CAREC Institute Contributes to Discussions on Financial Stability in the Region

The Director of the CAREC Institute, Mr. Syed Shakeel Shah, participated in the high-level panel discussion on “Dealing with Risks and Vulnerabilities: Tightening Global Financial Conditions Amid Post Pandemic Recovery and Geopolitical Conflict” at the 2022 CAREC Economic and Financial Stability Cluster High Level Policy Dialogue on October 4, 2022.

The CAREC region faces the rising inflation which has tightened global financial conditions, increasing investor concerns about elevated economic risks and inflation prospects in the region. A rapid increase in the policy interest rate may expose the financial system of CAREC countries to vulnerabilities that have built up from higher levels of debt and inflation. Higher financing costs are expected to weaken the solvency of firms and the repayment capacity of households. Central banks in the CAREC countries face a difficult choice between containing inflation and supporting credit growth and economic recovery. The dialogue brought together senior officials from ministries of finance, central banks, and other officials and private sector representatives from CAREC countries, as well as senior representatives from the ADB, the IMF and the WB to discuss emerging risks and vulnerabilities to financial stability in the region and propose innovative solutions and policies to mitigate these risks.

Mr. Subir Lall, Deputy Director of the IMF’s Middle East and Central Asia Department, delivered a keynote presentation on the IMF’s assessment of region’s outlook driven by two main factors: 1) heightened uncertainties associated with geopolitical developments, and 2) synchronized monetary tightening across the globe to deal with higher inflation. The recovery from the pandemic was mainly driven by strong domestic demand, supported by counter-cyclical policies, and borrowing in low-income countries. However, the strong response to COVID-19 has eroded the macroeconomic buffers that many countries in the region built up before the pandemic, and public debt has reached a historic high. Inflation and job losses have increased poverty in some countries. Food security in terms of availability and affordability remains a challenge. Remittances are also likely to decline due to the geopolitical tensions, reducing the disposable incomes of many, especially the poor. Continued inflation and rising poverty and inequality may exacerbate socio-political tensions, creating further risks to stability and growth. In response, central banks in the region have embarked on a tightening cycle by raising their interest rates. Global financial conditions tightened faster and sharper than expected that reflects the synchronized monetary policy response of central banks around the world to rising inflation.

“To ensure macroeconomic stability and resilience, countries need to rebuild the buffers that have served them well during the pandemic, but this must be done in such a way as not to damage the still fragile recovery,” said Mr. Subir Lall. Monetary policies in most countries should seek to contain demand pressures and bring inflation down. Where possible, exchange rates should be allowed to adjust and absorb external shocks. Fiscal consolidation should be a priority in countries with elevated debt levels and may entail cuts in lower priority expenditure, including subsidies, while protecting growth and spending on critical infrastructure, health and education. The limited policy space in many countries raises the urgency of structural reforms to promote more resilient, sustainable, and inclusive growth, create more jobs and generate higher incomes. Some of the policies include strengthening governance and the business climate, reducing the role of the state, diversifying trade, and supporting growing transition.

Mr. Syed Shakeel Shah stated that that even CAREC countries were able to reach their pre-pandemic economic growth rates, the new challenges such as geopolitical tensions and the conflict in Ukraine, high inflation and the disruption of global value chains worsen growth prospects. The particular concern is food inflation in the region, especially for net importing countries. CAREC countries have experienced food inflation of up to 20% in a region where food-related expenditure constitutes up to 42% of the total household expenditures. In addition, the external debt in some CAREC countries exceeds two-year export earnings that becomes visible in the trends in the foreign exchange reserves which have declined over the past two years. Central Asian economies are more resilient to the shock of the conflict in Ukraine because of higher remittances and inflow of money from Russia, a strong ruble because of policy taken by Russian government. However, the increased risk of escalation of the war continues to pose a serious threat for CAREC region. With a risk of global economic recession with anticipated crash of commodity prices and a new sanction package coming to force against Russia may have negative impact on the CAREC economies. The policymakers in the region should work closely with the international financial institutions to avoid situation of over-indebtedness and persistent macroeconomic imbalance, when compounded by an extended shock may result in the collapse of economies. Countries should continue economic restructuring, economic diversification, and to mainstream necessary reform processes so to strengthen their long-term macroeconomic framework.

The Director of the CAREC Institute emphasized the importance of the regional corporation in dealing with risks. The CAREC Regional Integration Index indicates at low economic integration of the region requiring more proactive actions to improve the trade of goods and services, and movement of capital and people. The “soft” side of the regional cooperation should be strengthened by introducing regional single windows data interchanges for easily flow of trade through borders. The CAREC countries should continue working on health issues and strengthen the current regional arrangements to prevent future outbreaks. Countries must work closely together on food security and climate change adaptation and mitigation as the region is already experiencing mega climate-related events. In this regard, the CAREC Program and Institute are working together to promote cooperation among countries in these areas and develop policy recommendations and conduct advocacy campaigns.

Country delegates  Mr. Koba Gvenetadze, Governor of the National Bank of Georgia, Mr. Jameel Ahmad, Governor of the State Bank of Pakistan, Mr. Enkhtaivan Ganbold, Deputy Governor of the Central Bank of Mongolia, and Mr. Rustam Tahirov, Head of the Financial Stability Department at the Central Bank of the Republic of Azerbaijan  further shared their experiences and insights on rising risks from deteriorating global economic outlook and tighter global financial conditions, as well as the policy measures their institutions are taking to mitigate those risks and vulnerabilities.