Document of The World Bank FOR OFFICIAL USE ONLY Report No. 17641-KG MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT, THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A JOINT COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE KYRGYZ REPUBLIC APRIL 14, 1998 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENT (Exchange Rate Effective February 1998) Currency Unit = Som Som 1 = US$0.056 US$ 1 = Som 17.7 GOVERNMENT'S FISCAL YEAR January 1- December 31 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank BOP Balance of Payments CAS Country Assistance Strategy CSAC Consolidation Structural Adjustment Credit EBRD European Bank for Reconstruction and Development EDI Economic Development Institute ESAF Enhanced Structural Adjustment Facility ESW Economic and Sector Work EU European Union FIAS Foreign Investment Advisory Service FSU Former Soviet Union GDP Gross Domestic Product GNP Gross National Product IBRD International Bank for Reconstruction and Development IDA International Development Association IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund MIGA Multilateral Investment Guarantee Agency PESAC Private Enterprise Structural Adjustment Credit PSRMAC Public Sector Resource Management Adjustment Credit TA Technical Assistance UNDP United Nations Development Program USAID United States Agency for International Development Vice President: Johannes Linn (IBRD) Vice President: Jemal-ud-din Kassum (IFC) Country Director: Kiyoshi Kodera (IBRD) Director: Andre Hovaguimian (IFC) Task Team: Nancy Cooke, (IBRD) Task Team: Stoyan Tenev (IFC) Peter Hansen (IBRD) FOR OFFICIAL USE ONLY KYRGYZ REPUBLIC COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS SUMMARY ....................................................... I. ECONOMIC, SOCIAL AND POLITICAL CONTEXT. ........................ II. MACROECONOMIC PERFORMANCE, PROSPECTS AND RISKS ...................... 4 A. Recent Economic Performance................................. 4 B. Growth Prospects, External Environment And Risks......... .... ............ 6 III. KYRGYZSTAN'S DEVELOPMENT CHALLENGES AND AGENDA .................7 A. Private Sector Development ............ ................... .....8 B. Poverty Alleviation, Human Resource Development and Social Protection ................... 11 C. Institutional Capacity and State Governance.. .................... .......... 12 D. Bank's Assessment of Government's Agenda and Areas of Difference . ............ 12 IV. BANK GROUP COUNTRY ASSISTANCE STRATEGY .................. ..... 13 A. Lessons of Experience from the Previous CAS ....................... ...... 13 B. Objectives of this CAS ........................................ .....14 C. Bank Group Assistance Program ....................................... 15 D. Lending Levels, Triggers and Creditworthiness ............................... 19 E. Risks to the Bank Group ............................................ 21 V. CONCLUDING REMARKS ............................................ 22 Text Tables: I Macroeconomic Performance Indicators, 1993-1997.......... ................ 5 2 Donor Collaboration: Selected Key Areas of Involvement .................... 18 Text Boxes: I Public Opinion Survey: Views from Kyrgyzstan ...................................2 2 Poverty in the Kyrgyz Republic....................................3 3 Triggers to Stay in High Case ........................................20 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Annexes: Al: High Case CAS Program Summary FY99-01 A2: Kyrgyz Republic at a Glance B 1: CAS Program Matrix B2: Selected Indicators of Bank Portfolio Performance and Management B3: Bank Group Program Summary, FY1999-2001 (page 1 of 3) IDA Base-Case Lending Program (page 2 of 3) IFC and MIGA Program, FY95-98 (page 3 of 3) B4: Summary of Nonlending Services B5: Social Indicators B6: Key Economic Indicators B7: Key Exposure Indicators B8: Status of Bank Group Operations in Kyrgyz Republic and Country Portfolio Overview and Issues IBRD Loans and IDA Credits in the Operations Portfolio (page 1 of 2) Statement of IFC's Committed and Disbursed Portfolio (page 2 of 2) B9: CAS Summary of Development Priorities Cl: Instruments to Meet CAS Program Objective C2: Actual and Proposed IDA Commitments and Disbursements (FY93-01) Attachment: Private Sector Assessment prepared by the International Finance Corporation (IFC) Map IBRD26822RI Kyrgyz Republic Country Assistance Strategy SUMMARY i. This is a joint CAS that integrates the assistance strategies of IBRD/IDA and IFC. It has been discussed with the Kyrgyz Government, members of Parliament, locally based donors and representatives of non-governmental organizations. The previous CAS was discussed by the Board in June 1995. ii. Kyrgyzstan achieved two years of solid economic growth in 1996-97, following five years of economic decline, and has made great strides in its transition to a market economy. The Government successfully completed a three-year ESAF arrangement with the IMF in 1997 and has stabilized the main macroeconomic balances. The economy is generally open and price mechanisms function freely. The Government has also implemented almost all of the policy measures identified in the 1995 CAS through four adjustment operations (privatization and enterprise reform, agricultural privatization, financial sector reform, and public sector resource management). iii. Despite this impressive track record of macro stabilization and policy reform, poverty has increased since the time of the last CAS. Absolute poverty increased from 40 percent of the population in 1993 to over 50 percent of the population in 1996 (the latest year for which data is available). Strong growth in 1997 may have ameliorated the increase in poverty during the previous years, but the overall poverty situation is serious and many elements of the population feel worse off than before the transition began. The Government has openly addressed this problem by declaring 1998 as "the year of fighting poverty" and has launched a National Poverty Alleviation Program that aims to increase employment, improve access to basic social services, improve the targeting of social assistance, and assure the timely payment of pensions. iv. Long-term growth prospects remain modest, despite the strong growth in 1996-97. Agricultural growth is constrained by land scarcity and low productivity. The large majority of state enterprises have been privatized, but the private sector has not yet really taken off. Investment levels are low, foreign investors are scarce, and the economy faces a number of external constraints. On balance, long-term growth prospects are assessed at about 4 percent per annum (about 3 percent in per capita terms), although growth could be faster during the next few years as the economy continues to bounce back from the severe decline in GDP suffered during 1991-95. A concerted program to liberalize the business climate further would contribute to higher growth rates. v. The Government's over-arching objective is to establish long-term sustainable growth. Without growth, there will be no meaningful reduction in poverty. Nor will the Government have the means to improve basic human services or institutional capacity. The Government sees the private sector as the main vehicle for achieving growth. The two broad thrusts of the Kyrgyz development strategy are thus private sector development and poverty reduction. vi. For private sector growth, priority is given to agriculture and the re-vitalization of agro-industry, which is appropriate in view of the large part of the population that depends on agriculture for its livelihood. Emphasis is also placed on improving the regulatory environment for business, in order to foster growth and boost job creation. For poverty reduction, the Government envisages a complementary strategy of increasing agricultural productivity to raise the incomes of the majority of the population that - 11 - lives in the rural areas, together with improving the targeting of social assistance, attaining the fiscal sustainability of the pension system to assure timely pension payments, and restructuring health and education services to increase efficiency and make better use of resources within the existing budget constraints. The Bank and the Government generally agree on the development agenda, although there are differences of view concerning the pace for achieving fiscal sustainability of the state pension system and for introducing cost recovery and economic pricing for commercial-type public services (heat, electricity, telecoms, water, irrigation and public transport). vii. The strategic objectives of the CAS are to attain sustained growth, particularly in rural areas, to reduce poverty, to improve governance and to strengthen public finances. The CAS proposes a high case lending program of $185 million IDA for FY99-01, which would be a continuation of the previous high case lending mode. The program includes two adjustment credits (one to achieve financial sustainability of the state pension system, and a second to improve the environment for private sector investment). IFC, FIAS and EDI would be active participants in formulating the policies for this second stage of structural reform. Seven investment projects focus on increasing agricultural productivity and incomes across a broad swath of the rural population where poverty is concentrated, and on social investments. A land registration project would support the completion of land reform program. The CAS program also includes focussed economic and sector work to underpin the lending program and help strengthen public finances in preparation for the day when the Kyrgyz Republic will no longer require budgetary support and would be better able to borrow on non-concessional terms. Over the next three years, the Bank Group will also continue support for aid coordination and institution building. viii. The Kyrgyz Republic is not a high risk country for the Bank Group, in view of its continued strong policy performance and the fact that the economy appears to be growing. Nevertheless, there are some risks stemming from a possible reversal in policy direction (which is not considered likely), institutional weakness in the implementation of Bank operations (which will be addressed through intensive supervision and training), and a stagnation in growth (which would serve as a negative demonstration effect for the rest of Central Asia and impede reform in those countries). A pro-active program of financial, technical and intellectual support for continued reform in Kyrgyzstan is the main safeguard against such developments. Risks outside the control of the Bank and the Kyrgyz include external factors such as lower commodity prices and political change in neighboring countries. Proposed Agenda for Board Discussion ix. In discussing the proposed country assistance strategy, the Board may wish to consider: * whether the structural policies the CAS proposes to address (sustainability of the pension system, improvement of the regulatory framework for business, and strengthening of public finances) are the appropriate areas of focus? * whether the choice of Bank Group instruments (lending, advisory and non-lending services) is appropriate to Kyrgyzstan's circumstances? * whether the program's focus on stimulating broad-based growth and complementary poverty reduction initiatives is the appropriate strategy to follow? MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT, THE INTERNATIONAL DEVELOPMENT ASSOCIATION AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY FOR THE KYRGYZ REPUBLIC 1. This is the second CAS for the Kyrgyz Republic.' It has been prepared jointly by IBRD/IDA and the IFC, in consultation with the Government of the Kyrgyz Republic members of Parliament, locally based donors and representatives of non-governmental organizations. It fully integrates the programs of the World Bank Group. A private sector assessment prepared by IFC (Attachment) supplements the information provided in the text. 2. This CAS comes at a time when the World Bank Group's relationship with the Government is evolving from a provider of post-independence emergency assistance to a steady development partner. Kyrgyzstan achieved two years of solid economic growth in 1996-97, following five years of economic decline, and has made great strides in its transition to a market economy. Yet, unlike several neighboring countries in Central Asia, Kyrgyzstan does not have large natural resources to finance the continuing transition process and finds itself at a considerably lower level of income than three years ago. Poverty has increased, and growth prospects remain modest. Despite efforts to facilitate a favorable investment climate, the private sector has not yet really taken off. Investment levels are low, and foreign investors are scarce. The Government is still establishing the institutional capacity to deal with the rapid changes in legislation that have been enacted to create a market economy and with the demands of implementing a growing public investment program. Public finances are fragile and require further strengthening and restructuring. This CAS discusses these challenges and sets out a strategy for how the Bank Group will work with the Government to address these issues over the next three years. I. Economic, Social and Political Context 3. Stabilization and Structural Reform. The current social and political situation needs to be viewed against the backdrop of five years of economic upheaval and rapid structural change. Following the breakup of the Soviet Union, Kyrgyzstan fell into a vicious spiral of declining production and macroeconomic destabilization with several consecutive years of negative GDP growth in the 15-20 percent per annum range and triple digit inflation. The Government undertook initial programs with the IMF and the Bank in 1993 which included significant trade and price liberalization and the introduction of a market exchange rate. Since then, it has established an impressive track record of stabilization and structural reform. It successfully completed a three-year ESAF program in 1997, and has stabilized the economy within the context of an open international environment. As a result of this program: * inflation declined to 15 percent in 1997; * the fiscal deficit no longer requires inflationary borrowing from the central bank; and * GDP bottomed out in 1995 and grew at about 7 percent per annum in both 1996 and 1997. 4. In terms of structural reform, the Government implemented all of the policy measures identified in the 1995 CAS, except public utility pricing and establishment of an unified land registration system. The first CAS (Report No. 14548-KG) was discussed by the Board in June 1995. -2- Through four Bank adjustment operations (privatization and enterprise reform, agricultural privatization, financial sector reform, and public sector resource management), the Government, inter alia, : * privatized about three-quarters (more than 1000) of the medium and large scale enterprises; * demonopolized and privatized the main agricultural processing complexes, including the bread and grain trade; * disbanded almost all state farms, distributed land shares for over one-half of the agricultural land, and created legal rights for long-term private leasehold of land; * restructured the financial sector, including liquidation of insolvent state banks and creation of a sound banking environment; * established regulatory agencies for utility regulation in electricity and telecommunications; * introduced government-wide procurement practices consistent with international standards; * overhauled government budget processes and established a stable framework for inter- governmental finance; and * transformed a system of myriad consumer subsidies into a targeted social safety net aimed to protect vulnerable elements of the population. 5. Social Attitudes and Poverty. The views of the Kyrgyz population on their social, economic and political situation in mid-transition (December 1996) are summarized in Box 1. Despite two years of growth in 1996-97, the social fabric remains severely stretched as a result of a cumulative 51 percent decline in GDP during the preceding five years. Whole industries closed down with resulting unemployment and dislocation of workers. Except for a small segment of the population that is engaged in the emerging private sector, the rest of the population is living considerably less well than during Soviet times. Real wages and consumption levels are about 40 percent below their former levels. GNP per capita (World Bank Atlas methodology) fell to $570 in 1996, considerably below its level at the time of the last CAS ($830 for 1993). As in other countries of the FSU, the older generation is less able to adapt to the changing economic times and longs for a return to the higher living standards of the previous regime. In short, the structural changes associated with the Government's notable policy achievements have nevertheless taken a large toll on the population (see Box 2: Poverty in the Kyrgyz Republic). Box 1: Public Opinion Survey: Views from Kyrgyzstan An independent national public opinion survey conducted in November/December 1996 showed a populace dissatisfied with the pace and results of reform, ambivalent about the type of economy appropriate to country circumstances, but hopeful for the future. A large majority favored letting citizens own land and allowing them to buy and sell it, provided it is regulated properly, but opposed permitting acquisition by foreign companies. A large majority welcome foreign investment, with young adults also receptive to privatization. Despite concerns about deterioration of the quality of life, there was optimism about the country's future prospects. Most felt relations among ethnic groups were good; however, there were significant differences between groups as to the country's policy direction and future prospects. While public sentiment strongly favored the election process, dissatisfaction with its functioning was indicated. The survey showed distrust of all branches of government and a sense that the justice system was failing the populace. Concerns about the court system and incipient corruption were cited, as were worries about the protection of civil rights. Nevertheless, order and discipline were believed necessary, and there were some consensus on the need to limit political and civil rights to maintain order. Respondents were interested in NGOs active in environment and charitable works; however, half noted that such organizations are not necessary, and a majority indicated that none exists in their communities. Source: International Foundation for Election Systems -3- Box 2: Poverty in the Kyrgyz Republic The Kyrgyz Republic faces a serious and growing poverty problem. In 1993, slightly more than 40 percent of the population were classified as poor. By 1996, at least half of the population had consumption levels below the poverty line. For a smaller part of the population, these shortfalls in consumption are very serious -- malnutrition rates among children (0-6) increased 25 percent over the period. Sixty-five percent of the population live in rural areas, where poverty continues to be significantly worse. Rural areas are largely demonetized and, in the more remote regions, are reverting to subsistence agriculture. Employment: Much transitional poverty has arisen from the broad changes in the labor market during the past four years (participation rates have fallen from 70 percent in 1993 to 52 percent in 1996). A large part of the decline has come from the fall in female participation rates (65 percent in 1993 to less than 45 percent in 1996), although male participation has also fallen, and men and the young are the most likely to be unemployed. Such drastic drops may primarily reflect involuntary movements out of the labor force (discouraged workers). For those in the labor force, unemployment has increased substantially, from 6.2 percent to 11.0 percent. Access to social services: The quality of health and education services has fallen substantially following reductions in public expenditure by about 50 percent in real terms since 1993. Modest fees for these services are now being introduced which should improve cost recovery and service quality. The high child malnutrition rates may indicate an absence of proper health care as much as a poor diet. While health care costs, as a share of household budgets, do not appear to be excessive, for each episode of illness these costs may be high. Social assistance: Social assistance is targeted increasingly to the poor, but the mechanisms for identifying the poor in rural areas need improvement. Resources for social assistance are spread very thinly--about $4 per month to about one million people (1/4 of population). In total. these resources amount to only about 1.5 percent of GDP. but ne%ertheless put a considerable strain on the budget. In order to minimize the burden on the budget. in 1998. social assistance %%as delinked from the minimum wage and replaced with a poverty line based on an annual assessment of the state's fiscal resources. the number of those in poverty, and forecasts of changes in consumer prices. Pensions and social insurance: The current pension sN stem is generous and some 20 percent of beneficiaries receive early retirement pensions, raising the cost of the si stem and depressing benetit levels. Further, social insurance taxes (39 percent of payroll co%ering pensions. unemployment and health insurance) discourage compliance and formal job creation. Howkever. pensions plaN an important role in preveming poverty. Poverty rates among pensioners are no higher than that of the total population, although data suggests that rural pensioners have been harder hit by arrears and untimelN deli% er than others. Gender: There are no significant gender issues in the K\ rg\z Republic. The counr has a highly literate and educated female population. Women are not more likeh\ than men to li\e in po%ertv. Indeed. people living in female headed households face a significantly decreased probabilitv of being in the lowest poverty quintiles. In large part this is due to an informal social safety net: female headed households receive twice as much in the way of food and three times the cash remittances from relatives and friends. Although there has been a decline in female labor participation rates, especially among the poorest quintiles. data in other parts of the region indicate that some of the decline may be voluntary: howe%er. this %%ill be tracked in subsequent surveys. The Kyrgyz Multipurpose Poverty Survey was conducted in 1993. Three subsequent surveys, Spring 1996, Fall 1996 and Fall 1997 were completed. A poverty profile from the Spring 1996 survey has been prepared and preliminary results from the Fall 1996 survey are available. Data from the 1997 survey are being evaluated. -4- 6. Political Economy. During the past five years, the Government has been preoccupied with macro stabilization and basic structural reform, which has been appropriate. Its commitment to economic reform has not wavered despite the political cost of staying the course. Lately, it has recognized the growing problem of poverty and has taken the bold step of publicly discussing its increased incidence. President Akaev has declared 1998 as the "year of fighting poverty" and has launched a wide-ranging National Poverty Alleviation Program, "Araket." This program seeks to provide employment generation, improved access to social services, more market-oriented labor legislation and pension reform. As a signal of the importance that the President attaches to the Araket program, he elevated the chief architect of the program to the position of Prime Minister in a March 1998 Cabinet reshuffle. 7. The new Government has been given the mandate to work with the Parliament on maintaining and improving the pace and direction of the reform process. The Parliament, which has passed an impressive body of market-oriented legislation, has on occasion undone key provisions through subsequent amendments. Some back stepping has been occurred on tax policy, utility regulation, privatization of large enterprises, and delays in land legislation, however, the overall policy direction remains solid. 8. Aside from dealing with increased poverty and the cohesiveness of policy direction, the major political challenge is to prevent vested interests from establishing or strengthening monopoly control over commercial and trading activities. Many privatized enterprises inherited the monopoly trading position of the former state system and are beginning to exert anti-competitive pressures in the absence of effective anti-monopoly regulation. A second important challenge is to ensure that the privatization of the remaining large state enterprises and utilities continue to be conducted in a transparent manner. II. Macroeconomic Performance, Prospects and Risks A. Recent Economic Performance 9. The economy has stabilized over the past two years and begun to regain some of the production lost during the 1991-95 period. As mentioned, GDP grew by about 7 percent per annum in 1996 and 1997. This was a notable achievement in view of the extent to which the economy had been pulled apart by the collapse of trade with the former Soviet Union, the introduction of market pricing throughout the economy (except public utilities), and the dislocations associated with the privatization and/or liquidation of most commercial enterprises and banks. 10. Growth Factors. It is not clear, however, whether these initial two years of growth are a signal of a permanent, sustained trend, or whether they represent mainly a "bounce-back" from overly depressed levels of production. This is because growth in 1996-97 can be attributed to several unique factors that are unlikely to recur. First and foremost was the coming-on-stream of the Kumtor gold mine. Investment in Kumtor was equal to about 10 percent of GDP in 1995 and 1996, which gave a big boost to the construction industry--domestic investment levels fell off sharply in 1997, however, reflecting the end of the investment phase of the project. Gold production started in 1997 (at the rate of about 550,000 oz. per annum), which alone added about 4 percent to GDP. Some further increase in gold production may occur in 1998, but production will level off thereafter. Second, the weather during the past two years was very favorable for agriculture, which grew at 10-13 percent each year. Also, the distribution of land shares and liberalized market prices undoubtedly contributed to the production increase, but the introduction of these policies was again a one-time event. Henceforth, agricultural production will be more directly related to increases in productivity, which may be more difficult to achieve. Third, industrial production benefited from the re- -5- entry into production of about 20 large firms whose production had been halted under the enterprise rehabilitation program. Finally, the public investment program, which is largely funded by external official donors, grew in size to about 3-4 percent of GDP. While the main benefits of the PIP will undoubtedly occur when the projects come on-stream, the initial boost to investment and growth from public investment expenditure has largely occurred. I. Fiscal developments were also favorable during 1996-97, although considerable further strengthening is required before the Government achieves fiscal sustainability. The most notable achievement has been a reduction in expenditure levels from 39 percent of GDP in 1993 to 26 percent of GDP in 1997.2 This reduction was achieved mainly through a reduction in consumer subsidies, transfers and net lending to state enterprises. It nevertheless also significantly reduced the level and quality of health and education expenditures, as well as maintenance of public infrastructure (which includes the very extensive irrigation network and associated series of dams). 12. With the reduction in expenditures, the fiscal deficit has come under control, although it is still high in absolute terms at about 9 percent of GDP. The large majority of the deficit has been financed from external sources, mostly on concessional terms and, in this respect, is not creating an onerous debt service burden. External financing has been mostly for general budget support purposes, but is gradually switching to finance the growing public investment program. To the extent domestic borrowing has been necessary, the Government has made a concerted effort to rely as much as possible on the emerging Treasury bill market and, starting with the 1998 budget, will no longer borrow directly from the National Bank of Kyrgyzstan. This phasing-out of borrowing from the NBK has directly helped reduce inflation and interest rates, which have declined from the high double-digit range three years ago to 15 percent and 26 percent, respectively, by the end of 1997. Table 1: Macroeconomic Performance Indicators - 1993-1997 1993 1994 1995 1996 1997 GDP Growth (% p.a.) -15.5 -20.1 -5.4 7.1 6.5 Investment (% of GDP) 11.7 9.0 18.3 25.2 14.4 Inflation - CPI - end of period 767.0 95.7 31.9 35.0 14.7 Fiscal Balance (% of GDP) -14.4 -11.6 -17.3 -9.5 -9.4 Total Revenue & Grants, of which 24.6 20.8 16.7 15.9 17.0 Tax revenues 14.5 13.6 15.0 12.7 13.1 Grants 8.6 2.5 0.3 0.9 0.7 Expenditures, of which 39.1 32.4 34.0 25.5 26.4 Subsidies and Transfers 16.9 7.4 7.5 5.9 5.2 Health & Education 6.8 9.1 10.2 8.4 8.0 Public Investment .. 4.9 4.8 3.8 3.9 Net Lending 8.9 4.7 3.4 0.4 0.5 Current Account Balance (% of GDP) -6.9 -11.3 -16.2 -23.3 -8.1 Source: National Statistical Committee and World Bank and IMF staff estimates Includes net deficit of the social fund. Public finance figures exclude the self-financed expenditures of the Social Funds (pensions, unemployment and disability compensation), about 5 percent of GDP. They include, however, transfers from the budget to the Social Funds, about 2 percent of GDP. Total Social Fund expenditure is, hence, about 7 percent of GDP. -6- 13. Public Sector Resource Management. A third major achievement in the area of public finances has been an overhaul of the Government's budgeting procedures and inter-governmental fiscal relations. Under the on-going Public Sector Resource Management Adjustment Credit (PSRMAC), a Budget Commission was created to set initial budget ceilings for drawing up the budget and to monitor and adjust expenditure during the course of the fiscal year. Expenditure is carefully controlled under a system of expenditure warrants, the public investment program is being integrated with recurrent expenditures into a consolidated budget, more informative and transparent accounts are sent to Parliament (and disclosed to the public), and internal audit systems are being strengthened. A clear system of revenue and expenditure sharing has also been set up between the central and local governments, including an equalization grant to help the poorest region meet wage payments for health and education. Under this system, transfers to local governments for health and education expenditures have become much more dependable, which has largely eliminated wage arrears for these services and reduced the need for ad hoc negotiation between levels of government. 14. Balance of Payments. The external sector has also registered significant improvement. Following two years of very high current account deficits in 1995-96 (which reflected the high import levels associated with the Kumtor gold mine investments), the current account balance was reduced to 8 percent of GDP in 1997, a level that is consistent with the external financing flows received by the Government budget. Exports have been rising at about 20 percent per annum (in US dollar terms) during the past three years, reflecting a rejuvenation of trade with neighboring countries as well as the start-up of Kumtor gold exports in 1997. Reserve levels are currently a comfortable three months of import requirements. B. Growth Prospects, External Environment and Risks 15. Despite the Government's considerable policy achievements, many reforms are still on-going, and the private sector faces considerable constraints that prevent it from fully responding to the new market environment. * The economy is primarily agricultural (45 percent of GDP). Agricultural growth is constrained by land scarcity and low productivity caused by scarce working capital, a disintegrated input and marketing system, out-of-date technology, poor research and extension services, and a deteriorating irrigation system which services 80 percent of the arable land. Efforts are underway to ease these constraints, but the returns in the form of increased productivity will be long-term in nature. * Most small and medium enterprises have been privatized, but they are either unable or reluctant to restructure their operations and do not generate enough internal cash flow to increase production. As a result, capacity utilization remains low, especially in agro- industries. Also they face a number of regulatory impediments that reduce the incentives for investment. * Financial intermediation remains very low (broad money is only 14 percent of GDP), and banks have only recently begun to extend long-term loans. * Domestic savings and investment levels are low (2 and 14 percent of GDP, respectively). Raising these levels will also be slow, in view of a high propensity to consume, the low level of financial intermediation and the structural problems of the fiscal deficit (see below). 16. External Environment and Risks. Kyrgyzstan also faces a number of exogenous constraints that will be difficult to change. -7- * It is geographically isolated from international markets and faces high informal barriers to trade in neighboring countries where high "tolls" are extracted for passage of goods along major transport routes. * Despite Kyrgyzstan's membership in customs unions with neighboring countries, its small size make it a price taker in negotiations for exporting electricity and water and for importing energy. * The heyday of donor premiums to support "the transition" is coming to an end, and assistance levels are likely to remain constant in real terms, at best. 17. In addition, the economy is vulnerable to a number of external risks, including setbacks in Russia (which is an important market for Kyrgyz agricultural exports), increases in the cost of oil and gas imports, and further declines in the gold price. Indeed, the recent decline in gold prices (to under $300 per oz.), if sustained, will reduce export earnings by up to $30 million (or 1.5 percent of GDP) per annum compared with the projections at the time the Kumtor project was initiated. Such shocks reduce the external resources available to the economy and slow down growth. 18. Outlook for Growth. For these reasons, the outlook for growth is positive but restrained. The positive forces unleashed by the structural reforms to date have to be balanced against the constraints still facing the economy. Taking these constraints into account, long-term growth prospects are assessed at 4 percent per annum (about 3 percent in per capita terms), although growth could be higher during the next few years as the economy continues to bounce back from the severe decline in GDP suffered during 1991-95. 19. Long-term growth could nevertheless be faster than 4 percent per annum with a concentrated effort to reduce the regulatory impediments to business and to improve the incentives for investment. In particular, the privatization of the remaining large state enterprises (electricity, telecoms, gas, cement, etc.) needs to be done in an open and transparent manner, in order to attract strategic investors who would bring the managerial expertise and financial resources needed to increase profitability, and, in the case of electricity, increase exports. More generally, the Government needs to eliminate the monopoly privileges of enterprises that were previously state-owned but are now private and, second, ensure that regulatory bodies carry out their functions free of political interference. 20. Growth will also be affected by the speed with which the Government raises public savings and eliminates the structural deficit in its fiscal position. This deficit is caused by poor tax administration which results in a low overall tax ratio (13 percent of GDP, excluding social insurance taxes for pensions, etc.), an overly generous pension policy (which contributes 1-2 percent of GDP to the deficit), and a reluctance to charge full economic costs for commercial public services (electricity, heat, telephone, water, irrigation, transportation, etc.). Concerted action is needed in all of these areas over the next three years. Also, public debt service, while not high at present (about 10 percent of government revenues in 1997), will need to be managed carefully to avoid rising rapidly if borrowing occurs on non- concessional terms. Public borrowing should therefore be mainly on concessional terms for both BOP and fiscal reasons. III. Kyrgyzstan's Development Challenges and Agenda 21. The Government's over-arching objective is to establish long-term sustainable growth. Without growth, there will be no meaningful reduction in poverty. Nor will the Government have the means to improve basic human services or institutional capacity. The Government sees the private sector as the -8- main vehicle for achieving growth. The two broad thrusts of the Government's development strategy are thus private sector development and poverty reduction. 22. For private sector growth, priority is given to agriculture and the re-vitalization of agro-industry, which is appropriate in view of the large part of the population that depends on agriculture for its livelihood. Emphasis is also placed on improving the regulatory environment for business, in order to foster growth and boost job creation. For poverty reduction, the Government envisages a complementary strategy of increasing agricultural productivity to raise the incomes of the majority of the population that lives in rural areas, together with improving the targeting of social assistance, attaining the fiscal sustainability of the pension system to assure pension payments, and restructuring health and education services to increase efficiency and make better use of resources within the existing budget constraints. A. Private Sector Development 23. Agriculture and Rural Development. Attaining long-term sustainable growth in agriculture is the greatest challenge facing the country. Strong agricultural growth would raise the incomes of a broad swath of the population who live in rural areas where poverty is concentrated and would reduce poverty for many, although not all, of those currently below the poverty line. Growth in agriculture will come from both livestock and irrigated crops, but, at least in the medium term, the growth rate is more likely to be on the order of 4-5 percent per annum, rather than the 10-13 percent of the past two years. Although Government intervention has largely disappeared (prices have been liberalized, state farms disbanded, land shares distributed, and small private farms have started to appear), the future structure of the sector is still emerging and many issues remain. Major issues include how to improve the efficiency of and stimulate a recovery in livestock, which has collapsed to a mere remnant of its former size due to increased feed prices and loss of markets. Pastures (common property that accounts for 45% of the total land area) need to be better managed, although pastures are recovering due to lower grazing pressures. Despite cessation of state orders, the Government has led a campaign to increase wheat production in a drive for self-sufficiency, which the country has now attained. However, wheat self-sufficiency has been achieved at a high economic cost, since Kyrgyzstan does not have a comparative advantage in this crop, and the Government needs to allow markets determine which crops should be grown. Lack of market information about prices and stocks (for both inputs and outputs) and limited domestic demand for agricultural commodities has contributed to this problem. Agricultural support services need to be established to replace the previous reliance on state farm managers and technical experts and to educate the new private farmers in farm management techniques and appropriate agricultural practices in a market economy. The major policy issue facing agricultural resource management is how to deal with a scarcity of land and to develop appropriate water use policies. In the past, this mix of scarce land and abundant water has led to extensive development of the irrigation system, which has been over- developed in some areas, but which has fallen into disrepair due to many years of underfunded maintenance. Rationalization of the system is required and cost recovery for water use will need to be introduced in a manner consistent with the growth of rural incomes. 24. The strategy for dealing with the above challenges was discussed and agreed with the Government during a Second International Agricultural Conference in Bishkek in December 1997. It envisages a combination of specific investments to provide public goods in agriculture, policy reform and institutional development. A large part of the Government's investment program will be allocated to rehabilitation of the irrigation system, initially at the main canal level and subsequently at the on-farm level through the establishment of water user associations which will assume responsibility for operations and maintenance of irrigation system within their areas. Appropriate water pricing policies will also be developed as part of this strategy. Public investment will also focus on adaptive research -9- and on rural advisory services, livestock and pasture management, rural infrastructure and market information systems to increase the efficiency of input and commodity markets. Policy reform will continue to support farm restructuring and the issuance of land share certificates to private farmers. Establishment of a nationwide land registration system will be essential for creating land markets (in both rural and urban areas) and for enabling farmers to increase their access to credit through collateralization of land use rights. In this regard, enactment of the draft Land Code and Land Registration Acts, which have been under debate in Parliament for the past two years, is a necessary prerequisite. Institution building needs to focus on human resource development in the public sector institutions dealing with agriculture, improving the quality of data relevant to the sector, promoting exports of agricultural commodities, and creating/strengthening institutions to support private agriculture, particularly agricultural inputs. 25. Environment and Natural Resource Management. The unsustainable use of natural resources presents a key environmental problem in the Kyrgyz Republic. The combined impact of extensive overgrazing, over-exploitation of fragile forest resources, inappropriate farming practices, poorly maintained irrigation systems and inefficient water resource management have led to severe land degradation and surface water pollution. As a result of weak forestry management, plantations for fuel- wood and building materials has virtually ceased and the country's watershed has been affected adversely. The Government strategy focuses on improving the legal and regulatory framework, including the introduction of project level environmental assessments; enhancing institutional capacity to enforce environmental standards; addressing past environmental liabilities and developing national biodiversity and water management strategies, within the framework of the Aral Sea Basin Program. 26. Privatization. An active private sector is rapidly developing as the Kyrgyz Republic moves to complete privatization of remaining state-owned enterprises. All medium and large enterprises have been at least partially privatized through a coupon auction program, and a majority of enterprises have been fully privatized through subsequent cash auctions. About 300 enterprises remain to be fully privatized over the next three years, including nine large infrastructure companies (energy, telecommunications, printing, aviation, etc.) and several dozen medium-size firms which are earmarked for privatization on a case by case basis to strategic investors. Many of the now-privatized enterprises require substantial restructuring, but their managements have been reluctant to do so out of fear of losing their jobs. Their managements also need considerable training to run companies effectively and develop markets for their products. 27. Corporate Governance. Enterprise restructuring has been hampered by a lack of good corporate governance to ensure that the interests of all shareholders are being addressed. The Government, with ADB support, is beginning to institute standard governance rules and procedures applicable to both public and private enterprises. Measures include the institution of company charters, appropriate supervisory and management structures, monitoring and reporting requirements, expediting the liquidation and restructuring of non-viable enterprises; and strengthening the legal framework for insolvency and ensuring its enforcement. Complementary efforts are ongoing to facilitate the adoption of international auditing standards. Much remains to be done however to develop local audit and accounting capacity. 28. Regulatory Environment. A multitude of new laws affecting the private sector has been adopted, but court decisions often remain unenforced, due to an ineffective and poorly trained judiciary. Companies face a myriad of regulations about which they are frequently uninformed, and private firms, including nascent industrial groups, operate in an atmosphere of weak enforcement of anti- competitiveness rules. Many taxation, accounting and disclosure issues have now been addressed, but - 10 - the tax regime remains burdensome, the accounting system has yet to be brought in line with international standards and disclosure rules are insufficient for outside investors. Finally, firms face difficulties in accessing essential economic and business information and consulting services. A more detailed assessment of the constraints facing the private sector, prepared by IFC, is attached to this CAS. 29. Legal Reform. Over the past four years the Government, with donor assistance, has initiated a systematic program to revamp its legislation and modernize the judiciary. These initiatives have been aimed at improving the efficiency, transparency and effectiveness of the law-making process, particularly with respect to economic legislation. Core economic legislation has been enacted, including, inter alia, a tax code, civil code, national procurement law, and laws on foreign investment, pledge, banking and bankruptcy. Advanced work on insurance, securities markets, investment funds, leasing, land and mining laws has been undertaken. Despite this impressive start, inconsistencies within the legislation remain and the capacity for interpretation, application and enforcement needs considerable strengthening. Support for legal drafting and judicial training is being provided by USAID, IDA and other donors, and ADB is supporting training for Arbitrage Court personnel. 30. Foreign Investment. The Government strongly desires to see an increase in foreign direct investment and has, with IDA/FIAS support, enacted a sound investment law which provides equal rights for local and foreign investors. But it has yet to establish an effective foreign investment promotion agency despite considerable advice from the Bank Group. Aside from a few major investments (e.g., in gold mining), Kyrgyzstan has had only limited success in attracting foreign investors. An essential element for attracting foreign investment to the energy and telecommunications sectors will be for the newly-created regulatory agencies to allow full cost recovery in utility pricing, which the Government has so far resisted. As a result of low cash flow, however, the electricity sector has neglected maintenance and underinvested for many years and now faces an increasingly critical situation of being unable to supply continuous service. Without reliable electricity, little foreign investment is likely to come to the country. The Government has also created multiple "free economic zones" which have served more as vehicles for avoiding taxes in a legal manner than for export promotion. Such abuses need to be eliminated and the law in this area overhauled. 31. Financial Sector. Following independence, the Kyrgyz financial sector was debilitated and the majority of the commercial banking system was technically insolvent. The Government has pursued a two-pronged strategy concentrating first on a fundamental restructuring of the banking system. With IDA support, the banking system has become increasingly robust with credit availability growing and interest rates declining. A small core of well managed commercial banks has emerged to serve the emerging private sector. The system currently comprises about 15 private banks (some with foreign ownership, including one with IFC participation); a Settlement and Savings Corporation and a rural finance institution, the Kyrgyz Agricultural Finance Corporation, which was created with IDA participation to provide medium-term finance to agriculture and agro-businesses. A system of rural credit unions is also being established with ADB support. 32. The priorities for the future development of the financial sector center on non-bank financial institutions. The Kyrgyz Stock Exchange was established two years ago and has accepted listings for about 40 firms, about 10 of which are actively traded. The main problem facing the KSE is the lack of adequate securities to trade, in particular, shares of the major state utilities (energy and telecoms), for which only 4-5 percent of their shares have been privatized through the coupon auction. Further privatization of these enterprises through the KSE would help develop the securities markets. Development of voluntary private pension funds is a second near-term priority and would complement - 11 - upcoming efforts to reform the state pension system (paras. 35 and 48). Other financial institutions needed for a market economy include insurance and leasing companies. 33. Transport and Infrastructure. Continued investment in transport and telecommunications is required to overcome Kyrgyzstan's geographic disadvantages. Inadequate infrastructure, particularly in the rural areas, is a bottleneck to generating employment and economic growth. While constrained budgets have precluded adequate investment, maintenance and rehabilitation, the transport and rural infrastructure sectors also suffer from inadequate policy framework, weak institutions, poor planning and inadequate cost recovery. Consequently, service quality is uneven, rural coverage is low and existing resources are not efficiently used. The challenge for the Government will be to work within the severely constrained fiscal envelope. The Government's transport sector strategy envisages investment to redress the severely debilitated transport and road services in key cities and complementary policy reform. In the rural areas, the strategy is aimed at improving the quality and availability of key infrastructure services (roads, bridges, markets, electricity, telecommunications services etc.) to the under-served rural population. B. Poverty Alleviation, Human Resource Development and Social Protection 34. Social Protection. At independence, the Kyrgyz Republic faced serious challenges, including insufficiently developed systems to monitor standards of living and provide social benefits to those most in need, lack of mechanisms for assisting the unemployed, a mismatch of training with the changing needs of the economy, and difficulties in funding the system of social protection. The decline in incomes, the removal of subsidies and the shifts in relative prices that have accompanied structural changes in the economy have imposed costs on some households, particularly the poor and those at the margin. Since 1993, the depth and incidence of poverty has increased (see Poverty Box), and poverty alleviation has become a top development priority. The Government, with IDA support (Social Safety Net Project, FY94), is improving the development, implementation, monitoring, and evaluation of its social assistance policy in order to ensure that its scarce social assistance resources are targeted effectively to the most vulnerable groups. 35. Pensions. The Kyrgyz pension system is overly generous in scope, with early retirement privileges and benefits that are high in relation to the average wage. Government subsidies to the Social Fund have become a major contributor to the overall fiscal deficit, and high payroll tax levels (39 percent, mostly for pensions but also including taxes for unemployment, disability and medical insurance) depress employment and wages while encouraging evasion. As a classic Pay As You Go system, current revenues are used to pay for current benefits and there is no contribution to national savings. The Government plans to work intensively to strengthen the fiscal sustainability, accountability, and effectiveness of the state pension system. At the same time, it anticipates development of a voluntary private pension tier that is well designed, regulated and supervised. 36. Improving Health Outcomes and Resource Allocation. The Kyrgyz health care financing and delivery system is a vestige of the centrally planned national health service system of the FSU. System inefficiencies, logistical problems and shortages resulting from the breakup of the Union, combined with the rapid devolution of responsibility without adequate resources and a decline in the overall budget, has led to a severe deterioration of services and outbreaks of some contagious diseases. The Government's sector strategy focuses on reversing these trends while introducing long-term efforts to develop a sustainable system capable of delivering cost effective and efficient health care. The strategy encompasses an integrated reform effort (Health Sector Reform Project, FY96) to promote primary health care and modern treatment protocols for diseases, delivery system restructuring, pharmaceutical - 12- system management and the introduction of incentive-based medical provider payment systems, including a new mandatory medical insurance fund. C. Institutional Capacity and State Governance 37. Civil Service Reform. Since independence the Government has faced the challenge of reorienting its functions to meet the needs of a market economy. It has begun to address the incentive structure of the public sector, look at alternative means of providing public services and strengthen the accountability of public sector officials and agencies. Over the past 18 months, a number of ministries have been merged, functions streamlined and a downsizing of the civil service by about 12 percent has been effected. Nevertheless, the functioning of the system remains weak and continues to be an obstacle to effective implementation of development policy. These institutional weaknesses have become more apparent as the atmosphere of crisis management has subsided into more routine administration of the public sector. Top technical levels within the civil service are leaving for the private sector, thus weakening the capacity for policy dialogue and policy coordination. Further, Government agencies lack the skills and experience to develop, implement, monitor and evaluate sectoral policies. The Government considers the development of a professional civil service cadre among its priorities and has sought technical and financial support for this effort from the UNDP and EU-TACIS. 38. Procurement Reform. Responding to the need for clear and transparent procurement system, the Parliament enacted a national procurement law in 1997. The law provides for a comprehensive public procurement system, consistent with international practices, World Bank guidelines and WTO agreements. A National Procurement Agency has been established to regulate and exercise oversight on public procurement. The system is being implemented and a number of efforts toward institutional strengthening are underway with IDA support through two IDF grants. The system, which serves as a vehicle to combat fraud and corruption, has successfully begun to introduce discipline in public expenditure and bolsters accountability by officials responsible for the administration of public procurement in the country. A national workshop to introduce the procurement policies and procedures was held in Bishkek in February 1998. D. Bank's Assessment of Government's Agenda and Areas of Difference 39. The Bank and the Government are in close agreement on most of the policies needed for further transition of the economy. Nevertheless, there are differences in some areas over the pace, scope and starting points for further reform. For example, to date, the Government and the Parliament have chosen to focus on administrative improvements to the current pension system rather than on more fundamental reforms. The Bank and the Government have recently agreed on making the achievement of financial sustainability of the state pension system the centerpiece of the up-coming Social Sector Adjustment Credit (SOSAC). Measures for expenditure containment that will be necessary to azhieve this goal are under discussion. 40. The Government and the Bank also have different views regarding the pace of introduction of cost recovery for public services. In this regard, the Government and the Parliament have emphasized the low level of wages and the burden that increased charges would place on the population. The Bank, on the other hand, is pressing for appropriate cost recovery policies to meet operation, maintenance and investment needs of the rapidly deteriorating infrastructure network (electricity, irrigation, water supply, public transportation). These issues are being addressed in the context of sector investment operations and sector analytical work. - 13 - 41. In the industrial sector, the Government's vision includes restoration of some of the former industries which have not proved viable in recent years. It also sees Kyrgyzstan as a center of high- technology, a mecca for tourism, and a regional banking center. While there may be some long-term potential in these latter areas, results are likely to be limited in the immediate future. Investment in these sectors should come from the private sector, rather than from the government budget. The Government's role should be limited to providing an open, transparent and properly regulated playing field for private sector development. The Bank, IFC, and FIAS will continue to work with the Government on improving the enabling environment for private sector investment. 42. Finally, the Government's new Poverty Alleviation program, Araket, takes a broad approach to poverty alleviation, encompassing labor legislation, pension reform, employment generation, access to social services and infrastructure, and better targeted social assistance benefits. At the same time, the program outlines a plethora of programs, of varying quality, that could greatly increase Government expenditure without significantly improving the impact on poverty. The Bank will work intensively with the Government, other donors and NGOs in the refinement and implementation of policies and key program activities. IV. Bank Group Country Assistance Strategy A. Lessons of Experience from the Previous CAS 43. The Bank has been a key donor and provider of policy advice on structural issues. This role has been reinforced by the Government's successful implementation of the high case lending program proposed in the FY96-98 CAS. The program encompassed extensive support for policy reform with selective investments in key sectors. A shift away from adjustment lending toward investment lending was envisaged by the end of the program period. Three risks were identified: policy slippage, adverse changes in the external environment and limited implementation capacity. Policy performance has been strong with only a few shortfalls (delay in following through with establishment of a land registration system and in attaining agreed levels of cost recovery for utility pricing). Despite the recent weakness in gold prices, the external environment remained relatively favorable over the past three years. However, the extent and depth of the transition has proven more difficult than expected, and the Government's financial position has not strengthened enough to phase out adjustment lending. 44. Implementation experience with investment projects is still at an early stage, but has generally been good (see Review of Portfolio Performance--Annexes B2 and B8). Nevertheless, institutional capacity has been a constraint. A number of measures have been put in place, but the problem has proven more complex and time intensive than originally envisaged, hence, considerable resources will be deployed to portfolio enhancement (para 50) over the CAS period. Some of the activities under ongoing projects and IDF grants are showing early promise and we are beginning to devolve some responsibility for grant supervision to the Resident Mission on a pilot basis. Concerted efforts among all donors will be required to reach common understandings on capacity building and to promote better utilization of technical assistance. 45. Among the initiatives which have begun to work well are the institutionalization ofjoint Government-Bank bimonthly portfolio reviews and regular CPPRs, for which the Government has taken an increasingly prominent role in planning, execution and follow-up. The Resident Mission has expanded during the CAS period and its impact, particularly with respect to the promotion of Government ownership, has enhanced project implementation. Greater integration of IFC and EDI - 14- programs with Bank operations is also beginning to be achieved through the assignment of their local officers in the Resident Mission. Bank-EDI collaboration with Parliament has proven successful in terms of producing sound legislation for procurement reform, budget reform and a new law governing foreign investment. B. Objectives of this CAS 46. Over the next three years, the Bank will continue to work with the Government in defining and implementing the second generation of structural reforms needed to continue the transition to a market economy and to establish sustained growth, which we see as the best vehicle for reducing poverty on a broad scale. In playing this role, we, together with EDI, intend to work closely with the Parliament to enhance its understanding of the rationale for further reform, in particular, the areas of pension reform and public utility pricing. 47. The strategic objectives of the CAS reflect the Government's development priorities. They are: (i) to attain sustained growth by clearing away the remaining policy and regulatory impediments to private sector activity through a consolidation of s;ructural reforms. The growth objective would be supported by a focused set of projects to increase agricultural productivity (irrigation, agricultural support services, livestock & pasture management) which have the potential to raise the incomes of a broad swath of the rural population where poverty is concentrated. (ii) to reduce poverty through a growth-enhancing strategy complemented by (i) specific investments to improve basic social services (health, rural water supply and sanitation, and public transportation); (ii) improvements to the system of social protection (assured payment of pensions, better targeting of social assistance, and a stronger capacity to monitor and assess poverty and to translate this analysis into effective sector policies); and (iii) a rural infrastructure project that would provide a direct, if temporary, boost to employment in rural areas. (iii) to improve governance through continued support for govemmenl--wide procurement, audit and budget reforms; further deregulation and enhancement of the competitive environment for business; and tax simplification. These efforts are complemented by bilateral donor support for judicial reform and ADB support for corporate governance. The program would also strengthen institutional capacity through establishment of a land registration system and through continued support for the regulatory agencies governing public utilities, privatization, foreign investment promotion, national statistics, and the Environmental Action Office. (iv) to strengthen public finances, in order to reduce the dependency on external budget support operations. Public finances would be strengthened through reforms that would eliminate the deficit of the existing Pay As You Go pension system, extend the land tax to urban areas, improve the standards for external debt management, and extend the principles of cost recovery and economic pricing to all commercialiy-oriented public services that are supported by Bank investment projects (power, telecoms, irrigation, public transport, and water supply). - 15- C. Bank Group Assistance Program 48. IDA Lending. The structural reforms envisaged in the CAS program would be supported by two adjustment operations: * a social sector adjustment credit (SOSAC) whose primary objective would be to achieve financial viability of the existing Pay As You Go pension system and, thus, assure the timely payment of public pensions. This would be achieved through rationalization of eligibility criteria for pension benefits, enhanced linkage of benefit levels with contribution history, and, to the extent possible within the overall financial constraints, some reduction of the extremely high social insurance contribution rates (39 percent) that are a major impediment to compliance. Measures to improve Social Fund accounting and management would also be supported under this credit, as would development of the legislative and institutional framework for supervision of private pension funds as part of a voluntary private pillar. Finally, SOSAC would support improved targeting of social assistance and a restructuring of unemployment benefits. * a consolidation structural adjustment credit (CSAC) -- a comprehensive structural adjustment operation that would provide the finishing touches to the reforms initiated under the previous five adjustment credits and introduce additional reforms needed to improve the environment for private sector investment and growth. The likely agenda could include the final stages of utility privatization, simplified business regulation, improvements in anti- monopoly and anti-competitive business policy, measures to ensure enforcement of new laws (judicial reform), tax simplification and possible reduction in general business tax rates to increase compliance and lessen the incentives for negotiation with the tax authorities, improved legal framework for private agricultural marketing and input distribution, further development of non-bank financial institutions, and further strengthening of the audit and budLget reforms initiated under the PSRMAC. 49. Investment lending would focus on agriculture, in particular, the rehabilitation of the irrigation system which is a priority for the Government. An irrigation rehabilitation project (FY98) for the main canals would be followed by an on-farm irrigation project (FY00) that would support formation of water user associations for maintaining local irrigation systems and introduction of an appropriate water pricing policy. Consistent with the strategy to promote growth in rural areas, a livestock and pasture management project and a rural infrastructure project are also included in the program. A land registration project would help create functioning land markets in both rural and urban areas and strengthen local government finances by providing the basis to levy and collect land tax. Investment lending would also emphasize social concerns through investments in public transportation, rural water supply, and a second health project that would continue the improvements in clinical effectiveness promote restructuring of the health system to improve its long-term financial viability, and promote public health strategies for dealing with communicable and non-communicable diseases. 50. Significant resources will be devoted to assist the Government in implementing the proposed program, as well as the existing portfolio which includes some challenging and complex projects. In addition to intensive supervision efforts, other portfolio enhancement instruments include: bi-monthly joint Government-Bank project reviews; continuous implementation of the ongoing Joint Implementation Action Plan (first developed at the 1996 CPPR); and specialized capacity building initiatives (e.g., procurement reform --para 38). Annex B8 provides more information on portfolio management. - 16- Non-lending Services 51. Economic and sector work (ESW) will be geared to defining the reform agenda for the CSAC. The on-going post-privatization study will identify remaining impediments to private sector development following the privatization process as well as needed improvements in the regulatory environment for business. Other proposed studies which will support the CSAC's focus on strengthening the climate for private sector investment include an agricultural input marketing strategy to defining strategies for the developing private input dealers and an update on financial sector reform that would focus on non-bank financial institutions. Economic work will emphasize the strengthening of public finances (also to be covered under CSAC) through (i) a land tax study to assess the revenue potential of extending the existing land tax from rural to urban areas, and (ii) a fiscal sustainability study that would assess the scope for reducing tax rates within the context of a stable long-term outlook for public finances. As part of our ESW strategy, we will rely on our collaboration with the IMF in preparing the annual Policy Framework Paper for the ESAF programs to stay up-to-date on macro developments and will not produce separate economic reports on the general economy. Sector work would support specific investment operations, such as the second health and livestock projects, as well as a forestry and watershed management note / action program. 52. Technical assistance and capacity building will be critical elements of the Bank Group strategy. It will be provided through a variety of instruments including project supervision, IDF grants and EDI programs. The Government's capacity to attract private investment is being strengthened through an on-going IDF grant which, inter alia, supports the establishment of a one-stop shop for foreign investors. These efforts will be coordinated with and supported by IFC, FIAS and MIGA. A future IDF grant will help develop a national information infrastructure strategy for private investment in the telecommunications sector. Capacity building will also be supported by EDI's program of training government officials and Parliamentarians who are directly engaged in issues concernmg the preparation or implementation of Bank operations, e.g., pension reform under SOSAC, and public utility pricing and management training. EDI involvement proved particularly useful in introducing the inter-governmental finance and budget reforms supported under PSRMAC. IFC Program 53. IFC's involvement in Kyrgyzstan has so far been concentrated in areas where conditions exist for an immediate impact on recovery and growth, i.e., the Kumtor Gold Mine and an investment in a modem joint-venture commercial bank. It has also assisted in attracting foreign investors by hosting an Investor's Conference. Further the Corporation has worked with several enterprises that were undergoing restructuring under the PESAC program to attract strategic investors but to date no investments have materialized. IFC is continuing to try to identify projects in the manufacturing and agribusiness sectors but to date, none have met its standard criteria for financing. In the present environment (see Attachment, Private Sector Assessment), potential projects are of very small size, there is a lack of credible foreign investors, and considerable effort and field presence is required to help small entrepreneurs transform a business concept into a business plan and to follow international business practices. For the coming years, IFC's strategy will focus on: * Institution-building in the area of capital markets. At present, IFC is evaluating a possible investment in the country's first housing finance fund. The development of this project faces a number of constraints related to the legal and regulatory environment for housing and mortgages, such as a lack of a comprehensive title registration system, an absence of a mortgage law, and other necessary laws and regulations. Some of these - 17 - constraints are being addressed through technical assistance (USAID) and the proposed Land Registration Project. IFC will also contribute to the IDA's study on non-bank financial institutions and to the financial market policies to be incorporated into the CSAC. * Support to SMEs. IFC will continue to seek ways to assist the SMEs through local financial intermediaries. To address the scarcity of skills and expertise in modem managerial, accounting and marketing practices, IFC, is also exploring opportunities to establish a local consulting firm to provide consulting services and training programs for local entrepreneurs in accounting, marketing and project finance. IFC's capacity to provide support to SMEs would be expanded if the Kyrgyz Republic were included in the Extending IFC's Reach Program. * Developing the mining sector, which has significant potential for export earnings. At present, IFC is working with foreign mining companies to develop the Taldybulak and the Jeruy gold fields and is assisting them with the preparation of environmental studies. Future progress will depend on the outcome of feasibility studies under preparation. Recent movements in gold prices, however, are likely to delay some projects. * Development of private sector infrastructure projects. Privatization of the industry and opening it to private investors would create opportunities for IFC in power, telecommunications and other sub-sectors. * Agribusiness and post-privatization restructuring. IFC will continue to explore ways to attract foreign investors in agribusiness and to assist with post-privatization restructuring. 54. MIGA has insured two projects so far in the Kyrgyz Republic, one in the mining sector (Kumtor gold mine) and one in the manufacturing sector (Coca-Cola). Currently, MIGA has one definitive application for a project in the service industry ($11 million) and five preliminary applications fro projects in sectors such as crude oil, forestry and mining, representing investments of approximately $620 million. MIGA, together with IFC and the Bank will provide capacity building training in foreign investment techniques. Kyrgyzstan is also a pilot country for MIGA's Privatization Link which connects potential investors and those engaged in privatization via the internet. MIGA/OECD are also organizing a conference on Mining Investment and Business Opportunities in June 1998. Partnerships, Selectivity and Coordination 55. The proposed program takes into account the comparative advantages and additionality offered by the Bank Group, other donor programs and IDA resource constraints. In certain areas, the Bank will either not be involved or our involvement will be of a limited nature. These include education, for which the ADB has taken the lead in supporting the development and financing (together with OPEC) of an Education and Training Master Plan and sector investment program, and roads, for which ADB and OECF have been key financiers. In other infrastructure areas, particularly energy and telecommunications, the ADB and EBRD play significant roles. The Bank will continue to work in partnership with them through supervision of ongoing investment projects and through IFC's involvement with private sector interests. Our future role will be largely confined to policy advice on implementation of the recently created regulatory bodies for those sectors and on the implementation of their privatization plans. Future Bank efforts in the financial sector will be limited to analytical work on non-bank financial institutions and preparation of the CSAC, supported and complemented by IFC. - 18 - Bilateral donors, notably the Swiss and Finns have taken a strong lead on forestry and watershed management. The Bank's proposed forestry sector note will complement these efforts. Bank involvement under the GEF and Aral Sea frameworks will also underpin these efforts. On legal and institutional reform, the USAID, EU-TACIS, UNDP and other donors have provided substantial technical assistance for a broad array of reforms dealing with the legal framework, reform of the judiciary, privatization, financial sector reform, etc. Future Bank Group efforts (including IFC and FIAS) will be concentrated on legislative reforms associated with Bank-financed operations and analysis of sector-specific legal issues in programmed ESW. Limited support for judicial training is supported under the ongoing FINSAC TA operation. Table 2 provides an overview of donor program areas of involvement. Table 2: Donor Collaboration: Selected Key Areas of Involvement World Bank IMF ADB EBRD EU UN IFAD DK GER JP CH NL UK USAID OPEC Grout System NO KHF FI WB IFC/EDI CA NDF Macro Framework Financial Sector IFC EDI Legal Reform PSD/Investment __IFC - 7i' Climate Fiscal Reform Governance CA Agriculture/Rural I EDI V FI 7 7/ 7 Dev./Land IFC Reform -7 - -FD-I F1 Environment/ EDI FI Forestry Land Reform Mining IFC CA Transport Oil/Gas/Power IFC DK,NO, NDF Urban/Water EDI Telecoms IFC Health EDI DK Education V DK Social Protection EDI Labor Mkt.Trng Modernization of EDI State Capacity Building 7 - CA - Canada GER - Germany DK - Denmark JP - Japan Fl - Finland CH - Switzerland NO - Norway NL - Netherlands NDF - Nordic Development Fund UK-KHF - UK Know-How Fund 56. The first stage of post-independence assistance to the Kyrgyz Republic was largely managed from donor capitals. Over the last 18 months, a gradual shift has occurred with a larger in-country international presence and a more formalized system of information dissemination and cooperation emerging. To date, there has been general agreement among donors on policy direction and priorities. However, at the operational level, lack of adequate dialogue has, on occasion, led to duplication of efforts and conflicting advice. There is a need for the Government to assume more forceful ownership, direction and coordination of programs. The recent mandate given to the Agency for Foreign - 19- Investment to manage external aid coordination is a welcome signal. However considerable caution will need to be exercised in order to prevent the Agency's multiple functions from diluting attention to this priority area. On the donors part, greater sharing of information at the project/activity level is needed and at the strategic level, advance consultations on respective country strategies is desirable. To assist with this task, the Bank will continue aid coordination efforts in the form of organizing Consultative Group meetings every 18-24 months, as well as a third international agricultural conference in Bishkek to assess progress against the strategy agreed during the recent second conference (para. 24). 57. The phasing of the IDA program of lending and non-lending services that will be used to achieve the CAS objectives is shown in Annex Al. The contribution of these instruments to achieving the CAS objectives is shown in Annex Cl. D. Lending Levels, Triggers and Creditworthiness 58. IDA Lending Levels. Kyrgyzstan has been in a high case lending scenario since it began borrowing from IDA in FY93. During FY96-98, the Government prepared and is implementing the full high case lending program envisaged in the 1995 CAS (10 projects, including three adjustment operations, totaling $223 million IDA). 59. The current CAS proposes a continued high case lending program of $185 million IDA for FY99-0 1. The proposed level is lower than the previous three-year period, which included a "transition premium" to help deal with the dramatic collapse in the economy, but is consistent with IDA's current availability of resources. Continued high case lending is justified because, in addition to Kyrgyzstan's continued strong track record of economic management and project implementation, (i) the impact of the transition has been much greater than was expected three years ago. Absolute poverty has increased significantly, and structural poverty is much deeper and will take much longer to redress. (ii) there is a continued need for balance of payments and budgetary support. The outlook for export earnings is less robust, in view of lower gold prices, and public finances remain weak, despite considerable adjustment to date (paras. 12-14). (iii) there is a clearly identified program of structural reform (SOSAC and CSAC) to justify continued BOP support. 60. The CAS program would allocate up to 40 percent of total lending (up to $70 million) for adjustment lending (SOSAC and CSAC). This is about the same proportion as during FY96-98, but due to differences in the patterns of disbursements between adjustment and investment operations, the proposed program would result in a declining share of quick disbursing assistance over the coming three years (from roughly 80 percent in FY96-98 to 40 percent in FY99-01) and a corresponding increase in the share of disbursements from investment projects. The pattern of commitments and disbursements is shown in Annex C2. - 20 - 61. Lending Triggers. The macroeconomic, portfolio and structural conditions for maintaining a high case lending program are set out in Box 3. SOSAC and CSAC would proceed only when the policy reforms for these operations are ready. Specifically, SOSAC will require agreement on a clear set of policy measures to attain financial sustainability of the existing state pension system within a defined time period. CSAC will require agreement on policies to improve the environment for private sector development and growth (para. 48). Significant delay with preparation of SOSAC or CSAC operations would indicate policy slippage. In this case, in addition to not proceeding with the adjustment operations, IDA would limit lending to the range of $115-140 million for investment projects. This medium case scenario assumes reasonable macro performance (no deterioration in the fiscal balance and moderate inflation), and agreement on key sector policies necessary for our projects, e.g., cost recovery in energy, irrigation and public transport. In view of the Government's strong track record of policy reform, we assess the probability of this intermediate case as low. Box 3: Triggers to Stay in High Case Macroeconomic * Government stabilization program supported by IMF on track Sustainability Portfolio * continuation of bi-monthly Joint Bank-Government Portfolio Reviews and Performance implementation of the Joint Implementation Plan * resolution of the problem project status of the two operations currently rated "U" by end-FY99 and maintenance of a portfolio with no more than 17 percent unsatisfactory projects Structural Reforms Satisfactory progress in the program of structural reform, including in: and Private Sector 0 adoption of a legal framework for establishing a land registration system consistent Development with the draft Land Registration Act by March 1999. * attainment of fiscal sustainability of the pension system and the development of a regulatory and legal framework for targeting social assistance. * preparation of a national irrigation rehabilitation action plan by end- 1999. * privatization of remaining large state enterprises, including telecommunications and energy, through case-by-case method, consistent with the Government Privatization Program 1998-2000 62. Creditworthiness. In the last CAS, it was envisaged that $25 million IBRD per annum would be available starting in FY98 to replace the IDA "transition premium". However, a recent creditworthiness study concluded that public finances are still too fragile and the impact of non-concessional borrowing too strong for Kyrgyzstan to borrow prudently on IBRD terms. Strengthening creditworthiness is therefore important to prepare for the eventuality that the availability of IDA resources may decline further and for the day when borrowing capacity will be determined more by financial indicators than by poverty indicators. Over the next three years, we will look for improvement in the following indicators of creditworthiness and make a further review before proceeding with lending on IBRD terms: * sustained GDP and export growth within an open trade, exchange rate and monetary regime. * strengthened government finances as indicated by financial sustainability of the state pension system, enhanced revenue capacity (e.g., an increase in the tax to GDP ratio from 13 percent to 14-15 percent), tightened procedures for contracting and on-lending external debt to state enterprises, and self-imposed restraint on public and publicly-guaranteed non- concessional borrowing (no more than $25 million per annum during 1998-2000). -21- * consolidation of structural reforms through measures as outlined above for the CSAC. In particular, the Bank will look for across-the-board implementation of economic pricing for public services (heat, electricity, telecoms, water, irrigation and public transport). * an increase in foreign direct investment as an indicator of improvement in the business and regulatory climate. E. Risks to the Bank Group 63. The Kyrgyz Republic is not a high risk country for the Bank Group, in view of its continued strong policy performance and the fact that the economy appears to be growing. The main risk to the CAS program is a reversal in policy direction that would delay the reform process and cause resources that were devoted to ESW and project preparation to be wasted. A failure to reach a consensus within the Government on reforming the state pension system is an example of this kind of risk. The failure to maintain an open and transparent business environment, free of anti-competitive business cartels, or the lack of transparency in the remaining privatization program represents a similar policy risk. In these cases, as discussed above, the Bank would not proceed with the SOSAC and CSAC adjustment operations. One implication is that the Bank would have to spend additional administrative budget to re- appraise these operations as and when the Government returned to an active program of policy reform. The likelihood of a reversal in policy direction does not appear high at this time, however, as there is no significant popular support for a return to the past policies of a command economy. The rural population is pressing hard for enactment of the now-delayed land laws and land registration system, and the business community is concerned with protecting its new-found freedom from state direction. The Government will nevertheless have to be conscientious in continuing its reform efforts in order to avoid "policy drift" and the consequent slowdown in Bank operations. 64. A second risk is institutional weakness in the implementation of Bank operations. The Bank's relationships with government ministries are still in the formative stage, and policy coordination, project implementation and procurement issues require more intensive attention than in countries that have been doing business with the Bank for decades. To address this situation, supervision missions will need to intensify capacity building efforts. This raises the cost of supervision, however, despite the efforts of the Bank's Resident Mission operations officers who greatly facilitate the day-to-day supervision of Bank projects. 65. An external risk to the Bank is a stagnation of growth or a renewed decline in the economy. Such a development would serve as a negative demonstration effect for the rest of Central Asia and impede reform in those countries. A pro-active program of financial, technical and intellectual support for continued reform in Kyrgyzstan is the main safeguard against such a development. - 22 - V. Concluding Remarks 66. The Kyrgyz Government has shown commitment and determination in its efforts to realize its vision of a modem, dynamic market-oriented economy based on greater political, economic and social participation. Growth, particularly in the rural areas, will be the key to the successful completion of its transition and equitable development. The first difficult steps have been taken and, after several years of severe economic hardship, are finally beginning to show results. The challenges inherent in the next phase of the transition are likely to prove more complex, and the international community and the World Bank Group will need to work in concert to assist the Government in meeting them. The proposed high case IDA lending strategy is appropriate to country needs and justified by policy and portfolio implementation performance. The program also pays due attention to assisting the Government in strengthening country creditworthiness to prepare for lending on IBRD terms toward the end of the CAS period. James D. Wolfensohn President By: Caio K. Koch-Weser Jannik Lindbaek Attachments Washington D.C. Annex Al KYRGYZ REPUBLIC: High Case CAS Program Summary FY99-01 (with indicative credit amounts in millions of US$) FY99-01 $ 185.0 Current Year (FY 98) FY 99 FY 00 FY 01 IDA Lending: Lending: Lending: Lending: Agr. Support Serv. 14.9 SOSAC 35.0 * Rural Water & Sani. 15.0 Health II 15.0 Irrigation Rehab 35.0 Land Registration 10.0 On Farm Irrigation 20.0 Rural Infrastructure 20.0 Power Supplemental .15.0 Public Transp & 20.0 Consolidation SAC 35.0 * Livestock & pasture 15.0 Maint. Mgmt. 64.9 65.0 70.0 50.0 Nonlending: Nonlending: Nonlending: Nonlending: ESW ESW ESW E Agricultural Policy Review Land Tax Study Health Restr. & Nutrition* Agr. Sector Policy Update Post Privatization & PSD Fiscal Sust. & Growth (with focus on finance) Creditworthiness Review Water Sector Note Forestry Sector Note Non-bank Fin Sector Update PFP* Urban Transport Sector Note Agr. Input Mktg. Strategy Livestock Subsector Note Poverty Update PFP* Poverty Update* (with labor TA/Capacity Bldg. PFP market focus) Agr. Exp. Promo. Policy (IDF) PFP* TA/Capacity Bldg. TA/Capacity Blde TA/Capacity Bldg. Aid Coordination Country Procurement External Debt Mgmt. TA Poverty Monitoring, Targeting and Third International Agr. Assessment & Workshop Strengthening the National Labor Mkts (IDF) Conference Agro Restart TA for Environmental Action National Information Infrastructure Agroprocessing Office (IDF) Policy (IDF) Strengthening the State Improving Agr Statistics Property Fund (IDF) (Natstatkom) (IDF) Strengthening National Procurement (IDF) Strengthening National Other Aid Coordination Statistics Agency (IDF) Biodiversity Project (GEF) Consultative Group Meeting Aid Coordination Second Intl. Agri. Conference Consultative Group Meeting * amount to be determined commensurate with policy content. Annex A2 Page 1 of 2 Kyrgyz Republic at a glance 4/8/98 Europe & POVERTY and SOCIAL Kyrgyz Central Low- - - Republic Asia income Development diamond' Population mid-1996 (millions) 4.6 479 3,229 GNP per capita 1996 (US$)' 570 2,180 500 Life expectancy GNP 1996 (billions US$) 1.8 1,043 1,601 Average annual growth, 1990-96 Population (%) 0.6 0.3 1.7 Labor force (%) 1.2 0.5 1.7 GNP Gross per -- primary Most recent estimate (latest year available since 1989) capita enrollment Poverty: headcount index (% of population) 45 Urban population (6 of total population) 39 65 29 Life expectancy at birth (years) 68 68 63 Infant mortality (per 1,000 live births) 30 26 69 Access to safe water Child malnutrition (% of children under 5) Access to safe water (% of population) 75 .. 53 Illiteracy (% of population age 15+) 3 .. 34 Gross primary enrollment (% of school-age population) 111 97 105 Kyrgyz Republic Male 110 97 112 -- Low-income group Female 111 97 98 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1975 1986 1996 1996 Economic ratios' GDP (billions US$) .. .. 1.5 1.8 Gross domestic investment/GDP .. 30.5 20.4 22.4 Exports of goods and services/GDP .. .. 29.5 30.7 Openness of economy Gross domestic savings/GDP .. 13.8 5.4 -0.6 Gross national savings/GDP .. 13.8 1.6 -3.9 Current account balance/GDP .. .. -16.2 -23.3 Interest payments/GDP .. .. 1.9 1.8 Savings Investment Total debt/GDP .. .. 50.8 59.6 Total debt service/exports .. .. 27.4 19.2 Present value of debt/GDP .. Present value of debtlexports Indebtedness 1976-85 1986-96 1995 1996 1997-05 (average annual growth) - Kyrgyz Republic GDP .. .. -5.4 6.5 4.6 GNP per capita .. .. -6.3 6.8 5.2 --- Low-income group Exports of goods and services .. -. 6.8 25.8 8.8 STRUCTURE of the ECONOMY 1975 1985 1995 1996 (% of GDP) Growth rates of output and investment I%) Agriculture .. 30.7 40.7 46.3 30- Industry .. .. 18.1 17.0 20 - Manufacturing .. .. 12.0 11.1 10 Services .. .. 33.9 29.8 -09 -20 - s Private consumption .. 64.1 80.8 83.9 -3o - General government consumption .. 22.1 19.9 17.2 Imports of goods and services .. .. 42.4 56.6 GDI - GDP 1975-85 1986-96 1995 1996 (average annual growth) Growth rates of exports and Imports (%) Agriculture .. .. -1.9 15.1 30 - Industry .. .. -10.6 2.7 25- Manufacturing .. . Services .. .. -6.6 -3.1 10 Private consumption .. .. -1.2 15.3 5 General government consumption .. .. -5.4 -8.5 -5 91 92 93 95 96 Gross domestic investment .. .. 12.0 36.2 -10o. Imports of goods and services .. .. 10.9 25.6 Gross national product .. .. -10.2 8.3 Exports Imports Note: Figures in italics are for years other than those specified, a. Calculated by using Atlas synthetic conversion factor. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. Annex A2 Page 2 of 2 Kyrgyz Republic PRICES and GOVERNMENT FINANCE 1976 1985 1995 1996 Domestic pfices Inflation (%) (% change) 1.000 Consumer prices .. .. 31.9 35.0 soo Implicit GDP deflator -2.3 -10.3 42.0 35.3 600 400 Government finance 200 (% of GDP) 0 Current revenue .. .. 16.4 14.7 91 92 93 94 95 96 Current budget balance -9.4 -6.5 -GDP def CPI Overall surplus/deficit .. .. -17.3 -9.5 TRADE 1978 1985 1995 1996 (millions US$) Export and import levels (mill. US$) Total exports (fob) .. .. 409 531 1 000 - Electric power .. .. 41 74 Gold .. .. 0 0 s00- Manufactures .. .. 247 298 Soo- Total imports (cif) .. .. 672 901 4oo Food .. .. 87 98 Fuel and energy .. .. 174 251 200 Capital goods .. .. 144 182 o Export price index (1995100) .. .. 100 96 90 91 92 93 94 95 96 Import price index (1995=100) .. .. 100 102 - lmpors Terms of trade (1995=100) .. .. 100 95 BALANCE of PAYMENTS 1975 1985 1995 1996 (millions US$) Current account balance to GDP ratio (%) Exports of goods and services -. . 448 562 Imports of goods and services . .. 632 926 90 9 2 93 94 95 :96 Resource balance .. .. -184 -364 s -- Net income .. .. -137 -148 _10- Net current transfers .. .. 79 89 Current account balance, before official capital transfers .. .. -242 -423 20 - Financing items (net) .. .. 294 462 Changes in net reserves .. .. -51 -39 .30 - Memo: Reserves including gold (mill. US$) .. .. 115 132 Conversion rate (locaV1US$) .. .. 10.8 12.9 EXTERNAL DEBT and RESOURCE FLOWS 1975 1985 1995 1996 (millions US$) Composition of total debt, 1996 (mill. US$) Total debt outstanding and disbursed .. .. 759 1,081 IBRD .. .. 0 0 G IDA .. .. 140 199 12 6 141 Total debt service .. .. 125 109 IBRD .. .. 0 0 IDA .. .. 1 1 E Composition of net resource flows 292 C Official grants .. .. 99 112 124 Official creditors .. .. 65 62 Private creditors .. .. 135 182 1 Foreign direct investment .. .. 96 46 Portfolio equity .. .. 0 0 D 190 World Bank program Commitments .. .. 60 60 A - IBRD E - Bilateral Disbursements .. 81 59 B - IDA D - Other multilateral F - Private Principal repayments .. .. 0 0 C -IMF G -Short-term Net flows .. .. 81 59 Interest payments 1 1 Net transfers .. .. 81 57 Development Economics 8/27/97 Note: Estimates for economies of the former Soviet Union are subject to more than the usual range of uncertainty. Annex BI Page 1 of 11 KYRGYZ REPUBLIC -- CAS Program Matrix (most likely scenario) Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors 1. Consolidate macroeconomic stability and creditworthiness, The economy has achieved a moderate level of stabilization. Output recovered. Fiscal consolidation has taken place mainly through expenditure-reduction measures, but deficit is too high to ensure long-lasting stability. Last year of three-year ESAF successfully concluded in December 1997; a new ESAF is expected to begin in early 1998. I-A. Sustainability of Budgetary Outcomes and Policies Fiscal deficit limited * Conclude 1998-2000 ESAF program IMF ESAF to the level that can be and observe its targets financed by T-bills sale and foreign assistance at concessional terms: (i) Revenue * Revenue levels remain New tax code adopted in 6/96 which * Further broaden Tax Base and rates Lending: IMF ESAF depressed despite modernized the VAT, income, and revenue base, Increase compliance likelihood by Consolidation SAC (FY00) USAID improvements in policy and profit, excise taxes and tax improve collection reducing overall payroll contributions GTZ support to administration administration rates and lower tax MoF ratescontainment or revenue enhancing thn Pic Threshold for minimum income taxes medium-term measures reduced, and enterprise-specific Identify remaining tax exemptions to Framework Paper (FY98- exemptions discontinued excisc, VAT, income and payroll taxes 00) and phase them out over CAS period Fsa Land tax modified as the main method Evaluate potential for land tax revenues Assessment (FY99) of taxing agriculture in both rural and urban areas and introduce tax in. urban areas Land Tax Study (FY99) Excise tax extended to all oil products, and equalized at higher rate the excise for all domestic and impotedoodsaxinisetdrat * Tighten border controls and an automated customs valuation system o Rely increasingly on targeted in-depth audits to detect tax evasion Annex B1 Page 2 of 11 Key Issues FY96-98 Strategy /Actions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors (ii) Expenditure Management Increase and Control effectiveness of expenditure by: * Continued effort needed to Revenue sharing scheme revised in * Further refining Revenue sharing andgrant schemes Lending: IMF ESAF match resources and 1997 with uniform tax sharing rates, grants structure * Retain uniform tax sharing rates across Public Sector Reform and EU /TACIS responsibilities equalization grants and earmarked all oblasts Management Credit LNDP grants (for health and education) * Develop mechanisms for establishing the (PSRMAC) (FY97) size and funding of equalization pool and fix the formula grant by resolution for 3 Non Lending: years Country Procurement * Retain the structure of categorical grants Assessment Report and for education and health Workshop (IDF) *Consolidating Planning, Execution and Control Fiscal Assessment (FY99) *Framework for prioritizing Law on Principles of the Budget legislation, * Adopt Law on Principles of the Budget and controlling prepared to improve budget planning institutions and * Implement an expenditure control / expenditures introduced but and execution and a Budget practices of the warrant system for all spending units to needs institutionalization commission (BC) created to provide prioritization and avoid arrears build up budget policy direction control framework * Institutionalize early preparation of cannual budgets, which include all public financed investments and a medium-C term financial forecasts (MTFF) MoF set expenditure ceilings for * Move to program-focused methods for ministries, abandoning the practice of estimating requirements in health and budget plan based on norms that education and for monitoring impact of neither resembles priorCityoprograms, spending programs nor enforces a budget Capaityforintenalfinncia auits* Clarify the responsibilities for external ica dat fonelFinniladt auditing between the Accounts 'ch amber and the State Financial Inspectorate (I) External Financing of Deficit T lhe institutional framework Borrowing policy broadly consistent, e Improve the process * Create a statutory committee to approve Non Lending: IMF ESAF for external debt contracting but IMF limits for nonconcessional for contracting debt all new external debt (MOF, NBK and External Debt Management and management is needed debt limits surpassed in 1997, which and issuing budget govemnment apparatus) TA (FY99) to contain its rapid growth could drive debt service ratios beyond guarantees *Limit non-concessional borrowing for (already at 80% of GDP) sustainable thresholds government and govemnment guaranteed Fiscal Assessment (FY99) debt Creditworthiness Review (FY01) (FY01) Annex B1 Page 3 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors 1-B. Fiscally Sustainable Approach to Social Assistance (i) Health Care * Financing methods need to Incentive based payment mechanism Further strengthen 9 Expand the pilot on provider payment Lending: WHO go in concert with type of for medical care providers developed primary health-care and FGP from Issyk-Kul to Bishkek and Health Reform (FY96) USAID service provided (which and tested in Issyk-Kul, to finance (PHQ delivery and Chui Health 11 (FY01) UNICEF should be mainly primary primary Family Group Practices financing and - Draft and approve needed regulations UK Know How health care) (FGP) refocus health and laws to enahle provider payment and Non Lending: Fund system to PIIC FGP to advance I lealth and Nutrition Note GTZ and KFW Introduction of more cost effective e Harmonize Mandatory Health insurance (FY00) UNDP treatment protocols and ambulatory law with FGP system care * Rationalize health facilities and beds further Reform of pharmaceutical procurement/management underway (Hii) Pensions SAnnual deficit of social Law on Pensions enacted in *Introduce fiscal Increase compliance rates through better Lending: ADB insurance is high due to low September 1997 gradually introducing suistainability in the administration SOSAC (FY99) EU TACIS compliance rates, low personal accounts. Pension deficits state pension 9 Review retirement policy PIIRD for PR average retirement age, and arc high and constitute a large scheme; support a Develop policy for farmers pensions to subsidization in rural areas percentage of the overall fiscal deficit, institutional either reduce implicit subsidy or increase Non-Lending: strengthening of the its transparency Non-hank Financial Sector SF; develop options Decrease payroll taxes with parallel cost Update (FY00) for future containment measures fundamental reform Improve SF accountability and transparency through implementation of accounting procedures consistent with IAS. Private pension funds exist Two private pension f ind ci are sevelop legislative e Clarify regulatory authority ofPxisting but unregulated, and their operating, but their activity is and institutional fods, regulate their portfolio medium term role vis a vis marginal and unregulated ofrmwork to itanagcricio aNbo coiinianicc WSco the State pillar is not clear supervision of reserves private pension eDesign and implement a medium-term funds strategy proceduresconsistentwit (iii Welfare Expenditures b As the economy recovers o Unified benefit established on the Continue to improve e Approve a new law on social assistance Lending: Ais3 resources need to focus on principles of income testing and slf- targeting of social satisfactory to IDA Social Safety Net (FY95) EUTACIS poverty alleviation and the selection to protect most Vlnerable assistance Striegthen capacity to analyze poverty Fiscal Assessment (FY99) low end of the income information that translates into policy Non Lending: ladder formulation Poverty Updates (FY98) (FY00) p a o t c r m la ce c t y raPoverty Monitoring (IDF) Annex BI Page 4 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors 2. Sustained Growth Through Private Sector Development: Albeit from a very low base, agricultural and industrial outpui began to grow due to pri%atizafion, agrarian reform. sound finance and foreign assistance. However, it is not clear how far these sectors have gone in achieving a fundamental restructuring 2-A. Privatization and PSD Non Lending: (i)Enterprise State Property Fund (IDF * Majority of new enterprises Tax rates remain high (social security * Decrease tax * Assess overall tax pressure on nascent grant); Post-privatization & GTZ choose to remain informal is 39% of wages, VAT is 20%, profit pressure for all private sector and formulate revenue- PSD (FY98); Fiscal tax 35%) enterprises neutral reduction plans Assessment (FY99) IFC: * Second phase privatization Coupons privatization completed for e Implement second * Complete individual privatization plans Financing for post- (case by case) to follow the all medium and large enterprises; phase privatization for utilities and large enterprises aimed at privatization restructuring successfully completed most ERRA enterprises liquidated or program, including attracting strategic investors and PSD through privatization through sold; bread complex and agro- utilities @ Terminate ERRA program investment funds and direct coupons processing conglomerate financing; SME demondpolized development Assistance (Ui) Governance * Weak management and low Government introduced "resolution on .Facilitate creation of * Implement accounting, reporting and Non-Lending: ADB Corporate level of motivation of some principles of corporate management"; a viable, well disclosure standards, and a statutory Post-privatization & PSD Governance of managers of privatized corporate law adopted functioning private mechanisms for their enforcement Reform enterprises still prevails sector * Review flow of vital business IFC: information to and within firms Training Program on Canada Accounting Deisverergniaton Credits from the budget eliminated, * Continue enforcing * Enterprise to seek financing on Dese orgizataito except in agriculture (to be phased out hard budget commercial terms without direct or Establishment of consulting biqudaseon prvae aitl r completely in the year 2000) constraints indirect govenment guarantees firm liquidatitoztio 2-B. Transparent Investment Climate Modernization of industry Law on FDI enacted in 8/97 with: (i) * Foster favorable * Establish FDI promotional agency Lending: EBRD through price-based equal treatment to foreign, joint and conditions for a Develop clear objectives regarding Free Consolidation SAC (FY00) IMF ESAF introduction of new local firms and (ii) no restrictions on attracting foreign Trade Zone Areas Non Lending: technology and attraction of profit and investment income capital, technologies Facilitate operation of international State Property Fund (IDF FDI repatriation, except for payments of and managerial Investment Funds grant) tax obligations experience * Simplifp registration procedures and IFCtEDI: reduce the number of permissions EDI seminar on FDI Full capital and current account required to establish joint ventures FIAS (FDI and Free Trade convertibility facilitates repatriation of * Apply for full WTO membership Zone Areas) investment income IFC Reach Program for SME Annex BI Page 5 of 11 Key Issues FY96-98 Strategy /Actions Measures World Bank Group Other Diagnosis Main achievernents Instruisents Donors 2-C. Financial Sector Deepening and Diversification () Banking Sector Reforms * Collateral legislation in place, The new laws on Banks, Pledge, and * Create an efficient * Complete the establishment of the Lending: USAID but enforcement capacity Bankruptcy prepared and enacted registry system Central Registry for Pledges in two FINSAC TA (FY97) GTZ needs strengthening additional oblasts Consolidation SAC (FY00) IMF ESAF A Central Registry for Pledges with o Strengthen the a Design and implement training for Post-Privatization & PSD four regional offices has been Judiciary judges and improve the legal information (FY98) established systems * Share of the State in Agroprom and Elbank in process of Finalize liquidation Complete liquidation of Agroprom and financial market reduced, liquidation; Promstroi and AK banks process, foster Elbank, achieve full solvency for but competition among recapitalized with private funds competition Promstroi and AK participants needs to * Complete the debt recovery process and increase Debt Resolution Agency (DEBRA) close the Debt Resolution Agency restructured a large number of loans, a Facilitate foreign investment in the sector conducted auctions of collateral, won a Strengthen the already established bases numerous arbitration cases, and paid for prudent banking off part of the creditors (i) Non-Bank Financial Institutions (NBFI) *Sound contractual savings Government has prepared new draft - Refine and enact 9 Enact appropriate legislation, clarify Lending: GTZ (support to institutions and specialized laws for Investment Funds, Insurance these new laws; regulatory authority for each type of FINSAC TA Insurance finance companies not yet Companies, Private Pension Funds - Clarify and contractual saving institution and Industry) developed and on Leasing; a set of new strengthen the specialized finance companies Non-Lending: USAID (Securities prudential regulations for Investment regulatory Non-bank Financial Sector market) Funds have also been prepared authority(s) over Update (FY00) NBFIs Post privatization & PSD (FY98) (rru) Capital Markets cStock market to serve as Kyrgyz Stock exchange (KSE) w Create a framework Inease participation of privatized Post-privatization & PSD USAIDIA to vehicle for raising new established but only about 26 for the orderly companies in KSE and bring attractive (FY98) local securities capital for redistribution of companies arc listed out of about 1300 development of the enterprises for sale market privatized assets Privatized companies; centPal capital market and Use KSE to market bonds I FC: depository to be established support expansion of * Improve enforcement capacity of the housing finance fund, securities market State Agency for Securities to protect central depository Revision to law on securities & stock right of investors market prepared i Adopt Law on securities & stock market Annex Bl Page 6 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors 2-D. Eliminating Labor Market Rigidities Appropriate incentives to Labor markets were made more * Review role of the * Review labor practices and laws to assess Lending: Swiss increase work effort and flexible through restructuring / State in the labor their consistency with labor mobility and Social Safety Net (FY95) GTZ allocative efficiepcy needed liquidation of enterprises market with the strengthening of the market SOSAC (FY99) * Review and improve mechanisms of job PHRD for PR search Non-Lending: * Develop and implement effective criteria Poverty updates (FY98) Discussion on new eligibility for * Reform for selecting and monitoring and FY(00) unemployment insurance began unemployment evaluating proactive employment Poverty Monitoring (IDF insurance programs grant) * In the short-term, tighten eligibility to avoid participation for multiple periods and adjust benefit level to avoid arrears buildup 2-E. Promoting Efficient and Profitable Private Agriculture () Land Privaization and Farm Restructuring * Land market needs further 25% of total arable land is placed in a Accelerate the 9 Clarify procedures for registering rights Lending: development and farm Land Redistribution Fund (LRF) and development of land and transactions in land shares and Agricultural Support IFAD restructuring needs to be 50% of the remaining 75% of arable markets by: prepare standard forms of contract for Services Project-- ASSP USAID accelerated land distributed sale and lease of land shares (FY98) => Ensuring that the 9 Design an overall framework for Land Registration Project Right for land use established in the right to use land auctioning LRF to ensure efficiency, (FY99) form of 99-year lease is legally equity and transparency safeguarded and * Educate public in the meaning of the Non Lending: Draft Land Registration Law prepared transformed into individual rights granted by the land Agricultural Policy in agreement with market principles a property right reform program Reviews (FY98) (FY01) that can be used 9 Issue 'regular' land share certificates to Int'l. Agricultural Pilot land registration program as collateral those who do not yet have them Conferences (FY98)(FYOI) implemented in two regions * Facilitate private ownership of land Land Tax Study (FY99) => Developing land 9 issue law on land registration 38000 private farms (individual and registration e Prepare procedural regulations on land IFC: group) have been established system further and real estate supporting the Possible investments in implementation of land registration agro-processing -> Distributing the system remaining land * Prepare, in accordance with market and issuing principles, and issue Land Code and land "regular" land mortgage law share certificates Annex BI Page 7 of ll Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors (ii) marketing and agricultural support services * Lack of competitive markets Most agro-processing enterprises are Further facilitate 9 Simplify the process to establish new Lending: ADB for inputs and outputs privatized; markets not yet increased enterprises (permits and licenses) Sheep Development Project competitive competition in the 9 Ensure that no inter-oblast trade harriers (rY96) markets for inputs remain ASSP (FY98) Inter-oblast trade restrictions made and outputs * Privatize farm machinery and fertilizer Rural Infrastructure (FY0I) illegal enterprises e Privatize seed production farms and Non-Lending: Private farms' share of marketable implement Seed Law and law on Plant Agriculture Inputs surplus increased dramatically, while Breeder Protection Rights Marketing (FY99) the corresponding share of large * Promote the establishment of private Int'l Agricultural enterprises declined input dealers Conferences (FY98) * Promote the establishment of private (FY01) leasing companies and service stations Agriculture Policy Reviews for agricultural machinery (FY98) (FY01I) IFC: Swiss * Lack of appropriate support Existing system of state procurement Initiate the e Establish rural development advisory Possible investments in IFAD services for private farmers of agricultural produce and establishment of service for private farmers agro-processing distribution of agricultural inputs is appropriate Strengthen training programs in being dismantled agricultural support management and farm technology for services emerging private farmers (Wi) livestock development Lending: *Efficiency and profitability Export taxes on wool removed in *Facilitate the * Facilitate creation of sheep breeders Sheep Development Project SDC of the livestock sector 1994, but full access to international establishment of associations to provide a framework for (FY96) remains low markets have not been secured due to appropriate private efficient production and marketing lack of quality produce and marketing production and e Help provide access to international Livestock and Pasture marketing systems markets for livestock product Project (FY0I) * Facilitate management and control of livestock industry by private sector Non-Lending: * Expand provision of advisory services Livestock Note (FY00) and training for private farmers * Introduce best practices for pasture management (*c) irrigation and rural infrastructure Irrigation system and rural Guidelines on water user associations Revitalize irrigation * Develop a strategy and action plan for Lending: Irrigation infrastructure have (WIJA) drafted, ad-hoc creation of and rural the rehabilitation, development and cost Rehabilitation (FY98) ADB deteriorated and are WUA, cost recovery introduced (with infrastructure with recovery from irrigation On-Farm Irrigation (FY00) FAO inefficient rayons keeping the revenue) hut user participation a Increase collection rates Rural nfrastructure(FYa w) government still finances most of the Facilitate WUA development operations and maintenance (O&M) * Promote recovery of all O&M costs or Non Lending: costs alternatively transfer irrigation O&M to Agricultural Policy Annex BI Page 8 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors WUA Reviews (FY98) (FY01) * Promote participatory irrigation, mainly Int'l Agricultural through transfer of irrigation O&M to Conferences (FY98) users (FY01) Aral Sea Basin Program GEF Project (FY98) (v) Rural Finance * Lack of rural finance is a Agroprombank has been liquidated * Establish KAFC to * Phase out budgetary subsidies on Lending: serious constraint to and replaced with a market-based operate agricultural credit program after 1999 Rural Finance (FY96) accelerate rural growth and agricultural credit system with commercially e Promote commercially sustainable Non lending: ADB reduce rural poverty minimum budgetary support * Establish lending operations of KAFC Agricultural Policy UNDP community-based * Provide sustainable access to financial Reviews (FY98) NGOs financial services to the rural poor Agriculture Inputs (FY01) intermediaries 9 Develop financially viable rural financial Marketing (FY99) * Recover and resolve institutions old agricultural debt * Charge positive interest rates (in real IFC-. terms) for rural credit Leasing 2-F. Alleviate infrastructure bottlenecks lpiTransport " Urban population depends Share of private operators has been 9 Set up institutional * Issue decrees to stipulate sound urban Lending on public transportation that growing rapidly and regulatory transport policy and implementation Public Transport & is increasingly unable to framework for the measures Maintenance (FY99) meet demand Privatization of State-owned operators competitive supply e Establish urban transport management Rural Infrastructure (FY01) has been initiated of services indepen- agencies in main cities dently of ownership Non Lending: * Improve fare Transport Note (FY98) " Insufficient cost recovery Single trip fare had increased policies mostly by and weak institutional and substantially reducing exemptions * Increase cost recovery regulatory framework and privileges prevent sound sector Initial assessment of required policy A Start renewing and development improvements is being conducted rehabilitating assets (RF) energy Cost recovery not yet Energy Law enacted 12/96, Electricity * Rationalize energy A Increase tariff by adopting a new rate Lending: achieved; this and other Law enacted 3/97 use/production and structure which reflects economic costs Power and District Heating ADB3 elements impair attraction of explore new sources * Set up a fund to help low-income (FY96) EBRD foreign investment State Energy Agency established to * Establish a households cope with new tariffs; Power Supplement (FY98) Danish regulate tariffs and license new regulatory/policy terminate all special tariff discounts Consolidation SAC (FY99) Swiss entrants framework for IFC: Norway restructuring the * Adopt privatization strategy financing for hydropower NDF Strategy for sector privatization sector to attract projects Annex BI Page 9 of II Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors developed and submitted to private investors * Improve billing and collection parliament performance of Kyrgyzenergo Kyrgyzenergo reestablished as ajoint- stock company (iii) telecommunidations Worst bottlenecks of network Promptly implement * Enact Telecom law Lending: EBRD addressed the regulatory and Telecom (FY94) policy framework * Establish tariff regulatory capacity Consolidated SAC (FY00) Institutional capacity (management & for further sector financial analysis) of Kyrgyz Telecom restructuring, aimed * KT to rebalance tariffs and maintain debt Non-Lending: (KT) strengthened; KT corporatized at ensuring orderly service ratio 1.5 National Information and autonomous development as well Policy (IDF) as at attracting e KT to stop all subsides to postal service Telecom Guarantee Sector regulatory and policy private investors (directly or indirectly) frameworks have been developed and a separate regulatory agency created * KT to establish economic and financial viability of its investments prior to their Private sector participation, with undertaking licenses issued to 3 paging companies, two e-mail providers and 2 cellular Implement increase of international operators tariffs with all CIS countries (it) rural infrastrif clu re Inadequate infrastructure is Road network reasonable, but in Prepare rural * Develop national plan for rural roads Lending: a major bottleneck for rural disrepair and not properly maintained; infrastructure a Facilitate creation of wholesale markets Rural Infrastructure (FY01) development lack of wholesale market facilities; strategy with Support modernization of obsolete communication systems appropriate communications systems in rural areas municipal role in infrastructure provision 2-C. Environmental management o Little progress in preventing Government completed a National *Reverse * Develop a plan to: (i) to cover 0 & M Lending: Switzerland unsustainable use of natural Environment Action Plan, finding: deterioration of and (ii) improve management skills at Rural Water Project (FY00) Finland resources - Water resources management is water infra-structure local levels USAID inefficient that is allowing * Clarify competence for regulation of Non Lending: UNDP - Forests regeneration is minimal, significant water water resource management Water Supply Note (FY99) UK with state owned forestry farms losses P Develop a strategy for forestry NEAP IDF without funds for controlling illegal management GEF Central Asian cutting and grazing Conserve and protect biodiversity Biodiversity Project Annex Bi Page 10 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors * Public health problems About 50% of waste-water treatment * Decrease risk of * Develop a strategy that could be related to environmental facilities are ineffective and 90% of all contamination of supported by IFI's or donors WHO causes municipal waste disposal sites do not underground * Define sanitary protection zones and meet sanitary conditions aquifers and train local authorities in water and Key aquifers have been contaminated infiltration into sanitation measures with heavy metals, radioactive surface water * Encourage implementation of pollution materials, oil or sanitary wastes in channel prevention incentives adjacent areas to mining and industrial * Develop monitoring, preventing and zones enforcement capacity There are a number of abandoned and active toxic waste dumps, some of which are in the middle of settlements 3. Poverty Reduction: Lia ing standards significantIl declined during the transition and as many as 50 percent of households ma% not be able to afford minimum consumpiion levels. While a number orhouseholds experience "cycical- posertN imainhs the unemplo,ed). other households experience "structural" poverny (including the elderlN and those li ing in depressed rural and agrarian areas). (i) Structural poverty * Structural reform to provide Monitoring ofpoverty facilitated by Increase & Improve targeting of social assistance to Lending: UNDP conducive environment for comprehensive household surveys effectiveness of the poorest (with lowest quintile SOSAC (FY99) ADB private sector initiatives and undertaken during the last three years social safety net receiving 60% of benefits) private sector investment * Improve reliability of essential social Health Sector Reform will be the driving force of services delivery, especially for poor and Health 1I (FY01) job creation in the years to children, including health and social Rural Infrastructure (FY01) come. However, a safety net (unified benefit, pensions) Rural Water (FY00) significant part of the * Focus safety net on the most remote rural population not able to areas where poverty is more acute Non Lending: benefit will continue to need Poverty Assessment Notes assistance (FY98) (FYO0) Poverty Monitoring (IDF) (ii) cyclical poverty *Unemployment is the main Initial analysis of data conducted, e Promote decen- *Clarify the roles and responsibilities of (See above) cause of cyclical poverty which suggest that cyclical poverty is tralized (NGO & the public and private sector, including greater in the rural areas, and is related community) job NGOs, in the design an delivery of social to unemployment generation activities services in the rural areas Encourage microcredits, public works and other outreach programs Annex BI Page 11 of 11 Key Issues FY96-98 Strategy lActions Measures World Bank Group Other Diagnosis Main achievements Instruments Donors 4. Legal and Regulatory Framework: The Kyrgyz Republi hab made an impremi%e headway in dralling and endting core economic legiblation for the appropriate functioning ol'a market economy. Time is now required to develop a transparen and predictable legal and regulatorN frame%ork i stein and to 4Irengthen inltiutional capacirN and implementation/enforcemen. Legal system needs A number of new legislation enacted, Build ajudiciary e Improve the ability of the judiciary to Lending; USAID strengthening for such as the Tax Code, part I of the system capable to apply legislation by streamlining court FINSAC TA Netherlands application of legislation Civil Code, the national Procurement implement procedures Consolidation SAC (FY00) Canada Law, Law on Foreign Investment, legislation in a aNDP Law on Pledge, Law on Banking, Law transparent and e Train judges and other legal experts in Non -Leading: on Bankruptcy, Energy Law, etc. predictable manner, the applications of specific laws Post-Privatization & PSD including all new (FY99) Other pieces of legislation advanced, procedures on * Dedicate adequate resources to the Non-bank Financial Sector such as laws on insurance, securities bankruptcy, judiciary Update (FY99) markets, investment funds, leasing, insolvency, mining and land, etc. mortgage and * Develop and strengthen legal information collateral, civil code, system tax code, and the like LaDevelop legal Public needs to be made system, including Avoid unnecessary involvement of USAID aware of rights and ways to enforce and notaries (e.g., in creation of enforcement obligations under the new disseminate laws, of security rights) through revision of legislative framework harmonize Civil Code implementation across the country *Develop comprehensive judicial reform FINSAC TA (FY96) increase program Consolidation SAC (FY00) transparency of processes and predictability of the system's timing and methods P:\KYRGYZ\CTRYIJNITCAS\POL-MAT7.DOC April 9, 1998 3:25 PM Annex B2 Kyrgyz Republic - Selected Indicators of Bank Portfolio Performance and Management Indicator 1995 1996 1997 1998 Portfolio Assessment Number of Projects under implementation' 6 11 11 10 Average implementation period (years) .88 1.05 1.63 2.05 Percent of problem projectsa c by number 0.00 9.09 9.09 10.00 by amount 0.00 5.42 5.63 7.26 Percent of projects at risk, d by number 0.00 11.11 10.00 22.22 by amount 0.00 8.15 7.26 16.47 Disbursement ratio (%)e 6.75 10.98 16.04 13.90 Portfolio Management CPPR during the year (yes/no) No Yes Yes Yes Supervision resources (total US$ thousands) 693.47 689.47 958.60 648.22 Average Supervision (US$/project) 115.58 62.68 87.15 64.82 Memorandum item Since FY80 Last five FYs Projects evaluated by OED by number 2 2 by amount (US$ millions) 120.0 120.0 Percent rated U or HU by number 0 0 by amount 0 0 a. As shown in the Annual Report on Portfolio Performance (except for current FY) b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: investment projects only. Generated by the Operations Information System (OIS) Annex B3 Page I of 3 Kyrgyz Republic - Bank Group Program Summary, FY 1999-2001 Proposed IBRD/IDA High-Case Lending Program, FY 1999-2001' Strategic rewardb Implementationb FY Project US$(M) (H/M/L) risks (H/M/L) 1999 LAND REGISTRATION 8.0 H M SOSAC 36.0 H H PUBLIC TRANSPORT & MAINTENANCE 21.0 M M Subtotal 65.0 2000 RURAL/WATER & SANITATION 15.0 M M ON-FARM IRRIGATION 20.0 M M CONSOLIDATED SAC 35.0 H M Subtotal 70.0 2001 HEALTH II 15.0 M M RURAL INFRASTRUCTURE 20.0 M M LIVESTOCK & PASTURE MANAGEMENT 15.0 M M Subtotal 50.0 Total, FY 1999-2001 185.0 a. This table presents the proposed program for the next three fiscal years. b. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L). Generated by the Operations Information System (OIS) on 04/09/98 Annex B3 Page 2 of 3 Kyrgyz Republic - IDA Base-Case Lending Program Past Current Plannect Category 1995 1996 1997 1998 1999 2000 2001 Commitments (US$m) 77.0 98.5 60.0 64.9 65.0 70.0 50.0 Sector (%)b Agriculture 58.4 11.8 0.0 76.3 16.0 29.0 30.0 Electric Power & Energy. 0.0 20.3 0.0 23.7 0.0 0.0 0.0 Environment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Finance 19.5 49.1 26.7 0.0 0.0 0.0 0.0 Population, Health & Nutrition 0.0 18.8 0.0 0.0 0.0 0.0 30.0 Public Sector Mgmt. 0.0 0.0 73.3 0.0 0.0 50.0 0.0 Social Protection, etc. 22.1 0.0 0.0 0.0 54.0 0.0 0.0 Transportation 0.0 0.0 0.0 0.0 30.0 0.0 0.0 Water Supply & Sanitation 0.0 0.0 0.0 0.0 0.0 21.0 0.0 Infrastructure 0.0 0.0 0.0 0.0 0.0 0.0 40.0 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Lending instrument (%) Adjustment loans' 58.4 45.7 73.3 0.0 54.0 50.0 0.0 Specific investment loans and others 41.6 54.3 26.7 100.0 46.0 50.0 100.0 TOTAL 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Disbursements (US$m) 49.1 84.2 62.8 73.0 55.0 74.0 53.0 Adjustment loans' 47.8 78.3 47.4 45.0 18.0 36.0 18.0 Specific investment loans and others 1.3 5.9 15.4 28.0 37.0 39.0 35.0 Repayments (US$m) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Interest (US$m) .4 .8 1.3 1.8 2.5 2.9 3.4 a Ranges that reflect the base-case (i.e., most likely) Scenario. for IDA countries, planned commitments are not presented by FY but as a three-year-total range; the figures are shown in brackets. A footnote indicates if the pattern of IDA lending has unusual characteristics (e.g., a high degree of frontloading, backloading, or lumpiness). For blend countries, planned IBRD and IDA commitments are presented for each year as a combined total. For future lending, rounded to the nearest 0 or 5%. To convey the thrust of country strategy more clearly, staff may aggregate sectors. Structural adjustment loans, sector adjustment loans, and debt service reduction loans. Note: Disbursement data is updated at the end of the first week of the month. Annex B3 Page 3 of 3 Kyrgyz Republic - IFC and MIGA Program, FY95-98 Past Category 1995 1996 1997 1998 IFC approvals (US$m)" 40.00 2.30 .15 0.00 Sector (%) 0.00 0.00 0.00 0.00 Financial Services 0.00 100.00 100.00 0.00 Mining & Metals 100.00 0.00 0.00 0.00 TOTAL 100.00 100.00 100.00 100.00 Investment instrument (%) Loans 75.00 87.00 0.00 0.00 Equity 0.00 13.00 100.00 0.00 Quasi-Equity b 25.00 0.00 0.00 0.00 Other 0.00 0.00 0.00 0.00 TOTAL 100.00 100.00 100.00 100.00 MIGA guarantees (US$m) 0.00 59.25 63.75 63.75 MIGA commitments (US$m) 0.00 0.00 0.00 0.00 aExcludes AEF projects. blncludes quasi-equity types of both loan and equity instruments. Generated by the Operations Information System (OIS) on April 6, 1998 Annex B4 Page 1 of I Kyrgyz Republic-Summary of Nonlending Services Product Completion FY Audiencea Objectiveb Recent completions Social Protection FY93 G.B,D KG.PS External Trade Policy FY94 G.B.D KG,PS Mining Sector FY94 G.B.D,PD KG.PS.PD Energy Sector FY95 G,B,D,PD KG.PS.PD NEAP FY95 G,B,D.PD KG,PS,PD Poverty Assessment Strategy FY95 G,B,DPD KG.PSPD Agr. Sector Review FY95 G,B,D,PD KG,PS,PD Tourism FY97 G,B,D KG,PD Renewable Energy FY98 G,B.D,PD KG,PS,PD Underway Agr. Policy Review FY98 G,D.B,PD KG,PD,PS Post Privatization FY98 G.D.B KG,PD,PS Poverty Update FY98 G,D,B KG.PD,PS Water Sector Note FY98 G,D,B KG,PD,PS Urban Transport Note FY98 G,D.B KG,PD,PS Planned Land Tax FY99 G,B,D KG,PS Fiscal Sustainability FY99 G,B,D KG,PS Forestry Sector Review FY99 G,B,D,PD KG,PS Agr. Input Dev. Strategy FY99 G,B,D,PD KG,PS PFP FY98-01 G,B,D KG Health & Nutrition Note FY00 G,B,D,PD KG,PS Non-ban Fin Sector Update FY00 G,B,D,PD KG,PS Livestock Sector Review FY00 G,B,D,PD KG,PS Poverty Update FY00 G,B,D,PD KG,PS Agr. Sector Update FY01 G,B,D,PD KG,PS Creditworthiness Review FY01 G,B PS Informal WTO Accession FY96** G PS External Debt Management FY96** G PS Comments on PIP FY96/97/98 G,B,D KG,PS,PD IDF Strengthening National Procurement (2) FY96/98 G,B,D,PD KG,PS,PD Strengthening State Propery Fund FY98 G,B KG,PS Strengthening Natd. Statistics Agency FY98 G,B KG,PS,PD Strengthening Nal. Env. Action Agency FY99 G,B,D,PD KG,PS,PD Strengthening Poverty Monitoring (IDF) FY00 G,B,D KG,PS National Information Policy (IDF) FY00 G,B,D KG,PS EDI Social Policy Ref in Tran Econ (SPRITE) FY98 G,PD KG,PD,PS Understanding the Transition in Central Asia FY98 G,PD KG,PD,PS Public Finance Reform Prog for Central Asia FY98 G,B KG,PD,PS Training Matrls on Env. Sust. Agric. for CA FY98 G KG ECA Irrigation FY98 G,PD PD,PS EDI/IFC Accounting Training Program FY98 PD KG Financial System Ref. - CA/Mongolia FY98 G PD Pension Reform & Financial Sec. Dev. FY98 G PD Securities Mkt Dev. (SMD)-ECA/Mongolia FY98 G PD a. Government, donor, Bank, public dissemination. b. Knowledge generation, public debate, problem-solving. ** completed (D FY96/97 completed, FY98 is underway Annex B5 Kyrgyz Republic Social Indicators Latest single year Same regionlincome group Europe & Central Low- 1970-75 1980-85 1990-95 Asia income POPULATION Total population, mid-year (millions) 3.3 4.0 4.5 487.6 3,179.9 Growth rate (% annual average) 2.2 2.0 0.9 0.2 1.6 Urban population (% of population) 37.9 38.2 38.6 65.3 286 Total fertility rate (births per woman) 4.9 4.2 3.3 2.0 3.2 POVERTY (% of population) National headcount index .. .. 45.4 Urban headcount index .. .. 32.0 Rural headcount index .. .. 52.2 INCOME GNP per capita (US$) . .. 700 2,220 430 Consumer price index (1990=100) Food price index (1990=100) INCOMECONSUMPTION DISTRIBUTION (% of income or consumption) Lowest quintile .. . 6.7 Highest quintile .. . 42.3 SOCIAL INDICATORS Public expenditure (% of GOP) Health .. . 3.5 Education .. Social security and welfare .. Net primary school enrollment rate (% of age group) Total Male Female Access to safe water (% of population) Total 75.0 53.0 Urban Rural Immunization rate (% under 12 months) Measles .. .. 89 83 77 DPT .. .. 83 90 80 Child malnutrition (% under 5 years) .. .. .. .. 42 Life expectancy at birth (years) Total .. 65 68 68 63 Male .. 62 63 64 62 Female .. 70 72 73 64 Mortality Infant (per thousand live births) .. 42 30 26 69 Under 5 (per thousand live births) .. .. 42 35 104 Adult (15-59) Male (per 1,000 population) .. .. 276 289 244 Female (per 1,000 population) .. .. 120 116 211 Maternal (per 100,000 live births) .. .. 80 World Development Indicators CD-ROM, World Bank, February 1997 Annex B6 Page 1 of 2 Kyrgyz Republic - Key Economic Indicators Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 National accounts (% of GDP at current market prices) Gross domestic product (market prices) 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Indirect taxes 6.2 7.3 6.9 6.1 6.6 6.7 6.8 7.0 7.1 7.2 7.3 7.1 Agriculture (at factor cost) 38.4 40.7 46.3 45.2 45.2 45.2 45.2 44.0 44.0 44.0 43.0 43.0 Industry (at factor cost) 23.9 18.1 17.0 20.8 20.8 21.0 21.0 21.0 21.0 22.0 22.0 22.0 Services(at factor cost) 31.6 33.9 29.8 27.9 27.5 27.2 27.0 28.0 27.9 26.8 27.7 27.9 Total Consumption 97.3 94.6 100.6 93.3 92.7 90.5 88.6 88.0 88.0 88.0 88.0 88.0 Gross domestic fixed investment 12.1 20.4 22.4 13.7 11.2 13.4 14.8 15.7 15.7 15.2 15.0 15.1 Government investment 4.2 5.8 5.8 5.5 5.4 5.4 5.4 5.4 5.4 Private investment and increase in stocks .. .. .. 10.2 5.8 8.0 9.7 10.6 10.7 10.1 9.9 9.9 Exports (GNFS)' 33.8 29.5 30.7 41.3 38.5 38.6 40.1 40.3 40.0 40.8 40.7 40.7 Imports (GNFS) 40.1 42.4 56.6 48.9 42.7 42.9 43.9 44.4 44.1 44.3 44.0 44.0 Gross domestic savings 2.7 5.4 -0.6 6.7 7.3 9.5 11.4 12.0 12.0 12.0 12.0 12.0 Gross national savings 1.1 1.6 -3.9 2.1 4.1 7.0 9.2 10.2 10.5 10.4 10.1 9.8 Memorandum items GDP (US$ million at current prices) 1103 1495 1814 1683 1881 2011 2161 2326 2508 2702 2909 3122 GNP per capita (US$, Atlas method) b 790 670 570 Real annual growth rates (%, calculated from 1995 prices) GDP at market prices -20.1 -5.4 7.1 6.5 6.0 4.5 4.5 4.5 4.5 4.3 4.3 4.2 Gross Domestic Income -20.2 -12.9 8.5 5.4 9.5 6.2 6.9 4.7 4.4 4.4 4.7 5.4 Real annual per capita growth rates (%, calculated from 1995 prices) GDP at market prices -19.4 -5.9 5.7 5.1 5.0 3.5 3.5 3.5 3.5 3.3 3.3 3.2 Total consumption -25.3 -10.0 18.3 -13.6 20.0 3.6 4.2 3.5 3.6 3.0 3.7 4.7 Private consumption -26.4 -7.3 18.0 -18.5 28.5 4.8 4.9 3.4 3.2 2.9 3.8 4.7 Balance of Payments (USSmillion) Lxports (GNFS)a 369 448 562 695 724 777 867 937 1004 1102 1184 1270 Merchandise FOB 340 409 531 633 688 737 806 870 944 1012 1089 1165 Imports (GNFS)a 476 632 926 754 804 863 950 1032 1106 1197 1280 1375 Merchandise FOB 459 588 783 641 692 745 803 862 926 986 1055 1140 Resource balance -107 -184 -364 -59 -81 -86 -82 -95 -102 -95 -97 -105 Net current transfers 29 79 89 65 69 70 70 70 70 70 70 70 (including otlicial current transfers) Current account halance -124 -242 -423 -137 -142 -137 -129 -136 -140 -138 -152 -174 (after official capital grants) Net private foreign direct investment 45 96 46 60 30 35 40 45 50 50 50 50 Long-tenn loans (net) 105 200 244 153 124 118 105 141 142 151 143 137 Official 106 65 62 173 149 134 159 159 152 159 147 118 Private -1 135 182 -20 -25 -16 -54 -18 -10 -8 -4 19 Other capital (net, including errors and omissions)' -5 -3 172 -42 -3 3 7 -28 -28 -43 -20 -33 Change in veservesd -20 -51 -39 -34 -9 -18 -23 -22 -25 -21 -21 19 (continued) Annex B6 Page 2 of 2 Kyrgyz Republic - Key Economic Indicators (Continued) Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Memorandum items Resource balance (%of GDP at current prices) -9.7 -12.3 -20.1 -3.5 -4.3 -4.3 -3.8 -4.1 -4.1 -3.5 -3.3 -3.4 Current account balance (%of GDP) -11.3 -16.2 -23.3 -8.1 -7.5 -6.8 -6.0 -5.8 -5.6 -5.1 -5.2 -56 Real annual growth rates (1995 prices) Merchandise exports (FOB) -5.1 12.1 35.2 28.7 6.1 3.8 5.2 5.6 6.5 5.2 5.6 5n Merchandise imports (CIF) -15.0 32.5 32.1 -9.6 13.8 8.9 9.1 7.4 7.6 7.6 X.3 9.3 Public finance ' (as % of GDP at current market prices) Current revenues and grants, ofwhich 20.4 16.4 14.7 16.6 17.5 17.5 17.7 11.1 18.2 11.4 11.7 1A 6 Tax revenues 13.6 15.0 12.7 13.1 13.3 13.5 13.9 14.3 14.5 14.7 14.9 149 Grants 2.5 0.3 0.9 0.7 1.4 1.1 0.9 0. 0.6 0.6 0.6 0.6 Current expenditures 22.9 25.X 21.2 22.o 20.8 19.2 184 18.0 17.8 17.7 17.5 17.5 Budgetary savings -2.5 -9.4 -6.5 -5.5 -3.3 -1.7 -0.7 0.0 0.4 0.7 1.2 1.1 Capital revenues 0.4 0.3 1.3 0.4 0.3 0.1 .0 0.1 0.1 0.1 0.0 0.0 Capital expenditure 4.9 4.8 3.8 3.9 5.8 5.8 5.5 5.4 5.4 5.4 5.4 5.4 of which externally financed PIP 3.9 3.8 3.2 3.2 4.7 4.6 4.2 4.0 3.8 3.6 3.5 3.5 Net lending 4.7 3.4 0.4 0.5 -0.2 -0.3 0.0 0.0 0.0 (.0 0.0 0.0 Overall balance -11.6 -17.3 -9.5 -9.4 -8.7 -7.1 -6.2 -5.4 -5.0 -4.6 -4.2 -4.3 Foreign financing 9.8 9.1 6.9 1.2 6.8 5.3 4.5 4.2 4.3 4.0 3.5 3.7 Monetary System Credit (net) 1.9 8.2 2.1 1.2 1.4 1.1 1.1 0.7 0.5 0.5 0.5 05 NBK R net 1.3 7. 1.9 0.4 0.4 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Commercial banks 0.5 0.4 0.1 0.5 0.7 0. 0.8 0.5 0.4 0.4 0.3 0.3 Nonbank 0.0 0.10 0.1 0.3 0.3 0.3 0.4 0.2 0.1 0.1 0.2 0.2 Privatization revenue (net) 0.0 0.0 0.5 0.1 0.5 0.7 0.6 0.4 0.2 0.1 0.1 1.1 Monetary indicators M2/GDP (% at current market prices) 12.8 16.8 14.3 14.4 14.0 14.7 14.7 15.5 15.5 16.2 16.2 16.2 Growth ofM2 (%) .. 76.7 22.9 26.5 16.6 19.5 11,4 15.9 9.9 15.2 9.2 9.0 Private sector credit growth / total credit growth (%) .. .. -152.0 30.9 52.1 21.8 58.2 63 4 66.6 69.0 72.2 74.1 Price indices( 1995 =100) Merchandise export price index 93 100 96 89 91 94 98 100 102 104 106 108 Merchandise import price index 91 100 101 97 94 95 96 98 100 103 104 105 Merchandise terms of trade index 103 100 95 91 97 99 102 102 101 101 101 103 Consumer price index (% growth rate) 95.7 31.9 35.0 14.7 11.1 8.9 6.6 5.6 5.2 5.1 4.7 4.6 GDP detlator (% growth rate) 180.9 42.0 35.3 17.5 13.2 8.9 6.6 5.6 5.2 5.1 4.7 4 6 a. "GNFS" denotes "goods and nonfactor services." b. Based on the Atlas synthetic conversion factor. The pace for introducing market exchange rates is currently being considered. c. Includes portfolio investments. d. Includes use of IF resources. e. Includes transfers to the Social Fund and the Public Investment Program. Annex B7 Page I of I Kyrgyz Republic - Key Exposure Indicators Estimate Projected Indicator 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total debt outstanding and disbursed (TDO) (US$m)a 436 759 1081 1319 1482 1621 1737 1856 1969 2086 2195 2303 Net disbursements (USSm)' 120 247 264 215 141 139 122 125 119 122 114 112 Total debt service (TDS) (USSm)' 14 125 109 109 131 166 191 189 197 213 216 164 Debt and debt service indicators (%) TDO'/XGS' 118.0 166.7 190.1 187.7 202.3 206.3 198.3 196.1 194.3 187.7 184.1 180.1 TDO/GDP 39.5 50.8 59.6 78.4 78.8 80.6 80.4 79.8 78.5 77.2 75.5 73.8 TDS/XGS 3.9 27.4 19.2 15.6 17.9 21.1 21.8 19.9 19.5 19.2 18.1 12.8 IDA exposure indicators (%) IDA DS/public DS 1.7 0.5 1.5 3.2 4.0 3.4 3.2 3.6 3.7 4.2 5.8 7.4 Preferred creditor DS/public 45.2 30.8 13.5 37.1 43.5 34.5 34.8 42.7 49.7 52.3 52.1 51,8 DS (%) IDA DS/XGS 0.1 0.1 0.2 0.2 0.3 0.3 0.3 0.3 0.4 0.4 0.6 0.7 IDA TDO (US$m)' 59 140 199 266 318 368 446 500 540 598 651 682 IFC (USSm) Loans 0 30 2 0 .. .. .. .. .. Equity and quasi-equity 0 10 0.3 0.2 .. .. .. .. .. MIGA MIGA guarantees (USSm) 0 59.3 4.5 0 .. .. .. .. .. a. Includes public and publicly guaranteed debt, private nonguaranteed, use of aMF credits and net short-term capital. b. Debt at current prices, in present value terms it is much lower. c. "XGS" denotes exports of goods and services. including workers' remittances. d. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the EVIF, and the Bank for International Settlements. c. Includes present value of guarantees. f. Includes equity and quasi-equity types of both loan and equity instruments. Annex B8 Page Iof2 Status of Bank Group Operations in Kyrgyz Republic IBRD Loans and IDA Credits in the Operations Portfolio Original Amount in US$ Millions Latest Latest Supervision Midterm Monitorable Audit SPN Mission Rating a/ Review Indicator Compln Loan or Fiscal Credit No. Year Purpose IDA Cancellations Undisbursed Disbursed DO IP IDA24910 1993 REHABILITATION 60.00 0.00 0.00 62.00 IDA26390 1994 PRIVATE & ENT. SAC 60.00 0.00 0.00 64.10 IDA26340 1994 TELECOMMUNICATIONS 18.00 0.00 5.94 12.06 1/97 S S 3/98 Y Y IDA27500 1995 APEAC 45.00 0.00 0.00 41.80 IDA27170 1995 PRIV. ENTERP. SUPP. 15.00 0.00 12.20 2.80 10/97 U U 6/97 N Y IDA26430 1995 SOCIAL SAFETY NET 17.00 2.00 4.12 10.88 10/97 S S 10/96 Y Y IDA28910 1996 FINANCIAL SEC. TECH. 3.40 0.00 2.13 1.27 10/97 S S N Y Y IDA28900 1996 FINANC. SECTOR ADJ. 45.00 0.00 0.00 45.00 10/97 N/A IDA28680 1996 POWER& DIST. IIEAT 20.00 0.00 18.12 1.88 10/97 S U 9/98 Y Y IDA28600 1996 HEALTH 18.50 0.00 10.95 7.55 10/97 S S 10/98 Y Y IDA28590 1996 SHEEP & WOOL IMPROV. 11.60 0.00 9.59 2.01 12/97 S S 6/00 Y Y IDA29590 1997 RURAL FINANCE 16.00 0.00 13.43 2.57 12/97 S S 6/99 Y Y IDAN0160 1997 PUB SEC RES MGT ADJ. 44.00 0.00 21.61 22.39 12/97 S S N N N/A 373.50 2.00 98.09 276.31 Active Loans Closed Loans Total Total Disbursed (IBRD and IDA): 61.51 211.90 273.41 of which has been repaid: 0.00 0.00 0.00 Total now held by IBRD and IDA: 161.50 210.00 371.50 Amount sold : 0.00 0.00 0.00 Of which repaid : 0.00 0.00 0.00 Total Undisbursed : 98.09 0.00 98.09 a. Following the FY94 Annual Review of Portfolio performance (ARPP), a letter based system was introduced (HS highly Satisfactory, S = satisfactory, U unsatisfactory, IIU= highly unsatisfactory): see proposed Improvements in Project and Portfolio Performance Rating Methodology (SecM94-901), August 23, 1994. A:\ANNEXB8.DOC April 14, 1998 12.35 PM Annex B8 Page 2 of 2 Kyrgyz Republic STATEMENT OF IFC's Committed and Disbursed Portfolio As of 31-Jan-98 (In US Dollar Millions) Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1995 Kumtor Gold 30.00 0.00 10.00 0.00 30.00 0.00 10.00 0.00 1996 Demirbank Kyrgyz 0.00 .30 0.00 0.00 0.00 0.00 0.00 0.00 Total Portfolio: 30.00 .30 10.00 0.00 30.00 0.00 10.00 0.00 Approvals Pending Commitment Loan Equity Quasi Partic 1997 DEMIR 0.00 .15 0.00 0.00 KYRGYZINCR 1996 DEMIRBANK 2.00 0.00 0.00 2.00 KYRGYZ Total Pending Commitment: 2.00 .15 0.00 2.00 Generated by the Operations Information System (OIS) on April 6, 1998 Annex B8 Attachment Page I of 2 Kyrgyz Republic: Country Portfolio Overview And Issues The Kyrgyz Republic joined the World Bank and the International Development Association (IDA) in September 1992. Since then, 13 IDA credits totaling approximately US$373 maillion equivalent have been approved with roughly 74 percent ($276 million) disbursed. Five credits have provided balance of payments support for the Government's Economic Reform Program. These include four completed operations: 1993 - the Rehabilitation Credit: 1994 - Privatization and Enterprise Sector Adjustment Credit (PESAC); 1995 - an Agricultural Privatization and Enterprise Adjustment Credit (APEAC); and 1996 - a Financial Sector Adjustment Credit (FINSAC). A Public Sector Resource Management Adjustment Credit (PSRMAC) is currently under implementation. Preparation of a sixth adjustment operation, focusing on pension reform, social assistance and employment is underway. ICRs for the Rehabilitation Credit and PESAC operations have been completed. The APEAC ICR will be circulated in May 1998. The current portfolio also includes four investment projects (telecommunications; health; power and district heat; and sheep development); two credit operations (private enterprise support project and rural finance); and two technical assistance projects (social safety net and financial sector). An irrigation rehabilitation project and an agricultural support project have been negotiated and are being presented for Board consideration together with the CAS. During the first three years of IDA's involvement in the Kyrgyz Republic project implementation was very strong. This reflected the heavy bias toward adjustment lending within the portfolio (68 percent of total lending to date). Early investment operations were largely based in the country's capital and environs and financed primarily goods and services rather than civil works. At the outset of the program, counterpart staff received intensive training. The majority of these staff remained with the implementation units for some time, thus enhancing overall country execution capacity. Recently the program has begun to shift toward heavier investment lending and more complex institutional development initiatives. With this transition, there has been a slight decline in implementation performance. Nevertheless overall portfolio performance remains generally sound and Government commitment to maintaining high standards from the presidential level downward, remains very strong. There are a number of reasons for this slight deterioration in implementation performance. These include to varying degrees: (i) lack of clarity with respect to Government responsibility and accountability (after three years of exceptional continuity in policy leadership, in recent months there have been a number of changes in ministerial portfolios and some shifts in organizational structure); (ii) evolving Government policies and procedures for endorsement of the design, preparation and implementation of projects with resultant weak coordination and communication among ministries, agencies and Goskominvest; (iii) high counterpart staff turnover in the project implementation units; (iv) weak domestic audit and accounting capacity; (v) occasional inadequate counterpart funding provisions; and (vi) an implementation lag between a rapidly changing legal environment and provisions for enactment of new and revamped legislation. The management of technical assistance has also been particularly problematic as there has been a somewhat limited recognition of the need for and acceptance of the value of foreign TA. The Government is aware of the need to tighten up portfolio performance and is taking action to redress the issues. It has initiated a number of steps to streamline Governmental procedures governing the management of foreign assistance and to introduce greater consistency, efficiency and rationalization into the project development and preparation process. As a first step, a Public Investment Program was developed in 1995. Since then, the Government has undertaken annual reviews and updates in order to ensure that its strategic priorities receive financing. IDA has reviewed the PIP on an annual basis; Annex B8 Attachment Page 2 of 2 including the 1998 PIP to be presented at the May 1998 Consultative Group meeting. Second, in late 1997 the Board of the State Committee on Foreign Investments (Goskominvest) received a stronger mandate to review project preparation at critical points (e.g., identification, appraisal etc.) and to endorse or stop further actions. Although these steps toward institutionalization of the process are encouraging, implementation of the new procedures has to date been inconsistent. During the February 1998 Country Portfolio Performance Review agreements were reached to strengthen the process. The Government takes implementation very seriously and there has been consistent high level attention to portfolio issues. Currently two projects are rated unsatisfactory: the Private Enterprise Support Project (PESP), whose design no longer meets current country conditions and the Power and District Heating Project. A restructuring plan for the PESP designed to promote participation by private sector banks was agreed in February 1998. A proposal for Board no-objection is to be transmitted shortly. The Power and District Heating project will require a supplemental Credit in the range of US$15 million owing to higher than anticipated bids for rehabilitation works. A mission in the field is discussing measures to improve KNHEC's financial situation. Procurement under IDA-supported operations has generally proceeded satisfactorily, but some delays have been encountered, particularly in selection of consultants for project related or free-standing TA programs. These delays are mainly attributable to the inexperience of the agencies involved and inadequate institutional capacity. However, during the past five years, the Government has directed its efforts for capacity building in the country and situation has substantially improved as compared to 1993. ICB and other methods of procurement were introduced under the first IDA-supported operation. The Government has realized the benefits of these procurement procedures, i.e., economy, efficiency, transparency and accountability. Therefore, these procurement procedures are now widely accepted in the country. Procurement processing under the IDA-supported operations has not encountered any major problems, warranting misprocurement or any other similar action. Reforms in foreign exchange and taxation regimes, and banking system have proven conducive to the participation of international suppliers and contractors. A Country Procurement Assessment Report (CPAR) has been completed. The report covers: (i) an analysis of the current procurement environment in the country; (ii) lessons of experience of procurement processing under the Bank supported operations; (iii) compatibility with the Bank guidelines of the newly developed legal and institutional framework to regulate and manage the public procurement in the country; and (iv) an action program to further strengthen the system and institutions responsible for oversight and administration of public procurement. The CPAR was discussed at a National Workshop for Parliamentarians, officials, private sector representative and the press in Bishkek in February 1998. A first CPPR was held in April 1996 and an Action Plan was developed. Measures agreed under the Action Plan have been implemented as agreed. Following the CPPR, the Resident Mission instituted quarterly meetings with the Directors of the Project Implementation Units, responsible for project execution. Since then, project implementation summaries are being prepared on a regular basis and circulated to key policymakers. A second CPPR was held in February 1998. Currently all projects are in compliance with respect to audits and mid-term reviews have been held for three operations and two are planned for CY1998. All projects have been supervised within the past four months. The Regional Advisor on Auditing and Accounting visited Bishkek in the Spring of 1997 to discuss capacity. Follow up auditing and accounting courses by EDI/IFC are envisaged. Kyrgyz officials participated in the Bank-organized Central Asia Procurement and Project Implementation Workshop in Istanbul in April 1997. Annex B9 Page 1 of 2 Kyrgyz Republic-CAS Summary of Development Priorities Network area Country Major issue Country Bank Reconciliation ofcountry and performance priority priority Bank priorities Poverty Reduction & Economic Management * Poverty reduction Fair to Good Major contraction in standard of living: structural High High problem deeper than anticipated. Country Still feeling impact of past negative growth. * Economic policy Good Three-year solid track record of stabilization and High High structural reform. Open trade regime and capital account. * Public sector Fair to Good Strong reform of public sector budget & intergovt. High High finances; gradual govt reorganization. More attention needed on governance and accountability. * Gender Good Equal participation and recognition. Appropriate Low Low attention in policy formulation and project design. Human Development Department * Education Good Financing and curriculum reform; balance among High Low ADB taking lead on education primary, secondary and tertiary. * Health, nutrition & Good Financing and protocol reform; refocus of system High High population toward primary health care. * Social protection Fair to Good Good and improving targeting of benefits but Moderate High SOSAC to strengthen existing overly generous, fiscally unsustainable pension system. TA to assess longer system; need for institutional strengthening of social term options (ADB). fund. Environmentally & Socially Sustainable Development * Rural development Good Prices liberalized; state control and state orders High High dismantled; export taxes eliminated; ownership shares and land use rights for 99 years transferred to state farm/collective workers. However, land scarcity, low productivity, disintegrated marketing & inputs sytems, out of date technology, poor research and extension services and debilitated irrigation network remain major constraints. * Environment Fair First Natil. Env. Action Plan designed with Moderate Moderate NGO/donor community play significant NGO involvement. Vulnerable leading roles. IDF Grant for watersheds & toxic waste sites. Need for greater Strengthening NEAP Agency. mainstrearning of concerns. * Social development Good Active and diverse NGO presence and press Moderate Moderate community. Finance, Private Sector & Infrastructure * Financial sector Good Comprehensive financial sector reform undertaken, High High leading to emergence of a viable banking system. Deepening of regulatory and supervisory framework for non-bank financial sector in progress. Annex B9 Page 2 of 2 Kyrgyz Republic-CAS Summary of Development Priorities Network area Country Major issue Country Bank Reconciliation ofcountry and performance priority priority Bank priorities * Private sector Fair to Good Ambitious privatization program largely completed. Moderate High CSAC; Post-privatization Government interference and over-regulation of study; Sector operations; private sector activities needs to be reduced. Complementary IFC and FIAS activities * Energy & mining Fair Appropriate regulatory framework on paper but High High Policy dialogue and assistance implementation of tariff policy weak. under Power & District Heating Project * Infrastructure Fair Widespread network deterioration. Reluctance to High Moderate Policy dialogue; CSAC charge full economic costs of public utilities and Public Transport & services. Maintenance Project Annex C1 Instruments to Meet CAS Program Objectives Poverty Governance & Strengthening Growth Alleviation Institutional Public Strengthening Finances On-going Projects Pub. Sec. Resource Mgmt. Adj. Cr. x x Social Safety Net x x Health x x Telecoms x x Power x x Private Enterprise Support x FINSAC TA x x Sheep x x Rural Finance x x Agricultural Support Services (FY98) x x x Irrigation Rehab. (FY98) x x Power Supplemental (FY98) x x New Proiects (FY99-01) SOSAC x x x Land Registration x x x x Public Transport & Maint. x x Rural Water & Sanitation x x On Farm Irrigation x x x x Consolidation SAC x x Health 11 x x x Livestock & Pasture Mgmt. x x Rural Infrastructure x x ESW (* = on-&Qing) Agricultural Policy Review *x x Post Privatization & PSD *x x Water Sector Note * x x Urban Transport Sector Note* x x Poverty Update *x Land Tax Study x x Fiscal Sustainability & Growth x Ag. Input Marketing Strategy x x Forestry Sector Note x x Health Restructuring Review & Nutrition Note x x Non-Bank Financial Sector Update x x Livestock Subsector Note x X Poverty Update (labor markets) x Agr. Sector Policy Update x x IBRD Creditworthiness Review x TA/Capachty Building (* = on-&oing) Country Procurement Assmt. & Workshop * x x TA for Agroprocessing Restart * x x Strengthening State Property Fund (IDF) *x x Strengthening National Procurement (IDF) * x x Strengthening National Statistics (IDF) *x External Debt Management TA x x Strengthening Nat'l Environ. Action (IDF) X x Matchmaking (RRTF) x Poverty Monitoring (IDF) x x Improving Agr. Statistics (IDF) x Agr. Exports Promotion Policy National Information Infras. Policy (IDF) Annex C2 KYRGYZ REPUBLIC - Actual and Proposed IDA Commitments and Disbursements, FY93-01 Enhanced Lending of US$185 million for FY99-01 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 Commitments Total 60 78 76 99 60 64 65 70 50 Adjustment 60 60 45 45 44 0 36 35 0 Investment 0 18 30 54 16 64 29 35 50 Disbursements Total 0 32 49 84 63 73 55 74 53 Adjustment 0 32 48 78 47 45 18 36 18 Investment 0 0 1 6 15 28 37 39 35 Actual and Proposed IDA Commitments ($,m) 100 80 70 60 so 40 30 20 10 0 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 0 Total U Adjustment 2 Investment IDA Disbursements ($,m) 90 80 70 60 50 40 30 20 00 10 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 - Total Adjustment - - Investment ANNEXC2.XLS  Attachment KYRGYZ REPUBLIC COUNTRY ASSISTANCE STRATEGY PRIVATE SECTOR ASSESSMENT I. INTRODUCTION 1. The private sector share in GDP has increased substantially in the Kyrgyz Republic, within the context of a significant decline in output. The increase correlates strongly with progress in privatization, liberalization and stabilization of the economy. According to some estimates, the share of the private sector in GDP has reached 60 percent at the end of 1997.1 This growth has originated from (i) enterprise privatization; (ii) small-scale investment in new businesses; (iii) foreign direct investment in joint ventures; and (iv) introducing the policies of market economics. 2. Ownership reform accounts for most of the increase in the private sector share in GDP. Most medium and large enterprises have been privatized, including the key agro-industrial enterprises. Also, initial steps are underway to privatize the remaining large enterprises, including the public utilities. State farms have been converted into corporate entities, and land use shares are being issued to the rural population. Spurred by liberalization and investment opportunities, a large number of new private businesses have been established. At the end of 1997, there were about 27,000 small and medium scale enterprises in Kyrgyzstan accounting for about 20 percent of GDP.2 With privatization nearing completion, the growth of the private sector share in future will come primarily from post-privatization restructuring (especially in agriculture) and the formation and growth of new firms. Over the period 1989-96, the country has attracted a relatively small amount of foreign direct investment- US$147 million, concentrated primarily in mining.3 3. Notwithstanding the significant progress in private sector development, future private sector growth faces a number of challenges and constraints. Some are exogenous and relate to the small domestic market, few areas of clear comparative advantage, geographic isolation from international markets and high informal barriers to trade (anecdotal reports of mafia and police extraction of bribes for passage along major transport routes in neighboring countries). Another set of constraints relates to the incomplete and unconsolidated nature of reforms. 4. This annex concentrates on the policy-related impediments to private sector growth in Kyrgyzstan. Section II contains an analysis of existing constraints to private sector development; Section III discusses short-term investment potential and critical issues in key sectors. II. CONSTRAINTS TO PRIVATE SECTOR DEVELOPMENT 5. Privatization and Property Rights. Kyrgyzstan has made significant progress with privatization over the past few years. The privatization of small SOEs was completed through competitive voucher and cash auctions. As of June 1997, all medium and large companies have gone through coupon auction and about 800 of the targeted 1300 SOEs have been fully or majority privatized. Despite substantial progress, ' EBRD, Transition Report 1997, p.14. The estimates of private sector share in GDP are subject to a great deal of uncertainty due to data limitations and differing definitions of private ownership. 2 Akayev, A., On State Economic Policy in 1998, Bishkek, October 1997. EBRD, Transition report 1997, p.126. -2- public sector enterprises still account for a large share of industrial output- 44 percent in 1996, and continue to claim the largest share of financial resources- 53 percent of total loans and credit to the economy4. 6. Ownership reform in the area of agricultural land has also been substantial. The Government has put in place a legal framework to establish privately owned family farms or restructured large farms with 99-year land use right. Land certificates (mostly temporary) have been issued to individual households and a system to register private land titles is being evaluated through a pilot. Despite this progress, land markets have been slow to develop. Limiting factors are the constitutional prohibition of full private land ownership and the inadequate land legislation and administration. Three important pieces of legislation are currently being considered: (i) the Land Code, which guarantees the right to buy, sell and inherit mortgage and transfer land use rights, and prohibits expropriation without compensation; (ii) the Law on Mortgage, which introduces procedures for land to be used as collateral; and (iii) the Land Registration Act, which establishes a unified land registration system. 7. Although the privatization program has proceeded faster in the Kyrgyz Republic than in other Central Asian countries, not much, if any, foreign investment has been attracted through this channel. Although formally not excluded from the privatization process, foreign investors have shown little interest due to several factors, such as, the difficulty in obtaining and interpreting enterprise financial information, as well as interest in investing only if a controlling position could be obtained. While many industrial enterprises, such as in the agro-industrial sector, have been already privatized, a number of attractive enterprises remain in the hands of the Government. Foreign investors' interest could be attracted if the government is prepared to offer the privatization of the remaining large and strategic state- owned enterprises, including those in various infrastructure-related sectors such as telecommunications, power, natural resources (mining), and cement. 8. The present agenda with respect to privatization is to divest the remaining state shares in the partially privatized companies. In addition, the government plans to start the privatization of 9 large monopolies, including utilities, with a view to attracting foreign investment. Finally, the Government will also be considering the disposition of some 4000 social assets divested from SOEs. However, the implementation of this agenda has experienced a number of recent setbacks. The State Property Fund's (SPF) intention to proceed with the privatization of public utilities faces political opposition, which in 1997 has forced the delay of offering stakes in Kyrgyzaltyn (the state gold mining company) and Kyrgyztelecom. A plan to privatize the power industry by 2000 also faces resistance, including from the state energy and fuel company itself. 9. Corporate Governance. There is little evidence of the impact of privatization on corporate governance and enterprise restructuring so far. However, severe impediments to restructuring continue to exist both with respect to internal and external factors affecting corporate governance. Regarding internal factors, the voucher process of privatization has led to a system of widely dispersed small shareholders that are unable to monitor the performance of firms or to influence the governance of the enterprises. Many companies are controlled by management and workers who not only lack modern management skills necessary for operations in a market environment, but also refuse to disclose adequate information about the firm's operations to outside investors. 10. Serious weaknesses exist with respect to the external mechanisms for enforcing good corporate governance. The overall legal framework and national accounting regulations are still being developed, 4 ADB, Proposed Loan for the Corporate Governance and Enterprise Reform Program, August 1997. -3- and are not being rigorously enforced. As a result they are not performing their roles as external disciplinary mechanisms in enforcing improved corporate governance. Soft budget constraints as manifested in inter-enterprise arrears, weak competition, and underdeveloped financial markets result in ineffective corporate governance at this stage. Despite the enactment of an Insolvency Law in 1994 and a series of government decrees aimed at imposing financial discipline, there have been only few cases of bankruptcy. Efforts are being made to overcome these problems. Out-of-court settlement procedures for creditors of insolvent enterprises have been introduced to side step the implementation bottlenecks in the legal system. A new bankruptcy law was adopted in October 1997 and a range of insolvency regulations and procedures are currently under preparation. The government has also received ADB's support for a program to improve corporate governance. 11. Financial Sector. There were 18 commercial banks and credit institutions with 120 branches at the end of 1997. Restructuring of the banking sector has been successful with the share of doubtful loans decreasing from 72% at the end of 1995 to 18% by the end of 1996. The Basle standards on capital adequacy were adopted in January 1996 and regulations were passed in September 1996 stipulating a stepwise increase in minimum capital requirements. Additional important regulatory changes concern improvements in the registration of pledges and the collateralization of loans, as well as the introduction of international accounting standards. Notwithstanding this progress, the reform program in the banking sector faces many challenges. Failure to establish a repayment culture, weak legal processes for taking possession of collateral as well as a basic distrust of the banking system remain large obstacles to creating an efficient banking system. In addition, lack of critical banking skills, especially skills related to credit risk assessment, continues to have a negative effect on lending practices. 12. Privatized and newly emerging enterprises need working capital and investment credit to grow and restructure, but their demand for financing is still unmet in many instances. The lack of credit, however, is not the binding constraint. Lenders have difficulties finding bankable projects as risks of defaults are substantial, potential borrowers don't have the skills to develop and present strong business plans, loan officers lack training in risk analysis and business plan evaluation, and the high returns on Treasury Bills discourage lending by commercial banks to businesses or individuals. Thus, despite a strong notional demand for funds, the effective demand is still limited. An example of these limitations is the fact that, although there are about twenty credit programs in the country from multilateral, bilateral and government sources, many are not yet lending at full capacity. 13. Though capital markets are underdeveloped, there are a number of non-bank financial institutions. These include 17 investment funds, 47 insurance companies, a stock exchange, a coupon privatization trading center, a state social fund and two pension funds. The government is in the process of amending prudential regulations governing investment funds and introducing new legislation governing insurance companies and pension funds. An independent share registry and tight listing requirements are expected to lead to higher transparency and property rights security. The institutional basis for a secondary market in shares has been established, but trading was still thin at the end of 1997. Some 120,000 physical and legal entities were registered by the end of 1996, but only around 200 issued bonds, bills or shares and only 5-10% of these were actively traded5. To develop further the domestic securities market, the government has designed and is implementing a three-year development program, which was adopted in September 1996. 14. Legal issues. The Kyrgyz Republic is fairly advanced in establishing the basic legal framework of a market economy. As in other countries in transition, however, the current phase of market 'EBRD, Transition Report 1997, p. 180. -4- institutions building is characterized by frequent changes in laws and regulations, inconsistencies among legislations6, weak administrative capacity to implement the laws7, lack of transparency and difficult access to legal informationg, and considerable bureaucratic discretion in interpreting and applying the rules. Partially as a result of this, there is still limited reliance on the formal legal system. For large foreign investments, special investment agreements have been established which often supersede the general legal codes. In addition, a growing unofficial business sector has emerged over the last couple of years, operating outside the formal legal system. These problems add to the low credibility of the new legal system at present and pose a particularly heavy burden on SMEs. 15. Important aspects of the legal framework are stillmissing. Current domestic accounting standards outside of the banking sector are still based on the old Soviet system, which distorts the measurement of revenues and profits. Labor legislation is outdated and based on the old Soviet Labor Code. 16. Regarding progress in the areas of pledge, bankruptcy and company laws, Kyrgyzstan is among the leading reformers in the FSU, but problems remain, especially with respect to implementation. The Law on Pledges provides for a single Pledge Registration Office for the registration of non-possessory pledges, which are permitted for any type of tangible or intangible property, both movable and immovable. It is not clear whether a pledgee has the right to enforce a pledge without seeking court assistance. The Company Law provides that joint-stock companies with more than a certain minimum number shares must maintain an independent share registry and that shareholders are entitled to vote by proxy at meetings. The Insolvency Law provides for a reorganization system through which a majority of creditors can reach a binding settlement with the debtor. 17. Management Expertise and Skills. Despite a literate population, blessed with a high level of technical skills, the private sector suffers from a lack of management, marketing and financial skills needed in an efficient market economy. Western business concepts are still new to Kyrgyzstan, and few people are versed in Western accounting methods, marketing and other management concepts. Few entities and individuals have the capability to prepare and present internationally acceptable financial reports to encourage external private investment. Many bankers indicate that few entrepreneurs are able to formulate project proposals to an acceptable level of competence and quality. Further, the fact that a local consultancy profession is still only embryonic means that very limited expertise is available to advise on such work. Developing these skills and expertise is one of the main challenges of successful economic transformation in Kyrgyzstan. III. INVESTMENT POTENTIAL AND SECTORAL ISSUES 18. With substantial progress in liberalizing and stabilizing the economy, the investment potential of the republic is closely linked with prospects for recovery in currently depressed industries and the potential for expansion in sectors that were repressed under the old system. Many segments of the economy are still suffering from a severe transformational recession as a result of (i) the breakup of 6 For example, many investors complain about the lack of coordination among the Foreign Investment Law, the new Tax Code, and the Free Economic Zones Law. ' On average, a party can be expected to wait between seven months and a year for a commercial case to be heard on its merits by a court in the most important commercial center and between seven months and one year for a final judgement for payment of a sum of money to be executed. 8 Important judgments are not generally published and accessible to practitioners. -5- payment mechanisms for cross-border transactions; (ii) the loss of traditional markets (iii) the end of large transfers from the central government of the FSU9; and (iv) the sharp deterioration in the terms of trade for the country's traditional exports particularly because of higher prices for energy and natural resource imports. The decline in GDP has been associated with major sectoral shifts in the composition of output. 19. The introduction of market forces into the economy has brought about significant structural changes, with some sectors contracting and others expanding. In the industrial sector, which was overbuilt during the Soviet era10 and characterized by a high degree of specialization and integration with the Union economy, the fall has been across-the-board, but particularly severe in military production, heavy industry and consumer manufactures uncompetitive with imports. The prospects for recovery through investments in restructuring are not very optimistic and the decline in some of the sectors is likely to be permanent. The agricultural sector has also inherited a highly distorted productive structure. Previous activities were overextended in its use of natural resources, inappropriately directed in terms of products and technology, and lacked incentives for the efficient use of inputs. As a result, farm organizations still face difficult restructuring and retrenchment similar to the situation of state-owned industrial enterprises. Although the distorted productive structure precluded a swift supply response to initial reforms, the growth potential of the sector is significant as the republic has strong comparative advantage in certain irrigation-intensive crops and livestock activities. Previously repressed, services have expanded dramatically with growth concentrated in private trade, finance and other business and consumer services. These activities represent an important locus for private wealth accumulation, which is now starting to be used to acquire industrial assets. The immediate export potential of this sector is however limited, although some attractive opportunities might exist in tourism. 20. With a small domestic market, difficult access to international markets and few marketable commodities, Kyrgyzstan's long-term growth prospects are inextricably linked with economic developments in its resource-rich neighbors. The country has few areas with immediate growth potential, the most important being agriculture, mining and energy. 21. Agriculture and Agriculture-related Industries. Agriculture is the lead sector of the Kyrgyz economy accounting for 48 percent of GDP and 49 percent of total employment in 1997. The share of agriculture and agro-industries was 38 percent in total exports and 23 percent in total imports. Over the last 6-7 years, the agricultural sector has shrunk considerably, but its share in GDP has increased. Especially severe was the decline in livestock production, which remains depressed. The agro-industrial sector is facing serious crisis- the decline in annual production from 1990 to 1996 is over 90 percent for most commodities. The Kyrgyz Republic has turned from being a net importer of primary agricultural products in 1993 to a net exporter in 1996. On the other hand, as far as processed agriculture is concerned, the country changed from being a net exporter in 1993 to a net importer in 1996. The potential to increase efficiency in the sector and growth in the rural economy is large and needs to be exploited with urgency. 22. The country has made significant progress to lay the foundation for private agriculture and is leading the way to agricultural reform in Central Asia. While appropriate decrees or laws have been issued, the progress of actual enforcement and implementation on the ground has been slow, particularly in some of the regions. There is a need to further deepen and broaden reforms related to land privatization ' Estimated at about 12 percent of GDP. "o De Melo et al., in "Circumstance and Choice: The Role of Initial Conditions and Policies in Transition Economies", World Bank WPS No 1866, estimate the level of overindustrialization at 6 percent of 1989 GDP. -6- (land code, land titling, land registration, and land market), farm restructuring, demonopolization and post-privatization support for agro-industry, and agribusiness development in the private sector. Despite liberalization of prices, trade and markets, the slow emergence of competitive input and output markets remains a major barrier to promote efficient, sustainable and profitable agriculture. Privatization has been successful in creating a large number of private entrepreneurs. However, it will take some time to restructure the privatized SOEs and make them efficient. Problems in the agro-industrial sector include poor product quality, poor packaging, declining demand, lack of credit and reduction in raw material supply. Revitalizing agro-industry is critical to modernize the agricultural sector and create rural employment. 23. Mining. The principal mineral products produced in the Kyrgyz republic include gold, antimony, mercury, molybdenum and uranium oxide. Significant potential exists in gold production and the country has attracted foreign investment in this sector. Cameco Corp. from Canada is operating the important Kumtor gold deposit. However, depressed gold markets are likely to slow the development of new projects in the sector. Market prospects for some of the other existing products, with the possible exception of antimony, are not very good. Many of the mining and processing facilities are producing at reduced levels or are closed because of the collapse of demand in Russia, production problems, obsolescent technology and /or exhausted deposits. In addition, over-staffing in most of the industries, and the trend towards international prices for electricity and petroleum products will require significant changes in production practices and technology for the metallurgical industries to be internationally competitive. 24. A new mining law has been passed by the parliament in August, 1997. While far from satisfactory in terms of international best practices, it does mark a first step towards a more competitive investment environment. Many mining investors will still seek to negotiate separate investment agreements with the authorities, which can provide for better investment terms. Nonetheless, improvements are needed in the overall investment environment for mining to ensure consistency in treatment of domestic and foreign investors. 25. Energy. The Kyrgyz Republic has abundant low-cost hydropower resources, which have been partially developed, small and declining oil and gas production, and a collapsing coal industry (despite significant resources). The largest potential is in hydropower. The currently installed capacity exploits only about 9 percent of hydropower potential. The government is considering several projects in the hydropower sector to increase installed capacity and rehabilitate and expand the distribution and transmission network. If long-term export potential could be secured, these projects might be attractive investment opportunities for international companies. The realization of the country's potential in hydropower generation depends on the progress of reforms in the sector and on the nature of energy trading arrangements with neighboring countries. 26. Reforms in the energy sector have been proceeding slowly, but consistently. Prices of electricity, district heating and household gas have been kept artificially low, although significant increases to prices were effected recently. The government's reluctance to raise these prices to desirable levels is weakening the energy supply industry and distorting the consumption patterns and investment requirements. However, a multi-year tariff policy aimed at promoting energy conservation among wasteful consumers and rapid rehabilitation of the network has been adopted recently. The government has also developed a strategy, to be endorsed by the Parliament, to unbundle and commercialize the power sector in order to attract private sector interest. A regulatory body has also been established. 27. Kyrgyzstan is generally disadvantaged by regional energy trading arrangements. The republic -7- produces less electricity during peak demand winter months than it could in order to store water needed down stream for summer irrigation, but is not compensated for this loss in production. In addition, electricity is exported at a price close to its cost of supply, while natural gas is imported at a price close to alternative fuels. Energy trade issues have the potential to be quite contentious in the region. A regional program to improve efficiency, promote market pricing, and regional cooperation in energy production and distribution would greatly benefit Kyrgyzstan. In this regard, a positive development is the first multi-year agreement at prime-ministerial level on water sharing among the Central Asian republics of Kazakhstan, Kyrgyzstan and Uzbekistan reached in March 1998. The Agreement includes provision for Kazakhstan and Uzbekistan to share equally in the purchase of summer hydropower from Kyrgyzstan and to make payments either through deliveries of coal and natural gas or through monetary arrangements equivalent to the replacement costs to support Kyrgyzstan's winter fuel needs. The adoption of this agreement is expected to contribute to the stabilization of water and energy supplies in Central Asia and would provide a framework in preparing agreements relating to the integration of energy systems in the region 1l. The acid test of the new agreement will come during the next winter heating season in Kyrgyzstan. "Source: US Department of Commerce's Business Information Service for the Newly Independent States, April 6, 1998. MAP SECTION 긷