The economies of Central Asia and Eastern Europe are expected to show no growth in 2016, following double-digit declines in trade and a 1.1% GDP contraction in 2015, according to the World Bank’s economic update titled "The Impact of China on Europe and Central Asia".

The South Caucasus, Central Asia and Russia will be particularly vulnerable to external pressures this year, with economic contractions forecast at 3.3%, 1.6% and 1.3% respectively. The challenges facing the region are complex, and require orchestrated government responses to the collapse in oil revenues, decline in remittances, depreciations, fall in real estate prices, increased non-performing loans and solvency problems in the banking sector.

Meanwhile, growth in Central Europe and the Western Balkans is expected to stabilise at around 3% in 2016 and 2017.

Europe's prospects are dimmed by a number of pressures. "Global trade is growing at a historically slow pace, partly because of disappointing growth in emerging economies," the WB notes, with trade growth at a mere 2% in 2015, 3 percentage points lower than the average for the last 25 years.

"Low and volatile oil prices, together with geopolitical tensions, remain a huge challenge for economies in the eastern part of the region. The refugee crisis is threatening a turn towards inward-looking policies in European countries, jeopardising free cross-border movements in the Schengen area. The Brexit referendum further tests European cooperation and integration. Terrorist attacks in France, Turkey and Belgium have heightened anxiety throughout the region."

Nevertheless, the outlook differs substantially in different parts of Europe, with the Western Balkans and Central Europe being growth champions, and the three economies in the South Caucasus expected to contract by 3.3% in 2016.

Eastern Europe and Central Asia are hit by a pervasive crisis as a result of steep declines in oil revenues and double-digit reductions in real incomes as a result of a sharp contraction in remittances. The result of these trends in oil producing countries are cutbacks on imports, which will prompt the need for an increase in other types of exports in order to keep the external balance of payments sustainable, the report posits.

Monetary instability has also exposed fragilities in banking sectors across the region because of large levels of dollarisation, with bad assets on the rise and profitability waning.

Meanwhile, the reduction in capital flows in the region has not been uniform, with a decline in lending to Russia from international banks and bond markets coinciding with a sharp rise of these capital flows to Turkey.

While Russia suffered from the added disadvantage of sanctions, its decline in capital flows resembles that of other oil exporters in the region, such as Azerbaijan and Kazakhstan.

Banks in these three countries have also suffered the effects of similar pressures - monetary instability, with dollarisation doubling in Azerbaijan in 2015, leading to massive conversion loses; a squeeze in local currency liquidity in Kazakhstan as a result of the tight monetary policy aimed at preventing the further devaluation of the tenge; and continued state support required for Russian banks, after a $16.5bn package introduced in December 2014 to recapitalise banks was used up.

Azerbaijan appears to have the worst hit banking sector in all of Eastern Europe and Asia, with the country scoring a red dot or "high alert" for currency depreciation, non-performing loans (NPLs) as a percentage of total loans, its open foreign exchange position, capital adequacy ratio, return on assets, and liquid assets to total assets.

The structural slowdown in the Chinese economy, which entails a decline in both exports and imports, will likely be positive for Eastern Europe and Central Asia, and negative for the European Union (EU), the report notes, as the trend will open up opportunities for low-cost manufacturers to boost their own exports.

As he Chinese economy is shifting from investments to consumption, from inward foreign direct investment (FDI) to outward FDI, and from low-skill intensive to skill-intensive production, it can have an adverse impact on exporters of investment goods and natural resources, while creating opportunities for countries at the lower end of manufacturing and for recipients of Chinese FDI, the multilateral lender writes.

The depreciations in Central Asia create opportunities for import substitution and increased penetration of the Chinese market, but these opportunities could be hampered by inflexibilities and vested interests that have emerged in oil producing countries in time.

Central Asia has been more open to trading with China than other regions, with China becoming the largest import provider outside the region, the WB notes in the report. While Chinese imports of Central Asian goods have increased more slowly than Chinese exports, China nevertheless accounted for 19% of Central Asia's exports and 8% of Russia's in 2014. A large portion of these exports were minerals and hydrocarbons, but developments in the Chinese economy are more likely to affect prices of non-oil commodities because they account for a larger share of exports. 

Overall, Europe and Central Asia have the potential to increase their exports to China, seeing how their exports will grow from a lower basis, while imports from China are expected to level off. Russia and Central Asia, in particular, are expected to increase their manufacturing exports to China by more than 10% in 2016 as a result of this trend and of the depreciation of currencies in the region.

Armenia

Armenia's economy is expected to grow by 1.9% in 2016, down from 3.1% in 2015 and 3.5% in 2014, on the back of fiscal tightening and external pressures such as the regional economic slowdown, a decline in remittances and low oil prices. The budget deficit is expected to remain high at 3.9% of GDP in 2016, although the fiscal position will improve over time as stimulus measures are phased out, which should boost revenue collection.

With remittances declining by an estimated 25.6% in 2015 following a 26.3% decline in 2014, domestic consumption will remain subdued, with purchasing power expected to be further affected by the removal of electricity subsidies in August 2016.

An exporter of minerals with a high dependence on hydrocarbon-exporting Russia, Armenia's economy will continue to be sensitive to commodity prices past 2016, which will affect prospects for economic growth and job creation, a problem in a country where the official unemployment level exceeds 18%.

Parliamentary and presidential elections in 2017- 2018 could further delay the implementation of structural reforms necessary to improve the business environment. Yerevan has to consolidate its fiscal position in order to contain the growth in the country's public debt, which exceeded 46% of GDP in 2015, the multilateral lender recommends.

Azerbaijan

WB expects Azerbaijan's economy to contract by 1.9% in 2016 on the back of low oil prices, tight monetary conditions and an erosion in real income because of inflation. Having dropped the currency's peg to the dollar a year ago, Azerbaiajn is poised to experience 14% inflation in 2016. The fiscal surpluses of past years, which were fuelled by oil and gas revenues, will be replaced by a fiscal deficit of 14% of GDP in 2016, which will be further compounded by higher-than-expected social spending and large public investments in projects such as the gas exploration and transport scheme Southern Gas Corridor (4.25% of GDP).

Current account surpluses of past years will be replaced by a deficit amounting to 4.7% of GDP in 2016, which will gradually decrease as oil prices pick up in 2017-2018. Poverty is expected to rise in 2016-2018, but data limitations such as the inaccurate statistics that Baku puts out regarding unemployment and income levels prevent the multilateral lender from making accurate predictions. The official poverty rate in Azerbaijan has been 5% since 2012.

Meanwhile, the increase in dollarisation, which ratings agency Fitch estimated at 80% of bank deposits in December, rising NPLs, reduced credit, an ineffictive monetary policy, and low levels of market development could lead to further bank failures, WB writes, following the closure of six out of the country's 43 banks in January and February.

Georgia

External pressures have already impacted Georgia's growth, which slowed to 2.8% in 2015 from 4.6% in 2014, and the trend is likely to continue in 2016, particularly as the country is scheduled to hold parliamentary elections in October. Despite these developments, WB projects economic growth of 3% in 2016, 4.5% in 2017 and 5% in 2018 as a result of large-scale foreign investments in a gas transit pipeline, hydropower projects and a deep-water seaport in Anaklia, on the Black Sea.

The current account deficit, a structural problem in Georgia, is likely to remain high at 10% of GDP in 2016 from 11% of GDP in 2015, but to decline in subsequent years. An anticipated tax reform is expected to increase the fiscal deficit in the short term, but to boost medium-term growth. Higher social spending, resulting from an increase in pensions in July and in teachers' salaries in April, will push the fiscal deficit to 5% of GDP.

Poverty alleviation and job creation efforts are expected to be supported by an increase in construction activity as a result of investments in infrastructure and growth in the tourism sector and related services. Politics remains a source of uncertainty, however, and consumer and business confidence could decline in the lead-up to the October election, while the pace of reforms will slow down.

Kazakhstan

The World Bank expects Kazakhstan’s GDP to fall by 0.1% in 2016, while inflation is expected to remain high, if the price of oil continues at the current $37 per barrel. The current account deficit is expected to worsen as the economy continues to adjust to low oil prices. Consumer prices are expected to rise by an average of about 13.7% over the year.

GDP growth is projected to pick up to about 1.9% in 2017 and 3.7% in 2018 at an average oil price of $48 per barrel in 2017 and $51.4 in 2018 and with the assumption that the Kashagan offshore oil-field will commence production on schedule, ie in October. However, sustaining higher growth rates will depend on implementation of structural reforms designed to support private sector development and economic diversification.

Kazakhstan’s economic outlook is vulnerable to three main sources of downside risk: first, oil prices may fall below $37 per barrel. Second, progress on the structural reforms to support diversification may stall, especially the privatisation of state-owned enterprises and key revisions to the regulatory framework, and, third, insufficient coordination between macroeconomic policies and structural reforms may adversely affect the quality of growth and its contribution to job creation, which could have negative welfare implications, the World Bank concluded.

Kyrgyzstan

The World Bank predicts GDP growth to decelerate marginally to 3.4% in 2016 as weak private demand negatively affects the agriculture, residential construction and service sectors. Meanwhile, gold output will decline slowly and industry will accelerate because of the depreciation of the som and the anticipated completion of several large industrial projects. Private consumption growth is expected to remain subdued, while implementation of the public investment programme will boost demand for construction and related services. Overall growth is projected to slow to 3.1% in 2017 before rebounding to 4.1% in 2018 with internal and external balances improving as public spending is curtailed.

External regional developments are the primary source of medium-term risk in Kyrgyzstan, the World Bank said, as the pace of the recovery in Russia and Kazakhstan will affect the performance of Kyrgyz exports, demand for Kyrgyz labour and, to a lesser extent, foreign direct investment inflows. “Adverse exchange rate developments could negatively impact domestic output growth through the financial sector, and a further depreciation of the ruble could slow the pace of poverty reduction by eroding the real value of ruble-denominated remittances.”

Domestic challenges relate to the speed at which Kyrgyzstan will be able to leverage EEU accession to boost exports and foster deeper regional trade integration. “Thus far, accession to the common market has not benefited Kyrgyz exporters to the extent anticipated due to higher external tariffs on key textile inputs for the garment industry and strict application of EEU technical and phytosanitary regulations at the Kazakh border,” the outlook concludes.

Tajikistan

The bank projects GDP growth rate to remain at about 4% in 2016 as the continued expansion of public investment counters the effects of an adverse external environment. A further decline in remittances, albeit at a slower pace, is expected to put downward pressure on private consumption growth. Large construction projects, some related to the 25th anniversary of Tajikistan’s independence, will continue to drive the rapid growth of the industry and construction sectors, while the depreciation of the somoni will encourage import substitution.

“High rates of public in-vestment and planned increases in public sector wages and benefits will further widen the fiscal deficit,” the outlook suggests, adding that growth is expected to accelerate over the medium term as the external environment improves, large-scale investment continues and remittances recover, but growth rates will remain below recent historical averages.

Risks to the outlook are tilted to the downside, the bank said. A weaker-than expected recovery in Russia and Kazakhstan could depress remittances, while a more severe slowdown in Turkey and China could reduce exports and foreign direct investment, the outlook concluded.

Turkmenistan

Turkmenistan is expected to face another “difficult” year in 2016 as the bank expects growth to slow further to 5% in 2016 under a baseline scenario that assumes an average oil price of $37 per barrel and continued fiscal consolidation. “If hydrocarbon prices stay low, they will adversely affect Turkmenistan’s GDP growth rate and its external and fiscal balances,” the outlook predicts.

Turkmenistan’s fiscal revenues and its balance of payments are highly dependent on external demand for its hydrocarbon resources and on their prices on global markets. As a result, a protracted oil glut presents significant downside risk, the World Bank concludes.

Uzbekistan

The outlook predicts the average GDP growth rate to slow by almost one percentage point to 7.2% in 2016-17. Low global commodity prices, an ongoing deceleration in China, and weak demand from Russia and Kazakhstan are expected to drive this trend. Increased public investment will sustain high rates of investment growth, while income tax cuts and public sector wage increases help to shore up private consumption, the bank suggests.

“However, Uzbekistan’s restrictive trade and foreign-exchange regimes, the monopolisation of certain sectors by state-owned enterprises, and frequent power outages caused by deteriorating infrastructure are projected to progressively diminish the return on in-vestment under the baseline scenario.”

“Improvements in the business climate for micro- and small firms, including efforts to expand their access to credit, will help the labour market absorb returning migrants. However, slowing income growth and a large influx of returning migrants will limit progress in reducing unemployment, poverty and inequality over the near term, with all three expected to re-main broadly unchanged through 2018,” the bank concluded. 

“A further decline in prices for its key export commodities – gas, copper, gold and cotton – or a more severe downturn among its main trading partners could adversely affect export receipts, domestic consumption, the current account and the fiscal balances.”