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A sharp slowdown in Russia and the depreciation of its currency have weakened the growth prospects for Caucasus and Central Asian (CCA) countries because of  close ties through trade, remittances and foreign direct investment, requiring CCA countries to exercise greater exchange flexibility and near-term fiscal easing and to speed up reform, according to the IMF.

In the Regional Economic Outlook Update published on January 21, the IMF said lower oil prices and increased geopolitical tensions would result in the Russian economy contracting by 3% in 2015. “This much weaker outlook obviously has a direct and strong impact on its neighbouring countries in the Caucasus and Central Asia which are connected to Russia both through trade, through remittances as well as through foreign direct investment,” Masood Ahmed, IMF director for the Middle East and Central Asia department, said presenting the outlook the same day.

The oil exporters in the Caucasus and Central Asia are also affected by the decline in oil prices that affects their budgets and their balance of payments, Ahmed said. Combined oil export losses in 2015 are expected to reach about $35bn or 8% of GDP in the CCA oil exporters, which are expected to result in current account surpluses in previous years turning into deficits of 2.7% of GDP, according to the update. “A deeper recession in Russia and a further depreciation of the ruble could have an additional negative impact on non-oil exports from CCA oil exporters.”

The IMF believes that a one percentage point decline in Russia's GDP growth is estimated to cut growth in CCA oil exporters (Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan) by 0.15 percentage points and in CCA oil importers (Armenia, Georgia, Kyrgyzstan and Tajikistan) by 0.4 percentage points. As a result, growth forecasts for the CCA region were cut from 5.6% (in the October update) to 4.9% (in the January update), for oil exporters from 5.7% to 4.9% and for oil importers from 4.9% to 4.4%.

Oil exporters

Asked by bne IntelliNews what CCA countries should do to sustain economic growth amid the falling price of oil, Ahmed said that they should use “the buffers that they have built up” to ensure that the reduction in the price of oil doesn’t have an immediate disruptive effect on government spending in the short term. The region’s two largest economies – Kazakhstan and Azerbaijan – have oil funds that have respectively accumulated $73bn and $27bn.

“The second thing that they can do – however, which is more of a medium term objective for them – is to ensure that they encourage the diversification of their economies by improving the business environment for the private sector,” he said, adding that the degree of private sector involvement and activity outside of the oil sector is still relatively small in these countries.

While advising oil exporters to use the oil fund money to avoid sharp cuts in public spending, the IMF suggested that oil exporters “should prudently treat the oil price decline as largely permanent and adjust their medium-term fiscal consolidation plans so as to prevent major erosion of their buffers and to ensure intergenerational equity”.

The IMF welcomed plans by the Azerbaijani and Kazakh governments, which are facing the twin shocks of lower oil prices and the deepening recession in Russia, to increase government spending and provide fiscal stimulus to the economy. “By contrast, Turkmenistan and Uzbekistan intend to maintain their earlier spending plans because prices for their gas exports have not been affected by the decline in oil prices,” the update says. “Although fiscal stimulus in response to adverse developments may be appropriate in some cases, countries would be well advised to maintain a cautious approach to fiscal policy, because a prolonged period of lower oil prices would ultimately require significant adjustment in most countries,” the IMF cautioned.

Ahemd believes that the persistent decline in oil prices increases the urgency for most oil exporters to step up structural reforms aimed at accelerating economic diversification away from oil. “Facing simultaneous external shocks, these countries are advised to allow greater exchange rate flexibility and maintain adequate reserve buffers,” Ahmed told bne IntelliNews.

The IMF expects a limited impact of declining oil prices on inflation in CCA oil exporters as these countries control petrol prices.

Oil importers

Some CCA oil importers are expected to gain from lower oil prices in 2015: Tajikistan about 2.5% of GDP, Georgia 2.25% and Armenia 1.75% of GDP (Kyrgyzstan less than 1%), the IMF forecasts. However, “the benefits to most CCA oil and gas importers have been limited in the near-term since their oil and gas imports are based on longer-term contracts,” Ahmed told bne IntelliNews. “If lower oil prices persist, they will benefit through reduced energy import bills.”

At the same time, in some Caucasus and Central Asia countries, however, transport costs for oil and fuels are high, and local markets lack strong competition to push down prices. “Overall, the effects of the deepening recession in Russia far exceed any relief from lower oil prices, leading to a downward revision of growth and fiscal and external current account balances in the CCA oil importers,” he said. “The sharp depreciation of the ruble, together with the slower economic activity in Russia, has depressed the value of exports, remittances, and FDI from Russia, which account for a significant share of some CCA economies.”Remittances, mostly from Russia, make up 42.1% of Tajikistan’s GDP, 31.5% of Kyrgyzstan’s and 21% of Armenia’s.

As countries with low buffers, the IMF advises CCA oil importers to save the oil import gain to strengthen their buffers and allow greater exchange rate flexibility to help adjust to the adverse shocks they are facing. “Moreover, spillovers from Russia’s slowdown increase the need to step up structural reform efforts, especially in the areas of the business environment, governance, education, and trade integration,” Ahmed said. “Visible progress in these areas will help boost financial flows, productivity, and support medium-term growth and job creation.”

Noting that the fund already has financial arrangements in place with Armenia and Georgia and is in active discussions with the Kyrgyz authorities, Ahmed said that the IMF stood ready to assist these countries should they require help in overcoming the adverse effects of the low oil prices and the Russian slowdown. In addition to advice on the direction of macroeconomic policies, the fund can also help countries build better institutions through technical assistance and training in various areas, including public financial management, financial sector reform, statistics, tax administration, and debt management, Ahmed told bne IntelliNews. “Finally we can provide financial assistance to support [their] economic reform programmes.”