Kyrgyzstan: Upgrade from 7/7 to 6/7 for medium- to long-term political risk

Forthcoming elections in October 2020

Following its independence from the Soviet Union in 1991, Kyrgyzstan was ruled by President Akayev until 2005. At that time, a popular revolution – the so-called Tulip revolution – overthrew the president. He was replaced by President Bakiyev whose term in office was marked by a constant power struggle with the parliament and a curtailment of civil liberties. A new popular revolution ousted the president in April 2010 and led to the adoption of a new constitution, which put in place a parliamentary republic. Since then, Kyrgyzstan has been ruled by multiparty coalitions. The political scene has stabilised over the past years as reflected by several peaceful election cycles and the upgrade of Credendo’s political violence rating to category 5/7 (from 6/7) in December 2017. Still, endemic corruption (126th rank in the corruption perception index published by Transparency International), cronyism and related political purge are recurring themes, which carry the risk of renewed unrest.

The last peaceful presidential elections took place in 2017. Sooronbay Jeenbekov, once a protégé of the former president Almazbek Atambayev (2011-2017), was elected as president in October 2017. Since then, his relation with his predecessor turned sour (cf. arrest of Atambayev in August 2019). The next legislative elections – scheduled in October this year – are likely to cause some turbulence (protests, fiscal slippages, politically motivated arrests). 

The stalemate over the border delimitation with Tajikistan and Uzbekistan and ethnic division result in a sporadic surge in tensions and violence. Tensions between the Kyrgyz and Uzbek communities in the south of the country sporadically erupt into violence (notably in 1990 and more recently in June 2010). On the positive side, Uzbekistan’s most constructive foreign policy has a positive spillover impact on the region as highlighted by the working group put in place to resolve the border dispute. 

The landlocked country has long tried to secure good relations with Russia and the United States. Indeed, the country hosted both Russian and American military bases for years. However, the country definitely turned to Russia by refusing to renew the lease of the US Manas military base following the Russian debt write-off in September 2012.  Kyrgyzstan joined the Russian-led Eurasian Economic Union (EEU) – whose members include Russia, Belarus, Kazakhstan and Armenia – in May 2015 and agreed in March 2019 to enlarge Russia’s military base, highlighting the role of Russia as a security guarantor. Tension between Russia and China arises from the growing Chinese economic presence (incl. loans related to infrastructure developments). Despite some sporadic tensions arising from the presence of the Chinese labour force, the relations between the Kyrgyz and Chinese authorities are good. 

High reliance on gold and private transfers

The economy is characterised by volatile but strong growth (on average 4% y-o-y in 2008-2019), large resource endowments (mineral, forest, arable land) and a large potential in hydroelectricity production, the agriculture sector and tourism. Large infrastructure gaps, deficient governance and rule of law, and the high cost of financing hinder private investment and the realisation of growth potential, along with the low quality of education and onerous regulations. 

The high reliance on private transfers – which account for almost 30% of GDP and more than 45% of current account receipts – and on one gold mine Kumtor – which accounts for almost 10% of GDP and more than 10% of current account receipts – constitutes a large vulnerability. As a result, the country is not immune to external risk arising from an increase in the US/China trade tensions (even if tensions are easing in the short term) and slower growth in Russia and Kazakhstan. 

The current account balance of the fuel-importing country has been in deficit since 2006. Looking ahead in the medium/long term, the current account deficit (excl. official transfers) is expected to fluctuate between 15% and 20% of current account receipts (8-10% of GDP), coming with a large trade deficit. As the Kumtor production is expected to cease in 2026, the current account deficit would (further) widen if other mines do not compensate for the reduction in output. 

Even if public debt has been on a downward trend since 2015 driven by the appreciation of the exchange rate and debt relief from Russia in 2018, it remains sizable at almost 60% of GDP in 2019. Also, it is largely denominated in foreign currency which makes the public finances vulnerable to exchange rate depreciation. The share of concessional debt diminished drastically from 70.7% in 2010 to 46.8% in 2018 along with the increase in debt owed to bilateral official creditors.  

The public financial management remains weak and characterised by an oversized civil service, untargeted social transfers and large energy subsidies (including transfers to the loss-making state-owned enterprises). On the positive side, despite their increase, public interest payments remain relatively low. Tax revenues are relatively high at around 20% of GDP. The overall fiscal deficit is expected to be moderate even if fiscal slippages ahead of the parliamentary election scheduled in October 2020 might not be ruled out. 

Lower financial risk 

Gross external debt ratios increased sharply between 2008 and 2016 (to more than 115% of GDP), driven partly by Chinese-funded investment. Since then, it has decreased slightly to 100% of GDP in 2018. Most of the external debt is long term. About half of the external debt consists of public debt and a large but decreasing share is concessional. The debt service ratio is relatively low. The risk related to the continued deterioration of the net international investment position (from -20% of GDP in 2004 to -92% in 2018) is mitigated by the fact that foreign direct investment accounts for more than 45% of the external liabilities and that portfolio investments are almost non-existent. This low integration with the global financial market limits the exposure to surge in portfolio flows’ volatility. 

Even if the level of gross foreign exchange reserves has slightly diminished since 2017, their level is adequate as they covered more than 3 months of imports in October 2019 and three times the limited short-term external debt. On the negative side, the central bank continues to intervene in the foreign exchange market to support the currency, which could put pressure on foreign exchange reserves in case of a large external shock. 

Upgrade MLT political risk

In August 2016, Credendo downgraded Kyrgyzstan’s MLT political risk to category 7/7. Indeed, a sharp rise in public external debt driven mainly by Chinese-funded investment projects pushed the MLT political risk to category 7/7. Since then, the external debt burden relative to GDP has decreased significantly. As a result, Credendo decided to upgrade the MLT political risk of Kyrgyzstan to category 6/7. This category correctly captures risks related to the forthcoming parliamentary election, the fragile public finances, the planned closure of the Kumtor mine in 2026 and external risks arising from lower growth in its main trade partners and migration destinations Russia and Kazakhstan as well as from the escalation of US/China trade tensions (even if tensions are easing in the short term). 

Analyst: Pascaline della Faille - p.dellaFaille@credendo.com