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ROMAN MOGILEVSKY AND AZIZ ATAMANOV
try’s business climate and a heavy tax burden—notably the payroll tax—on formal enterprises. Recently, NSC published data from a household survey on informal employment in 2004–05 (figure 9, panel B). These data conform to the expectations that remittances have a positive influence on employment in market services and sectors producing consumer goods. Inflow of remittances, together with tourism export revenues and some other balance-of-payments items, leads to an increase in the supply of foreign exchange in the domestic currency market.14 NBKR is a major buyer of foreign currency. In 2001–06, the net cumulative purchase of NBKR on the interbank currency market was US$375 million; of that amount, US$186 million was for 2006 only. This allowed NBKR to increase its net foreign reserves from som 2.6 billion (US$55 million) in 2001 to som 24.7 billion (US$647 million) in 2006. This policy resulted in a larger money supply. Monetary aggregate M2x grew from som 8.2 billion (US$172 million) at the end of 2001 to som 32.3 billion (US$847 million) at the end of 2006. Remarkably, until 2007 this rapid growth in the supply of money (31.5 percent a year on average) did not cause serious inflation. The average annual inflation rate (based on the consumer price index) in 2002 to 2006 was just 4.0 percent. This is a good result, accounting for numerous unfavorable external shocks (such as an increase in the price of oil and gas). Obviously, the surge in money supply has been absorbed by the growing demand for money. Monetization of the economy increased from 11.1 percent of GDP in 2001 to 28.5 percent of GDP in 2006, the result of a deeper financial market, a reduction of in-kind settlements between economic agents, and, probably, some substitution of foreign currency by soms in domestic economic transactions and savings of the population. However, the inflation situation changed dramatically in 2007; in the first 10 months of 2007 the consumer price index grew 20.1 percent, which is more than its cumulative growth in four previous years. While this inflation hike was triggered by external price shocks, the inflationary pressure of the quickly growing money supply also had a role. The global trend of the depreciation of the U.S. dollar also affected the som, which appreciated strongly (by more than 20 percent) versus the U.S. dollar in nominal terms in 2001 to 2006. This nominal appreciation, however, does not mean an overall appreciation of the Kyrgyz currency (see figure 10). In real terms, the som appreciated 17 percent for non-CIS countries, but depreciated 30 percent for CIS countries—mainly vis-à-vis the ruble—due to higher inflation in Russia and stronger nominal appreciation of the ruble versus the U.S. dollar. Therefore, exchange rate developments increased the competitiveness of imports from non-CIS countries in the domestic market and the competitiveness of Kyrgyz exports in CIS markets. Stronger price competitiveness of Kyrgyz goods in CIS markets, coupled with the robust growth of these economies, led Kyrgyz exports to these countries to increase 2.2 times in U.S. dollar terms in 2006 compared with 2001. As mentioned, imports also strongly increased in 2001–06, but only part of this increase could be related to real exchange rate developments, as imports from CIS countries grew even faster than imports from non-CIS countries, despite unfavorable real exchange rates.