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3. The Caucasus and Central Asia: In the Midst of the Crisis

International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
October 2009
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For many countries in the Caucasus and Central Asia (CCA) region, the impact of the global economic downturn has been severe, but prospects for energy importers and exporters differ starkly. For energy importers, the economic outlook remains challenging and recovery in 2010 is likely to be gradual, primarily because of their linkages with Russia. In particular, remittances have fallen sharply, hurting low-income households. Fiscal policy should remain accommodative in 2010 to support growth and mitigate the impact on the poor, but continued concessional donor support will be needed to prevent a buildup of unsustainable debt levels.

The region’s energy exporters will benefit from rising energy prices and are likely to rebound more sharply, with the exception of Kazakhstan, which will be held back by the lingering effects of its banking crisis. These countries should use part of their anticipated recovery in revenues to push ahead with structural reforms to diversify their economies and, especially in the case of Kazakhstan, to restore financial sector health. CCA countries should continue to preserve exchange rate flexibility or move toward flexible exchange rate regimes over time to help maintain competitiveness. To best take advantage of the expected global recovery, Central Asian economies would benefit from enhanced regional cooperation, particularly in the areas of infrastructure, energy trade, and water sharing.

Caucasus and Central Asia

The CCA region consists of eight former Soviet Union republics. In the north, the region borders on Russia and, in the east, on China. Both neighbors are key economic partners for the landlocked CCA region. There are four oil and gas exporters (Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan) and four oil and gas importers (Armenia, Georgia, the Kyrgyz Republic, and Tajikistan). CCA countries differ substantially in terms of per capita GDP, which ranges from US$795 in Tajikistan to US$8,500 in Kazakhstan.

Population, in millions (2008)

PPP valuation of country GDP, in billions of U.S. dollars (2008)

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

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

Some Signs of Resilience Amidst the Crisis

The impact of the global downturn has been more severe than expected for many countries in the CCA region, but it has also varied markedly.

Most CCA energy exporters have weathered the global downturn reasonably well. Three out of the four energy exporters—Azerbaijan, Turkmenistan, and Uzbekistan—are projected to grow by between 4 percent and 8 percent in 2009, despite a large drop in exports (Table 3.1). In these countries, all of which have ample public savings accumulated during previous boom years, growth has been supported mainly by public spending. The exception is Kazakhstan, which, despite a large publicly financed anticrisis program, is facing a contraction of real GDP by 2 percent, in part driven by a banking crisis. In 2010, the energy exporters are expected to benefit from the recovery of energy demand, and growth is projected to range from 2 percent in Kazakhstan to 15 percent in Turkmenistan (Figure 3.1).

Table 3.1CCA Energy Importers Are Hard Hit(Real GDP growth: annual change; percent)


CCA energy exporters6.82.55.5
CCA energy importers5.6−4.62.2
Kyrgyz Republic7.61.53.0
Commonwealth of Independent States15.5−6.82.1
Sources: National authorities; and IMF staff estimates and projections.

Armenia, Azerbaijan, Belarus, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

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

Armenia, Azerbaijan, Belarus, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Figure 3.1Modest Recovery Is in the Offing for 2010

(Real GDP growth; percent)

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

The CCA energy importers have been severely hit by the global slowdown, largely due to economic linkages with Russia (Box 3.1). Output in Armenia will fall more sharply than in other countries (roughly 15 percent in 2009), but it also grew faster in previous years, fueled by an inflow of remittances and a construction boom. Looking at the last five years as a whole, including this year’s downturn, Armenia’s cumulative growth performance remains somewhat stronger than that of the other energy importers. The Kyrgyz Republic and Tajikistan, on the other hand, may achieve modestly positive growth in 2009, driven by a bumper harvest and a marked diversification away from imports.

The fall in output in the CCA energy importers, combined with declining remittances and depreciating exchange rates, is projected to result in a 20 percent drop in per capita disposable income measured in U.S.-dollar terms. As a result, recent gains in poverty reduction are reversing.

On a positive note, recent data suggest that the economic downturn for energy importers may bottom out during the second half of 2009, and modest growth—in the range of 1 percent to 3 percent—should return in 2010.

Box 3.1Economic Prospects in Major Partner Countries and the CIS

The Russian economy is projected to contract by 7½ percent in 2009, followed by a modest recovery of 1½ percent in 2010. While the contraction appears to have bottomed out and fiscal stimulus is gaining traction, markedly lower oil prices and a sharp reversal of capital inflows are expected to exert a significant drag on domestic demand. The investment-consumption nexus that underpinned Russia’s impressive economic performance in recent years has faltered. With sluggish investment growth dampening labor productivity, real wages are likely to remain stagnant. For the CCA, this outlook implies weak export demand from Russia in the near future, and suggests that remittances may not reach their precrisis levels of 2008 for some time. Despite its own difficulties, Russia continues to provide official assistance (primarily to the Kyrgyz Republic) and project financing to CCA countries.

China is set to remain a source of export demand and government financing for some Central Asian countries.1 While China was also hit hard by a sharp fall in exports, a slowdown in the real estate market, and excess capacity in various industries, its economy is still projected to grow by over 8 percent in 2009. This is being driven by an expansion in credit of 23 percent of GDP during the first half of 2009 that has boosted investment, particularly in public infrastructure. In addition, domestic fiscal stimulus has been significant. As a result, recent data are encouraging, and there are signs of an economic turnaround taking hold. For Central Asian governments, China is also an important source of budget financing. For example, China is expected to provide bilateral financing of up to US$5 billion to Kazakhstan, which has gross external financing needs of US$16.5 billion in 2009. In Tajikistan, official loans from China are financing about 30 percent of public investment projects in 2009. Lastly, China has been building its commodity stocks, which may have helped CCA exports.

Countries of the Commonwealth of Independent States2 outside the CCA are facing a contraction in 2009, followed by a tentative recovery in 2010. Links with Russia (both trade and remittances) have compounded the effects of the global recession, and GDP growth is projected to be only 2.1 percent in the CIS region in 2010.

1 With respect to trade, China is an important export destination for Kazakhstan, the Kyrgyz Republic, and Uzbekistan.2 Armenia, Azerbaijan, Belarus, Kazakhstan, the Kyrgyz Republic, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

Economic activity in the Commonwealth of Independent States (CIS) is projected to contract by 7 percent in 2009, more than the average for the CCA energy importers. The expected recovery in 2010—with a projected growth of 2 percent—is in a similar range to projections for CCA energy importers, but lower than for CCA energy exporters.

Modest External Demand Slated as Driver of Growth in 2010

An important channel through which the global economic crisis has affected the region—both the energy importers and some energy exporters (Azerbaijan and Uzbekistan) as well—is through a marked drop in remittance inflows (Box 3.2). Remittance outflows from Russia declined by about 30 percent during the first six months of 2009. In turn, remittance inflows into Armenia, Georgia, the Kyrgyz Republic, and Tajikistan—for which monthly or quarterly data are available—contracted by 20 percent to 60 percent, although the rate of decline appears to have stabilized by mid-2009. With many migrants working in the Russian construction sector, the decline in remittances is highly correlated with activity in that sector (Figure 3.2). These dramatic shifts have depressed domestic consumption and construction activity across the region, both of which were buoyed by remittances in the run-up to the crisis. In 2010, given the weak outlook for Russia, remittances are expected to stagnate, and thus, contribute little to the recovery in the CCA.

Box 3.2The Macroeconomic Consequences of Declining Remittances and the Response of the International Community

Remittance flows are typically a stable and important source of external financing, but they have become a key transmission channel of the global crisis in the CCA. Remittance flows are often countercyclical, with migrants sending more money home when their home country is experiencing a downturn. They also tend to increase as migrants’ incomes increase. As such, these flows are credited with raising income levels of recipient families, buffering them against consumption volatility, and helping reduce fluctuations in output at the macroeconomic level. The experience of the CCA in recent years, however, has been the reverse. In the run-up to the current crisis, when Russia—the CCA’s most important source of remittances—was booming, remittance flows to the region increased by about eightfold between 2003 and 2008, and the CCA economies enjoyed high growth rates (Table 1). But in 2009, with the global crisis centered in remittance source countries, migrants facing falling incomes or unemployment, and CCA economies suffering a decline in growth, remittance flows have also declined sharply.

Table 1Remittances to CCA Countries(Millions of U.S. dollars, 2008)
ArmeniaAzerbaijanGeorgiaKyrgyz RepublicTajikistan
Workers’ remittances123.61,416.1305.11,224.1
Compensation of employees929.2102.3419.2
Migrants’ capital transfers9.436.07.88.3
Remittances from Russia (percent of total)
Remittances/GDP (percent)
Growth of remittances 2003–08 (average annual; percent)52.066.826.376.573.7
Sources: National authorities; and IMF staff estimates.
Sources: National authorities; and IMF staff estimates.

The fall in remittances is exacerbating the slowdown in growth. The global crisis is transmitted to the CCA through traditional channels, mainly trade, but also through financial flows. In addition, the fall in remittances is depressing domestic consumption and investment. Notably, private consumption is highly correlated with remittances, with a 10 percent decrease in the latter dampening consumption by 2 percent to 4 percent. Thus, the impact during the current crisis is reversing the effect of remittances in preceding years, when remittances fueled a strong growth episode through their effects on consumption and investment—particularly in real estate—leading to a construction boom in some countries (Figure 1).

Figure 1Armenia: Remittances and Construction Output

(Index, 2001=100)

Sources: National authorities; and IMF staff estimates.

Poverty is rising in the CCA as the main breadwinners of lower-income households living abroad face falling incomes and job losses. The effect of the fall in remittances is compounded by the contraction of economic activity at home, where the poorest CCA countries have been hit the hardest. Under current projections, gross national disposable income per capita in U.S.-dollar terms is declining (Figure 2), reversing years of progress toward poverty reduction and making the Millennium Development Goals even harder to achieve in the requisite time (Table 2).

Figure 2Gross National Disposable Income per Capita1

(U.S. dollars)

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

1 Defined as GDP + nonfactor income + transfers.

Table 2Demographics and Poverty
Poverty rate (percent)Infant mortality (number of deaths/1000)Life expectancy at birth (years old)
Sources: National authorities; and IMF staff estimates.
Sources: National authorities; and IMF staff estimates.

At the same time, lower remittances are depressing fiscal revenues, constraining the scope for countercyclical fiscal policy and government support to poor households. The main fiscal impact of lower remittances is on indirect taxation, which in the CCA accounts for about 40 percent of total tax revenues. The decline in remittances is estimated to result in a 14 percent decline in value-added tax (VAT) revenues in 2009, mostly through lower consumption of domestic and imported goods, compounding the shortfall in other tax revenues due to the economic crisis. Indeed, government revenue is set to decline by 1 percent to 5 percent of GDP across the remittance-dependent countries in the CCA.

The international community has responded quickly by increasing its support to CCA energy importers (Table 3). Multilateral and bilateral donors have stepped up budget grants to CCA governments. The IMF has entered into new or augmented programs with all four CCA energy importers—these programs accommodate an easing of fiscal policy and are focused on protecting key social and development expenditure. Thus, assistance from the international community has substituted for remittances as a countercyclical source of external financing during this crisis.

Table 3Support from the International Community(Percent of GDP)
ArmeniaGeorgiaKyrgyz RepublicTajikistan
Budget grants
IMF disbursements
Sources: National authorities; and IMF staff calculations.
Sources: National authorities; and IMF staff calculations.

This external assistance has allowed governments to adopt a number of initiatives to support poor households, as well as the economy at large in 2009. Subsidies and transfers to households have been increased (Georgia, the Kyrgyz Republic, and Tajikistan), VAT rates have been reduced to lower the retail price of imported foodstuffs (the Kyrgyz Republic and Tajikistan), social safety nets are being revamped (Armenia, the Kyrgyz Republic), pensions have been increased (the Kyrgyz Republic) and training programs for returning migrants are being introduced (Tajikistan).

For 2010, there is a need for continued support from the international community. With remittances not projected to return to their previous levels in the near future, social spending needs will remain acute. This implies that external assistance will continue to be necessary. According to current projections, however, such support from the international community may decline in 2010.

Figure 3.2CCA Remittance Inflows Are Declining Sharply

(Remittance inflows; percent: year-on-year)

Sources: National authorities; and IMF staff estimates.

In addition, all CCA countries are being affected by weak global demand. Exports of goods and services are set to decline by an estimated 25 percent in U.S.-dollar terms in 2009 (Figure 3.3). An exception is Turkmenistan, where oil production volumes are rising. The energy and commodity exporters, of course, are more severely affected, as are countries that rely heavily on exports to Russia, such as Armenia.

Figure 3.3Exports Have Contracted Sharply in 2009 …

(Exports of goods in U.S. dollars; percent: year-on-year)

Source: IMF, Direction of Trade Statistics.

Imports of goods and services are also expected to fall—on average by 10 percent—in 2009 (Figure 3.4). Still, net external demand is a drag on growth in 2009. In 2010, exports should recover across the region, especially those of energy exporters, as global demand for fuel picks up. With imports projected to rebound only modestly, net external demand is likely to provide a growth impulse, particularly for energy exporters.

Figure 3.4… but Imports Have Also Fallen

(Imports of goods in U.S. dollars; percent: year-on-year)

Source: IMF, Direction of Trade Statistics.

Most CCA countries are faced with deteriorating current account balances in 2009 due to falling remittances and net external demand (Figure 3.5). Current account positions are projected to remain weaker than before the crisis in 2010—except in Georgia and Turkmenistan—mainly because of declining grant inflows, and despite a recovery in exports and remittances. In the case of energy importers, current account deficits are large, suggesting the need for external adjustment in the future.

Figure 3.5External Balances Are Weakening

(Current account balance; percent of GDP)

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

Responsive Macroeconomic Policies Help Region Cope

Governments and central banks have responded to the downturn with a wide range of instruments (Table 3.2). Expansionary fiscal and monetary policies have been pursued in 2009, and exchange rates in most countries (except Azerbaijan and Turkmenistan) have depreciated against the U.S. dollar.

Table 3.2CCA: Policy Responses to the Crisis
CountryFiscal StimulusExchange Rate DepreciationMonetary EasingLiquidity SupportIncreased ProvisioningCapital InjectionsDeposit Guarantees
Kyrgyz RepublicEnhanced
Sources: National authorities; and IMF staff assessments.
Sources: National authorities; and IMF staff assessments.

Fiscal policy has been largely accommodative in 2009 (Figure 3.6). All CCA governments are aiming for expansionary fiscal policies, involving lower primary fiscal surpluses (energy exporters) or widening primary fiscal deficits (energy importers). Based on the methodology discussed in the appendix, automatic stabilizers are being allowed to work, and discretionary fiscal stimulus is being provided in response to the crisis.1

Figure 3.6Fiscal Policy Is Expansionary

(Change in the non-oil primary fiscal deficit, 2009; percent of non-oil GDP)

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

Tax revenue as a percentage of GDP is declining sharply in a number of countries, partly reflecting the impact of declining remittances on the tax base. While energy importers entered the crisis with already weak or vulnerable fiscal positions, donor support, including from Russia and China, is helping to finance social spending to alleviate the impact of the crisis (Box 3.2).

In 2010, more fiscal stimulus may be needed in some countries. Only Kazakhstan, the Kyrgyz Republic, and Turkmenistan are currently targeting additional fiscal stimulus in 2010. In other CCA countries (Armenia, Georgia, and Tajikistan), governments are facing limited fiscal space due to emerging financing constraints and already high debt levels (Figure 3.7). In these countries, where grant support is also projected to decline significantly as a percentage of GDP compared with 2009 (Figure 3.8), additional highly concessional donor financing will be needed.

Figure 3.7Debt Levels Are Rising …

(Public debt; percent of GDP)

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

Figure 3.8… and Grant Support Is Declining

(Energy importers: grants; percent of GDP)

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

With the growth slowdown and inflation falling rapidly (Figure 3.9), central banks in Armenia, Azerbaijan, Georgia, Kazakhstan, and Tajikistan have pursued monetary easing through cuts in their main policy rates and direct liquidity support to the banking sector. In some countries (Azerbaijan, Georgia, Kazakhstan, and Tajikistan), the authorities have also lowered reserve requirements. However, the effectiveness of monetary policy in easing credit conditions has been limited, given the small size of financial sectors in the region, as well as highly dollarized balance sheets in some countries. Concerns over pressures on the exchange rate have also constrained monetary policy, particularly during the initial phase of the crisis. Looking ahead, with international commodity prices and global interest rates poised to rise again, the scope for further easing of monetary policy may be limited.

Figure 3.9Inflation Is Declining Rapidly

(Consumer price inflation; average; percent: year-on-year)

Source: DataStream.

During 2009, exchange rates in most CCA countries have depreciated against the U.S. dollar, but not against the Russian ruble (Figure 3.10). In turn, real effective exchange rates have also depreciated (Figure 3.11). The exceptions are Azerbaijan and Turkmenistan, which maintain their peg against the U.S. dollar at the precrisis level. While the depreciation has helped restore competitiveness, several countries (Armenia, Georgia, and Tajikistan) still face large current account deficits and high external financing needs that are met only through official financing, suggesting a need for greater exchange rate flexibility. In some cases, balance sheet dollarization may call for a gradual approach. Where banks have sizable exposure to unhedged foreign currency borrowers, a large depreciation could undermine asset quality and add to the already high stress in financial systems.

Figure 3.10Most CCA Currencies Have Depreciated Against the U.S. Dollar but Not the Russian Ruble

(Local currencies against the U.S. dollar and Russian ruble, Aug. 31, 2008–Aug. 31, 2009; upward movement indicates appreciation)

Source: IMF, Information Notice System.

Financial Sector Vulnerabilities Are a Key Downside Risk

Financial sectors across the CCA are under pressure. Nonperforming loans are increasing in most countries (Figure 3.12), and capital adequacy ratios are weakening in some countries (Kazakhstan, the Kyrgyz Republic, and Tajikistan) as slower economic activity and declining remittances are affecting bank profitability and incomes. In some countries with high loan dollarization (Armenia, Georgia, Kazakhstan, and Tajikistan), the depreciation of local currencies could further erode debtors’ ability to pay. Weakening asset quality is affecting private sector credit growth (Figure 3.13), and borrowing costs are rising in some countries (Figure 3.14). Loan-loss provisions are depleting capital and restricting banks’ ability to extend new loans. In addition, slowing deposit growth and illiquid international funding markets (accessed mainly by Kazakhstan) are hindering credit growth.

Figure 3.11Losses in Competitiveness Are Reversing

(Real effective exchange rate; index, Jan. 2005 = 100; upward movement indicates appreciation)

Source: IMF, Information Notice System.

Figure 3.12Nonperforming Loans Are Rising

(Nonperforming loans; percent of total loans)1

Sources: National authorities; and IMF staff estimates.

1 Cross-country comparisons are constrained by differences in country definitions of regulatory regimes.

Figure 3.13Credit Growth Slows

(Credit to the private sector; percent change: year-on-year)

Source: IMF, International Finance Statistics.

Figure 3.14Rising Lending Rates Could Hold Back Investment

(Real lending rate; percent)1

Sources: National authorities; and IMF staff estimates.

1 Lending rate for Georgia is on loan flows for all maturities.

The Kazakhstani banking sector has been particularly hard hit by its balance sheet exposure to construction, real estate, and foreign exchange lending to unhedged borrowers, as well as by the burden of maturing external liabilities. The stress in the Kazakhstani banking sector has spilled over to the Kyrgyz Republic, which is dominated by subsidiaries of Kazakhstani banks (accounting for close to 50 percent of the loan portfolio).

These vulnerabilities call for close monitoring of CCA financial systems as well as enhanced supervision and crisis preparedness. There are some indications that prudential standards, including on provisioning, are not always strictly enforced, allowing vulnerabilities to linger. Crisis preparedness frameworks could be further developed by specifying the roles and responsibilities of the central bank and ministry of finance. Efforts under way to reform existing deposit insurance systems (Tajikistan) or to fully capitalize the newly introduced deposit insurance systems (the Kyrgyz Republic) should be pushed forward to strengthen confidence in the banking sector. In Turkmenistan and Uzbekistan, directed lending is holding back the development of these countries’ nascent banking systems.

Medium Term: Raising Potential Growth

Looking beyond the current crisis, a key question is how to raise potential growth in a region where per capita GDP levels remain low. For energy exporters, global demand will be the d*river of the oil economy and thus also determine governments’ ability to develop the non-oil economy. In Turkmenistan and Uzbekistan, significant gains could be realized by further liberalizing the economy and expanding the private sector. For energy importers, rising oil prices could weigh on growth, though there will also be positive spillovers from regional energy exporters and Russia. Given the slow recovery projected in industrial countries, future growth would benefit from a diversification of exports toward dynamic emerging economies in the region (including China). Many of the energy importers, too, would benefit from further reforms to support private sector activity and strengthen the investment climate.

A second question relates to the future path of remittances. The rapid growth of remittances up to 2008 was closely correlated with developments in the Russian construction sector; for the Kyrgyz Republic, Kazakhstan’s construction sector was also of importance. With subdued prospects for the Russian economy, remittances are not likely to reach their precrisis levels for a number of years. CCA economies that were heavily dependent on migrant workers must, therefore, find ways to provide returning migrants with gainful employment. While this infusion of labor could provide growth opportunities, increased investment is needed to realize this potential. In the near term, however, returning migrants are likely to add to fiscal pressures. Governments must balance the need to provide adequate social safety nets (including training) with continued public infrastructure investments that complement private sector development.

Regional cooperation can foster growth in the Central Asian economies. Historically, these economies have been tied closely together via the silk route, which brought prosperity to the region.

Today, intraregional trade is well below potential; improved infrastructure could help reopen traditional trade routes, providing growth impulses across the region. Moreover, Central Asian economies would benefit from closer cooperation on energy trade and the efficient use of water resources. Upstream countries (the Kyrgyz Republic and Tajikistan) have significant hydropower potential, including for seasonal export, which should be balanced against the irrigation needs in downstream agricultural areas. Armenia’s economy could benefit from an opening of its borders with Turkey.

A number of regional fora provide opportunities for deepening the economic ties within the region. The Central Asian Regional Cooperation Program (CAREC), for example, strives for “development through cooperation.” Its objectives are to increase economic growth and poverty reduction, expand and diversify trade, and strengthen the capacity for regional cooperation and integration. Specifically, CAREC seeks to improve transportation networks and foster regional and global trade, including through customs modernization. In the trade policy area, CAREC assists member countries with opening up their economies, including through accession to the World Trade Organization, and reducing tariff and nontariff barriers to (regional) trade.


Authorities in Armenia, Azerbaijan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan are providing a discretionary fiscal stimulus. In Georgia, the government followed an expansionary fiscal stance in 2008, and in Kazakhstan, quasi-fiscal measures—not captured in the estimations presented above—have been used to support the economy.

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