Heavily reliant on commodity exports, remittances and tourism, the economies of the Caucasus and Central Asia and their financial systems are vulnerable to volatile external shocks.
The Chart of the Week shows how exposed countries in the region are to such disruptions, which in the past have caused economic downturns and financial distress.
Although the situation remains uncertain, the ongoing pandemic and the conflict in Ukraine could also have a substantial impact.
The CCA region’s financial systems are particularly vulnerable to the impact of external shocks on economic activity. At times, favorable external conditions have spurred large credit expansions and raised systemic risks. These booms have sometimes been followed by busts.
Indeed, adverse external shocks, such as the global financial crisis and the 2014-15 oil price shock, led to sharp contractions in credit and asset prices, which created a legacy of problem loans and resulted in costly public interventions to bail out banks.
Several features of regional banking systems have amplified these vulnerabilities. First, dollarization in CCA economies is well above emerging market peers. Second, banking sectors are small, concentrated, and often largely state-owned. Finally, gaps in banking regulation and supervision also contributed to the weak quality of bank loan portfolios and capitalization.
The pandemic has hit CCA economies hard in the past two years, but its impact on financial sectors has remained limited, helped by emergency measures to support households, businesses, and banks. However, the COVID shock is now compounded by the implications of international sanctions imposed on Russia, a country with sizable economic and financial linkages with CCA countries.
Looking ahead, stronger macroprudential policy frameworks will help increase financial sector resilience and mitigate the impact of large financial cycles and external shocks in CCA countries. As experience in a few of these countries already shows, strong macroprudential policy frameworks have a key role in moderating credit and asset price booms, building larger buffers in bank balance sheets against adverse shocks, and reducing risks from common exposures and interlinkages between financial institutions.
Enhanced regulatory and legal frameworks for bank resolution and insolvency would also limit risks to financial stability and the public sector. Finally, reforms that reduce the role of state and promote competition would support greater financial inclusion and more sustainable credit and economic growth.
Rayah Al-Farah is an Economist at the Resident Representative Office of the IMF in Jordan, providing policy and technical advice on structural reforms under the EFF program. Prior to joining the team in Amman, she worked in the Middle East and Central Asia department of the IMF, covering the Caucasus and Turkmenistan. She has co-authored analytical papers and worked on research projects covering inclusive growth, financial inclusion, social spending, private sector development, and macroprudential policies. Rayah holds a B.A. in Economics from Wellesley College, and a Master’s in Global Human Development from Georgetown. University.
Klakow Akepanidtaworn is an economist in the IMF’s Institute of Capacity Development Macro-Modeling and Monetary Division. Previously, he worked as a desk economist for Armenia in the IMF’s Middle East and Central Asia Division and contributed to policy-related publications such as MCD Regional economic outlook. His research interests include Monetary Policy, Empirical Asset Pricing, Institutional Investors, and Financial Stability. He holds a Ph.D. in Financial Economics, and MBA from the University of Chicago Booth School of Business.
Sanan Mirzayev is an Economist at Strategy, Policy and Review (SPR) Department of the IMF. Since joining the IMF in 2017, he has worked in area and functional departments, with a focus on debt sustainability, balance of payments, and monetary policy issues in several developing countries. The analytical projects he worked on covered drivers of inflation, financial cycles, foreign direct investment flows, and private sector development. His current work focuses on assessing impact of commodity price shocks on sovereign risk and debt sustainability of the market access countries. Before joining the staff, Sanan worked as an Advisor to Executive Director at the World Bank and IMF and as a senior economist at a developing country central bank. Sanan received a Master’s degree in International Economics from the Johns Hopkins University.
Ezequiel Cabezon, Padamja Khandelwal and Iulia Teodoru contributed to this blog, which is drawn from research included in two departmental papers, “Macroprudential Policies to Enhance Financial Stability in the Caucasus and Central Asia” and “Managing Financial Sector Risks from the COVID-19 Crisis in the Caucasus and Central Asia".
This article first appeared at the IMFBlog, a forum for the views of the International Monetary Fund (IMF) staff and officials on pressing economic and policy issues of the day. The views expressed are those of the author(s) and do not necessarily represent the views of the IMF and its Executive Board. Reprinted with permission.
