## cca-chapter-3 ## Source details **Canonical URL:** [cca-chapter-3](https://www.imf.org/-/media/files/publications/reo/mcd-cca/2019/october/english/cca-chapter-3.pdf) ## Other formats - [Markdown version](/-/media/files/publications/reo/mcd-cca/2019/october/english/cca-chapter-3.pdf.md) - [Structured JSON version](/-/media/files/publications/reo/mcd-cca/2019/october/english/cca-chapter-3.pdf.json) --- ### Global trade tensions and outlook - Global trade tensions and slowing growth in key trading partners are affecting the Caucasus and Central Asia (CCA) region. - Overall growth for the CCA region is expected to remain about 4½ percent in 2019–20, largely owing to a looser fiscal stance. - Growth in the region’s major trading partners is projected to fall from 3.2 percent in 2018 to 2.3 percent in 2019. - Import growth in those trading partners is projected to decline from 11.4 percent in 2018 to –1.4 percent in 2019. - Projected changes in trade and current accounts: - Growth in exports of goods and services of oil and gas exporters is projected to drop from 23 percent in 2017–18 to about –1.7 percent in 2019–20. - Export growth in oil and gas importers is projected to decline noticeably yet less dramatically. - Import growth in oil and gas exporters is projected to decelerate from 10 percent in 2017–18 to 5.6 percent in 2019–20. - The CCA region’s current account balance is projected to decline from a surplus of 0.3 percent of GDP in 2018 to a deficit of 1.5 percent of GDP in 2019–20. - Downside external risks: - Intensified trade tensions - Slower global growth - Lower commodity prices - Rising geopolitical risks - Domestic risks and upside potential: - Slowing reform momentum - Upside potential from accelerated reforms in Kazakhstan and Uzbekistan ### Fiscal stance, inflation, and medium-term growth - Fiscal expansion: - The CCA region’s general government fiscal balance is projected to decline by 1.5 percent of GDP from 2018 to 2019 to 0.6 percent. - Country and sector growth projections: - In oil and gas importers, GDP growth is projected to decelerate from 5.2 percent in 2018 to 4.7 percent in 2019–20. - Non-oil GDP growth in oil and gas exporters is projected to increase from 3 percent in 2018 to 4.9 percent in 2019–20, supported by pickup in consumer lending and stronger construction, manufacturing, and services demand in Kazakhstan, Turkmenistan, and Uzbekistan. - Inflation and expectations: - Inflation remains in the double digits in Turkmenistan and Uzbekistan at 13.4 and 14.7 percent, respectively, mainly owing to high credit growth and increases in utility tariffs. - Inflation expectations are generally well-anchored elsewhere in the region. - Medium-term projections and fiscal metrics: - The region’s medium-term growth is projected to remain about 4½ percent, assuming a resumption in trading partner growth and a recovery in oil and gas production. - Government debt levels are projected to remain stable at about 23 percent of GDP for oil and gas exporters and 49.8 percent of GDP for oil and gas importers this year. - Labor market challenge: - Expected 4 million new entrants (12 percent of the labor force) over the next 10 years, placing pressure on job creation and convergence in living standards. ### Productivity and structural challenges - Total factor productivity (TFP) growth has slowed considerably across the CCA region: - For oil exporters, TFP was positive in 2008–13 when average global oil prices rose 6 percent a year but became negative in 2014–18 when average prices fell 8 percent a year. - Competitiveness assessment: - IMF assesses exchange rates to be in line with fundamentals for most countries following devaluations after 2014–16 shocks. - CCA countries compare well with peers on perceptions of non–price competitiveness and rate higher than emerging Asia on measures of human capital, though lower than emerging Europe. - Key impediments to leveraging advantages: - Lower-than-peer performance on access to finance, the tax burden on the formal economy, and the cost of regulation. - High trade costs and transport times: the average cost to ship a container to Shanghai or Rotterdam is more than five times higher for most CCA countries compared with emerging Europe. - Declining share and quality of noncommodity exports for oil and gas exporters since 1995; lower FDI inflows and lower participation in global value chains (GVCs). - Large role of state-owned enterprises (SOEs) impeding efficiency and entrepreneurship; example: in Kazakhstan SOEs account for about half of total value added, one-third of employment, and hold assets equal to nearly one-half of GDP. - Implicit guarantees on SOE liabilities pose fiscal risks if fiscal support is required. ### Competitiveness, trade integration, and policy priorities - Policy priorities to foster higher and more inclusive growth: - Strengthen competitiveness, leverage comparative advantages, and foster diverse sources of growth to reap gains from trade and integration into GVCs. - Promote private-sector-led growth, improve efficiency of SOEs, and ensure a well-functioning labor market. - Address weaknesses in banking systems (noted in Azerbaijan, Kazakhstan, Tajikistan). - Modernize monetary policy frameworks to support greater exchange rate flexibility (Azerbaijan, Kyrgyz Republic, Tajikistan, Turkmenistan, Uzbekistan). - Strengthen fiscal institutions to support fiscal consolidation and rebuild buffers where needed (Armenia, Azerbaijan, Kazakhstan, Tajikistan), including strengthening fiscal rules, fiscal transparency, and efficiency of tax regimes and revenue administration. - Invest in infrastructure and human capital. ### Policies to promote participation in GVCs and attract FDI - Transport and connectivity: - Improving transport infrastructure could lower trade costs and boost FDI. - Example estimates: Belt and Road Initiative (BRI) transport projects could increase trade by 9.7 percent and reduce transport time by more than one-third. - A 10 percent decrease in trade time is associated with a 12 percent increase in FDI (World Bank 2019b). - Caution: infrastructure projects must deliver benefits that outweigh costs, including higher debt costs. - Trade liberalization and digital integration: - Reducing impediments to trade could increase integration into GVCs and encourage adoption of productivity-enhancing technologies, supporting e-commerce and telecommunications. - Attracting foreign investment and rule of law: - Policies that reduce expropriation risks and streamline entry procedures are critical to develop capital, technology, and managerial know-how for GVC integration. - Strengthening rule of law and contract enforcement would foster innovation and protect intellectual property rights. ### Comparative advantage and sectoral diversification - Strategic sectors identified by revealed comparative advantage (RCA) analysis: - For oil and gas exporters: mineral, metal, and chemical products. - For oil and gas importers: agricultural products and textiles. - Policy implications: - Allocate resources toward more dynamic and productive sectors to diversify exports. - Given limits to upgrading commodity quality, consider developing manufacturing and agribusiness where quality can increase more rapidly. - Remove impediments to growth in sectors with high RCA to realize export potential. ### Reforming SOEs and Promoting Private Sector Jobs - State-owned enterprises: problems and reforms - SOEs in the CCA region share common problems: requirements to provide public services, overstaffing, insufficient oversight, loss-making, and potential fiscal costs. - Compared to other regions, SOEs in the CCA tend to be involved in a broader range of quasi-fiscal activities, including noncore activities such as hospitals, tourism, and schools, and have weaker financial reporting. - SOEs can provide public goods and effectively manage public assets given transparent and sound corporate governance; but SOEs can be inefficient or make losses if they lack proper incentives, good governance, or hard budget constraints. - Research suggests that price and governance reforms can improve SOE financial performance as measured by return on equity (Baum and others, forthcoming). - Policy recommendations for SOEs: - Reform SOEs that create fiscal risks, lack profitability or financial stability, or rely heavily on government subsidies or guarantees. - Strengthen corporate governance, improve management, and harden budget constraints. - Improve incentives (for example, pricing and accountability) and reduce subsidies. - Separate SOE ownership from supervisory functions. - Compensate SOEs for service mandates. - Create independent boards, hire professional managers, and hold them accountable for financial and operational plans (including by fixing annual and midterm objectives). - Implement international accounting standards, and regularly publish reports on financial and operational performance, including financial and fiscal risk statements. - Where SOEs operate in commercial markets, make them compete with private firms and consider privatization (IMF 2016b). ### Labor market and job creation - To absorb new workers and boost inclusive growth, countries should pursue policies that promote efficient operation of labor markets, provide appropriate protection to workers, and remove impediments to job creation. - Supply-side measures: - Boost the quality of education and ensure that workers have the right skills, especially for sectors that are growing and adapting to new technologies. - Demand-side measures: - Ensure taxes and regulations do not make hiring too costly. - Structural measures: - Focus on policies, such as employment or social insurance and active labor market policies, that protect workers while promoting flexible labor markets (IMF 2019c). ### Private sector development - Governments should remove excessive regulation and give attention to areas identified as constraints to doing business. - Key constraints to address include: access to finance, taxes and regulation, inflation, and weak governance. ### CCA Region: Selected Economic Indicators, 2000–20 (Percent of GDP, unless otherwise indicated) - Values preserved exactly as presented: - CCA - Real GDP (annual growth) 7.8 2.3 4.0 4.2 4.4 4.4 - Current Account Balance 0.6 25.9 22.3 0.3 21.3 21.7 - Overall Fiscal Balance 1.9 22.5 22.8 2.1 0.6 0.1 - Inflation (year average; percent) 8.9 10.5 9.4 8.3 7.6 7.6 - CCA oil and gas exporters - Real GDP (annual growth) 8.0 2.1 3.8 4.1 4.3 4.4 - of which non-oil growth 8.3 1.5 3.4 3.0 5.1 4.6 - Current Account Balance 1.9 25.6 21.9 1.5 20.5 21.0 - Overall Fiscal Balance 2.7 22.1 22.6 2.6 1.0 0.5 - Inflation (year average; percent) 9.2 11.6 10.0 9.0 8.1 7.9 - CCA oil and gas importers - Real GDP (annual growth) 6.2 3.5 6.0 5.2 4.9 4.5 - Current Account Balance 29.0 28.3 24.7 27.9 27.1 26.7 - Overall Fiscal Balance 22.9 25.4 24.3 22.1 22.6 22.6 - Inflation (year average; percent) 7.0 1.8 4.6 2.7 3.8 4.5 *Source: International Monetary Fund | October 2019.* ### Section 1 ### cca-chapter-3 - Section 1 ### Global trade tensions and outlook - Global trade tensions and slowing growth in key trading partners are affecting the Caucasus and Central Asia (CCA) region. - Overall growth for the CCA region is expected to remain about 4½ percent in 2019–20, largely owing to a looser fiscal stance. - Growth in the region’s major trading partners is projected to fall from 3.2 percent in 2018 to 2.3 percent in 2019. - Import growth in those trading partners is projected to decline from 11.4 percent in 2018 to –1.4 percent in 2019. - Projected changes in trade and current accounts: - Growth in exports of goods and services of oil and gas exporters is projected to drop from 23 percent in 2017–18 to about –1.7 percent in 2019–20. - Export growth in oil and gas importers is projected to decline noticeably yet less dramatically. - Import growth in oil and gas exporters is projected to decelerate from 10 percent in 2017–18 to 5.6 percent in 2019–20. - The CCA region’s current account balance is projected to decline from a surplus of 0.3 percent of GDP in 2018 to a deficit of 1.5 percent of GDP in 2019–20. - Downside external risks: intensified trade tensions, slower global growth, lower commodity prices, rising geopolitical risks. - Domestic risks: slowing reform momentum; upside potential from accelerated reforms in Kazakhstan and Uzbekistan. ### Fiscal stance, inflation, and medium-term growth - Fiscal expansion: - The CCA region’s general government fiscal balance is projected to decline by 1.5 percent of GDP from 2018 to 2019 to 0.6 percent. - Country and sector growth projections: - In oil and gas importers, GDP growth is projected to decelerate from 5.2 percent in 2018 to 4.7 percent in 2019–20. - Non-oil GDP growth in oil and gas exporters is projected to increase from 3 percent in 2018 to 4.9 percent in 2019–20, supported by pickup in consumer lending and stronger construction, manufacturing, and services demand in Kazakhstan, Turkmenistan, and Uzbekistan. - Inflation and expectations: - Inflation remains in the double digits in Turkmenistan and Uzbekistan at 13.4 and 14.7 percent, respectively, mainly owing to high credit growth and increases in utility tariffs. - Inflation expectations are generally well-anchored elsewhere in the region. - Medium-term projections and fiscal metrics: - The region’s medium-term growth is projected to remain about 4½ percent, assuming a resumption in trading partner growth and a recovery in oil and gas production. - Government debt levels are projected to remain stable at about 23 percent of GDP for oil and gas exporters and 49.8 percent of GDP for oil and gas importers this year. - Labor market challenge: - Expected 4 million new entrants (12 percent of the labor force) over the next 10 years, placing pressure on job creation and convergence in living standards. ### Productivity and structural challenges - Total factor productivity (TFP) growth has slowed considerably across the CCA region: - For oil exporters, TFP was positive in 2008–13 when average global oil prices rose 6 percent a year but became negative in 2014–18 when average prices fell 8 percent a year. - Competitiveness assessment: - IMF assesses exchange rates to be in line with fundamentals for most countries following devaluations after 2014–16 shocks. - CCA countries compare well with peers on perceptions of non–price competitiveness and rate higher than emerging Asia on measures of human capital, though lower than emerging Europe. - Key impediments to leveraging advantages: - Lower-than-peer performance on access to finance, the tax burden on the formal economy, and the cost of regulation. - High trade costs and transport times: the average cost to ship a container to Shanghai or Rotterdam is more than five times higher for most CCA countries compared with emerging Europe. - Declining share and quality of noncommodity exports for oil and gas exporters since 1995; lower FDI inflows and lower participation in global value chains (GVCs). - Large role of state-owned enterprises (SOEs) impeding efficiency and entrepreneurship; example: in Kazakhstan SOEs account for about half of total value added, one-third of employment, and hold assets equal to nearly one-half of GDP. - Implicit guarantees on SOE liabilities pose fiscal risks if fiscal support is required. ### Competitiveness, trade integration, and policy priorities - Policy priorities to foster higher and more inclusive growth: - Strengthen competitiveness, leverage comparative advantages, and foster diverse sources of growth to reap gains from trade and integration into GVCs. - Promote private-sector-led growth, improve efficiency of SOEs, and ensure a well-functioning labor market. - Address weaknesses in banking systems (noted in Azerbaijan, Kazakhstan, Tajikistan). - Modernize monetary policy frameworks to support greater exchange rate flexibility (Azerbaijan, Kyrgyz Republic, Tajikistan, Turkmenistan, Uzbekistan). - Strengthen fiscal institutions to support fiscal consolidation and rebuild buffers where needed (Armenia, Azerbaijan, Kazakhstan, Tajikistan), including strengthening fiscal rules, fiscal transparency, and efficiency of tax regimes and revenue administration. - Invest in infrastructure and human capital. ### Policies to promote participation in GVCs and attract FDI - Transport and connectivity: - Improving transport infrastructure could lower trade costs and boost FDI. - Example estimates: Belt and Road Initiative (BRI) transport projects could increase trade by 9.7 percent and reduce transport time by more than one-third. - A 10 percent decrease in trade time is associated with a 12 percent increase in FDI (World Bank 2019b). - Caution: infrastructure projects must deliver benefits that outweigh costs, including higher debt costs. - Trade liberalization and digital integration: - Reducing impediments to trade could increase integration into GVCs and encourage adoption of productivity-enhancing technologies, supporting e-commerce and telecommunications. - Attracting foreign investment and rule of law: - Policies that reduce expropriation risks and streamline entry procedures are critical to develop capital, technology, and managerial know-how for GVC integration. - Strengthening rule of law and contract enforcement would foster innovation and protect intellectual property rights. ### Comparative advantage and sectoral diversification - Strategic sectors identified by revealed comparative advantage (RCA) analysis: - For oil and gas exporters: mineral, metal, and chemical products. - For oil and gas importers: agricultural products and textiles. - Policy implications: - Allocate resources toward more dynamic and productive sectors to diversify exports. - Given limits to upgrading commodity quality, consider developing manufacturing and agribusiness where quality can increase more rapidly. - Remove impediments to growth in sectors with high RCA to realize export potential. *Source: International Monetary Fund | October 2019.* ### Section 2 ### Reforming SOEs and Promoting Private Sector Jobs ### State-owned enterprises: problems and reforms - SOEs in the CCA region share common problems: requirements to provide public services, overstaffing, insufficient oversight, loss-making, and potential fiscal costs. - Compared to other regions, SOEs in the CCA tend to be involved in a broader range of quasi-fiscal activities, including noncore activities such as hospitals, tourism, and schools, and have weaker financial reporting. - SOEs can provide public goods and effectively manage public assets given transparent and sound corporate governance; but SOEs can be inefficient or make losses if they lack proper incentives, good governance, or hard budget constraints. - Research suggests that price and governance reforms can improve SOE financial performance as measured by return on equity (Baum and others, forthcoming). - Policy recommendations for SOEs: - Reform SOEs that create fiscal risks, lack profitability or financial stability, or rely heavily on government subsidies or guarantees. - Strengthen corporate governance, improve management, and harden budget constraints. - Improve incentives (for example, pricing and accountability) and reduce subsidies. - Separate SOE ownership from supervisory functions. - Compensate SOEs for service mandates. - Create independent boards, hire professional managers, and hold them accountable for financial and operational plans (including by fixing annual and midterm objectives). - Implement international accounting standards, and regularly publish reports on financial and operational performance, including financial and fiscal risk statements. - Where SOEs operate in commercial markets, make them compete with private firms and consider privatization (IMF 2016b). ### Labor market and job creation - To absorb new workers and boost inclusive growth, countries should pursue policies that promote efficient operation of labor markets, provide appropriate protection to workers, and remove impediments to job creation. - Supply-side measures: - Boost the quality of education and ensure that workers have the right skills, especially for sectors that are growing and adapting to new technologies. - Demand-side measures: - Ensure taxes and regulations do not make hiring too costly. - Structural measures: - Focus on policies, such as employment or social insurance and active labor market policies, that protect workers while promoting flexible labor markets (IMF 2019c). ### Private sector development - Governments should remove excessive regulation and give attention to areas identified as constraints to doing business. - Key constraints to address include: access to finance, taxes and regulation, inflation, and weak governance. ### CCA Region: Selected Economic Indicators, 2000–20 (Percent of GDP, unless otherwise indicated) - Average 2000–15, 2016, 2017, Projections 2018, 2019, 2020 — values preserved exactly as presented: - CCA - Real GDP (annual growth) 7.8 2.3 4.0 4.2 4.4 4.4 - Current Account Balance 0.6 25.9 22.3 0.3 21.3 21.7 - Overall Fiscal Balance 1.9 22.5 22.8 2.1 0.6 0.1 - Inflation (year average; percent) 8.9 10.5 9.4 8.3 7.6 7.6 - CCA oil and gas exporters - Real GDP (annual growth) 8.0 2.1 3.8 4.1 4.3 4.4 - of which non-oil growth 8.3 1.5 3.4 3.0 5.1 4.6 - Current Account Balance 1.9 25.6 21.9 1.5 20.5 21.0 - Overall Fiscal Balance 2.7 22.1 22.6 2.6 1.0 0.5 - Inflation (year average; percent) 9.2 11.6 10.0 9.0 8.1 7.9 - CCA oil and gas importers - Real GDP (annual growth) 6.2 3.5 6.0 5.2 4.9 4.5 - Current Account Balance 29.0 28.3 24.7 27.9 27.1 26.7 - Overall Fiscal Balance 22.9 25.4 24.3 22.1 22.6 22.6 - Inflation (year average; percent) 7.0 1.8 4.6 2.7 3.8 4.5 *Source: International Monetary Fund | October 2019.* --- _Source: https://www.imf.org/-/media/files/publications/reo/mcd-cca/2019/october/english/cca-chapter-3.pdf_