining sector. It draws on the findings of more than 30 strategic documents and proposes a prioritized approach with a timeline for implementation of various measures. The poor score of the Kyrgyz Republic on various public sector performance rankings (including the CPIA, WGI), confirms the appropriateness of the focus on public sector reforms. However, while the adoption of the roadmap is a good first step, the Kyrgyz authorities need to improve their track record on ensuring effective adoption and later on implementation of the measures in order to reap the benefits of the reforms. 14| Economic and Structural Policies Kyrgyz Republic: Moderating Growth and a Challenging Outlook Figure 14. Some aspects of competitiveness are gradually improving. (On a scale from 0-7, 7 is best) (Change compared to 2012-2013) Innovation Business sophistication Market size Technological readiness Financial market development Labor market efficiency Goods market efficiency Higher education and training Health and primary education Macroeconomic environment Infrastructure Institutions 0.0 1.0 2.0 3.0 4.0 5.0 6.0 -0.5 0.0 0.5 1.0 Source: World Economic Forum, Global Competitiveness Report 2014-15. The authorities are making efforts to improve the business environment. The authorities are developing a Private Sector Development Strategy, which similar to the PSRR, will provide a unified framework for the government’s efforts to improve the business environment. Also, reforms are underway in the financial sector (including further development of credit registry systems), private public partnerships and regulatory reform (inspections). To foster openness and connectivity, the authorities are unilaterally opening the Kyrgyz airspace for air traffic with a number of countries and are discussing with the Bank reforms in telecommunications. Still, a number of deficiencies continue to exist. Discussions with the private sector confirmed the importance of public sector and business environment reforms to support higher investments and job creation in the formal private sector. Common themes emerging included the need to reform tax policy and administration (including VAT refund, removal of the sales tax, broadening of the tax base and reducing the high social insurance contributions) and to simplify the permits issuance processes in order to reduce compliance costs and provide incentives for formalization. Businesses asked for more frequent and substantive industry–government policy dialogue (including improvements in the Regulatory Impact Assessment, greater representation of businesses in supervisory bodies), more transparent and accountable implementing agencies, higher quality judicial decisions as well as reforms in the public administration. This should improve policy predictability and minimize discretion and arbitrary interpretation of regulations. Businesses also suggested that the high interest rates limit access to finance with adverse impact over their competitiveness. Badly-needed reforms in the energy sector are finally been initiated. Amendments to the Law on Energy introduce in mid-2014 aim to clearly delineate powers and responsibilities and to create a settlement center for transparent accounting and monitoring of electricity and financial flows. Also, the powers to set tariffs were transferred from the legislative to the executive, thus opening up the way for badly needed, gradual, tariff adjustments. Medium-term tariff plans were adopted recently for gas, heating and electricity tariffs and as of mid-2014 the authorities started adjusting the tariff rates. In addition, the authorities are increasing the transparency of the power sector companies by requiring them to publish extensive information on their performance. These measures are expected to over time reduce the quasi-fiscal deficit of the energy sector (estimated at around 3 percent of GDP), improve the quality of services for consumers and increase the attractiveness of investments in the sector. Economic and Structural Policies |15 Kyrgyz Republic: Moderating Growth and a Challenging Outlook The accession to the Customs Union (CU) of Belarus, Kazakhstan and Russia will introduce a number of structural changes in the economy. The authorities recently agreed on a Roadmap for Kyrgyz accession to the Customs Union comprising of more than 100 measures (both legislative changes and infrastructure upgrades) and have been revising a large number of laws to make them compliant with CU regulations which could allow the country to enter the CU in 2015. With policy instability being one of the largest constraints to doing business, the rapid changes may be further increasing the anxiety of the accession process. 6 In an effort to support the accession process, the Kyrgyz and Russian governments reached an agreement on a US$200 million grant facility to support the implementation of the road map as well as US$1 billion concessional credit facility to finance development projects in the Kyrgyz Republic. 6 World Economic Forum, Global Competitiveness Report 2013-2014, available at: http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2013-14.pdf 16| Economic and Structural Policies Kyrgyz Republic: Moderating Growth and a Challenging Outlook D. Outlook We project growth rates for 2014 to moderate to 3 percent and remain in the range of 4- 4.5 percent over 2015 -17. With lower agriculture output, a possible adverse impact of electricity supply disruptions on businesses due to low water levels at the main hydropower plant, the increased tensions in relations with Tajikistan and Kazakhstan affecting trade activities and a possibility of further economic slowdown in Russia we revised our growth forecast for this year down to 3 percent from the earlier 4 percent. At the same time, the medium-term outlook has also become more challenging reflecting structural deficiencies in main trading partners, as well as more tense foreign trade relations, including from stricter enforcement of CU regulations. In the new environment, the authorities should ensure macroeconomic policies support stability, but also increase reform efforts to unleash the potential of the economy and to improve the protection of the most vulnerable. Figure 15. Growth in the region will slow down. Figure 16. Commodity prices are expected to weaken. (In percent per annum, simple average) (In real 2010 US dollar, 2010=100) 10.0 125.0 120.0 8.0 115.0 110.0 6.0 105.0 4.0 100.0 95.0 2.0 90.0 85.0 0.0 80.0 Russia Kazakhstan China 2013 2014 2015 2016 2017 2010-2013 2015-2017 Energy Food Precious metals Source: IMF World Economic Outlook, April 2014. Source: World Bank Commodity Outlook, June 2014. The stimulus from the external environment is likely to weaken. Even beyond the current geopolitical tensions related to the crisis in Ukraine, projections for the medium-term growth rates of the Russian economy have been cut to less than 2 percent reflecting capacity constraints, declining gains from terms of trade and lack of structural reforms. The developments surrounding Ukraine are likely to push the Russia growth rate down to around 0.3 percent in the next few years. Kazakhstan is also trying hard to stimulate the economy to reach rates of growth of around 5 percent. China’s growth rate is expected to slightly moderate with, so far, modest implications for demand from Central Asia. These trends will continue to depress demand for Kyrgyz export and will also affect remittances. Furthermore, prolonged tensions and the sanctions against Russia will affect financial flows as well as the overall investment sentiments and may disrupt supply chains and transport links in the broader region, though the exposure of the Kyrgyz Republic appears to be limited. The Russian ban on imports of some food products from countries that introduced sanctions towards Russia could provide an opportunity to Kyrgyz exporters to gain market share on the large Russian market. Still, given the structural issues in the Kyrgyz agro-processing sector as well as the poor harvest, the impact is likely to be marginal. The Kyrgyz agriculture sector is Outlook |17 Kyrgyz Republic: Moderating Growth and a Challenging Outlook excessively fragmented and inefficient and in general fails to meet (with the exception of few producers) the standards imposed by the CU reflecting issues with quantity, packaging, quality but also customer preferences. The agro-processing sector suffers from low investment levels and inability of producers to ensure supply reflecting issues with access to land and finance, risk- management, availability of seed materials and low prevalence of international recognized certification HACCP and ISO standards), taxation and agri-business financial services etc. Furthermore, any increase in exports to Russia is likely to lead to price pressures domestically and could hurt the poor and bottom 40 percent. Informal trade, a large employer in the Kyrgyz Republic is facing an uncertain future as Customs Union regulations are implemented more rigorously by Kazakhstan. Recently, Kazakhstan introduced more stringent controls at its border with the Kyrgyz Republic in an attempt to ensure duty-free access only to Kyrgyz-made products. Anecdotal evidence suggests that this measure is having a significant impact over re-exports (mostly of Chinese goods mediated through the large bazaars in the Kyrgyz Republic) which have slowed down in 2014. Given the large number of people employed in this sector, a large number of traders may be forced to exit the market affecting negatively employment and domestic demand. With Russia no longer providing employment opportunities, absorbing the growing work force can be a problem. The accession of the Kyrgyz Republic to the Customs Union is also likely to add an additional layer of uncertainty over medium-term growth prospects. For the garments sector, a key employer and foreign exchange earner in the country, joining the Customs Union will lead to increased tariffs on imports and more formalization at the border, both of which can be expected to increase the cost of textiles and hence reduce the industry’s competitiveness. Simulations done recently by the World Bank suggest that production costs may increase between 3.6 percent and 7.7 percent or perhaps even more. The accession will also provide opportunities for Kyrgyz exporters; however, failure to meet CU standards and technical regulations may dent export opportunities. In addition, higher prices, as Customs Union tariffs and regulations are introduced, will affect household demand. Politically, a number of challenges are likely to affect business sentiments over the medium- term. Domestically, the elections planned for 2015 are likely to heat-up the domestic political scene, but are also an opportunity for the Kyrgyz Republic to demonstrate that democratic principles are increasingly starting to take hold. Internationally, the fragile water-energy balance in the region could easily be undermined if the energy situation in the Kyrgyz Republic remains dire or countries in the region fail to find a common understanding regarding the use of scarce water resources. Also, it is widely assumed that the completion of the withdrawal of NATO forces from Afghanistan at the end of the year and the ending of the operations in Central Asian countries will leave a security vacuum in Afghanistan, in which the risk of an escalation in drug-related activity is expected to increase. On the upside, a strong pipeline of public investments, a healthy banking sector and a strong agenda for reforms in natural resource management may open up possibilities for growth. Investments in energy and communications are likely to remain strong over the next few years, including the start of construction of the line D of the Central Asia – China gas pipeline, the North- South road rehabilitation of power plants, and upgrade of road links, with financing secured from China or multilateral (WB, EBRD) and regional development banks (ADB, EaDB). With a capital adequacy ratio or above 20 percent, the banking sector is relatively well-placed to support businesses if opportunities emerge. Gold prices are expected to remain stable amid conflicting developments as pressures for lower prices caused by a robust recovery in the US economy are off- set by reinforced safe-haven demand for gold resulting from the mounting geo-political tensions in 18| Outlook Kyrgyz Republic: Moderating Growth and a Challenging Outlook number of regions globally. However, realizing the country’s full potential in mining would require that it moves out of the list of “least attractive jurisdictions for investment” where it is currently placed in some international rankings. 7 The lower growth environment will generate a number of challenges. The Kyrgyz Republic has generated relatively few jobs in recent years. The number of employed was basically flat between 2010 and 2013 with the small reduction in the unemployment rate coming as a result of a growing inactive population. With growth in 2015 and 2016 likely to be capital intensive, these trends are not expected to change significantly. In fact, a rapid decline in re-exports, largely mediated through wholesale markets, is likely to result in job destruction. The authorities need to carefully reconsider policies in order to adjust to the new realities and ensure improved welfare even in a lower growth environment. Also, the underlying weaknesses of the budget are likely to re-surface. The better than expected fiscal outcome in 2013 improved slightly the liquidity of the budget, but, fiscal buffers remain thin limiting the options to respond to the volatility in economic developments, including the current slowdown. To make a more meaningful progress in poverty reduction and shared prosperity, the Kyrgyz Republic needs to tackle the agenda of “inclusive growth”. Growth in the Kyrgyz Republic over the last decade has been generally pro-poor with episodes of growth being correlated with poverty reduction and with growth in consumption of the bottom 40 percent. In fact, during 2000-2013, the semi-elasticity of growth on poverty was a robust -0.5. 8 However, this relationship is not linear and has weakened in recent years reflecting lower and more volatile growth and price shocks. Actually, while the link between growth and poverty reduction is robust at higher growth rates (above 5 percent), it appears significantly weaker at lower growth rates. With growth rates over the medium-term of around 4.5 percent, significant structural and public expenditure reforms are needed to ensure growth is inclusive, i.e. to achieve poverty reduction and gains in shared prosperity. In absence of reforms, poverty reduction gains are likely to be modest. Figure 17. Growth has been pro-poor but the relationship Ensuring growth is inclusive would has weakened in recent years. require job creation and improved (In percent for GDP growth and percentage points for change in protection of the vulnerable. Inclusive poverty) growth requires the generation of jobs for 12.0 the poor, typically in low-skilled, labor 10.0 intensive industries. Labor income 8.0 accounts for close to two thirds of the 6.0 disposable income of the average Kyrgyz 4.0 and almost 60 percent of the income of the 2.0 poorest 10 percent. Investments in human 0.0 -2.0 capital (earlier entry into and higher -4.0 quality of education; higher quality health -6.0 services etc.) are likely to increase -8.0 employability and wages. Furthermore, sizeable amounts of benefits in the Kyrgyz Republic are targeted towards the well-off GDP growth rate, in % Change in poverty rate, in p.p. and improved targeting of social benefits Source: Bank staff calculations based on data from NSC. to the more vulnerable can also help 7 http://www.fraserinstitute.org/uploadedFiles/fraser-ca/Content/research- news/research/publications/mining-survey-2013.pdf 8 This implies that a 1 percent growth in GDP per capita is associated with reduction of the headcount poverty rate by 0.5 percentage points. Based on authors’ calculations. Outlook |19 Kyrgyz Republic: Moderating Growth and a Challenging Outlook reduce poverty. The ongoing creation of the unified registry of recipients of social transfers is an important first step that will allow, over time, streamlining and better targeting the large and inefficient social spending. Similarly, it will be important to protect the most vulnerable mitigate the impact of the ongoing energy price increases. The fiscal challenge over the medium term will continue to be to support economic activity and improve protection of the vulnerable while contributing to macroeconomic stability. However, this task will be made more difficult by the lower revenues as a result of the more modest economic growth rate. The medium-term fiscal framework envisages an investment-led expansion that may see public debt increase to 57 percent of GDP by 2016 increasing the risks for fiscal sustainability. Furthermore, the framework is based on somewhat optimistic assumptions for growth rates of the economy and tax revenues. In the absence of tax policy and administration reforms, these revenue targets are unlikely to be met and the authorities should be ready to adjust the fiscal framework adequately. Without reforms in public service delivery, the commitments made on the expenditure side could be difficult to accomplish. On the expenditure side, the medium-term fiscal framework envisages a robust increase in capital expenditures (mostly foreign-financed). Actually, excluding foreign financed investments, the general budget is projected to run a surplus of around 2.2 percent of GDP on average between 2015 and 2017. Strict controls are envisaged over wages and goods and services spending, which may be difficult to maintain with the upcoming elections and also undermine the ability of the public sector to attract and preserve high quality staff. Furthermore, outcomes of public spending remain suboptimal, including in social protection, education and public investment management. Current health financing is insufficient for a meaningful improvement in quality of services while the current rates of social insurance contributions create disincentives for formality and increase the burden of pensions. The recently completed Public Expenditure Review (PER) provides recommendations that could support fiscal consolidation while improving the outcomes of public spending. Inflationary pressures from international food and energy prices are expected to moderate; however, spikes in inflation due to external shocks cannot be ruled out. Good harvests over the last two years have kept grains prices low recently and these trends are expected to continue. With international prices of food and energy expected to moderate, some tightening of fiscal policy and increasingly more efficient monetary policy, inflationary pressures should moderate. However, the eventual accession to the CU is likely to increase prices as tariffs adjust to the new (mostly higher) levels as will the gradual increase in administered energy prices. Similarly, continued uncertainty resulting in larger fluctuations of the som will further increase prices. The current account is expected to widen slightly over the medium-term. Gold exports are expected to remain robust as prices are projected to remain largely stable (in the range of around US$1,300 per troy ounce), over the medium term. Non-gold exports are expected to be constrained by the slower growth in main trading partners and gradual introduction of CU standards and practices. On the upside, easier access to CU members and preferential access to the Russian market could help off-set some of the negative impact. Slower re-exports will also reduce imports; some recovery is expected as import-intensive infrastructure projects continue. With Russian growth of around 0.3 over the medium-term, transfers are expected to remain stable. 20| Outlook Kyrgyz Republic: Moderating Growth and a Challenging Outlook Appendix Economic and Social Indicators: Kyrgyz Republic 2006-15 Selected Indicators 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Projections Income and Economic Growth GDP Growth (% change, y-o-y) 3.1 8.5 8.4 2.9 -0.5 6.0 -0.1 10.5 3.0 4.0 4.5 GDP per capita growth (% change, 2.0 7.7 6.4 1.6 -1.6 4.9 -1.9 9.4 1.9 3.0 3.5 y-o-y) GDP per capita (US$) 546 727 972 864 875 1,120 1,182 1,280 1,277 1,308 1,386 Gross investment ( % of GDP) 22.5 21.0 20.2 22.9 23.9 24.3 26.2 25.6 27.3 28.8 29.2 Public ( % of GDP) 4.3 4.8 4.2 5.0 5.4 5.8 7.7 7.2 10.0 12.4 11.5 Private ( % of GDP) 18.2 16.3 16.1 17.8 18.5 18.6 18.5 19.4 17.3 16.5 17.8 Money and Prices Inflation, consumer prices (% 5.1 20.1 20.1 0.0 19.2 5.7 7.5 4.0 10.0 8.0 7.0 change, y-o-y, end of year) Inflation, consumer prices (% 5.6 10.2 24.5 6.8 7.8 16.6 2.8 6.6 8.0 7.1 6.0 change, y-o-y, period average) Treasury bill rate (91-day, annual 4.76 4.82 12.66 10.87 4.6 8.05 6.14 4.85 average) Nominal exchange rate (LCU/US$, 38.12 35.50 39.42 44.09 47.10 46.48 47.40 49.25 end of period) Real effective exchange rate index 92.5 103.0 111.0 103.0 111.3 112.5 112.6 113.4 (2000=100) M0 (% of GDP) 17.1 18.8 15.6 16.8 18.8 16.5 17.6 17.7 M2 (% of GDP) 28.4 30.3 25.8 28.4 31.4 27.8 31.7 34.5 Fiscal (% of GDP, unless otherwise indicated) Revenues 26.4 30.3 29.9 32.1 30.5 31.8 33.8 33.9 33.8 34.1 33.6 Expenditures 28.5 30.6 29.9 35.6 36.8 36.4 39.1 37.9 39.5 41.4 39.1 Current 24.2 25.8 25.7 30.6 31.4 30.9 31.4 30.7 29.5 29.0 27.6 Capital 4.3 4.8 4.2 5 5.4 5.5 7.7 7.2 10.0 12.4 11.5 Overall fiscal balance before grants -2.9 -2.6 -1.9 -8.6 -9.1 -7.8 -7.9 -6.5 -7.7 -9.9 -7.3 Overall fiscal balance after grants -2.1 -0.3 0 -3.5 -6.3 -4.6 -5.3 -4.0 -5.7 -7.3 -5.5 Primary fiscal balance -1.24 0.3 0.8 -2.7 -5.4 -3.6 -4.4 -3.1 -4.5 -6.5 -4.5 Total public debt 72.5 56.8 48.5 58.0 60.3 50.1 49.0 47.7 52.0 56.3 57.2 External public debt 69.8 54.6 41.2 52.8 55.1 45.9 45.9 44.8 48.1 51.9 52.8 External Accounts (current US$ millions, unless otherwise indicated) Real export volume growth (% 8.9 25.8 9.1 -1.1 -11.7 16.5 -23.6 35.1 7.5 6.3 9.0 change, y-o-y) Real import volume growth (% 45 11 13.6 -19.4 -6.9 13.7 25.0 16.5 -1.6 4.6 5.9 change, y-o-y) Merchandise exports 1,106 1,338 1,874 1,694 1,833 2,365 2,247 2,518 2,686 2,869 3,125 Merchandise imports 1,792 2,623 3,767 2,828 2,993 4,022 4,955 5,614 5,588 5,894 6,297 Services, net -82 80.3 -96.8 -9.1 -231.1 -20.9 -184 82 -94 -127 -135 Workers' remittances, net 717 988 1,430 1,012 1,244 1,662 1,952 2,101 2,100.0 2,310.0 2,495.0 Current account balance -100 -268 -795 -117 -307 -403 -991 -1,022 -862 -873 -884 As percent of GDP -3.5 -7.0 -15.5 -2.5 -6.4 -6.5 -15.0 -14.1 -11.7 -11.4 -10.8 Foreign direct investment 179.0 194.6 409.9 189.6 437.6 693.7 292.4 757.6 250 500 550 External debt, total 2,235 2,503 3,423 3,947 4,240 4,754 5,189 6,007 6,348.0 6,731.2 7,117.2 as percent of GDP 78.8 65.8 66.7 84.3 88.4 76.7 78.6 83.3 86.0 88.1 88.8 Appendix |21 Kyrgyz Republic: Moderating Growth and a Challenging Outlook Population, Employment and Poverty (% of population, unless otherwise indicated Population, total (millions) 5.2 5.3 5.3 5.4 5.4 5.5 5.6 5.7 5.8 5.8 5.9 Population growth (% change, y-o- 1.0 1.0 1.0 1.2 1.2 1.2 1.7 2.0 1.1 1.0 1.0 y) Unemployment rate (% of labor 8.3 8.2 8.2 8.4 8.6 8.5 8.4 8.3 force) Poverty headcount ratio at national 39.9 35 31.7 31.7 33.7 36.8 38.0 37.0 poverty line Poverty headcount ratio at US$1.25 5.94 1.9 6.39 6.23 6.7 5.03 … … a day (PPP) Poverty headcount ratio at US$2 a 32.11 29.4 20.74 21.69 22.9 21.64 … … day (PPP) Inequality - income gini 38.69 33.43 37.29 36.19 36.51 33.38 … … Life Expectancy 67.7 67.9 68.4 69.1 69.3 69.6 70.0 70.2 Other GDP (current LCU, billions) 113.8 141.9 188.0 201.2 220.4 286.0 310.5 350.0 388.7 426.4 470.1 GDP (current US$, billions) 2,837.4 3,805.4 5,131.3 4,683.0 4,793.5 6,199.0 6,605.1 7,211.9 7,381.4 7,640.4 8,178.1 Doing business ranking 90 94 68 41 44 70 70 68 Hdi (human development index) 0.606 0.612 0.616 0.617 0.615 0.621 0.622 … scores CPIA (overall rating) 3.6 3.7 3.7 3.7 3.7 3.6 3.6 3.6 Economic management 4.0 4.2 4.2 4.2 4.2 4.2 4.0 3.8 Structural policies 4.0 4.0 4.2 3.8 3.8 3.7 3.7 3.7 Social Inclusion and Equity 3.6 3.6 3.6 3.6 3.6 3.6 3.6 3.6 Policies Public Sector Management and 2.8 2.9 3.0 3.0 3.0 3.0 3.1 3.1 Institutions Notes: (p) Indicates preliminary data; ".." indicates not available. 1/This indicator is ranked out of 175 countries in 2006 and 2007, 178 in 2008, 181 in 2009, 183 in 2010 and 2011, 185 in 2012 and 189 in 2013. 2/ The HDI ranking in 2001 is in relation to 175 countries; from 2005 to 2008, to 177; in 2009, to 181; in 2010, to 169 countries; and, in 2011, to 187 countries. Appendix |22