Tough Times Ahead in Kyrgyzstan

Russia’s military action against Ukraine, which began in February 2022, alongside unprecedented sanctions against Russia were expected to cause a rapid collapse of Kyrgyzstan’s economy for several reasons. First, Kyrgyzstan is one of the world’s top recipients of remittances from migrant workers — constituting roughly 30 percent of GDP in recent years. Almost all these remittances come from Russia, where a quarter of the country’s working-age population resides. Russia is also Kyrgyzstan’s largest foreign trade partner.

By the end of 2021, Russia’s shares of Kyrgyz imports and exports were 33.6 percent and 24.9 percent, respectively. The key goods exported to Russia include agricultural products, clothing and accessories, and non-precious metals. Major imported items are fuels and lubricants, metals, timber, foodstuffs, and vehicles. Russia can hardly be replaced, if at all, when it comes to many essential goods. Furthermore, Russia connects Kyrgyzstan with world markets, especially the EU, through its transport and logistics routes.

Central Asian Spillover

It is no exaggeration to say that Kyrgyzstan is part of the Russian economy, and the alleged economic crisis in Russia due to sanctions and the war economy would naturally have major effects on the country. In March–April, international financial institutions such as the World Bank and the International Monetary Fund predicted a 5- to 10-percent decline in GDP, a rising unemployment rate, and rising poverty. The author of this article also forecasted major consequences for the Kyrgyz economy in the very near future.

The first weeks of hostilities confirmed these forecasts. The Kyrgyz som, the national currency, declined in value by more than 20 percent in a matter of days.

The country saw disruptions in deliveries from Russia due to export restrictions imposed by Russian authorities on about 200 items to protect the domestic market, including foods, technologies, telecommunications, medical equipment, vehicles, agricultural machinery, electrical equipment, railway cars and locomotives, containers, turbines, machine tools, and more. Many domestic exporters complained that Russian customers refused to buy Kyrgyz products due to the sharp drop and high volatility of the rouble’s exchange rate against the som.

The sanctions and higher risks caused significant logistical barriers in shipping goods, including European goods, to Kyrgyzstan, as transportation companies refused transit through Russia. Because of restrictions on the Russian financial system, including the exclusion of key banks from SWIFT , Kyrgyz labour migrants faced major difficulties transferring money home, while businessmen were sometimes unable to pay for goods and services. Many migrants returned home, while the reduced number of flights between Russia and Kyrgyzstan affected tourism negatively.

Bouncing Back?

The downturn did not last long, and by May the situation had stabilized. By November 2022, nine months after the war began, many of the expected threats to Kyrgyzstan’s economy had not yet manifested. From January to October 2022, GDP growth was about 7 percent. Remittances from January to September 2022 totalled 2.21 billion US dollars, even higher than in the same period in 2021. These figures explain why the national currency has recouped its initial losses, with it now trading at a higher level than prior to February 2022 compared to the world’s reserve currencies. The government of the Kyrgyz Republic even managed to increase public revenues and raise salaries for public sector employees and pensions for retirees.

What could explain the refutation of the spring forecasts of a crisis in Kyrgyzstan? First of all, the Russian economy has proven to be much more resistant to sanctions than anticipated. Despite some decline in GDP, Russia's economy has not collapsed — in fact, the rouble has strengthened substantially. Therefore, migrant workers from Kyrgyzstan and other Central Asian countries can still work in Russia and producers can ship their products to Russian customers.

Either Kyrgyzstan will rebuild quickly and adapt to the new economic reality, or it will face years of poverty and misery.

Domestic foreign trade statistics for 2022 show an increase in imports by 80 percent, suggesting that during the sanctions period, some goods entered Russia through Kyrgyzstan as grey or parallel imports, thereby increasing the country’s re-export revenues. Kyrgyzstan’s banking sector has posted record-breaking profits in 2022, which may serve as indirect confirmation that the country’s financial system has seen increased use as a result of the sanctions on Russia’s financial sector. Specifically, foreign currency transactions alone increased eight-fold in the first nine months of 2022, suggesting that many Russian companies and nationals turned to Kyrgyzstan’s banks for foreign trade payments, foreign currency purchases, and fund withdrawals.

Another factor contributing to Kyrgyzstan's economic growth this year was an almost twofold increase in the number of Russian nationals, commonly called “relocants”, fleeing restrictions and the threat of mobilization in Russia. According to the Border Guard Service of the State Committee for National Security of the Kyrgyz Republic, 479,096 Russian nationals arrived in the country during the first nine months of 2022.

The influx of relocants into Kyrgyzstan has boosted domestic demand, as well as growth in the hotel, service, trade, and construction sectors. Some other effects, however, were not so promising, especially rental price hikes. According to Eurasian Economic Union (EAEU) legislation, Russian nationals can stay in Kyrgyzstan for an unlimited period and enjoy the same working conditions and rights as locals, which has stirred fear of competition for jobs among Kyrgyz nationals.

The Worst Is Yet to Come

The above factors have so far led to solid economic growth in Kyrgyzstan, as well as in Armenia, Georgia, and Tajikistan. But does that mean all is well? Certainly not.

The factors affecting the Russian economy, such as sanctions, increased defence spending in contrast to shrinkage of other sectors, human capital reduction caused by migration and mobilization, and the boycott by many international companies are still there and their effects will likely accumulate. De-escalation and a peaceful resolution to the conflict between Russia and Ukraine are not yet on the horizon. On the contrary, the conflict is likely to ratchet up, meaning that the risks to Kyrgyzstan’s economy will remain. Moreover, the first manifestations of the aggravating crisis are already obvious.

First, remittances to Kyrgyzstan in September 2022 were lower than those in September 2021. Prior to that, remittances were higher than in the previous year for every month from April through August. The persistence of this trend would be a sign of the harmful effect of the crisis on labour migrants.

Second, Kyrgyzstan saw some signs of a gradual devaluation of the national currency in October–November 2022, with ordinary citizens and businesspersons increasingly complaining about the absence of dollars and euro in exchange offices.

Third, Kyrgyzstan’s exports in the first three quarters of 2022 amounted to only 61 percent compared to the previous year. Surveys of exporters focused on Russia as their traditional market revealed an increasing drop in demand primarily for expensive and premium products.

Fourth, there are major issues with the state budget. Since 2015, Kyrgyzstan has been a member of the EAEU, receiving a fixed share of 1.9 percent of the Union’s customs fees. According to recent statements by the Ministry of Finance, the military conflict in Ukraine and additional sanctions against Russia have caused EAEU revenues to fall. Alongside rising expenditures, this decline increased the budget deficit by the end of 2022 to a historic 35 billion som, or around 400 million US dollars (about 5 percent of GDP).

The worst-case scenario for Kyrgyzstan is to step under the Iron Curtain that is currently closing down around Russia.

Undoubtedly, this is just the beginning of the public finance complexities, as the authorities optimistically increased budget expenditures in the current fiscal year. Patching up the budget deficit in the coming years will be a major challenge for Kyrgyzstan, especially given the upcoming peak foreign debt payments.

Fifth, perhaps the most painful problem currently facing the country is the high inflation rate. According to official data, it is now as high as 12.1 percent, and could possibly rise to 15.5 percent by the end of the year. At the same time, according to the Food and Agriculture Organization of the United Nations (FAO), a 46-percent rise in food prices in Kyrgyzstan increased poverty rates by one third. More than 2 out of 7 million Kyrgyz nationals live on less than 125 som (1.5 US dollars) per day.

Another fact to keep in mind is that Kyrgyzstan is largely dependent on energy imports: 100 percent of all natural gas, almost all its gasoline and diesel fuel, and most of its coal. Energy resources are primarily supplied to Kyrgyzstan by Russian companies — specifically, gas supplies are monopolized by Gazprom.

So far, Kyrgyzstan has not seen any major increase in the prices of imported gas and fuel and lubricants, but will inevitably face it in the coming years. Russian companies’ falling export revenues from supplies to the EU will be compensated by other markets. Currently, coal prices have already risen by more than 20 percent compared to last year. In this regard, an interesting phenomenon is the export of Kyrgyz coal to EU countries (Latvia and Poland), albeit in small quantities. The country had never before exported coal to EU countries. Currently, the Kyrgyz authorities have introduced state regulation of coal prices and a ban on coal exports in order to keep prices stable for domestic consumers.

Crisis as Opportunity

In a broader context, Kyrgyzstan is also affected by the emerging recession in the EU and the world due to the sanctions and rising energy prices. Although Kyrgyzstan’s economy is not as heavily integrated into international capital markets, it is still dependent on foreign investment. The tightening monetary measures currently taken by the EU and US central banks will reduce international investment flows to emerging markets in general and to Kyrgyzstan in particular.

Previous global financial crises in 1997 and 2008 demonstrated that the Kyrgyz economy was largely affected through Kazakhstan and Russia, who are heavily dependent on international capital market conditions and commodity prices. The implications for Kyrgyzstan manifested as decreased revenues from labour migration, increased unemployment, and economic downturn. In the event of a global recession, a potential drop in the price of gold — the country’s key export commodity — would cause a deterioration of its balance of payments and a devaluation of the national currency.

It is safe to say that Kyrgyzstan will face one of the worst economic crises since independence in the coming years. This time around, the difficulties will not only be temporary. Kyrgyzstan is heading towards a breakdown of its economic model, based on the re-export of Chinese goods to neighbouring countries and remittances from labour migration, mainly to Russia, which has operated for the last quarter-century.

Kyrgyzstan will have to find new markets for domestic goods and new destinations for migrant workers. The problem is aggravated by an excess of labour resources due to high birth rates in recent decades, with about 150,000 job seekers entering the labour market annually and no new jobs for them in sight. Therefore, poor labour migration opportunities will cause rapid spikes in the unemployment rate and aggravated social tensions. Russia, with its demographic challenges, has been the natural destination for these flows. Other countries in the region do not have such a demand for labour, but rather also have a surplus labour force and high birth rates.

To overcome the crisis, Kyrgyzstan should drastically strengthen trade and economic cooperation and integration with other Central Asian countries. So far, these opportunities have been extremely underutilized despite the fact that the region’s economies are mutually complementary in many sectors, from water and energy to tourism, and naturally offer an opportunity to form a single market.

One of the alternatives is more active participation in China’s New Silk Road project, including the construction of the China–Kyrgyzstan–Uzbekistan railroad, which has been delayed for more than 20 years. This new transport corridor between China and the EU would bypass Russia, possibly accessing the markets of the Middle East and South Asia and dramatically expanding logistical opportunities for the export of domestic raw materials and goods to world markets.

Kyrgyzstan will certainly face hard times. One should expect a drop in GDP, rising prices, a creeping devaluation of the som, substantial impoverishment, and finally, high unemployment rates as the biggest challenge. Kyrgyzstan will have to completely restructure its economy. With this restructuring being inevitable, the country’s authorities can only accelerate it through the right measures and reforms and thereby shorten the period of economic crisis.

Either the country will rebuild quickly and adapt to the new economic reality, or it will face years of poverty and misery. The worst-case scenario for Kyrgyzstan is to step under the Iron Curtain that is currently closing down around Russia. Sitting back and waiting for the hard times to pass is not an option. Kyrgyzstan will have to change and learn to live in a new way. The time has come.