Between 2000 and 2014, the economies of the Caucasus and Central Asia (CCA) expanded at an average rate of more than 8% per year. Although there were difficult moments, the region staged a swift recovery every time. In 2000, just two years after the Russian financial crisis, economic growth had rebounded to nearly 8%. In 2010, right after the global financial crisis, economic growth was back to almost 7%.
This time is more challenging. Amid a climate of economic slowdowns in key trading partners and a deep and persistent slump in commodity prices, the CCA countries are facing the prospect of a slow and uncertain recovery. Growth in 2016 is set to decline sharply to 1.3%, and projected to average less than 4% over the next 5 years. Should that pattern be realized, growth of CCA’s living standards – as compared with other emerging markets and developing countries – would decelerate, partially undoing the significant progress these countries have accomplished since independence.
Therefore, 2016 represents an important juncture for the CCA – a time to take bold steps toward laying the foundations for growth to be resilient, sustainable, and inclusive.
Shocks to the system
The shocks affecting the region over the past two years have not been small. That’s particularly so for the region’s four oil exporters – Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan – whose export earnings are down $60bn since 2014, or some 20% of their combined GDP in 2016. These losses have forced them to use some $20bn of their savings to cover the gap.
The effect of the commodity price slump – not just oil, but also copper, aluminum, and cotton, vital for many countries in the region – has been compounded by subdued economic conditions in Russia (itself the world’s second largest oil exporter) and continued slowdowns in China and Europe. All three are key trading partners for the CCA, while Russia is also an important source of investment and remittance flows, especially for the CCA’s oil-importing countries.
Initially, most CCA countries used their savings to support domestic demand. However, amid weak revenues, budget deficits have widened by an average of some 6 percentage points of GDP since 2014. In an effort to gradually improve their finances, many countries have started to reduce public spending through lower investments, but others continue to support economic activity while demand is still low.
The CCA countries also took a critical step toward cushioning the effects of the external shocks by allowing for exchange rate adjustment. Some took a step further and let their currencies be increasingly determined by market forces. This has not only mitigated the external and fiscal impact of the shocks, but helped unwind earlier appreciations, supporting competitiveness, and limited foreign exchange reserve losses.
Fiscal accommodation and currency adjustment have undoubtedly helped mitigate the effects of the shocks, but they have also come at a cost. First, they have resulted in rapid increases in public debt in several countries. Second, they have generated temporary inflationary pressures in a few of them. And third, they have further highlighted the fragility of their highly dollarized financial systems. Therefore, the region will be more vulnerable to future adverse events, be they lower commodity prices or weaker partner growth, which means further actions are needed.
In this climate, countries should use fiscal policy to generate the most growth possible – by redirecting expenditure towards education, health, and infrastructure – while safeguarding their social safety nets. Credible multi-year fiscal plans that ensure long-term fiscal sustainability are also needed to keep public debt within manageable limits. Another key challenge is the modernization of monetary and exchange rate policy frameworks, including the adoption of credible nominal anchors, the strengthening of central bank independence, and improved efforts to communicate policy intentions. The region should also safeguard the stability of its financial sector by strengthening its surveillance and crisis management policies.
Diversify or die
These actions are necessary but, on their own, they will be insufficient to improve resilience in the event of new shocks. Therefore, countries should diversify away from commodities and reduce their reliance on remittances. We are encouraged to see so many countries drawing up diversification and privatization plans. However, clear and decisive actions are needed now to implement them, including improving governance, accountability, property rights, and financial intermediation – areas in which the CCA needs to catch up with other emerging markets.
Such deep structural change will allow the region to enjoy more sustained and inclusive growth, which will boost living standards and lower poverty for present and future generations.
Juha Kähkönen is Deputy Director, IMF Middle East and Central Asia Department