International Conference

«Conflicts in the Caucasus: History, the Present and Prospects for Resolution»

Baku (Azerbaijan) 22-23 October, 2012 and Tbilisi (Georgia) 25-26 October, 2012

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ECONOMY

Alymbek BIIALIEV

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Alymbek Bilaliev, Ph.D. (Econ.), columnist of the newspaper Respublika, economic advisor to the governor of the Issyk Kul Regional Administration (Issyk Kul, Kyrgyz Republic)

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The country’s economy in 2005 was expected to develop in line with the trend characteristic of the previous five years, when the government had traditionally focused on macroeconomic policy, paying less attention to the real sector. Thus, in accordance with Government Decision No. 756 of 13 October, 2004, monetary policy was designed to maintain low inflation (not exceeding 4.6%).

It was assumed that such a rate of inflation would take shape under the combined impact of internal and external factors: an increase in the money supply controlled by the National Bank of the Kyrgyz Republic, the impact of the government’s fiscal measures, adjustment of the rates charged for the services of natural monopolies, seasonal fluctuations in the prices of agricultural products, and also changes in the economic situation in Kyrgyzstan’s trading partners and fluctuations in world prices. The National Bank continued its floating exchange rate policy, which it planned to pursue by means of currency interventions designed to smooth out any sharp exchange rate fluctuations associated with seasonal changes in demand for foreign currency or short-term speculative operations. In annual terms, the exchange rate of the national currency (som, KGS) against the US dollar was projected at 42 soms per dollar.

The government planned that macroeconomic stability would help to achieve GDP growth of 5% (as in previous years). However, a weak point of the government’s plans was that the increase in this basic economic indicator was to have been achieved largely through growth in agriculture and the service sector. Total GDP was projected at KGS 100.1 billion (about $2.5 billion), with these two sectors of the economy accounting for over 72% of the total. Industrial production was expected to fall by 3.6% compared to 2004, mostly as the result of a decline in the production and processing of gold from the Kumtor mine. In agriculture, it was planned to achieve real production growth of 5.3%, mostly owing to crop production. This growth was to have been achieved by introducing progressive techniques in seed farming and livestock breeding; by developing private veterinary services, technical service centers and markets of mineral fertilizers, pest control chemicals and agricultural machinery; by expanding access to credit resources and establishing new credit unions; by developing microcredit and promoting agricultural exports.

In order to develop the service sector, the government planned to continue upgrading the legal framework for business activity, and also to promote an expansion of this sector through the development of modern services, including telecommunications and tourism. The demand for services was to have been sustained by a rise in household income. Real growth of total output in this sector was projected at 8.2%, mostly due to the development of market services: trade, repair of cars, household appliances and articles of personal use, and also transport and communication services, hotels and restaurants.

State policy in the field of tourism was traditionally designed to create favorable conditions for foreign investment, promote national tourism in world markets, form an optimal tourism management structure by combining the interests of the state and private producers of these services, and develop domestic tourism.

Investment policy in 2005 was expected to reduce the amount of government-guaranteed foreign loans under the Public Investment Program (PIP) while increasing the amount of private investment, including foreign direct investment. The plan was to reduce PIP to 3.3% of GDP. Overall, investments in the economy and the social sphere from all funding sources were projected at about KGS 12 billion (approximately 12% of GDP).

Poverty reduction remained a strategic goal. Economic growth was expected to reduce the poverty rate to 42-43% (based on a rate of 45.9% for 2004, calculated by the country’s National Statistics Committee using a new technique of integrated household budget and labor force surveys). As the result of a reform of the public sector remuneration system, an optimization of the public administration structure and development of the economy, the average monthly wage in nominal terms was expected to reach 2,434 soms (with a real increase of 6.2%), exceeding the minimum consumer budget (1,860 soms) by 31.2%.

In assessing government economic policy for 2005, one should note that it was well-justified within the framework of the conditions in which the economy had developed in previous years, and there was reason to expect that the plan targets would be met. However, the revolutionary events of 24 March, 2005, led to serious changes both in government activities and in the economic situation. President Askar Akaev fled the country, and the government resigned. The new revolutionary authorities hastily appointed a provisional government, which was naturally unable to gain control of the situation in the country right away. The criminal redistribution of property that got underway in the republic and political contract killings scared away many investors, resulted in a scaling down of production and caused a flight of capital from the country. All of this naturally had an effect on the state of the economy, and statistical data point to a sharp drop in many indicators. On the other hand, targeted attacks on business, which particularly intensified during the campaign to track down the property of the Akaev family, made many investors question the advisability of investing in Kyrgyzstan.

In 2005, real GDP fell by 0.6%. This was due to a decline in industry by 12.1% as the result of a drop in production at enterprises specializing in the development of the Kumtor gold deposit (by 23.7%) and to a 4.2% decline in agriculture caused by a setback in crop production (by 7.5%). The share of these sectors in the structure of GDP was 46.6%. Inflation rose to 4.9%, exceeding the level of January-December 2004 by 2.1 percentage points. Prices rose by 9.8% for food products, 2.0% for nonfood products, and 3.2% for paid services. Fuel and lubricant prices rose by an average of 23.1%, which was due to an increase in world oil prices and disruptions in the supply of petroleum products to the domestic market.

The situation in the foreign exchange market was characterized by greater stability in the exchange rate of the dollar compared to the same period of the previous year. Its official effective exchange rate in relation to the som was down by 3.9% to 41.0 soms per dollar.

In the first 11 months of 2005, state budget revenues totaled KGS 18,036 million (102.2% of the target figure), going up by 11.8% from the same period of 2004 due to an increase in tax revenues. These amounted to KGS 14,619.7 million (101.9% of the target figure), with a 16.6% increase from the same period of the previous year.

The State Customs Inspection contributed KGS 6,315.1 million to the state budget (an increase of 19.5%), or 102.8% of the plan target. This was due to a sharp increase in receipts of single tax collected from natural persons in view of changes in customs legislation. The main reason for the increase in tax revenues from foreign economic activity was the growing volume of imports.

The State Tax Inspection collected a total of KGS 7,063.0 million (101.5% of the target figure), up 12% from the same period of 2004. This overall increase was due to the collection of larger amounts of income tax as the result of a rise in the average wage, and also significant amounts of profit tax levied on large enterprises.

The current expenditures of the state budget in the first 11 months of the year (excluding expenditures for public debt service) totaled KGS 17,751.8 million (94.7% of the target figure), with an increase of 11.6% from the same period of the previous year.

At the same time, the country’s external debt continues to exert significant pressure on the economic situation. That is why the new government made active efforts to reduce the debt burden. In particular, it signed bilateral debt restructuring agreements with Russia, Germany, France and Denmark, and also exchanged notes to that effect with Japan. An additional condition of debt restructuring was a partial capitalization of interest for 2005-2008. The government also carried on negotiations on this subject with Turkey and Korea, and Pakistan converted its $10 million credit into a grant for the Kyrgyz Republic.

In the banking system there was a continued trend towards an increase in deposits. From the beginning of the year, deposits increased by 34.9%, and the amount of issued credits, by 17.1%. At the same time, interest rates on credit still remain high (24-25%).

In the first 11 months of 2005, the foreign trade turnover reached $1,597.7 million, going up by 6.1% compared to the same period of 2004. However, exports fell by 6.4% to $618.3 million, which was due to a reduction in the exports of gold by 17.4%, sugar by 34.1%, fruits and vegetables by 18.6%, and electricity by 12%. The main factor behind the decline in gold exports was a drop in the physical volume of gold production by 23%. Imports in that period totaled $979.4 million and were up 15.9%, mostly as the result of an increase in imports of oil products (1.3 times), specialized machinery for various industries (1.8 times), medical and pharmaceutical products (by 38.9%), electrical machines, devices and instruments (by 51.3%), and coal, coke and bricks (by 17%).

The republic’s major trading partners for imports from the CIA countries were Russia (33% of total imports), Kazakhstan (16.2%) and Uzbekistan (5.7%), and from non-CIS countries, China (7.7%), the U.S. (6.7%) and Germany (3.9%).

The rise in imports and the fall in exports led to an increase in the trade deficit from $184.7 million in January-November 2004 to $361.1 million, which was due to the republic’s high demand for imports of oil products, raw materials and other goods not produced in the republic or produced in insufficient quantities.

During the year, much attention was paid to intensifying bilateral and regional trade and economic cooperation. Thus, the republic took part in meetings of the EurAsEC heads of state; in the work of an SCO summit, the EU-Kyrgyzstan subcommittee and the intergovernmental working group on the creation of a Central Asian common market; and in a number of meetings of high-level experts from the ECO member countries.

The republic continued its work along the lines of the World Trade Organization. Within the framework of the Doha Round, Kyrgyzstan set forth its position regarding an improvement of transit provisions, the joint statement of the WTO countries on a liberalization of logistics services, and participation in a joint statement of CIS states members of the WTO in negotiations on agricultural and industrial goods. There was also an active effort to develop trade and economic relations with Pakistan, Iran and the EU countries for the purpose of attracting investment into the republic’s economy.

In order to protect the domestic market and support national producers, the government began drafting a new law on customs tariffs, which provides for duty-free imports of industrial equipment and components required for production in the republic.

Work was underway to attract and coordinate technical assistance, program loans and grants provided by international organizations and foreign donors.

As noted above, the downturn in industrial production was due to a decline in production at the Kumtor enterprises, whose share in total industrial output was 38.1%, and in the structure of GDP, 5.5%. In order to compensate for the retired capacity of JV Kumtor Gold Company, it is necessary to bring on stream as soon as possible the developed commercial reserves of the Jerooy and Taldy Bulak Levoberejny gold deposits, and also to stabilize gold production at the enterprises of the Kyrgyzaltyn Open Joint Stock Company by switching the Makmalzoloto plant to the exploitation of underground reserves at the Makmal deposit, by developing open-pit reserves at the Altyn Tir site (Solton Sary deposit), and by renovating the concentration plant at the Tereksai mine.

In the sector for the production and distribution of electricity, gas and water, real growth amounted to 1.6% due to an increase in thermal power generation by 2% and services in the distribution of electricity by 0.7%, fuel gas by about 50%, and thermal power by 2.3%. At the same time, electricity generation fell by 1.7% from the same period of the previous year due to a reduction in electricity supplies to Russia (58.9%) and Tajikistan (73%). According to operational data, total exports of electricity were down to 2,270.7 million kWh (84.5%), while its exports to Kazakhstan and China increased (117.6% and 106.6%, respectively). Based on the results for the first nine months of 2005,¹ the quasi-fiscal deficit (QFD) in the electricity sector amounted to KGS 5,367 million ($130.8 million). System losses increased (43% compared to 41% in the first nine months of 2004).

In October, 170 industrial enterprises (27.7% of their total number) were at a complete standstill.

The decline in agricultural output by 4.2% compared to the previous year was caused by a 7.5% reduction in crop output, whose share in total agricultural output was 60.4%.

In the service sector, real growth in 2005 amounted to 12.6%, which was 3.8 percentage points below the figure for 2004 in view of a slowdown in services as a result of the March events.

At the same time, the number of cellular subscribers increased 2.1 times from the beginning of the year, and the number of Internet users, 2.6 times. Under a project known as E-Government, work was underway with Korea’s Global Code corporation in order to attract investment.

As of 1 July, 2005, the number of tourist companies registered in the republic was 4.7 thousand, or 0.2 thousand more than in 2004. Gross value added in the tourist sector was KGS 1,431.5 million (3.8% of GDP). However, in the first half of the year there was a decline in the number of foreign tourists visiting the country by 60.3 thousand, which was another direct consequence of the March events.²

In the first six months of the year, the republic had 163.3 thousand small and medium enterprises (excluding peasant and private commercial farms), or 12.9 thousand more than in the same period of 2004. The annual increase in the number of small and medium enterprises leads to an actual increase in the number of audits and inspections in this sector. The share of gross value added by small and medium enterprises in that period was 37.2% of GDP.

Fixed capital investment in the construction, renovation, expansion and retooling of facilities amounted to KGS 10,631.8 million (97.0% of the figure for 2004). The rate of fixed investment fell compared to 2004: by 74.8% for foreign grants and humanitarian aid, by 22.7% for state budget funds, by 50.7% for local budget funds, by 28.2% for foreign credits, and by 12.5% for household and other funds. Total expenditures on investment projects under the Public Investment Program for the first 10 months of the year amounted to KGS 203.1 million, including external financing of investment projects (excluding grants)—KGS 2,443.4 million (73.5% of the annual plan target), and in the part of internal co-financing of investment projects—KGS 208.4 million (47.0% of the target figure).³

In order to raise the living standards of low-income households, the basic part of the statutory pension was established at 258 soms ($6.2), with a differentiated increase in its insurance part. Public sector wages were increased as well: by 50% for employees of the Ministry of Internal Affairs, by 30% for workers in culture, and by 15% for workers in education (except higher education institutions) and health care. As a result, the average monthly wage in January-November was 2,481.8 soms ($60.5), with a real increase of 11.9% from the same period of 2004. At the same time, there was an increase in unemployment: in the first 10 months of the year, the number of jobless people reached 199.4 thousand (up 10%), and the number of people officially registered as unemployed, 68.0 thousand.

Unless the government takes resolute measures to promote economic activity (in Kyrgyzstan, such activity should manifest itself in the narrow segment of export-oriented industries), even a marginal increase in the production of goods and services, given the country’s average wage of $60, will be stunted by limited domestic demand. In market conditions, this will nip business initiative in the bud. In this context, it is not surprising that there is a steady downturn in investment in the construction, renovation, expansion and retooling of facilities. Moreover, most capital investments, insignificant as they are, now go into the development of small enterprises, which can do little to enhance the country’s economic potential, and are mostly oriented towards the domestic market. That is why the increase in employment by 80 thousand recorded in 2000-2004 was mostly due to an increase in the number of non-wage workers: people engaged in peasant (private) farming and in individual labor activity. Evidently, the economy is dominated by petty commodity production. The latter cannot provide a basis for resolving the problem of export expansion, which alone can ensure long-term economic growth in the republic. As a result of the petty commodity character of the economy, in 1999-2003 the share of wage workers in the economically active population fell from 40.5% to 33.6%. Over the past two years, the situation has worsened still further.

Unless the new government is able to reverse the investment trend within a short time and redirect investments towards large-scale export-oriented production, the country will hardly ever recover from the current crisis. It cannot be ruled out that the indecision of the republic’s authorities in carrying out radical political and socioeconomic transformations could very soon, even within the next two or three years, plunge the country into upheavals similar to the Tulip Revolution.

One should also bear in mind the various negative factors serving to worsen the situation in the republic.

First, there is the huge external debt burden, which exceeds the safety threshold in relation to GDP (over 84% with a threshold value of 80%). Of course, one can say that the Kyrgyz Republic is close to the threshold value, that many countries have been in such a situation and that there is nothing to fear. However, this would be true for Kyrgyzstan if the republic (in the absence of current revenue caused by the decline in GDP) had appropriate assets abroad. Given such assets, we could finance our development and ensure high rates of economic growth. Unfortunately, the republic has no such assets. No wonder the International Bank for Reconstruction and Development has included Kyrgyzstan among countries with an excessive debt burden. That is why it is under constant threat of default with all that this implies.

On the other hand, debt service payments (in some years, up to 40% of budget expenditures) are a large drain on the state’s scant resources. With a budget of only $400-450 million, this makes it impossible to allocate funds for development or for the solution of social problems. According to the Kyrgyz finance minister, if the government manages to reach an agreement with its major creditors, in 2006 the country will have to pay only KGS 1.2 billion (instead of KGS 3.2 billion), but this is only a question of debt restructuring and not a complete write-off. The republic’s present leadership has set itself an ambitious goal: to resolve the external debt problem in the immediate future once and for all so as not to leave this burden to future generations. The slowdown in GDP growth in 2005 to the point of negative values makes it necessary to finance a certain part of budget expenditures out of external borrowings. But in the conditions of the country’s inability to pay and a reduction in assistance from international financial organizations and donor states, Kyrgyzstan will have to rely on its own efforts. The whole point is whether it can ensure the necessary economic growth solely with the use of domestic resources. From 2000 on, this growth hinged on the development of the Kumtor gold deposit. As soon as the gold miners reduced their output, there was a drop in GDP (in 2005). This points to the instability of economic growth based on the mining industries, agriculture and the service sector, which are strongly influenced by natural climatic factors and the degree of social stability. As evident from the record of the developed countries, sustainable economic growth can be achieved mostly through the development of industry, especially its manufacturing sectors. In Kyrgyzstan, on the contrary, industry has been losing ground from year to year: in the past four years alone, its share in GDP has shrunk from 23% to 14%.

That is why the reasons for the optimism of the country’s present leaders, who promise economic growth of 8% for 2006, are hard to understand. After all, these has been no lessening of the impact of negative factors, either subjective (poor governance, corruption, shadow economy) or objective (huge external debt, low propensity to save).

The second negative factor conducive to a further worsening of the situation in the republic is the low saving capacity of the population. For many years this capacity did not exceed 18%, and in the recent period it has tended to decline. The experience of rapidly developing countries (Malaysia, Taiwan, Singapore, South Korea) shows that significant economic growth requires a savings rate of at least 30%. In view of the population’s low propensity to save, investment activity tends to decline as well, as we find from the data of the National Statistics Committee (see Table).

Table

Dependence of Investment Activity on the Propensity to Save

	1999	2000	2001	2002	2003
Gross capital formation (as % of GDP)	18.0	20.0	18.0	17.6	11.8
Gross savings (as % of GDP)	1.2	14.4	16.8	17.4	7.6
Fixed capital investment (as % of previous year)	121.5	137.3	85.5	90.4	93.4

In order to achieve a savings rate of 30%, at the initial stage is it necessary to ensure fixed capital investment of KGS 25-30 billion ($625-750 million) per year. If we create the most favorable conditions for investment, then we can attract for these purposes, at best, KGS 8-10 billion of domestic savings (totaling about KGS 2 billion in bank deposits plus KGS 6-8 billion “under the mattress”). But in actual fact it is only possible to attract about 50% of this amount, because the rest are savings “for a rainy day,” which households will never invest in the economy. Consequently, domestic savings can provide $100-125 million for investment purposes. The remaining $500-625 million worth of annual investment will have to come from external sources. In order to attract foreign investors into the country’s export-oriented sectors, it is necessary to take unprecedented measures without delay in order to create the best possible conditions for their operation (as well as for the operation of domestic investors), because otherwise the current stagnation of production could rapidly develop into a large-scale systemic crisis of the whole economy, a crisis with unpredictable consequences.

Finally, the third factor is poor governance, which is currently the greatest threat capable of causing chaos not only in the economy, but also in society as a whole. The entire system of state administration is disorganized. The country’s new leadership has no clear-cut strategic goals or programs for the further development of Kyrgyz society, which has resulted in chaotic and spontaneous managerial decisions and a delayed response to arising problems. That is why the authorities have not yet put in place a new government structure oriented towards the development and pursuit of our own active policy instead of a strategy of survival and strict obedience to the prescriptions of international financial institutions. Kyrgyzstan should not fall victim to the ongoing globalization of the modern world, but should make active use of its advantages (including the advantages of WTO membership) for its own development while protecting itself against the negative aspects of this process by the thousand-year traditions and world view of the Kyrgyz people.

Given the above-mentioned specific features of the current systemic crisis in the republic, it would make sense to take the following steps in the short-term perspective.

First, we must restore the tax holiday (five years) for investors putting their money in export-oriented lines of production. Tax rates should not be reduced on any account, because this could lead to a sharp drop in budget revenue and prevent the government from meeting its social obligations. And this, in turn, could trigger a social explosion and thwart the efforts to modernize the economy. Those who did not pay taxes in the past will not pay them at reduced rates either, so that the priority task now is to fight the shadow economy. In this process, one should not try to reduce some taxes and compensate the losses by introducing other taxes, as the government is doing today. This will not ease the tax burden, so that there can be no question of tax policy playing an incentive role.

Second, we must declare a general economic and a tax amnesty. This will help to reduce the shadow sector and to increase the collection of taxes and duties, so compensating for the losses from the tax holiday.

Steps should simultaneously be taken to stiffen the penalties for shadow activities. An amnesty should be prepared and carried out in the shortest possible time, because the disintegration of society’s economic basis is becoming increasingly irreversible. According to experts, the shadow sector has already reached 60-70% of the entire economy.

Third, we must drastically reduce the bureaucratic apparatus, upgrade the structure of executive agencies and improve the methods of their activity. This can only be achieved through a reform of the republic’s entire state structure based on the development and adoption of a new Constitution.

There is no doubt that the present system of government, defined as a presidential-parliamentary republic, is objectively conducive to an unprecedented spread of corruption, which is a characteristic feature of almost all CIS countries. For Kyrgyzstan, which has no abundant natural resources such as oil, gas or timber to cushion the blow struck by corruption at the living standards of the bulk of the population, the key condition for a recovery from the permanent crisis is to overcome corruption (or at least to keep it within reasonable limits).

Such are the economic realities in the Kyrgyz Republic. And unless resolute steps are taken without delay, the situation is bound to worsen.

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¹ Some data will be available only by mid-2006. _{Back to text}
² No data for the whole of 2005. _{Back to text}
³ No data for the whole of 2005. _{Back to text}