Natalia Pipia l Palladium - Jun 25 2021
How Changing Tax Codes Are Ensuring Stability and Growth in Kyrgyzstan Despite COVID-19

Source: S2JK

More than 1.5 million Kyrgyz people live below the poverty line, approximately one-quarter of the total population. They work predominantly in the agricultural, services, and textiles sectors, which are largely informal and significantly underperforming in today’s economy.

Businesses that come out of the shadows and formally register can sell their products abroad, access finance, and better support their employees, but formalising a business is time-consuming and costly. In the Kyrgyz Republic, it requires companies to make ‘social tax’ payments of more than 25 per cent of employees’ salaries to the national Social Fund, from which social insurance and pension payments are made.

Changes to the Tax Code of the Kyrgyz Republic and amendments to the laws on state social insurance came into effect in January 2020 with support from the Palladium-implemented Governance in Action (GIA) program. The reforms allow businesses in the textiles sector to reduce social fund payments from 27.25 to 12 per cent. For companies with more than 50 workers, the payment is calculated on the average salary size, to incentivise growth and a move from informal hiring to formal employment contracts.

Latest figures provided by the Social Fund show that eight of the Kyrgyz Republic’s 11 biggest textiles companies have significantly increased the number of workers they are formally employing, some by several hundred. This has driven an overall increase in Social Fund revenue, despite the rate reduction. Interviews with business leaders, associations, and workers also suggest it is helping the textile industry survive the economic downturn triggered by COVID-19, which has pushed an estimated additional 700,000 people into poverty.

Nurgazy Myshiev, Director of the TransTextile and Salkyn group of companies, explained that in the past, high social fund taxes have limited their growth. Since the reduction, they have hired more workers, and formalised contracts, which has provided stability for both the company and their workforce during the pandemic.

“It has solved the problem of high staff turnover,” Myshiev said. “Now we can transfer wages direct to employees’ bank accounts, which gives them a record of their wages, allowing them to access finance. Labour relations have improved, staff are staying longer, which is hugely beneficial for us and allows us to commit to better staff training.”

“This stability has made us more resilient during the pandemic. During quarantine, we sewed masks, medical gowns and protective suits, providing jobs for our workers and benefiting the state,” Myshiev added.

In 2011, Elmira Syzdykova came out of retirement to start work as a seamstress in Bishkek because her pension wasn’t enough to support her family. Like many workers in the textile sector, she had no contract. She says this changed when the social fund tax was lowered, providing her with a regular salary and access to a pension plan.

“Now there is always work, and the conditions are better. Our shift starts at 8 AM and ends at the agreed time. We are given lunch and breakfast, and there are a range of dishes to suit everyone’s tastes,” Syzdykova adds.

Good for All Businesses No Matter the Size

Last year, the JIA business association reported an increase in individual entrepreneurs registering as companies with staff over 50 people, to enjoy the benefits of the new law. A switch to formal contracts is also helping larger businesses enter higher-value export markets. Garment producer Cool Bros expanded to a new factory in the Batken province, and last year started making clothes for a customer in Germany, which was previously sourcing from manufacturers in Bangladesh.

Askat Mazhitov Cool Bros Chief Accountant noted the importance of formalising business for their customers. “German customers first of all look at the conditions in which their order is fulfilled. They want to know whether there are good conditions for workers - that the factory is warm and free of child labor, whether employees are provided with good food, and so on.”

“With formalised contracts in place, we can demonstrate that the conditions our employees work in are good. Now we are exporting to Germany for the first time,” he adds.

The amendment to social fund payments is part of a wider drive to remove barriers to formalisation for Small and Medium-sized Enterprises (SMEs) in the Kyrgyz Republic. Nearly 50 per cent of GDP created by the private sector comes from SMEs, and without growth in the private sector the Kyrgyz Republic will remain a lower-middle income economy.

As part of the UK-funded GIA program, Palladium is working with the Ministry of Finance and Economy to extend the social tax reduction to SMEs in all sectors, reducing the informal economy so that more workers have security and stability. The Government’s recent commitment to a new investment strategy, led by a dedicated Ministry of Investment, gives hope that additional job creation is on the horizon, as the Kyrgyz Republic increases exports and domestic production in the post-COVID recovery.

The Governance in Action (GIA) program convenes ‘issue groups’ of motivated individuals and institutions from the political and business communities to champion legislative and policy reforms to increase prosperity through greater inclusion and transparency in Kyrgyzstan. The project addresses economic constraints in different sectors, supports national reforms and improves the Government and Parliament’s ability to efficiently provide public services to its citizens. S2JK is part of the Governance in Action (GIA) program, funded by UK aid from the UK government, implemented by Palladium.

Natalia Pipia is the GIA Team Leader and has worked in 50+ countries in the Middle East, Eurasia, and Southeast Asia implementing private sector development, innovation, and entrepreneurship programs funded by various donors.