Regional Outlook
The war is having a devastating impact on human life and causing economic destruction, both in Ukraine and Russia. According to our estimates, which are changing as the war continues, Ukraine’s GDP will contract by 45% in 2022 and Russia’s by over 11%. So, this will lead to significant economic losses in our region. And this is the second major shock to trigger a recession in the region in two years. In 2020, the year of the COVID pandemic, the region contracted by 2% and this time output is forecasted to contract by 4.1%, which is a fall twice as steep. In addition to Ukraine and Russia, four other countries—Belarus, Moldova, Kyrgyz Republic, and Tajikistan—are expected to fall into recession. And growth projections have been downgraded in nearly all countries in the region due to spillovers from the war.
Risks to the Outlook
The outlook is subject to many risks, but the most important one is escalating war, which could significantly worsen the situation. A further worsening of the conflict could also fragment regional integration and disrupt critical trade and investment links, which would have important long-term consequences. Financial stress is possible and is another risk—higher interest rates, tightening financial conditions, declining portfolio flows, the need for high debt levels and reduced ability to service them, depreciation, can all lead to strain on the financial sector. And if the war continues, even contagion is possible. Third significant risk is inflationary pressures. Now, the inflationary pressures were already there before the war. But with the war, rising commodity prices and currency depreciation could make things worse, leading to runaway inflation and requiring a much tighter monetary policy, which is difficult during recessions. And finally, COVID of course could make a comeback. A much more deadly, virulent strain could complicate things significantly.
Policy Priorities
These are challenging times for policymakers. Now, crises obviously do not negate the need for focusing on long-term challenges. And long-term challenges don’t change just because there is a crisis. This is a region which is still transitioning to a market economy, promoting growth, the private sector, strengthening human capital, building institutions and governance are always important and still important. But obviously when there are issues of stability, it becomes a priority to strengthen stability and resilience. And to that effect, it’s important for policymakers to support global and regional integration to ensure regional trade and linkages remain intact. Also, during these times it is important to shore up macro stability, including bolstering central bank independence, fortifying macro buffers and frameworks and prudential measures, so that policymakers can follow credible macro policies and communicate these policies clearly. A second important area for these times is, when the time comes, to be able to promote inclusive recovery to reduce inequality. This is very important to ensure there is no social unrest and unhappiness. For example, social protection for recovery is going to be very important to protect the most vulnerable, including those that are migrants and refugees. And finally, we still have to keep our eye on securing a sustainable future by bolstering a green and resilient recovery. So, improving energy efficiency, reducing waste in energy consumption, and technological innovations to transition to cheaper, cleaner, and more reliable power are more important than ever before.
Major Transmission Channels
The war is impacting the region and is also having a global impact through important transmission channels. These include commodity shock, trade, financial markets, remittances, tourism, and, of course, the refugee crisis. The first three—commodities, trade, and financial shocks—are actually global shocks, which then will impact the region through secondary effects as well. Let me first talk about commodities. Both Russia and Ukraine are major exporters of commodities: energy, food, metals. For example, Russia accounts for 25% of global natural gas exports. And Russia and Ukraine account for about a quarter of all global wheat exports. Europe is particularly dependent on Russian energy imports. With disruptions, it’s difficult to substitute for these significant amounts, so supply shortages lead to price shocks, pushing up inflation everywhere. Also, food security concerns arise in the South Caucasus, Central Asia, as well as countries in Middle East and Africa. Now the second shock is through trade in general. We know Russia and Ukraine are only 2-3% of global trade, but the war and the sanctions have disrupted trade routes, increased global shipping and insurance costs—impacting global value chains that were struggling to recover from COVID disruption. So, together with higher commodity prices, additional strains on global value chains are further fueling inflationary pressures. And, of course, Russia is a critical export destination for many countries in Eastern Europe, South Caucasus, Central Asia and the Baltics, so there is also a direct impact. Now, financial market transmission is also important, because countries were already facing tightening financial conditions before the war. But because of the worsening outlook and with the war there is weakening investor confidence and flight to safety, which leads to renewed portfolio outflows and currency depreciation in the region. And particularly affected are those countries that have high current account deficits or large shares of foreign exchange denominated debt, non-resident debt, or short-term debt, which could all struggle to rollover their debt and face significantly higher debt service obligations. Now, the war is also disrupting income flows, remittance flows, and tourism, for example, from Russia and Ukraine represent important sources for some of our countries in the region. Remittances from Russia count for 30% of GDP in some Central Asian countries such as Kyrgyz Republic and Tajikistan. Russian and Ukrainian tourists are also an important source of income for countries such as Turkey, Georgia, Moldova, Montenegro, and Poland. And finally, the war is causing a huge humanitarian crisis. Since it started close to four million refugees fled Ukraine, with over half crossing into Poland and many to Hungary, Moldova, Romania. So, with the number of refugees estimated to grow much more in the coming months, the host countries will need help accommodating them and to ensure that delivery of basic services are provided.
