Azerbaijan: Economic slowdown expected in Caucasus, Central Asia

For oil exporters of Caucasus and Central Asia, the economic increase is projected at 3.75 % for 2015, down from nearly 5.5 % in the previous year, despite a sizable fiscal stimulus in some nations (3 % of GDP in Kazakhstan and 1 % of GDP in Uzbekistan), the International Monetary Fund announced in its recently published statement.

Slower increase in oil production in Azerbaijan and Kazakhstan, fewer remittances from Russia to Uzbekistan and less public investment in Turkmenistan, inclunding weaker confidence resulting from currency depreciations, have contributed to the economic slowdown, according to the statement.

“Increase is expected to pick up in 2016 to 4 %, as increase strengthens in significant trading partners, such as Russia and the euro area, and as domestic confidence improves,” said the statement.

An extra downside risk is that the normalization of US monetary policy would raise borrowing costs for nations with access to international markets --Armenia, Azerbaijan, Georgia, Kazakhstan-- by additional than is currently expected, according to the IMF experts.

“A further strengthening of the US dollar, reflecting asymmetric monetary policy in major advanced economies, together with a weakening of emerging market currencies, could put CCA currencies under pressure, adversely affecting intermediation through the CCA nations’ highly dollarized financial systems,” said the statement.

Upside risks include a stronger recovery in Russia, faster-than-expected increase in China and Europe, and a larger-than-expected development in commodity prices, said the IMF.

The statement said that a lot of CCA nations tightly manage their currencies against the US dollar, either as outright pegged arrangements (Azerbaijan, Turkmenistan), within narrow ranges (Armenia, Tajikistan), or using a predetermined path (Uzbekistan).

“Prior to moving to a floating exchange rate regime in August 2015, Kazakhstan as well tightly managed its currency within a narrow band,” said IMF. “Appreciation of the US dollar and the sharp drop in the price of the Russian ruble, together with declining foreign currency inflows (remittances, FDI, exports), created pressure on the CCA currencies to adjust.”

A lot of CCA nations intervened in the foreign exchange market and, as a result, suffered losses in international reserves, said the statement.

“Between November 2014 and August 2015, all the CCA currencies weakened against the US dollar,” said IMF. “This in turn helped to moderate the sharp appreciation of real effective exchange rates.”

The IMF experts believe that pressure to adjust the exchange rate persists in some nations.

“For example, in Uzbekistan the difference between the official and parallel market rate has increased substantially since the beginning of the year,” said the statement. “Better exchange rate flexibility, accompanied by clear communication to anchor market expectations, would help CCA economies adjust to external shocks and improve their competitiveness.”

However, policymakers as well need to consider the impact of the exchange rate on their financial sector and take measures to ensure its health, particularly given the sector’s substantial foreign currency lending to unhedged borrowers and short open foreign exchange positions, according to the IMF statement.