Juha Kähkönen of the International Monetary Fund -

The Caucasus and Central Asia (CCA) region has been hit by a perfect storm of large global and regional shocks – a slump in prices for oil and other commodities, sharp movements in the value of the dollar and the ruble, and spillovers from Russia’s slowdown. These shocks, which are likely to be long lasting, having already weakened growth prospects in the region, urgently require a greater policy response from governments and central banks.

The outlook for the CCA region is the worst since the 2008-09 global crisis. Economic growth in the region is expected to decline in 2015 by 2 percentage points (pp) to 3.25%, significantly below the average of the past few years and, more importantly, much lower than what is needed to generate enough employment opportunities. The decline is largest among the CCA oil and gas importers, where links with Russia, via remittances, are particularly strong.

The CCA currencies have also been hurt, a consequence of declining exports and remittances, a strengthening US dollar, and a sharp depreciation of the ruble. To protect their international reserves and retain competiveness, CCA oil and gas importers have, to varying degrees, allowed their currencies to depreciate against the dollar. The CCA oil and gas exporters have also devalued their currencies.

The recovery in growth for 2016 and beyond is expected to be much more subdued compared with previous slowdowns – namely the 1998-99 crisis in Russia and the 2008-09 global crisis – when growth in the CCA sharply rebounded in the year following both slowdowns. The more drawn-out nature of the recovery reflects the likely more long-lasting nature of the current shocks and, in some countries, weak domestic productivity growth owing to low investment and lack of reforms. In addition, returning migrants, and a declining number of new migrants, are putting pressure on the domestic labour markets and social programmes.

Policy responses to these challenges, to this point, have been piecemeal and focused on the short term. Many countries in the region are, understandably, trying to shore up near-term growth by increasing government spending. Yet, given the new realities of the external environment, they also need to develop plans for consolidating their fiscal positions in the years to come.

The exchange rate adjustments, so far, have not been sufficient to prevent the loss of competitiveness or a weakening of current account balances and international reserves. But they are creating inflationary pressures, and monetary policy may need to be tightened in response. The challenge is that a combination of weakening currencies, tight domestic liquidity, high interest rates and slowing growth are putting strain on the financial sectors in some countries, where most loans are in foreign currency and held by unhedged borrowers.

Further efforts by central banks to monitor and mitigate risks, and strengthen crisis management frameworks, are therefore needed. It is also important to improve monetary, fiscal, and financial sector policy frameworks. This means greater transparency, better communication, clearer accountability and, importantly, a stronger medium-term focus.

Deeper structural reforms would help bolster medium-term growth, make it more inclusive and create jobs. Reforms need to focus on improving governance and the business environment, better integrating the region into the global economy, and raising workers’ skills through improved health and education programmes.

The region’s economies are facing some of the most challenging times since the global financial crisis. Yet these times, with the right policy actions, can also bring new opportunities, leading to a better future for the people in the region.   

Juha Kähkönen is Deputy Director, Middle East and Central Asia Department for the International Monetary Fund. For further discussion, see “Caucasus and Central Asia: Oil Price Decline and Regional Spillovers Darken the Outlook”, IMF Regional Economic Outlook Update for the Middle East and Central Asia, May 2015.