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Rating Action:

Moody's affirms the Kyrgyz Republic's B2 issuer rating, maintains stable outlook

20 Nov 2017

Singapore, November 20, 2017 -- Moody's Investors Service ("Moody's") has today affirmed the Kyrgyz Republic's local and foreign currency issuer ratings at B2 and maintained the outlook at stable.

The factors supporting the rating affirmation are Moody's expectations that:

1. Fiscal metrics will continue to constrain the rating. In particular, the government's debt levels will remain relatively high for a small economy, although the fiscal deficit and debt levels are likely to ease in coming years. A large and stable revenue base and the largely concessional nature of government debt will continue to keep servicing costs low.

2. The economy's shock absorption capacity will remain low due to its small size, a lack of operational scale in a number of sectors, and low incomes. These constraints outweigh Moody's expectations for ongoing solid growth rates.

3. The Republic's institutional strength will continue to develop, albeit from weak levels, including through ongoing reform in partnership with the International Monetary Fund (IMF).

The stable outlook balances upside risks related to solid economic growth, ongoing reforms, a large revenue base and low costs of concessional funding and downside risks from potentially more adverse developments in fiscal metrics in particular if fiscal consolidation is significantly delayed.

The local-currency bond and deposit ceilings and the foreign currency bond ceiling are unchanged at Ba3. The foreign currency bank deposits ceiling is unchanged at B3.

RATINGS RATIONALE

RATIONALE FOR AFFIRMATION OF RATING AT B2

HIGH DEBT BURDEN CONSTRAINS THE RATING, ALTHOUGH LARGE REVENUE BASE AND LOW FINANCING COSTS STABILISE FISCAL METRICS

Our assessment of the Kyrgyz Republic's low fiscal strength reflects a relatively large debt burden for a small, low-income economy, at 58.9% of GDP at the end of 2016.

A large depreciation of the som against the US dollar in 2015 was largely responsible for the rise in the debt-to-GDP ratio from 46.2% in 2013 given that nearly all the government's debt is denominated in foreign currency. Since then an appreciation of the som in the first half of 2016 and subsequent stability, have partially unwound the currency effect.

We estimate that the fiscal deficit peaked at 4.6% of GDP in 2016 reflecting large infrastructure spending. The pace of fiscal consolidation has been slower this year than earlier expected, particularly following an increase in government spending ahead of the presidential elections. However, and in concert with the IMF, the authorities plan to streamline a range of current tax exemptions and take other measures to broaden the tax base, as well as improving the efficiency of public administration. Recent changes to tariff policy for the energy sector should also contribute to reducing energy subsidies and lift cost recovery. Given the authorities' past record of progress on reform in collaboration with the IMF, and signs of an improvement in domestic political stability, we expect that fiscal consolidation will continue.

Mitigating elevated debt, the Kyrgyz Republic's large and stable revenue base, with government revenues amounting to 35% of GDP in 2016, shores up debt affordability. The debt structure also contributes to low debt servicing costs. The government's foreign currency debt is on highly concessional terms, which offsets the impact of currency fluctuations on government finances. Reflecting the concessional nature of much of the government's debt, interest payments remain very low, at 3.3% of revenues, and significantly lower than the median of B rated sovereigns (9.2%).

LOW SHOCK ABSORPTION CAPACITY, GIVEN SMALL OPERATIONAL SCALE, LOW COMPETITIVENESS AND VERY LOW INCOMES

The economy's low shock absorption capacity is also a constraint to the sovereign rating.

Our assessment of the Kyrgyz Republic's economic strength reflects the economy's small size, its volatile growth compared with B-rated peers and very low incomes (GDP per capita of $3,520 in 2016 at purchasing power parity). In particular, with 2017 GDP of only $7 billion, the Kyrgyz Republic is one of the smaller economies among rated sovereigns. Small operational scale constrains scope for productivity improvements. These features outweigh the economy's strong growth potential.

Partly driving the limited capacity to absorb negative shocks, the economy significantly relies on gold mining and remittances, two sources of incomes that can be relatively volatile at times. Remittances to the Kyrgyz Republic amounted to 30.4% of GDP in 2016, the second-highest globally. Russia (Ba1 stable) is the origin of 98% of remittance inflows registered in money transfer systems. About 500,000 documented Kyrgyz workers and another half million undocumented Kyrgyz nationals are reportedly employed in the Russian Federation.

The Kyrgyz Republic scores poorly in international competitiveness rankings, with corruption, political and policy instability, government bureaucracy, and small scale lowering its scores. It is ranked 102nd out of 137 countries in the World Economic Forum's Competitiveness survey, lagging behind its regional peers.

On the positive side, donor support remains conducive to growth. The Kyrgyz Republic benefits from significant financial and technical assistance provided on both multilateral and bilateral bases.

In turn, donor support contributes to high investment levels. At around 33% of GDP in 2017, investment is high and exceeds the median for B-rated countries of 22% of GDP. The government has engaged in large investments in infrastructure and the energy sector by borrowing externally, with about half of the projects financed by Export-Import Bank of China (The) (A1 stable).

Moreover, ample, low-cost and as yet largely untapped natural resources should boost the Kyrgyz Republic's growth potential. Hydropower accounts for nearly 90% of electricity generation; yet less than 10% of hydropower potential is currently utilized, according to the Asian Development Bank (Aaa stable). There are challenges to the sector's development related to regulated tariffs, which have been raised but remain below production costs. In November 2015, Tajikistan (B3 stable), the Kyrgyz Republic, Afghanistan (unrated) and Pakistan (B3 stable) signed a final agreement to connect their grids through the CASA-1000 project, which will provide new export markets for Kyrgyz electricity during summer months, although completion is not likely until at least 2020. One constraint is the availability of financing, which has caused delays in several investments in new hydropower plants.

From a longer term perspective Kyrgyz Republic's growth prospects are positive and will balance ongoing scale and competitiveness constraints. According to United Nations (UN) projections, the Kyrgyz Republic benefits from a much more favorable demographic outlook than most CIS credits. Even with substantial emigration flows, the UN projects working age resident population to increase at an average rate of over 1% over 2018-2032. The old age dependency ratio is also likely to decline over the same period, in stark contrast to the Caucasus region or European CIS.

DEVELOPING, ALBEIT RELATIVELY WEAK, INSTITUTIONAL STRENGTH

The Kyrgyz Republic's institutional strength continues to develop from low levels.

Ongoing collaboration with the IMF, including the renewed Extended Credit Facility, has had positive effects on data collection and dissemination, an enhanced monetary policy framework, stronger domestic banking sector supervision and a reasonably transparent budgetary framework. Reflecting the strong commitment of the authorities to past reform programs we expect continued improvement as the IMF program matures and the implemented measures gradually take effect. In particular, among notable institutional reforms, the 2016 passage by Parliament of the Budget Code has improved the predictability of fiscal policy. The benefits of these changes should continue to unfold.

The authorities have also agreed to change the decision-making and monitoring process for public investment projects, including by formalizing the gate-keeper roles of the Ministries of Economy and Finance and providing an initial assessment and prioritization of projects based on their economic value and accounting for financial constraints prior to inclusion in the next national development strategy. This should lead to improvements in the effective allocation of fiscal resources.

However, significant constraints to the institutional framework remain. Measures of the Kyrgyz Republic's Worldwide Governance Indicators are generally low and show a mixed picture on recent trends with a weakening of Government Effectiveness in recent years. More positively, reforms implemented since the 2010 Revolution have led to improvements in indicators of Rule of Law, Voice and Accountability and Political Stability. Monetary policy effectiveness also remains constrained by weaknesses in the transmission mechanism reflected in a lack of alignment of policy rates with market rates and some lack of clarity in the forward looking components of the central bank's communication policy.

Institutional strengthening will be in part related to the political climate. In this respect, the Kyrgyz Republic stands out among its regional peers as the only sovereign in Central Asia with a recent track record of democratic political transition and increasingly entrenched democratic institutions.

Not unexpectedly in a period of democratic transition of power, the process has seen periods of instability and despite reforms aimed at ensuring political stability and continuity in policy making, the governance framework has proved fragile. This is reflected in our scoring of domestic political risk as Moderate, denoting a moderate probability that domestic political instability rises and derails reform progress. However, recent signs such as the ongoing smooth transition of power following the recent presidential election suggest an improvement in domestic political stability and a positive backdrop for further reform.

RATIONALE FOR STABLE OUTLOOK

The stable outlook balances upside risks related to solid economic growth, ongoing reforms, a large revenue base and low costs of concessional funding; and downside risks from potentially more adverse developments in fiscal metrics in particular if fiscal consolidation and structural improvements, including those to boost energy and transport infrastructure, are significantly delayed.

WHAT COULD CHANGE THE RATING UP

Upward credit pressure could develop as a result of (1) fiscal consolidation efforts that lead to a significant reduction in the government's debt burden; (2) growth-enhancing structural reforms, especially if combined with continued evidence of domestic political stability.

WHAT COULD CHANGE THE RATING DOWN

A downgrade could result from: (1) a marked increase in financing needs due to wider for longer fiscal deficits combined with a substantial deterioration in financing conditions; (2) withdrawal of or a significant reduction in donor support, which would add to the government's borrowing costs; or (3) economically destabilizing domestic and/or regional political tensions.

GDP per capita (PPP basis, US$): 3,520 (2016 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 3.8% (2016 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -0.5% (2016 Actual)

Gen. Gov. Financial Balance/GDP: -4.6% (2016 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -7.0% (2016 Actual) (also known as External Balance)

External debt/GDP: 121.8% (2016 Actual)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 16 November 2017, a rating committee was called to discuss the rating of the Kyrgyz Republic, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutional strength/framework have not materially changed. The issuer's fiscal or financial strength, including its debt profile has not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Martin Petch
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Atsi Sheth
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
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