Russia's nascent recovery bodes well for the region; Crimea struggles after two years of annexation
June 8, 2016
After a continued deceleration in the period between 2011 and 2014, the economy of the Commonwealth of Independent States (CIS) took a hard hit in 2015 and contracted 2.6% as a sharp fall in commodities prices and the deepening recession in Russia weighed heavily on the region’s performance. The last time the Commonwealth experienced a downturn was in 2009 when the region was greatly impacted by the global financial crisis. At the beginning of 2016, weakness persisted, although the region’s economic activity did show more resilience to heightened volatility in global financial markets and a renewed fall in commodities prices, particularly in oil and gas. An aggregate GDP growth estimate elaborated by FocusEconomics shows that, following the 3.0% year-on-year contraction in Q4 2015, the economy of the Commonwealth decreased 1.1% in Q1. Q1’s reading was revised up from the 2.0% contraction estimated earlier and mainly reflected a better-than-expected GDP growth figure in Russia.
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Russia’s economy contracted 1.2% annually in Q1, which came in above the 3.8% decrease observed in Q4, and was better than the respective 2.0% drop and 1.4% contraction that analysts and Russia’s Ministry of Economic Development had expected. Q1’s softer-than-expected contraction and additional data suggest that the recession in Russia bottomed out early in 2016 and leading indicators hint at a gradual recovery in the second half of the year. The positive developments seen in Russia bode well for a gradual recovery in the region since the ripple effects from a Russian recovery will be felt in the rest of the economies that comprise the CIS. Moreover, the nascent recovery in oil prices will start to alleviate pressure on oil-producing countries’ public finances, ease volatility in exchange rates and boost confidence in the region.
The state of Crimea following two years of annexation
It has been over two years since Russia annexed Crimea and the peninsula has become the center of confrontation between Russia and the West. Aligning Crimea’s economy to Russia’s has also been difficult. The peninsula has become a large burden on Russia’s public finances since the Russian government has poured funds into the region without successfully improving the living standards of its citizens. Moreover, the region has become more militarized. The level of polarization between the East and the West has increased, and Crimea’s trade with neighboring economies has deteriorated drastically. Tourism—Crimea’s biggest money maker—as well as production and trade have all been affected by the annexation. Part of the deterioration can be explained by the international sanctions imposed upon Russia, including a ban on imports of goods from Crimea and Sevastopol; the prohibition of tourist services; the prohibition of energy exploration; and rail, water and air links to the rest of Ukraine have been suspended, leaving Crimea accessible only from Russia.
Crimea’s isolation became more critical toward the end of 2015 due to some major events. Since September 2015, Tatars and Ukrainians have tried to block transit and traffic to the peninsula from other parts of Ukraine. In November, Ukrainian power lines feeding into Crimea were blown up by alleged Ukrainian activists, causing massive blackouts in the peninsula. Moreover, Turkey’s downing of a Russian warplane that had infringed on Turkey’s boarder with Syria on 24 November 2015 caused a sharp deterioration in relations between Ankara and Moscow. This prompted the Kremlin to impose economic sanctions on Turkey, which included a ban on imports of goods that likely hit the peninsula hard given the strong trade links between Crimea and Turkey. Crimea’s economy remains heavily dependent on Russia in times of increased strain on the federal budget. Even in the medium term, the costs of financing infrastructure in Crimea will be high and will take place within the likely context of feeble economic growth in Russia. Nevertheless, for the Russian leadership, Crimea represents more of a political and strategic issue than an economic one, given that it is a source of legitimation for the government of President Putin and a source of mobilization for Russian troops. This, in turn, will make it difficult for any future Russian leader—once President Putin’s government leaves office—to achieve a resolution on Crimea’s international status without undermining his own domestic support.
Region benefits from a brighter outlook for Russia and commodities
A sharp fall in commodities prices, particularly oil and gas prices, caused enormous economic stress in the region in 2015 and the beginning of 2016. Heading into the second half of 2016, the outlook for commodities prices is better, while the Russian recession seems to have bottomed out earlier this year and the economy appears to now be in recovery mode. This is good news for the region’s economic prospects for this year, but slower growth in China, the potential for renewed volatility in global financial markets in the wake of uncoordinated global monetary policy and geopolitical risks cast a shadow on the outlook.
Analysts surveyed this month by FocusEconomics expect that a difficult external environment will continue to exert downward pressures on the Commonwealth’s economic outlook, although an expected increase in commodities prices, particularly in oil prices, will likely provide some relief for the region’s economy. Forecasters see that the Commonwealth’s economy will contract 0.7% this year, which was revised up 0.1 percentage points from last month’s forecast. Next year, analysts predict the economy to bounce back strongly and expand 1.6%.
This month’s mild improvement is entirely due to an upward revision to Russia’s growth projection. Moreover, given that the ripple effects from a gradual recovery in Russia are expected to spread slowly throughout the region, analysts maintained the forecasts for Kazakhstan and Moldova. Conversely, weakness persists in the rest of the region and GDP growth projections for the economies of Armenia, Azerbaijan, Belarus, Kyrgyzstan, Tajikistan and Uzbekistan were cut over the previous month.
Regarding the three countries that are not included in the regional GDP aggregate, analysts raised the 2016 GDP growth forecast for Georgia, while they cut the projection for Turkmenistan. Analysts left the 2016 GDP projection unchanged for Ukraine.
BELARUS | No signs of green shoots in Q2
Reduced remittances inflows and the spillover effects from Russia’s economic downturn caused the Belarusian economy to contract for the first time in nearly 20 years in 2015. Ongoing weakness in neighboring Russia and still-low oil prices have kept economic activity depressed. Data released by the Statistical Institute showed that the economy contracted 3.6% annually in Q1, which marked the fifth consecutive quarterly decline. Latest indicators from the start of the second quarter suggest that the recovery remains elusive despite some mixed signs. In April, industrial production expanded for the first time in over a year while retails sales contracted. Meanwhile, the government continues to hold talks with the IMF regarding a USD 3.0 billion loan. Belarus is hoping to use the loan to honor its debt commitments of USD 3.3 billion that are due this year alone.
The economy’s outlook is grim. Weak external and domestic dynamics coupled with debt repayments in foreign currencies are constraining growth prospects. Furthermore, a weak economic recovery in Russia will keep remittances inflows and export growth depressed. FocusEconomics Consensus Forecast panelists see GDP falling 1.5% in 2016, which is down 0.3 percentage points from last month’s forecast. For 2017, the panel projects that the economy will rebound to a 1.5% expansion.
KAZAKHSTAN | Economy has much room for improvement
Economic activity took a hit at the beginning of the year against a backdrop of low oil and gas prices and a protracted recession in Russia. Preliminary data show that GDP decreased 0.2% year-on-year in the first quarter, which marked the country’s first economic contraction since 2009. A breakdown of data by sectors shows that growth was dragged down by a deterioration in services and industry. Weak domestic demand, in particular private consumption, likely weighed on services growth in Q1. Meanwhile, the industrial sector, particularly the hydrocarbons sector, was hit hard by a renewed fall in commodities prices. More recent data suggest that the deterioration in the industrial sector persisted at the outset of Q2 as industrial output moved deeper into negative territory in April.
The Kazakh economy lost strength considerably in 2015 and economic weakness is expected to persist this year fueled by the spillovers from the protracted Russian recession and a slow recovery in oil and gas prices. Economists surveyed this month expect the economy to expand 0.3% in 2016, which is unchanged from last month’s forecast. Next year, GDP is seen accelerating to a 2.1% expansion.
RUSSIA | Worst of downturn has passed
In the first quarter, the Russian economy continued to adjust to the shocks of lower commodities prices, global financial volatility and international sanctions, contracting 1.2% annually. However, the contraction was milder than expected as the government’s economic policy—a free floating exchange rate, an injection of liquidity into the banking sector and limited fiscal stimulus—cushioned the economic shockwaves, buttressed confidence and stabilized the banking system. Signs of some green shoots were corroborated by April data for industrial production and the external sector: industrial output continued to stabilize and exports, while still in the doldrums, contracted at the slowest pace since February of last year. On a negative note, the federal budget deficit increased in April. In order to cover it, the government drew down part of the assets in the Reserve Fund, tapping into its rainy day fund for the first time this year.
The economy has started to show signs of stabilization following last year’s collapse. Yet the recession is expected to continue this year as forecasters project the economy to contract 1.1% due to still low oil prices, weak private consumption and the government’s fiscal consolidation measures. Nonetheless, analysts lifted Russia’s 2016 GDP growth forecast by 0.2 percentage points over the previous month due to brighter prospects for a recovery in oil prices. For 2017, forecasters expect the economy to increase 1.3%.
UKRAINE | Hesitant economy is on a slow path to recovery
After over two-years of contraction, Ukraine’s economy returned to growth in the first quarter of 2016, although the pace of expansion was meagre. Fewer military clashes and more stable price pressures have helped lead to a stabilization in economic data and the economy appears to have started on a modest recovery path. Industrial production recorded a third consecutive expansion in April and the economy’s stabilization led the Central Bank to reduce capital controls in May. Meanwhile, the IMF gave a tentative green light in May for a disbursement of fresh funds, conditional on a number of reforms. The funds had been delayed for months amid political turmoil in the country and are expected to be distributed in July.
A more stable political environment and progress on the IMF program should help economic growth to pick up pace throughout the year. However, the economy will remain in a fragile state and the recovery is expected to be modest compared to last year’s pace of decline. The FocusEconomics panel sees the economy growing 1.1% this year, which is unchanged from last month’s forecast. For 2017, the panel sees the country accelerating to a 2.5% expansion.
INFLATION | Inflation stabilizes in April after five consecutive drops
Recent data show that inflation in the Commonwealth stabilized at the beginning of the second quarter. According to a regional estimate, inflation was 7.9% in April, which was in line with March’s reading. Prior to April, inflation had fallen uninterruptedly from a peak of 13.8% in October 2015. April’s reading was the result of a stabilization in Russia’s inflation, while inflation in Azerbaijan and Kazakhstan increased. In Belarus, Kyrgyzstan, Moldova and Tajikistan, inflation continued falling.
Inflation in the region remained low at the outset of Q2, but significant upward pressures remain. Economists surveyed this month by FocusEconomics expect inflation in CIS to end this year at 8.0%. This month’s forecast was unchanged over the previous month and reflected that lower inflation projections for Armenia, Belarus, Kyrgyzstan and Russia compensated for higher forecasts for Kazakhstan, Tajikistan and Uzbekistan. Azerbaijan and Moldova were the countries for which analysts left the projections unchanged.
The inflation forecast for Ukraine, which is not included in the regional estimate, was cut over the previous month. Looking forward, analysts predict that inflation in the region will fall further to 6.4% in 2017.
Written by: Ricardo Aceves, Senior Economist
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