Central Asia’s Belt-Road Divots
A new International Monetary Fund research paper predicts “massive” investment inflows into the Central Asia-Caucuses (CCA) from China’s Belt and Road Initiative the next decade, while citing a long list of banking and capital market, fiscal and monetary policy and trade and business environment changes needed to handle the influx. External sovereign bond performance from the eight countries surveyed, including Azerbaijan, Kazakhstan, Georgia and Tajikistan, was sluggish in the first half as investors soured on illiquid frontier market plays with higher global interest rates, and recognized the area’s continued currency, commodity, remittance and debt shocks. The Fund noted strides since 2014 in economic diversification and integration, exchange rate flexibility and private sector-led growth, but called for greater tariff and non-tariff “opening up” beyond World Trade Organization membership and capital account liberalization. It urged financial sector and structural reforms to improve the lending and infrastructure foundation for “full benefits” under BRI and other cross-border projects.
Regional cooperation has also come through the Eurasian Economic Union (EEU) with Russia and other pacts, but low scores persist on trade intensity measures such as openness and value chain participation. Exports concentrate in a few products, with a decade-long import compression trend among both oil consuming and producing countries. Despite aggregate $350 billion GDP in the eight markets, intra-CCA commerce around 10% of the total is “low by international standards” due to administrative and currency restrictions. Average tariffs rose from the previous 4% when Armenia and the Kyrgyz Republic joined the EEU, and Kazakhstan and Uzbekistan ban and impose quotas on a wide range of items. The BRI, already with $10 billion in investments, has been underutilized as a commercial corridor into Europe’s supplier network, according to the report. The WTO in turn has yet to admit Azerbaijan and Turkmenistan as members, and the region has not implemented the 2017 facilitation agreement on customs automation and simplification.
Capital inflows have been flat the past decade mainly in the form of foreign direct investment, and energy exporters Azerbaijan and Kazakhstan also receiving a modest portfolio version are the overwhelming targets. While Armenia and Georgia lifted exchange controls, they remain in place across the CCA, especially with underlying bank fragility and high dollarization ratios. Fiscal deficits reached 5%, and public debt 50% of GDP in most of the group in the 2014-16 crisis period, and tax and spending adjustments are mixed while binding credible “rules” institutionalizing them are absent. Government wage bills and subsidies are bloated, and public investment lacks efficiency and productivity tests for BRI projects to assess merits and limit liabilities. Interference continues in exchange rate and monetary policy, as most of the profiled countries are reluctant or do not have technical capacity to allow respective free-float and inflation-target regimes. The central banks carrying out these functions are often not independent or transparent in practice, and local currency use can be discouraged by prudential rule distortions.
Bank asset quality and competition were weak before the latest balance sheet scare, which prompted large-scale rescues and restructurings. Azerbaijan’s biggest state-owned lender is in voluntary debt rescheduling equivalent to 9% of GDP, and Kazakhstan’s two leading units merged in 2017 after the government injected billions of dollars in capital and liquidity support. Bad loan ratios encompass a wide range from 5% in Georgia to 50% in Tajikistan under local classification criteria, and financial inclusion lags other developing economies, with commercial bank household deposits at 30% of GDP. Regular surveys reveal scant saver trust and borrower applications due to steep interest rates and paperwork requirements. Credit growth has sputtered since 2015, and correspondent relationships were also severed with foreign counterparts on creditworthiness, integrity and business size concerns, with US providers entirely pulling out of the Kyrgyz Republic. The non-bank share of financial system assets is small with “underdeveloped to nonexistent” stock and bond markets, as operating and supervisory frameworks do not meet emerging market standards. Kazakhstan’s launch this year of the Astana International Exchange to remedy these defects is “ambitious” in view of outstanding governance issues and rival regional hubs in Asia and the Middle East with better frontier investor records, the report suggests in a likely preview of second half disappointment.
