Oil and Russia: Twin Shocks for the Caucasus and Central Asia

The Caucasus and Central Asia (CCA) will be challenged in 2015 by the double shock of lower oil prices and the economic recession in Russia. Oil prices have declined by more than 50 percent since June 2014, and markets expect that they will stay at about $57 per barrel on average in 2015, rising gradually to $72 per barrel by 2019. Prices for other commodities, such as metals, have also declined, affecting some economies in the region. Moreover, the deepening recession in Russia, to which many CCA countries are closely linked through trade, remittances, and foreign direct investment, and the sharp depreciation of the ruble, are weakening investor sentiment and economic prospects, and exerting pressure on the exchange rates across the region. Economic growth has also been weakening in China, another important trading partner for the CCA.


Lower oil prices will have different implications for oil exporters and importers. In exporting countries, a decline in oil prices results in losses in export and budget revenues. Most exporters need oil prices to be considerably above the $57 projected for 2015 to cover government spending, which has increased in recent years in response to rising social pressures and infrastructure development goals. On current policies, growth in the CCA oil exporters is expected at about 4.9 percent this year, 0.8 pp of GDP below the IMF’s October 2014 Regional Economic Outlook projection


What can policymakers do in face of the twin shocks of lower oil prices and the deepening recession in Russia? Over the near term, the region’s oil exporters can use their savings from past oil revenues or borrowing to shore up declining economic growth. Indeed, governments in Azerbaijan and Kazakhstan are expected to introduce a fiscal stimulus. Uzbekistan and Turkmenistan intend to maintain their earlier spending plans because prices for their gas exports have not been affected much by the decline in oil prices and Russia’s slowdown has a relatively smaller impact on these economies.


However, without changing their economic policies, countries are likely to run out of their buffers within a few years if oil prices stay low and the situation in Russia does not improve. CCA oil exporters would need to scale down their medium-term spending plans, aiming for slowing growth of spending. Reigning in current spending instead of cutting investment in infrastructure, education, and health would help minimize the impact on economic growth.


On the other hand, most oil importers are benefiting from lower oil prices: their energy import bills are reduced, and, where these reduced costs are passed on to the private sector, they lower production costs for firms and raise disposable income for consumers. However, the effects of the deepening recession in Russia far exceed the relief from lower oil prices, leading to a downward revision of growth in the CCA oil-importing countries by 0.4 pp to 4.4 percent in 2015 compared to the IMF’s October 2014 Regional Economic Outlook projection. The sharp depreciation of the ruble, together with the slower economic activity in Russia, has also depressed the value of remittances from Russia, which are quite significant, particularly in Armenia, the Kyrgyz Republic, and Tajikistan.


Faced with external shocks, many oil importers are pausing their fiscal consolidation plans to support near-term growth. However, as soon as growth outlook improves, countries should start rebuilding their fiscal and external reserves to improve their resilience to future shocks. Oil importing countries where fiscal sustainability is a concern would be well advised to save the windfall gains from lower oil prices to reduce public debt. Given uncertainty about the persistence of lower oil prices and the availability of external financing, importers should be cautious about making new large spending commitments.


Although policy responses will differ depending on whether the country is an oil importer or exporter, a common theme is the need for greater exchange rate flexibility to help the CCA economies better adjust to the adverse shocks they are facing and increase the effectiveness of monetary policy. Moreover, spillovers from Russia’s slowdown increase the need to step up structural reform efforts, especially in the areas of the business environment, governance, education, and trade integration. Visible progress in these areas will help boost productivity, and support medium-term growth and job creation.

Op-ed by Juha Kähkönen, Deputy Director, Middle East and Central Asia Department, International Monetary Fund

For further discussion, see “Learning to Live with Cheaper Oil Prices amid Weaker Demand”, IMF Regional Economic Outlook Update for the Middle East and Central Asia, January 2015 [http://www.imf.org/external/pubs/ft/reo/2015/mcd/eng/mreo0115.htm].




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