Low oil price, Russia slowdown to continue affecting Caucasus/Central Asia, IMF says

By bne IntelliNews May 19, 2015

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Economic activity in the Caucasus and Central Asia (CCA) region will continue to decelerate in 2015, mainly as a consequence of lower commodity prices, spillovers from Russia’s economic slowdown and a strong dollar, the International Monetary Fund (IMF) says in its latest Regional Economic Outlook Update released May 18.

“Where fiscal space and available financing allow, temporary fiscal easing would help economies respond to weakening demand and declining remittances. Over the medium term, fiscal consolidation is needed to rebuild depleted buffers and adjust spending plans to the new regional and global economic context,” the outlook says. “In light of the depreciation of the ruble and the appreciation of the dollar, greater exchange rate flexibility would ease pressure on reserves while helping oil exporters adjust to lower oil prices.”

With a sharp decline in oil prices and expected contraction of Russia’s economy in 2015, the CCA outlook is projected to weaken further: growth is expected to decline by another 2 percentage points (pp) this year to 3.25%, a downward revision of 2.5pp from the IMF’s October 2014 outlook.

Economic growth in the CCA declined by 1.25pp to 5.25% in 2014, according to the IMF, in part driven by lower commodity prices (in the latter half the year) and the economic slowdown in Russia, which has close linkages with the region through remittances, trade and foreign direct investment.

Among the CCA oil exporters – Kazakhstan, Azerbaijan, Turkmenistan and Uzbekistan – the impact from lower oil prices and Russia’s contraction is being amplified by a slowdown in domestic oil production (Kazakhstan, Azerbaijan), with delays in development of new oil fields (Kazakhstan). “As a result, growth in the CCA oil exporters is projected to decline by 2pp to 3.25% in 2015.”

Among the CCA oil importers – Armenia, Georgia, Kyrgyzstan and Tajikistan – domestic demand is weakening as remittances decline, while lower prices for non-oil export commodities (gold, copper and aluminium) are reducing export revenues. The boost from lower global oil prices to growth is partially offset by currency weakening and incomplete pass-through to local fuel prices because of low competition (Armenia, Kyrgyzstan) and long-term contracts that keep energy import prices rigid, the outlook suggests. “Overall, growth in this group of countries is projected to slow by 3pp to 1.5% in 2015.”

Inflationary pressures

The outlook says inflationary pressures were rising on the back of currency depreciation across the region. Despite slight declines in 2014 – owing to lower global food and commodity prices, weakening economic activity, and monetary tightening in some countries (Armenia, Kazakhstan, Georgia and Tajikistan) – inflation is expected to rise by 1pp to 7% in the region this year.

Declining exports and remittances as well as ruble depreciation have put pressure on the CCA currencies, resulting in Turkmenistan and Azerbaijan devaluing their currencies in early 2015. Meanwhile, Armenia, Georgia, Tajikistan and Kyrgyzstan have allowed their currencies to depreciate against the dollar to a varying degree to protect international reserves and support the domestic currency value of remittances. “As a result of the strong pass-through, coupled with credit growth (Kyrgyz Republic), inflation will reach double digits in the Kyrgyz Republic and Tajikistan. In other countries, inflation will remain contained, as increases in import and food prices will be offset by lower wage and input cost pressures, reflecting subdued domestic demand and lower oil prices.”

External positions 

Lower oil prices and remittances will sharply weaken external positions in the CCA region in 2015, with the current account balance in the CCA oil exporters is expected to turn from a surplus of 3% of GDP in 2014 to a deficit of 2.5% in 2015, reflecting large oil export revenue losses and, in some cases, stronger import growth effected by fiscal easing, the IMF said.

“The current account deficit in the CCA oil importers is expected to worsen slightly to 11% in 2015. A large drop in remittances is expected to offset gains from lower oil prices and moderating import growth.”


The balance of risks remains tilted to the downside as key risks relate to a larger-than-expected slowdown in trading partners, particularly Russia, China, or the Eurozone, lower oil prices, and/or a faster-than-expected tightening of global financial conditions, the IMF believes. “For example, a deeper contraction in Russia would further slow remittances, exports, and direct investment. A continued depreciation of the ruble would further depress the value of remittances from Russia (Armenia, Kyrgyz Republic, Tajikistan).”

A further decline in oil prices would weaken the external and fiscal balances of the CCA oil exporters, while any additional benefit for the CCA oil importers is likely to be partly offset by adverse spillovers from a resulting further slowdown in Russia, the outlook predicts. “An increase in external financing costs from a tightening of US monetary policy would adversely affect countries that may borrow in the international markets (Georgia, Kazakhstan).”

Medium-term fiscal easing

While the drop in oil prices is expected to endure for some time, Russia’s recession is likely to be temporary, the outlook forecasts. While some CCA oil exporters – Kazakhstan and Uzbekistan – are expected to use their large fiscal buffers to provide counter-cyclical stimulus to the economy over the near term (in Kazakhstan, for example, through increases in infrastructure spending), Azerbaijan and Turkmenistan plan to undertake sizable consolidations in 2015 and over the medium term as investment levels are already high and reaching capacity constraints, and “fiscal stimulus through capital spending is not advisable” in these countries, according to the IMF.

The counter-cyclical fiscal stance (especially in Kazakhstan), together with lower oil prices, is contributing to a turn in the oil exporters’ fiscal balance from a surplus of about 1.5% in 2014 to a deficit close to 3% in 2015. “Fiscal breakeven prices have risen in CCA oil exporters in recent years, and countries such as Azerbaijan and Kazakhstan cannot cover government spending at oil prices below $58, as is currently projected for 2015.”

“As soon as cyclical conditions allow and before buffers are exhausted, all CCA exporters need to return to the path of fiscal consolidation to rebuild buffers, strengthen fiscal sustainability, and ensure a fair sharing of resource revenues with future generations,” the outlook says, suggesting pension reforms (Azerbaijan) and the scaling down of energy subsidies (Turkmenistan and Uzbekistan) should continue, along with steps to improve the quality and efficiency of public spending.

The fiscal deficits among the group of CCA oil importers is projected to rise from about 2.5% in 2014 to about 4.5% in 2015, mainly because of lower revenue collection due to weaker growth, and because of higher capital spending (a significant amount financed by China) in an effort to shore up domestic demand (Armenia, Kyrgyzstan). “Given limited fiscal space, the oil importers need to return to consolidation soon. Prioritising capital spending, streamlining current expenditures, eliminating tax exemptions, and improving revenue administration would rebuild buffers and create space to raise targeted social transfers and productive infrastructure investment, which would boost potential growth and make it more inclusive.”

Exchange rate flexibility and tackling dollarisation

The external pressures from the twin shocks of lower oil prices and Russia’s slowdown, as well as ruble depreciation and dollar appreciation, suggest that greater exchange rate flexibility will be needed for some countries to absorb the shocks, retain competitiveness in the face of upward pressure on the real exchange rate, and prevent a drain on reserves, the IMF says. In countries where inflation is expected to be elevated, central banks should tighten monetary policy by raising the policy rate and improving liquidity management so as to contain excess liquidity, while using macroprudential instruments to discourage excessive credit growth.

“In the medium term, efforts should focus on making monetary policy more effective in the context of high dollarisation. A gradual move toward more flexible exchange rates, together with credible monetary and exchange rate frameworks, and deeper domestic financial markets would not only make monetary policy more effective but would also help to reduce dollarisation,” the IMF says.

The regional countries have allowed their national currencies to depreciate to reflect the devaluation of the ruble, low oil prices and falling remittances. Kazakhstan had been widely expected to devalue the tenge, but the February announcement of a snap presidential election on April 26 and a string of national holidays (the last one – Astana Day on July 6 – coincides with President Nursultan Nazarbayev’s 75th anniversary) that has followed the election postponed the move at least until early July.

Financial sector challenges

The current economic environment is testing for the region's banks, as financial systems are facing pressures from multiple sources, the outlook says. “Currency depreciations, against the backdrop of dollarised banking systems and foreign currency lending to unhedged borrowers, increase credit and solvency risks,” it notes. “The depreciations also increase currency mismatches and exacerbate the already high dollarization by encouraging substitution into dollars on the deposit side and curtailing demand for foreign currency loans.”

Slowing economic growth increases the credit risks, especially in countries “where bank governance and underwriting standards are weak and directed lending is common”. Falling remittances may erode banking system liquidity and the debt-servicing capacity of households, which account for a significant share of banks’ loan portfolios. With Russian banks facing a credit crunch, cross-country banking linkages with Russia could be a “conduit” for further liquidity pressures in some countries, the outlook says. “Supervisers will need to intensify surveillance of the financial systems, especially in countries where nonperforming loans are high (25% in Kazakhstan and 27% in Tajikistan) or rising (for example, Armenia) and capital adequacy ratios are declining. Forbearance and evergreening of loans should be avoided; instead, banks should be required to appropriately classify the loans and have adequate provisions.”

The IMF suggests that liquidity support by central banks should be limited to solvent banks that face temporary liquidity challenges, and shareholders should be required to provide capital to undercapitalised banks. “In addition, crisis management frameworks should be strengthened.”

Need for structural reforms

While some CCA countries have already undertaken market-enabling reforms such as privatisation and price liberalisation, progress in market deepening, governance and closing infrastructure gaps has been slow in other countries. The IMF believes intensified efforts in these areas would create jobs, alleviate poverty and diversify economies away from reliance on commodity exports and remittances. “Further reforms of business regulations are urgently needed. For example, the requirements for starting a business need to be based on simple and transparent rules.”

The IMF credits Kyrgyzstan with a new law on the fiscal regime for mining activities which should enhance transparency in the country’s mining sector marred in ownership issues and scandals. Trade integration, labour market reforms and increasing competition in domestic industries (for example, in the energy sector in Armenia) would benefit the region, the IMF concluded.

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