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IMF: CIS economies are suffering a triple blow

24 April 2009 14:32 (UTC +04:00)

Baku. Vugar Israfilov â€“ APA-Economics. Among all the regions of the global economy, the CIS countries are forecast to experience the largest reversal of economic fortune over the near term, IMF said in a report.

The reason is that their economies are being badly hit by three major shocks: the financial turbulence, which has greatly curtailed access to external funding; slumping demand from advanced economies; and the related fall in commodity prices, notably for energy.

The large direct impact of the financial market turmoil on CIS economies reflects the abrupt reversal of foreign funding to their largest nonfinancial firms and, more important, their banking systems (Figure 2.5). Prior to the crisis, all but a few economies with less externally linked financial sectors (Azerbaijan, Tajikistan, Turkmenistan, Uzbekistan) relied significantly on external funding to sustain domestic borrowing that far outstripped domestic demand for bonds or deposits.

Soon after the crisis struck, both nonfinancial firms and banks found it very difficult to renew funding from investors, who steered clear of anything but the safest assets. Adding to the pressure, households began to switch from domestic- to foreign-currency- denominated assets. Russia, Kazakhstan, Belarus, and Ukraine were hit hard, with the first two drawing down large amounts of foreign currency reserves to buffer the impact of the shock on the exchange rate.

These economies are expected to have only very limited access to external financing over the near term, with the exception of Russia, which should be able to better sustain rollover rates. Belarus and Ukraine have faced difficulties meeting their external obligations and have received IMF financing; Armenia and Georgia are also receiving IMF support, although Georgiaâ€™s arrangement predates the financial crisis.

The beginning of the financial crisis coincided with slumping prospects for exports and commodity prices because of rapidly weakening activity in the advanced economies. This has added to the pressure faced by CIS economies with open banking systems and severely undercut growth prospects for the commodity exporters, including Russia, Kazakhstan, and Ukraine, but also the less open economies, for example, Turkmenistan. Other countries, including the Kyrgyz Republic, Tajikistan, and Uzbekistan, are expected to suffer from falling foreign remittances, particularly from migrant workers in Russia. The current account balance for the area as a whole is expected to run a zero balance in 2009, a major switch from posting a large current account surplus in 2007â€“08 (Table 2.5).

However, prospects differ noticeably between energy exporters and importers: the former are projected to see large current account surpluses evaporate because of falling commodity prices, while the latter see a sharp narrowing of their external deficits because of tightening financing conditions. Although many CIS economies are better positioned to weather a crisis than they were in the aftermath of Russiaâ€™s 1998 debt default, the fallout will nonetheless be severe. Real GDP in the region, which expanded by 8Ð… percent in 2007, is projected to contract by just over 5 percent in 2009, the lowest rate among all emerging regions. In 2010, growth is expected to rebound to more than 1 percent.

With currencies under pressure, inflation is expected to remain close to double digits in the net energy exporters, despite slowing activity. Inflation pressures are expected to recede more quickly for the net energy importers. The key challenge facing policymakers in the CIS is to strike the right balance between using macroeconomic policies to buffer the effects of net capital outflows on activity and maintaining confidence in local currencies. With most countries operating under pegged exchange rate regimes, monetary policymakers have had to choose between drawing down reserves, raising policy rates to defend pegs, and allowing exchange rates to depreciate.

Countries that could afford to, including Russia and Kazakhstan, initially drew down foreign exchange reserves. Faced with very strong pressures, however, they have since changed their tack: Russia has allowed the ruble to depreciate substantially below its earlier band and has raised interest rates, while Kazakhstan has opted for a step devaluation of some 18 percent (see Figure 2.5).

Other countries, including Ukraine and Belarus, experienced large currency depreciations early in the crisis. The problem these economies face is that rapid currency depreciation raises the effective debt burden on nonfinancial firms that have borrowed in foreign currency. In fact, the share of foreign-currency-denominated credit in domestic bank credit stretches from close to 30 percent in Belarus and Russia, to about 50 percent in Kazakhstan and Ukraine, and to some 70 percent in Georgia. Meeting these foreign currency obligations as exchange rates depreciate has required major cutbacks in investment and employment in several of these economies.

By the same token, defaults would further exacerbate already intense strains on bank balance sheets and diminish prospects for renewed credit growth. In these circumstances, public support for the banking system is critical. Countries whose banking sectors are struggling with the need to roll over foreign debtâ€“â€“for example, Belarus, Georgia, Kazakhstan, Russia, and Ukraineâ€“ â€“have already deployed remedial measures. These include provision by the central banks of ample liquidity, public guarantees, funding for recapitalization (including from international financial institutions), and nationalization.

It will be crucial to carefully assess bank balance sheets with a view to writing off bad assets in a proactive manner, determining which banks have sound medium-run prospects, and replenishing their capital as needed, drawing on budgetary resources rather than central bank support. With significant public support needed for banks and difficult conditions in capital markets, room for fiscal policy stimulus is limited in most CIS countries. Belarus and Ukraine have needed to tighten. Georgia and the Kyrgyz Republic can afford to let automatic stabilizers work, provided sufficient donor support is forthcoming. Azerbaijan, Kazakhstan, Russia, and Uzbekistanâ€“ â€“all of which posted fiscal surpluses ahead of the crisisâ€“â€“have allowed automatic stabilizers to operate and have eased fiscal policy to sustain growth.