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3
problem (with external debt
denominated in foreign currency) will have difficulties in servicing their external debt since in
“bad times” the real exchange rate tends to weaken and, consequently, to reduce the power of
domestic output over foreign claims, (B. Eichengreen et al, 2003). Besides, the inability of the
country to serve its external debt will reduce willingness of borrowers to lend in the future
and thereby to accentuate the pro-cyclical nature of capital flows. Additionally, the currency
mismatches
4
, either in the public sector, the corporate sector or other sectors can also generate
serious problems for the economy (particularly if there is a reversal of foreign exchange
inflows) if the liabilities in foreign exchange greatly exceed their foreign exchange assets or
earnings.
The composition of capital inflows can have an important influence on the
vulnerability of countries to exogenous financial shocks caused by current crisis since not all
capital flows are equal. In case of ex-USSR countries, the sources of foreign exchange
inflows vary - in some cases it is primarily oil export earnings (Kazakhstan, Russia,
Azerbaijan), in others capital flows such as portfolio, official and foreign direct investment
(Georgia), and in others remittances (Tajikistan, Kyrgyz Republic and Uzbekistan).
Generally, most of the foreign exchange inflows in CIS countries are long-term in nature.
Remittances, which are transfers of money by foreign workers to their home countries,
are likely to be a relatively long-term source of foreign exchange. They are an increasingly
important source of external finance for Central Asian countries. Usually, “this type of inflow
is considered independent from shocks in international financial markets and is generally
countercyclical; meaning that part of the impact of a shock is typically offset by remittances”
(C. Dieterich, 2007). However, remittances are highly dependent on economic development
of sending country. For instance, remittances directing to Tajikistan, Uzbekistan and Kyrgyz
Republic are highly dependent of economic situation in Kazakhstan and Russia as well as of
world oil prices. As we will show later, the drop in oil and gas revenues in Russia and
Kazakhstan has not only played havoc on the government budget, but also on the countries’
once thriving construction and banking industry. Because of this construction slowdown
many of the jobs which supply remittances for foreign workers from other Central Asian
countries are drying up. Therefore, countries like Tajikistan, Uzbekistan and Kyrgyz
Republic, which are highly dependent on remittances, are affected by current economic crisis
in indirect ways. Thus, we can observe sort of retransmission of US-made crisis to poorer
countries of Central Asian region via the deterioration of economic situation in Kazakhstan
and Russia.
3
The original sin is defined as an inability of a country to borrow abroad in its own currency, (B. Eichengreen et
al. (2003).
4
Currency mismatches are differences in the values of the foreign currency denominated assets and liabilities on
the balance sheet of households, firms, the government and the economy as a whole (B. Eichengreen et al.
(2003).
5
Another important type of foreign exchange inflow into the CIS countries (especially
in Russia, Kazakhstan and Azerbaijan) is Oil Revenues. Despite the general view that foreign
inflows arising from oil exports are potentially volatile due to large fluctuations in oil prices,
in the “good times” (i.e., before the crisis) this type of inflow was considered by oil-exporter-
countries as a medium to long-term inflows. The reason for it was the outlook which has
indicated a relatively high level of world demand for petroleum products for the next few
years. However, the current global recession and a sudden change in oil prices show the
volatility of such inflow. For instance, with oil and gas prices dropping because of declining
demand, Kazakhstan has already had to revise its budget for 2009-2011 budget, setting the
price at $40 (Central Asia Foreign Policy Blog, 2008).
Concerning capital inflow such as portfolio, official and foreign direct investment, the
economic literature discusses two types of factors that affect capital these types of inflows:
“push factors” in the originating country of the capital flows, for example, low interest rates in
the U.S. and Europe, which motivate investors to look for more attractive investment
opportunities elsewhere; and “pull factors” in the countries where capital flows to, for
example, enhanced macroeconomic stability and improvements in the business climate, (C.
Dieterich, 2007). However, as some of the factors determining capital inflows are beyond the
host country’s control, it is difficult to predict whether inflows are a short-term or a stable,
long-term phenomenon. In general, flows like Foreign Direct Investment (FDI) and, perhaps,
international portfolio flows are not only presumed to be more stable and less prone to
reversals (S-J. Wei, 2006), but are also believed to bring with them many of the indirect
benefits of financial globalisation such as transfers of managerial and technological expertise.
On the other hand, portfolio inflows, invested in equities and bonds, are more volatile than
FDI, but more stable than inflows in form of lending by foreign banks. At the same time, the
growth in net short-term inflows could be a source of concern for policymakers, as short-term
flows could be associated with higher volatility and risk of sudden reversals. This may be
particularly important for those countries that receive the greater share of these short-term
inflows, countries like Russia and Kazakhstan, (W.H. Buiter and A. Taci, 2003).
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