Economic crisis in Central Asia and the Transcaucasus

Some notes from May 2009

In many of the economies of Central Asia and the Transcaucasus, the low level of development of their financial sectors and their low level of participation in the international capital markets were thought likely to insulate them from the impact of the global financial and economic crisis, which surfaced in the US property market in the second half of 2007.

With the escalation of the crisis since in September 2008, however, two clear channels of transmission of the crisis to the region have emerged. The first is directly, through precipitous declines in the prices of the region's main commodity exports—most notably hydrocarbons, but also metals. The second is indirectly, through the impact of financial turmoil on the real economies of Russia and Kazakhstan.

These two factors will have a differential impact, depending on the extent that each economy depends on Russia and Kazakhstan for sources of economic growth, as well as on whether they are net exporters of hydrocarbons (Kazakhstan, Azerbaijan, Uzbekistan and Turkmenistan) or importers (Kyrgyzstan, Tajikistan, Georgia and Armenia). These factors will condition the likely severity of the impact of the global crisis on the economies of particular countries, as well as their response to it.

For many countries in the region, economic growth held up reasonably well in 2008. In the case of the hydrocarbons exporters, this was because of very high prices for oil in the first half of the year. In other cases, the continued strength of neighbouring economies until the final months of 2008 helped to sustain the inflows of workers' remittances on which they heavily depend (the IMF estimates that remittances to the Kyrgyz Republic equalled around 25% of GDP in 2008, and for Tajikistan the figure was 50%). The increased price for gold was an additional factor sustaining foreign earnings for Uzbekistan and the Kyrgyz Republic, for which gold is a leading export item. However, the final quarter of 2008 and the first quarter of 2009, very sharp falls in trade and industrial output across the region—in part, as nervous businesses drew down on stocks—signalled that the crisis has arrived.

For the main hydrocarbons exporting countries, the fall in oil prices presented not only the prospect that the severe deterioration in the terms of trade would have a strong negative impact on domestic demand growth, but also that it would greatly reduce current-account surpluses and put pressure of fiscal revenue. Nonetheless, for many of these countries, including Kazakhstan and Azerbaijan, the oil boom of the past eight years has allowed them to build up a financial buffer, in the form of oil windfall funds, with which to tackle the effects of the crisis.

In contrast, for the hydrocarbons importing countries, the benefits of falling oil and food prices—two of the main factors behind the year-long inflationary surge across the region from the second half of 2007—are unlikely to make up for the multiple impacts of the regional economic downturn.

In Russia, the downturn was triggered by rising risk aversion globally, with a very rapid reversal of capital flows forcing an expensive defence of the rouble and, in January 2009, an eventual exchange-rate devaluation. In Kazakhstan, the foreign lending to domestic commercial banks, which was used to fund a credit boom in the non-oil sector, came to a halt much earlier, in late 2007, precipitating a sharp fall in property prices and a rapid slowdown in the construction sector—previously two of the drivers of Kazakh GDP expansion.

In the years since Russia's 1998 financial crisis, the region's trade dependence on Russia has declined, although for some countries—Kazakhstan, Uzbekistan and the Kyrgyz Republic—trade with Russia was still equal to 4-5% if GDP in 2008. More important perhaps this time around, according to a study by the IMF, is the likely negative impact on growth of a fall in financial flows from the region's largest economies. More tangibly still, especially for the Kyrgyz Republic and Tajikistan, but also for Georgia and Armenia, is the likely swift cut back in remittance inflows. This will not only affect consumption and poverty levels, but also investment demand, through the cut back in demand for residential construction and small business start-up capital.

Broadly, the responses of the various government's have been as follows:

• to try to protect the financial sector (especially important in Kazakhstan);
• to attempt external stabilisation and, if necessary, exchange-rate adjustment;
• if possible, to initiate fiscal measures to counter the impact that the drop in demand has on living standards; and
• to try to continue with measures to improve the business environment so as to put the economy on a better footing to attract investment once the worst of the global crisis passes.

Using either their own resources or those of foreign donors, this combination of strategies has a chance to allow the economies of the region to avoid severe destabilisation in the short term. However, threats to maintaining broad economic stability will depend on the length and depth of the crisis—in particular, whether Russia and Kazakhstan are able to resolve the problems in their domestic banking sectors. It could also depend on an absence of major outbreaks of social and political unrest, which would disrupt the implementation of anti-crisis measures, but to which the Kyrgyz Republic, Tajikistan and Georgia look acutely exposed.