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June
2016
Eurasia
Growth prospects
Highlights
The Caucasus and Central Asia region contracted by 3.0% in 2015, weighed down by Russia entering deep
recession and by the sharp drop in commodity prices since mid-2014. We expect a further contraction of
0.5% this year. As the chart below shows, although EM currencies have rallied in recent months, many
(including the Russian rouble) remain more than 50% down compared with the start of 2014. While this has
boosted export competitiveness, this is of limited help as global trade has been very subdued over the last
year. Moreover, currency weakness pushed inflation higher, increased US$ debt payments, reduced
households’ purchasing power and firms’ input costs and limited the scope of central banks to relax policy.
And the recent fuel price rally largely reflects a number of recent supply outages and we expect the oil price
to remain under downward pressure in H2 2016. But we have upgraded our forecast for Russia recently and
now expect a 1.0% contraction this year (from -2.4% in February) as a result of the slightly improved outlook
for oil prices and better-than-expected Q1 activity. However, Russia is such an important trade partner and
source of remittances for its neighbours that any contraction will weigh heavily on the region, as the chart
below shows, with several countries joining Russia in recession.
Furthermore, we expect only a modest recovery over the medium term, with the region seen growing by an
average of 2.2% in 2017-20. This compares with an average of 3.7% in 2010-13. And this is conditional on
geopolitical relationships remaining reasonably calm and assumes commodity prices will increase gradually
over the medium term, with oil prices breaching $70pb by end-2020. There are a number of other risks. The
working-age population is already falling in Russia, the Ukraine and Belarus and this is likely to weigh on
long-term growth prospects and put public finances under pressure across the region. In addition, overdependency on oil and gas revenues adds to the fiscal solvency risk in many countries in the region,
although slow diversification should boost longer-term growth prospects.
Real GDP growth in Eurasia
Uzbekistan
Eurasia: Exchange rate against the US$
Average
2017-20
2016
Turkmenistan
Kyrgyzstan
Ukraine
Kazakhstan
2015
Georgia
Belarus
Mongolia
Kazakhstan
% change
since Jan 1
2015
Azerbaijan
Azerbaijan
Russia
Uzbekistan
Belarus
% change
since Jan 1
2016
Georgia
Ukraine
-10
-8
-6
-4
-2
0
2
Source : Oxford Economics/Haver Analytics
% change
since Jan 1
2014
Russia
4
6
8
-80
-60
-40
-20
0
20
Source : Oxford Economics/Haver Analytics
1
June
2016
Russia
In response to an improving outlook for oil prices and a better-than-expected performance in Q1, we now
expect a shallower recession in 2016 than previously, with ‘flash’ estimates suggesting that the economy
contracted by just 1.2% year-on-year. Other signs are emerging that the worst of the recession is over, but
we still expect a ‘U-shaped’ recovery, with a slow and protracted return to growth. We now forecast GDP will
contract by 1.0% in 2016 followed by growth of 1.5% in 2017.
But as the economy continues to adjust, it will receive limited policy support. Despite the improving outlook,
low oil prices will keep the budget under severe strain. Lower-than-expected revenues, coupled with stillhigh spending ahead of an election year will lift the deficit to 3.6% of GDP this year, considerably higher
than the 3% target. Russia has returned to the international capital markets for the first time since the
imposition of sanctions, selling a US$1.75 billion Eurobond, but this will have only a limited impact on
plugging the budget deficit.
On monetary policy, we see 150bp of rate cuts in H2 2016 but there are mounting risks that stalling inflation
(7.3% in March and April) and stubbornly high inflation expectations may limit the ability of the central bank
to cut rates. We think the scope for further rouble (RUB) strength is limited. Likely renewed pressure on oil
prices and a souring of investor sentiment towards emerging market assets will limit the RUB rise, and we
see it falling to RUB72/US$ by year-end.
Russia and Ukraine: Short-term interest rates
Russia: GDP and industrial production
%
32
% year
30
Ukraine discount rate
28
Industrial
production
F'cast
20
24
Russia: Interbank rate (31 to 90 days)
10
20
16
0
12
Russia: 10 year bond yield
-10
8
4
0
Jan 11
Jan 12
Jan 13
Source: Haver Analytics
-20
Russia: 1-week repo rate
Jan 14
Jan 15
Jan 16
GDP
-30
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020
Source: Oxford Economics
2
June
2016
Kazakhstan
With the economy in recession, the central bank has signalled that it will prioritise growth over inflation by
cutting the main policy rate to 15% from 17% on 5 May. The move was justified by easing pressure on the
KZT as well as signs of “reduced inflation expectations” among a survey of the general population. Certainly
the KZT has been fairly stable against the US$ in recent weeks, and is over 15% stronger than its endJanuary low of KZT390.9. But this mainly reflects the pick-up in oil prices. If oil prices fall back, then the rate
cut may need to be reversed. Furthermore, headline inflation has continued to rise, to 16.5% in April, the
highest since 2008. We expect inflation to fall sharply from October this year as the impact of devaluation
drops out of the annual comparison, with the rate forecast to be just within the 6-8% target range by
December, although any renewed plunge in oil prices could threaten this.
Unfavourable external factors, and their impact on exports, the KZT, inflation, liquidity, consumption and
economic confidence, saw GDP fall 0.2% in Q1 and brought credit rating downgrades from both Moody’s
and Fitch in recent months. A modest recovery is seen in 2017, when GDP is forecast to rise by 2% after an
expected 0.5% decline this year. As well as stabilisation in oil and metal prices and gradual improvement in
key trading partners’ performance, we see the benefits from structural and policy reforms feeding through
and the impact of fiscal stimulus.
3
June
2016
Azerbaijan
GDP shrank by 4.5% year-on-year in the first four months of 2016, continuing the weakening seen in H2
2015. Within this, non-oil GDP plunged 6.8%, led by declines in construction and transport, while oil GDP is
also estimated to have fallen. Indeed, separate figures from the state oil company show oil production down
9.6% in Q1, with natural gas output 4.2% lower. For 2016 as a whole, we see GDP shrinking 2.7%, with
non-oil activity gaining some support from the recent pick-up in oil prices and the AZN, increased social
spending on pensions and social assistance, and a 10% hike in public sector wages. Further ahead,
economic growth should gradually return as oil prices recover, external demand rises, policy loosens, and
infrastructure investment boosts the construction sector.
Since dropping to a low of AZN1.66/US$ in mid-March, the currency has appreciated by some 10%. This
reflects the stronger oil price and waning emerging market turmoil, as well as the impact of a tightening in
monetary and fiscal policy and other policy measures and the benefit of some underlying strengths in terms
of policy buffers. Any reversal in oil prices, concern about China or the increased risk of war with Armenia
over Nagorno-Karabakh could trigger renewed AZN weakness.
4
June
2016
Armenia
The economy grew by 3.0% last year, led by steady growth in agriculture and industry and helped by higher
government spending. However, fixed investment and household spending fell, affected by lower
remittances from Russia. Expansionary policy is estimated to have driven the fiscal deficit sharply higher
last year, to close to 5% of GDP, but fiscal policy is likely to be tightened over the medium term, weighing on
growth prospects. With tighter fiscal policy and Russia (Armenia’s biggest trading partner) currently in
recession, GDP growth is likely to remain sluggish in 2016 and 2017, at 2.1% and 2.5% respectively. In
May, the central bank upgraded its forecast for 2016 growth from 1.5-2.6% to 2.7-3.6% on recently stronger
industry and services activity, but the regional outlook remains uncertain so we are more cautious. Indeed
the risks are still to the downside, with Armenia highly vulnerable to external shocks. Further conflict in the
Nagorno-Karabakh region is another risk to growth.
Belarus
The economy shrank by almost 4% in 2015 and is expected to contract again, by about 2%, this year as low
oil prices squeeze the normal re-export premium – widening the current account deficit – and tight monetary
policy adds to the investment constraints. High interest rates have stabilised the currency after its sharp
depreciation in 2015; but this has not reduced inflation fast enough to prevent real BYR appreciation holding
back sales to main markets. Although the more stable BYR is starting to rein in inflation and enabled a small
interest rate cut (to 24%) in April, the move into sizeable fiscal deficit means monetary policy is likely to
remain tight. The smaller GDP decline in 2016 will be due mainly to renewed export growth. President
Lukashenko, re-elected last year, is expected to retain control of parliament after elections due by
September. However, the continuing recession, a growing reliance on Russia and China, and low election
legitimacy will keep political risks high, despite the weak and fragmented opposition.
Georgia
Despite GDP growth of 3.4% in March, the economy needs another 1-2 years to return to trend after the
trade shocks that forced sharp currency depreciation in 2015. The wide external deficit and low investment
will mean full-year 2016 growth of about 2.6%. Growth will climb back to around 5% in 2018-19 as external
trade relations improve, attracting more FDI, but there are a number of risks. Tensions are already rising
between the ruling Georgian Dream, the opposition National Movement and other groups ahead of the
October parliamentary election. The outcome could be indecisive, making it hard to form another stable
coalition. External political risks are also kept high by tensions between old (Russia-focused) and new (EUfocused) trading partners. Rising net exports and remittances will bring the external deficit below 10% of
GDP by 2018, but the wide gap leaves the recovery very dependent on both FDI and IMF support.
Kyrgyzstan
GDP growth slowed to 3.5% in 2015 from 4.0% the year before, hit by sharply weaker activity in
Kyrgyzstan’s two main trading partners, Russia and Kazakhstan. We expect growth to slow even more
sharply this year, to 1.3%, as the outlook for global trade remains subdued. The currency depreciated
against the US$ by nearly 30% last year, creating inflationary pressures, but these were partially offset by
lower food prices keeping inflation to an average of 6.5% in 2015. But food prices have picked up in recent
months and this, combined with further depreciation of the currency, is likely to drive inflation higher this
year, averaging close to 9%. Gold output is also likely to remain modest this year and disputes about the
Kumtor gold mine, which are estimated to have cut 1% from GDP growth in 2015, provide downside risk to
our forecast, on top of the already-high external risks.
5
June
2016
Moldova
GDP contracted modestly in 2015, hit partly by lower agricultural output. In 2015, US$ exports fell by 15%
and US$ remittances were down by 30% (but still accounted for nearly 20% of GDP). Moldova has been
forced to keep monetary policy tight after the economy was disrupted by large-scale banking sector fraud.
This stance has helped to limit the depreciation of the exchange rate and contain inflationary pressures, but
inflation still averaged close to 10% last year while bank lending fell sharply as borrowing became more
expensive. We expect the economy to grow by 1.5% in 2016 but this is conditional on solid agricultural
output and on credit growth beginning to improve. We see Moldova growing by about 5% a year in 2018-19,
provided recovery is well-established across the rest of the region.
Mongolia
Growth has slowed sharply in Mongolia in recent years due to the slowdown in activity in China, Mongolia’s
main export partner, and by lower mineral prices. GDP growth peaked at 17.3% in 2011 and averaged
about 11% in 2010-14 but then slowed to 7.8% in 2014 and 2.3% in 2015. Furthermore, we expect the
economy to contract slightly this year and grow only very modestly in 2017. Moreover, pressures on the
budget and the balance of payments mean that macroeconomic policy is likely to remain tight over the
medium term. The key challenges that policymakers face are to diversify the economy beyond commodities,
to reduce vulnerability to external shocks and to tighten fiscal policy to put the budget on a more sustainable
footing over the longer term.
Tajikistan
Overseas remittances, largely from Russia, are estimated to account for almost 50% of GDP and these fell
by a third in local currency terms in 2015 and by more than 40% in US$ terms. As a result, and with most
key commodity prices sharply lower and monetary policy tight, GDP growth slowed to 6.0% in 2015 from
6.7% in 2014. Financial support and FDI from overseas, particularly from China, helped to cushion the
slowdown but the dependence of the economy on remittances, aluminium and cotton, and financial support
and FDI, leaves it vulnerable to further external shocks. We expect growth to slow to just under 4% in 2016,
before gradually picking up to 6% in 2019-20.
Turkmenistan
GDP growth slowed from 10.3% in 2014 to 6.4% in 2015, driven down by sharply lower oil and gas prices
and weaker demand in main trading partners. Growth is forecast to be little changed at about 6% this year.
And with hydrocarbons making up more than 90% of exports, and the price of natural gas still sharply lower
than a year earlier, there are significant downside risks to the economic outlook. However, within the region,
Turkmenistan enjoys strong macroeconomic fundamentals; after its visit in April, the IMF praised
Turkmenistan’s proactive response to external shocks, devaluing the menat in January 2015, cutting
investment spending and subsidies, increasing tax revenues from the non-hydrocarbon sectors and
strengthening the regulation of banks. In addition, the oil price at which the fiscal and external balances will
break even is estimated to be the lowest in the region, offering Turkmenistan more protection from low
commodity prices than some of its neighbours. We expect the economy to grow by a solid 6% pa over the
medium term as Turkmenistan’s long-term gas contracts with China limit the downside risks.
6
June
2016
Ukraine
The government of Prime Minister Arseniy Yatsenyuk, which accelerated reforms in 2015, collapsed in April
with much of its programme still to be implemented. The new government is still pro-western and committed
to the IMF programme, but is much less technocratic and no less corrupt than the previous one. Gradually
accelerating GDP growth in 2016-18 will keep the fiscal deficit under control, while export revival stabilises
the current account deficit around 1% of GDP and a steadier currency allows inflation to subside further. But
prospects for investment upturn have weakened, keeping the medium-term growth rate capped around 3%.
The export revival that restarted production growth in H2 2015 will continue driving recovery this year,
helping to keep the UAH stable and reducing the risk of renewed depreciation that would quicken inflation
(whose slowdown to 1.6% in Q1 2016 enabled the central bank to cut its discount rate 400bp in April/May to
18%). But low reserves will keep currency and inflation risk high until IMF support is reaffirmed. With the
external deficit reopening slowly and the budget deficit seen at around 3% of GDP, the recovery could stall
in 2017-18 if business environment improvements are insufficient to restore investor confidence.
Indeed risks have moved to the downside because of the coalition’s diminishing parliamentary majority and
fading EU, US and IMF confidence in its ability to deliver reform. Although ruling parties’ sharp loss of
support since 2014 has been partly to other pro-reform groups, the export recovery may tempt the new
government to delay the reforms needed to raise FDI and rebalance the budget.
Uzbekistan
Uzbekistan’s GDP grew by 8% in 2015 according to official data, the ninth successive year of expansion of
8% or more. But as ever, there is considerable doubt about the reliability of the data. Notwithstanding the
impact of higher public investment and rising commercial lending in sustaining domestic demand, one would
have expected growth to slow due to the impact of recession in Russia and slowing activity in Kazakhstan,
Ukraine and China – all key trading partners and the main sources of remittances. Indeed, remittances from
Russia fell 50% to US$2.3bn in 2015.
From the supply side, the main growth contributors were industry (up 8%) and services (up 14%), with
construction expanding by 17%. And agriculture grew by 6.8% aided by favourable weather. On the demand
side, investment (up 9.5%), led by surging public investment, was the key growth driver. While a 17%
increase in public sector wages helped private consumption to remain reasonably robust, the plunge in
remittances will have dampened spending.
We forecast growth will slow to 7.2% in 2016 due to the weak external outlook, including continued
recession in Russia, further slowdown in China and falling GDP in Kazakhstan. But as in 2015, growth will
be supported by public investment and domestic lending, while real wage growth and large pension
increases will support private consumption. Over the medium term, the economy is expected to grow by
around 7.5% pa, supported by strong government spending and a gradual recovery in key commodity
prices. But Uzbekistan’s reliance on commodities leaves it vulnerable to any further slide in prices, while a
longer than expected downturn in Russia would hit exports and remittances even harder. And domestically,
there is still no obvious successor to President Karimov, ruler since 1989.
7
June
2016
Eu ra s ia : Gro w t h
% An n u a l GDP Gr o w t h
Russia
Kazakhstan
Azerbaijan
Armenia
Belarus
Georgia
Kyrgyzstan
Moldova
Mongolia
Tajikistan
Turkmenistan
Ukraine
Uzbekistan
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
4.5
7.3
4.9
2.2
7.7
6.2
-0.6
7.1
6.4
6.5
9.2
3.8
8.5
4.0
7.5
-1.4
4.7
5.5
7.2
5.9
6.4
17.3
2.4
14.7
5.5
8.3
3.5
5.1
2.1
7.1
1.5
6.4
0.6
-0.7
12.3
7.5
11.1
0.2
8.2
1.3
6.0
5.8
3.3
1.2
2.5
10.8
9.4
11.6
7.4
10.2
0.0
8.0
0.7
4.3
2.7
3.5
1.7
4.6
4.0
4.6
7.8
6.7
10.3
-6.6
8.1
-3.7
1.2
1.0
3.0
-3.9
2.8
3.5
-1.0
2.3
6.0
6.4
-9.9
8.0
-1.0
-0.5
-2.7
2.1
-2.0
2.6
1.3
1.5
-0.2
3.9
6.0
1.7
7.2
1.5
2.0
1.2
2.5
1.8
4.5
3.5
3.0
0.7
4.1
6.0
2.5
7.5
1.5
4.0
3.3
3.0
2.5
5.0
5.5
4.9
5.6
4.9
6.0
3.0
7.5
1.6
5.0
4.5
3.5
3.5
5.1
6.5
5.1
6.8
6.0
6.0
3.0
7.0
1.5
5.0
4.5
4.3
3.3
4.9
6.5
4.0
6.4
6.0
6.0
2.5
6.5
Source: Oxford Economics
8