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Kyrgyz Republic: Selected Issues

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
February 2016
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Income Inequality in the Kyrgyz Republic1

While extreme poverty has declined, overall poverty remains relatively high compared to regional peers. Addressing growth bottlenecks focused on income inequality has been constrained by volatile growth, high population growth, poor infrastructure, and weak institutions. Looking ahead, reducing income inequality would benefit from achieving macroeconomic stability, redesigning fiscal policy, broadening access to finance, improving the business environment, and building human capital.

A. Trends in poverty and income inequality

1. Poverty has considerably decreased over the past decade, but still remains high relative to regional peers. Extreme poverty, defined by poverty at US$1.25 a day, fell below 2 percent in 2008, and increased somewhat afterward, but remains below 5 percent. The overall poverty increased between 2008 and 2012, and then declined marginally in 2013. Nevertheless, still about 80 percent of the population lives below US$5 a day.

Poverty Indicators

(Percent of popualtion)

Source: World Bank, Global Poverty Working Group.

Poverty Headcounts at National Poverty Lines

(Percent of population in 2012)

Source: World Development Indicators.

2. Poverty is concentrated in rural areas. Almost three quarters of the poor live in rural areas. According to the World Bank,2 poverty levels vary across region, so called “oblast”, in the country. Poverty across “oblasts” varies a lot, as well as within an “oblast” over several years. Key factors explaining volatility of poverty indicators within an “oblast” over the years are quality of agricultural harvest and remittances flows. Remittances represent a relatively significant share of families’ income—reaching up to 20 percent in southern “oblasts”—and are important for alleviating poverty.

Rural vs. Urban Poverty

Source: World Development Indicators.

Source: The World Bank.

Poverty Level by Provinces(As percentage of population)
201120122013
Nationwide36.838.037.0
Batken Province35.634.253.9
Jalal-Abad Province45.355.746.4
Issyk-Kul Province29.528.139.5
Naryn Province49.939.943.8
Osh Province44.751.443.4
Talas Province50.239.623.1
Chuy Province28.616.623.6
City of Bishkek18.421.420.4
Source: KGZ National Statistics Committee.
Source: KGZ National Statistics Committee.

3. Income inequality improved in the first decade following the independence, but has deteriorated since. Income inequality improved during the 1990s when there was a strong push for reforms. However, with reform fatigue and deterioration in many governance indicators in early 2000, the inequality trends reversed. Notably, the 2010 civil conflict, political instability, and banking crisis wiped out the bulk of the achievements made in fighting poverty in the early 2000s. The Gini coefficient stood at 33.4 percent in 2011, with the poorest quintile earning 7.7 percent and the richest quintile 41.4 percent of income.

Kyrgyz Republic: Gini Coefficients

Sources: World Development Indicators.

Change in Gini Index

(In Gini points)

Sources: World Development Indicators.

4. Of additional concern, is land inequality given the importance of the agriculture and mining sector which accounts for 15 percent of GDP. According to the FAO statistical 2009 yearbook, land GINI in the Kyrgyz Republic was 90 based on their 2002 survey.

5. The relatively poor performance in reducing income inequality is due to the fact that economic benefits from national economic growth have not trickled down to the poor. The growth incidence curve for the Kyrgyz Republic in 2006 and 2011 confirms little improvement in reducing the income gap between the rich and the poor.3 Real GDP growth rates for the groups in the lower parts of the income distribution are well below the middle part of the distribution.

Growth Incidence Curve

(Average yearly rate of change in 2006-11)

Source: IMF staff estimates.

Income Distribution by Quintile in the Kyrgyz Republic

(Percentage held by a quintile)

Sources: The World Bank.

6. Given the current income inequality level, unemployment is relatively high and concentrated among youth and women. The official unemployment rate currently stands at 8.5 percent, but it is relatively high compared to other countries which have similar income inequality. In particular, unemployment is concentrated among youth and women.

Unemployment and Inequality 1/

(Latest available observation)

Sources: WEO and WDI.

1/ Blue represents a decrease and red an increase in the unemployment rate between 2009 and 2014. The size of the bubble illustrates the magnitude of the change in the unemployment rate.

Unemployment Structure

(Percent)

Source: KGZ National Statistics Committee.

7. While the gender-related human development index for the Kyrgyz Republic is relatively high, income disparities between genders are present. According to the latest available data, the ratio of female to male salaries is 74.3 percent, even though women are more educated. Difference in the GNI per capita among genders is even more pronounced (estimated US$2,228 for women vis-à-vis US$3,837 for men).

Human Development Index (HDI)

Sources: Human Development Report 2014 (UNDP).

Gender-related Development Index

(Ranking)

Sources: Human Development Report 2014 (UNDP).

B. Obstacles to reducing income inequality

8. Volatile and nondiversified economic growth and high inflation. The growth in the Kyrgyz republic is very volatile. Episodes of high growth were interrupted by the 2002 natural disaster in the south of the country and the gold production shock, the 2005 tulip revolution, the 2010 revolution, and the 2012 gold production shock. Growth is highly dependent on gold production and trade. These shocks held back progress in fighting poverty. Also inflation is a regressive and arbitrary tax, the burden of which is typically borne disproportionately by those in lower income brackets.

Volatility of Real GDP Growth

(Standard deviation over avearge, 1995–2015)

Sources: IMF staff estimates.

Consumer Price Index Inflation

(Percent)

Source: IMF staff calculations.

9. The Kyrgyz Republic has a young population with high growth rates. The population growth remains strong with 2.5 percent per annum. The population is young with one third below the age of 15 and only 6 percent over the age of 65. According to estimation by the UNICEF,4 the Kyrgyz Republic is among top 20 countries with the largest youth share in their respective populations. In addition, the average size of the family has increased relative to a decade ago, which would require the creation of more jobs to absorb young job seekers.

Population Pyramid

(Thousands)

Source: 2009 National Census.

10. Difficulties in the business environment. The country’s business climate has improved somewhat since 2010. Nonetheless, businesses in the country face burdensome regulations, which discourage new entrants. Despite the government’s efforts, political instability and corruption remain important obstacles in doing business. Also the quality of public service provided to businesses sets unfavorable business climate. Limited reforms against a backdrop of difficult internal and external conflicts have weakened the business environment.

Most Problematic Factors for Doing Business

(Percent of resposnes)

Sources: The Global Competitiveness Report 2014–15

11. Limited access to finance. People in remote areas have limited access to banking services, including payment and transfer services and deposit facilities. While the number of accounts increased over the last few years, financial activity remains concentrated in the larger cities (Bishkek, Osh and Jalal-Abad). This is mainly because of the high costs associated with operating branches in rural areas. Limited bank competition; concentration of lending to large established companies; poor financial infrastructure; and limited financial literacy among SMEs are all impediments.

12. Weak institutions. Despite some progress, the Kyrgyz Republic ranked in the bottom twenty percentile with regard to the rule of law and control of corruption. Transparency is needed to achieve good governance as it helps reduce opportunities for corruption, cut the cost of government services and reduce inequalities across geographic distances.

Institutional Quality in 2014

(Lower number implies better institutional quality)

Source: World Economic Forum, Global Competitiveness Report 2014–2015.

Governance Indicators

(In percentile rank)

Source: Worldwide Governance Indicators.

13. Sizable informal economy. The Large size of the informal economy in the Kyrgyz Republic limits the state capacity to deliver governance and strong institutions, which in turn discourages participation in, and expansion of, the formal economy. Empirical analysis suggests that the size of informal economies is influenced predominantly by the quality of institutions.5 Not only do informal firms operate without paying taxes, but informal enterprises often have much lower productivity rates. Informal sector workers often have low wages, poor working conditions, and little employment protection or benefits.

Size of the Informal Economy

(Percent of GDP, 2008)

Sources: IMF MCD Regional Economic Outlook (2012)

14. Quality of education. While the government has made some progress in increasing access to education, yet the Kyrgyz Republic remains behind its regional and sub-regional neighbors. For instance, its primary school net enrolment ratio is below the average net enrollment ratio in the region. Over 80 percent of 15 year olds are scored at "functionally illiterate" levels.6

C. Policies to reduce income inequality and promote inclusive growth

15. Ensure macroeconomic stability. A broadly stable macroeconomic environment is a prerequisite for achieving sustained economic growth. The government should implement appropriate policies that would aim to ensure moderate inflation, contain output volatility, and ensure that public debt levels can be sustained over time. High and unstable inflation, sharp fluctuations in domestic demand and risks of a public debt crisis are toxic for longer-term private investment, given the uncertainty and large downside risks that they create.

16. Redesign fiscal policy. The current social protection scheme is complex and costly, with only one fifth of those in the poorest quintile benefiting from social programs. The authorities’ program should rightly focus on rendering social spending more efficient in tackling poverty. Both tax and expenditure policies need to be carefully designed to balance distributional and efficiency objectives. Options for redistributive policies that help minimize efficiency costs include: (i) consolidating social assistance programs and improving targeting; (ii) expanding cash transfer programs as administrative capacity improves; and (iii) improving access of low-income families to education and health services. To make such options viable, the government should be mindful of: (i) streamlining nonpriority spending; (ii) reducing regressive energy subsidies; and (iii) strengthening public financial management. Importantly, redistributive fiscal policy should be consistent with fiscal sustainability.

17. Enhance resource mobilization. A strong domestic revenue base is an imperative if the state is to finance essential public services, including health, education, and infrastructure spending, over the medium term. In this context, a progressive personal income tax could be considered over the medium term by applying it to all labor income above a reasonable threshold, and covering capital income.

18. Improve the efficiency of the public investment program. In general a scale-up in the public investment program can help address the country’s development needs and increase the economy’s potential. Given an absorptive capacity constraint, however, the country is already implementing ambitious plans. Against this backdrop, improving the efficiency of the public investment program is crucial. Successful implementation of the program will require ensuring high-quality spending, in particular by addressing potential absorptive capacity constraints and by adopting strong project appraisal and procurement policies.

19. Broaden access to finance. A well-functioning financial system is crucial. At a minimum this requires financial stability. Reforms for broadening financial access and supporting financial sector development should focus on increasing competition among banks (thereby incentivizing them to lend more broadly), strengthening financial infrastructure, expanding financial instruments, (e.g., Islamic finance, mobile payments, and microfinance), and providing training to strengthen financial literacy.

20. Resilient business environment. Ambitious and decisive structural reforms are necessary for a better business environment and strong private-sector-led growth. Corruption and the lack of infrastructure remain key constraints. In addition, many complain about excessive discretion and nontransparent intervention. Institutional and regulatory reform should aim at ensuring a level playing field that provides equal access to economic opportunities, reducing the scope for discretion (to reduce the likelihood of petty corruption), clearing regulatory barriers to formality, improving transparency, and strengthening institutional autonomy and accountability. In order strengthen the business environment, the country should: (i) continue to streamline the de facto regulatory burden; (ii) monitor the business environment via business surveys to identify the bottlenecks in the implementation of legislation and major constrains for doing business; (iii) improve access to information in general, and in particular, on government operations and contracts to increase transparency and eliminate perceived corruption; and (iv) streamline bureaucratic procedures in obtaining and registering land titles.

21. Promote employment. Labor market policies should promote higher employment and equality of opportunity to work. The authorities should review labor market regulations to reduce distortions that discourage hiring and skills building. They could also change recruitment and compensation policies to ensure that salaries do not bias job-seekers toward the public sector, which would limit economic growth by trapping workers in less productive public-sector jobs and deter investment in the private sector. The government can also consider active labor market policies—in particular vocational training and educational programs for workers—within the envelope of available fiscal resources to facilitate and improve the match of workers to jobs, especially for vulnerable groups.

22. Address the negative effects of informality. To reduce the barriers to business and labor formality, policymakers should improve the regulatory framework for business. Entry regulations should be simplified and compliance costs reduced, while at the same time creating an environment that fosters a fairer enforcement of regulation. Simplifying tax regulations would increase formality, and could raise tax revenues. Such reforms will provide incentives for existing informal firms to pay taxes, increase their investments, and ultimately to operate in the formal economy.

23. Build human capital. Equipping the current and future labor force with relevant skills is important to increase countries’ productivity and growth, which would, in turn, reduce income inequality. For instance, establishing a national training fund could be considered over the medium term, subject to successful implementation of public finance reforms, particularly by improving tax administration and spending efficiency. Reforming education systems will boost the pool of skilled workers demanded by the private sector and will enhance opportunities for investments in human capital, thereby aiding social mobility. In particular enabling women’s labor market participation—by introducing child-related cash transfer to families with children, public spending on services for families with children and financial support for families provided through the tax system—to reach their full labor market potential can help reduce inequality and vulnerability and raise growth.

24. Improve data quality and availability. The limited availability and poor quality of key economic, financial, and social data impede a detailed, realistic assessment of the country’s growth inclusiveness. In particular, the poverty statistics for recent years disclosed by the authorities do not closely match the aggregate consumption inferred from the national account. Strengthened statistical capacity would help identify problem areas and provide an evidence-based analysis, which would allow policymakers to make educated decisions.

1

Prepared by Dragana Ostojic and SeokHyun Yoon.

2

World Bank (2013) Kyrgyz Republic-Poverty Mapping: Methodology and Key Findings.

3

Growth incidence curves identify the extent to which each decile of households ranged by their income level benefited from growth.

4

Ortiz et al. (2012), “When the Global Crisis and Youth Bulge Collide”, UNICEF.

5

Singh et al. (2012), “Growth, Institutions, and the Underground Economy” IMF Working Paper (WP/12/47).

6

World Bank (2009), Program for International Student Assessment.

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