Opening Up in the Caucasus and Central Asia (PDF)

This Departmental Paper was prepared by IMF staff under the supervision of Juha Kähkönen and Mark Horton.
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External shocks that have affected the CCA region since 2014 have placed pressure on macroeconomic balances and the current growth model. As a result of lower commodity prices, weaker remittances, and slower growth in key trading partners (Russia and China), growth and current account balances weakened and public debt has risen. With these conditions and pressures likely to persist, growth will remain subdued unless the region can find new growth drivers; diversify away from natural resources, remittances, and public spending; and generate much stronger private sector–led activity. Increased exports of non-commodity goods and services is a clear area of opportunity. If it is well managed, the Belt and Road Initiative (BRI) could boost investment, trade, and economic prospects considerably for the region.

Growth Rates and Inflation

Source: IMF, World Economic Outlook.
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Trade and capital account liberalization

Increased trade openness would yield significant economic benefits to the region. Despite some recent progress toward trade diversification, CCA countries remain weakly integrated with the global economy, and intraregional trade is low. The BRI offers opportunities to strengthen trade integration by using new infrastructure networks and transitioning toward more non-commodity and services exports. Additional trade liberalization — including through various trade arrangements — and intraregional trade are also needed.

While capital flows have been relatively low and many CCA countries retain restrictions on capital account transactions, change is underway as countries seek to benefit from greater economic integration. However, when a country liberalizes capital accounts, it should take care to ensure that banks and government are able to manage the risks associated with greater — and potentially more volatile — capital flows. Specific near-term actions should include cleaning up bank balance sheets, improving the regulatory and supervisory framework, and addressing other risks, including those related to dollarization.

Economic frameworks and institutions

CCA countries are trying to improve fiscal balances following recent shocks, but a more ambitious fiscal adjustment would be preferable to rebuild buffers and deal with possible future shocks and greater economic integration. Policy efforts should focus on revenue mobilization, rationalizing no priority expenditures, strong social safety nets, and improving public spending, as investment opportunities — including public-private partnerships (PPPs) — are expected to grow in the context of various integration initiatives. Such efforts would support fiscal consolidation while allowing for more pro-growth spending. Fiscal risks will require scrutiny as more public investment and infrastructure projects get underway. This scrutiny will require more robust budgetary institutions, fiscal rules, and risk management capacity.

Monetary policy frameworks across the CCA need to be further strengthened to support economic integration. The move toward greater exchange rate flexibility in the region is a positive development and will help CCA countries weather future external shocks. While the choice of an alternative nominal anchor should reflect country-specific circumstances, inflation targeting has been gaining ground in the region. By promoting price stability, inflation targeting can play a role in financial sector reforms and market development as well as stimulating investment, economic integration, and growth. To successfully transition to inflation targeting, countries will need strong political commitment, ongoing development of institutional capacity, and efforts to address lingering financial stability concerns, including restoring the health of bank balance sheets. Adopting similar inflation targets would promote greater exchange rate stability and trade and financial links among CCA countries.

Healthier banking systems and deeper capital markets in CCA countries would support regional and global integration by promoting more efficient intermediation, financial inclusion, larger capital flows, infrastructure investment, and economic diversification. To facilitate this transformation, bank balance sheets need to be strengthened, intermediation enhanced, transparency improved, financial inclusion encouraged, and correspondent banking relationships (CBRs) promoted. Companies could diversify their financing sources and promote investment opportunities by developing capital markets.