The Caucasus and Central Asia (CCA) region continues to navigate a wave of external shocks – the slump in global prices of oil and other key commodities, the slowdown in Russia, sharp movements in the value of the ruble and US dollar, and, more recently, increased financial volatility in China. The immediate impact has been severe, with regional growth set to hit a 15-year low in 2015. Governments and central banks have responded in a timely manner, but with these shocks likely to be long-lasting, will it be enough?
The slump in global oil prices has reduced export receipts by some $45bn this year, translating into significant fiscal revenue losses for oil exporters. For oil importers, there have been complications too. The benefits of lower oil prices have materialized only slowly, and have been more than offset by lower prices of other key commodities and sharp declines in remittances from Russia – an oil exporter and a key trading partner. This is especially the case in Armenia, Kyrgyzstan and Tajikistan, where the share of remittances to GDP exceeds 20%. Under these conditions, local labour markets and social assistance programmes are struggling to cope with returning migrants. Also, the sharp movements in the Russian ruble and the dollar have put CCA currencies under pressure. Moreover, the recent bout of volatility in China, an increasingly important trading partner and source of foreign investment, has further eroded confidence and heightened risks for the region.
Where conditions have permitted, governments and central banks have responded with policies ranging from temporary fiscal expansions in support of economic activity, to currency depreciations for bolstering competitiveness and curbing reserve losses. For example, Kazakhstan, Kyrgyzstan and Uzbekistan have all undertaken fiscal stimulus programmes. Similarly, measures to increase exchange rate flexibility have ranged from limiting the size and number of interventions in Armenia, to adopting a freely floating regime in Kazakhstan.
But the adverse external environment is likely to stay for a while, and there is a significant risk of further deterioration going forward. Under these conditions, recovery in the CCA is anticipated to materialize only gradually, with growth picking up modestly in 2016 and remaining well below 2000–08 levels in the coming years. This begs the question: are the policy actions seen so far sufficient? The short answer is no.
More work to be done
For one, fiscal expansions have raised concerns about long-term sustainability, which is essential for macroeconomic stability and sustained growth. Most oil exporters have been relying on their savings to finance their deficits since they cannot balance their budgets with oil prices where they are. Similarly, oil importers have seen their public debt increase rapidly. This means governments have to reduce spending in the medium term to ensure buffers are not depleted and enough is saved for future generations. One way could be through improving the quality of public expenditure; for example, by carefully choosing infrastructure investment projects that boost potential growth. Similarly, social expenditure should be safeguarded and well targeted to ensure growth inclusiveness. In addition, governments need to identify alternative sources of revenue, especially in commodity-dependent economies.
Secondly, while helpful in absorbing the external shocks, exchange rate adjustment has triggered inflationary pressures and increased financial sector vulnerabilities. To fully grasp the benefits of exchange rate flexibility, financial sectors and monetary policy frameworks need to be strengthened. In particular, monetary policy actions should aim primarily at mitigating inflationary pressures and anchor expectations, taking into consideration economic activity and financial stability. At the same time, highly dollarized financial systems require stepping up financial supervision, macro-prudential regulation, and crisis management frameworks.
Finally, the World Economic Forum’s “2015–16 Global Competitiveness Report” shows that most CCA countries continue to make strides toward improving competitiveness. However, more needs to be done to unlock the region’s growth potential. It is particularly important to adopt structural reforms that improve the business environment, raise the quality of education, promote financial development, and reduce dependence on remittances and commodity exports. Intensified efforts in these areas would create jobs, alleviate poverty, and support economic prospects.
Op-ed by Juha Kähkönen, Deputy Director, Middle East and Central Asia Department, International Monetary Fund.