The Asian Development Bank (ADB) has issued a new major report – the Asian Development Outlook (ADO) 2007 Update. The Update revises GDP growth projections made in March’s ADO 2007 for six of the seven countries in Central Asia (not Tajikistan). This lifts the subregional projection to 11.1% from 10.3%. In the first half of 2007, these countries showed evidence of quickening economic activity.

In Azerbaijan, the pickup was driven by the contribution of net exports on the back of an increase in oil production of almost 65% (year on year) in the first half. Kazakhstan’s growth is being pushed higher by strong growth in domestic demand, despite a negative contribution of net exports of goods and nonfactor services. Growth in Turkmenistan has been raised on account of strong gas exports. Uzbekistan also continues to benefit from a favorable external environment, with net exports the main contributor to growth.

Domestic demand is the main driver of growth for Armenia and the Kyrgyz Republic — the other two countries with raised forecasts — and for Tajikistan. In all three, disposable incomes continue to be boosted by remittance inflows. Armenia and the Kyrgyz Republic are seeing a greater pickup than expected in private investment activity related to FDI inflows. Tajikistan’s outlook remains unchanged though, and energy shortages continue to hurt the mainstay of industry, aluminum. The authorities have ramped up public investment spending, but are relying on external sources. The sector pattern of growth across Central Asia shows that construction- and services-driven activity is continuing to accelerate.

Inflation in five countries is on the rise due to rapid monetary expansion resulting from strong foreign exchange inflows and much expanded public spending. The Update revises upward the average inflation rate projection for 2007 to 9.7% from 8.6%.

In Azerbaijan, 12-month consumer price index inflation rose to 15.2% in July 2007, driven by a loose fiscal policy, unsterilized interventions in the foreign exchange market, and upward adjustments in administered prices. In Kazakhstan, larger bank borrowing than last year has lifted domestic demand and inflation. Upward adjustments in administered prices were the main factor in raising inflation in Tajikistan. Uzbekistan’s officially reported inflation rate for the first half of 2007 was 2.2%, but the findings of a recent IMF review mission suggest that although inflation has eased somewhat, 10% is a reasonable estimate. A widening current account surplus (and overall surplus) there continues to exert upward pressure on monetary aggregates.

The subregion’s economies (with the exception of Tajikistan) are generally coping with real exchange rate appreciation induced by 30 Asian Development Outlook 2007 Update strong net foreign exchange inflows. In an environment where most of these inflows are expected to be sustained over the medium term, real appreciation pressures are likely to persist. Since influencing the real exchange rate is impossible beyond the short term, central banks should accord primacy to ensuring low inflation, and not resist an orderly appreciation in nominal exchange rates.

The Update revises marginally upward the subregion’s projected current account surplus for 2007 to 3.5% from 3.2%. Export growth in the main hydrocarbon-exporting countries (Azerbaijan, Kazakhstan, and Turkmenistan) was strong in the first half of 2007. Uzbekistan, too, is realizing large surpluses in both its trade and current accounts. Export growth is picking up across the subregion but is accompanied by accelerating import demand, yielding widening trade deficits.

Subregional prospects

The external environment is expected to be quite favorable in 2008, yet the pace of domestic reforms to energize the private sector will also be an important determinant. While world energy prices are expected to stabilize, they will remain at relatively high levels, supported by global demand. Accordingly, GDP growth forecasts for most hydrocarbon exporters are being revised upward. Nonenergy commodity prices, in particular base metals, are expected to soften only slightly in 2008 while gold prices are expected to remain high. With larger production capacities being installed, exporters of base metals (Armenia and Tajikistan) and gold exporters (Kyrgyz Republic and Uzbekistan), should see improved export performance.

For the subregion as a whole, the Update revises upward the GDP growth forecast for 2008 to 10.1% from 9.4%. But surging foreign exchange inflows with potential inflationary consequences will remain a problem, and the inflation forecast for 2008 is revised up to 9.1% from 7.9%. The average current account surplus as a share of GDP has been adjusted upward from 3.3% to 3.6%, mainly due to higher hydrocarbon exports in several countries; capital inflows will also support a high overall balance.

Country highlights

Armenia

Projected GDP growth for 2007 is uprated to 11.0% given the better than expected growth for the first half of 2007 of 11.2%, which largely reflected continued expansion in construction and services. Inflation edged up to 4.5% (year on year) in June 2007, strongly suggesting that the central bank will tighten monetary policy further to achieve its end-of-year inflation target of 4.0%. Fiscal policy remains prudent, with an improving ratio of tax revenue to GDP and moderately higher capital expenditure financed from official external assistance. Exports are recovering from a slump in 2006 but import demand is even stronger, widening the trade gap. Still, the projected current account deficit for 2007 has now been slightly reduced from ADO 2007, reflecting larger inward remittances; FDI inflows are likely to cover this deficit.

Azerbaijan

Azerbaijan’s GDP growth for this year is also revised upward, from 25% in ADO 2007 to 27%, as is the forecast for 2008, from 17% to 20%. The economy grew at a torrid 36.2% year on year during the first 5 months of 2007, powered by large increases in oil production and exports (as new projects move toward full production), which spurred growth in construction and services. Full-year inflation, too, is adjusted upward, from 14% to 18%. Excessive expansion in public spending and the money supply has fanned inflation pressures and, as expected, pushed inflation into double digits in January–June 2007. The central bank has tried to tighten monetary policy and is allowing the manat to appreciate gradually, but this by itself is unlikely to rein in inflation. Of concern is the projected non-oil fiscal deficit as a share of nonoil GDP since the authorities persist with steep increases in current and capital expenditures. With import growth slowing (as import-dependent hydrocarbon projects near completion), the trade and current accounts are posting large surpluses. FDI inflows, which had boosted investment rates in the last few years, are on the wane. Domestic investment has recently registered an uptick, but a sustained improvement will depend on a significant amelioration in the business climate and in governance reforms.

Kazakhstan

The GDP growth projection for 2007 has been raised from 8.6% to 9.0%; the forecast for 2008 is kept at 8.9%. The pickup in growth in the first half of 2007 stemmed from higher oil production and continued strong domestic demand, driven by private consumption and investment spending. Projected inflation in 2007 is adjusted upward to 8.5% from 8.0% in ADO 2007. Consumer price inflation eased slightly (8.1% year on year in June 2007) but inflationary pressures stemming from excessive foreign borrowing by commercial banks for onlending remain a major concern. The central bank has tightened monetary policy, raising the discount rate and reserve requirements for foreign currency borrowing. Central government spending is expected to be higher than in the original budget, but so too is revenue. The planned increase in the nonoil fiscal deficit as a share of non-oil GDP is moderate and within a "prudent band." Export growth has been buoyant and the trade balance is in surplus, but significant deficits in its services and income balance are widening the current account deficit (fully covered by FDI inflows). Structurally, the Government has taken several initiatives for improving the competitiveness and productivity of the non-oil sector, but the financial sector remains vulnerable to currency and interest rate risks.

Kyrgyz Republic

Growth for this year is now put at 6.0%, from 4.0% earlier, and the forecast for next year is upgraded from 5.0% to 7.0%. The economy grew strongly in the first half of 2007, by 9.2% relative to the same period last year, with good performance from construction and services and a recovery in industry. Consumer price inflation in January–June 2007 was moderate at 4.8%. Export growth has strengthened, but imports — mainly energy, consumer durables, and capital goods — have outpaced it. In the financial and capital accounts, FDI inflows, particularly from Kazakhstan, have picked up, helping build foreign exchange reserves. Structural reforms have made some progress, particularly in the areas of business regulation, and privatization of energy and banking.

Tajikistan

At 7.3%, economic growth was strong in the first half of 2007, buoyed by higher investment spending and remittance-fueled consumption. Full-year growth is kept unchanged at 7.5%. Energy shortages affected aluminum production. With the pass-through of higher natural gas export prices charged by Uzbekistan and with upward adjustment in electricity tariffs, inflationary pressures are likely to persist for the rest of the year. The Update therefore revises upward projected inflation for 2007 from 7.0% to 11.4% (the 12-month rate at end-June 2007 was 9%). Following debt relief under the Multilateral Debt Relief Initiative, the external debt strategy has taken another turn with the authorities’ plan to contract significant amounts of concessional loans to finance infrastructure.

Turkmenistan

Stronger than expected gas exports propelled growth in the first half of 2007, such that GDP growth for 2007 and 2008 is revised upward to 10.0%. At the start of the year, the new Government launched some reforms in education, public health, and social protection, but is keeping the management of hydrocarbon revenues nontransparent and off the budget.

Uzbekistan

The Update upgrades projected GDP growth for 2007 from 7.4% to 8.0% and for 2008 from 7.1% to 7.5%. High investment spending and net exports drove first-half 2007 growth of 9.7%. Inflation is expected to be pushed still higher: for 2007 from 9.0% to 10.0% as a sharp increase in net foreign assets has fed monetary expansion. Price pressures are likely to build in August 2007 when large wage and pension hikes come into effect. Following negotiations for higher prices in export contracts as well as greater investment, natural gas exports are becoming more important in the export commodity structure. A portion of these receipts is being channeled into the Uzbekistan Fund for Reconstruction and Development.