Chris Weafer of Macro-Advisory -
The countries that border the Caspian Sea share a great deal of common history and culture. At one point Turkish influences dominated the region, while during the pre- and early-Islamic period Iran was the premier political and cultural influence. In more recent times, Russia and the Soviets exerted the greatest influence and shaped many of the current political, administrative and economic structures we see in the Central Asian and Caucuses states. In the future the region, now routinely referred to as the Caspian Corridor, is set to become much more important, not least because it is the critical link in China’s ambitious Maritime Silk Road project and also because of the return of Iran as an important regional political and economic power. India is also starting to be less insular and is looking to expand both its political and economic influence in the region.
In aggregate, if we include only the Russian population west of the Urals and the Iranian population in the northern half of that country, the total number of people in the “Corridor” is over 200mn and the combined nominal GDP is $2.9 trillion, based on 2014 data. On a purchasing power parity (PPP) basis the combined GDP is $5.6 trillion, which places it between India and Japan on the World Bank’s GDP/PPP ranking. The Corridor is also where 17% of the world’s oil reserves and 46% of its natural gas reserves is to be found.
Today, the countries of the region have more than a shared history; they are all grabbling with many similar economic issues and also have some opportunities that are not only cross-border, but which will only be fully realized if all of the states work together.
The first obvious common problem is that all are hydrocarbon dependant states and are therefore suffering the effects of reduced budget revenues. The table below shows that budget revenues in all states are close to, or above, 50% of the total. The figure for Iran was previously much higher but has been reduced due to the impact of sanctions which forced a cut of almost 1 million barrels of daily oil exports. The decline of more than 50% in the price of oil, and the associated contagion to gas prices, means that while all (ex-Iran) enjoyed budget surpluses and rising financial reserves up to this year, they are all now running deficits and have had to dip into savings plus cut spending. That has contributed to the much slower pace of growth expected in the region this year and next.
The second problem is the contagion from the region’s dominant currency, the ruble. The sharp drop in the exchange rate of the Russian ruble boosted the competitive position of Russian products while making it more difficult for producers in Central Asia and the Caucuses to sell to the Russian market. Kazakhstan has been forced to respond by moving to an almost free-float regime while Azerbaijan and Turkmenistan have had one-off devaluations of their controlled currencies. It is expected that those countries will have to devalue again in the coming months while the ruble, Rial and Tenge are expected to weaken further into the end of this year (table below).
The forced devaluations have led to increased risks in the banking systems of the three smaller nations as a result of the high content of foreign exchange (mostly US dollars) in their loan portfolios. The threat is of a large spike in non-performing loans (NPL), which would then force banks to try to raise more capital or seek rescue loans from their respective governments. Banks in Azerbaijan and Kazakhstan are especially affected, albeit the Astana government has promised to use some of the Sovereign Wealth Fund to compensate depositors. Getting reliable macro data from Turkmenistan is always challenging.
The recession in Russia is also having a negative effect on regional economies due to reduced demand for imported goods from its neighbours. None of the other economies has any significant exposure to worker remittances from Russia, but other countries in the region with which they trade do and, as a result, the fallout from Russia has also had another knock-on effect. The slowdown in China’s growth has had a negative effect on the price of most commodities, which in turn has cast a great deal of uncertainty over the region’s growth. That has hit investor sentiment and contributed to a slowdown in inward investment, especially outside of large oil and gas projects.
The forced currency devaluations and weakening economies have hit the general population hard across the region. This has cut the spending power of local currency savings and also fueled inflation growth and, particularly in the case of Kazakhstan, raised the cost of debt servicing. There has also been an increase in job losses and wage growth has slowed sharply in all of the Caspian economies. The upshot of all this has been a drop in disposable incomes, a fall in living standards and, according to opinion polls, an increase in public dissatisfaction. Kazakhstan has responded to the threat of the economic decline leading to social problems with the promise of financial compensation. This threat was also the main reason why the country brought the presidential election forward by almost 18 months. The Azerbaijan government’s response has been to adopt a greater nationalist stance, and put the rejection of Western criticism of political trends and also the increasingly dangerous conflict on the border of Nagorno-Karabakh across the front pages of the mass-media.
Russia’s monetary policy response to the oil price decline has flip-flopped between hawkish and dovish. The Central Bank of Russia spiked its benchmark rate to 17% in mid-December and then salami-sliced it back to 11% over the first half of this year. It has now shifted back to a hawkish stance while waiting for inflation to ease. Kazakhstan and Iran have followed the hawkish path and boosted their respective benchmark rates to 16% and 21% respectively. Both fear inflation and social instability more than slowing growth. Azerbaijan has gone in the opposite direction and cut its benchmark rate to 3% this year. The impending parliamentary elections in early November no doubt being a factor in that decision.
But apart from the shared problems, the countries of the Caspian Corridor also have some common opportunities. The most obvious of those currently are linked to China’s programme to build an extensive transport web to allow it more efficiently to get its goods to markets in Europe, Africa and the Middle East, while also securing raw material import routes. Plans are already in place, some already constructed, to build rail links across Kazakhstan to the other regional states and, from there, to destination markets. That will allow transit states to build logistics centres, as well as take advantage of the extensive transport network for their own trade.
The expected return of Iran to the global market also offers potential for expanded trade within the Caspian Corridor countries, but also to benefit from Tehran’s plans to build its own export infrastructure to global markets.
Right now, the region is of greater interest to strategic investors in transport, hydrocarbons and other extractive industries. This is where the available opportunities are most visible. But as the countries eventually stabilize their respective economies and start to focus on the opportunities offered by China, Iran and India, plus the need to reduce future hydrocarbon vulnerability, more sectors will open up. The Caspian Corridor is never going to replicate the Asian Tiger economies, but for investors in the right sectors and with the right approach, this is a region that will be very profitable over the next decade.
Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise & focus on underlying trends, real political risks, & opportunities in Russia/CIS, Eurasia Union, & Mongolia. Follow him on @ChrisWeafer
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