KYRGYZ FACE ECONOMIC AND FINANCIAL CHALLENGES

C O N F I D E N T I A L SECTION 01 OF 03 BISHKEK 000152 SIPDIS DEPT FOR SCA/CEN (GORKOWSKI), TREASURY FOR LAWRENCE NORTON E.O. 12958: DECL: 02/23/2019 TAGS: ECON PGOV EFIN SOCI KG SUBJECT: KYRGYZ FACE ECONOMIC AND FINANCIAL CHALLENGES REF: BISHKEK 144 BISHKEK 00000152 001.2 OF 003 Classified By: Amb. Tatiana Gfoeller, Reason 1.4 (b) and (d). ¶1. (C) Summary: Despite Kyrgyz official forecasts of 6% economic growth in 2009, independent experts anticipate low or negative growth this year. Tax revenues are falling because of the economic slowdown and a substantial decrease in value added tax, and the Kyrgyz Ministry of Finance is preparing a supplemental budget to reflect the growing budget imbalances. Remittances from the estimated one million Kyrgyz working abroad are declining, and the Kyrgyz Central Bank has injected at least $100 million to keep the Kyrgyz som from falling against the dollar. As economic conditions in Kazakhstan and Russia deteriorate and the government's budget gap widens, the Kyrgyz government will have fewer resources available this year to cover its obligations. While more traditional donors have provided some budgetary support, the lure of a substantial Russian assistance package has distracted focus from underlying problems in the Kyrgyz economy. End summary. Economic Slowdown -------------- ¶2. (SBU) Kyrgyzstan's economy appears to be heading toward a severe slowdown. Despite official predictions of 6% economic growth for 2009 (reftel),outside experts, including the local International Monetary Fund (IMF) representative, are now forecasting a sharp slowdown to zero or negative economic growth for Kyrgyzstan in 2009. Several large local food and drink producers in Bishkek are currently operating at only 30-50% of capacity. Remittances from the estimated one million Kyrgyz working abroad, mainly in Russia and Kazakhstan, are also reportedly down significantly. Two former Kyrgyz Central Bank employees, who maintain regular contact with former Central Bank colleagues, told Emboff February 19 that the volume of remittances has dropped by nearly half, to an annual figure of about $850 million. Local businesspeople are also concerned about the impact in Kyrgyzstan of continued economic difficulties in Kazakhstan and Russia. On the positive side, inflation, which approached an annual rate of nearly 30% earlier in 2008, moderated to 15-20% by the end of 2008. Growing Imbalances -------------- ¶3. (SBU) An expanding trade imbalance, with Kyrgyz exports amounting to less than half of the Kyrgyz Republic's $3.5 billion import bill in 2008, will further strain Kyrgyz finances. The Kyrgyz Republic imported nearly $123 million in natural gas, mostly from Uzbekistan, in 2008, and, based on an agreed tariff rise from $145 to $240 per thousand cubic meters, may pay up to $204 million for a similar volume in ¶2009. Despite President Bakiyev's February 11 pledge to increase electricity export prices to offset the higher natural gas bill, the low level of the hydroelectric reservoirs will limit the amount of excess electricity available for export in 2009. ¶4. (SBU) Tax law changes have diminished government revenues. A new tax code, which became effective on January 1, reduced value added tax (VAT) from 20% to 12%, while instituting other new taxes, such as a property tax. For January 2009, customs and tax revenues were down by around 20%. President Bakiyev has suggested reviewing the VAT rate in the spring, and the IMF is dispatching a technical assistance team to Bishkek in March to review the tax issue with Kyrgyz officials. The tax shortfalls were not unexpected. A lawyer who observed the Kyrgyz Parliament's debate of the tax code told Emboff that "Parliament knew the BISHKEK 00000152 002.2 OF 003 tax cuts would result in a significant budget shortfall, but decided not to do anything about it." The Kyrgyz Ministry of Economic Development has also estimated that electricity rationing this past fall and winter has reduced government tax collections by $17.4 million, or nearly 1.5% of expected government revenues in 2009. ¶5. (C) President Bakiyev signed the 2009 budget into law in January, but the Kyrgyz Ministry of Finance is already planning to submit a supplemental budget in the coming months to account for the deteriorating fiscal conditions. According to a summary provided by the IMF, the new budget reduces revenue projections by $50 million and increases planned expenditures (ostensibly for social spending) by $75 million. A Russian pledge of $150 million in financial aid, if disbursed and not redirected, may fill this budget gap. (Note: The total Russian assistance package will be discussed septel. End note.) Currency Factors -------------- ¶6. (C) The Kyrgyz Central Bank has intervened repeatedly in recent months in the currency market to try to stabilize the Kyrgyz som against the dollar. IMF personnel credited the Central Bank for doing a good job in stabilizing the currency, noting that the Central Bank has injected nearly $100 million into the currency markets since December 2008 to prevent a rapid devaluation of the som. As a signal of high dollar demand, spreads in the dollar/som buy/sell rate for the day when Kazakhstan devalued its national currency expanded quickly, but narrowed after the Central Bank injected over $4 million the same day into the market. ¶7. (SBU) Although the Kyrgyz som has only weakened slightly against the dollar and Kyrgyz capital markets are considered somewhat removed from global finance, the Kyrgyz government has established a $50 million emergency fund, using Central Bank assets, for any instability in the Kyrgyz banking sector. However, guidelines for distribution of such funds are not yet clear. The som is expected to weaken gradually against the dollar, but may receive a boost if dollar-denominated Russian financial assistance materializes. Filling the Gaps -------------- ¶8. (C) Recognizing the growing budgetary shortfalls for 2009, Kyrgyz officials have approached numerous international institutions and governments for financial assistance. The IMF approved a $100 million Exogenous Shocks Facility, which will distribute funds over an 18-month period. During a February 4 donor community meeting with Kyrgyz officials, Astana-based European Commission regional Ambassador Norbert Jousten trumpeted a planned grant of 13 million euros ($16.3 million) for additional budgetary support to the Kyrgyz Republic. However, Kyrgyz officials now appear to be mesmerized by Russian pledges of financial assistance. Promised Russian grants, loans, and debt forgiveness, which total about $2.3 billion, could help bridge the budgetary gaps if the funds materialize and are spent appropriately. Comment -------------- ¶9. (C) With complaints from rural areas over unpaid government salaries, power cuts and persistent corruption growing, the Kyrgyz government finds itself in 2009 in an increasingly difficult budgetary situation. The VAT rate may be increased to 16% to counter the decline in tax revenues. However, officials continue to cite rosy economic forecasts and (superficial) improvements in business conditions. BISHKEK 00000152 003.2 OF 003 Unless the Kyrgyz government receives a significant revenue injection, its ability to cover its obligations will become increasingly limited later this year. GFOELLER