Key Considerations and Forecasts -- September 1998

Major concerns	§ The major concern for portfolio investors is the limited number of relatively large companies operating in sectors of potential interest. § Another reason to worry is the national economy’s high level of dependency on the environment. To some extent this is a good factor, showing the openness of the economy and its accelerated integration into the international community. But, at the same time, a recent cyanide leakage in the Issyk Kul lake caused a shocking decrease in the number of tourists visiting this recreation area. As a result, the regional economy seriously suffered from a sharp decline in revenues. § Apart from its obvious positive effect, the accession of Kyrgyzstan into the WTO has a set of negative side effects. The anticipated reduction in tariffs and duties, as a part of the accession package could weaken the system which protects the infant domestic economy from external competition. Some discussions currently featured in the local and regional media raise concerns over the fate of Kyrgyz companies in light of lightening the trade regime, increased competitiveness, and therefore, the inevitable number of bankruptcies among domestic companies. § Growth in the national economy is very much dependent upon the fate of a limited number of companies. Even reports from the National Statistics Agency stress that 1997’s growth was mainly due to the start of operations (close to full capacity) at the Kumtor Gold JV. This influenced (and distorted) many aspects of the national statistics, from construction to external sector accounts, thus making Kumtor-related activity key in the country’s growth.
Some positive thoughts	§ Despite close economic ties between the countries of the former Soviet Union and the high degree of openness of the national economy, macroeconomic statistics shows that there is no direct correlation between the financial turmoil in Russia and Kyrgyzstan economic stability. § Because of the lack of companies available to strategic and/or portfolio investors, the Government is very much dedicated to keeping pace with privatisation. Fairness and transparency in blue chip privatisation may be the major argument in attracting foreign participants to the domestic stock market. § The country is favourably positioned in terms of the predictability of the privatisation process. Most of the strategic privatisations so far have taken place under the advisory supervision of western experts from a limited number of organisations (WB, USAID). This is highly favourable for the investor community since the privatisations were well structured and fair. § Kyrgyzstan is to be assigned a sovereign credit rating later this year. Experience shows that the assignment of a first ever sovereign credit rating (usually no matter how low/high this rating might be) leads to a boom of interest by various investors (mostly portfolio) to the stocks of that country. We strongly believe that this fact will positively influence activity with Kyrgyz stocks.
Forecasts	On the macroeconomic side, we expect GDP growth of about 8-10% (Y/Y, Som denominated), with moderate inflation (around 12%). As far as growth prospects are concerned, agriculture and the contributions of Kumtor gold mine will remain the major engines of GDP growth in 2H98 and 1999.
Dependency of growth upon a single project: increased vulnerability	In the meantime, because GDP growth was mainly attributed to the increased output and, subsequently, exports at the Kumtor Gold while other sectors’ contributions remained low, the GDP growth forecasts very much depend on the continued path of Kumtor expansion. However, 1997’s output at Kumtor is considered to be close to its peak, which puts a question mark over whether or not high growth rates can continue. We believe that GDP growth rate forecasts will very much depend on the whether Government leases/sells other gold fields or finds other engines for growth. We would like to stress the multiplication effect of the Kumtor gold project: apart from the obvious increase in exports, there was a highly correlated increase in the country’s construction and import figures. An IMF study points out a trend observed in construction in 1994-97: Kyrgyzstan experienced a boom in construction in 1995 when this sector grew 62% over the year and this growth was dominantly from the Kumtor project. Later, in 1996, when the major construction works at the mine were over, national construction figures were down 19%.
… and fear of 'Dutch decease'	Such a mono dependency represents a serious threat to the national economy, especially since this project is resource extraction related. This situation is worrisome as world gold prices are currently declining. The announced plans to expand the gold extraction industry does not lighten the situation since that means that Kyrgyzstan will remain dependent on a single product. Moreover, we may observe in the future some elements of ‘Dutch decease’ when rapidly developed export oriented extraction industries do not give way to the development of processing industries. This could create a vicious cycle.
Don’t forget about the good parts!	However, one of the key positive sides of this Kumtor story (from a growth factor point of view, leaving out other positive side effects such as employment, increased exports, etc.) is that the growth of the GDP was driven by private sector forces. To this end, Kyrgyzstan is perhaps the first CIS country to achieve such quality of growth.
Budget outlook	We also believe the country’s monetary and fiscal authorities will be able to maintain a stable exchange rate of the national currency, the Som and keep the budget deficit low (8-10 per cent) in 1998. Afterwards, for the 1999 budget, the parliament is expected to decide to make the state budget the only recipient of all dividends and other payments received by KyrgyzAltyn (the state mining company) from Kumtor, which will positively affect the budget. Other fiscal amendments include improvements in the tax administration. In order to tightly control expenditures, they will eliminate all indirect subsidies (by the year 2000) and limit budget loans for agricultural enterprises to Som 50 million in 1998-99.
Diversification of budget revenue sources	Moreover, increased budget pressure and fiscal considerations will push privatisation ahead. With few attractive assets to sell, Government will focus on the privatisation of Kyrgyztelecom and on contracting out gold mines.
Pension reform	Although the Kyrgyz Republic has not done too much in the way of designing and implementing pension system reform so far, the government intends to facilitate this process in the near future. Major changes are expected to happen in 1999-2000 after the submission of a detailed plan for pension system reform by the World Bank and IMF in September 1998 (source: IMF country study).
Outlook for borrowing on the international capital markets	One of the fundamental issues facing the Government is whether the country should borrow money on international capital markets or not. Two major arguments against external borrowing outside of traditional borrowing from international financial institutions are: (i) the fear of loosing preferential regime of borrowing at the IMF and World Bank, (ii) the small size of the required borrowing, and (iii) a general fear of foreign borrowing after the destabilising events in Russia. i) The country could loose its current preferential status. Being currently classified by international financial institutions as a low income country (based on GDP per capita indicators), Kyrgyzstan enjoys a number of special term loans (below-market special interest rates, extended maturities and grace periods). For example, one of the World Bank loans was at a 0.75% interest rate for 30 years with a grace period of 10 years. Regardless of the general market situation, eurobond issue could never attract money on such favourable conditions. Moreover, considering the current low GDP per capita and other macroeconomic indicators, the country’s potential credit rating might make borrowing very expensive . ii) Kyrgyzstan does not need a lot of money. Experience shows that the minimum justified amount of international bond borrowing is about USD 100 million. Kyrgyzstan simply does not need that much – 1997’s GDP of about USD 1.7 billion and a 1997 budget deficit of USD 85 million do not justify such extensive borrowing. iii) General fear of borrowing. During the last several years, heavy debts led to financial crisis in a number of countries (Latin America, South East Asia and Russia, for example). This has caused a fear of borrowing for non-experienced borrowers (such as Kyrgyzstan). So far, the prospects for eurobond issue in the foreseable future are unclear. However, there are some arguments in favour of issuingance of sovereign eurobonds: i) This would serve as a benchmark for Kyrgyz corporations which have shown their intentions to raise money for their investment programmes through international borrowing ii) The experience of many CIS countries shows that interest by foreign direct and portfolio investors intensifies after the country is assigned a credit rating by an international rating agency and after a benchmark eurobond is issued by the Government. This measure would positively affect investor attitudes towards country and would likely lead to increased stock market activity.
Our publications	Kazkommerts Securities initiated coverage of several Kyrgyz companies and has published reports on Kyrgyztelecom and KyrgyzEnergo. We also plan to issue publications on other major Kyrgyz companies and sectors (banking, stock markets, mining, construction materials, and consumer goods). Our coverage of other Central Asian economies includes a bi-monthly supplement to the Kazakhstan Weekly News (distributed via email, fax, and the Internet) which highlights major events in Kyrgyzstan and Uzbekistan.