## 3. Caucasus and Central Asia: No Room for Complacency ## Source details **Canonical URL:** [3. Caucasus and Central Asia: No Room for Complacency](https://www.imf.org/-/media/files/publications/reo/mcd-cca/2017/october/ccanovember1/9-chapter-3.pdf) ## Other formats - [Markdown version](/-/media/files/publications/reo/mcd-cca/2017/october/ccanovember1/9-chapter-3.pdf.md) - [Structured JSON version](/-/media/files/publications/reo/mcd-cca/2017/october/ccanovember1/9-chapter-3.pdf.json) --- ### Growth Outlook - Oil exporters - Growth picked up from a post-1998 low of 2.4 percent last year to 3.5 percent in 2017 and is projected at 3.7 percent in 2018. - Kazakhstan: construction, transportation, and agriculture strengthened in late 2016; further improvement expected with advances in Kashagan oil field operations and continuation of structural reforms. - Azerbaijan: 2016 contraction extended into Q1 2017 at a slower pace due in part to lower oil production under the OPEC-led agreement and ongoing financial vulnerabilities; projected to resume growing in 2018 with a gradual recovery constrained by fiscal consolidation. - Turkmenistan: 2016 growth supported by strong agriculture and services; short-term stability projected owing to rising natural gas exports to China, expansionary credit policies, and industrial policies. - Medium-term: growth among CCA oil exporters expected to pick up slowly given relatively subdued external conditions, reinforcing the need to reduce hydrocarbon dependence. - Oil importers - Growth was 3.3 percent last year, some 0.5 percentage point below the 2015 outturn. - Drivers of the 2016 slowdown: reduced remittances and commodity exports, and weak domestic demand (notably in Armenia and Georgia). - Offsetting strength: Tajikistan (fiscal expansion supporting industry and construction) and the Kyrgyz Republic (higher gold production and stronger industrial and services activity). - Projections: growth in oil importers projected to strengthen to almost 4 percent this year and next as remittances and external demand recover. - Country notes: Georgia’s acceleration expected to be stronger than in the May 2017 update; Armenia expected to pick up in 2017 with higher copper prices and remittances; Kyrgyz Republic and Tajikistan expected to see moderated growth due to stabilizing gold production and financial sector distress, respectively. - Medium-term: activity in oil importers expected to remain on a recovery path, assuming gradual realization of structural reform dividends. ### Financial Sector Weaknesses - High vulnerabilities in several countries are restraining growth and lending. - Country-specific financial support and interventions - Azerbaijan: largest state-owned bank undergoing voluntary debt restructuring worth some 9 percent of GDP. - Kazakhstan: authorities provided support to the financial sector equivalent to about 4 percent of GDP this year; two largest banks merged. - Tajikistan: authorities intervened in two major banks, providing support totaling some 6 percent of GDP. - Impacts: deterioration in asset quality, bank profitability, and large shares of underperforming loans have adversely affected lending. - Relatively resilient systems and improving indicators - Armenia: merger of three banks, capital injections to meet new regulations; improved profitability and lower NPL levels. - Georgia: marginal increase in NPLs, banks report adequate capital and liquidity after acquisitions of smaller banks. - Kyrgyz Republic: dollarization declined, capitalization adequate, but NPLs remain high. - Turkmenistan: strong credit growth supports development but raises future credit-quality risks. - Recommended actions to promote resilience - Enable accurate assessment of banks’ health. - Develop effective bank resolution frameworks. - Enhance prudential regulation and supervision. - Resolve governance issues. - Macro linkage: oil prices, anticipated to remain subdued, have historically been closely tied to the region’s credit cycle and could persistently drag on activity; resilient financial sectors are needed to channel savings to productive investments and support diversification. ### Fiscal Consolidation - Recent deterioration: fiscal balances worsened in 2016 relative to 2015 in many CCA countries (notable exceptions: Azerbaijan and Kazakhstan) as policymakers accommodated lower commodity revenues and remittances. - Near-term projections: overall balances projected to improve in many countries this year and next, reflecting higher revenues in some and lower public expenditures in others, aided by unwinding of previous public investment booms. - Oil exporters - Overall fiscal deficits anticipated to widen by some 1.6 percentage points of GDP on average this year relative to 2016, largely reflecting one-time fiscal transfers to the financial sectors in Azerbaijan and Kazakhstan. - Medium-term: oil exporters’ fiscal deficits projected to decline further to 0.4 percent of GDP on average. - Deficit financing: asset drawdowns (Kazakhstan, Turkmenistan) and foreign debt issuance (Azerbaijan, Kazakhstan). - Oil importers - Recent higher deficits from fiscal accommodation and financial sector support (Tajikistan) were mostly financed through foreign debt and other foreign financing (Tajikistan issued debt domestically). - Overall deficits projected to decline to 4.2 percent in 2017 and 3.7 percent in 2018. - Projected to gradually decline to 1.9 percent of GDP on average by 2022. - Revenue measures: Armenia’s 2016 tax code expected to raise revenues by about 2 percentage points of GDP over the medium term; improved tax administration and expenditure restraint in Tajikistan; wage bill reform in the Kyrgyz Republic. - Non-oil fiscal trajectory (oil exporters): non-oil fiscal deficits projected to increase to 17.6 percent of non-oil GDP this year from 13.9 percent in 2016, but decline to 10.9 percent of non-oil GDP in 2022. - Policy guidance - Continue fiscal consolidation to reduce debt and rebuild buffers, while carefully calibrating pace and composition to avoid undermining medium-term growth. - Strengthen public spending efficiency: select projects with highest productivity and potential growth impact, streamline wage bills (limit staff numbers and bonuses, implement civil service reforms), while preserving critical social expenditures. - Mobilize additional revenues through reducing tax exemptions and strengthening collections. - Anchor consolidation in strong, credible multiyear frameworks and promote transparency and accountability in public fund use. ### External Balances - Current account: reached 6.4 percent of GDP in 2016, some 2.8 percentage points more than in 2015. - Cross-country patterns in 2016 - Deterioration in almost all oil exporters due to lower oil prices. - Improvement in most oil importers: Armenia’s current account deficit marginally improved to 2.3 percent of GDP (new copper mine and export rebound to Russia); Kyrgyz Republic’s deficit narrowed by about 6 percentage points of GDP (strong gold exports, low fuel import prices, remittances pickup); Tajikistan’s deficit narrowed by some 2 percentage points of GDP as exports recovered and imports contracted only moderately despite remittance declines. - Exchange rates - Depreciation and unification: Azerbaijan and Kazakhstan allowed currencies to move more freely; Uzbekistan unified official and parallel rates with the som losing about half of its value at the official rate and liberalized some foreign currency transactions. - Real effective terms: Azerbaijan, Kazakhstan, and Uzbekistan depreciated relative to pre-oil-price-drop period; Turkmen manat appreciated in real effective terms over past several years despite a 2015 step devaluation. - Oil importers: Armenia’s real effective exchange rate moved laterally since 2015; Georgia’s REER remained below preshock levels; Tajikistan’s somoni depreciation brought REER below historical averages; Kyrgyz Republic’s 2015–16 depreciation largely reversed. - Projections - Most CCA current account balances projected to improve gradually in 2017 and beyond reflecting gradual external condition improvements and country-specific factors. - Kazakhstan: oil exports projected to increase as Kashagan becomes fully operational though a near-term return to surplus is not expected. - Turkmenistan: external deficits projected to remain sizable over the medium term due to large public investment projects, low hydrocarbon prices, and high import content of domestic spending despite growing hydrocarbon exports and export-promotion/import-substitution policies. - Oil importers: current account deficits expected to increase in 2017 and decline gradually through 2022, reflecting a pickup in imports partially offsetting remittance recovery since mid-2016. - Policy implication: high reliance on commodity exports and remittances underscores the need for continued diversification. ### Monetary Policy Frameworks - Inflation - Regional inflation peaked at double digits during 2016 and is projected to moderate to 8.9 percent in 2017. - Drivers: easing price pressures in Kazakhstan; anticipated pickup in inflation in most other countries though remaining subdued among oil importers. - Country examples: Georgia’s inflation projected to accelerate from excise tax increases, exchange rate pass-through, and higher commodity prices before converging in 2018 to the 3 percent target; Armenia’s inflation projected to remain in line with the official medium-term target range of 4±1.5 percent despite higher food prices; Turkmenistan facing upward pressure from higher import prices, public sector wage growth, and expansionary credit; Uzbekistan’s inflation projected to accelerate into double digits due to high money growth and rapid som depreciation. - Regional projection: inflation projected to decline gradually to 5.9 percent by 2022. - Policy rates and transmission - Many countries have begun unwinding restrictive policies; exceptions include Azerbaijan, Georgia, and Tajikistan where policy rates were increased. - Tajikistan: National Bank of Tajikistan raised its policy rate twice in 2017 to reach 16 percent, increased sales of NBT bills, and raised reserve requirements. - Azerbaijan: central bank raised policy rate sharply in late 2016 from 7 percent to 15 percent. - Kazakhstan, Armenia, Kyrgyz Republic: rapid policy rate cuts in some cases with limited impact on bank lending and deposit rates, indicating weak monetary transmission. - Policy guidance - Strengthen and make monetary policy frameworks credible: establish clear objectives, enhance central bank communication, improve transmission mechanisms, and expand analytical toolkits. - Maintain exchange rate as a shock absorber and preserve foreign exchange reserve buffers; limit direct market interventions to disorderly conditions. - Pace monetary easing consistent with inflation developments to protect price stability, support financial development, and aid dedollarization. - Continue improving liquidity management and develop a local currency yield curve. - Country examples of progress: Central Bank of Armenia improving liquidity forecasting and instruments; National Bank of Georgia publishing policy rate path forecasts; Kyrgyz Republic narrowing policy rate corridor and moving toward inflation-targeting. ### Structural Reforms for Inclusive Growth - Urgent need to implement structural reforms to achieve strong, sustainable, and inclusive growth via diversification and private sector job creation. - Recent trends: catch-up to living standards stalled by recent slowdown; youth unemployment declines in oil exporters since 2002 have stalled and in some cases reversed; reductions in youth unemployment after the global financial crisis in oil importers have also halted. - Implication: with external conditions projected to remain relatively subdued, follow-through on reforms is critical to secure future income and employment gains. ### Reforms and Structural Initiatives - Kazakhstan: - Launched the 100 Concrete Steps and 3rd Modernization Initiative to address public administration, business environment, competitiveness, and commodity dependence. - Planned reduction of the role of the state through privatizations; first wave expected in 2018. - Armenia: - Established the Center for Strategic Initiatives in January 2017 to foster public-private partnerships and attract foreign direct investment. - Reforms in the energy sector and the tax system have proceeded successfully; additional reforms underway to tackle corruption, improve competition and the business climate, and attract FDI. - Georgia: - Planning to introduce a public-private partnership law; strengthen monitoring of contingent liabilities from partnerships and state-owned enterprises. - Tajikistan: - Structural fiscal reforms should aim to improve service delivery, enhance the business climate, and reduce fiscal risks. - Turkmenistan: - New seven-year development plan creates an opportunity to broaden and deepen market-oriented reforms. - Uzbekistan: - Announced a comprehensive economic and social reform package, including a reform of the foreign exchange system. - Regional emphasis: - Accelerating implementation of structural reforms to support private sector development is critical for diversification, attracting productive investments, and creating jobs. - Reforms to strengthen governance, transparency and accountability, and property rights are necessary to fully benefit from China’s Belt and Road Initiative and the strengthening global economy. ### Risks: Short Term vs. Medium Term - Short term: - Continued strengthening of the global economy, trade, and some commodity prices implies a balanced risk outlook for the CCA region. - Upside regional risks: for Georgia, stronger-than-expected returns from trade integration; for the Kyrgyz Republic, deeper ties with China and projects financed by the Russian-Kyrgyz Development Fund; for Kazakhstan, benefits from structural reforms, enhanced regional cooperation, deeper relations with Uzbekistan, and a stronger recovery in Russia. - Medium term (downsides emphasized): - Inward-looking policies in advanced economies could adversely affect global trade and commodity prices. - Monetary policy normalization in advanced economies, notably in the United States, could trigger rapid tightening in global financial conditions, leading to exchange rate volatility and depreciation, increasing public debt and exacerbating financial sector vulnerabilities across the CCA. - Economic pickup could delay structural reforms, risking a missed window of opportunity and prolonged mediocre economic performance that harms living standards. - Specific vulnerability noted: - Exchange rate depreciation could further increase public debt and exacerbate region’s financial sector vulnerabilities. ### Financial Sector Vulnerabilities and Policy Priorities (Box 3.1) - Key message: - Recent external shocks exposed continued financial vulnerabilities; addressing them requires stronger regulation and supervision, improved bank resolution frameworks, and strengthened governance to limit fiscal risks and support growth. - Immediate priorities for policymakers: - Assessing banking sector health: - Bring reporting of nonperforming loans (NPLs), including off-balance-sheet items, in line with international best practice. - Undertake independent asset quality reviews to assess viability of banks; particularly acute in Azerbaijan and Kazakhstan where NPLs do not include assets transferred to special purpose vehicles and asset quality reviews have not been implemented. - Use reviews to formulate strategies to address NPLs and assess provisioning and capitalization needs to enable timely interventions. - Improving bank resolution frameworks: - Ensure state support is provided only for viable banks under strict conditions (time-bound recapitalizations with close oversight, corrective actions avoiding forbearance, clear restructuring plans, management replacement, reduced/eliminated shareholder participation if necessary). - For insolvent institutions, liquidation options should allow orderly closure while protecting retail customers through deposit insurance programs. - Resolution authority should have political and operational independence, sound governance, adequate resources, transparent processes, rigorous evaluation and accountability, and protection against liability for actions and omissions taken in good faith. - Enhancing prudential regulation and supervision: - Strengthen consolidated supervision and macroprudential frameworks; continue steps to reduce dollarization risks. - Examples from Georgia and Armenia: stricter rules on banks’ open positions in foreign currency, more restrictive liquidity requirements on foreign currency, higher risk weights and stricter limits on foreign-currency-denominated loans. - Strengthening corporate governance: - Address weak governance and opaque bank ownership to prevent related-party lending, excessive risk taking, and discretionary regulatory support. - Establish strong governance emphasizing transparency, clear executive and board responsibility, limited public sector influence, independent risk management, compliance, and internal control units. ### Growth-Friendly Fiscal Policy Options (Box 3.2) - Context: - Most CCA countries allowed fiscal deficits to increase during large external shocks in 2014–15 to contain impacts on output and jobs, but this led to rapid increases in public debt in some cases and added fiscal costs from financial sector support. - Policymakers must restore sound public finances and rebuild buffers over the medium term in a growth-friendly way while maintaining scope for productive public investment; structural reforms must proceed in parallel. - Key considerations: - Enhancing revenue: - Tax revenue is a key lever for growth-friendly consolidation and fairness. - Broadening direct and indirect tax bases, reducing widespread tax exemptions, and improving revenue administration (including taxing higher-net-worth individuals more effectively) would provide additional revenues and improve distribution of tax burden. - Many CCA countries (Armenia, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan) are pursuing revenue-increasing policies but more ambitious fiscal targets and reforms are needed. - Strengthening expenditure policy: - Consolidation should create space for growth-enhancing investment and fairer, better-targeted social safety nets by curtailing government wage bills, inefficient and regressive subsidies, and poorly targeted social benefits. - Most countries (except Tajikistan and Uzbekistan) plan curtailment of current expenditures; Georgia and the Kyrgyz Republic plan sizable public sector wage bill cuts. - Energy subsidies remain large in the Kyrgyz Republic, Turkmenistan, and Uzbekistan; further subsidy reform would free space for targeted social spending. - Reforms to boost efficiency and productivity of public investment should be implemented before considering large increases in public investment. - Anchoring fiscal consolidation: - Well-designed fiscal rules can support consolidation but must be tailored to political economy settings to avoid circumvention (for example, shifting spending outside the government perimeter). - Improvements in public financial management, including medium-term budgeting, would help anchor consolidation plans. ### Selected Economic Indicators — CCA: Selected Economic Indicators (Projections and averages) - Real GDP Growth (Annual change, percent) - Average 2000–13: 8.3 - 2014: 5.3 - 2015: 3.1 - 2016: 2.5 - 2017: 3.6 - 2018: 3.7 - By country, Real GDP Growth (Annual change, percent) - Armenia: 7.6; 3.6; 3.3; 0.2; 3.5; 2.9 - Azerbaijan: 11.3; 2.7; 0.6; –3.1; –1.0; 1.3 - Georgia: 5.9; 4.3; 2.9; 2.7; 4.0; 4.2 - Kazakhstan: 8.0; 4.3; 1.2; 1.1; 3.3; 2.8 - Kyrgyz Republic: 4.5; 4.0; 3.5; 3.8; 3.5; 3.8 - Tajikistan: 7.9; 6.7; 6.0; 6.9; 4.5; 4.0 - Turkmenistan: 11.3; 10.3; 6.5; 6.2; 6.5; 6.3 - Uzbekistan: 7.0; 8.1; 8.0; 7.8; 6.0; 6.0 - Consumer Price Inflation (year average, percent) - CCA aggregate: 9.2; 5.9; 6.4; 10.5; 8.9; 7.8 - By country, Consumer Price Inflation (year average, percent) - Armenia: 4.2; 3.0; 3.7; –1.4; 1.9; 3.5 - Azerbaijan: 6.4; 1.4; 4.0; 12.4; 12.0; 8.0 - Georgia: 5.5; 3.1; 4.0; 2.1; 6.0; 3.0 - Kazakhstan: 8.5; 6.7; 6.7; 14.6; 7.3; 6.5 - Kyrgyz Republic: 8.7; 7.5; 6.5; 0.4; 3.8; 5.1 - Tajikistan: 13.9; 6.1; 5.8; 5.9; 8.9; 8.0 - Turkmenistan: 5.5; 6.0; 7.4; 3.6; 6.0; 6.2 - Uzbekistan: 14.9; 9.1; 8.5; 8.0; 13.0; 12.7 - General Government Overall Fiscal Balance (percent of GDP) - CCA aggregate: 3.1; 2.3; –3.5; –2.2; –3.4; –1.0 - By country, General Government Overall Fiscal Balance (percent of GDP) - Armenia1: –3.2; –1.9; –4.8; –5.6; –3.3; –2.7 - Azerbaijan1: 7.5; 2.7; –4.8; –1.1; –0.3; 0.7 - Georgia: –2.9; –2.9; –3.8; –4.1; –3.8; –3.8 - Kazakhstan: 3.2; 2.4; –6.3; –4.1; –6.6; –2.0 - Kyrgyz Republic: –4.5; 1.0; –1.2; –4.5; –3.0; –2.4 - Tajikistan: –2.7; 0.0; –1.9; –10.6; –6.5; –5.4 - Turkmenistan2: 4.3; 0.9; –0.7; –1.3; –1.1; –0.1 - Uzbekistan: 3.4; 4.3; 2.8; 2.7; 0.3; 0.7 - Current Account Balance (percent of GDP) - CCA aggregate: 0.8; 2.3; –3.6; –6.4; –4.9; –4.2 - By country, Current Account Balance (percent of GDP) - Armenia: –8.9; –7.6; –2.6; –2.3; –3.6; –3.2 - Azerbaijan: 8.8; 13.3; –0.4; –3.6; 1.9; 2.5 - Georgia: –11.0; –10.7; –12.0; –13.3; –11.9; –10.7 - Kazakhstan: –0.9; 2.8; –2.8; –6.4; –5.3; –3.8 - Kyrgyz Republic: –1.3; –16.0; –16.0; –9.7; –11.6; –12.0 - Tajikistan: –4.5; –2.8; –6.0; –3.8; –6.3; –6.2 - Turkmenistan: –7.7; –6.4; –14.0; –21.0; –15.4; –14.3 - Uzbekistan: 4.9; 1.7; 0.7; 0.7; 0.9; 0.3 *Prepared by IMF staff; sources within the chapter include national authorities and IMF staff estimates and projections.* ### 3. Caucasus and Central Asia: No Room for Complacency ### 3. Caucasus and Central Asia: No Room for Complacency ### Growth Outlook - Oil exporters - Growth picked up from a post-1998 low of 2.4 percent last year to 3.5 percent in 2017 and is projected at 3.7 percent in 2018. - Kazakhstan: construction, transportation, and agriculture strengthened in late 2016; further improvement expected with advances in Kashagan oil field operations and continuation of structural reforms. - Azerbaijan: 2016 contraction extended into Q1 2017 at a slower pace due in part to lower oil production under the OPEC-led agreement and ongoing financial vulnerabilities; projected to resume growing in 2018 with a gradual recovery constrained by fiscal consolidation. - Turkmenistan: 2016 growth supported by strong agriculture and services; short-term stability projected owing to rising natural gas exports to China, expansionary credit policies, and industrial policies. - Medium-term: growth among CCA oil exporters expected to pick up slowly given relatively subdued external conditions, reinforcing the need to reduce hydrocarbon dependence. - Oil importers - Growth was 3.3 percent last year, some 0.5 percentage point below the 2015 outturn. - Drivers of the 2016 slowdown: reduced remittances and commodity exports, and weak domestic demand (notably in Armenia and Georgia). - Offsetting strength: Tajikistan (fiscal expansion supporting industry and construction) and the Kyrgyz Republic (higher gold production and stronger industrial and services activity). - Projections: growth in oil importers projected to strengthen to almost 4 percent this year and next as remittances and external demand recover. - Country notes: Georgia’s acceleration expected to be stronger than in the May 2017 update; Armenia expected to pick up in 2017 with higher copper prices and remittances; Kyrgyz Republic and Tajikistan expected to see moderated growth due to stabilizing gold production and financial sector distress, respectively. - Medium-term: activity in oil importers expected to remain on a recovery path, assuming gradual realization of structural reform dividends. ### Financial Sector Weaknesses - High vulnerabilities in several countries are restraining growth and lending. - Country-specific financial support and interventions - Azerbaijan: largest state-owned bank undergoing voluntary debt restructuring worth some 9 percent of GDP. - Kazakhstan: authorities provided support to the financial sector equivalent to about 4 percent of GDP this year; two largest banks merged. - Tajikistan: authorities intervened in two major banks, providing support totaling some 6 percent of GDP. - Impacts: deterioration in asset quality, bank profitability, and large shares of underperforming loans have adversely affected lending. - Relatively resilient systems and improving indicators - Armenia: merger of three banks, capital injections to meet new regulations; improved profitability and lower NPL levels. - Georgia: marginal increase in NPLs, banks report adequate capital and liquidity after acquisitions of smaller banks. - Kyrgyz Republic: dollarization declined, capitalization adequate, but NPLs remain high. - Turkmenistan: strong credit growth supports development but raises future credit-quality risks. - Recommended actions to promote resilience - Enable accurate assessment of banks’ health. - Develop effective bank resolution frameworks. - Enhance prudential regulation and supervision. - Resolve governance issues. - Macro linkage: oil prices, anticipated to remain subdued, have historically been closely tied to the region’s credit cycle and could persistently drag on activity; resilient financial sectors are needed to channel savings to productive investments and support diversification. ### Fiscal Consolidation - Recent deterioration: fiscal balances worsened in 2016 relative to 2015 in many CCA countries (notable exceptions: Azerbaijan and Kazakhstan) as policymakers accommodated lower commodity revenues and remittances. - Near-term projections: overall balances projected to improve in many countries this year and next, reflecting higher revenues in some and lower public expenditures in others, aided by unwinding of previous public investment booms. - Oil exporters - Overall fiscal deficits anticipated to widen by some 1.6 percentage points of GDP on average this year relative to 2016, largely reflecting one-time fiscal transfers to the financial sectors in Azerbaijan and Kazakhstan. - Medium-term: oil exporters’ fiscal deficits projected to decline further to 0.4 percent of GDP on average. - Deficit financing: asset drawdowns (Kazakhstan, Turkmenistan) and foreign debt issuance (Azerbaijan, Kazakhstan). - Oil importers - Recent higher deficits from fiscal accommodation and financial sector support (Tajikistan) were mostly financed through foreign debt and other foreign financing (Tajikistan issued debt domestically). - Overall deficits projected to decline to 4.2 percent in 2017 and 3.7 percent in 2018. - Projected to gradually decline to 1.9 percent of GDP on average by 2022. - Revenue measures: Armenia’s 2016 tax code expected to raise revenues by about 2 percentage points of GDP over the medium term; improved tax administration and expenditure restraint in Tajikistan; wage bill reform in the Kyrgyz Republic. - Non-oil fiscal trajectory (oil exporters): non-oil fiscal deficits projected to increase to 17.6 percent of non-oil GDP this year from 13.9 percent in 2016, but decline to 10.9 percent of non-oil GDP in 2022. - Policy guidance - Continue fiscal consolidation to reduce debt and rebuild buffers, while carefully calibrating pace and composition to avoid undermining medium-term growth. - Strengthen public spending efficiency: select projects with highest productivity and potential growth impact, streamline wage bills (limit staff numbers and bonuses, implement civil service reforms), while preserving critical social expenditures. - Mobilize additional revenues through reducing tax exemptions and strengthening collections. - Anchor consolidation in strong, credible multiyear frameworks and promote transparency and accountability in public fund use. ### External Balances - Current account: reached 6.4 percent of GDP in 2016, some 2.8 percentage points more than in 2015. - Cross-country patterns in 2016 - Deterioration in almost all oil exporters due to lower oil prices. - Improvement in most oil importers: Armenia’s current account deficit marginally improved to 2.3 percent of GDP (new copper mine and export rebound to Russia); Kyrgyz Republic’s deficit narrowed by about 6 percentage points of GDP (strong gold exports, low fuel import prices, remittances pickup); Tajikistan’s deficit narrowed by some 2 percentage points of GDP as exports recovered and imports contracted only moderately despite remittance declines. - Exchange rates - Depreciation and unification: Azerbaijan and Kazakhstan allowed currencies to move more freely; Uzbekistan unified official and parallel rates with the som losing about half of its value at the official rate and liberalized some foreign currency transactions. - Real effective terms: Azerbaijan, Kazakhstan, and Uzbekistan depreciated relative to pre-oil-price-drop period; Turkmen manat appreciated in real effective terms over past several years despite a 2015 step devaluation. - Oil importers: Armenia’s real effective exchange rate moved laterally since 2015; Georgia’s REER remained below preshock levels; Tajikistan’s somoni depreciation brought REER below historical averages; Kyrgyz Republic’s 2015–16 depreciation largely reversed. - Projections - Most CCA current account balances projected to improve gradually in 2017 and beyond reflecting gradual external condition improvements and country-specific factors. - Kazakhstan: oil exports projected to increase as Kashagan becomes fully operational though a near-term return to surplus is not expected. - Turkmenistan: external deficits projected to remain sizable over the medium term due to large public investment projects, low hydrocarbon prices, and high import content of domestic spending despite growing hydrocarbon exports and export-promotion/import-substitution policies. - Oil importers: current account deficits expected to increase in 2017 and decline gradually through 2022, reflecting a pickup in imports partially offsetting remittance recovery since mid-2016. - Policy implication: high reliance on commodity exports and remittances underscores the need for continued diversification. ### Monetary Policy Frameworks - Inflation - Regional inflation peaked at double digits during 2016 and is projected to moderate to 8.9 percent in 2017. - Drivers: easing price pressures in Kazakhstan; anticipated pickup in inflation in most other countries though remaining subdued among oil importers. - Country examples: Georgia’s inflation projected to accelerate from excise tax increases, exchange rate pass-through, and higher commodity prices before converging in 2018 to the 3 percent target; Armenia’s inflation projected to remain in line with the official medium-term target range of 4±1.5 percent despite higher food prices; Turkmenistan facing upward pressure from higher import prices, public sector wage growth, and expansionary credit; Uzbekistan’s inflation projected to accelerate into double digits due to high money growth and rapid som depreciation. - Regional projection: inflation projected to decline gradually to 5.9 percent by 2022. - Policy rates and transmission - Many countries have begun unwinding restrictive policies; exceptions include Azerbaijan, Georgia, and Tajikistan where policy rates were increased. - Tajikistan: National Bank of Tajikistan raised its policy rate twice in 2017 to reach 16 percent, increased sales of NBT bills, and raised reserve requirements. - Azerbaijan: central bank raised policy rate sharply in late 2016 from 7 percent to 15 percent. - Kazakhstan, Armenia, Kyrgyz Republic: rapid policy rate cuts in some cases with limited impact on bank lending and deposit rates, indicating weak monetary transmission. - Policy guidance - Strengthen and make monetary policy frameworks credible: establish clear objectives, enhance central bank communication, improve transmission mechanisms, and expand analytical toolkits. - Maintain exchange rate as a shock absorber and preserve foreign exchange reserve buffers; limit direct market interventions to disorderly conditions. - Pace monetary easing consistent with inflation developments to protect price stability, support financial development, and aid dedollarization. - Continue improving liquidity management and develop a local currency yield curve. - Country examples of progress: Central Bank of Armenia improving liquidity forecasting and instruments; National Bank of Georgia publishing policy rate path forecasts; Kyrgyz Republic narrowing policy rate corridor and moving toward inflation-targeting. ### Structural Reforms for Inclusive Growth - Urgent need to implement structural reforms to achieve strong, sustainable, and inclusive growth via diversification and private sector job creation. - Recent trends: catch-up to living standards stalled by recent slowdown; youth unemployment declines in oil exporters since 2002 have stalled and in some cases reversed; reductions in youth unemployment after the global financial crisis in oil importers have also halted. - Implication: with external conditions projected to remain relatively subdued, follow-through on reforms is critical to secure future income and employment gains. *Source: 3. Caucasus and Central Asia: No Room for Complacency (PDF chapter).* ### 1. Oil exporters2. Oil importers ### 9-chapter-3 - 1. Oil exporters2. Oil importers ### Reforms and Structural Initiatives - Kazakhstan: - Launched the 100 Concrete Steps and 3rd Modernization Initiative to address public administration, business environment, competitiveness, and commodity dependence. - Planned reduction of the role of the state through privatizations; first wave expected in 2018. - Armenia: - Established the Center for Strategic Initiatives in January 2017 to foster public-private partnerships and attract foreign direct investment. - Reforms in the energy sector and the tax system have proceeded successfully; additional reforms underway to tackle corruption, improve competition and the business climate, and attract FDI. - Georgia: - Planning to introduce a public-private partnership law; strengthen monitoring of contingent liabilities from partnerships and state-owned enterprises. - Tajikistan: - Structural fiscal reforms should aim to improve service delivery, enhance the business climate, and reduce fiscal risks. - Turkmenistan: - New seven-year development plan creates an opportunity to broaden and deepen market-oriented reforms. - Uzbekistan: - Announced a comprehensive economic and social reform package, including a reform of the foreign exchange system. - Regional emphasis: - Accelerating implementation of structural reforms to support private sector development is critical for diversification, attracting productive investments, and creating jobs. - Reforms to strengthen governance, transparency and accountability, and property rights are necessary to fully benefit from China’s Belt and Road Initiative and the strengthening global economy. ### Risks: Short Term vs. Medium Term - Short term: - Continued strengthening of the global economy, trade, and some commodity prices implies a balanced risk outlook for the CCA region. - Upside regional risks: for Georgia, stronger-than-expected returns from trade integration; for the Kyrgyz Republic, deeper ties with China and projects financed by the Russian-Kyrgyz Development Fund; for Kazakhstan, benefits from structural reforms, enhanced regional cooperation, deeper relations with Uzbekistan, and a stronger recovery in Russia. - Medium term (downsides emphasized): - Inward-looking policies in advanced economies could adversely affect global trade and commodity prices. - Monetary policy normalization in advanced economies, notably in the United States, could trigger rapid tightening in global financial conditions, leading to exchange rate volatility and depreciation, increasing public debt and exacerbating financial sector vulnerabilities across the CCA. - Economic pickup could delay structural reforms, risking a missed window of opportunity and prolonged mediocre economic performance that harms living standards. - Specific vulnerability noted: - Exchange rate depreciation could further increase public debt and exacerbate region’s financial sector vulnerabilities. ### Financial Sector Vulnerabilities and Policy Priorities (Box 3.1) - Key message: - Recent external shocks exposed continued financial vulnerabilities; addressing them requires stronger regulation and supervision, improved bank resolution frameworks, and strengthened governance to limit fiscal risks and support growth. - Rationale: - Sound financial sectors channel savings to productive investments, reduce volatility, and cushion adverse shocks; but effective regulation and supervision are needed to avoid banking sector vulnerabilities amplifying downturns and generating strong fiscal pressures. - Observations: - Some countries (Armenia, Georgia, Kyrgyz Republic) have strengthened regulation and supervision; progress slower in Azerbaijan, Kazakhstan, and Tajikistan where policy responses focused on keeping financial sectors operational and comprehensive stability programs were only recently announced. - Immediate priorities for policymakers: - Assessing banking sector health: - Bring reporting of nonperforming loans (NPLs), including off-balance-sheet items, in line with international best practice. - Undertake independent asset quality reviews to assess viability of banks; particularly acute in Azerbaijan and Kazakhstan where NPLs do not include assets transferred to special purpose vehicles and asset quality reviews have not been implemented. - Use reviews to formulate strategies to address NPLs and assess provisioning and capitalization needs to enable timely interventions. - Improving bank resolution frameworks: - Ensure state support is provided only for viable banks under strict conditions (time-bound recapitalizations with close oversight, corrective actions avoiding forbearance, clear restructuring plans, management replacement, reduced/eliminated shareholder participation if necessary). - For insolvent institutions, liquidation options should allow orderly closure while protecting retail customers through deposit insurance programs. - Resolution authority should have political and operational independence, sound governance, adequate resources, transparent processes, rigorous evaluation and accountability, and protection against liability for actions and omissions taken in good faith. - Enhancing prudential regulation and supervision: - Strengthen consolidated supervision and macroprudential frameworks; continue steps to reduce dollarization risks. - Examples from Georgia and Armenia: stricter rules on banks’ open positions in foreign currency, more restrictive liquidity requirements on foreign currency, higher risk weights and stricter limits on foreign-currency-denominated loans. - Strengthening corporate governance: - Address weak governance and opaque bank ownership to prevent related-party lending, excessive risk taking, and discretionary regulatory support. - Establish strong governance emphasizing transparency, clear executive and board responsibility, limited public sector influence, independent risk management, compliance, and internal control units. ### Growth-Friendly Fiscal Policy Options (Box 3.2) - Context: - Most CCA countries allowed fiscal deficits to increase during large external shocks in 2014–15 to contain impacts on output and jobs, but this led to rapid increases in public debt in some cases and added fiscal costs from financial sector support. - Policymakers must restore sound public finances and rebuild buffers over the medium term in a growth-friendly way while maintaining scope for productive public investment; structural reforms must proceed in parallel. - Key considerations: - Enhancing revenue: - Tax revenue is a key lever for growth-friendly consolidation and fairness. - Broadening direct and indirect tax bases, reducing widespread tax exemptions, and improving revenue administration (including taxing higher-net-worth individuals more effectively) would provide additional revenues and improve distribution of tax burden. - Many CCA countries (Armenia, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan) are pursuing revenue-increasing policies but more ambitious fiscal targets and reforms are needed. - Strengthening expenditure policy: - Consolidation should create space for growth-enhancing investment and fairer, better-targeted social safety nets by curtailing government wage bills, inefficient and regressive subsidies, and poorly targeted social benefits. - Most countries (except Tajikistan and Uzbekistan) plan curtailment of current expenditures; Georgia and the Kyrgyz Republic plan sizable public sector wage bill cuts. - Energy subsidies remain large in the Kyrgyz Republic, Turkmenistan, and Uzbekistan; further subsidy reform would free space for targeted social spending. - Reforms to boost efficiency and productivity of public investment should be implemented before considering large increases in public investment. - Anchoring fiscal consolidation: - Well-designed fiscal rules can support consolidation but must be tailored to political economy settings to avoid circumvention (for example, shifting spending outside the government perimeter). - Improvements in public financial management, including medium-term budgeting, would help anchor consolidation plans. ### Selected Economic Indicators — CCA: Selected Economic Indicators (Projections and averages) - Headline: Real GDP Growth (Annual change, percent) - Average 2000–13: 8.3 - 2014: 5.3 - 2015: 3.1 - 2016: 2.5 - 2017: 3.6 - 2018: 3.7 - By country, Real GDP Growth (Annual change, percent): - Armenia: 7.6; 3.6; 3.3; 0.2; 3.5; 2.9 - Azerbaijan: 11.3; 2.7; 0.6; –3.1; –1.0; 1.3 - Georgia: 5.9; 4.6; 2.9; 2.7; 4.0; 4.2 - Kazakhstan: 8.0; 4.3; 1.2; 1.1; 3.3; 2.8 - Kyrgyz Republic: 4.5; 4.0; 3.5; 3.8; 3.5; 3.8 - Tajikistan: 7.9; 6.7; 6.0; 6.9; 4.5; 4.0 - Turkmenistan: 11.3; 10.3; 6.5; 6.2; 6.5; 6.3 - Uzbekistan: 7.0; 8.1; 8.0; 7.8; 6.0; 6.0 - Consumer Price Inflation (year average, percent): - CCA aggregate: 9.2; 5.9; 6.4; 10.5; 8.9; 7.8 - By country, Consumer Price Inflation (year average, percent): - Armenia: 4.2; 3.0; 3.7; –1.4; 1.9; 3.5 - Azerbaijan: 6.4; 1.4; 4.0; 12.4; 12.0; 8.0 - Georgia: 5.5; 3.1; 4.0; 2.1; 6.0; 3.0 - Kazakhstan: 8.5; 6.7; 6.7; 14.6; 7.3; 6.5 - Kyrgyz Republic: 8.7; 7.5; 6.5; 0.4; 3.8; 5.1 - Tajikistan: 13.9; 6.1; 5.8; 5.9; 8.9; 8.0 - Turkmenistan: 5.5; 6.0; 7.4; 3.6; 6.0; 6.2 - Uzbekistan: 14.9; 9.1; 8.5; 8.0; 13.0; 12.7 - General Government Overall Fiscal Balance (percent of GDP): - CCA aggregate: 3.1; 2.3; –3.5; –2.2; –3.4; –1.0 - By country, General Government Overall Fiscal Balance (percent of GDP) — Central government unless noted: - Armenia1: –3.2; –1.9; –4.8; –5.6; –3.3; –2.7 - Azerbaijan1: 7.5; 2.7; –4.8; –1.1; –0.3; 0.7 - Georgia: –2.9; –2.9; –3.8; –4.1; –3.8; –3.8 - Kazakhstan: 3.2; 2.4; –6.3; –4.1; –6.6; –2.0 - Kyrgyz Republic: –4.5; 1.0; –1.2; –4.5; –3.0; –2.4 - Tajikistan: –2.7; 0.0; –1.9; –10.6; –6.5; –5.4 - Turkmenistan2: 4.3; 0.9; –0.7; –1.3; –1.1; –0.1 - Uzbekistan: 3.4; 4.3; 2.8; 2.7; 0.3; 0.7 - Current Account Balance (percent of GDP): - CCA aggregate: 0.8; 2.3; –3.6; –6.4; –4.9; –4.2 - By country, Current Account Balance (percent of GDP): - Armenia: –8.9; –7.6; –2.6; –2.3; –3.6; –3.2 - Azerbaijan: 8.8; 13.3; –0.4; –3.6; 1.9; 2.5 - Georgia: –11.0; –10.7; –12.0; –13.3; –11.9; –10.7 - Kazakhstan: –0.9; 2.8; –2.8; –6.4; –5.3; –3.8 - Kyrgyz Republic: –1.3; –16.0; –16.0; –9.7; –11.6; –12.0 - Tajikistan: –4.5; –2.8; –6.0; –3.8; –6.3; –6.2 - Turkmenistan: –7.7; –6.4; –14.0; –21.0; –15.4; –14.3 - Uzbekistan: 4.9; 1.7; 0.7; 0.7; 0.9; 0.3 *Prepared by IMF staff; sources within the chapter include national authorities and IMF staff estimates and projections.* --- _Source: https://www.imf.org/-/media/files/publications/reo/mcd-cca/2017/october/ccanovember1/9-chapter-3.pdf_