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IMFSurvey Magazine: Countries & Regions

Crisis Brings Reversal of Fortune to Caucasus and Central Asia

Oil worker in Kazakhstan: CCA oil exporters have seen a sharp turnaround in their external and fiscal balances (photo: Reuters/Shamil Zhumatov).


Crisis Brings Reversal of Fortune to Caucasus and Central Asia

By Dima Jardaneh
IMF Middle East and Central Asia Department

March 10, 2009

  • Growth stalls in Caucasus and Central Asia as global crisis hits
  • Region’s ties to Russia make it vulnerable to the downturn in that country
  • IMF, regional officials meet in Bishkek to share crisis management strategies

Growth in the resource-rich Caucasus and Central Asia (CCA) is projected to slow to under 2 percent in 2009 from 6 percent in 2008, as the deepening global crisis hits the region hard, the IMF says in its latest regional forecast.

Awash with commodity export receipts, capital inflows, and remittances, the countries of CCA made significant economic gains in recent years, with real per capita GDP growing impressively. Oil exporters in the region were able to build up substantial reserves including in sovereign wealth funds, while low-income countries benefited from the boom in the larger economies, with domestic demand in these countries heavily reliant on trade receipts and remittances from neighboring countries. Now, however, the global crisis is reversing many of these gains.

Bleak outlook for 2009

With the onset of the global financial crisis, economic conditions in CCA—comprising Armenia, Azerbaijan, Georgia, Kazakhstan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan—have deteriorated sharply. Countries hardest hit by the crisis are those that are very reliant on Russia or have large external financing needs. For most countries in the region, Russia remains a main trading partner and a major source of remittances. The slowdown in Russia is hurting growth via trade and remittance channels, spilling over to domestic demand.

Commodity exporters are being affected by the decline in global demand and the sharp drop in commodity prices, while those countries that are more closely integrated with international financial markets are experiencing serious financing constraints. The external dimension of the crisis is reflected clearly in current account projections, with the region expected to shift, on average, from a large current account surplus in 2008 to a small deficit in 2009. With lower growth and commodity prices, the average fiscal position is similarly moving from a surplus into a deficit.

As a result of the large external shocks, the pace of economic growth in the region is already estimated to have slowed considerably to 6 percent in 2008, from 12 percent in 2007. It is projected to fall well below 2 percent in 2009, with risks clearly on the downside, particularly if the situation in Russia worsens. Meanwhile, the drop in growth and lower commodity prices are dampening inflationary pressures across the region.

Pressures on financial sectors in the region have intensified, especially in those countries where banks face large external rollover needs, but also in other countries not directly exposed to the global financial difficulties. With the deterioration in economic and financial conditions, credit growth has come to a halt in most countries, and loan losses have started to rise and are likely to increase further.

Furthermore, the large depreciation of the Russian ruble has put pressure on regional currencies. Policymakers have faced the challenge of maintaining competitiveness while ensuring stability in financial sectors with large external liabilities and foreign currency loans to unhedged borrowers. The actual or expected depreciation of national currencies has also contributed to a drop in deposit growth and increasing dollarization.

IMF conference in Bishkek

These issues were the subject of discussion at a March 4 conference jointly organized by the IMF and the National Bank of the Kyrgyz Republic. The regional conference, held in the Kyrgyz capital of Bishkek, focused on how to mitigate the effects of the global financial turmoil on CCA. Bringing together central bank governors and senior government officials from the region, the conference served as a forum for policymakers to discuss their experiences in managing the impact of the crisis in their countries. In his opening remarks to participants, Igor Chudinov, the Prime Minister of the Kyrgyz Republic, highlighted the timeliness and the importance of the subject to the region.

The Bishkek conference brought together senior government officials from the region to discuss how to mitigate the effects of the crisis (photo: Veronica Bacalu).

The unprecedented scale and severe impact of the crisis on the global economy makes this a highly uncertain time, with mounting risks for the CCA economies. Conference participants highlighted four main transmission channels of the crisis to the region:

• The difficulty of obtaining foreign capital, with the largest impact observed in Kazakhstan because of the large share of private external financing in the banking sector;

• Lower oil and commodity prices, the impact of which is most pronounced in the four energy exporting countries—Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan—which have seen a sharp turnaround in both their external and fiscal balances;

• Lower remittances primarily from Russia, which will impact the smaller countries in the region, where remittances account for at least 20 percent of GDP. With less work available for migrant workers in host countries, some of them will return to their home countries, contributing to a worsening in social indicators and putting additional pressures on social spending; and

• Lower trade flows in view of the slowing growth in trading partners.

Coping with the crisis

Conference participants identified three key policy actions to help buttress against the impact of the crisis in the short term and address longer-term challenges that would help the region better withstand external shocks in the future.

• Make use of room for fiscal stimulus. Oil-exporting countries in the region have fiscal space to increase spending to protect the poor and support domestic demand by drawing down the foreign currency assets they accumulated in the boom years. For the other countries, there is less scope for increased spending within current financing envelopes, but it is still important to allow automatic stabilizers to work and increase support to vulnerable segments of the population and returning migrants. Donors, therefore, need to step up with increased budget support so as to limit the erosion in poverty gains across the region, conference participants observed.

• Strengthen the financial sector. While the impact on financial sectors to date has varied across countries in the region, policymakers noted that they were all moving to strengthen their regulatory and supervisory frameworks. Conference participants agreed that banks’ asset quality would deteriorate and that it was important for banks to adequately provision against deteriorating assets. All countries in the region will need contingency plans to ensure preparedness against potential liquidity and solvency problems in banks. Development of the financial sector should be accompanied by strengthening the regulatory and supervisory frameworks to ensure that the stability of the financial system is safeguarded.

• Consider whether further exchange rate adjustment may be helpful. Faced with depreciation pressures, some countries have allowed their currencies to adjust, while others have chosen to maintain stable rates so far. Participants at the conference noted that exchange rate policy decisions depend on competitiveness concerns, the degree of dollarization in the financial sector, and the starting position—i.e., whether the country has a large reserve buffer. But they agreed that in most countries exchange rate adjustment could help absorb the large external shocks and stem the decline in reserves.

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