For the Caucasus and Central Asia (CCA), the emergence of China as a regional economic player has helped fill a void created by the breakup of the Soviet Union.

For the CCA, the strengthening of economic ties has led to increased trade and investment, boosting growth prospects, while China has benefited from the CCA’s natural resources. This partnership has also led to the revival of the so-called Silk Road — a network of road and rail links between China and Europe — as well as the One Belt, One Road initiative, which will allow China to foster more investment and cooperation with as many as 65 countries throughout Southeast Asia, Oceania and Africa. The latter initiative, in particular, is helping to close the CCA’s infrastructure gaps, moving the region closer to its goal of becoming a more dynamic emerging market economy. 

How large are the trade and financial linkages? 

Trade between China and the CCA region has grown almost tenfold over the past decade, to $48bn at end-2014 from only $5bn in 2005. China is the main trading partner for the Kyrgyz Republic, Tajikistan and Turkmenistan, accounting for more than 25% of those countries’ total trade. Exports to China are concentrated mostly on oil and gas, minerals and metals, while imports consist mostly of manufactured goods. China’s official lending to the CCA region has also soared, rising from $262mn in 2007 to $4,435mn in 2014. However, this also means that rapidly rising external debt obligations to China — particularly in the aforementioned Kyrgyz Republic, Tajikistan and Turkmenistan —are increasing their vulnerabilities. Banking sector linkages, meanwhile, remain moderate. China occasionally extends short-term financial assistance through budgetary loans and currency swaps, which could help mitigate external shocks. 

What are China’s vehicles of engagement?

Besides existing ties to traditional Chinese institutions such as the Agricultural Development Bank of China (ADBC), the China Development Bank (CDB) and the Export-Import Bank of China, the regional integration initiatives will be supported by the recently established $40bn Silk Road Development Fund, and the $100bn Asian Infrastructure Investment Bank (AIIB). These partnerships are expected to allow China to invest an additional $30bn-$35bn in the CCA region over the next three-to-five years, mainly in infrastructure and mining.

How could CCA countries capitalize on Chinese engagement in the region?

While a sharp slowdown in China could bring negative spillovers for the CCA region, the growing linkages might also provide offsetting diversification gains for both the CCA (through increased access to finance from China, particularly through large infrastructural loans which) and China (through new markets for Chinese goods). To maximize the growth and employment effects of Chinese investment and trade, and to ensure external debt sustainability, CCA countries need to have supportive policies in place. As such, implementing prudent debt management strategies, and subjecting investment projects to rigorous appraisal, would strengthen the capacity to manage rapidly growing external debt. Streamlining tax incentives, facilitating local hiring, and strengthening the business climate would also help create a level playing field for both domestic and foreign investors.

Eddy Gemayel is IMF Mission Chief for the Kyrgyz Republic and Ritu Basu is IMF Economist for Tajikistan