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Mr. Mark A Horton, Hossein Samiei, Mr. Natan P. Epstein, and Mr. Kevin Ross
Since late 2014, exchange rates (ERs) and ER regimes of the Caucasus and Central Asia (CCA) countries have come under strong pressure. This reflects the decline of oil and other commodity prices, weaker growth in Russia and China, depreciation of the Russian ruble, and appreciation of the U.S. dollar, to which CCA currencies have historically been linked. Weaker fiscal and current account balances and increased dollarization have complicated the picture. CCA countries entered this period with closely managed ER regimes and, in many cases, currencies assessed by IMF staff to be overvalued. CCA central banks have price stability as their main policy objective, and most have relied on ER stability to achieve this objective. Thus, the first policy response involved intervention in local foreign exchange (FX) markets, often with limited communication. In this context, the IMF staff has reviewed ER policy advice and implementation strategies for CCA countries.
Mr. Mark A Horton, Hossein Samiei, Mr. Natan P. Epstein, and Mr. Kevin Ross

4 ) and unclear policy responses in many CCA countries. Strong links with Russia and lower exports and reduced remittances have contributed to weaker current account and fiscal balances. 1 High dollarization has complicated all aspects of ER policy decisions, as it has limited monetary policy transmission mechanisms and raised financial soundness concerns. These factors have led some central banks to work to stabilize ERs. Indeed, the policy response of some CCA central banks has lacked clarity, consistency, and effective communication. Capital flight has not

Mr. Mark A Horton, Hossein Samiei, Mr. Natan P. Epstein, and Mr. Kevin Ross

-mail: publications@imf.org www.imfbookstore.org www.elibrary.imf.org Contents Executive Summary Chapter 1. Introduction Recent ER Movements Monetary and ER Regimes in the CCA Assessment of CCA Currency Misalignments CCA Financial Sectors Capital Controls in the CCA Central Bank Independence and Transparency in the CCA Chapter 2. ER Policy Advice IMF ER Policy Advice and Rationale Macroeconomic Policy Advice Under Current Conditions Monetary Policy Modernization in Support of Greater ER Flexibility ER Adjustment Chapter 3

Sami Ben Naceur, Amr Hosny, Gregory Hadjian, and Ms. Natalia T. Tamirisa

context, proper sequencing of policies is essential. For example, countries with less flexible exchange rate regimes can start by gradually widening the exchange rate bands, managing liquidity more efficiently, and improving the monetary transmission mechanism through more effective policy rates. Generally, policies that target the de-dollarization of deposits contribute to de-dollarization of loans ( Garcia-Escribano and Sosa, 2011 ). Effective communication by CCA central banks will be critical . More transparent and effective communication by central bank officials

Miss Mercedes Vera Martin, Mr. Tarak Jardak, Mr. Robert Tchaidze, Mr. Juan P Trevino, and Mrs. Helen W Wagner

strengthened to address nonbanking financial institution vulnerabilities. Weaknesses in consolidated and cross-border banking supervision should also be addressed. Some CCA central banks do not have the power to conduct consolidated supervision, which hinders the identification of risks in banking groups. In some countries, legislation allows the supervisor to carry out consolidated supervision over limited activity of the group. Legislation is needed that clearly identifies the relationship between the bank and the rest of the group, to ensure compliance with related

Mr. Sami Ben Naceur, Amr Hosny, and Gregory Hadjian
Dollarization rates in the Caucasus and Central Asia (CCA) region are among the highest in the world, with adverse consequences for macroeconomic stability, monetary policy transmission, and financial sector development. Using dynamic panel data models, we find that foreign exchange deposits and loans in the CCA are mainly driven by volatile inflation and exchange rates, low financial depth, and asymmetric exchange rate policies biased toward depreciation. Although there is no unique formula for success, empirical studies and cross-country experiences suggest that credible monetary and exchange rate frameworks, low and stable inflation, and deep domestic financial markets are essential ingredients of any de-dollarization strategy. In implementation, policymakers need to consider proper sequencing of policies, effective communication as well as risks from potential financial disintermediation and instability, and/or capital flight.
International Monetary Fund. Middle East and Central Asia Dept.
The countries in the Caucasus and Central Asia (CCA) have recorded significant macroeconomic achievements since independence. These countries have grown more rapidly-—on average by 7 percent over 1996–2011—-than those in many other regions of the world and poverty has declined. Inflation has come down sharply from high rates in the 1990s and interest rates have fallen. Financial sectors have deepened somewhat, as evidenced by higher deposits and lending. Fiscal policies were broadly successful in building buffers prior to the global crisis and those buffers were used effectively by many CCA countries to support growth and protect the most vulnerable as the crisis washed across the region. CCA oil and gas exporters have achieved significant improvements in living standards with the use of their energy wealth.
Mr. Peter J Kunzel, Phil de Imus, Mr. Edward R Gemayel, Risto Herrala, Mr. Alexei P Kireyev, and Farid Talishli

. To successfully anchor expectations, the central bank needs to be assigned a clear inflation targeting mandate and granted strong de facto operational independence. Government interference in the central bank’s operations (for instance, through fiscal dominance or directed lending) must be discontinued. This is a tall order in some emerging and developing countries that are used to tightly controlling financial systems and allocating financial flows on the basis of other policy objectives. While CCA central banks appear to be relatively independent and transparent

Miss Mercedes Vera Martin, Mr. Tarak Jardak, Mr. Robert Tchaidze, Mr. Juan P Trevino, and Mrs. Helen W Wagner
External shocks since 2014—lower oil prices and slower growth in key trading partners—have put financial sectors, mainly banks, in the eight Caucasus and Central Asia (CCA) countries under increased stress.  Even before the shocks, CCA banking sectors were not at full strength. Asset quality was generally weak, due in part to shortcomings in regulation, supervision, and governance. The economies were highly dollarized. Business practices were affected by lack of competition and, in most countries, connected lending, which undermined banking sector health. Shortcomings in financial regulation and supervision allowed the unsound banking practices to remain unaddressed. The external shocks exacerbated in these underlying vulnerabilities. Strains in CCA banking sectors intensified as liquidity tightened, asset quality deteriorated, and banks became undercapitalized. These challenges have required public intervention in some cases.
Mr. Peter J Kunzel, Phil De Imus, Mr. Edward R Gemayel, Risto Herrala, Mr. Alexei P Kireyev, and Farid Talishli
The Caucasus and Central Asia (CCA) countries are at an important juncture in their economic transition. Following significant economic progress during the 2000s, recent external shocks have revealed the underlying vulnerabilities of the current growth model. Lower commodity prices, weaker remittances, and slower growth in key trading partners reduced CCA growth, weakened external and fiscal balances, and raised public debt. the financial sector was also hit hard by large foreign exchange losses. while commodity prices have recovered somewhat since late 2014, to boost its economic potential, the region needs to find new growth drivers, diversify away from natural resources, remittances, and public spending, and generate much stronger private sector-led activity.