This is a difficult moment for policymakers. With the global economy facing an uncertain outlook amid extraordinary challenges, leaders around the world are confronted with a pressing question: What policies and reforms can they implement now to prepare their countries for what lies ahead?
When Russia invaded Ukraine in February, countries in the Caucasus and Central Asia (CCA) were expected to be among the hardest hit by the war’s fallout due to their proximity and close economic ties to Russia and Ukraine. But surprisingly, more than six months later, economic activity in most of the region’s countries is holding up well and even booming in some. Why? First, so far, Russia has been facing a much shallower contraction than initially expected. Second, workers and firms from Russia have relocated en masse to several CCA countries. As a result, income and financial inflows have surged across the region. And third, an important shift of supply routes traditionally served through Russia is supporting the region’s trade. These factors have prompted an upgrade of the IMF’s growth forecasts to 3.8 percent for 2022.
This is good news. But the region is not out of the woods. It remains highly exposed to the war through trade, remittances, tourism, and financial flows, all now significantly less predictable. The beneficial inflows and relocations seen this year may prove temporary. And a protracted war in Ukraine, broadening sanctions on Russia, and a deteriorating global environment are casting an ever-larger shadow over the region’s outlook. Even oil exporters, currently benefiting from higher global energy prices, face risks from possible disruptions to the transport and pipeline infrastructure used to export oil and gas.
Meanwhile, stubbornly high inflation-driven by elevated and volatile food and energy prices-is putting pressure on households across the region. Poorer households are most at risk from high food prices as they tend to spend a greater share of their income on food. And if Russia were to experience a prolonged recession, remittance inflows, a lifeline for the poor, could plummet, raising poverty and inequality and exacerbating already elevated sociopolitical tensions.
Amid this extraordinary uncertainty, countries in the region have an opportunity to embark on a transformative path to prepare for the difficult times ahead. Governments must decisively address pressing near-term challenges, but they must also not lose sight of the criticality of structural reforms that boost growth. Crucially, they must invest in strengthening their country’s ability to weather future shocks.
To do this, central banks will need to first control inflation, which is essential for economic stability and for protecting the poor. Inflation is expected to remain in double digits in 2023 throughout the CCA. While high commodity prices are partly to blame, demand pressures are also building, and wages are rising. Central banks in the region have already raised interest rates in response. However, additional increases may be needed, especially where there is evidence that inflation is becoming entrenched.
Countries with high fiscal deficits should seek to broaden their tax bases and cut lower priority expenditure to free up resources to enhance pro-poor spending on infrastructure, health, and education. Targeting policy support to the most vulnerable would help alleviate poverty and inequality risks. At the same time, strengthening social safety nets will help contain poverty and prepare countries to be more responsive to future shocks. Oil exporters have an opportunity to maximize the benefits of windfall oil revenues for advancing their diversification plans.
However, while confronting near-term challenges, pressing ahead with transformative reforms can help build resilience to future shocks and expand opportunities.
Medium-term growth for the CCA is projected to fall to 3.5 percent, just half of its historical average.
The region can do better if reforms to address long-standing structural issues are implemented now. Reforms that promote inclusiveness and enhance resilience should be prioritized: redesigning tax systems to make them more equitable, reducing informality, fostering private sector development, accelerating digitization, and taking measures to adapt to climate change. In addition, integrating relocated workers and firms and providing them with the opportunity to thrive would strengthen countries' growth prospects.
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CCA countries have weathered the pandemic crisis well. The initial spillovers from the war in Ukraine have so far been contained. Still, the uncertain outlook and challenges ahead call for audacious measures. But countries need not face these challenges alone. In the IMF, they have a trusted partner that stands ready to help.