Macroeconomic Framework of Kyrgyzstan
Economic Analysis and Forecast
User’s Manual
Boris Petkov
Macroeconomic Advisor
Ministry of Economy and Antimonopoly Policy of the Kyrgyz Republic
Bishkek, Kyrgyz Republic
February 20, 2012
Table of Contents
1.
Introduction ............................................................................................................. 3
2.
Forecasting scenarios ............................................................................................ 3
2.1
Baseline scenario ................................................................................................... 3
2.2
Policy scenario ....................................................................................................... 4
3.
Before starting ........................................................................................................ 4
3.1
Assess the economic situation ............................................................................... 4
3.2
Identify exogenous factors ...................................................................................... 4
4.
Establishing the forecasting scenario – an overview .............................................. 4
5.
Types of projections for individual items ................................................................. 6
6.
Hands-on Forecasting of the main macroeconomic aggregates ............................ 7
7.
Forecast performance ............................................................................................ 9
8.
Concluding remarks................................................................................................ 9
9.
Annex 1 ................................................................................................................ 11
10.
Annex 2 ................................................................................................................ 11
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1. Introduction
This macroeconomic model (Macroeconomic Framework of Kyrgyzstan –MFK) aims to provide a
consistent framework for macroeconomic analysis and forecast at the Government (Ministry of
Economic Regulation) of Kyrgyzstan. It provides the basis for: i) analysis of the Medium Term
Budget Framework and other planning documents; ii) improving government's ability to negotiate
with International Financial Institutions; and iii) helping to structure demand from government for
macro data. The key features of MFK are:
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based on current practice – inspired by similar models created by the World Bank and
International Monetary Fund;
takes a comprehensive look at the whole economy to improve the analysis of direct and
indirect economic effects;
this comprehensive look necessitates consistency between main macroeconomic aggregates
and accounts;
historical data is used as a starting point for projections;
econometrically estimated parameters could be easily incorporated into the model (data
existence permitting);
spreadsheet-based simulation follows decision-making practices to make projections;
simpler than RMSM-X, hence more accessible and suitable for collaboration across
government departments;
philosophy of simulation and experimentation – more informative than Computable General
Equilibrium Models (CEMs)
The elimination of internal and external imbalances is achieved through stabilisation policies within
-- data -- consistency framework. The main priority with a forecasting scenario within the macrofiscal framework is to formulate a way to attain low inflation together with an externally balanced
position. Furthermore, maintaining stable growth of GDP or at least minimising output losses and
unemployment is of principal importance.
The starting point in any such exercise is the baseline scenario. In the baseline scenario, forecasts
are made of the main macroeconomic variables for the respective year assuming unchanged
economic policies. A baseline scenario is also referred to as a passive programme, because it does
not include explicit targets. An active programme, on the other hand, includes explicit policy
targets, mainly with respect to the inflation rate and the external payments position. It aims at
setting policy instruments such that these targets are achieved.
A financial programme designed by the IMF is normally a policy programme. The output is a set of
specific targets. These targets refer to macroeconomic variables over which the governmental
institutions have certain discretion, e.g., ceilings on domestic credit and growth of high-powered
money. These targets must be consistent with broader macroeconomic objectives, such as economic
growth, price stability and the Kyrgyz Republic’s ability to meet external payment obligations.
Therefore, an assessment of economic problems with reference to national objectives is obligatory
in preparing a financial program. It requires that a consistent set of policy instruments, necessary for
implementation of the essential adjustments is identified and quantified through the analysis of the
main macroeconomic accounts. These are: i) the national accounts (NA); ii) the balance of
payments (BOP); iii) the government accounts (GA), and iv) the monetary survey of the banking
system (MON).
2. Forecasting scenarios
2.1 Baseline scenario
A baseline scenario is constructed under the assumption that policies do not change from the recent
past. Its principal aim is to show whether existing problems are likely to remain broadly constant, to
be resolved without explicit intervention by the authorities, or to worsen over time. Thus, it gives
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the general policy direction. A baseline scenario does not include explicit targets. It is sometimes
also referred to as a passive programme.
2.2 Policy scenario
In a policy scenario, targets must be specified. The overall objective of achieving either internal or
external balance has to be translated into specific targets. Examples of targets could be the overall
balance of payments position and the monetary base (or possibly credit ceilings instead of the
monetary base). The determination of specific targets sets the stage for the development of the
appropriate policy package. Output and employment are more elusive targets, as governments are
not in a position directly to determine the growth of their economy. Nevertheless, the targets must
be set such that they are consistent with projected output growth.
It is important to keep in mind that when the government introduces major policy shifts and
structural reforms, behaviour in the post reform period may significantly differ from expectations.
The success of a reform program also depends on the credibility of the implementing authorities.
Thus, hypothesis on the expected response of exogenous variables to new policies may prove to be
difficult to be specified correctly.
3. Before starting
3.1 Assess the economic situation
Knowledge and understanding of the Kyrgyzstan’s economic, institutional and socio-political
structures, recent economic developments and available policy instruments is indispensable to
forecasting and policy analysis. It is essential to understand the nature, source and severity of the
economic imbalances. Policy instruments that might be available to address such imbalances must
also be identified and evaluated. Relevant policy instruments are reserve money and various ways
to intervene fiscally, for example through taxation.
To understand the economic imbalances, it is important to assess their origin, their nature, and the
length of time over which they have evolved. Their origin can be internal (for example, excessive
monetary expansion or fiscal deficits or a combination of both) or external (for example, excessive
reduction in reserves, or trade imbalance). Their nature can be cyclical, structural or seasonal. The
span of time can be short or long.
3.2 Identify exogenous factors
Kyrgyzstan is progressively more trading on international markets and hence is a subject to demand
shocks emanating from the rest of the world. Global economic developments, therefore, need to be
taken into account. The impact on key variables, over which the authorities have no control, should
explicitly be taken into consideration in any macroeconomic forecast exercise.
Of particular significance are the external assumptions, including: i) evolution of oil prices; ii)
interest rates; iii) demand and output in other countries in the region and in the world. Practically,
the optimal way to proceed is to use forecasts by, for example, the IMF, to compile such numbers.
4. Establishing the forecasting scenario – an overview
This (simple, yet comprehensive) macroeconomic framework is quite useful forecasting tool. It can
be applied to produce valuable scenarios by means of strong judgement and rigorous observation of
all macroeconomic identities. Projections in the macroeconomic framework are developed account
by account (block by block). Even though the focus is on one account at a time, the overall
objectives must always be kept in mind and the spill-over effects due to the macroeconomic
interrelations and impact of policy interventions on variables in other accounts must be taken into
consideration.
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In fact, forecasting within this context is rather an iterative procedure. First, the relevant indicators
in each account are forecasted individually. Second, the results are merged within an integrated
macroeconomic accounting context. Third, because many items (for example export and import of
goods and services) appear in more than one account, it is necessary to examine the impact of the
forecasted items in one account on the results for other accounts. It may be the case that they do not
seem right and it is necessary to redo certain parts of the forecasting exercise in the individual
accounts before an integrated and meaningful set of forecasts covering the entire economy is
attained.
There are potentially various ways of preparing given projections. The most widespread method,
which we are going to use here as well, is to start with a preliminary projections for value added at a
sector of economic activity level, followed by projections of the expected future price level in the
economic system (CPI / GDP deflator). These projections underpin the rest of the forecast
consisting of individual aggregates in the balance of payments, the government account and the
monetary survey of the consolidated banking system. Iterations would be required at various stages
to ensure accounting and behavioural consistency.
The following concrete steps may prove useful to follow:
 Project real growth for each sector of economic activity in percentage terms such that a
growth rate for the GDP at basic prices is obtained. The growth rate must be sensible for
each individual activity at basic prices. Each individual growth rate must take into account
past developments and expected events;
 Set the projected price level on the basis of the expected rate of inflation. Thus, price
inflation in the framework is exogenous;
 Combine the projected price level with projected real GDP to get projected nominal GDP;
 Decide the source of data for economic variables appearing in more than one account and
link the various accounts using the set of macroeconomic identities. Many items, for
example, public investment, emerge in more than one account. Such variables should be
listed and it must be determined in which account the projection should be made and in
which account or accounts the projected values for that variable should be taken as given;
 Determine residual in the national accounts. For GDP by expenditure, final consumption by
households is the selected residual;
 Project remaining variables in the national accounts, monetary survey, balance of payments
and government account. This is done primarily on the basis of the projected path for the
GDP or sub-components thereof;
 Derive / confirm consistency in the future evolution of inflation;
 Carry out the final part of the forecasting exercise, i.e., checking the results and ensuring
that the economic picture obtained from the forecasting exercise is plausible and consistent.
Depending on the concrete circumstances, all or a few of the steps may need to be repeated
and / or corrected. Finally, carefully check the output of the entire model, making sure that:
 the projected paths of all variables that appear in more than one account appear
plausible in each and every one these accounts. If not, go back to all variables for
which no reasonable time path has been found and repeat the exercise as many times
as necessary;
 the aggregated items, e.g., current account balance and total budget revenue seem
right;
 the projected path of the money supply looks plausible and has some relation with
past trends;
 that the exogenously projected path of price inflation is reasonable in view of the
projected path of GDP and general economic conditions assumed.
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5. Types of projections for individual items
-- Projections are made by using prior information. This is applicable for a limited set of items only,
mainly borrowing and debt repayment, interest payments and interest receipts and grants. This is the
most preferred type of projection.
-- Projections are made as a function of the projected percentage growth rate of other variables,
which serve as proxies. Alternatively, projections can be made as a share of such a proxy – the
result is the same. This type of projection is normally second best – if prior information is available,
it should be used.
-- If no proxy can be identified, projections are best guesses of growth rates, normally
extrapolations of recent trends. This method is normally the least preferred and should only be used
if prior information is not available and no proxy has been identified.
For extrapolations, the best way to proceed is often to introduce a chart and try to understand better
the trend (if any) observed over long-period of time and as well over the recent past. This should be
done in a such way that a suitable extrapolation method can be identified – a suitable extrapolation
method being a method that yields a forecasted path that is a reasonable continuation of the recent
trend. One of three extrapolation methods described below should normally be used1:
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Exponential increase or decrease: If the trend could be characterised by such a curve, one of
the two formulae for average growth rate normally yields the best result (in deriving a path
that is a continuation of the recent trend). Two formulas can be used:
1) =Average (observationt-1; observationt-2, observationt-3; ...observationt-i)
2) =(observation last/ - observation first)^(1/No. of observations less 1)
The first formula normally yields a more pronounced growth path and the second a more moderate
growth path. Usually, by examining the chart, it is clear which one yields a better continuation of
the recent trend.
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Linear increase or decrease: If the chart shows that trend formed by past observations was
linear or that past observations hovered around a linear path, the trend function in Excel
normally yields the best result. The trend function is constructed as
=trend(series of past observations, series of past reference periods, new reference period)
The trend function projects values that follow the same linear path that was observed in the recent
past.
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No discernible trend: If the chart shows that there was no discernible trend formed by past
observations the average function in Excel normally yields the best result. This is the case
when past observations increased in some years and decreased in others. The average
function is constructed as
The forecaster has to decide which type of projections is most appropriate given the analytical
purpose and the type of data available. It should be noted that if the forecaster is tolerably confident
that future is likely to break with the recent past, extrapolations are not suitable forecasting methods
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If a behavioral assumption is made, the structural design is simply:
yt = a xt variable y is proportionate to variable x
yt = a g(xt) variable y is proportionate to the growth rate of variable x
yt = yt-1 variable y is a constant
yt = yt-1 xt / xt-1 variable y and variable x are assumed to have an identical growth rate
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6. Hands-on Forecasting of the main macroeconomic aggregates
On a practical level, we proceed by creating spreadsheets containing formulas and linking the
assumptions to the projected parts of each account.
The MFK contains five interlinked Excel spreadsheets: i) “Source” – containing the basic data set;
ii) “Data Transformation’11”, where historic data for the year 2011 is taken (linked to) from the
“Source” and transformed in accordance with the forecast’s needs; iii) “Projections Y1” – standing
for the spreadsheet containing projections for one year (i.e., 2012); iv) “ Projections Y5” –
designating the spreadsheet containing projections for four years period (i.e., 2012-2015); v) “GDP
Assumptions” – this block of the model projects real GDP value added; and vi) “Revenue
Forecasting”, which represents a simple revenue forecasting model. These spreadsheets are depicted
in Annex 2. It would be useful to familiarise oneself with these as a preliminary step towards
making your acquaintance with the MFK”s Excel spreadsheets by following through the formulas
and links they contain.
1. Real GDP value added is projected exogenously on the basis of aggregated projected
real growth rates by sector of economic activity;
Each economic activity is forecasted independently at constant prices.
If possible, projections should be made separately for output and intermediate consumption
rather than for the value added. However, if data are not available on output and
intermediate consumption, it might be necessary to use value added.
In our case we use value added, whereby the projections are done at basic prices, removing
the tax component. Taxes on production and imports are projected in the government
account.
Projections are made for four sectors of economic activity: agriculture, industry,
construction and services. Assumptions about real growth rates for each activity take into
account a number of factors including recent past behaviour, policies that are currently in
place, and projected exogenous factors. These growth rates are applied to the numbers
actually obtained in previous years to determine the forecasted value added for each activity.
Subsequently, the projected values for each activity are added together to arrive at the total
projected value added in the economy.
It is very important that the economist(s) involved in the forecasting exercises understand
directly from the source what the expected economic developments are.
2. Price deflator of GDP is calculated as a geometric average of sectoral deflators;
3. Public consumption set as a policy;
4. Public investment set as a policy;
5. Private consumption derived as a residual;
6. Private investment based on historical annual average rate of growth over recent past;
7. Exports and imports linked to the rate of change in GDP;
Imports of goods and services projections are treated as depending on GDP growth.
Projections of exports of goods are linked to performance of the economy (GDP growth) as
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well. Forecasts of world commodity prices provide additional important information in this
respect and also are to be taken into account.
Projection of service receipts is linked to performance of relevant activities like trade and
other foreseeable policies or developments. For instance, an enhancement of hotel facilities
and promotion of the country as a tourist destination, may provide essential inputs to the
projection process.
8. Other current income also linked to GDP;
The government transfers are often related to the current transfers projected in the
government account. They must be determined jointly with the government account to get
the envisaged inflow of transfers for budget support.
9. Capital and Financial BoP is exogenous;
10. Revenue is linked to projections of tax base, modified by tax rates and collection
efficiency;
The starting point for the government account is to use the projections made in the
government budget and assess the various items against the projected GDP. Where
inconsistencies are identified, modifications must be made or clarifications sought.
The revenue sources are disaggregated as follows:
 Income tax, linked to incomes;
 Profit tax, linked to operating surplus;
 VAT (domestic), linked to value added;
 VAT (traded goods), linked to imports;
 Excises (domestic), linked to consumption;
 Excises (imports), linked to imports;
 Foreign trade taxes, linked to trade (mostly import duties);
 Sales Tax;
 Vehicle Tax;
 Emergency Fund;
 Land Tax;
 Social contributions, linked to incomes;
Furthermore the revenue projections are linked to the following parameters:
 changes in tax rates
 changes in the collection efficiency
 changes in tax base, within a sector
Projections of VAT would normally be linked to growth in value added, since this is the
base on which the tax is levied. If value added projections can be broken down into sectors,
and there is data on the sectoral contribution to VAT on domestic goods, then it should be
possible to provide more detailed projections of VAT from each sector.
11. Foreign financing is projected exogenously;
Data on projected loan disbursements and repayments, debt rescheduling, forgiveness and
accumulation of arrears should be available from (a debt management department) the
National Bank and the Ministry of Finance. Information about planned sales of foreign
exchange by the central bank should be used to make short-term projection of reserves.
12. Net foreign assets derived from the BoP; NFA=NFA(-1) +∆NFR;
13. Government borrowing is taken from the residual GA financing requirement after taking
into account foreign financing;
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14. Private sector lending is related to economic agents confidence and monetary policy
stance;
15. Standard conversions for current to constant prices and from Soms to USDs are applied.
The -- closure -- approach taken in the model is to steer clear of circularity (at this stage) and to
make all projections (recursively) on best estimates basis, then check and assure behavioural
consistency between variables.
7. Forecast performance
Once a forecast scenario has been established, it is important to assess how well it performs. This
involves the following steps:
1. Keep track of projections to be able to compare them to the actual values when they are
available;
2. Measure performance of the model by comparing the projection to the actual values, e.g., by
looking at a plot of the two series (projected and actual). An effort should be made to explain
differences and specifically 'big' differences in a specific period. This is essential since in this way
one can improve the projections;
8. Concluding remarks
It is important to bear in mind that one should forecast as an economist not as an accountant.
Furthermore, we need to be constantly aware that models do not incorporate all available
information. How one could possibly incorporate this (“missing”) information? In short:
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Forecasts are mostly the result of a combination of model output and judgement;
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When the forecast from the model is obtained, experts will judge the output and adjust it
accordingly;
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Judgement can be incorporated in the model through the ”add factors”
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“add factors” reflect:
 Information not present in the model, e.g., expectations, recent changes in
consumer and business confidence, changes in risk premium, etc.
 Changes in the economic structure of the country not yet taken on board in
the model;
 Errors in data;
 All other causes for the model to deviate from reality;
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Add factors can be introduces in individual rows (of the Excel tables);
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Economic interpretation of these add factors is an essential ingredient of forecasting;
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Forecasting is a major and time consuming exercise, which includes:
 Update the data set;
 If necessary change the structure of the model;
 Extrapolate your exogenous variables;
 If necessary re-estimate (part of) the model;
 Produce a first model forecast;
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 Evaluate the output in view of other relevant information, e.g., survey data,
intentions and future plans of major economic players, known major
investment projects, etc.;
 Calculate and interpret add factors and evaluate their recent behaviour;
 Decide on the future values of these add factors: keep, delete or change them
on well explained economic grounds;
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Scenario analysis -- any forecast is uncertain because:
 Extrapolation of exogenous variables;
 The model cannot fully explain reality;
 Our judgement may be wrong;
 The central forecast is only one drawing from a probability distribution;
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Risk analysis -- alternative scenarios of:
 Exogenous variables;
 Judgement;
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Examples: Commodity prices, World business cycle; Domestic shocks such
as consumer and business confidence; Government budget, etc.
Future development needs:
 The data set should be evaluated, extended and updated;
 Behavioural equations (data permitting) should be estimated and significant
parameters should be incorporated into the model;
 Dynamics should be introduced in these equations;
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Finally and perhaps most importantly:
 Forecast are not an aim in themselves – they are needed to implement correct
policies;
 Models and sound judgement are equally needed to produce good forecasts;
 A good forecaster needs to be able to explain her forecast in a credible way.
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9. Annex 1
10. Annex 2
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