1. 1 Economic Developments, Prospects, and Policy Issues in the Caucasus and Central Asia Presentation at the World Bank ECA Workshop February 15, 2008 Sena Eken Middle East and Central Asia Department International Monetary Fund

2. 2 Outline of Presentation Regional developments and outlook Individual country prospects and challenges Common policy issues for the region

3. 3 Real GDP Growth (Annual average change; in percent) Caucasus and Central Asia (CCA) is one of the fastest growing regions in the world (high commodity prices, expansionary macroeconomic policies, strong capital inflows, rapid credit growth, and rising asset prices fueling strong domestic demand). Growth is set to slow, but still high at around 9 percent in 2008.

4. 4 Inflation in the Caucasus and Central Asia (Average inflation, GDP weighted, annual percentage change) Inflation is up sharply, led by higher food prices. Even before the external food price shock, inflation was rising steadily. December 2007 12-month inflation numbers range from 7 percent (Armenia) to 20 percent (Kyrgyz Republic and Tajikistan).

5. 5 External Current Account Balance (In percent of GDP) Demand pressures are also boosting imports and trade deficits in several countries. Capital inflows have financed these deficits; reserves have risen. But capital flows can be volatile; eventually, the deficits will need to fall.

6. 6 Armenia Key policy challenges: – Reducing inflationary pressures: tighten monetary and maintain fiscal discipline, while maintaining exchange rate flexibility. – Improving the revenue effort: increase the tax-to-GDP ratio in a transparent and non-discriminatory manner. – Enhancing productivity and competitiveness to promote broad based growth: improve the business climate, modernize the tax administration, and enhance domestic competition. Annual percent changeIn percent of GDP

7. 7 Azerbaijan Key policy challenges: –Ensuring an efficient, sustainable, and transparent use of oil revenues: adopt medium-term budgeting, improve coordination between monetary and fiscal policies, and strengthen expenditure management. –Reducing inflation: restrain fiscal stimulus and tighten monetary policy. –Improving competitiveness: step up financial sector reforms, improve the business climate, and tackle governance problems. Annual percent changeIn percent of GDP

8. 8 Georgia Key policy challenges:  Regaining investor confidence and ensuring FDI inflows: maintain macroeconomic stability and continue strong economic reforms.  Reducing inflation and the current account deficit: with substantial fiscal tightening, as budgeted, and a moderately contractionary monetary policy.  But pressures on fiscal policy are intensifying, so getting inflation back to single digits will be a challenge. In percent of GDPAnnual percent change

9. 9 Kazakhstan Key policy challenges  Dealing with sudden stop in external funding of the banking system: possibly increase exchange rate flexibility if pressure on tenge re-emerges.  Reducing banking sector risks: strengthen prudential regulations and intensify banking supervision.  Sustaining impressive economic performance: continue prudent management of oil revenue and intensify structural reforms. Annual percent changeIn percent of GDP

10. 10 Kyrgyz Republic Key policy challenges: –Reducing inflation: tighten monetary policy, reduce unsterilized intervention in the foreign exchange market, and allow appreciation of the exchange rate. –Fiscal consolidation: broaden the tax base and improve tax administration; move ahead with civil service reform. –Strengthening the underpinnings of growth: improve the regulatory environment and accelerate structural reforms. Annual percent changeIn percent of GDP

11. 11 Tajikistan Key policy challenges: –Reducing inflation: implement a more cautious fiscal policy and a tighter monetary policy. –Avoiding new cycle of excessive borrowing: put in place a well-defined debt management framework and contract debt only on concessional terms. –Reforming the banking sector and strengthening independence of central bank: discontinue subsidized and directed lending operations, and strengthen regulatory and supervisory framework. Annual percent changeIn percent of GDP

12. 12 Turkmenistan Key policy challenges:  Strengthening non-hydrocarbon sectors and boosting employment: implement market-oriented economic reforms-- the phased unification of the exchange rates and reforms in the pricing, financial, and fiscal areas.  Limiting sharp increases in price level: appreciate the market exchange rate and further liberalize imports.  Strengthening public finance management: extend the coverage of the budget using revenue from exchange rate unification, and improve treasury management and budget transparency. Annual percent changeIn percent of GDP

13. 13 Uzbekistan Key policy challenges: –Reducing inflation: further tighten monetary policy, maintain a cautious fiscal stance, and allow exchange rate to appreciate. –Enhancing financial deepening: discontinue the role of banks in non-core activities and remove restrictions on cash withdrawals. –Stimulating private sector development: eliminate barriers to trade, liberalize the foreign exchange system, and remove extensive regulations in the economy. Annual percent changeIn percent of GDP

14. 14 Common Policy Issues Macroeconomic performance has been strong and near-term growth prospects look favorable. However,  Inflation has become a significant problem.  Risks to the outlook are tilted to the downside. If the global credit crunch and market turmoil continue, growth in developed countries could slow sharply, with spillovers through trade and financial linkages: –lead to a decline in oil and commodity prices; –adversely affect external financing conditions (largest impact where portfolio and bank inflows are significant). Tackling inflation while maintaining strong growth is the key macroeconomic challenge.

15. 15 Common Policy Issues (continued)  Tackling inflation Policy makers should focus on preventing the food price shock from passing through into prices more generally. In several countries, there is room to tighten monetary policies, by raising interest rates and reducing foreign exchange market intervention to allow more exchange rate appreciation. Plans in several countries to loosen fiscal policies by raising government spending should be reconsidered. Fiscal restraint needs to be maintained to cool domestic demand and reduce inflationary pressures.

16. 16 Common Policy Issues (continued)  Maintaining strong growth If the global economy slows sharply and the external demand and inflows decline, flexible exchange rates and moderate fiscal loosening could help cushion impact. However, to maintain strong performance:  policies need to focus on preserving the macroeconomic stability that has underpinned recent success; and  the challenge of diversifying the regions’ production base needs to be addressed through reforms that encourage greater private sector investment.