Macroeconomic performance

The economy recovered in 2013 after the shocks of the previous year. The combination of a strike and weather-related disruption at the Kumtor gold mine caused GDP to contract by 0.9 per cent in 2012. Given the one-off nature of these shocks, it was not surprising that the economy rebounded strongly in 2013, growing by 10.5 per cent. However, real GDP growth moderated significantly in the first half of 2014 to 3.3 per cent year-on-year (with non-Kumtor growth at 2.6 per cent). Growth was driven primarily by industrial output (increasing by 8.6 per cent), construction and services. However, a 6 per cent decrease was observed in the mining sector during this period. The slow-down in Russia has negatively affected the inflow of remittances, which accounts for around 30 per cent of nominal GDP.

Headline inflation slowed to 6.6 per cent in 2013 and stood at 6.7 per cent year-on-year for the January to August 2014 period. Inflationary pressures primarily stem from a significant depreciation of the Kyrgyz som, following the weakening of the Russian rouble and the 20 per cent devaluation of the Kazakhstani tenge in February 2014. In response, the National Bank of the Kyrgyz Republic (NBKR) tightened its monetary policy in early 2014 to fend off pressures on the som. Currency depreciation picked up in March and the NBKR had to intervene heavily to smooth out the sharp fluctuations. The NBKR’s policy rate was increased from 4.5 per cent to 6 per cent in March 2014. The currency has stabilised since May 2014, allowing the NBKR to start accumulating reserves.

The external and fiscal balances recovered slightly. The current account deficit declined from 25.9 per cent of GDP in 2012 to 23.4 per cent in 2013 helped by the recovery in gold exports and an increase in private current transfers. Restrained government spending and higher-than-expected revenues brought the government deficit down to 3.8 per cent of GDP. In June 2014 the Executive Board of the International Monetary Fund (IMF) completed a sixth and final review under the Extended Credit Facility arrangement for the Kyrgyz Republic and approved the disbursement of SDR 9.5 million.

GDP growth in 2014 is expected to slow significantly. Remittances and, to a lesser extent, external trade are transmission channels for spillovers from the Russian economy. The base effect following high growth in 2013, and the fragility of the banking sector – which is constraining the ability of banks to increase lending – are also contributing to lower growth in 2014. Growth is expected to improve slightly in 2015, although there remains significant uncertainty due to the risk of further slow-down in the Russian economy. There are also risks to joining the ECU, which in the short term could have a negative effect on growth. However, in the long run the benefits of joining are expected to have a more positive impact than if the Kyrgyz Republic decided to stay outside of the ECU. Some of the negative short-term effects will be mitigated through the use of funds provided by Kazakhstan and Russia for the implementation of the country’s road map to accession.

Major structural reform developments

The Kyrgyz Republic’s accession to the ECU is expected to be finalised by the end of 2014. The road map endorsed by Belarus, Kazakhstan and Russia on 29 May 2014 requires significant legislative changes for the Kyrgyz Republic, including 112 legal acts that the country needs to implement for its harmonisation with the ECU’s legal framework. The entire road map consists of 181 provisions and covers nine areas, including customs management, sanitary and veterinary control, technical regulation, transport and infrastructure. Russia is supporting the country by providing financial assistance to the Kyrgyz Republic to facilitate the implementation of its road map. The two countries have agreed to set up a Kyrgyz-Russia Development Fund with an authorised capital of US$ 500 million and borrowed funds of around US$ 500 million. Russia has also committed to provide US$ 200 million on a grant basis to speed up the Kyrgyz Republic’s economic integration into the ECU.

The uncertainty surrounding Kumtor’s future poses risks to mining sector development and investor confidence. In September 2013 Centerra Gold entered into a non-binding Heads of Agreement with the Kyrgyz government, which outlines a restructuring of the Kumtor deal, under which Kyrgyzaltyn JSC would exchange its 33 per cent share in Centerra Gold for 50 per cent interest in a Kumtor joint venture, with an increase of the Kyrgyz share to 67 per cent after 2026. Parliament adopted the Kumtor resolution in February 2014 following a review of the previously negotiated non-binding HoA. The Kyrgyz government approved Centerra Gold’s mine plan for 2014 only in June 2014, just a few days ahead of a deadline set by the Canadian investor, which had threatened to shut down operations otherwise. Concerns have been raised, however, that the planned works could damage the Davydov glacier. In total, Kumtor’s gold production is expected to be around 550,000 to 600,000 ounces in 2014. The lack of a permanent solution to the Kumtor mine situation remains one of the most important issues affecting the attractiveness of the Kyrgyz Republic as an investment destination, particularly for foreign investors. The government is continuing to actively seek a solution that could hopefully reduce uncertainty and therefore improve the investment climate.

Significant vulnerabilities remain in the financial sector. The banking system is still recovering from the 2010 crisis. At the time, seven banks were placed under temporary administration. While the reported levels of NPLs have remained relatively low (5.9 per cent), the true quality of assets is uncertain. These vulnerabilities, aggravated by weak corporate governance and a general lack of confidence in the banking sector, continue to pose a risk to growth. In September 2013 a new banking code was submitted to parliament, but it is yet to be approved. The code emphasises the modernisation of the legislative system and harmonisation of various laws, which should contribute to higher transparency and increased confidence in the financial sector.

The NBKR started implementing a new monetary policy framework in March 2014. The board of the NBKR decided to set up a new operational framework to enhance the role of the monetary policy and strengthen its transmission mechanism by using the policy rate as an operational target. The central bank also reactivated instruments to create a policy rate corridor, introduced a short-term liquidity facility, and started to announce the schedule of its board meetings and issue press releases after each meeting.

Parliament adopted a sustainable development programme in December 2013. The programme represents an administrative tool to implement the National Sustainable Development Strategy for 2013-17. The new strategy will focus on maintaining political stability, improving social development and promoting shared prosperity. This will be achieved by improving governance, accelerating economic growth, maintaining macroeconomic stability and debt sustainability, and advancing structural reforms.