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Rising Financial Pressures from the East

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It’s hard to get a break in the Europe and Central Asia region, it seems – even a short one. Hit hard by the troubles in the Eurozone at the beginning of the decade, emerging and developing countries in Eastern Europe are, at the beginning of this year, contending with renewed fears. Meanwhile, external pressures have built up on the Central Asia side as well.

All eyes turned to Russia recently, when on 16 December the ruble plunged by more than 11 percent, despite the Central Bank of Russia’s last-minute interest rate hike of 6.5 percentage points to 17 percent. When it looked like Russia’s turmoil might spread to global markets, western economies sat up and paid close attention.

What may have gone unnoticed, however, is the ongoing impact on our client countries in the Europe and Central Asia region. Many economies are vulnerable to negative developments in Russia, but its neighboring countries are especially so. And, those neighbors already experiencing weak macro-financial conditions are most at risk.

While some economies in the region are in relatively good shape, countries such as Armenia, Belarus, Georgia, Kyrgyz Republic, Moldova and Ukraine (facing additional unique circumstances) are burdened by low GDP growth and/or heavy public/external debt. In addition, Tajikistan, Moldova, and Ukraine already have fragile financial sectors. Oil and commodity rich countries may have the benefit of accumulated foreign-exchange reserves, but recent price movements could expose vulnerabilities from weak non-oil/commodity balances.

So, with increasing pressures on the eastern side of the region, how can we better understand the risks to countries’ financial sectors … and avoid an economic “double whammy” – from Eurozone and Russia developments – in the region?

To begin with, we suggest looking at three important transmission channels: trade, remittances, and financial flows.


A trade shock can affect a financial sector’s profitability and asset quality. Countries with a higher share of trade to GDP (i.e., more open economies) and with a high proportion of trade with Russia may be most affected. Belarus, Ukraine, Moldova, Armenia, and to a certain extent, Georgia, fit this profile. In addition, oil and commodity price drops are already adversely impacting other oil/commodity exporters such as Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan.

The likely devaluation of local currencies will put pressure on banks’ balance sheets through open foreign-exchange positions (foreign-exchange liabilities exceeding foreign-exchange assets), and a deterioration in the quality of unhedged foreign-exchange loans (lending in foreign currency to borrowers with local currency income sources).


Remittance flows can affect a financial sector’s liquidity and profitability. Workers’ remittances from Russia are an important part of national income and financial sector flows, affecting deposits and fees, in Tajikistan, Kyrgyz Republic, Moldova, Armenia, and Georgia.

Remittance flows may decline with a lag, holding steady for a while – but only to weaken in response to negative growth and decreased employment. The immediate impact of the ruble depreciation may be amplified if the Central Bank of Russia was to introduce foreign-exchange controls – as workers in Russia will have no choice but to send remittances home in rubles.

Financial Flows

Financial flows can also have an immediate and direct impact. Many of Russia’s neighbors can also be linked to its economy through both foreign direct investment and banking. Although foreign direct investment from Russia accounts for less than 1 percent of GDP in most countries, several major Russian banks have significant market shares in Armenia, Belarus, and Ukraine. And, most local subsidiaries of Russian banks rely on parent funding.

Some large European Union banking groups, with a strong presence in Russia and the Europe and Central Asia region, are being seriously affected by the weakness of the ruble and by prospects of Russia entering a severe recession. A potential worsening of the crisis could induce further deleveraging of debt in certain countries and, in some cases, exacerbate existing vulnerabilities in their financial sectors.

But, we shouldn’t look only at these three traditional transmission channels – that is, admittedly, too narrow an approach. After all, contagion and panic can be just as powerful these days when it comes to influencing policy decisions.

Stressed markets may initially differentiate among the affected countries in terms of vulnerability to a Russian downturn, but general risk aversion among international investors could spill-over to a more serious regional contagion. In this case, country-specific deposit runs, as well as runs on the respective local currencies, cannot be ruled out. We saw this occur with the Belarusian and Armenian currencies after the end-of-year sharp devaluation of the ruble.

All in all, we can’t let our guard down. These turbulent times remind us that we should advise our client countries to use the “good times” to prepare for the “lean times” – and not take action only when problems arise. You just never know what’s around the corner!

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