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Global Economic Outlook
Commonwealth of Independent States: Q2 2010 Outlook
By Rachel Ziemba and Kavitha Cherian
- Recovery across the region will be constrained by slow Russian growth.
- Energy exporting countries will register stronger growth than their counterparts.
- Curtailing expanding fiscal deficits will be a challenge.
Outlook Update: Higher Commodity Prices Assisted Growth
RGE expects the CIS region excluding Russia to a register a mild 3% recovery in 2010, as external demand picks up. The global slowdown eroded growth in these economies, many of which are commodity-dependent, through a slowdown in exports and capital flows. The sharp slowdown in Russia exacerbated the effects in the region through lower remittances, employment and trade. Funds from the IMF, past savings and bilateral investment flows helped the CIS states avoid balance of payments crises. Commodity exporters such as Kazakhstan, Ukraine and Belarus have posted gains as commodity prices rose. Uzbekistan and Azerbaijan, which continued to grow during 2009, should see growth accelerate in 2010. Trouble resolving banking sector issues, including an increase in non-performing loans, remains a risk in the region, especially as the need for foreign finance remains high.
Growth Dynamics: Export Driven Growth
External demand will stimulate recovery as domestic demand remains too weak across most of the region. Growing demand from Asia and China in particular, has helped boost exports and investment. Infrastructure development abroad helped fuel a revival in base metal demand, helping several regional markets to improve. Ukraine’s industrial output increased along with steel demand. Armenia, Tajikistan and Belarus witnessed a similar pattern and shuttered mines have reopened. Armenia registered a deep double digit contraction in 2009 but a revival in base metal exports assisted in posting positive growth early in 2010. Aluminum accounts for nearly 70% of all exports in Tajikistan, and the strengthening of demand helped the country record positive growth in 2009. A recent RGE analysis, “Aluminum Illuminations: Prices and Fundamentals,” and the Q2 commodity outlook argue that aluminum prices experienced a V-shaped recovery in 2009 but that the long-term fundamentals are precarious.
Given the uncertainties of global growth, commodity demand and investment, the region’s more closed economies outperformed, especially Uzbekistan. Uzbekistan’s implementation of fiscal stimulus policies helped curb the effects of the crisis. As a fuel exporter it is expected to post stronger growth in 2010, though it will remain below boom year levels. Azerbaijan is another fast growing energy exporter in the region where government infrastructure plans and low reliance on external finance kept growth in the high single digits (9%). Higher petroleum prices and continued infrastructure development will result in even more impressive growth figures in 2010, though growth will remain below the heady pace achieved in 2008.
Figure 1: Diverging Regional Growth Patterns
Source: World Economic Outlook Database October 2009, RGE Data
Kazakhstan, by contrast, was weighed down by its banking sector weaknesses and its reliance on foreign inflows for corporate finance, and is still in the process of recovering from the housing bust, which began in 2007. However, the increase in oil and metal prices and the use of past savings led to a stronger-than expected recovery in 2009, helping the country avoid a recession. The increase in industrial output and banking sector restructuring supports a recovery of 3% in 2010.
Regional currencies should continue to face appreciation pressure in 2010 as growth prospects improve and commodity prices remain high. Their sharp devaluations in 2009 helped boost export competitiveness only marginally, given that much of trade is regional. For countries like the Ukraine, the devaluation also boosted debt service costs, given the dominance of foreign debt. Limiting currency appreciation suggests that the central banks of the more open economies will accumulate reserves. In addition to the Kazakh tenge and the Ukranian hyrvnia, the Belarusian ruble, Azeri manat, Armenian dram and Tajikistan somoni are expected to strengthen as exports pick up in 2010.
Risks: Neighborhood Spillovers and Financing Issues
RGE’s expectations of a slower-than-consensus and export-led recovery in Russia could depress the outlook for its neighbors, given their reliance on trade with and investment and remittances from Russia. The World Bank estimated that Europe and Central Asia witnessed the steepest decline of remittances among emerging-market regions—with remittances down 15% in 2009. Remittances should pick up only gradually in 2010-11 as the labor markets in Russia remain tight and anti-immigrant sentiment remains high.
A reversal of the capital inflows that have fed equity market bouncebacks in the Ukraine and Kazakhstan, as well as Russia, is a risk. Ukraine has become reliant on foreign portfolio investment to fuel its current account deficit. Stronger resource prices should support portfolio and direct investment, despite the shallowness of the markets. Yet with access to leveraged capital lower than during the boom years, inflows should be lower. While foreign portfolio inflows are slowly returning to the region, they are not expected to pick up to pre-crisis levels until 2012. The region is attracting more foreign direct investment, particularly from China, with Kazakhstan still the largest recipient.
The toppling of the Kyrgyz government could have implications not only for the domestic economy but also for its neighbor, Kazakhstan, which could have to absorb any flow of people from a protracted conflict. While an extended protest seems unlikely, given the way in which regional powers have recognized the new government, political risks have risen ahead of the forthcoming election. Investment decisions, including a potential Chinese mining investment, may be on hold till after the election. In addition to the president’s repressive policies, the economic crisis and ongoing water shortages exacerbated economic stress, especially through higher electricity prices.
Policy Implications: Foreign Lifelines Allow Accommodative Policy
The IMF has extended programs to many countries in the region, helping maintain expansionary fiscal policy. Aside from its deal with Ukraine, most programs are on track and have helped maintain government spending. The IMF extended support to Kyrgyzstan through the Exogenous Shocks Facility (ESF) with a focus on tackling energy shortages and stimulating growth in Kyrgyzstan. The government has already raised electricity tariffs as a cost-cutting measure, which along with aging power infrastructure and lower water levels has contributed to power shortages. The IMF assisted Tajikistan under the Poverty Reduction and Growth Facility (PRGF) and was impressed by the resilience the country showed in the face of slumping remittances—energy infrastructure spending is on the rise, but social spending will climb also.
The IMF extended Stand By Agreement (SBA) loans to Armenia, Belarus and Ukraine. All countries except Ukraine have roughly complied with IMF conditions and are thus on track with the IMF program, receiving timely disbursals of their loans even though Armenia, like Ukraine, faced a double-digit contraction. As prescribed, Belarus curbed spending in 2009 and kept the fiscal deficit at 1% of GDP. Ukraine is yet to adopt a 2010 budget, but it is expected to be an austere one in order to allow for the IMF loan to resume. Supported by past savings, Kazakhstan adopted an expansionary budget, running up a higher deficit. Almost 50% of the budget went toward social spending, especially wage hikes.
Monetary policy will remain accommodative, and inflationary pressures are picking up. Lower consumer demand and food costs helped lower inflation. The disinflationary trend facilitated some monetary accommodation, but rates in the region remain negative in real terms. Inflation is expected to accelerate in 2010 (remaining well below 2008 levels) as food and fuel prices rise and domestic demand begins to improve on the back of returning remittances and credit growth. Many countries are moving towards inflation targeting.