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B.1. The Caucasus and Central Asia: Incipient Recovery

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
May 2010
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Substantial external shocks hit the Caucasus and Central Asia (CCA) region in 2009, but their impact on economic growth was cushioned by the policy reponse and donor support. For 2010, a recovery across the region is projected as the global economy, and in particular Russia, picks up peed.

For the energy exporters:

  • Growth will be strongest in Turkmenistan and Uzbekistan, where governments should start exiting from their accommodative policies as growth gains traction. Kazakhstan is seeing a slower recovery, and will need continued policy support in 2010.

  • Policies should turn to facilitating private-sector development and, in some countries, diversifying away from the hydrocarbon sector.

For the energy importers:

  • Armenia, Georgia, and Tajikistan target a neutral or modest tightening fiscal stance in 2010, while the recovery has yet to gain firm traction. Fiscal constraints curtail governments’ room to maneuver, and additional donor support would provide needed fiscal room. In the Kyrgyz Republic, the political events of April can be expected to weigh on the economic outlook.

  • Over the medium term, the countries’ large current account deficits need to be reined in to reduce external vulnerabilities.

Protracted political tensions are affecting energy trade and tranport in Central Asia, and are thus holding back the region’s growth potential.

Financial sector stress has built up during the crisis and constrains credit growth, which in turn weighs on the outlook for most CCA countries. Policies should aid banks with repairing their balance sheets.

Sources: IMF, Regional Economic Outlook database; and Microsoft Map Land.

Note: The country names and borders on this map do not necessarily reflect the IMF's official position.

Region Managed Well the Challenges Posed by External Shocks in 2009

As most countries around the world, the CCA region—and in particular the energy importers—was hit hard by external shocks in 2009. Exports of goods and services fell across the region, with Kazakhstan registering the sharpest decline of 37 percent, and Uzbekistan the most moderate of 3 percent. In addition, Armenia, Georgia, the Kyrgyz Republic, Tajikistan, and Uzbekistan saw remittance inflows, mainly from Russia, drop by up to a third. The turmoil in international financial markets affected Kazakhstan most markedly, which is more integrated with global financial markets—evidenced by a net outflow of US$5 billion in private portfolio capital since the beginning of the crisis until end 2009—and to a lesser degree Armenia and Georgia.

The impact of these sizable external shocks on growth was cushioned by the policy response and donor support. Countercyclical fiscal and monetary policy helped moderate the impact of the external shocks. In the energy importers, donor support helped finance the fiscal stimulus, whereas the energy exporters relied on savings. Moreover, depreciating exchange rates against the U.S. dollar and the Russian ruble during the first half of 2009 helped redirect demand toward domestic supplies, with imports of goods and services contracting in most CCA countries by 14–30 percent in 2009—the fall in imports also reflected lower oil prices.

Still, growth in the energy importers declined: Armenia saw the largest decline in growth to – 14 percent and Georgia’s growth fell to – 4 percent. In the Kyrgyz Republic and Tajikistan, growth remained positive in the range of 2 to 3 percent (Figure B.1.1 and Box B.1.1). Most CCA energy exporters fared even better. Helped by an increase in oil and gas sector output and significant fiscal expansions, growth in 2009 was only moderately lower than in 2008, but substantially lower than in 2007.

An Incipient Recovery

Recent developments point to an incipient recovery across the region. Exports started to pick up in most countries during the second half of 2009 (Figure B.1.2). Likewise, there is some evidence that the decline in remittances is slowing, or that they are increasing again during the first months of 2010, for example by 15 percent in Tajikistan. Capital inflows also have turned positive again, though they remain lower than before the crisis. However, these trends are far from uniform and, in a number of countries, stress in the banking sector is holding back credit growth and weighing on economic activity.

Figure B.1.1Economic Growth to Recover from the Crisis

(Real GDP growth; percent)

Sources: IMF, World Economic Outlook; national authorities; and IMF staff projections.

Figure B.1.2Signs of Recovery

(Annual growth; percent)

Source: National authorities.

1 Simple average for Armenia, Georgia, and Kazakhstan.

2 Simple average for Georgia, Kyrgyz Republic, and Tajikistan.

A downside risk to the growth outlook for Central Asia stems from a recent intensification of protracted political tensions that are affecting energy trade and transport. Looking ahead, enhanced cooperation in the areas of energy trade and water sharing would benefit the region’s growth potential. In the Kyrgyz Republic, the domestic political developments in April could dampen growth compared to previous projections.1

Policy Options as Recovery Takes Hold

Energy exporters should consider exiting from accommodative policies as growth gains traction. Turkmenistan and Uzbekistan are expected to grow by 12 and 8 percent, respectively, in 2010. In both countries, fiscal policy remains expansionary, and tighter polices would help prevent a buildup in inflationary pressures. In Azerbaijan, non-oil growth is expected to pick up, and the authorities target a narrowing of the non-oil deficit, given the scope to improve expenditure efficiency and the need to ensure medium-term fiscal sustainability. Growth in Kazakhstan is projected to be slower at slightly more than 2 percent, and the mildly expansionary fiscal stance implied by the 2010 budget is appropriate.

Box B.1.12009: Similar Shocks, Different Growth Outcomes

The CCA energy importers were hit by similar external shocks during 2009, yet their growth outcomes are very different, ranging from – 14 percent in Armenia to 3 percent in Tajikistan. The sharp contraction in Armenia reflects the bursting of a construction boom, which had previously contributed to high growth rates. Net external demand provided only little offset. Georgia also suffered a contraction, but one that was less severe than in Armenia, partly because GDP growth had already slowed sharply in 2008 in the aftermath of the conflict with Russia. Moreover, while both Armenia and Georgia experienced roughly the same decline in domestic demand, net external demand provided a much bigger offset in Georgia. In the Kyrgyz Republic and Tajikistan, net external demand provided a welcome counterbalance to the contraction in domestic demand, resulting in positive but small growth. In addition, growth held up better in these two countries owing to their larger agriculture sectors, which seem to have been relatively insulated from the impact of the global crisis.

Table 1Impact of the 2009 Crisis on Growth in CCA Energy Importers(Percent)
Cumulative growth, 2000.08 Growth, 2009144.6 -14.479.0 -4.046.0 2.394.6 3.4
Exports of GNFS in percent of GDP, 2008 Percent change in exports of GNFS in 200914.4 -22.428.7 -15.959.2 -6.916.8 -5.5
Imports of GNFS in percent of GDP, 2008 Percent change in imports of GNFS in 200939.4 -22.358.3 -29.992.5 -22.572.1 -23.7
Contribution of net exports to growth in 20091.412.314.813.6
Remittance inflows in percent of GDP, 2008 Percent change in remittance inflows in 20099.7 -28.97.8 -16.029.4 -28.549.4 -33.4
Agriculture in percent of GDP in 200815.88.125.420.0
Sources: National authorities; and IMF staff calculations.Note: GNFS = Goods and Non-Factor Services.
Sources: National authorities; and IMF staff calculations.Note: GNFS = Goods and Non-Factor Services.

A key challenge for CCA energy exporters over the medium term is to sustain growth and achieve sustained employment gains. In that regard, economic policies should be set so as to facilitate private-sector development and, in some countries, diversify away from the hydrocarbon sector. While oil and gas reserves are likely to last for at least 20 years and more, production is likely to level off or even decline. For example, in Azerbaijan, oil production is projected to start declining by 2014, so that the hydrocarbon sector would contribute negatively to overall GDP growth, and the non-hydrocarbon sector needs to become the engine of growth. Turkmenistan, on the other hand, has the fourth-largest reserves of natural gas in the world, and production volumes are expected to increase for some years to come. Similarly, Uzbekistan has a diversified export base, with oil and gas accounting for only one quarter of all exports. However, both countries have business environments that are less friendly than others in the region.

CCA energy importers have limited fiscal room and are mostly aiming for a neutral fiscal stance or modest fiscal adjustment in 2010. In Armenia and Georgia, overall fiscal deficits are likely to improve by up to 2 percent of GDP in 2010 (Figure B.1.3). In Tajikistan, the fiscal stance remains broadly neutral. In the Kyrgyz Republic, the recent political events are projected to weigh on revenue collection, but the government can draw on saved bilateral assistance to overcome any immediate stress on the budget.

With the recovery still nascent and growth likely to remain below the rates achieved prior to the global financial crisis, governments should stand ready to provide continued fiscal stimulus if the expected growth does not materialize. However, governments are running out of fiscal room, as donor support is expected to decline in most countries compared to 2009, and public debt as a percent of GDP has increased sharply (Figure B.1.4). As such, additional donor support would provide room for countercyclical spending and public investment to enhance the region’s medium-term growth potential.

Figure B.1.3Fiscal Policy Stance

(Overall fiscal balance; percent of GDP)

Sources: IMF, World Economic Outlook; national authorities; and IMF staff projections.

Current account deficits remain high in the CCA energy importers, ranging from 8–15 percent of GDP. While financing appears secured in the short term, such large deficits constitute external vulnerabilities. In Armenia and Georgia, foreign direct investment currently finances 50 percent or more of the countries’ current account deficits, and central banks are expected to accumulate gross reserves. Tajikistan can rely less on foreign direct investment but, like Armenia, benefits from donor support—including concessional lending—even if it is declining.

Figure B.1.4Energy Importers Have Limited Fiscal Room

(Government grants and public debt; percent of GDP)

Sources: National authorities; and IMF staff projections.

In all countries, external debt is increasing in percent of GDP. As the region recovers, policies should be set with a view to reducing current account deficits and containing external debt at sustainable levels.

Preserving Recent Competitiveness Gains

With rising international commodity prices, inflation could increase again in 2010, though inflation rates are projected to stay below 10 percent—similar to those in Russia, but higher than in advanced-economy trading partners (Figure B.1.5). Depending on the exchange-rate regime, these inflation differentials could lead to a reversal of competitiveness gains realized in some countries since early 2009, which would weigh on external demand as a driver of growth (Figure B.1.6). In this context, monetary and exchange-rate policy should preserve the welcome slowdown in inflation during 2009 and safeguard competitiveness.

Exchange-rate regimes differ across CCA countries and are changing. During the crisis, most countries abandoned their de facto exchange-rate pegs and allowed currencies to depreciate against the U.S. dollar and the Russian ruble. As of March 2010, Armenia and Georgia maintain a flexible exchange-rate regime, only smoothing excess volatility, and nominal exchange rates have depreciated recently, which should help maintain competitiveness. Azerbaijan and Turkmenistan follow a de facto peg against the U.S. dollar, which has helped anchor inflation differentials, and competitiveness thus will depend on the U.S. dollar’s movements against the exchange rates of these countries’ trading partners. Kazakhstan has announced a move toward wider bands, which would allow the central bank to more effectively pursue domestic objectives while preserving competitiveness. Uzbekistan pursues a crawling exchange-rate depreciation in support of its export industries.

Figure B.1.5Early Signs of Price Pressures?

(Consumer price index; period average; annual growth; percent)

Sources: IMF, World Economic Outlook; and national authorities.

Figure B.1.6Recent Gains in Competitiveness

(Real effective exchange rate, index, Jan 2008 = 100; upward movement indicates appreciation)

Sources: IMF, World Economic Outlook; national authorities; and IMF staff projections.

Credit Growth Has Slowed Substantially and Financial Sectors Are Under Stress

The global financial crisis has led to mounting stress in CCA banking systems, which has caused a sharp slowdown in private-sector credit (Section B.2). Stress arose from three sources. First, nonperforming loans increased as loan dollarization was high and unhedged borrowers were hit by depreciating exchange rates (Figure B.1.7). Second, banks saw a sharp reduction in funding—partially driven by lower remittances—that had fueled strong credit growth during the precrisis years. Kazakhstan was particularly hard hit because of its reliance on external wholesale funding. And third, subdued confidence in a low-growth environment is holding back both credit demand and supply. With impaired balance sheets, lackluster funding growth, and weak confidence, credit to the economy has slumped. This is likely to weigh on growth.

Figure B.1.7Financial Sector Stress Building Up

(Nonperforming loans; percent of total loans)

Source: National authorities.

1 90-day basis.

Repairing bank balance sheets is the priority. In Kazakhstan, the authorities have made progress toward resolving banking sector difficulties, including by injecting public capital into troubled banks and supporting key sectors of the economy to safeguard asset quality. As a result, confidence has strengthened, and interbank rates have declined. However, systemwide asset quality remains a concern, and a comprehensive assessment of on- and off-balance sheet risks is needed.

In other countries as well, policies should aid banks to repair their balance sheets as a prerequisite for a recovery of credit. This includes recognizing losses and dealing with nonperforming loans. In some cases, temporary government liquidity injections to overcome funding problems may help restore credit growth. Over the medium term, dedollarization would help reduce vulnerabilities emanating from currency mismatches that were a key transmission channel of the crisis. Successful episodes of dedollarization are mainly characterized by sustained periods of macroeconomic stability.

In addition, developing local debt markets and implementing prudential regulations to ensure a proper pricing of currency risks, such as higher capital charges for foreign-exchange loans to unhedged borrowers, can facilitate the process of dedollarization (Section B.2).

Table B.1.1.Selected Economic Indicators: CCA
Average 2000–052006200720082009Proj. 2010Proj. 2011
Real GDP Growth9.413.612.
(Annual change; percent)
Kyrgyz Republic4.
Consumer Price Inflation9.79.311.416.
(Annual change; percent)
Kyrgyz Republic6.55.610.
Central Government Fiscal Balance0.
(Percent of GDP)
Kyrgyz Republic1-5.6-2.1-0.30.0-3.1-8.1-7.7
Current Account Balance-
(Percent of GDP)
Kyrgyz Republic-0.1-3.1-0.2-8.13.5-15.4-12.5
Sources: National authorities; and IMF staff estimates and projections.

General government.

State government.

Sources: National authorities; and IMF staff estimates and projections.

General government.

State government.

The projections for the Kyrgyz Republic in this chapter do not reflect the impact of these developments.

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