Journal Issue

CIS conferences: Trade reform, financial sector development keys to sustained growth in Kyrgyz Republic

International Monetary Fund. External Relations Dept.
Published Date:
June 2003
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Ten years ago, the Kyrgyz Republic became the first CIS country to leave the ruble zone and issue its own currency (the som). Like other CIS countries, it faced hyperinflation when prices were liberalized, but the authorities could do little to control monetary expansion because financial relations among the CIS countries lacked clarity. It was soon clear that the Kyrgyz Republic needed a national currency to facilitate its macroeconomic stabilization efforts.

But the actual decision to exit the ruble zone was a difficult political step. As President Askar Akaev noted, the Kyrgyz people had had money in circulation since ancient times, but now steps were being taken to create a national currency, perhaps for the first time in several millennia. Ten years after making that decision, Akaev stated with complete confidence “that the introduction of the som was an absolutely correct and timely step.” And the data bear witness to this. Inflation has declined to 2.3 percent in 2002 from 929 percent in 1993; economic growth in 1996-2002 averaged 4.7 percent; and the exchange rate has, apart from the period of the Russian financial crisis of August 1998, been fairly stable and has appreciated relative to the U.S. dollar over the past three years.

Sustaining strong growth

What could the Krygyz Republic do to continue to grow at a higher rate than the world economy? Clearly, strong policies and determined implementation of needed reforms would be essential. In his remarks, IMF Deputy Managing Director Eduardo Aninat highlighted three key steps for further progress:

  • Liberate the business and investment climate from poor governance and corruption;
  • Speed up financial sector reform by showing no tolerance for substandard banking performance. Banks that do not meet prudential banking standards, he said, must simply be closed down; and
  • Eliminate the quasifiscal deficit of energy companies; otherwise, prudent fiscal policies will be undermined.

Regional perspective

Looking beyond the Kyrgyz Republic, John Odling-Smee (Director, IMF’s European II Department) noted that most countries in the CIS have recorded strong macroeconomic performances since the 1998 financial crisis in Russia. Oil-exporting countries and countries that have made headway in implementing market reforms have done particularly well.

The challenge now, Odling-Smee said, is to sustain growth, and in this regard, trade reform is key. Trade openness in the CIS region is low, representing just 12 percent of GDP in 2002. This contrasts with 32 percent in other transition countries and 49 percent in the European Union (EU). Such a low level of trade, he explained, restricts growth opportunities. The direction of causality between trade liberalization and growth may still be the subject of hot debate, he added, but no country has achieved sustained prosperity under autarky or by restricting trade. Calculations suggest that the CIS as a whole should have 50 percent more trade than it currently has; for the Kyrgyz Republic, trade could be four times higher.

So, asked Shamshad Akhtar (Deputy Director General, Asian Development Bank), what’s holding the CIS back? She pointed to a whole host of constraints, principally a lack of diversification (both in terms of products and markets), poor infrastructure, and weak border and transit links, in part due to deficiencies in customs organizations. Easing these constraints, she indicated, would require enhanced regional cooperation; the pursuit of purely national strategies is just not effective.

Developing the financial sector

Trade is not the only area in which there is significant scope for improvement. Despite strong macroeconomic performance throughout the past several years, the CIS-7 (Armenia, Azerbaijan, Georgia, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan) have had a significantly lower level of monetization (relying on the use of money rather than barter) and a sharply slower pace of remonetization than other transition countries. Why the level of financial intermediation has remained so low in these economies was the focus of the May 12-13 conference, which was held with financing assistance from FIRST (an umbrella organization of bilateral donors that delivers financial sector technical assistance). One reason cited for the low level of financial intermediation has been continued large spreads between deposit and lending rates, with both rates remaining high in real terms. High real lending rates have, predictably, meant a low level of credit to the private sector, and many enterprises still rely on their own resources for investment financing (see table below).

Gianni De Nicoló (Senior Economist, IMF’s Monetary and Financial Systems Department) argued that the region’s high real interest rates for loans can be traced to a combination of low depositor trust in the banking system and high credit risk. And the high credit risk is not, he said, related to macroeconomic conditions. Among the problems fueling the high credit risk are difficulties in assessing credit (due to weak auditing and accounting standards), weak legal environments that offer limited protection of creditor rights; and poor risk-management practices in banks. Martin Raiser (Director for Country Strategy and Analysis, European Bank for Reconstruction and Development) cited another important factor—opening a bank account made an enterprise visible to the tax authorities. Given current incentives for remaining in the shadow economy, many businesses opt to stay outside the formal banking system.

One means of encouraging deposits is to offer deposit insurance. But as is well known, there are moral hazard risks associated with introducing deposit insurance in an underdeveloped banking system with weak banking supervision. Conference delegates were divided on both the desirability and the appropriate timing for the introduction of such a scheme.

Kazakhstan had moved rapidly to set up a deposit insurance scheme while simultaneously strengthening the banking system. The Kyrgyz Republic has been taking steps to strengthen banking supervision ahead of the introduction of deposit insurance.

Strengthening the banking system also entails getting the state out of the banking business. Tunc Uyanik (Sector Manager, World Bank) advised governments to limit their role in the sector to creating the necessary institutions, mechanisms, and incentives to ensure prudent banking practices and proper regulation and monitoring of the banking system. Each of the CIS-7 countries started with a fully state-owned banking system, but most have since moved out of commercial banking. At present, only Azerbaijan and Uzbekistan maintain a significant stake in the banking sector, and Azerbaijan is in the process of divesting its holdings. Vadim Kubanov (Deputy Chair, Azerbaijan National Bank) explained that state holdings would be largely eliminated following the planned sale of the International Bank of Azerbaijan (which holds about 60 percent of banking sector assets) to a combination of strategic and local investors.

And how was private sector banking faring in the region? Initial experience with private banks—that is, through 1995-96—was disappointing. Private banking typically consisted of a few former state banks that had changed their names but little else and a large number of pocket banks with low capitalization tied to specific enterprises or individuals. The situation has improved since then, argued Adalbert Winkler (Senior Economist, European Central Bank). Private banks have begun to grow in size as macroeconomic stabilization has taken hold and banking supervision has been strengthened.

Indeed, Winkler suggested, the development of private sector banking mirrored experience in the more advanced transition countries, except for the role of foreign banks. In some EU-accession countries, foreign banks hold up to 80 percent of bank assets and led the development of the sector. In contrast, foreign banks have played a modest role in the CIS-7 with little apparent impact on the quality of banking services or in stimulating competition. Suerkul Abdybaly (Member of Board, National Bank of the Kyrgyz Republic) noted that most of the foreign banks in the Kyrgyz Republic operate as payments/settlements systems for their clients. Representatives from other central banks cited similar experiences in their countries.

Underdeveloped financial sectors constrain CIS-7 economies(percent)
M2/GDP ratio
Other CIS11.011.612.914.416.218.122.1
Domestic currency lending-deposit spread
Real deposit interest rates
Real lending rates

Central and Eastern Europe plus the Baltics.

Data: IMF, International Financial Statistics

Central and Eastern Europe plus the Baltics.

Data: IMF, International Financial Statistics

While effective banking sector regulation and supervision were acknowledged to be an essential part of a stable banking system, commercial bankers participating in the conference expressed concern over what they termed a clear trade-off between policies to strengthen bank solvency through tighter and closer bank supervision and the cost to borrowers. In their view, regulation was already tight and was fueling the development of nonbank financial institutions that went largely unregulated.

Finally, given the interest in spurring private sector enterprise, the discussion turned to the issue of how to help fledgling businesses take off and small and medium-sized enterprises find the capital needed to expand. At present, all agreed, micro, small, and medium-sized enterprises had very little access to bank finance.

According to Ira Lieberman (Senior Policy Advisor, World Bank), microfinance institutions were beginning to develop in the region, but these are currently dominated by nongovernmental organizations that rely on donor funding rather than local savings. These microfinance institutions are also concentrated, he said, in the urban areas rather than in the rural areas that are crucial in many CIS-7 economies. Isaac Svartsman (IMF Advisor to the National Bank of the Kyrgyz Republic) ended on a practical note, cautioning that it was important to remember that microfinance can achieve only so much and effective supervision of these institutions will be necessary, too.

The full text of the presentations and background papers for the conferences are available, in English and Russian, on the website of the National Bank of the Kyrgyz Republic (

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