Kyrgyz Republic: Selected Issues

This Selected Issues paper undertakes a detailed analysis of the inflation dynamics and its determinants in the Kyrgyz Republic to shed light on the unprecedented inflationary surge since 2021. It employs two complementary methodologies to model a complex interplay between domestic and global factors, and policy variables. The paper constructs a new comprehensive measure of inflation expectations, encompassing both adaptive and forward-looking components, and as an additional novelty introduces external variables to the Phillips curve framework. The empirical analysis suggests that in addition to global food prices, which have historically driven inflation in the country, the role of domestic factors have become more prominent. On the other hand, the paper finds a much stronger contribution of liquidity conditions to inflation. This suggests a disconnect between policy interest rates and market liquidity, which needs to be addressed for better functioning of monetary policy transmission. The main policy implication is that to strengthen the effectiveness of monetary policy and support National Bank of Kyrgyz Republic’s intended transition to an inflation-targeting framework, excess liquidity needs to be drained and brought in conformity with the policy rate. This will require discontinuation of central bank’s participation in the domestic gold market, which is the main source of liquidity injections.