Kyrgyz Republic Improving Fiscal Risk Management in the Kyrgyz Republic September 2022 Macroeconomics, Trade, and Investment Global Practice Europe and Central Asia Region Document of the World Bank GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of September 2, 2022 Currency Unit = Kyrgyz Som (KGS) US$1 = KGZ 80.78 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS DeM Debt Management DMS Debt Management Strategy DMU Debt Management Unit EPP JSC Electric Power Plants FCF Finance and Credit Fund FCCL Fiscal commitments and contingent liabilities FRU Fiscal Risk Unit IFR Information on Fiscal Risks FRWG Fiscal Risk Working Group IMF International Monetary Fund iSOEF Integrated State-Owned Enterprises Framework IDA International Development Association IFRS International Financial Reporting Standards IPSAS International Public Sector Accounting Standards JSC Joint stock companies KPI Key Performance Indicators KGS Kyrgyz Republic Som LGs Local governments MoEC Ministry of Economy and Commerce MoF Ministry of Finance NEHC National Energy Holding Company NESC JSC National Electricity Grid PEFA Public Expenditure Framework Assessment PIM Public Investment Management PPP Public-private partnership SDFP Sustainable Development Finance Policy SE State enterprises SOEs State-owned enterprises SPMF State Property Management Fund TA Technical Assistance WB World Bank 2 Vice President Anna Bjerde Country Director Tatiana Proskuryakova Country Manager Naveed Hassan Naqvi Regional Director Lalita Moorty Practice Manager Sandeep Mahajan and Antonio Nucifora Task Team Leader Gohar Gyulumyan 3 Contents Acknowledgement………………………………………………………………………………………………………..…………………………6 Executive Summary....................................................................................................................................... 7 I. Background.................................................................................................................................. 10 II. Findings and Recommendations ................................................................................................. 12 1.1. Fiscal Risk Monitoring and Management .................................................................................... 12 Findings ....................................................................................................................................... 12 Recommendations ...................................................................................................................... 17 1.2. Macroeconomic Fiscal Risks ........................................................................................................ 17 Findings ....................................................................................................................................... 17 Recommendations ...................................................................................................................... 19 1.3. Fiscal risks associated with public debt ....................................................................................... 20 Findings ....................................................................................................................................... 20 Recommendations ...................................................................................................................... 21 1.4. Fiscal risks from lending and on-lending activities...................................................................... 22 Findings ....................................................................................................................................... 22 Recommendations ...................................................................................................................... 24 1.5. Fiscal risks from SOEs .................................................................................................................. 25 Findings ....................................................................................................................................... 25 Recommendations ...................................................................................................................... 27 1.6. Risks associated with the execution of local budgets ................................................................. 28 Findings ....................................................................................................................................... 28 Recommendations ...................................................................................................................... 29 1.7. Fiscal risks from Public-Private Partnership ................................................................................ 29 Findings ....................................................................................................................................... 29 Recommendations ...................................................................................................................... 30 1.8. Fiscal risks other than debt-related ............................................................................................ 31 Annex 1. Summary of Recommendations……….……………………………………………………………………………………..31 Annex 2. Kyrgyz Energy Sector SOEs’ Risks…………………………………………………………………………………………….34 Annex 3. Overview of Credit Risk Assessment Methodologies……………………………………………………………….35 4 Figures Figures 1: Real GDP growth rate (1997-2021) .............................................................................................. 7 Figures 2. Fiscal Revenues, expenditures, and overall balance (1997-2021) ...................................... 7 Tables Table 1. Fiscal risk matrix for the Kyrgyz Republic ...................................................................................... 11 Table 2. Summary of relevant legislation (*) .............................................................................................. 12 Table 3. Breakdown of public debt (% of GDP) ........................................................................................... 20 Table 4. Breakdown of public loans (as of July 2021) ................................................................................ 22 Table 5. Summary of sources of fiscal risks from SOEs ............................................................................... 25 Table 6. PPP projects disclosed in the draft IFR .......................................................................................... 30 Charts Chart 1: Sources of fiscal risks..................................................................................................................... 10 Chart 2. Flowchart of units involved in the preparation of the fiscal risk statement ................................. 14 Chart 3. Generic flowchart for public lending cycle.................................................................................... 23 Box Box 1. IFR outline ....................................................................................................................................... 16 5 ACKNOWLEDGEMENTS This Note is produced by a World Bank (WB) team consisting of Cigdem Aslan (Lead Debt Specialist), Lilia Razlog (Senior Debt Specialist), Gohar Gyulumyan (Senior Economist), Bakyt Dubashov (Senior Economist), Natalia Manuilova (Senior Financial Management Specialist), Henry Eshemokhai Aviomoh (Young Professional), Esin Celasun (Consultant) and Shota Gunia (Consultant). Sarah Nankya Babirye (Program Assistant, EECM1), Leah Laboy (EECM2) and Aizhan Tursalieva (Program Assistant, ECCKG) provided administrative support. Jyldyz Djakypova and Natalya Iosipenko helped to disseminate the Policy Note. The team is grateful to Naveed Hassan Naqvi (Country Manager, ECCKG), Antonio Nucifora (Practice Manager, GMTE2), Ivailo Izvorski (Practice Manager, EMFMD), and David Stephen Knight (Lead Economist and Program Leader for Central Asia) for guidance, review, and valuable comments. The team appreciates useful comments from peer reviewers Sebastian Michael Essl, Senior Economist (EMFMD), and Gregory Kisunko, Senior Public Sector Specialist (EAEG1). The team also appreciates the International Monetary Fund (IMF) collaboration and comments provided by Alexandra Solovyeva, IMF Economist. The team is grateful for the collaboration of various public agencies of the Kyrgyz Republic, including the Ministry of Finance (MoF), the State Property Management Fund (SPMF) under the Ministry of Economy and Commerce (MoEC), the Finance and Credit Fund (FCF) under the Ministry of Finance and the National Energy Holding Company (NEHC). The team expresses appreciation to the MoF Deputy Minister Mr. Ruslan Tatikov, the President’s Administration’s representative, Mr. Almaz Primov, the Head of Debt Management Department, Mr. Nurbek Akjolov, the Head of the Fiscal Risk Unit (FRU), Ms. Mira Toktonalieva, the Chairman and Deputy Chairman of the SPMF Mr. Mirlan Bakirov and Mr. Kanat Ryskulov, the Head of the Public Property Policy Management Department Ms. Nurzhanat Zhusupova, the Head of the Public Investment Program Division Mr. Erlan Ajikulov, as well as representatives of the Finance and Credit Fund (FCF) Mr. Bakyt Esenov and Mr. Abdanbek and the National Energy Holding Company. The engagement and dialogue conducted in the framework of this ASA has informed different policy documents. These include the IFR updated in the spring of 2022 as one of the Policy and Performance Actions (PPAs) committed to by the Kyrgyz government in the context of the International Development Association’s (IDA) Sustainable Development Finance Program (SDFP) in FY22. This task was financed by the Debt Management Facility and ASA on Fiscal Risk Assessment and Fiscal Policy for the Environment. The team will remain engaged with key government agencies in FY23 to support their efforts towards the institutionalization of fiscal risk identification and management in the context of the IDA’s SDFP policy. 6 I. Executive Summary The objectives of this report are to (i) assess the government’s current practice of managing fiscal risks based on the Information on Fiscal Risks (IFR) produced by the MoF in 2021; and (ii) to provide a recommendation to counterparts from the MoF, MoEC, and SPMF, and to other relevant stakeholders to improve fiscal risk management practices. The Kyrgyz Republic is a small, open, and lower-middle-income country with a GDP per capita of $1,300 and total GDP of $8.8 bn in 2021. It has been growing by 4 percent per annum on average over the past two decades, driven mostly by gold exports and migrants’ remittances, accounting for 10 and 33 percent of GDP in 2019, respectively. This high dependence on growth drivers from exogenous factors and high concentration of remittances in one source country has led to significant vulnerability to external shocks and volatility of growth rates (Figure 1). The recent such experience was in 2020 when the COVID-19 pandemic hit hard and led to an 8.4 percent GDP contraction. A modest economic recovery began in 2021, with a 3.6 percent GDP growth contributed mostly by non-gold sectors. Recovery continued in the first half of 2022, with GDP expansion exceeding 6 percent, y-o-y, supported by industry, including gold production, retail trade, and services. However, the deteriorated regional and global policy environment is projected to pose serious challenges for the Kyrgyz economy mainly because of the expected decline in remittances and elevated food prices, which are projected to worsen the economic situation and poverty in the Kyrgyz Republic in 2022-23. The main challenges facing the Kyrgyz Republic are the low resilience of its economy to shocks, as well as a narrow and unsophisticated economic base. Figure 1: Real GDP growth rate (1997-2021) Figure 2: Fiscal Revenues, expenditures, and overall balance (1997-2021) 15.0 50 4 40 0 10.0 30 -4 20 -8 5.0 10 -12 0 -16 0.0 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 -5.0 Revenue (LHS) -10.0 Expenditure (LHS) Real GDP growth Real non-gold GDP growth Overall balance (RHS) Source: WB staff calculations based on data of the National Statistical Committee of the Kyrgyz Republic. Throughout the past two decades, the Kyrgyz authorities have substantially improved the country’s fiscal stance to maintain macroeconomic stability. Systematic improvements in tax and customs systems and progress regarding non-tax revenues and official grants have helped to increase revenue collection from about 20 percent of GDP in the late 1990s to about 32-33 percent in 2021. This solid progress helped to reduce the fiscal deficit from about 10 percent of GDP to around 1 percent during the same period, with the exception being 2020 when the deficit widened to above 4 percent of GDP to accommodate COVID-response public spending (Figure 2). 7 Notwithstanding past progress, the fiscal system of the Kyrgyz Republic faces several structural and operational inefficiencies which diminish its capacity to support growth and absorb shocks. The Kyrgyz Republic’s revenue intake, at 33 percent of GDP, is higher than that of its regional and income peers. But this high level of fiscal revenues has not proven sufficient to support even greater spending commitments averaging at about 35 percent of GDP during 2019-21. While putting serious pressure on fiscal revenues and the overall fiscal balance, this high level of public spending has not translated into efficient and quality public service delivery.1 Furthermore, the composition of public spending with a high (12 percent of GDP) and growing share of public sector wages and a low (below 3 percent of GDP) and declining share of public investment programs in total spending leads to concerns over insufficient investment in growth-enabling public infrastructure, amongst other issues. Also, the high level of public expenditures, dominated by recurrent spending, has not enabled the creation of buffers to provide a fiscal response to adverse shocks. This structural issue became more evident in 2020 when the authorities responded to the pandemic at the cost of deteriorating the country’s debt burden by about 10 percentage points of GDP (to 68 percent of GDP). The World Bank’s recently published Public Expenditure Review reveals other weaknesses and gaps in the Kyrgyz Republic’s fiscal system. It draws attention to the large quasi-fiscal deficits of the energy sector and contingent liabilities of the pension system, which could undermine the country’s fiscal sustainability if not addressed. Other challenges refer to SOEs' weak governance and operational efficiency and inadequate incentives for subnational governments to improve their public financial management practices. The current report adds analytical knowledge to the fiscal system of the Kyrgyz Republic by reviewing the existing legal, institutional, and methodological frameworks used by the government in producing Information on Fiscal Risks. The team has reviewed the government’s business processes in fiscal risk identification, analyses, and management. Improved knowledge of the origin of fiscal risks and analytical skills to assess the magnitude of these risks may assist the Kyrgyz authorities in prioritizing and producing response policies. To commence this iterative process, the team shared the draft version of this report with the MoF, which helped them produce an advanced version of the IFR in April 2022.2 The report's main conclusion is that while the fiscal system of the Kyrgyz Republic is exposed to high risk, the country remains at an early stage of institutionalizing fiscal risk management. The main sources of fiscal risks include: (i) poor financial performance and operational efficiency of state-owned enterprises (SOEs), especially those in the energy sector, with an accumulated large stock of debt to the government fluctuating at around 17-20 percent of GDP during 2018-2020; (ii) macro-fiscal vulnerabilities triggered by global, regional and domestic shocks; (iii) heightened public debt burden which is assessed as posing a moderate risk of debt distress; and (iv) the liabilities of extra-budgetary funds. Initial steps have been taken towards monitoring fiscal risks with the issuance of certain regulations, establishing a fiscal risk unit (FRU) at the MoF, creating an inter-agency working group, and preparing the draft IFR. Yet the report concludes that more needs to be done to fundamentally improve fiscal risk management and institutionalize this practice. The legal, institutional, and reporting frameworks are fragmented and require strengthening to improve overall fiscal risk management, monitoring, and reporting. One of the main shortcomings is data constraints and the client’s weak analytical and implementation capacity to manage fiscal risks. The data constraint also affected the depth of this report’s 1 Public Expenditure Review for the Kyrgyz Republic, World Bank 2020 2 All analyses of this report refer to, and recommendations are drawn based on the 2021 IFR document. 8 analysis. The team has not been provided with adequate information and data to undertake certain analyses and prepare a detailed fiscal risk matrix for the Kyrgyz Republic. The content and the coverage of the IFR document need systematic improvement. The 2021 IFR did not include risks associated with the energy sector. Given that the sector’s SOEs hold 91 percent of non- financial SOEs’ liabilities, equivalent to 21 percent of the country’s GDP,3 and are incurring heavy losses with a significant impact on the country’s public finances, the absence of this important source of fiscal risk in a published IFR stands to decrease the value and visibility of the document. The reporting requirements outlined by the MoF are not complete. Of all the SOEs, the energy sector should be the one to inform the MoF regularly, given that the government’s lending and on-lending portfolio is highly concentrated in this sector and constitutes a substantial source of fiscal risk. This issue is further explored in the SOE section. Annex 1 of this report presents the team’s recommendations in greater detail, grouped as follows: i) preparation and publication of an IFR, ii) institutional setup for fiscal risk management, iii) fiscal risk analysis, iv) macroeconomic, fiscal risks, v) lending and on-lending operations, vi) public debt, vii) coordination among units, and viii) the reporting framework. The main recommendations of the report refer to the following aspects of the IFR: • The preparation and publication of the IFR require a more robust legal framework (to be implemented in 2023-24). The authorities should develop a detailed information collection and exchange framework to produce the IFR through a government decree or by amending the Budget Code. The legal framework should define data request templates, endorse the methodologies for analyzing each source of fiscal risk, and describe the scope of the publicly disclosable version of the IFR. • It is paramount to reflect on and analyze fiscal risks starting with major risks, including those from the energy sector as the main source of contingent liabilities (to be implemented in 2023). Then, the IFR could best reflect on other fiscal risks and sequence them according to their scale and likelihood of materialization. • Building staff capacity is essential to identify, analyze, and manage each source of fiscal risk, starting with the substantial ones such as the energy sector (to be implemented in 2023 onwards). It is recommended that the authorities use existing tools such as the PPP Fiscal Risk Assessment Model (PFRAM) developed by the WB and IMF, and the relevant units of the MoF such as the FRU and the Center for PPPs to develop a credit risk assessment methodology for SOEs to be adopted by relevant units. • The institutional setup for fiscal risk management needs to be strengthened (to be implemented in CY2023). The interagency working group could be established through a Cabinet Decree. It would be important to clearly define the objectives, functions, and tasks between involved units in the decree while giving the FRU ownership and the leading role. Such action would also help coordinate the fiscal risk-related units of different ministries and agencies. 3 WB (2021): Kyrgyz Republic iSOEF Assessment. 9 • The IFR should be improved, updated, and published regularly. It should be made more concise and annexed to the draft law on the State Budget before its submission to Parliament, as is the common international practice. II. Background The fiscal system of the Kyrgyz Republic is exposed to high risks. The main sources of fiscal risks include: (i) the poor financial performance and operational efficiency of state-owned enterprises (SOEs), especially those in the energy sector, with a large accumulated stock of debt to the government fluctuating at around 17-20 percent of GDP during 2018-2020 4 (SOEs have no government guaranteed debt, and unguaranteed SOE borrowing is considered immaterial); (ii) macro-fiscal vulnerabilities triggered by global, regional and domestic shocks (such as the 2008 global financial crisis, 2014 food price shock, 2016 oil price shock, 2020 COVID-19 pandemic, and the international arbitrage over the country’s largest gold mine ongoing since 2021); (iii) a heightened public debt burden which is assessed as posing a moderate risk of debt distress, and (iv) the liabilities of extra-budgetary funds. Chart 1: Sources of fiscal risks Sources of fiscal risks Risks from contingent Macroeconomic risks liabilities Economic Inflation Explicit Implicit growth Exchange rate PPP Guarantees Bailouts Settlement (loans, PPP)1/ (SOEs, local of litigations gov., banks) Natural disasters 1/ On-lending activities could also be added to this category. While they are not explicit contingent liabilities but assets to be recovered from the beneficiaries, they expose the government to credit risk (e.g., beneficiary not honoring its debt) similar to that arising from guarantees. The government is committed to improving broader fiscal risk management, though little information is currently publicly available. Since 2017, a section on budgetary risks has been included in the explanatory note of the State Budget package. In 2021, the MoF prepared the inaugural IFR. Although unpublished, the document contains several sources of fiscal risk with useful information. However, the 4WB (2021): Kyrgyz Republic integrated State-Owned Enterprises Framework (iSOEF) Assessment, which can be found at https://openknowledge.worldbank.org/handle/10986/35581. 10 document is missing the major source of fiscal risk stemming from the contingent liabilities related to the energy sector SOEs. The IFR produced and published by the MOF in the spring of 2022 reflected more information on fiscal risks and slightly improved analytics on the likely materialization channels of fiscal risks. The updated IFR is envisaged to inform the preparation and discussion of the 2023 state budget. The 2022 IFR includes certain policy measures to mitigate fiscal risks and their ex-post impact on the State Budget. However, the quality of the IFR document needs to be continuously improved in terms of diagnostic aspects, to reveal and draw policymakers’ attention to the most urgent risks, and in terms of the policy response to suggest relevant mitigation measures to manage those risks. Table 1. Fiscal risk matrix for the Kyrgyz Republic 5 Contingent Liabilities Direct Liabilities Explicit • • Explicit liability for obligations of SOEs • Bonds and loans: 65% of GDP, as of Sept. 2021 (non-corporate enterprises only) (KGS6 407 billion as of year-end 2021, 85% in foreign currency) • Legal protection of natural monopolies from bankruptcy • Execution of LGs budget: about KGS 5.6 billion (0.9% of GDP) (**) • Legal obligation to support financial sector SOEs if they suffer financial distress • Fiscal commitments to PPPs: KGS 98 million for three signed projects (about 0.0002% of GDP) (**) • Extra-budgetary funds: KGS 2 million (**) Implicit • • Unguaranteed local government debt (0%) • Present value of future public spending • On-balance-sheet liabilities of extrabudgetary funds • Unguaranteed SOE non-government borrowing (considered to be immaterial) (*) • Bail-out of energy sector SOEs (KGS 108 billion, or US$1.3 billion, 17% of GDP) • Contingent liabilities from PPP: KGS 92 million for three signed projects (about 0.0001% of GDP) (**) Accounts Receivable (Contingent) Explicit Collection from budget lending and on-lending: KGS 158bn (about 25% of GDP) due by SOEs, public financial institutions, and other entities (out of which LGs’ share does not exceed 0.4 percent of GDP) (** and ***) 5 The amounts indicated in the fiscal risk matrix represent the maximum exposure. The team was only able to identify some of them, based on the information shared by the authorities. 6 1 USD = 84.80 Kyrgyz Republic Som (KGS) as of year-end 2021. 11 (*) Source: WB (2021): Kyrgyz Republic iSOEF Assessment (**) Source: Draft 2021 IFR (***) Source: Explanatory Note for the Draft Law on State Budget 2022 While the draft 2021 IFR report addressed some of the sources of risks, the Kyrgyz Republic’s exposure to fiscal risks might be more diversified. The sources discussed in the following sections are viewed as the most important ones (macroeconomic shocks, public debt, lending and on-lending, risks from SOEs, public-private partnership (PPP) contracts, and local governments (LGs)) based on the experience of other countries and highlighted as significant for the Kyrgyz Republic in WB and International Monetary Fund (IMF) reports. See the most observed sources of fiscal risks and their classification in Figure 1 and a high- level fiscal risk matrix populated by the WB team based on the information obtained during its mission in January-February, and from publicly available documents in Table 1. III. Findings and Recommendations7 1.1. Fiscal Risk Monitoring and Management Findings The Budget Code of the Kyrgyz Republic envisages fiscal risk assessment as part of general provisions for budget formulation. Article #80 of the Budget Code lists fiscal risk assessment as one of the main requirements of the government in formulating the annual budget or the medium-term fiscal parameters. Also, Article #90 specifies draft normative acts and lists the assessment of fiscal risks as one of the required documents to be attached to the explanatory note of the draft law on the State Budget. However, the current legal framework for fiscal risk assessment lacks more detailed provisions to regulate relations between the MoF and line ministries, stipulate specific deadlines by sub-legislation, and establish procedures for producing fiscal risk assessments (Table 2 provides the list of legal documents). Table 2. Summary of relevant legislation (*) Legislation Relevant fiscal risks Date Description Budget Code Macroeconomic May 16, Article 80: The requirement for fiscal risk shocks 2016, No. 59 assessment is one of the main requirements of the government in formulating the annual budget or the medium-term fiscal parameters. Article 90: The assessment of fiscal risks is one of the required documents to be attached to the explanatory note of the draft law on the State Budget. Step-by-Step Macroeconomic December The draft revision covers the methodology for Guideline on shocks, public 27, 2021, assessing macroeconomic, fiscal, revenue Assessing Fiscal revenue forecasts, No. 26- П projection, debt, budget lending, and contingent Risks public debt, lending, liability risks, as well as risks related to SOEs and guarantees, quasi-fiscal activities. 7 This report focuses on risks from macroeconomic shocks and debt-related fiscal risks covering the SOEs, PPPs, LGs, and the lending portfolio. Other risks are beyond the scope of this report. 12 litigations, PPPs, SOEs Law of the Kyrgyz SOEs August 8, This law defines the legal framework of state policy Republic on 2011, N 149 concerning natural monopolies in the Kyrgyz Natural Republic. It aims to balance consumer interests and Monopolies the effective functioning of entities acting as natural monopolies, ensuring the availability of goods and services. Regulation of the Macroeconomics, May 13, The regulation defines the roles of the Coordination PPP, Public 2011, N215 Coordination Council for Macroeconomic and Council on Investment Investment Policy under the Government of the Macroeconomic Management Kyrgyz Republic as a consultative and advisory body and Investment that ensures the adoption of collective decisions on Policy the development and implementation of macroeconomic and investment policies. Regulations on the SOEs, except for the December This regulation defines the legal and organizational State Property energy sector 10, 2021, basis for the activities of the SPMF under the MoEC Management Fund N300 of the Kyrgyz Republic. under the Ministry of Economy and Commerce PPP law PPPs August 11, Definition of PPPs, emphasis on the fair distribution 2021, N98 of the risks between public and private partners. (*): This table is not comprehensive and includes most legislation related to overall fiscal risks, SOEs and PPPs. There is some institutional setup conducive to fiscal risk management. The legislation makes it clear that the MoF is the institution in charge of evaluating and monitoring fiscal risks. Within the MoF, the dedicated FRU, namely the Division on Budget Analysis and Fiscal Risks, provides a solid basis for the institutionalization of the identification, analysis, and disclosure of fiscal risks. The FRU is responsible for assessing and monitoring fiscal risks with input provided by various structural units of the government and preparing the IFR (see Figure 2). The FRU employs four staff including the division chief. There is also an interagency working group, the Fiscal Risk Working Group (FRWG), established to prepare the IFR on an ad-hoc basis. 13 Chart 2. Flowchart of units involved in the preparation of the fiscal risk statement The impact of the institutional changes that took place in December 2021 remains to be seen but risks further complicate the oversight of fiscal risk management. At first glance, these changes seem to have fragmented the fiscal risk management and monitoring environment. For example, the Ministry of Finance and Economy was split into the MoF and MoEC less than a year after merging. Oversight of the SOEs was divided between the SPMF and NEHC. Also, the SPMF was moved to the MoEC, making it an affiliated entity of the MoF. The FCF under the MoF, formerly the State Agency for Budget Lending, was given an additional mandate regarding the management of financial assets, which allows the FCF to become a shareholder of SOEs. The working group approach used in developing the draft IFR is unlikely to work due to the December 2021 reorganization when the SPMF left the system of the MoF. The SPMF is the SOE ownership body, and fiscal risks assessment is beyond the scope of its competencies. Furthermore, it may create a conflict of interest as fiscal risk analyses of the SOEs prepared by the SOE ownership body risk being biased. Regardless of the reorganization, the FRWG format does not provide long-term efficiency for the FRS development process unless there is a formal distribution of the objectives, functions, and tasks between involved units/agencies, where the FRU has ownership and plays a leading role within the entire process. The fiscal risk legal framework is mostly fragmented. The set of legal documents relevant for the management of risks from SOEs consists of: (i) the Law of the Kyrgyz Republic on Natural Monopolies in the Kyrgyz Republic, (ii) Regulations of the Coordination Council on Macroeconomic and Investment Policy under the Government of the Kyrgyz Republic, and (iii) Regulations on the State Property Management Fund under the Ministry of Economy and Commerce of the Kyrgyz Republic. These documents fragment 14 the SOE legislation because each creates conflicting regulatory assignments from different legal instruments. The MoF took a significant step forward by updating the “2016 Guidelines for Compiling Information on Fiscal Risks� in December 2021 - via the Order of the Minister of Finance N26-П 27.12.2021 - and adopting the “Step-by-Step Guideline on Assessing Fiscal Risks.� The guideline includes an improved methodology for assessing macroeconomic, fiscal risks. Additionally, it is extended with the guidance on assessing the specific fiscal risks the country faces or may face in the future. The document includes relevant guidance on the type of information to be included in the IFR, such as the tables on the quasi- fiscal activities of SOEs and credit risk assessment methodologies. The guideline creates a good basis for the MoF to build and maintain capacity for fiscal risk analysis. It correctly highlights the importance of starting the process with the largest and most likely sources of fiscal risk. Furthermore, it mandates the FRU to prepare the note on fiscal risks to be annexed to the budget, lists the names of the entities responsible for each type of risk, and defines the timeline for providing input to the FRU under the Budget Policy Department of the MoF. The 2022 Explanatory Note for the Draft Law on State Budget 2022 covers certain useful provisions on fiscal risks but misses a section of the energy sector risks. The note includes information on macroeconomic and specific fiscal risks, like certain SOEs, PPPs, and government debt. But the coverage is limited and mostly descriptive. Regarding the energy sector, there is only information on the stock of lending to the energy sector SOEs. The draft IFR produced by the MoF in May 2021 was the first attempt to elaborate on fiscal risks with the potential to impact the republican budget but remained unpublished. The preparation of such a document was a PPA under the IDA’s SDFP engagement. For the current cycle of the SDFP, the government of the Kyrgyz Republic has upgraded the IFR by incorporating certain mitigation measures, publishing the document on the MoF website in May 2022.8 The draft 2021 IFR identified 11 different risks that are under the purview of the MoF. These risks consist of those associated with macroeconomic management and the quality of macro-projections, public debt and budgetary lending, risks emanating from the execution of local budgets, the operations of off-budget funds, litigation risks, SOEs, PPPs, and other contingent liabilities that pose treats to fiscal suitability in the Kyrgyz Republic (see Box 1). The IFR informed the 2022 explanatory note of the 2022-24 three-year budget package submitted to Parliament in October 2021. The unpublished draft IFR highlights the following: i) The fiscal system remains vulnerable to significant shocks affecting the level of current spending, tax collection, and other parameters. ii) The capacity for macroeconomic forecasting, particularly revenues, is weak and relies on unrealistic assumptions. iii) Funding of the execution of local budgets’ expenditures from the republican budget is uncertain due to ineffective planning. iv) Public debt is vulnerable to major shocks such as the exchange rate and growth. 8 The link to the Information on Fiscal Risks – http://minfin.kg/ru/novosti/reforma-upravleniya-gosudarstvennymi- finansami/informatsiya-po-fiskalnym-riskam-na-2022-2024-gody 15 v) Overdue budgetary lending and on-lending payments increased partly due to currency depreciation. vi) The two extra-budgetary funds, the social fund, and the mandatory medical insurance fund, are likely to become significant sources of fiscal risk given the demographic changes in the Kyrgyz republic. vii) The fiscal risk from the three SOEs appears to be low, although the performance of one of them worsened in 2020. Box 1. IFR outline • Macroeconomic Fiscal Risks • Fiscal risks associated with the quality of government revenue forecasting • Fiscal risks associated with public debt • Fiscal risks associated with budget lending • Risks associated with the execution of local budgets • Risks associated with the expenditure of extrabudgetary funds • Fiscal risks associated with other contingent liabilities o Litigation risks o Risks associated with commitments for PPP projects o Fiscal risks of state-owned enterprises • Other fiscal risks o Risks associated with the flow of international financial assistance The 2021 IFR, however, did not include risks associated with the energy sector. Given that the energy sector SOEs hold 91 percent of non-financial SOEs liabilities, equivalent to 21 percent of the country’s GDP 9 , and are incurring heavy losses with a significant impact on the country’s public finances, the absence of this important source of fiscal risk in a published IFR would decrease the value and visibility of the document. The reporting requirements outlined by the MoF are currently incomplete (for example, the NEHC does not report to the MoF unless requested). Of all the SOEs, the energy sector should be the one to inform the MoF regularly, given that the government’s lending and on-lending portfolio is highly concentrated in this sector and constitutes a substantial source of fiscal risk. This issue is further explored in the SOE section. The data collection mechanism for fiscal risks presents other challenges. While different subdivisions from agencies are required to collate and report fiscal risks to the FRU, this aggregation creates challenges in aggregating fiscal risks from operationally quite segregated departments. Also, the procedures for reporting or information gathering by the FRU are not defined in any document. Challenges in obtaining information and data prevent the analytical units from building the capacity to undertake a sound risk assessment, especially when conducting macroeconomic risk analysis. The use and publication of regular risk reports such as the IFR can help build risk analysis capacity in the FRU. While 9 WB (2021): Kyrgyz Republic iSOEF Assessment. 16 the draft IFR contains highly important topics, it lacks focus and direction in outlining the main cause of fiscal risks and objective of analyzing these risks. The government of the Kyrgyz Republic's main existing fiscal risk management tool is the monitoring of selected risks through disclosure in the explanatory note to the State Budget and, since 2021, the draft IFR. There is no lending and on-lending fee, except for the 0.5 percent margin on the interest rate for certain on-lending contracts to compensate for the credit risk of the beneficiaries. There is a budget appropriation to the State Budget reserve, capped at 2 percent of total budget expenditures. When the amount in reserve becomes insufficient, resources are moved across budget items. Recommendations The preparation and publication of the IFR require a more robust legal framework. The authorities should develop a detailed information collection and exchange framework for the production of the IFR through a government decree or by amending the Budget Code. This means preparing data request templates, strengthening the methodologies for analyzing each source of fiscal risk, and describing the content of the results to be shared with the public. In particular, for the SOEs, the SPMF, NEHC, and other relevant agencies should provide all the necessary data on the financial performance of the SOEs to the FRU. In turn, the FRU should prepare fiscal risk analysis based on the data provided by these agencies. It is paramount to include the risks arising from the energy sector as the main source of contingent liabilities and begin the IFR with this topic. Then, the fiscal risks should be sequenced according to their size and the likelihood of materialization. The MoF should build the capacity to identify, analyze, and manage each source of fiscal risk, starting with the large ones such as the energy sector. It is recommended that the authorities use existing tools such as the PPP Fiscal Risk Assessment Model (PFRAM) developed by the WB and IMF. The relevant units of the MoF, such as the FRU and the Center for PPPs, should develop a credit risk assessment methodology for SOEs to be adopted by relevant units, such as the FRU SPMF and NEHC10. The government should strengthen the institutional setup for fiscal risk management. For example, the interagency FRWG could be established through a decree. It would be important for the decree to clearly define the objectives, functions, and tasks among involved units while giving the FRU ownership and the leading role. Such action would also help coordinate between the fiscal risk-related units, such as MoF, MoEC, SPMF, and NEHC. The IFR should be improved, updated, and published regularly. It should be made more concise and annexed to the first submission of the draft law for the State Budget, which is common practice internationally. 1.2. Macroeconomic Fiscal Risks Findings Fiscal risks emanating from macroeconomic management in the Kyrgyz Republic are high. This high degree of risk exposure is associated with: (i) high dependence on key macroeconomic variables from exogenous factors; and (ii) weak institutional capacity to produce credible projections. The first set of issues makes the Kyrgyz fiscal system highly vulnerable to external shocks that transmit through 10 See Annex 2 for an overview of the most used credit risk assessment methodologies. 17 remittances, financial, trade, and investment channels, leading to uncertainties in macroeconomic projections. The second set of issues might be explained by several factors, including the relatively low level of public sector salaries, high staff turnover, frequent structural reorganization in key ministries, a weak performance management system, etc. Usually, the actual outcomes of macroeconomic indicators turn out to be lower than projected (or the historical average) levels. This is because downside risks often materialize, leading to complexities and ad-hoc policy responses. The materialization of macroeconomic risks was not assessed properly, and policy responses were envisaged ex-ante. The high dependence on exogenous factors leads to uncertainties and high volatility of macro- indicators, posing risks to fiscal revenue collection and expenditure execution. Globally the Kyrgyz economy is one of those highly dependent on private transfers from abroad (remittances), which account for about 30 percent of GDP. A reduction in remittance inflow immediately affects the level of GDP and tax revenue collection, as well as pressuring public spending as the country’s poverty profile deteriorates. The other key indicator for the Kyrgyz economy is the international price of gold. Gold accounts for 30 percent of total exports from the Kyrgyz Republic and generates 10 percent of its GDP. Any shock that affects gold exports leads to a notable decline in GDP, and thus a decline in fiscal revenues and the need to find alternative sources of foreign exchange to service public debt or pay for imports. The draft 2021 IFR reflects and draws attention to all main macroeconomic indicators. The latter refers to GDP, CPI, ER, CAB, exports, imports, transfers, etc. However, it does not present or analyze the main external and domestic factors affecting the trend of macroeconomic indicators. Also, the IFR does not provide analyses of risks materialized during the previous period/year. Besides the IFR, the government elaborates in a section on Risks to Implementation of the Republican Budget (hereafter referred to as the risks section) as part of the explanatory note of the State Budget package. The risks section of the 2022 budget document reflects two broad sets of risks: (i) macroeconomic risks; and (ii) risks to the resource component of the budget. The latter is broken into eight specific risks of: • Tax and non-tax revenues, • Resources mobilized through the issuance of government securities, • Resources mobilized from external sources, • Budget lending, • Expenditure side of the budget, • servicing public debt, • Health and social protection system, and • Legal disputes and court proceedings. The section on macroeconomic risks provides a list of domestic and external factors likely to affect the implementation of the 2022 budget. Most of the reflected risks pertain to external factors and only two to features of the domestic economy (high share of informality officially estimated at 23.5 percent) and remaining tariff/customs barriers. 18 The Kyrgyz Republic is a member of the Russia-led Eurasian Economic Union (EEU) and is highly dependent on and exposed to developments in the Russian economy. It receives 1.9 percent (about $200 million annually) of all customs duties collected by EAEU member countries.11 Russia is one of the largest non-gold trading partners of the Kyrgyz Republic, accounting for 15 percent of total exports and the bulk of major imports such as energy and fuel. Russia is also a major source of remittances to the Kyrgyz economy (71 percent of total remittances in 2021). Finally, Russia has a significant share (18 percent in 2020) of FDI in the Kyrgyz economy. Although it is highly concentrated in the extractives sector, the Kyrgyz Republic remains among the countries most exposed to Russian FDI. There is no direct exposure to the financial sector as no Russian banks operate in the Kyrgyz Republic, and Russian capital in the banking sector is extremely limited. However, certain remittance channels (including Western Union) with Russia are now closed, with consequent implications for correspondent banking relationships. The above suggests that the next IFR document should give due attention to the Kyrgyz economy’s exposure and vulnerability to geopolitical risks and elaborate on the main channels through which these risks may transmit to the Kyrgyz economy. Other improvements to the macro-fiscal risks section of the IFR document may include non- discretionary expenditure items of the state budget. Such expenditure items refer to the public sector wage bill, which has been claiming a large share of public spending (about 10 percent of GDP) and has been on the rise. This trend may lead to fiscal sustainability concerns if wage increases are not accompanied by other measures to streamline and downsize the public administration system and introduce performance evaluation practices and other human resource management reforms to ensure a correlation between the pay and performance of public servants. The 2021 IFR missed out on an elaboration of measures to mitigate the implications of identified risks, while the risks section of the budget document did not. However, the latter being too generic creates difficulty in making an attribution. The suggested mitigation measures refer to enhancing financial discipline, prioritizing spending by line ministries and defining specific results for resource allocation, increasing the efficiency of public resource use, ensuring a balanced republican budget, reforming the public administration system, advancing budget legislation, and restricting new spending initiatives by ministries that are not backed by financial resources. However, there is neither quantitative nor qualitative assessment of the implications of the identified risks on the fiscal outcomes. Recommendations The macroeconomic fiscal risks section in the IFR can be improved as follows: • Shorten the description of official statistics regarding the actual outcomes of macro indicators and present more facts demonstrating structural vulnerabilities and reflecting on risks materialized in the preceding period. • Reveal the main sources of macroeconomic risk for each indicator and update these risks annually. • Describe more clearly the transmission channels of each shock (COVID, international prices, global demand/trade, etc.) with quantification of positive and negative implications. 11 Customs revenues are redistributed among EAEU members via an agreed formula. 19 • Conduct sensitivity analyses of main fiscal aggregates (revenues, expenditures) to changes in macroeconomic parameters (GDP growth, exchange rate, gold price increase, remittances, etc.). • Conduct scenario analyses with a clear description of assumptions for baseline, optimistic (upside risks), and pessimistic (downside risks) scenarios to explore the impact of shocks on several macroeconomic parameters simultaneously. • Merge the Revenues and Macro sections - and reflect risks associated with poor forecasting quality in the institutional risks section. • Elaborate on measures that could mitigate and minimize the implications of macroeconomic risks on the fiscal system. One potential suggestion could be to enhance fiscal buffers to weather the implications of materialized macroeconomic risks. 1.3. Fiscal risks associated with public debt Findings Both total external and external public debt ratios declined in 2021, owing mainly to GDP growth in nominal terms and exchange rate stability. Total external public debt is expected to decline to 51.6 percent of GDP as of the end of November 2021 from 58.3 percent at the end of December 2020. The MoF continues to primarily rely on multilateral and bilateral borrowing sources and pursue domestic borrowing. Domestic public debt remains relatively limited, at an estimated 8.9 percent of GDP at the end of October 2021, down from 9.8 percent as of end-December 2019 (Table 3). The domestic market is dominated by buy and hold investors. The secondary market has yet to develop and is unlikely to do so as long as the financial system has excess liquidity and until more diverse investors with different investment horizons, benchmark requirements and liquidity needs emerge. Table 3. Breakdown of public debt (percent of GDP) 2019 2020 October-2021 Contingent liabilities from government Public debt 51.6 68.1 60.6 guarantees do not yet exist. No government External debt 43.3 58.3 51.6 guarantees have been issued recently, Domestic debt 8.3 9.8 8.9 though the FCF is preparing a guarantee issuance resolution to support the private Source: MoF. sector, including PPPs. The MoF prepares a three-year Debt Management Strategy (DMS), which is approved by government resolution. The debt management strategy for 2020-23 highlights debt sustainability as a core objective. It indicates that the Kyrgyz Republic can contract only a concessional borrowing with a 35 percent grant element and bans the issuance of government guarantees. The strategy’s objectives are to ensure the availability of funding to cover the government's financing needs at the lowest possible cost and a reasonable level of risk, as well as to develop the government securities market and maintain public debt sustainability. The Explanatory Note for the Draft Law on the State Budget 2022 includes a useful section on the public debt portfolio and policies on external and domestic borrowing. The note specifies that no Eurobonds or guarantees will be issued during the year and that domestic borrowing will be done on market terms. It also identified the currency risk of the debt portfolio as the highest risk, requiring close monitoring of its impact on fiscal sustainability. 20 The government continues to prioritize concessional external borrowing of at least 35 percent while restricting funding from any external creditor to 50 percent of the total external debt. In its latest debt management strategy, the government is not pursuing the issuance or placement of foreign currency bonds in external financial markets. For domestic debt, the government aims to increase the share of longer-term bonds (5-,7- and 10-year Bonds) in the overall domestic debt portfolio to extend the average maturity of domestic debt. According to the DMS, the government aims to increase domestic borrowing gradually to support domestic capital market development. Despite a thorough analysis of diverse borrowing strategies and their cost and risk implications for the preparation of the debt management strategy, the current DMS document does not conclude with selecting a preferred strategy or a corresponding borrowing plan. Overall, the government has rigorously followed a strategy of borrowing at highly concessional terms. The debt portfolio is characterized by its long maturity and fixed interest rates. Currently, variable interest rate debt from external sources is limited to two creditors. The total debt maturing within one year as a percentage of debt is only about 6 percent. The interest rate risk in foreign currency is low. But interest and refinancing risks are higher for local currency debt. The country’s current outstanding debt has a relatively smooth redemption profile over the coming decade. The major risk to the outstanding portfolio comes from its currency composition. With a major share of the government’s outstanding debt denominated in foreign currency, there is high vulnerability to exchange rate shocks, particularly in USD. To improve the quality of the Debt Management (DeM) strategy document, it should conclude the analysis undertaken during the preparatory work by selecting a preferred borrowing mix. The preferred strategy should assist the government in achieving its DeM objectives over the medium term and contribute to developing the domestic market. Debt management reporting to the parliament is part of the Budget Execution report prepared by the MoF. This annual report includes an analysis of the domestic debt market and the approved vs. actual issuances of government securities, stock for external and domestic debt, debt by currency, and a short analysis of planned, vs. actual debt services for external and domestic debt. Recommendations Further improvement of the assessment of the fiscal risk exposure of the debt management policy implementation in the IFR requires enhanced quality of the public medium-term DMS document. It is vital that the DMS is updated annually, similar to budget legislation and the medium-term fiscal framework. The publicly available version of the DMS should guide on the preferred medium-term borrowing strategy. The risk assessment of the debt portfolio should elaborate on high exposure to foreign currency risks and limited mitigation options, and also add information on risks associated with the portfolio’s maturity profile. It should also describe the evolution of the costs and risks of the public debt portfolio and key aspects of risk management. Clearly defined categories of debt included in the public debt reports would further facilitate the identification of the gaps in debt data. Specifying the types of public debt included in the medium-term debt management strategy, public debt management reports, and debt statistic publications is necessary. The IFR should also add a reference to the portfolio of government guarantees and the absence of risks associated with loan guarantees in the current portfolio. Given the new government policy on the issuance of government guarantees, this situation might change in the next DMS period. 21 The MoF should start monitoring and publishing more comprehensive public sector debt data, including LG and SOE debt, as well as on-lent debt, to address broader fiscal risks. 1.4. Fiscal risks from lending and on-lending activities Findings According to the Explanatory Note for the Draft Law on State Budget 2022, public loans to legal entities and individuals totaled KGS 158 billion (25 percent of forecasted GDP for 2021) as of July 1, 2021. Out of this total, 86 percent were on-lending loans (referred to as foreign loans), 11 percent were direct lending (referred to as budget loans), and the remaining 3 percent were other types of loans (the majority of which were classified as mortgage loans) (Table 4). The energy sector SOEs and public banks were the largest beneficiaries of public loans, with 87 percent and 7 percent shares, respectively. The reported overdue loans corresponded to 4 percent of the total and 3 percent of on-lending loans, while they were immaterial (0 percent) for both the energy and banking sectors. These figures for current loans do not reflect restructured debt that underwent maturity extension and principal payment rollover, as long as they are contractually on time at the time of reporting. Energy sector SOEs’ debt, which makes up the vast bulk of Kyrgyz SOE debt, has been regularly restructured since 2015. As a result, overdue debt figures do not accurately reflect the real performance of public loans, which has been weaker than suggested by the overdue debt. The collection of overdue direct loans was successful and above target for six consecutive years between 2015 and 2020 due to improvements in loan documentation, regulatory and legal changes, as well as more systemized registration of collateral provided by borrowers that back the loans. Table 4. Breakdown of public loans (as of July 2021) Total: KGS 158 billion (25% of GDP) Out of which: Out of which: On-lending 86% Energy SOEs 87 percent Lending 11% Public banks 7 percent Other (mortgage loans, etc.) 3% Other 6 percent Source: Explanatory Note to the Draft Law for the State Budget 2022 In the same report, the total debt to the government of 14 legal entities, including 11 SOEs, is listed per beneficiary. These entities' total outstanding debt stock, as of September 1, 2021, was KGS134 billion. This list does not provide the breakdown between direct and on-lending debt and debt in arrears. The debt of two energy sector SOEs, JSC National Electricity Grid (NESC) and JSC Electric Power Plants (EPP), the two largest beneficiaries, made up 96 percent of the total outstanding debt. In the IFR, the section dedicated to budget loans has broadly the same information as the explanatory note, except for the list of the largest beneficiaries of government lending. Both reports contain information on the trends and drivers of overdue debt, collection performance, and projections. Depreciation of the local currency against USD and EUR is cited as the main reason for the accumulation of debt in arrears. However, neither report provides clear information on total outstanding restructured 22 loans12 nor the legal entities with the largest debt in arrears. Furthermore, the definition of ‘overdue loans’ is missing in both reports. Chart 3. Generic flowchart for the public lending cycle Loa n Revi sion by the Finance Negotiations with a pplication/project a nd Credit Fund, a counterparts a nd proposal by SOE/line dedicated s election credi tors mi nistry/MOFE commi ssion a nd the Counci l of Government a nd, for projects, Di s bursement of Submission to the Agreement signed by funds a nd, for pa rl iament for a l l parties, in projects, ra tification a ccordance with La w i mplementation i n International Moni toring by Col l ection of Fi nance and Credit repa yments by Fund a nd, for Fi nance and Credit projects, Public Fund a nd transfer to The FCF is responsible for the approval, monitoring, and collection of both direct and on-lending loans. However, the FCF is not responsible for the recording, consolidation, and reporting. Other units of the MoF, such as the Debt Management Unit (DMU), Public Investment Unit (PIM), and the Budget Policy Department, are responsible for these tasks. Yet the WB team could not confirm the existence of clear guidance on on-lending operations and the allocation of responsibilities for recording on-lending transactions. There are two separate regulations for public loans. The regulation for direct loans is detailed and includes a credit risk assessment methodology (including financial ratio analysis with pre-set limits). Since the WB team did not see a regulation dedicated to the processes and policies regarding on-lending, it could not assess its completeness and sufficiency. A generic flowchart showing the lending cycle (for both 12The explanatory note refers to the deferral of the debt repayments of two energy sector SOEs, JSC National Electricity Grid (NESC) and JSC Electric Power Plants (EPP), during 2020. However, it is not stated whether this a partial or full deferral of their debt repayment obligations for that year. Historically, such loans have been rolled over from year to year, at least starting from 2015 (WB (2021): Kyrgyz Republic iSOEF Assessment). Furthermore, information on accumulated deferrals is missing. 23 direct and on-lending loans) based on the meetings of the WB team with officials from the FCF and Public Investment Unit and the regulation on direct loans can be found in Figure 3. No regularly updated and publicly available consolidated reports or bulletins include detailed information on on-lending loans, with breakdowns by beneficiary and lender. As mentioned above, the explanatory note of the 2022 budget and the draft IFR report contain useful, albeit incomplete, information. The decision criteria on how the financial terms and conditions of the original loan are reflected in on- lending loans are unclear. In most cases, the currency risk is passed on to the beneficiary. This is in line with best practices; however, it increases the beneficiary’s overall credit risk and hence, the need for close monitoring. While the maturity is always equivalent, the interest rate of the on-lent loans is set slightly higher (0.5 percent) than the initial interest rate to compensate for the beneficiary’s credit risk. However, the past performance of the on-lending loans (considering the sizeable restructuring in the energy sector) suggests that this margin has not provided a sufficient buffer. The WB team has identified a potential moral hazard embedded in the confidentiality clauses of the on- lending contracts between the MoF and the beneficiaries. These clauses prevent the detailed disclosure of the identities of the beneficiaries of on-lending, which might act as an incentive for the non-payment of debt by the beneficiaries. Recommendations The on-lending reporting framework should be strengthened. An MoF unit, either the DMU or FCF, should clearly be designated as responsible for publishing a regularly updated and consolidated report on lending and on-lending. The details of this report should include: • Total outstanding lending and on-lending debt stock, broken down by maturity, interest rates, and currency • Breakdown of the on-lending stock by the largest beneficiaries (for example, the top 10, 20, or 50 beneficiaries, depending on the concentration of the portfolio) and the respective details on maturity, interest rates, and currency • Breakdown of the on-lending stock by lender and the respective details on maturity, interest rates, and currency • Outstanding debt in arrears restructured debt and repaid debt arrears by beneficiary • Updated credit risk assessment on the largest beneficiaries (with input from the FRU, see the section below on SOEs) • Debt service (principal plus interest) schedule for all outstanding debt stock by lender and by the largest beneficiaries The subsequent updates of the IFR should contain all the above information. It would be useful if figures were presented relative to GDP to give the reader a better understanding of their magnitude and the potential impact of unpaid on-lending debt on fiscal accounts. Certain information could be shared in charts, for example, the debt service to show the redemption profile. Some of the more detailed information could be presented in an annex of the document. 24 The confidentiality clauses in the on-lending contracts between the MoF and beneficiary should be revised. The contracts should not impede the full disclosure of the beneficiaries and those beneficiaries who are in arrears. The FCF should follow a set of transparent and established guidelines regarding transferring the original loans' financial terms and conditions to on-lent loans. These guidelines should include the details for each type of loan and provide the accompanying rationale. 1.5. Fiscal risks from SOEs13 Findings Table 5. Summary of sources of fiscal risks from SOEs Contingent Liabilities14 Explicit • Honoring on-lending debt received by SOEs and/or of government guarantees given for SOEs’ direct debt • Honoring of shareholders’ agreement that makes the government responsible for SOEs’ other liabilities Implicit • Honoring other SOE debt that does not enjoy explicit guarantees or that is not covered by any other contract, such as a shareholders’ agreement • Bailing out and/or recapitalization of SOEs that are facing insolvency or that have become insolvent The Kyrgyz Republic has two main categories of SOEs determined according to their legal status. Most entities by number are not subject to corporate legislation and are categorized as state enterprises (SEs). The largest and strategically most important entities are set up and categorized as joint stock companies (JSCs) and are subject to stricter financial reporting, disclosure, and audit requirements. They are regulated by legal frameworks applicable to all JSCs in the country. The bulk of SOE debt is concentrated among the energy sector SOEs operating under the JSC legal framework. The SOE institutional framework is fragmented. Energy sector SOEs are owned by the NEHC, which, in turn, is owned by the Ministry of Energy. All energy sector SOEs that operate under the NEHC umbrella are JSCs. The SPMF is responsible and plays an ownership role for the remaining SOEs. The latter are also linked to their respective line ministries, particularly concerning industry policies and regulatory matters. The upcoming changes in the FCF’s scope, which might allow the MoF to become a shareholder in the 13Table 5 summarizes the most common sources of fiscal risks stemming from the contingent liabilities of SOEs. 14The most common source that could trigger contingent liabilities stemming from SOEs is a decline in profitability that ultimately threatens the entity’s solvency. A decline in profitability could be the result of various factors: 1) macroeconomic shocks (such as to GDP growth or exchange rates), 2) SOEs’ involvement in quasi-fiscal activities that are not compensated by the government (such as the insufficiency of regulated prices/tariffs), 3) factors intrinsic to the individual SOEs (such as unsustainable business models and strategies, operational inefficiencies, mismanagement and corporate governance issues). 25 energy sector SOEs, could further complicate coordination and responsibility allocation among the various governmental units. According to the WB’s 2021 Kyrgyz Republic iSOEF Assessment, government loans to SOEs amounted to 19 percent of GDP as of the end of 2018. Out of this total, 87 percent comprised on-lending debt, and on- lending to two energy sector SOEs, the NESC and EPP, comprised 95 percent of this debt. The report states that energy sector SOEs are not considered capable of servicing this debt in full without first introducing major reforms to strengthen their financial viability, which is evidenced by recurring debt rollovers for SOEs from at least 2015 to date.15 SOEs’ borrowing framework is not clearly established. Various units are responsible for different stages of the process, although there are no transparent cross-unit communication and coordination channels. By law, SOEs cannot contract debt from foreign sources directly, and therefore on-lending is their only means of obtaining concessional foreign debt. On-lending contracts are signed bilaterally between the MoF and the beneficiary SOE, and the SPMF and NEHC do not get involved in this process. SOEs are allowed to borrow in local currency from the MoF and domestic, commercial banks, in line with respective authority approvals as stated in their charters, and the latter volumes are not considered material. The Budget Code does not allow the government to provide guarantees for local borrowing by SOEs. However, by law, the government becomes responsible for the liabilities of the SOEs, should their assets be insufficient to pay off their debts16. Such an arrangement might lead to moral hazard by removing the incentive for the SEs to perform well. This might increase the government’s exposure to fiscal risks as there are no legal limits on SOE borrowing. By law, SOEs cannot directly contract loans from international or foreign sources other than via the Government. Hence, the on-lending of such concessional resources from the Government to the SOEs allows for proper fiscal risk monitoring, assessment, and control over SOEs’ borrowing levels. Loans from local commercial banks remain rather small, and government loan guarantees for SOE borrowing are not permitted under the Budget Code. At the same time, Kyrgyz SOEs—energy sector SOEs in particular— have been unable to borrow at market terms for several reasons, i.e., their excessive leverage ratios, limited ability to service loans, and insufficient revenues to cover expenses, to mention a few. This setup provides a solid fiscal monitoring framework but restricts the SOEs’ ability to access markets directly and bear the consequences of their direct interaction with the creditors. While prudent at this point in time, it may be useful to allow the SOEs to access market lending instruments directly with a medium-term perspective. There is no centralized SOE monitoring framework and no designated government unit in charge of aggregating and reporting the financial information of the SOEs. As a result, an aggregated SOE report or bulletin is unavailable, preventing public access to key information such as the total value of the SOE portfolio. 17 The SPMF and NEHC are responsible for monitoring the financial performance and government transactions of their respective SOEs. However, neither are required to submit regular reports on SOEs' financial situation and creditworthiness to the MoF. There is no approved methodology for credit risk assessment adopted by any governmental unit, including the SPMF, NEHC, and FCF. A Key 15 See Annex 2 for a summary of the Kyrgyz energy sector SOEs’ risks. 16 According to the WB (2021): Kyrgyz Republic iSOEF Assessment, total liabilities of the SEs, over which the government has explicit contingent liabilities, amounted to 1% of GDP as of the end of 2018. 17 One of the proposed FY22 performance and policy actions (PPAs) is that the MoF publishes on its website the detailed list of borrowings of all energy sector SOEs, and ensures that their IFRS-based audited financial statements and the accompanying notes for CY21 are publicly disclosed on the SOEs’ own websites in line with the requirements of the Law on Accounting. 26 Performance Indicator (KPI) system, developed and approved by the SPMF, has been in place since 2018. And yet the conclusions and performance of the SOEs vis-à-vis the KPI targets are not publicly available. JSCs are subject to stricter corporate governance and reporting requirements than SEs. JSCs are required to prepare and disclose their International Financial Reporting Standards (IFRS) based on annual audited financial statements. Yet, in practice, most JSCs do not comply with their disclosures differentiating by coverage and details disclosed, thus making it impossible to obtain the information necessary for comprehensive fiscal risk analysis or financial monitoring. The SEs also often fail to comply with minimum governance standards, including annual reporting. Although useful, the section dedicated to the SOEs in the IFR is incomplete. The report includes a detailed credit assessment and helpful financial ratio analysis of three non-energy sector SOEs. SOEs covered in the IFR are not the largest in the country, nor do they represent the greatest source of fiscal risk. A comprehensive overview of the SOE universe, as well as the analysis of the riskiest SOEs, are missing. The report does not mention the energy sector SOEs, their poor financial performance, and difficulties in honoring their debt to the government. Additionally, the quasi-fiscal activities of the SOEs are not described and quantified sufficiently. Recommendations The institutional setup surrounding the monitoring, assessment, and reporting of SOE financial performance and indebtedness should be centralized and strengthened. A clearer allocation of roles and responsibilities among the FRU, FCF, SPMF, NEHC, and the Department of International Cooperation of the MoF should be established regarding SOE financial monitoring and fiscal risk assessment. As recommended in section 1.2, the MoF/FRU should develop a credit risk assessment methodology adopted by the FRU, SPMF, and NEHC (See Annex 3 for an overview of the most used credit risk assessment methodologies). A designated MoF unit should be tasked with aggregating and reporting the detailed financial information of all the SOEs and publishing the statistics regularly in a report or bulletin. The MoF’s FRU could be such a unit due to its positioning within the MoF and its mandate and responsibility for monitoring fiscal risk. It is essential for the risks arising from the energy sector SOEs to be analyzed and strategies for managing these risks to be made publicly available in the IFR, budget documents, and elsewhere. Monitoring and reporting of the energy sector SOEs should become more transparent and follow a clearer process. The NEHC and its subsidiaries should be requested to submit their respective financial statements directly to the MoF, which, in turn, should carry out a regular and timely assessment of debt levels, repayments, arrears, and restructuring. NEHC, MoF, Ministry of Energy, and MoEC units should work jointly on the options to resolve the energy sector SOEs’ debt in arrears and improve their capital positions while reducing the debt burden. Strengthen SOE transparency by enforcing current financial reporting and disclosure requirements. This requirement should be extended to the largest SEs, and vigorously enforced by the State Service for Regulation and Supervision of Financial Markets (Gosfinnadzor) in cooperation with the MoF. Further, periodic, aggregate SOE portfolio reporting by the NEHC and SPMF (specifying main SOE performance trends and the government´s sector policy and reforms) compiled, elaborated, and published at least annually on an official website is required. A group of the most significant non-corporate SOEs should be identified, and their financial reporting and audit requirements should be aligned to those applicable to public and private JSCs. 27 Clearly outline and implement procedures for the FRU to assess SOE-related fiscal risks. This should be based on the data it receives from the SPMF, NEHC, FCF, and other units. The FRU unit should also adopt a methodology to quantify the impact of quasi-fiscal activities. Introduce annual aggregate reporting on the SOE portfolio with main financial information metrics and debt statistics. Currently, aggregate reporting on the Kyrgyz SOE portfolio is unavailable, which prevents public access to key information such as the total value of the SOE portfolio. It is highly recommended to conduct such aggregate reporting on the SOE portfolio, including detailed information on on-lending. Furthermore, such aggregate SOE reporting should become part of the annual budget legislation package submitted to the Kyrgyz Parliament (Jokorku Kenesh). The subsequent updates of the IFR should ultimately contain the following information on SOEs (items that require further capacity building can be added gradually over time): • Publish comprehensive aggregate and individual reports of all the SOEs (for example, key financial information, sectors, operational information, debt statistics, etc.) • List of the most indebted SOEs with their respective debt, debt in arrears, and restructured debt (if this information is provided in the section on on-lending, the SOE section can refer to that section instead of repeating the same information) • Focus analysis on the most important and indebted SOEs, starting with the energy sector SOEs – the NEHC and all its subsidiaries. In the medium term, this analysis should be expanded to include SEs, starting with the largest entities with existing or potential for significant borrowings, such as Kyrgyz Railways (SE Kyrgyz Temir Zholy). • Introduce transparent and impartial qualitative and quantitative credit risk assessment of the largest and riskiest SOEs (particularly the energy sector SOEs) • Implement quantification of the fiscal risks stemming from SOEs (for example: provision of expected and unexpected losses and probabilities of default) • Implement quantification of quasi-fiscal activities. 1.6. Risks associated with the execution of local budgets Findings Fiscal risks from LGs do not appear to be high, except for the deviations stemming from the execution of LG budgets. Lending and on-lending to LGs do not exceed 0.4 percent of GDP, corresponding to 12 percent of the LG budget. The share of arrears is 0.01 percent of GDP, which, while low, has been increasing since 2019, according to the IFR. LGs have not borrowed on their own for nearly a decade. The LGs section of the draft IFR provides a detailed overview of the LG budgets, covers the sources of risk and the inter-budgetary relations, including certain types of transfers regulated by the Budget Code, and provides an estimate of the fiscal risks. There is, however, no information on the LG-owned enterprises, which is usually a source of large fiscal risk and requires further study in the Kyrgyz Republic. The IFR states that maximum fiscal risk exposure from LGs amounts to KGS 5.6 billion, or 0.9 percent of GDP. The information and methodology provided on the IFR are hard to follow and not detailed enough to explain the calculation of this estimated risk amount. 28 According to the 2021 PEFA, the quarterly and annual financial reports of LGs are produced within three months of year-end. But these are only audited by the Chamber of Accounts every second year in a longer timescale. Furthermore, financial statements are not publicly available. Recommendations The authorities should continue summarizing the risks from executing LG budgets in the IFRs more concisely. The methodology for evaluating the fiscal risks from LGs should be described in greater detail as an annex to the document. Given that the current exposure from LGs appears to be lower than in other areas such as the SOEs, the authorities might include more advanced analysis of the LGs in the IFRs in the medium term. Additional resources on identifying, analyzing, and disclosing fiscal risks from LGs might be built only after properly addressing the major areas of fiscal risk. At the same time, the analysis of LG-owned enterprises should be prioritized in case they present a significant risk in the Kyrgyz Republic, similar to the SOEs. A consolidated report on the financial position of all LGs should be published annually and referenced in the IFRs. Such a report should include the main financial metrics and debt statistics, among others. 1.7. Fiscal risks from Public-Private Partnership Findings The new PPP Law (No 98) was adopted by the President of the Kyrgyz Republic on August 11, 2021. It defines PPPs as the cooperation between public and private partners for developing and implementing projects for the creation and/or upgrading, operation, and maintenance of infrastructure facilities and/or infrastructure services. One of the main principles of the law is the fair distribution of the risks between public and private partners. However, how such an allocation of risks is to be achieved is not clearly defined in the law18. According to other countries’ experiences, the actual meaning of adequate allocation of risks can, in practice, become a source of controversy. The Center for PPPs, recently created under the MoEC, is in charge of coordinating the preparation and financial closure of the PPP projects. According to the MoEC website19, there are currently 32 PPP projects at different stages of development. Of these, three PPP projects have commenced, three are at the private partner selection stage, and 26 are under preparation. The website includes summary information about all of these projects, with brief descriptions and the stages of the project. For most of them, the investment amount is also mentioned. However, there is no information about the implementing institution and the fiscal commitments and contingent liabilities that each project might create. The IFR covers the three projects currently under construction or operating (Table 6). The document includes a preliminary estimate of the Fiscal Commitments and Contingent Liabilities (FCCL) from these three projects, which total KGS 98 million. While this is useful, the annual fiscal commitments for the electronic ticketing project are missing. Only information until 2028 is provided for all projects. Additionally, the report does not contain sufficient information or the methodology for the calculation of these numbers, which makes it hard to assess the accuracy and relevance of these estimates. 18 http://cbd.minjust.gov.kg/act/view/ru-ru/112275?cl=ru-ru 19 http://mineconom.gov.kg/ru/direct/7/192/178 29 The Kyrgyz Republic is at the early stages of implementing the International Public Sector Accounting Standards (IPSAS). Therefore, it is even more difficult to evaluate the FCCL from PPPs, which are long- term projects requiring an accrual accounting approach. Accruals accounting according to IPSAS, however, is challenging during the institutional transitioning period. Table 6. PPP projects disclosed in the draft IFR Implementing Body Name of the Project Purpose FCCL Cost Ministry of Health of Organization of Establishment of four Payment 10 MLN the Kyrgyz Republic hemodialysis services in hemodialysis units in cities obligations for EUR Bishkek, Osh, and Jalalabad of the Kyrgyz Republic. health services Ministry of Culture, Renovation of the Kyzyl- Improving the quality of No fiscal 0.45 Information, and Kyrgyz Republic Cinema20 film services to the commitments MLN Tourism of the Kyrgyz population USD Republic The City Hall of Bishkek Electronic ticketing of Introduction of a unified Payment for a 2.9 public transport electronic ticketing system committed MLN for public transport in number of e- USD Bishkek tickets Fiscal commitments to PPPs (KGS 98 million for three signed projects) Source: Draft 2021 IFR The MoF is responsible for assessing the risks arising from the PPPs and providing an opinion to the MoEC. Also, aside from fiscal risks, the MOF can assess Public Finance Availability and the Value-for- Money of each project, which is linked to the type of FCCL that a project can generate. However, it is unclear which units within the MoF hold these responsibilities, and how they are divided between the PPP unit and the FRU. Recommendations The role and analytic capacity of the FRU in assessing fiscal risks arising from PPPs should be increased. The FRU should be able to identify the FCCLs resulting from a PPP project. To this end, close cooperation with the PPP unit and access to financial contracts are essential. At this relatively early stage of the PPP agenda, steps should be taken on the implementation and institutionalization of best practices for the management of risks from the PPPs. Standards and technical tools in assessing PPP projects include: • Start treating direct liabilities coming from PPPs according to IPSAS 21. Also, it is possible to proceed with implementing only certain standards based on the priorities of further increasing the fiscal transparency of the country. Applying IPSAS 32 is the best practice for properly treating service concession agreements22. 20 While this project is categorized as a PPP because of the involvement of both public and private partners, given that the government (the public partner) has no contractual commitments except for giving the private partner the right to use the state-owned land for real-estate development for a period of 49 years, the agreement is more akin to a lease contract. 21 https://www.ifac.org/system/files/publications/files/B8%20IPSAS_32.pdf 22 For example, Georgia has a fiscal rule which consists of keeping the sum of PPP Liabilities and government debt below 60% of GDP. The PPP liabilities portion of the rule is evaluated according to IPSAS 32. 30 • Rely on tools such as the PFRAM 2.0 developed by the IMF and WB to assess fiscal costs and risks arising from PPP projects. • Complement the risk analysis with in-house analysis based on the specifics and needs of the country. While having the capacity to assess projects with PFRAM is a useful asset for the fiscal risk team, it is still insufficient – a comprehensive project and cost-benefit analysis is still necessary. The quality and relevance of the project should be evaluated23. And so, a mixture of the standardized plus custom tools presents the most effective solution. The IFR, MoF, and MoEC websites should include more granular information about the current PPP portfolio and pipeline. This includes information such as the investment amount, risk sharing between the public and private sectors, the FCCL created by each project, including their terms and conditions (e.g., currency of the fiscal commitment). 1.8. Fiscal risks other than debt-related Extra-budgetary funds and legal claims against the government are risks worth analyzing and managing as they are major sources of fiscal risk in many countries. The IFR dedicates a detailed section to the risks from the Social Security Fund and Mandatory Medical Insurance Fund, wherein it describes the deviation between planned and actual transfers. Such analysis and information should be updated and shared in future IFRs. Regarding litigation risks, the IFR only provides the definition and potential sources for the Kyrgyz Republic without any specific information. Once the greatest sources of fiscal risk are well identified and evaluated, and management strategies have been developed, the authorities could explore the significance of these risks for the Kyrgyz Republic. The analysis of litigation risks requires a methodology distinct from the methods used for debt-related fiscal risks in terms of data collection and conceptual framework. Therefore, a unit should be made responsible for building capacity on this. Another important source of fiscal risk comes from the financial sector, which is not under the purview of the MoF. Financial sector regulators and the central bank usually monitor and manage this risk. However, a comprehensive fiscal risk statement should at least mention this risk as a significant implicit contingent liability and reference relevant documents. Going forward, the authorities should consider a management framework covering all the risks that can threaten public finances. 23 https://blogs.worldbank.org/ppps/fiscal-risk-ppps-whats-problem-what-do 31 Annex 1. Summary of Recommendations RECOMMENDATIONS TIMELINE24 RESPONSIBLE ENTITY Energy sector coordination The NEHC, MoF, Ministry of Energy, and MoEC units to work jointly to resolve the ST MoF, MoEC, energy sector SOEs’ debt in arrears and improve their capital positions Ministry of Energy, NEHC Preparation and publication of an IFR Develop a detailed information collection and exchange framework for the ST FRU implementation of the “Step-by-Step Guideline on Assessing Fiscal Risks� (government decree or amending the Budget Code) Include the fiscal risks stemming from the energy sector SOEs as the first item in ST FRU the IFR Prioritize the largest sources of fiscal risk, increasing the scope and level of detail ST FRU over time and including risk management strategies for each source of risk ST-MT MoF, MoEC, Elaborate on potential risk mitigation policies Ministry of Energy, NEHC Improve (make it more concise, among other improvements), update and publish MT FRU the IFR regularly Institutional setup for fiscal risk management Institutionalize the interagency FRWG through legislative documentation that ST MoF defines the objectives, functions, and tasks of involved units and gives the FRU the ownership and leading role Clearly allocate roles and responsibilities among the various MoF and MoEC units ST MoF, MoEC with regards to SOE financial monitoring, reporting, and fiscal risk assessment Fiscal risk analysis Increase the role and analytic capacity of the FRU in identifying, assessing, and ST MoF (FRU, Center managing the different sources of fiscal risks, such as SOEs, PPPs, and LGs, with for PPPs, etc.), input from all related entities MoEC, SPMF, NEHC Use existing tools such as PFRAM to analyze fiscal risks from PPPs and start MT MoF (FRU/PPP developing in-house analytical tools to analyze those fiscal Center) Develop a credit risk assessment methodology for SOEs to be adopted by relevant MT MoF (FRU) units, such as the FRU, FCF, SPMF, and NEHC Start treating direct liabilities coming from PPPs according to IPSAS MT MoF (FRU/PPP Center) Explore whether fiscal risks stemming from extra-budgetary funds or legal claims MT FRU are significant Consider developing a comprehensive risk management framework covering all LT FRU risks that could jeopardize public finances, including those stemming from the financial sector Macroeconomic fiscal risks Describe the transmission mechanisms of each macro source of risk and conduct ST MoF scenario/sensitivity analyses Lending and on-lending operations Review confidentiality clauses in the on-lending contracts with the beneficiary MT FCF 32 Establish a set of transparent guidelines for the transfer of financial terms and ST FCF conditions of the original loans to on-lent loans Public debt Improve the quality of the public medium-term DMS document ST DMU Improve the content of the DMS document, public debt management reports, ST DMU and debt bulletins by clearly defining categories Add a reference in the IFR to the DMS Reporting framework (for IFR, see above) Designate a MoF unit responsible for publishing a regularly updated and ST Debt consolidated report on budget lending and on-lending with a high level of detail Management Unit, FCF Designate a MoF unit responsible for aggregating, reporting, and regularly ST MoF publishing detailed financial information on the entire SOE portfolio (main financial metrics and debt statistics per SOE and overall) Request the NEHC and its subsidiaries to submit their respective financial ST MoF statements directly to the MoF Enforce the current financial reporting and disclosure requirements and align the ST MoF, State most significant SEs’ requirements with those of JSCs. Service for Regulation Require periodic, aggregate SOE portfolio reporting by the NEHC and SPMF ST SPMF, NEHC (specifying main SOE performance trends and the government´s sector policy and reforms) compiled, elaborated, and published at least annually on an official website Publish detailed information about PPPs, including sources of FCCL in the IFR, ST FRU, MoF, MoEC MoF, and MoEC websites Annually publish a consolidated report on the financial position of all LGs MT MoF 33 Annex 2. Kyrgyz Energy Sector SOEs’ Risks25 The energy sector makes up the bulk of the Kyrgyz SOE universe by asset size and social importance. In 2018, the SOEs in this sector made up 48.5 percent of total SOE assets (about 24 percent of GDP) and 62 and 91 percent of non-financial SOEs’ assets and liabilities, respectively. The sector's liabilities were equivalent to 21 percent of GDP in the same year. The energy sector is highly indebted and the largest recipient of government lending to SOEs. In 2018, the total debt stock of the sector amounted to 89 percent of its assets. In turn, the sector comprised 95 percent of total outstanding government loans, corresponding to 18.2 percent of GDP in the same period. Energy sector SOEs have not been able to fully service their debt to the government in recent years, even though their borrowings are long-term and on highly concessional terms. This has resulted in the government regularly restructuring its debt by lengthening its maturities and rolling over its principal payments since at least 2015. Debt restructuring provides only a temporary solution, and the probability of the government fully recovering these loans is low without effective reform actions to improve the financial viability of energy sector SOEs. The inability of the energy sector SOEs to repay their debt stems from their poor profitability. The sector reported a combined loss of KGS 3.4 billion and KGS 9.3 billion in 2018 and 2017, respectively (USD 50 million and USD 135 million, respectively). While the 2017 results were negatively affected by the revaluation of foreign-currency-denominated debt and fixed assets by one SOE, the underlying trend is that of substantial losses. The main factor behind the poor performance is tariffs charged to customers being lower than the average full cost of service. Tariffs are determined by government regulation. For political reasons, the government has been reluctant to raise tariffs to customers to levels that would ensure the financial viability of the energy SOEs. Subsidies received from the government have proven to be insufficient to cover costs. The sector's profitability is also expected to worsen over the medium term because of the forecasts of less favorable hydrological conditions leading to lower water levels in dams. The energy sector SOEs will need to undertake massive levels of capital investment to maintain the delivery of energy supplies to the population. However, the SOEs lack the resources to fund their investment requirements to maintain and rehabilitate their aging capital assets, which are in poor condition. The estimated capital investment requirements of the energy sector average at 4.2 percent of GDP during 2021-2030. Without major reforms (including tariffs) to improve the financial viability of the energy sector SOEs and to attract private investment into the sector, the government will have to fund the sector’s investment requirements to avert a collapse of energy supplies. 25 This section is based on the findings of the WB (2021): Kyrgyz Republic iSOEF Assessment. 34 Annex 3. Overview of Credit Risk Assessment Methodologies Credit risk assessment methodologies can be grouped into four broad categories: 1. Credit ratings: This methodology is based on the scoring of an entity's qualitative and quantitative risk factors on a relative basis and the weighted aggregation of these factors to a risk rating (for example, from 1 to 5, or from A to D). The platform on which the scoring is made is called a scorecard. The qualitative risk factors are related to the business profile of the entity analyzed, such as sector risk, competitive position, management quality, corporate governance, and business model. The quantitative risk factors include financial ratios for profitability, liquidity, solvency, and debt coverage. Fitch Ratings, Moody’s, and Standard and Poor’s are the main global credit rating providers. 2. Statistical models: This methodology entails the statistical measurement of the credit quality of an entity based on observable historical entity characteristics, such as financial ratios and its historical credit performance (i.e., default and/or payment history), mainly via regression analyses. The Altman z-score model is the most common starting point for risk units keen to employ statistical models. It provides a standard formula with default parameters and variables, and the final score is converted to a probability of default. The Atman z-score can be tailored for entities operating in different countries and sectors if there is sufficient historical data. 3. Financial modeling: This methodology involves constructing scenarios and estimating an entity’s financial performance under each scenario, such as base-case and stress scenarios. Scenarios could be related to both macroeconomic variables (changes in GDP growth, interest rates, exchange rates, etc.) and variables related to the entity (change in customer demand, input costs or personnel costs, and in tariffs, etc.). 4. Structural models: These models estimate an entity’s probability of default based on its leverage and the volatility of its assets. They are based on option pricing theory. The most used types are the Merton model and the KMV model. These methodologies are versatile and can be used to assess creditworthiness independent of whether an entity enjoys explicit/implicit guarantees or not. Since they all have advantages and drawbacks, they are often used in conjunction with others. 35