Azerbaijan and Kazakhstan, along other oil exporting countries in Middle East and North Africa (MENA) and the Caucasus and Central Asia (CCA) could see their macroeconomic stability undermined by low oil prices unless they make efforts towards fiscal consolidation, structural reforms and financial sector supervision, the International Monetary Fund (IMF) said in a report published on June 8.

MENA and CCA are home to 11 of the top 20 exporters of hydrocarbons in the world, which have seen their export and budget revenues and GDP growth affected by the 60% reduction in oil prices since mid-2014. Budget receipts from oil and gas have declined by as much as 10% of GDP in the case of Azerbaijan and Algeria, the IMF said in the report titled “Learning to Live with Cheaper Oil”.

In CCA, these trends have resulted in the lowest economic activity in two decades, just as financial sector vulnerabilities and external pressures have risen despite currency weakening. Better financial sector supervision and stronger macroeconomic policy are needed to maintain financial stability, while fiscal adjustments and structural reforms would ensure sustainability in the medium term, the multilateral lender writes.

With only a modest uptick in oil prices to $45 per barrel expected, some CCA countries -like Azerbaijan - have diligently mitigated the impact of oil price volatility by slashing public spending. The effects will translate into manageable public deficits in CCA in upcoming years. Unlike MENA countries, which are expected to incur $900bn in budget deficits in 2016-2020, CCA countries will contain budget deficits to $32bn in the next five years, the report notes. Nevertheless, in order to balance their budgets, CCA hydrocarbon exporters would have to further slash their existing public spending by one quarter.

While cutting public spending could result in lower economic growth of approximately 25 basis points (0.25%) per year, the IMF believes that spending reductions on inefficient expenditures could have a lower-than-usual effect on growth, and are necessary after years of generous public spending financed from oil exports.

CCA exporters, most notably Kazakhstan and Azerbaijan, also differ from their counterparts in MENA in how they handled pressures on monetary stability. While Gulf Cooperation Council (GCC) countries chose to maintain currency pegs, Azerbaijan, Kazakhstan and Algeria let their currencies depreciate. Both approaches can be feasible, the IMF report notes, but depreciating currencies need continued support in the form of containing risks related to higher inflation and financial stability. Inflation is expected to reach double digits in Azerbaijan and Kazakhstan in 2016, a record in the last 15 years.

“Oil exporters that decide to introduce more exchange rate flexibility will need to substantially modernise their monetary policy frameworks, develop more liquid money and foreign exchange markets and strengthen communication,” the multilateral lender writes. Desirable modernisation would include clarifying monetary policy objectives, increasing independence of the central banks, deepening analytical capabilities, and improving effectiveness of the interest rate instrument.                                           

The decline in liquidity in CCA economies has prompted a slowdown in credit growth, a trend that was compounded by depreciations and non-performing loans (NPL). The lower access to credit will likely affect private sector growth at a time of declining public spending, negatively impacting job creation and economic growth, the report notes.

Depreciation has also put pressure on banks' balance sheets, as unhedged borrowers became unable to repay dollar-denominated loans. The full effect of the depreciations and economic slowdown on asset quality is slowly becoming evident, as NPLs tend to accumulate with a lag.

IMF recommends that “in the short term, policies should be geared toward mitigating rising liquidity, credit, and exchange risks. There is a particular need to ensure coherence in fiscal and monetary operations to avoid amplifying liquidity shocks, improve liquidity-forecasting capabilities at central banks, ensure effective liquidity-assistance frameworks, enforce open-position limits, and ensure appropriate loan classification and provisioning”.

Enhancing institutional quality by tackling corruption and bureaucracy and improving contract enforcement are needed in order for Kazakhstan and Azerbaijan to stave off an anticipated upsurge in unemployment as a result of depressed growth in 2016-2021.

“The good news is that policymakers have started responding to this new reality, and substantial progress has already been made, especially with respect to fiscal consolidation. But the fiscal outlook remains challenging despite the consolidation measures adopted so far, and additional sustained policy effort will be needed over a number of years. Policymakers will need to be proactive in addressing the challenges posed by lower oil prices for the financial system, and should step up structural reforms to boost medium-term growth prospects,” the report concludes.