Kyrgyz Republic

Country Report November 2003

Kyrgyz Republic

November 2003

The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group.

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Contents

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2004-05 7 Political outlook 8 Economic policy outlook 9 Economic forecast

12 The political scene

16 Economic policy

20 The domestic economy 20 Economic trends 24 Sectoral trends

28 Foreign trade and payments

List of tables 9 International assumptions summary 11 Forecast summary 17 Consolidated government operations, Jan-Aug 19 Main economic policy indicators 21 Basic data, Jan-Sep 2003 23 Consumer prices, 2003 24 Manufacturing production, 2003 27 Gross agricultural output, Jan-Sep 27 Main macroeconomic indicators 29 Composition of trade, Jan-May 2003 30 Direction of trade 31 Balance of payments, national series 33 Main external indicators

List of figures

12 Gross domestic product 12 Consumer price inflation 21 Real GDP growth, Jan-Sep 2003 22 Nominal monthly wage 24 Gold output 32 Debt stock

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Kyrgyz Republic 3

Summary November 2003

Outlook for 2004-05 The president, Askar Akayev, is likely to seek ways in which to remain in power beyond the December 2005 presidential election, despite his repeated claims that he will stand down from office when his term expires. At this stage, the Economist Intelligence Unit expects Mr Akayev’s supporters to try to change the constitution in order to allow the president an extra term in office, at least. In any case, Mr Akayev now has life-long powers with which to exert influence behind the scenes, even if he is unable to keep the presidency. Electoral considerations, together with the need to support an impoverished population, will prevent the government from tightening fiscal policy. However, a marked loosening is unlikely, since it would jeopardise much-needed financial assistance from the multilaterals. The impact of loose fiscal policies will also be mitigated by tight monetary policy, which will help to keep average annual inflation low, at around 3-4%. Despite continued problems with revenue collection, tax performance will be helped by a rebound in the gold sector and a gradual upturn in foreign investment from Russia and Kazakhstan. These factors will also sustain real GDP growth at around 4.5-5.5%. However, growth will be constrained by rising imports, which will also keep the current account in deficit.

The political scene The president has reiterated his intention to stand down in 2005, but the increasingly harsh measures taken by the authorities to discredit and thwart the opposition cast doubt on the reliability of his statements. Hizb-ut-Tahrir (Party of Freedom) continues to be perceived as the Kyrgyz Republic’s primary security threat. Russo-Kyrgyz relations have strengthened with the official inauguration of the Russian military base at Kant, and by efforts towards closer economic co-operation.

Economic policy After a strong first half, rising expenditure has led the IMF to express concerns about fiscal overshooting. The draft budget for 2004 implies a deficit of 0.6% of GDP, using the Economist Intelligence Unit’s macroeconomic assumptions.

The domestic economy Real GDP grew by 5.1% in January-September 2003, a rebound largely explained by a recovery at the Kumtor gold mine. Inflation remained essentially flat over the first nine months of the year. Although average wages remain low, even by regional standards, real incomes continued to grow strongly in the third quarter of 2003.

Foreign trade and payments The first-quarter current-account balance was in surplus, but trends in merchandise trade over the first eight months of 2003 suggest that it will return to deficit as the year progresses. Gold sales continued to dominate in the Kyrgyz Republic’s markets outside the Commonwealth of Independent States (CIS), and electricity exports are becoming increasingly important within it. Editors: Dafne Ter-Sakarian (editor); Anna Walker (consulting editor) Editorial closing date: November 13th 2003 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Kyrgyz Republic

Constitution The Kyrgyz Soviet Socialist Republic declared its independence in August 1991 and changed its name to the Kyrgyz Republic. Its constitution was approved on May 5th 1993. The president’s powers were enhanced by a referendum held in February 1996. Further changes to the presidency and the constitution were made in a referendum held in February 2003

National legislature The 313-member Jogorku Kenesh of the Soviet era was divided in 2000 into a 105-member bicameral parliament, elected for a five-year term

National elections February 20th and March 12th 2000 (parliamentary) and October 29th 2000 (presidential); next elections due in February 2005 (parliamentary), November-December 2005 (presidential)

Head of state The president, Askar Akayev, was elected unopposed in October 1991; he was re-elected in December 1995, with 71.6% of the vote, and in October 2000, with 74% of the vote

National government The president appoints a prime minister, who forms a government. The present cabinet was formed in June 2002

Main political parties Communist Party of the Kyrgyz Republic; Asaba National Revival Party (nationalist); Erkin, the Kyrgyz Republic Progressive and Democratic Party (Erk; nationalist); Ata-Meken Socialist Party (social democratic); Democratic Movement of the Kyrgyz Republic; Union of Democratic Forces; Democratic Party of Women; War Veterans’ Party; Moya Strana (My Country)

Prime minister Nikolai Tanayev Head of the National Security Service Kalyk Imankulov First deputy prime minister Kurmanbek Osmonov Deputy prime minister Dzoomart Otorbayev Deputy prime minister; minister of transport & communications Kubanychbek Zhumaliyev

Key ministers Agriculture Aleksandr Kostyuk Defence Esen Topoyev Ecology & emergencies Satyvaldy Chyrmashev Education & culture Ishenkul Boldzhurova Finance Bolot Abildayev Foreign affairs Askar Aitmatov Foreign trade & industry Sadriddin Dzhiyenbekov Health Mitalip Mamytov Interior Bakirdin Subanbekov Justice Daniyar Narymbayev Labour & social affairs Roza Aknazarova State property & investment Ravshan Zheyenbekov Tour ism & spor ts Okmotbek Almakuchkov Central bank chairman Ulan Sarbanov

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Economic structure

Annual indicators 1999a 2000a 2001a 2002a 2003b GDP at market prices Som bn 48.7 65.4 73.9 75.2 89.8 GDP US$ bn 1.2 1.4 1.5 1.6 2.0 Real GDP growth (%) 3.7 5.4 5.3 -0.5 6.0 Consumer price inflation (av; %) 35.9 18.7 6.9 2.1 3.0 Population (m) 4.8 4.9 5.0 5.1 5.1 Exports of goods fob (US$ m) 462.6 510.9 480.2 498.1 582.1 Imports of goods fob (US$ m) -551.0 -506.3 -441.2 -552.0 -635.9 Current-account balance (US$ m) -252.0 -125.9 -52.6 -85.1 -69.2 Foreign-exchange reserves excl gold (US$ m) 229.7 239.1 263.5 288.9 414.2 Exchange rate (av) Som:US$ 39.01 47.70 48.38 46.94 44.70 a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2002 % of total Components of gross domestic product 2001 % of total Agriculture & forestry 39.7 Private consumption 66.3 Industry 27.3 Public consumption 17.3 Services 34.8 Gross fixed investment 14.5 Change in stocks 1.7 Net exports -0.2

Principal exports 2002 % of total Principal imports 2002 % of total Precious & semi-precious metals 33.8 Mineral products 28.0 Mineral products 12.8 Machinery & equipment 15.2 Textiles 12.2 Chemicals 13.3 Food, beverages & tobacco 6.2 Food, beverages & tobacco 8.1 Machinery & equipment 5.5 Textiles 6.6

Main destinations of exports 2002 % of total Main origins of imports 2002 % of total Switzerland 20.3 Kazakhstan 21.1 Russia 16.4 Russia 19.9 China 8.4 Uzbekistan 10.2 Kazakhstan 7.5 China 10.1 US 7.4 US 8.1

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Quarterly indicators 2001 2002 2003 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Government finance (Som m) Revenue & grants 3,032.4 3,930.4 2,850.3 3,320.9 3,853.0 4,367.9 2,887.1 4,224.1 Expenditure & net lending 2,979.0 4,471.9 2,789.4 3,436.9 3,641.1 5,322.8 2,684.9 3,979.8 Balance 53.4 -541.5 60.9 -116.0 211.9 -954.9 202.2 244.3 Wages & prices Monthly earnings (Som) 1,338 1,351 1,423 1,575 1,623 1,842 1,683 1,867 Monthly earnings (% change, year on year) 11.7 -4.7 12.2 21.2 12.0 36.3 18.3 18.5 Consumer prices (1995=100) 307.7 308.6 314.9 319.7 316.4 316.6 323.5 329.6 Consumer prices (% change, year on year) 6.5 3.7 2.7 0.5 2.8 2.6 2.7 3.1 Producer prices (1995=100) 383.0 378.6 384.9 397.5 398.6 399.7 413.2 398.3 Producer prices (% change, year on year) 12.9 6.7 4.8 4.8 4.1 5.6 7.4 0.2 Financial indicators Exchange rate Som:US$ (av) 47.78 47.87 47.91 47.67 46.09 46.07 46.03 43.16 Exchange rate Som:US$ (end-period) 47.70 47.94 47.96 46.15 46.00 46.10 45.59 41.18 Lending rate (av; %) 35.6 37.3 39.9 36.5 34.8 24.8 34.1 17.6 Money market rate (av; %) 14.7 12.1 8.1 5.0 5.4 n/a 5.5 4.0 M1 (end-period; Som m) 5,151 5,558 5,808 6,247 6,930 7,677 8,067 8,669 M1 (% change, year on year) 12.5 20.7 30.8 41.0 34.5 38.1 38.9 38.8 M2 (end-period; Som m) 7,627 8,234 8,725 8,863 9,896 11,023 11,511 11,922 M2 (% change, year on year) 4.7 11.3 21.9 26.8 29.7 33.9 31.9 34.5 Sectoral trends, production Coal & lignite (‘000 tonnes) 92.6 223.2 58.8 79.9 94.9 225.4 66.4 166.0 Natural gas (m cu metres) 5.0 9.5 9.9 5.7 6.8 7.7 6.9 6.7 Crude petroleum (‘000 tonnes) 18.5 18.8 17.1 19.4 19.4 19.6 18.2 18.9 Electricity (m kwh) 3,085 3,576 4,106 1,982 2,123 3,690 4,912 2,303 Cement (‘000 tonnes) 130.9 85.9 90.0 159.9 171.2 111.7 94.0 201.5 Foreign trade (US$ m) Exports fob 131.3 122.1 113.1 123.6 114.4 134.4 119.9 113.8 Exports (fob) to CISa 58.6 31.9 33.8 36.7 45.5 52.4 39.6 38.4 Imports cif -118.3 -143.6 -138.9 -131.6 -150.6 -165.7 -126.2 -168.4 Imports (cif) from CISa 65.4 82.1 82.0 71.1 77.8 91.7 67.2 96.4 Trade balance 12.7 -21.3 -25.8 -8.0 -36.2 -31.3 -6.3 -54.6 Balance of payments (US$ m) Merchandise trade balance fob-fob 21.4 -13.6 -10.6 0.6 -24.0 -20.0 1.9 n/a Services balance -4.6 -11.3 -1.3 -0.5 2.3 -7.5 -1.9 n/a Income balance -11.2 -24.6 -10.0 -16.0 -8.9 -24.8 -7.3 n/a Net transfer payments 11.8 17.0 16.3 14.7 26.6 28.6 15.1 n/a Current-account balance 17.4 -32.6 -5.6 -1.4 -3.9 -23.7 7.9 n/a Reserves excl gold (end-period) 215.5 263.5 257.2 242.3 269.4 288.8 311.2 302.5 a Commonwealth of Independent States. Sources: Kyrgyz National Statistical Committee; IMF, International Financial Statistics.

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Outlook for 2004-05

Political outlook

Domestic politics The president, Askar Akayev, has repeatedly stated that he will stand down once his term of office expires in December 2005, but this has not quelled speculation that he will seek to remain in his post. Indeed, given the prevailing authoritarian drift in Central Asia, the Economist Intelligence Unit believes that it likely that Mr Akayev will seek to reinterpret the constitution in order to remain president. Alternatively, he could either reposition himself as prime minister—after turning the presidency into a largely ceremonial post—or secure the presidency for his wife, Mayram Akayeva, and thus continue to exert influence behind the scenes. In June 2003 Mr Akayev obtained extensive constitutional privileges that will allow him to retain a powerful position even if he steps down. As first president of the independent Kyrgyz Republic, Mr Akayev will enjoy lifetime privileges and immunity from prosecution. In this, as in other political form- ulations, the Kyrgyz Republic has followed the example of Kazakhstan, where the president, Nursultan Nazarbayev, has ensured that, even if he stands down, he will still have priority access to his successor. This prerogative is also likely to flow from the benefits granted to Mr Akayev. However, the situation in the Kyrgyz Republic is not completely analogous to that in Kazakhstan—let alone in other, more repressive, Central Asian states. The opposition in the Kyrgyz Republic is stronger, partly because it has deeper societal divisions to exploit. Since the Soviet period—and arguably even before that—there has been a pronounced north-south divide in the country along both economic and clan lines. As a result, domestic politics are not as amenable to central control as is the case elsewhere in the region. Mr Akayev’s position could therefore yet come under threat, especially if the government’s pursuit of fiscal discipline coincides with further economic difficulties—such as those experienced in 2002. The parliamentary election scheduled for February 2005 will thus be an important barometer both of public opinion, and of the state’s ability to deploy its administrative resources effectively. The opposition’s opportunities for campaigning have been severely curtailed, and its parties will not make a strong showing. Nevertheless, the Ar-Namys (Dignity) party and its jailed leader, Feliks Kulov, have a relatively high profile in the republic, and this could still pose difficulties for the authorities in the election.

International relations Mr Akayev is pursuing what Central Asian leaders call a “multi-vectoral” foreign policy. This entails managing relations with the larger powers that have an interest in Central Asia—traditionally, Russia and China, but also, since September 2001, the US. Mr Akayev has taken this strategy further than his counterparts in other Central Asian states, however, by allowing a deploy- ment, now made permanent, of Russian troops at Kant (near the capital, Bishkek), while retaining the US military presence at Manas airbase (now renamed Peter Ganci airbase). Increasingly close military co-operation with China could add yet another dimension to the Kyrgyz Republic’s foreign

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relations. The country’s openness to all the major powers in the region has not only raised fears of heightened geopolitical competition in an already unstable area, but has also caused disquiet in Kazakhstan and Uzbekistan. The battle for influence in Central Asia has traditionally been fought between these two states, usually to the detriment of the Kyrgyz Republic. Mr Akayev’s courting of so many powerful patrons, however, could significantly strengthen his country’s position regarding its two larger neighbours. Tensions will continue between Uzbekistan and the Kyrgyz Republic over the issue of their shared border, and over the exchange of energy and natural resources, despite the conclusion of bilateral deals in these areas. However, relations between the two countries are expected to remain stable, as long as Mr Akayev maintains a crackdown on the activities of religious extremists—a p0licy long favoured by the Uzbek president, Islam Karimov. Nevertheless, unrest in the southern regions of the Kyrgyz Republic has at times led to demands from the country’s substantial Uzbek minority for greater cultural and political rights, and there is a risk that this could be exploited by the Uzbek government in an attempt to further its aspirations to regional hegemony.

Economic policy outlook

Policy trends The Kyrgyz government is heavily reliant on multilateral funding, and will therefore need to continue to comply with IMF conditions if it is to go on receiving financial assistance. However, the government will also need to ease the hardships of the population, especially in the politically restive southern regions. This will be especially important in 2005, when both parliamentary and presidential elections are scheduled. Since running a loose fiscal policy is the most immediate means of poverty relief at the government’s disposal, combining economic discipline and political necessity will be the government’s main problem over the forecast period, and this will carry with it risks to the pace of economic and structural reform more generally. Given these contradictory needs—to attract IMF funding while maintaining a looser fiscal policy than the IMF recommends—the government’s planned solution is to pay off the Kyrgyz Republic’s debts to the IMF in 2004. However, as there are persistent problems with revenue collection and few alternative sources of revenue, we view this target as an unrealistic. The government’s search for financing is made difficult by strong domestic opposition to the sale of state assets, which will continue to hinder deep- reaching structural reform and rapid privatisation over the forecast period. Investors are also wary of the poor business environment and high levels of corruption. These factors will ensure that only foreign investors who are at home with the business environment in Central Asia will seek opportunities in the Kyrgyz Republic, which essentially means Russian and Kazakh companies. The sale of assets to such firms can also be less controversial, owing to the long-standing links between the elites of these countries.

Fiscal policy A series of natural disasters and upward revisions to social outlays have pushed up budget expenditure and raised IMF concerns of a substantial deficit

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in 2003—despite a strong first-half performance. Although we agree that the government’s projected deficit of 0.15% of GDP is overly optimistic, we think that the IMF’s worst-case projection of a 1.5% of GDP deficit is also unlikely. Instead, we expect the deficit to remain below 1% of GDP. Nevertheless, the IMF’s warning will lead the government to sequester expenditure where possible, given the Kyrgyz Republic’s reliance on IMF funding. In addition to this, a second-half recovery in the gold sector—where tax is more easily collected from the large foreign concerns that predominate—is likely to have boosted revenue in the second half of the year. Although with elections looming in 2005 the government is unlikely to tighten policy significantly over the forecast period, the need to maintain good relations with the IMF will act as a constraint on fiscal loosening. Indeed, the government will endeavour to meet the IMF’s benchmarks. However, weak administrative capacity will mitigate the impact of IMF-sponsored reform. For instance, the government has extended value-added tax (VAT) to agricultural goods and introduced a property tax, but implementing these measures is proving difficult. Consequently, although we expect further progress on tax reform, its impact on revenue is likely to be marginal at best.

Monetary policy Despite the Kyrgyz government’s conflicting commitments, the National Bank of the Kyrgyz Republic (NBKR, the central bank) has been able to maintain its independence and pursue a relatively tight monetary policy. This has played a crucial role in the country’s rapid disinflation over 2001-03, and we expect the NBKR to maintain a reasonably tight monetary policy throughout the forecast period. Nonetheless, the bank operates within significant constraints, since it has limited policy instruments with which to pursue financial deepening and to sterilise the rising levels of foreign-exchange inflows related to financial assistance. At this stage, these inflows are sterilised by the fiscal and external deficits, and do not therefore exert significant pressures on the money supply. Nonetheless, the weakness of the NBKR in these and other fields points to a continued lack of financial intermediation in the Kyrgyz Republic.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 GDP growth World 2.9 3.3 3.9 4.1 OECD 1.8 1.8 2.4 2.6 EU 1.0 0.6 1.9 2.3 Exchange rates ¥:US$ 125.4 115.7 109.8 114.8 US$:€ 0.9 1.1 1.2 1.2 SDR:US$ 0.77 0.71 0.68 0.70 Financial indicators ¥ 2-month private bill rate 0.10 0.05 0.10 0.10 € 3-month interbank rate 1.70 1.08 1.38 3.56

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International assumptions summary (% unless otherwise indicated) 2002 2003 2004 2005 Commodity prices Oil (Brent; US$/b) 25.0 27.6 19.6 18.9 Gold (US$/troy oz) 310.3 354.0 323.8 307.5 Food, feedstuffs & beverages (% change in US$ terms) 12.7 5.6 1.7 5.8 Industrial raw materials (% change in US$ terms) 2.2 8.9 3.0 4.3 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates. The global economy is showing signs of recovery, and the main short-term risks to our forecast have receded. However, in the early stages, the recovery will remain fragile, and our forecasts still suggest that the OECD will take until late 2004 to regain a trend pace of growth. The US economy is still not generating significant numbers of new jobs, and in the euro zone, the outlook is still weak. As a result of its dependence on gold for hard-currency revenue, the Kyrgyz Republic’s export earnings had been adversely affected in recent years by weak global prices for this commodity. Global gold prices have rebounded in 2002-03, and although they will resume a downward trend in 2004-05, they will remain above US$300/troy oz. Growth in Russia—which tends to act as an economic engine for the Commonwealth of Independent States (CIS)—will remain around 4% in 2004 and 2005. This will help to offset a fall in Kyrgyz exports to Western markets—especially since Russian import demand is expected to remain solid over the forecast period.

Economic growth Kyrgyz real GDP grew by 5.1% year on year in January-September 2003, boosted by a recovery at the Kumtor gold mine, which offset the effects of a poor agricultural harvest. This has led us to raise our full-year growth forecast from 5% to 6% on the expectation of continued growth in industrial output, helped by the low basis of comparison. Real GDP growth will trend down in 2004 to 4.5%, partly as a result of less favourable external factors—such as a slowdown in Russian real GDP growth—but primarily because of rising import volumes. In turn, this is linked to industrial recovery, underpinned by a gradual but steady increase in investment from Russia and Kazakhstan. Rising real incomes will also prove a small but sustained spur to domestic growth. In 2005 the start of gold production at the Jeruy mine will push up real GDP growth to 5.5%. However, the government’s continued reluctance to tackle follow-up agricultural reform—after an aggressive start immediately after independence— remains a significant risk to our relatively conservative forecast. The agricultural sector—which has helped to prop up the economy in past years—continues to suffer from substantial problems, including insufficient liquidity. In the continued absence of follow-up reforms and restructuring, agricultural sector growth might decelerate further. With agriculture constituting 35% of GDP, this is a source of concern regarding the Kyrgyz Republic’s economic outlook over the long term.

Inflation Persistently low inflation—it was essentially flat over the January-September period—has led us to revise down our average annual inflation estimate for

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2003 to some 3%, broadly in line with the IMF’s latest forecast of 3.3%. Although we still expect sustained economic growth and rising real incomes to drive up consumer prices over the forecast period—especially in 2005, an election year— these factors will be partly offset by tight monetary policy and falling oil prices, which will reduce fuel costs.

Exchange rates The NBKR will continue to limit its interventions on the foreign-exchange market to the minimum required to smooth daily fluctuations and strengthen international reserves. Reserves remain far above the levels recorded after the 1998 regional financial crisis, and are already sufficient to cover around five months of goods and services imports. Continued reserve accumulation should permit the bank to cushion the som against seasonal pressures, and, together with low inflation, allow the currency to return to a trend of real depreciation against the US dollar.

External sector The world price for gold—the Kyrgyz Republic’s main export commodity—will fall back in 2004 and 2005, but rising output will offset the decline in prices to some extent. Moreover, we anticipate an increase in the volumes and prices of agricultural exports, as well as a recovery in electricity sales to Uzbekistan, which should also help to push up export revenue in both years of the forecast period. Electricity sales to Russia and Kazakhstan should also help to boost exports to these countries over the forecast period. Nonetheless, import costs will continue to exceed export revenue, as expenditure on capital goods picks up, owing to rising investment in the gold sector. As a result of these mutually offsetting trends, the current-account deficit will remain relatively stable in both US dollar terms and as a percentage of GDP.

Forecast summary (% unless otherwise indicated) 2002a 2003b 2004c 2005c Real GDP growth -0.5 6.0 4.5 5.5 Exports of gold ('000 kilograms) 25 26 27 28 Consumer price inflation (av) 2.1 3.0 2.7 3.6 Lending rate 36.2 33.0 32.0 30.0 Government balance (% of GDP) -1.1 -0.6 -0.5 -0.7 Exports of goods fob (US$ m) 498 582 604 639 Imports of goods fob (US$ m) -552 -636 -656 -707 Current-account balance (US$ m) -85 -69 -71 -76 Current-account balance (% of GDP) -5.3 -3.4 -3.4 -3.5 Exchange rate Som:US$ 46.94 44.70 46.00 48.00 Exchange rate Som:€ 44.35 50.60 56.58 56.88 Exchange rate Som:Rb 1.50 1.45 1.44 1.41 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

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The political scene

Mr Akayev might still extend In recent months, media speculation in the Kyrgyz Republic has mounted as to his term whether the president, Askar Akayev, will attempt to stay in office when his term ends in December 2005. There is a risk that he might try to hold on to power, either through further changes to the constitution, or by priming a loyal successor (from within his own family or from among the leading political figures in the government and presidential apparatus) who could be relied on to protect the interests of the Akayev family. The authorities are currently intensifying their efforts to crush the radical opposition—in particular, the Ar- Namys (Dignity) party—and are intent on making more changes to the electoral code. The Economist Intelligence Unit therefore regards the first scenario—an extension of the president’s term through constitutional amendments—as increasingly plausible. Notwithstanding Mr Akayev’s frequent affirmations that he intends to retire from politics to concentrate on his scientific studies—or the denials of his wife, Mayram Akayeva, that she has aspirations to replace him—the authoritarian measures Mr Akayev has taken in 2003 to strengthen the presidency and handicap opposition parties suggest a certain disingenuousness on his part. In February Mr Akayev managed in a nationwide referendum to secure public approval for constitutional amendments that increased his powers at the expense of parliament and made it more difficult for political parties to gain seats in the legislature (August 2003, page 13). Since then, rumours have surfaced that the Committee for State Structure, Lawfulness and Constitutional Legislation in parliament’s upper house is examining the legality of the president making a bid for a third term in office. In September, participants of the Congress of Association of Kyrgyz Entrepreneurs called on Mr Akayev to run as a candidate in the 2005 presidential election so that he could complete the reforms that he started. The authenticity of this type of public endorsement of the leadership has been greeted with scepticism by some opposition politicians, who see it as an

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attempt by the authorities to fix the notion of Mr Akayev’s enduring leadership in the public mind.

Ar-Namys broadens its The government’s increasingly harsh attitude towards Ar-Namys provides an constituency even clearer indication that Mr Akayev perceives the party as a serious challenger in future parliamentary and presidential elections, which are to be held in February and December 2005, respectively. Mr Akayev appears to be particularly concerned about the party’s leader, Feliks Kulov, who has been in prison on charges of corruption since the announcement of his candidacy for the October 2000 presidential elections. Incarceration has only served to increase Mr Kulov’s popularity. His outspoken criticism of the government’s mishandling of the economy, of the Ak-Suu killings and of Mr Akayev’s increasing authoritarianism, have brought Mr Kulov new supporters in the south of the country, where the Ak-Suu riots took place. People living in the south have traditionally felt excluded from political processes. The majority of politicians in power—including Mr Akayev and those who might replace him— represent the interests of the northern regions and clans, and have thus far done little to appeal to southern constituencies. Mr Kulov’s efforts to appeal to southerners could therefore increase his chances of being able to challenge Mr Akayev.

It is unlikely that Mr Kulov Although a recent poll undertaken in the Kyrgyz Republic has shown that will be released public recognition of political parties is poor, Ar-Namys is the best known among them. The party has also gained much publicity abroad for the plight of its leader. For instance, in early October members of Ar-Namys in exile picketed the UN headquarters in New York, where Mr Akayev was speaking at the 58th Session of the organisation’s General Assembly. Moreover, Mr Kulov’s international profile and image as the defender of democracy in the Kyrgyz Republic may well be enhanced by his inclusion in the list of nominees for the Sakharov Prize for Freedom of Thought. This popularity will only reduce further any prospects for Mr Kulov’s release from prison before the next elections—despite increased lobbying on this point by international human rights organisations, the US Congress and the European Parliament. Mr Kulov appealed to the Kyrgyz Supreme Court to overturn his conviction for embezzlement, but the outcome of the court’s review in August— confirming that the verdict against him was correct—was a foregone conclusion, given the executive’s influence over the judiciary. A further obstacle was placed in Mr Kulov’s way in September as a result of Mr Akayev’s revisions to the law on amnesty—ahead of the release of 7,000 offenders—whereby perpetrators of economic crimes will be required, once amnestied, to repay to the state one- third of the sum for which they were convicted of stealing. Moreover, the authorities have intensified their campaign against Ar-Namys by targeting other members of the party’s leadership. In May a member of the party’s political council, Tynchtykbek Dulatov, was arrested on dubious charges of kidnap at a polling station during the February referendum. In late July the party’s deputy chairman, Emil Aliyev, was arrested on equally suspect charges of embezzlement, following his open criticism of Mr Akayev’s harassment of political opponents. Although in the past Mr Akayev has not personally vilified

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his opponents, at the fourth roundtable talks between the government and political parties and non-governmental organisations (NGOs)—the latest in a series of meetings that the opposition claims are designed to appease the international community—he took pains to discredit the leaders of Ar-Namys.

The opposition’s access to Stronger tactics are also being employed by the authorities to control the media is curtailed independent media, thereby curtailing the opposition’s opportunities to air their views. A new initiative to create a Media Council—ostensibly to arbitrate in disputes between the authorities and the media—is expected in reality to provide the government with yet another means of restricting the freedom of expression of independent journalists. More significantly, the electoral code is being changed to disqualify from running those election candidates who use the foreign media to publicise their manifestos. The opposition will suffer from this measure, since the closure of several local independent newspapers has meant that it has become more reliant upon coverage in Russian-owned papers, which enjoy wide circulation in the Kyrgyz Republic. The new measure will make it extremely difficult for opposition candidates to campaign effectively in the run up to the 2005 elections. In the light of this, the pace at which the government is expediting expansion of the national broadcast system so that it will cover the whole population by next year suggests that Mr Akayev is seeking to make certain his advantage in the forthcoming campaign. Despite these increased difficulties, the resolve of the opposition to challenge the government on its policies and end Mr Akayev’s rule has not been broken, even if their ability to do so remains weak and at the level of vocal criticism only. Leaders of the main opposition parties, including the Movement for the Resignation of Akayev, and Reforms for the People, held their August Congress in Ak-Suu. The main agenda centred on creating a political and economic programme that would attract public support, and the elaboration of strategies in preparation for the elections in two years’ time. However, the main obstacle to development of a common strategy remains a lack of unity on specific issues of economic policy.

A multi-vectoral approach is Despite the government’s acknowledgement that the threat of large-scale reaffirmed aggression against the Kyrgyz Republic has lessened, armed incursions by small groups of terrorists and radical Islamists are still perceived to present a continuing menace. Consequently, the republic is maintaining its efforts to develop security relations simultaneously with all three major powers in the region—Russia, China and the US—and to downplay the contradictions of that policy. In return, the Kyrgyz Republic is accruing significant financial rewards, both in terms of aid and vital investment in various impoverished sectors of the economy (which may help Mr Akayev to improve stability), as well as in assistance to re-equip and train its own military forces.

Russian base brings promise of The deal to allow the reinforcement of the permanent military airbase at Kant investment by Russian forces acting on behalf of the Collective Security Treaty Organisation (CSTO) is mutually beneficial on several levels. It provides tangible economic advantages for the Kyrgyz Republic and strategic ones for Russia that are arguably as important to both sides as the security aspects. In

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September Mr Akayev met the Russian president, Vladimir Putin, partly to lobby for a boost in Russian investment in Kyrgyz industry. The visit appears to have been a success, since Mr Putin’s inauguration of the base in October was accompanied by a bilateral economic summit at which plans for further investment by Russia’s regions in Kyrgyz agriculture, water resources and the privatisation of military and energy enterprises were put forward. In addition, favourable conditions for Kyrgyz labour migrants—which constitute one-tenth of the republic’s population—to work in Russia were agreed. The security gains from the establishment of the Russian base are an extra deterrence to would-be terrorists—a deterrence that the US-led forces’ base at Manas airport has provided alone up until now. The Russian agreement has also raised the status of the Kyrgyz Republic to the level of a “strategic ally” of Russia. For Russia, Kant represents something of a recovery of its strategic reach in Central Asia—weakened by the collapse of the USSR—and is seen by the Russian Ministry of Defence as a first step to an increased regional presence.

US forces will remain at While on his visit to Moscow, Mr Akayev made veiled criticisms of the US Manas presence in the Kyrgyz Republic and of its strategic aims, even though Russia has officially accepted the need for continued stabilisation efforts in Afghanistan. Mr Akayev is likely to have wanted to convey to his Russian counterpart that, in contrast with the permanent status of the Russian airbase on Kyrgyz territory, the coalition’s presence is only temporary. However, Mr Akayev’s comments should not be taken at face value, since it would not be in the Kyrgyz Republic’s interest for the Western forces to withdraw. The US is reported to have paid thus far US$80m to modernise Manas airbase—now renamed the Peter Ganci airbase—with US$6m being allocated in 2003 for military and technical aid, and additional sums earmarked to tighten border security. In any event, the authorisation appears to have been given in September for an extension to the mandate of the coalition forces for a further three years, although the size of the contingent has recently been halved.

Hizb-ut-Tahrir is still a source Although the Kyrgyz government has been making considerable efforts to of concern protect the state from attacks by armed militants belonging to groups based outside of the Kyrgyz Republic—such as the Islamic Party of Turkestan (formerly called the Islamic Movement of Uzbekistan) and the Uighur Liberation Organisation—it maintains that the greatest threat is from within, in the shape of Hizb-ut-Tahrir (Party of Freedom). This banned grouping has a political agenda, which centres on garnering support from sections of the population who are socially and economically vulnerable in order to bring about regime change. The organisation is now thought to comprise 2,000 small cells actively engaged in spreading anti-government propaganda. As Hizb-ut-Tahrir’s support base in the country has reportedly spread over the past year or so, the security services have increasingly sought to portray it as a terrorist organisation, rather than as one that is merely subversive. They claim that the party has links to al-Qaida and the Islamic Party of Turkestan, and that it is prepared to use force to bring about the government’s downfall. In particular, Hizb-ut-Tahrir has been blamed for perpetrating several violent attacks against officials in public places this year, although the evidence for this

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appears to be based more on conjecture than fact. Moreover, the government has now alleged that human rights activists and political opposition members have formed connections with Hizb-ut-Tahrir with the intention of carrying out acts of sabotage and terrorism in the republic. Such accusations not only cast doubt on the charges already brought against Hizb-ut-Tahrir members, but also suggest that a larger crackdown by the security services against all dissenters—in the name of maintaining stability—is imminent.

Tensions over Uzbek border Tensions have been increasing between the Kyrgyz Republic and Uzbekistan in increase recent months over the latter’s delaying tactics in talks over border demarcation, and over further deaths of ethnic Kyrgyz from landmines laid on the joint frontier. Border delimitation negotiations inched forward in August, when delineation of half of the 1,295-km-long frontier was agreed, and a protocol signed to speed up approval of the rest of the border by the end of 2003. However, the two countries have held over 40 meetings on this issue in the past three years and an early completion of the matter is highly unlikely. A dispute arose recently in the Uzbek enclave of Sokh, which is located on Kyrgyz territory, over the re-erection of a border post. In March the post had temporarily been transferred to a different location, but after it reappeared villagers demanded its removal and blocked part of the Osh-Batken highway in protest. This led to irate exchanges between the authorities in the Ferghana region in Uzbekistan and the Batken region on the Kyrgyz side. Boundaries are an emotive issue in Central Asia, and the Kyrgyz government caused an outcry in 2001 when it agreed to surrender this district in return for land from the Tayan region in Uzbekistan. Further deaths and injuries of Kyrgyz nationals from Uzbek mines in the border areas of South Batken in late October have added to the current friction. Uzbekistan did not respond to demands made by the Kyrgyz Ministry of Foreign Affairs this summer to clear the mines, which were laid at in 1999 in order to prevent armed Islamic radicals entering Uzbek territory.

Economic policy

Budget could go off track after Although the Kyrgyz Republic recorded a budget surplus in January-August, and disappointing tax performance the Kyrgyz government was praised by the IMF for its economic policy achievements in July, by end-August the IMF had altered its view that the 2003 budget was on target, warning instead that state expenditure was in danger of overshooting revenue considerably. The prime minister, Nikolai Tanayev, conceded that budget revisions would be necessary in the light of a resolution increasing social payments by Som800m (US$19m), and because of unexpected costs caused by a series of natural disasters. In October parliament announced its revisions to the budget, with state revenue set at Som13.8bn (US$330m) and expenditure at Som14bn. This will result in a deficit of Som124m, or 0.15% of GDP. However, the IMF believes that loss of control over spending, as well as lower than expected tax revenue, could widen the budget deficit to Som1.3bn by the end of the year, equal to 1.5% of GDP.

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Earlier in the year the government introduced a new property tax and a higher, 20% rate of value-added tax (VAT) on the sales of large agricultural producers, in order to broaden the tax base and increase tax revenue. However, the implementation of both taxes, as well as collection performance, has been inadequate, leading to the IMF’s doubt as to the feasibility of the government’s budget projections. Moreover, additional tax measures are unlikely to yield better results. In October the government introduced a sales tax on the turnover of the country’s 10,000 market traders, designed to add an estimated Som80m to the state coffers and inhibit the workings of the shadow economy. The announcement of this measure was poorly received, however, and resulted in strikes by traders. The avoidance rate will almost certainly be high, and the new tax is also likely to have a knock-on effect on consumer prices.

Consolidated government operations, Jan-Aug (Som m, cumulative) 2002 2003 Total revenue and grants 8,496 9,681 Total revenue 8,004 9,512 Current revenue 7,937 9,492 Tax revenue 6,286 7,157 Income tax 692 775 Profit tax 531 577 Value added tax 2,861 3,173 Excise taxes 659 721 International trade taxes 252 265 Non-tax revenue 1,652 2,335 Capital revenue 67 20 Grants 492 169 Expenditure 8,690 9,439 Administration, defense & Internal security 2,287 2,789 Education 2,107 2,188 Health care 951 888 Social insurance and security 1,406 1,531 Housing and public utilities 657 712 Leisure, cultural and religious activities n/a 265 Subsidies to economic sectors 999 832 Budget balance -194 242 Internal financing -98 -315 External financing 539 370

Source: National Statistical Committee (NSC).

Budgetary strategy appears The draft budget for 2004, which features projected increases in both state contradictory revenue and state expenditure compared to 2003, was approved by parliament in October. Revenue is to total Som14.1bn and expenditure Som14.7bn, producing a deficit of Som561m—or some 0.6% of GDP, using the Economist Intelligence Unit’s nominal GDP forecast. However, revenue again hinges on achieving substantially increased proceeds from taxes, and the government continues to rely on foreign grants and credits to finance the budget deficit. This strategy does not seem consistent with its aim of paying off the Kyrgyz Republic’s debt to the IMF by 2004—after which the government would seek a Paris Club debt write-off amounting to US$450m.

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The draft also reflects the aims set out by the president, Askar Akayev, to achieve strong economic results before the presidential and parliamentary elections in 2005—which in turn might bolster his popularity and help him to remain in power beyond his allotted term of office. The 2004 budget centres on increased social payments and wages: Som6.46bn, or 44% of total state expenditure, is being allocated to social spending, with Som500m set aside for a 30% pay increase for teachers and doctors. Some deputies lobbied for an even higher salary increase of 50% for public-sector workers, but the government rejected this proposal as unfeasible. Pensions are also to be increased. These policies are designed to achieve Mr Akayev’s ambitious objective, stated at his annual address to the nation in October, to increase the population’s real incomes by 100% by the end of the decade. The larger spend could conceivably be partly offset by a corresponding slashing of expenditure on the state administration, but the government has been vague as to where the economising is likely to take place.

New body set up to tackle Another source of potential concern related to the Kyrgyz Republic’s govern- electricity problems ment finances is the quasi-fiscal deficit in the energy sector. As in other former republics of the USSR, the Soviet legacy of cheap energy for both consumers and industrial users has been a politically difficult one to address. In effect, Kyrgyzenergo, the electricity generating company, subsidises the rest of the economy, not only by operating at or below cost-recovery levels, but also by allowing substantial build-ups in arrears. As of November, energy arrears in Osh alone—the Kyrgyz Republic’s second-largest city—amounted to Som126m, and the total quasi-fiscal deficit of the electricity sector in 2002 was equivalent to some 13% of GDP. The Kyrgyz Republic aims to bring down this deficit to below 7% of GDP by 2006, and to this end the president has established a new post, of special representative of the president on electropower safety, which carries with it the status of deputy prime minister. The special representative is to supervise the enforcement of payment compliance, oversee tariff increases, and elaborate a system to cushion the impact of these measures on low-income consumers.

Government seeks to promote A key focus of the government’s strategy for growth is export promotion, energy exports to the CIS particularly of processed goods and energy resources. Over the past two years, the Kyrgyz Republic’s trade with countries in the World Trade Organisation (WTO) has risen sharply at the expense of that with the Commonwealth of Independent States (CIS), although Kyrgyz industry remains unable to compete with producers of finished goods in developed markets. Indeed, the Kyrgyz Republic’s membership of the WTO has not brought any practical advantages, given that its main trade partners in the CIS—most notably Russia—are not also members. The government hopes that China’s entry into the WTO will eventually allow the Kyrgyz Republic to position itself as a gateway to the east. However, it is doubtful whether the Kyrgyz Republic’s membership of the WTO will on its own make the country sufficiently attractive to compete with Russia and Kazakhstan as entry points to China. Therefore, despite the continuing problem of illegal trade barriers with neighbouring countries, the

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government is relying on achieving higher volumes of commodity and energy exports to the CIS. Such a strategy necessitates improved trade co-operation within the CIS, something that has thus far proved elusive. In particular, the Kyrgyz Republic is in direct competition with both Uzbekistan and Tajikistan in terms of key exports (cotton and hydroelectricity, respectively). As a result, although official commitment to Central Asian regional organisations is strong, the government is aware that a more pragmatic approach is likely to yield better results, and has focused on improving trade with Russia and Kazakhstan—the latter being both an export destination and a transit route for Kyrgyz exports to the former. Recent political co-operation between Russia and the Kyrgyz Republic has encouraged further economic links, building on Russian investment in the Kyrgyz military-technical sector. The Kyrgyz Republic has signed agreements on gas and electricity exports to the Russian regions with the Russian electricity and gas monopolies, United Energy System (UES) and Gazprom.

Six areas are to be made more The development of potential export sectors is also to be accomplished by attractive for foreign investors attracting greater foreign direct investment (FDI) into the Kyrgyz Republic. The government has in the past relied on loans and trade credits to finance investment in manufacturing, but this has proved an insufficient source of funds, amounting to only 7% of GDP. The government has sought to simplify the visa regime, as well as to remove administrative barriers and restrictions on entrepreneurs in order to encourage foreign investors to the country. However, these measures have had little impact, as pervasive corruption and a lack of attractive opportunities have thus far kept investors away. The government nonetheless hopes to attract FDI into six areas, of which two— hydroelectric power and gold mining—are already key sectors in this respect. The other four sectors targeted are tourism, financial services, information technology (IT) and agro-processing. Of these, agro-processing is probably the one with the most realistic prospects, as there is already substantial Russian and Kazakh investment into the sector.

Main economic policy indicators Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Central budget revenue (Som m) 2001 763 826 909 863 1,199 1,016 1,150 1,029 853 935 1,136 1,863 2002 675 975 1,200 1,162 982 1,177 1,059 1,266 1,528 1,115 1,226 2,028 2003 821 943 1,123 1,685 1,195 1,345 1,294 - - - - - Central budget expenditure (Som m) 2001 580 759 890 858 867 851 1,030 1,167 782 1,470 1,349 1,654 2002 523 942 1,325 1,004 1,117 1,316 1,137 1,327 1,177 1,443 1,374 2,506 2003 723 942 1,020 1,365 1,361 1,254 1,483 - - - - - Central budget balance (Som m) 2001 183 68 19 5 332 164 120 -138 71 -535 -213 209 2002 152 33 -124 158 -135 -139 -78 -61 351 -329 -149 -478 2003 98 0 103 320 -165 90 -190 - - - - -

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Main economic policy indicators Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate (Som:US$; av) 2001 48.70 49.07 49.27 48.70 49.30 48.54 47.78 47.82 47.73 47.77 47.90 47.94 2002 47.97 47.85 47.92 47.97 47.95 47.10 46.09 46.12 46.07 46.01 46.03 46.17 2003 46.45 46.12 45.52 44.68 43.28 41.53 42.32 - - - - - Real effective exchange-rate index (CPI-based; 1997=100) 2001 65.7 66.5 66.5 68.1 69.7 70.9 70.2 67.3 67.1 67.4 68.1 69.1 2002 69.3 70.0 69.4 68.9 69.2 70.5 69.2 69.1 69.1 68.7 68.3 68.6 2003 67.3 67.5 68.3 70.8 73.4 73.8 69.8 71.1 - - - - Real effective exchange-rate index (PPI-based; 1997=100) 2001 80.7 83.4 86.6 87.4 88.2 91.1 93.8 91.6 91.9 92.2 92.8 94.1 2002 94.1 95.2 96.2 96.4 95.3 98.8 98.8 95.9 97.0 96.6 95.9 96.2 2003 95.5 95.2 92.7 94.6 97.0 98.8 96.4 - - - - - M2 (Som m) 2001 7,193 7,102 7,159 7,207 7,004 6,991 7,272 7,389 7,627 7,701 7,840 8,234 2002 8,226 8,432 8,725 8,758 8,978 8,863 9,160 9,512 9,896 10,571 10,795 11,023 2003 11,646 11,477 11,511 11,756 12,074 11,922 12,416 - - - - - M2 (% change, year on year) 2001 12.1 9.6 11.1 10.1 5.8 0.9 1.1 -0.5 4.7 -0.5 6.3 11.3 2002 14.4 18.7 21.9 21.5 28.2 26.8 26.0 28.7 29.7 37.3 37.7 33.9 2003 41.6 36.1 31.9 34.2 34.5 34.5 35.5 - - - - - Commercial bank lending rate (av; %) 2001 46.6 39.4 45.0 38.6 42.6 40.6 34.9 43.9 35.6 40.9 40.4 37.3 2002 41.0 41.8 39.9 39.4 37.1 36.5 35.5 37.2 34.8 35.5 31.3 24.8 2003 24.3 24.6 34.1 28.3 19.6 17.6 ------Commercial bank deposit rate (av; %) 2001 17.2 18.6 15.2 16.6 12.1 14.2 12.3 11.4 12.3 11.2 10.7 12.5 2002 10.3 10.4 8.6 7.7 7.6 7.4 7.5 6.8 7.9 7.7 6.9 5.9 2003 6.4 6.2 5.5 6.6 5.4 5.3 ------

Source: IMF, International Financial Statistics.

The domestic economy

Economic trends

Real GDP growth accelerates to Economic expansion in the Kyrgyz Republic has proceeded unevenly in 2003, to 5.1% in January-September a large extent because of the country’s considerable dependence on the Kumtor gold mining facility. Since the construction of the mine was completed in the mid-1990s, Kumtor has accounted for around 40% of industrial production. Kumtor output during the first half of 2003 continued to suffer as a result of an accident experienced at the mine in mid-2002, but the recovery of production in the third quarter of 2003 brought a rapid acceleration in real GDP growth. After growing by 2.3% year on year in January-June, the Kyrgyz economy expanded by 5.1% in January-September, according to the National Statistical Committee (NSC).

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Basic data, Jan-Sep 2003 (% change, year on year) GDP 5.1 Industrial production 14.0 excl Kumtor production 9.6 Agricultural production 0.6a Construction 0.5 a Gross output, including hunting and forestry. Source: National Statistical Committee (NSC).

Kumtor, electricity and The nine-month data confirm that Kumtor has once again assumed its role as a domestic demand spur growth leading driver of economic growth—particularly as the agricultural sector suffered a sharp fall in output during the third quarter of 2003, and much of the manufacturing sector continues to stagnate (see Sectoral trends). Disaggregated official data explicitly quantify Kumtor’s significance, showing that, excluding Kumtor, the industrial sector grew by 9.6% year on year in January-September, compared with a 14% rise in industrial production when the mine is included in the data. Similarly, when Kumtor output was stagnant during the first half of the year, the 14% year-on-year industrial growth recorded outside Kumtor dwarfed the 2.5% growth in industrial output recorded once the mine was included. The relatively strong growth shown by the January-September data reflected a rebound in the construction sector, which had slumped by almost 5% during the first half of 2003, but which was up marginally in the first nine months of the year. The nine-month performance also reflected the ongoing expansion in output in the electricity sector, one of the country’s most important industries. In addition, services continued to grow strongly, helped by rising incomes and the presence of Western and Russian military forces in the country. During the first three quarters of the year, retail trade turnover rose by 12% year on year, and hotel and restaurant services grew by more than one-quarter.

Cabinet raises forecast, but In anticipation of a significant upturn during the second half of the year, the growth is still a concern government raised its 2003 annual growth target from 5.2% to 5.8-6% at the

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beginning of August. Growth rates such as these are insufficient if the Kyrgyz Republic is to not only recover from the years of post-Soviet decline, but also to catch up, even with the rest of the region. Kyrgyz growth in the first nine months of 2003 was the slowest in the Commonwealth of Independent States (CIS). This includes not just countries such as Tajikistan, which grow strongly because they are starting from an extremely low base, but also more developed countries such as Kazakhstan and Russia, where growth rates might be expected to be moderate. Furthermore, concerns over the sustainability of the Kyrgyz Republic’s current patterns of growth persist. These concerns reflect limited diversification away from an excessive dependence on Kumtor, the slow pace of reforms in the banking sector, and the continued fragility of the agricultural sector (as underlined by the 2003 harvest results). Perhaps most seriously, investment in the economy remains well below what is needed to modernise the largely obsolete infrastructure inherited from the Soviet Union. Capital investment during the first half of the year fell by 6.4% year on year, at Som2.8bn (US$67m). Of this, only Som820m (US$20m) was spent on new equipment. The country’s capital stock has declined steadily since independence, and gross investment, at under 20% of GDP, remains inadequate to boost the competitiveness of non- gold parts of the economy.

Unemployment falls as real In line with the economy’s expansion, the number of unemployed workers incomes rise was down slightly, according to the NSC, to 88,400 by October 1st, compared with 101,400 a year earlier. The number of workers officially classified as unemployed is far lower, at under 60,000. These data reflect the fact that few workers bother to register with unemployment offices, given the low chance of securing benefits (well under 10% of those who are officially unemployed receive any sort of benefits). Among the employed, however, living standards are rising. The latest headline data report an average monthly wage of Som1,775 (US$35) during the first half of 2003. This is roughly one-tenth more than the minimum consumer budget, which the authorities assessed at Som1,524 in January-September. Neverthess, salaries are rising relatively sharply, and the first-half average monthly wage was 18.5% higher than during the year-earlier period. Given relatively low rates of price inflation, this translates into considerable real wage growth and a notable rise in average real incomes— which in turn has helped to fuel domestic consumption demand. The ongoing rise in real incomes is helping to alleviate the acute poverty problems that have proliferated in the Kyrgyz Republic since independence. Poverty has emerged as a particular concern in remote rural areas. Although poverty rates have eased moderately since the late 1990s, almost half of the population is still estimated to live below the poverty line. Moreover, the recent strong rise in real wages has not been evenly distributed, with wages in relatively low-paying sectors, such as health and agriculture, increasing far more slowly than elsewhere. Wages in these sectors are still only around half of the national average. A similar disparity is also apparent across regions, with poverty particularly severe in the least industrialised regions, such as Naryn in the north-east and the agricultural regions in the south. Moreover, despite three years of relative currency stability and strong increases in wage rates, in

US dollar, terms Kyrgyz wages remain low, even by comparison with wages elsewhere in the region. In the first half of 2003 the average monthly wage in neighbouring Kazakhstan was US$145, and it was US$160 in Russia.

Deflation in June-September Cumulative consumer price inflation over the first nine months of 2003 was cancels out earlier price rises essentially flat. This compares with a cumulative increase in prices of around 4.5% in January-May, and reflects seasonal deflation during the harvest period in June-September. The consumer price deflation recorded this year in June- September reflected a marginal decline in prices for non-food goods in June and July, partly attributable to lower fuel prices, but mostly to four straight months of sharply falling food prices. Although prices for less seasonally sensitive food products—such as meats, fish, dairy goods and sugar—remained relatively stable, prices for fruit fell by a cumulative 40% in July-September, and for vegetables, by two-thirds in June-September. As a result, by September prices for food were 2.4% down on those at the start of the year, while non- food prices were essentially unchanged. The most significant price changes since the start of the year were in services, which rose at a double-digit rate between January and September. This was almost entirely the result of a sharp rise in telephone tariffs in July and August, with official data showing a 7% rise each month in communications prices. In contrast, household tariffs (for water, electricity and fuel) have remained relatively steady. The government has now promised not to change electricity tariffs over the remainder of the year, and has lowered its 2003 inflation forecast from 4% to 3.3%.

Consumer prices, 2003 (% change since Jan 1st) Jan Feb Mar Apr May Jun Jul Aug Sep Total 0.9 1.3 2.0 3.0 4.5 2.5 0.8 0.1 0.0 Food 1.4 2.3 3.7 5.9 8.9 5.6 1.2 -1.6 -2.4 Non-food 0.0 -0.3 -0.7 -1.1 -1.6 -1.9 -2.0 -0.8 0.3 Services 0.9 1.3 1.3 1.2 1.1 1.2 7.5 12.3 12.5

Source: NSC.

The Som weakens slightly, but The Kyrgyz currency, the som, has weakened marginally against the US dollar is still stronger than in January since the middle of 2003, but in early October was still around 8% stronger than at the start of the year. The som’s continued strength—it has been appreciating against the US dollar for over two years now—reflects currency stability within the region, a relatively sound mix of fiscal and monetary policy, and greater macroeconomic stability. The som’s strengthening against the US dollar is also a reflection of the relative weakness of the latter on world currency markets over the past year. In contrast to its performance against the US dollar, the som has weakened against the euro.

Sectoral trends

Manufacturing struggles in the Industrial production in January-June grew by only 2.5% year on year, first half constrained by low levels of output at the Kumtor mine. The slump in Kumtor production resulted in a contraction of almost 9% in the metallurgy sector (itself caused by a 10.2% fall in gold refining), which accounts for more than half of total manufacturing output. Consequently, manufacturing output as a whole fell by 1.4% year on year in January-June. A more significant fall was only prevented by the strong showing of the agro-processing sector, which accounts for more than 20% of manufacturing output; food production rose at a double- digit rate over the first half of the year. The food sector is one of the few with the potential to attract foreign investment, and Russian companies—including Wimm-Bill-Dann—are already well established. Outside of food-processing and gold refining, the rest of Kyrgyz manufacturing is relatively small, with sectors such as rubber and plastics, chemicals and oil products each accounting for only around 1-2% of total manufacturing output over the first half of 2003. Most of these sectors—particularly light industries, such as textiles—posted a year-on- year decline in output in this period.

Manufacturing production, 2003 (% change year on year) Jan-Mar Jan-Jun Food 10.7 12.9 Textiles & garments -26.5 -15.4 Leather -6.8 -22.4 Oil products -0.3 -17.1 Chemicals 8.5 11.2 Rubber & plastic products 9.9 -3.1 Metallurgy 4.4 -8.5 Engineering 4 -1.7 Electrical & electronic equipment 13.3 12.4 Total 6.2 -1.4

Source: Interfax, Statistical Report.

Third-quarter data improve More recent data for the third quarter of 2003 suggest that a pick-up in Kumtor because of a pick-up in gold production reversed the industrial sector’s poor showing of the first half of the year. Industrial production growth accelerated sharply from mid-year, rising by 10.8% in January-August and by 14% in January-September. Kumtor’s role in this has been decisive: Kumtor production in January-May had fallen by more than 10% to around 6.96 tonnes, but by July, cumulative production since the start of the year was up by nearly 7%, at 10.36 tonnes. The upturn in Kumtor production translated into a 4.6% rise in total Kyrgyz gold output (to 11.14 tonnes) in January-July—in contrast to the double-digit decline recorded during the first five months of 2003.

Diversification away from The fact that Kumtor still accounts for 90% of total gold production underlines Kumtor proceeds slowly the government’s slow progress in encouraging the development of new mines. Kyrgyzaltyn, the state-controlled company that owns the majority stake in Kumtor, is involved in three other mines, but these are substantially smaller than Kumtor. The mine at Makmal is expected to produce only around 1.4-

1.5 tonnes of gold in 2003, slightly above what was produced in 2002 (in contrast, Kumtor will produce over 20 tonnes). Moreover, the reserves accessible through open-pit mining at Makmal are by now almost exhausted, and only limited additional reserves are available through underground mining. The mines at Soltan-Sory and Tereksay produced less than 200 kg of gold in 2002, and output at Tereksay is only expected to rise to over 2 tonnes annually beginning in 2004. Expenditure on exploring potential new gold sites is reported to have fallen to a record low in 2002, with only a handful of foreign players conducting at most limited explorations. With open-cast mining at Kumtor not expected to continue for more than another five or six years, the government urgently needs to develop a number of alternative goldfields including, for example, the one at Taldy-Bulak in the Chui region. However, Kyrgyzaltyn, which received the licence to the mine in late 2002, has yet to mobilise the investment resources needed to develop the lode, and it appears unlikely that the mine will begin commercial extraction before 2005 at the earliest. The Taldy-Bulak mine consists of estimated gold reserves of around 100 tonnes.

Construction starts at Jeruy The Kyrgyz authorities have had more success in Jeruy, a gold deposit in the Talas region that will help to diversify away from excessive reliance on Kumtor. The mine is two-thirds owned by the Norox Mining Company, a subsidiary of Oxus Mining (UK), with the remainder owned by Kyrgyzaltyn. According to Oxus, preliminary construction at Jeruy is now under way, with gold production due to start by mid-2005. Total annual output is expected to be 180,000 oz over the 11-year life of the mine. The start of construction comes following the completion of a feasibility study in August. The study estimated the need for around US$60m in capital expenditure, and reported that the main construction phase at the mine could start in April 2004. The Jeruy mine could produce in excess of 2.5 tonnes annually thereafter. The Jeruy and Taldy-Bulak deposits—together with Kumtor and a fourth deposit at Ishtamberdy—account for more than 80% of the Kyrgyz Republic’s total explored reserves of just under 390 tonnes.

Electricity output is up, and Aside from gold, the only other industrial sector attracting significant foreign export possibilities expand investment is electricity. This remains one of the largest sectors in the country. Output—at least from hydroelectric facilities—has been growing strongly so far in 2003, albeit from a very low base. In 2002 electricity output had fallen by almost 15%, as a result of a sharp fall in sales to neighbouring markets. During the first three quarters of 2003, electricity output rose by 16% year on year, to 9.5bn kwh, as a result of greater export potential. Around 1.1bn kwh was exported during this period, or double the year-earlier volumes. The Kyrgyz Republic plans to produce just under 13.2bn kwh of electricity in 2003, up from 11.8bn kwh in 2002. Disaggregated data for January-August 2003 show that around half of electricity exports during this period went to Kazakhstan, with the bulk of the remainder going to Uzbekistan and Tajikistan, and a small portion to China. As of September, exports also begun to Russia from the Toktogulsk hydroelectric plant in the north-west of the country, via Kazakhstan. These are set to climb

significantly in coming years, with the two sides reported to have agreed to a long-term supply contract in September. This sort of agreement could lead to as much as 1.5bn-2bn kwh being exported annually to Russia alone. The Kyrgyz Republic is also reported to be in talks with Tajikistan and Kazakhstan over the possibility of long-term contracts to supply a combined 3bn kwh of electricity annually. Kyrgyz export capacity will rise substantially once a number of hydroelectric projects are completed, most notably the Kambarata 2 hydroelectric plant on the Naryn river. When completed (the second plant is only around 30% finished), the Kambarata plants could produce more than 6bn kwh of hydroelectric power annually.

Agriculture slumps in As a result of a sharp year-on-year decline in September, output in the September agricultural sector was only marginally up during the first three quarters of 2003, compared with the year-earlier period. Agricultural production rose by 4.1% in January-August in real terms, but was only 0.6% up year on year in January-September. The effect that September had in dragging down output for the first three quarters of 2003 as a whole is a function of the fact that it is by far the most important month for three major crops—vegetables, tobacco and potatoes. September is also one of the three harvest months for grain, which is the country’s most important crop, accounting for almost 60% of the Kyrgyz Republic’s 1.195m ha of cultivated land. None of these major crops performed well this year. The volume of the grain harvest was down by 9% as of the end of September, which reflects both inclement weather—including heavy rains, floods and landslides in the south of the country during the spring growing season—and a reduction in the area planted to grain. It also reflects a shift by Kyrgyz farmers away from grain and towards more profitable crops, in the wake of their experience in 2002, when the large harvest pushed down prices for food grain. This shift by producers has resulted in a significant increase in the area planted to cotton, tobacco, potatoes, sugarbeet and vegetables, at the expense of grain crops. However, most of these other crops performed poorly in 2003 as well. Vegetables were down by almost one-quarter, cotton by almost 20%, tobacco by around 10%, and the potato harvest by 7% (potatoes are the second most important crop in the country). The only crop that saw any year-on-year improvement was sugarbeet, which was up by around one half as of the end of September. However, this represents only a fraction of the annual harvest, as most of the crop is harvested in October and November.

Animal husbandry products Animal husbandry is traditionally an important part of the Kyrgyz agricultural help to mitigate a poor harvest sector. Although it has declined in importance since independence, it still contributes significantly to overall production. In 2002, for instance, the value of animal husbandry products was equal to around three-quarters of the total value of crop production. So far in 2003 animal husbandry has helped to ensure at least some expansion in agricultural output, with meat and milk production rising by just under 2% in January-September, and eggs by over 10%. Wool production was unchanged year on year.

Gross agricultural output, Jan-Sep ('000 tonnes, unless otherwise indicated) 2002 2003 Meat 244.6 248.4 Milk 911.8 928.1 Eggs (m tonnes) 193.1 213.9 Wool 11.6 11.6 Grains 1,737.6 1,582.1 Potatoes 929.0 868.9 Vegetables 704.1 530.9 Cotton 73.9 60.4 Tobacco 6.5 5.8 Sugarbeet 5.5 8.5

Source: National Statistical Committee (NSC).

Agriculture remains the More so than in almost all other former Soviet republics, the agricultural sector backbone of the economy remains critically important in the Kyrgyz Republic. Total agricultural output during the first three quarters of 2003 was Som40.8bn (US$97om), compared with Som35.7bn in industrial output produced during this period. Moreover, during the industrial collapse that followed the break-up of the Soviet Union and the centrally planned system, the agricultural sector actually increased in importance, particularly as it offered a vital safety net for many unemployed workers displaced by the post-Soviet dislocation. According to data published by the IMF, the agricultural sector employed around 530,000 workers in 2002, up by almost 40% since independence, and more than all other sectors combined. By way of contrast, industrial unemployment has fallen by more than half since independence and was only 76,000 in 2002.

Main macroeconomic indicators Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Unemployment ('000) 2001 59 61 61 62 62 62 62 62 61 60 59 61 2002 61 62 62 63 63 63 63 62 62 61 61 60 2003 60 61 61 61 61 60 60 59 59 – – – Unemployment rate (%)a 2001 9.7 9.9 10 10.1 10.4 10.4 10.5 10.5 10.3 10.2 10.1 10.3 2002 10.5 10.6 10.7 10.8 10.8 10.7 10.8 10.7 10.6 10.6 10.5 10.5 2003 10.5 10.6 10.7 10.8 10.7 10.6 – – – – – – Consumer prices (% change, month on month) 2001 1 1.3 0.6 1.6 2.3 -0.9 -1.9 -2.4 0 0.4 0.3 1.4 2002 0.7 0.4 -0.1 0.5 1.3 0.2 -1.1 -0.7 0.1 -0.3 0.3 0.9 2003 0.9 0.4 0.7 1 1.4 -1.9 -1.7 -0.7 -0.1 – – – Consumer prices (% change, year on year) 2001 8.5 8.7 7.8 9.2 10.1 8.4 8.2 6.2 5.2 4.1 3.3 3.7 2002 3.5 2.6 1.9 0.8 -0.2 0.9 1.7 3.4 3.5 2.8 2.8 2.3 2003 3.5 2.5 3.2 3.8 3.9 1.7 1.1 1.1 0.9 – – –

Main macroeconomic indicators Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Producer prices (% change, month on month) 2001 -0.7 2 3.6 -0.2 0.8 -0.1 1.2 -0.7 0.3 -1 -0.4 0.5 2002 0.6 0.1 2.2 1.3 -0.3 2 0.9 -3.4 1.5 0.2 0 0.9 2003 3.3 0.3 -2 -2.5 0.3 -0.3 – – – – – – Producer prices (% change, year on year) 2001 30 17 18.5 10.4 11.3 14.1 14.7 13.7 10.4 8.8 6 5.2 2002 6.6 4.6 3.3 4.8 3.7 5.8 5.6 2.7 3.9 5.2 5.6 6 2003 8.8 8.9 4.4 0.5 1.2 -1.1 – – – – – – a Unemployment rate derived from monthly unemployment figures and quarterly labour force and employment data. Source: National Statistics Committee; Interstate Statistical Committee of the CIS; Economist Intelligence Unit.

Foreign trade and payments

Trade deficit rises above The trade deficit was US$92.5m in January-August 2003, up from US$53.3m US$90m in January-August during the year-earlier period. The rise in the deficit reflected a 14.6% increase in import expenditure, by far exceeding the 4.6% rise in export revenue. This rather modest rise in exports, however, disguises the extent to which foreign sales have picked up since June: during the first half of the year, export revenue actually declined year on year, owing to a slump in the export volumes of gold, cotton fibre and tobacco. The moderate growth achieved over the first eight months of the year, therefore, suggests an exceedingly strong pick-up in exports in July and August. This is probably linked to the increase in gold production at the Kumtor mine, as gold remains by far the most important Kyrgyz export commodity, usually accounting for around 45% of total export earnings—more than the next six categories of exports combined.

Import compression unwinds On the import side, Kyrgyz trade is also highly concentrated, but to a lesser further degree, with fuel imports accounting for slightly more than one-quarter of all import expenditure over the first five months of 2003. This is underlined by the increasing importance of oil-rich Kazakhstan as a source of imports. Between the first half of 2001 and the first half of 2003 Kazakhstan’s share of the Kyrgyz market rose from 16% to 22%. Most recently, imports from Kazakhstan have been further aided by the Kyrgyz authorities’ reduction in the excise duty on petrol and diesel fuel, which became effective on April 1st. Aside from the first quarter of 2003, imports have risen rapidly year on year since late 2001. This reflects the gradual unwinding of the import compression experienced in 1999-2001, when expenditure on imports fell year on year during 12 consecutive quarters. Although import compression was instrumental in containing the country’s external imbalances, its reversal will be a necessary prerequisite for expanding and modernising the non-gold parts of the industrial sector. However, the slow pace at which machinery and equipment imports are expanding is of concern in this respect. Purchases of these imports, which account for roughly one-quarter of all purchases outside of the Commonwealth of Independent States (CIS), declined by around 7% year on year during the first five months of 2003.

Composition of trade, Jan-May 2003 (US$ m unless otherwise indicated) % change year on year % of total Exports Vegetables 7.0 13.4 3.5 Food, beverages & tobacco 11.4 -27.3 5.7 Mineral products 23.2 35.2 11.5 Chemicals 3.0 -61.7 1.5 Textiles 23.9 1.9 11.9 Precious & semi-precious metals 88.2 13.2 44.0 Non-precious metals 8.8 11.4 4.4 Machinery & equipment 10.5 12.3 5.2 Transport vehicles 6.0 -25.8 3.0 Total incl others 200.7 4.6 100.0 Imports Vegetables 6.4 -42.6 2.7 Food, beverages & tobacco 19.8 28.0 8.2 Mineral products 64.3 -5.3 26.5 Chemicals 25.9 1.0 10.7 Textiles 13.6 -5.9 5.6 Non-precious metals 13.5 28.3 5.6 Machinery & equipment 34.6 -7.1 14.3 Transport vehicles 17.4 22.9 7.2 Total incl others 242.4 6.9 100.0

Source: Interfax, Statistical Report.

Gold dominates sales outside Despite lower export volumes, the Kyrgyz Republic has still seen a boost in gold of the CIS export earnings, thanks to buoyant world prices. Gold sales have accounted for the vast majority of exports to non-CIS markets since the start of Kumtor mining in the second half of the 1990s. In recent years, the Kyrgyz Republic had generally sent its gold either to Germany or Switzerland, but as of last year, the United Arab Emirates (UAE) appears to have replaced Germany as a major buyer. Germany’s share of exports fell from over 40% in the first half of 2001 to under 1% in the first half of 2003, while the UAE’s share rose from negligible amounts to over 20%. The only other non-CIS country with which the Kyrgyz Republic does any substantial trade is neighbouring China. However, the expansion of exports to China has proceeded slowly, in part as a result of poor transport and border infrastructure. Indeed, in 2003 exports to China declined by over one-third during the first half of the year. This was the result of a slump in sales of cattle hides and inorganic chemicals. Other than China, the most significant bilateral trade outside of the CIS has been a result of the Western military presence in the Kyrgyz Republic. Between the fourth quarter of 2001 and the first quarter of 2003, for instance, the establishment of a base for coalition forces at Manas was behind a sharp rise in sales of aviation fuel to the US. Although these sales to the US appear to have ended as of the second quarter of 2003, similar sales to Canada have now begun. Over the first half of 2003 exports to Canada soared from negligible levels to almost US$13m, primarily because of sales of aviation fuel. This puts Canada roughly equal with China as the third-largest non-CIS export destination.

Russia remains by far the most For the Kyrgyz Republic’s non-gold export sectors, the neighbouring CIS states important CIS market and Russia represent by far the most important markets. During the first half of 2003 the CIS took just under one-third of all exports, more than half of which went to Russia alone. According to the latest composition of trade data available, around 15% of sales to CIS markets in January-May consisted of cotton fibre, with tobacco accounting for just over 10%, light-bulbs and clothes around 7-8% each, and electricity 5% (a share that is likely to rise with increased energy co-operation between the Kyrgyz Republic, Kazakhstan and Russia). The only sharp shift in exports to CIS markets came with a surge in sales to Tajikistan during the first half of the year (boosted by rising sales of electricity), and a cumulative fall of almost 40% in export earnings from Uzbekistan. This latter development was partly attributable to a sharp slump in sales of electricity during the first quarter, and, to a lesser extent, to a reduction in slate and clay exports. The imposition of increasing border and trade restrictions in Uzbekistan is likely to have also played a major role in reducing official trade between the two countries. However, small-scale smuggling across the border is rife, and has already caused several border incidents this year. Consequently, official statistics understate the true extent of Uzbek-Kyrgyz trade.

Direction of trade (US$ m unless otherwise indicated) 2001 2002 2003 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year 1 Qtr 2 Qtr Exports Non-CIS 73.8 91.6 88.8 79.7 87.2 69.1 82.4 321.0 80.8 75.9 Switzerland 52.9 57.1 110.0 45.6 36.9 2.4 11.5 99.1 44.0 5.8 UAE 0.2 0.2 0.4 0.0 12.4 27.6 28.8 68.8 10.0 41.2 China 5.3 4.7 10.0 7.4 12.4 13.2 8.2 41.0 7.1 5.5 US 0.2 6.0 6.2 5.3 13.8 9.0 8.0 36.1 4.6 0.6 Germany 0.7 0.5 1.2 0.7 0.1 0.7 0.2 1.8 0.4 0.6 CIS 57.5 30.5 164.6 33.5 36.4 45.3 52.0 167.1 39.1 37.9 Russia 12.0 16.2 28.2 18.3 19.8 13.7 28.2 80.0 23.9 16.3 Kazakhstan 14.5 7.5 22.0 5.6 9.5 11.4 10.4 36.8 7.9 12 Tajikistan 1.2 1.7 2.9 1.4 1.8 2.0 5.0 10.2 3.9 4.4 Uzbekistan 28.6 3.4 32.0 5.8 3.4 15.8 2.9 27.8 1.8 3.1 Total 131.3 122.1 253.4 113.2 123.6 114.4 134.4 488.1 119.9 113.8 Imports Non-CIS 54.1 64.2 10.9 57.9 63.3 73.5 74.8 269.8 58.8 73.4 China 14.2 14.1 28.3 15.1 15.0 13.9 15.1 59.0 9.9 27.4 US 3.8 10.0 13.8 5.4 11.5 14.9 15.6 47.4 11.1 10.5 Germany 6.0 8.1 14.1 5.7 6.5 8.5 10.7 31.4 7.4 9.5 Turkey 3.8 5.0 8.8 3.8 4.4 4.2 4.5 16.6 5.6 7.9 CIS 64.2 79.4 251.0 81.0 68.3 77.1 90.9 317.2 67.4 95.0 Kazakhstan 22.7 26.1 48.8 34.0 26.2 31.1 32.6 124.0 25.3 40.8 Russia 24.3 24.1 48.4 23.1 27.7 29.6 36.3 116.6 26.5 42.4 Uzbekistan 13.1 24.8 37.9 19.5 11.4 12.2 17.1 60.2 12.3 6.7 Total 118.3 143.6 261.9 138.9 131.6 150.6 165.7 587.0 126.2 168.4

Source: National Statistical Committee (NSC).

Current-account surplus is The preliminary balance-of-payments data released by the National Statistical unlikely to hold Committee (NSC) show a small current-account surplus of around US$8m for

the first quarter of 2003. This compares favourably with a deficit of US$6m in the year-earlier period, and represents the Kyrgyz Republic’s first quarterly surplus since the third quarter of 2001. The move into surplus is partly a result of the development of a US$2m surplus on trade in goods, which in turn was explained by a decline in import expenditure and a modest rise in export revenue. Given the preliminary customs data available for subsequent months, this trend is almost certain to have reversed during the second quarter, when imports expanded sharply and exports dropped. The current-account surplus recorded in the first quarter is also a consequence of a reduction in the incomes deficit, which was US$7m during the first quarter of 2003. The combined effect of these trends on the incomes and goods balances more than outweighed the slight increase in the services deficit and the reduction in the transfers surplus during this period. Both of these latter categories have benefited significantly from the foreign military presence in the Kyrgyz republic, and both services exports and inflows of transfers (related to grants and aid) remain above their mid-2001 levels.

Balance of payments, national series (US$ m) 2001 2002 2003 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Goods: exports fob 109.4 132.2 123.2 116.9 125.0 116.7 139.5 120.4 Goods: imports fob -97.5 -110.8 -136.8 -127.5 -124.4 -140.7 -159.4 -118.4 Trade balance 11.9 21.4 -13.6 -10.6 0.6 -24.0 -19.9 1.9 Services: exports 16.8 29.2 20.5 27.8 30.9 43.9 35.8 31.3 Services: imports -30.3 -33.8 -31.8 -29.1 -31.5 -41.6 -43.3 -33.1 Services balance -13.5 -4.6 -11.3 -1.3 -0.5 2.3 -7.5 -1.9 Income balance -22.3 -11.2 -24.6 -10.0 -16.0 -8.9 -24.8 -7.3 Net transfers 14.2 11.8 17.0 16.3 14.7 26.6 28.6 15.1 Current-account balance -9.7 17.4 -32.6 -5.6 -1.4 -3.9 -23.7 7.9 Capital account -8.1 -12.8 -7.1 -4.1 -5.0 -12.1 -6.7 -0.8 Financial account -14.1 -12.7 45.3 33.5 3.4 12.8 34.8 24.2 Direct investment -8.5 11.4 -14.9 4.7 -12.2 9.0 3.2 1.9 Portfolio investment -0.1 0.3 0.1 2.2 0.8 -9.5 -5.6 11.1 Other investment -10.2 -26.0 53.2 26.5 15.1 17.3 24.4 16.5 Capital & financial account balance -22.2 -25.5 38.2 29.4 -1.6 0.8 28.1 23.5 Net errors & omissions 30.1 2.5 8.3 -24.0 0.0 20.8 10.0 -33.5 Overall balance -1.8 -5.5 13.9 -0.3 -3.0 17.7 14.5 -2.1 Financing 1.8 5.5 -13.9 0.3 3.0 -17.7 -14.5 2.1 Change in gross reserves (- indicates increase) 6.7 7.7 -41.2 3.4 0.7 -31.3 -16.6 -10.5 IMF -5.5 -2.9 9.3 -4.9 -5.6 10.3 -5.8 7.1

Source: NSC.

Despite Russian involvement, The Kyrgyz Republic’s undiversified export mix and its excessive reliance on FDI inflows are minimal gold sales reflects the general pattern of inflows of foreign direct investment (FDI) into the country over much of the past decade: the vast majority of the country’s total FDI stock comes from the development of the Kumtor gold mine during the mid-1990s, whereas other sectors have struggled to attract any significant investment. The sizeable inflows recorded in the second half of the 1990s—including over US$80m in 1997 and US$120m in 1998—reflected almost entirely investment into the gold sector. Since construction at the mine ceased

in 1999, the country has seen only limited FDI inflows. Balance-of-payments data from the NSC indicate that net FDI amounted to less than US$5m in 2002. Inflows remained small in the first quarter of 2003, with preliminary data showing net FDI flows of just under US$2m. However, the Kyrgyz Republic’s prospects for attracting FDI have improved slightly, as Russia has emerged as one of the few countries expanding its presence in the Kyrgyz economy. Russian capital has purchased manufacturing facilities, established a significant presence in agro-processing, and is exploring additional investment in aluminium and tin production. Moreover, at a Kyrgyz- Russian investment forum held in October, the two sides reached a deal for Russia to take a 40% share in the Kyrgyz firm Ainur, a small-arms munitions plant, as part of a restructuring of Kyrgyz debts to Russia. Other firms in the Kyrgyz defence and energy sectors are also likely to come under Russian ownership as part of debt restructuring.

Paris Club talks continue The total stock of public foreign debt stands at US$1.64bn in the second half of 2003, just over half of which is composed of loans from international financial institutions (IFIs). Just over half of the remainder consists of low-interest bilateral development assistance, and the rest come from other bilateral creditors. The government hopes to complete restructuring of the national debt by the end of 2004, and is nearing completion of a comprehensive deal with its Paris Club creditors. The government reports having reached agreement with nine of its 12 bilateral creditors as of mid-October, with agreements still outstanding only with India, Pakistan and Kuwait. The creditors with which the government has already reached agreement include the two largest bilateral creditors, Japan and Russia, which account for 38% and 33% of the bilateral debt, respectively. According to the government, the restructuring achieved to date has helped to reduce debt repayments in 2003 and 2004 from around US$60m annually to US$19m in 2003 and US$14m in 2004.

Main external indicators (US$ m unless otherwise indicated) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Foreign reserves 2001 239 235 228 221 216 214 212 211 215 233 227 264 2002 264 263 257 256 280 242 263 256 269 276 281 289 2003 287 283 311 301 308 303 328 325 341 – – – Gold 2001 22 22 22 22 22 22 22 22 24 24 24 23 2002 23 23 25 25 25 26 27 27 27 27 27 28 2003 28 28 28 28 28 29 29 29 32 – – – International reserves 2001 261 258 250 242 237 236 234 233 240 257 251 287 2002 287 286 282 281 305 268 290 282 296 302 308 317 2003 316 311 339 329 336 331 356 353 373 – – –

Source: IMF, International Financial Statistics.