The impact of the COVID-19 pandemic in Central Asia has been profound, as the region’s economies were still feeling the effects of the 2008-09 Global Financial Crisis and the 2014-15 commodity-price shock. The region’s aggregate GDP shrank by almost 2% in 2020 according to official data, erasing at least four years of per capita income gains in some countries and pushing an estimated 1.4m people into poverty (OECD, 2021[4]). The lingering effects of the pandemic and a slow vaccination rollout throughout 2021 accounted for a slower than expected recovery, even if activity strengthened in the second half of the year, driven by strong domestic consumption. This trend was supported by large remittance flows, especially in Kyrgyzstan and Tajikistan (IMF, 2022[5]; OECD, 2021[4]).
Weathering Economic Storms in Central Asia
The longer-term impacts of the war might exacerbate fiscal imbalances across Central Asia
Central Asian governments are still dealing with the consequences of the pandemic
A fragile post-COVID recovery has not allowed governments to regain fiscal space
Figure 13. Fiscal dynamics in Central Asia (% of GDP)
Notes: Data for 2022-2023 are estimates.
Source: (IMF, 2022[22]).
Overall, since 2020, fiscal space across the region has drastically declined and debt ratios have risen, due initially to a sharp decline in commodity prices and remittances in early 2020, and then to the cost of fiscal support packages. Most Central Asian countries took comprehensive measures to respond to both the sanitary and economic emergencies created by the COVID-19 pandemic, with fiscal support packages ranging from 3.5% of GDP in Tajikistan, to 5.7% in Uzbekistan, 6.1% in Kyrgyzstan, and 7.3% in Kazakhstan (OECD, 2021[4]). While this effort proved crucial in helping the region’s economies withstand the slowdown, it also put great pressure on public finances. Throughout 2020 and early 2021, countries witnessed a large reduction of fiscal space and mounting external debt, as current accounts and fiscal balances were driven into the negative. While Central Asian governments have gradually reduced support measures, higher debt and a surge in inflation throughout 2021 did not result in a notable improvement of their public finances (IMF, 2022[5]).
So far, sustained consumption has supported government revenues
Remittances represent a substantial share of government revenues and GDP across Central Asia, comparable and sometimes even larger than the countries’ share exports of goods and services (Figure 14). The increase in remittances in the first half of 2022 has contributed to boost consumption and government revenues in Kyrgyzstan, Tajikistan and Uzbekistan. The relocation of Russians with a comparatively high purchasing power, as well as of firms that used to be active in Russia, is further supporting consumption and generating additional tax revenues across the region (EUAA, 2022[86]).
Figure 14. Remittances and current-account dynamics in Central Asia
Note: *Data for 2021 are estimates. No data available for Turkmenistan.
Source: (KNOMAD, 2022[87]; World Bank, 2022[44]).
The main contribution is likely to come from both indirect consumption taxes, such as the value-added tax (VAT), as well as, in the longer run, corporate income taxes, and even personal income taxes if some of the newly arrived migrants settle on a more permanent basis in their host country. In the short run, VAT income which represents on average 33.6% of tax contributions to national budgets across the region (OECD, 2021[4]), will be the most immediate support to government revenues.
However, in the longer run, financial market developments might weigh negatively on the sustainability of public finances
The pandemic already demonstrated that the ability of Central Asian countries to engage in debt-financed government spending remains restricted by relatively high borrowing costs and reduced access to financial markets. Only Kazakhstan, which has been issuing sovereign and corporate bonds since 1996, and Uzbekistan, which entered international debt markets in 2019, appear to have a relatively good position vis-à-vis external borrowing costs. Following the start of Russia’s war in Ukraine and until August 2022, sovereign bond spreads rose between two and three times more in Central Asia than in other emerging markets, which suggests investors’ concerns about Central Asia’s close political, economic and financial ties with Russia. Until May 2022, financial markets seemed, for instance, to be more concerned with Kazakhstan’s long-term sustainability prospects, as 10-year bond yields increased more than 2-year yields. Indeed, between the week of February 24 and end of May, these yields increased respectively by 184 and 114 basis points (bp). Since May, both yields have continued to increase, yet the two year maturity has seen the strongest relative increase. Between early May and end of August indeed, the 2-year bond yield increased by 246 bp, in comparison to 35 bp for the 10-year yield (World Government Bonds, 2022[88]; Investing.com, 2022[89]). Such a trend reversal might appear surprising given that globally financial conditions for oil exporters deteriorated relatively less as oil and gas prices surged, however might be the expression of an increased risk sentiment for Central Asia1.
This comes against the backdrop of the pandemic which induced an increase in debt in 2020 that only slowly began to reverse in 2021, except for Mongolia, due to the lasting cost of fiscal support packages, and tightened global financial conditions, which put pressure on local currencies and sovereign spreads. The continued tightening of monetary policy in the United States and other OECD economies might lead to increasingly stringent financial conditions for Central Asia over the medium-term, while tighter domestic monetary policies to target inflation are increase borrowing costs and diminish fiscal space, at a time where debt will be carried over the next years. This could prove a major challenge to debt sustainability in Kyrgyzstan and Tajikistan especially, where fiscal space is already limited (IMF, 2022[22]; OECD, 2021[4]). Both countries are indeed still considered to have respectively moderate and high debt distress risk according to the IMF, mainly due to their dependence on exports (of raw materials) whose revenues are integral to their ability to service public borrowing (IMF, 2020[90]; IMF, 2020[91]; IMF, 2021[92]; IMF, 2022[93]).
Figure 15. Debt sustainability in Central Asia
Notes: (1) Exports refer to total exports of goods and services, expressed as % of GDP based on the nominal GDP of the given year. (2) Government debt refers to all government or publicly backed liabilities, both internal and external, and is expressed as % of GDP. (3) The debt-to-export revenue (DER) is a commonly used indicator of sustainability of debt (rhs), expressed as a simple ratio of export earnings to outstanding debt; a lower number indicates that outstanding liabilities can be settled more quickly using export earnings. (4) The assessment of debt distress is taken from debt sustainability analyses compiled by the IMF in their most recent country reports for Kyrgyzstan, Tajikistan, and Uzbekistan.
Source: (IMF, 2022[22]).
In the longer run, the disentangling of Central Asia’s economic relations with Russia might accelerate China’s economic presence in the region
Central Asia could benefit from a rethinking of China’s regional trade strategy
In recent years, China has become one of Central Asia’s main trading partners (Figure 16), as well as an important source of investment and credit. China runs trade surpluses with all Central Asian countries except Turkmenistan, which mainly exports mineral and energy resources to China while importing little in return (IMF, 2022[22]). Room for expanded export dynamics exists, in particular for non-energy related commodities, as energy and mineral resources constitute the bulk of Central Asian exports to China, with Kazakhstan’s exports to China dominated by crude oil, petroleum gas, refined copper, ferroalloys, and radioactive chemicals, and coal for Mongolia. The picture is very similar for Uzbekistan, Kyrgyzstan and Tajikistan where metals represent the largest share of exports to China (UNCTAD STAT, 2022[1]).
Over the past decade, especially with the Belt and Road Initiative (BRI), China has also deepened its political and financial presence in Central Asia. Recently investments have expanded beyond energy supply infrastructure, and discussions were engaged to open up the Chinese consumer market to Central Asia’s food exports in an attempt to ensure food security. If the Chinese market were indeed to open up to Central Asian products, new business opportunities might come along at a moment when the Russian market is increasingly problematic. A joint China-Central Asia summit in January 2022 called for a doubling of bilateral trade turnover by the end of the decade and for increased Chinese investment in the region.
The current disruptions to Chinese freight and traffic through Central Asia, especially on the northern route transiting via Russia to Europe, might force China to rethink its regional trade strategy, and could allow Central Asian countries to take a more strategic role vis-a-vis their large neighbour. However, strict zero-COVID policies throughout 2021 and the first nine months of 2020 in China resulted in additional and increasing border restrictions, especially with Kazakhstan and Mongolia, which might slow down possible trade reorientation (EBRD, 2022[94]), and casts doubt on China’s willingness to engage with the region as import partners rather than just transit corridors (Eurasianet, 2021[95]). In the medium-term, if China’s economic slowdown were to persist, prospects for increased exports from Central Asia might look bleak.
Figure 16. Evolution of China-Central Asia trade (2016-2020)
Source: (UN Comtrade, 2022[2]).
However, Central Asia’s debt exposure to China could increase amidst tightening global financial conditions
Debt sustainability in Central Asia needs to be considered mainly as an issue of state revenue management, dollarisation, and exposure to a limited number of creditors, rather than an issue only of debt levels (OECD, 2021[4]). Indeed, the high level of dollarised debt for some countries leaves them vulnerable to exchange-rate movements and the tightening of global financial conditions, following, among other things, the normalisation of the US monetary policy (IMF, 2022[5]). The issue appears most pressing for Tajikistan and Uzbekistan which have almost all of their debt in USD (respectively 100% and 97%) (Reuters, 2022[96]; OECD, 2021[4]). If global financing conditions were to deteriorate further, Central Asian countries could seek financial support from China, as the interest of other investors might fade. However, the region’s debt exposure to China already seems to be high, while the pandemic has highlighted the inherent sustainability issues it raises. Indeed, Kyrgyzstan, Mongolia and Tajikistan have seen their external debt to China increase drastically over the past decade, due to large amounts of funding for infrastructure projects under the BRI (Center for Global Development, 2018[97]). If the exact amounts and terms of China-held debt (both official bilateral loans and alternative loans channelled through SOEs) are unclear, recent research suggests that on average over 2000 to 2017, it could amount to close to 30% of GDP in Kyrgyzstan and Tajikistan, 25% in Turkmenistan, close to 20% in Kazakhstan and Mongolia, and about 10% in Uzbekistan. Official data from Kyrgyzstan even reports a debt exposure as high as 42% of GDP in 2022 (Standish, 2022[98]).
Table 4. Debt exposure of Central Asian countries to China
Source: (AidData, 2021[99]; IMF, 2022[22]).
The pandemic has highlighted China’s ambiguous stance towards Central Asia, as well as the difficulty some Central Asian governments face in servicing their debt. Tajikistan and Kyrgyzstan benefitted from the G20 Debt-Service Suspension Initiative (DSSI) in 2020 and 2021, the purpose of which was to allow low-income countries meet their social spending objectives throughout the pandemic, but conditions on their obligations to China have at best been only partially reduced, as China has not acceded to the countries’ request for debt write-offs. While information on Chinese debt relief and suspension remains scarce, Tajikistan appears to have benefitted from USD 40 million debt relief from China under the DSSI in 2020, though additional debt relief was refused in 2021, and Kyrgyzstan’s requests seem to have been unsuccessful (China-Africa Research Initiative, 2022[100]). The main issue seems to stem from the structure of Central Asia’s debt exposure to China, as a non-negligible amount appears to occur outside sovereign channels, resulting in off-budget debt exposure to China (AidData, 2021[99]). Consequently, even though China was a signatory of the DSSI, it only applied DSSI terms to debt owned by its two official bilateral creditors (Eximbank and CIDCA); it did not extend this relief to other sources of finance used, in particular under the Belt and Road Initiative. Available information suggests that the region has increased its reliance on short-term, expensive, and sometimes resource-backed borrowing, which raises risks of debt unsustainability and distress, while reducing both future debt servicing capacity and access to concessional financing (OECD, 2020[101]; Natural Resource Governance Institute, 2020[102]; IMF, 2019[103]; OECD, 2021[4]; AidData, 2021[99]).
Note
← 1. The 2-year bond yield exceeds the 10-year one since early August, which might indicate some fears of economic slowdown.