Economic Outlook for the Central Asian and Caucasus Region
John Odliing-Smee, Director, European II Department, International Monetary Fund
Recent economic developments
Dispute the Russian crisis, there has been some acceleration of output since the mid-1990s in the region as a whole (including Mongolia).
Only Kazakhstan recently recorded a fall in output (-2.5 in 1998), but it was badly hit by the fall in commodity prices as well as the Russia crisis (Table 1). Although many countries were hit by the collapse of the Russian export market, imports also fell and GDP - at least recorded GDP - did not fall.
Following the Russian crisis, most countries in the region allowed their exchange rates to depreciate and, as a result, there was a jump in prices. However, this seems to have produced only a temporary blip in inflation, which is now falling in most countries. Only Turkmenistan and Uzbekistan are forecast to have significantly higher inflation during 2000 than during 1999 (Table 2), and a very small increase from 2 percent to 3 percent is forecast for Armenia; otherwise inflation in 2000 is forecast to be below that in 1999 in the countries of the region.
There are, however, problems of macroeconomic balance that need to be addressed. First, fiscal deficits are large in some countries (Table 3). Even when they can be readily financed in a non-inflationary way, especially by borrowing abroad, the accumulation of debt is worrisome in some countries, and debt interest payments are crowding out other expenditures.
Second, current account deficits have remained large in many countries, and the external debt burden has risen sharply because of this (Tables 4 and 5). Questions about the sustainability of external debt arise in some of the poorest countries of the region.
What should be done?
On the macroeconomic stabilization side, further adjustment of imbalances is urgently needed in most countries in the region:
• national saving must rise to service external debt and to finance more investment;
• government saving in particular must rise - in other words government deficits must be reduced more in most countries;
• in some countries, unproductive investments, many financed by borrowing abroad, must be reduced;
• cutting government deficits requires not only strengthened tax collection, but also a reduction and rationalization of government expenditures. Too few countries have made the structural changes that are needed to adjust the government sector to what can be sustained by a smaller economy and to what is needed for a market as opposed to a centrally-planned economy. The effectiveness of education and health services must be enhanced. The number of budget sector workers should be cut and unnecessary activities (especially interfering in the economy) eliminated. In most countries government must increase financing of new activities that support the market, for example, civil courts and anti-trust and securities regulatory commissions. The remaining positions should be filled with well-trained staff at higher salaries, to improve the quality of government services and reduce corruption. The social safety net should be targeted on the most vulnerable groups.
Turning to growth, we expect somewhat faster growth (nearly 5 percent for the region) in all countries, except Azerbaijan and Uzbekistan, in 2000 than in 1999 because of the stronger commodity prices, the faster growth in the region as a whole (led by Russia), and the continuation of structural reforms. The exceptional growth in Azerbaijan in 1998 and 1999 was due to increased oil production and may not be sustained; and growth in Uzbekistan may be reduced due to the slow pace of economic reforms and less foreign borrowing.
Although growth rates are respectable, the countries of the region could do much better, given the excess capacity and quality of the labour force.
Much can be done to improve the prospects for growth and the investment climate:
• reform the role of the state, so that it is regulator of economic activity, not the prime mover;
• closely related to this, reduce corruption by increasing transparency, deregulation and proper punishment of offenders, however senior;
• adopt transparent, non-arbitrary and stable laws and regulations;
• enforce property rights and contracts.
If progress is made in these areas, and macroeconomic stability is maintained, we can expect to see an expansion of economic activity and new investment. It will be especially important to attract foreign direct investment because of what it can also bring in terms of management, financial and marketing skills. But domestic investors will have to account for the bulk of investment over the medium and long term: despite the historically low level of incomes, there continue to be substantial amounts of private saving, most of it abroad and some of it waiting for suitable investment opportunities at home.
We now know that the transition process will be long in the Central Asian and Caucasus region. Some countries have barely begun major reforms, while most of them have partially reformed but are now finding it difficult to complete the economic reform process. In these latter countries, the winners from the partial reforms - key groups in the economy and their political supporters - have an interest in preventing further reforms because these would dilute their economic rents. The task for leaders is therefore to push ahead with reforms so that economic growth and hence living conditions for the population as a whole will improve, even though the vested interests will lose their privileges. Without such reforms, genuine market economies will not be created, growth will be anemic, indebtedness will grow, and macroeconomic and social stability will be threatened. There is no economic reason why, despite the present difficult conditions, all the countries of the region should not show strong growth over the medium and long term. But this will require firm political will to push through difficult but essential market-oriented reforms, to create a law-based economy without government interference, and to overcome corruption.
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