How COVID-19 and Oil-price Drop Hit EU Eastern Partner Countries

How COVID-19 and Oil-price Drop Hit EU Eastern Partner Countries

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The FINANCIAL -- The impact of the Covid-19 crisis on public health in the six EU Eastern Partner (EaP) countries remains limited with 187 reported fatalities in the region as of 14 April. Armenia, Azerbaijan and Georgia (because of their proximity to Iran) saw the region’s first cases of Covid-19 in late February. Swift containment measures and limited intra-regional mobility have so far helped limit the spread of the virus, and the number of recorded cases remains relatively low in the South Caucasus. Read main finding by The Organisation for Economic Co-operation and Development (OECD) research.

As the epicentre of the pandemic shifted first to Italy and then to other West European states in early March, the Republic of Moldova and Ukraine started to record more cases and adopted containment measures similar to those of other European countries: closure of educational institutions, limitations on international travel, and restrictions on public gatherings. Strict containment measures imposed in Georgia at the start of the outbreak have already led to promising initial results in flattening the curve of new infections.

Currently, Belarus is the only EaP country without comprehensive containment measures in place. The public health situation could change dramatically, even in a very short period. However, the immediate impact of the crisis on the region has so far been primarily economic. The simultaneous shock on supply and demand has already reduced economic activity in key European, North American and Asian markets more severely than during the Great Recession of 2008-09. The OECD estimates that the decline in the level of output is equivalent to a decline in annual GDP growth of up to 2 percentage points for each month that strict containment measures remain in place. If the shutdown lasted for three months, with no offsetting factors, annual growth could be between 4-6 percentage points lower than otherwise.

Of course, the ultimate impact on annual GDP growth will depend not only on the magnitude and duration of national shutdowns, but also on the extent of reduced demand for goods and services in other parts of the economy, and, critically, the speed at which fiscal and monetary policy support takes effect.

Nonetheless, it is clear that the crisis will weaken short-term growth prospects substantially. The economic impact on the EaP region is further exacerbated by the fall in oil prices, which directly hits Azerbaijan and Belarus but also affects some of the other EaP countries through the impact on trade and remittances, particularly Armeniaand Georgia. The oil-price drop will likely push Russia into recession for the second time in five years.

Containment and social distancing measures, vital for slowing the spread of the pandemic, are also having a severe economic impact, particularly on small and medium enterprises (SMEs), as demand for services other than foodretail has plummeted. EaP countries have implemented significant reforms in recent years to support their SMEs and build better institutional environments to enable their success (for more information, see the SME Policy Index 2020: Eastern Partner countries).

However, the current crisis will require the adoption of comprehensive support packages that encompass not only direct SME support through credit lines and loan guarantees but also fiscal and social policy measures. Intensive support will also be needed in the medium to long-term, especially to help SMEs recover quickly from the crisis by supporting digitalisation of SMEs, more flexible regulation and expedited access to finance for SMEs.

International organisations, including the European Union are helping the region respond to the crisis.

The EU is alreadyreallocating €140 million of funds to support the immediate responses and the use of existing funds of up to €700 million to mitigate the socio-economic consequences of the crisis. The duration and depth of the current turmoil remain uncertain. Still, many observers expect profound changes to the global economic system, both on the micro-level, with changes in organisational cultures, and on the macro-level with reconfigurations to the current mode of globalisation.

Following the outbreak of the Covid-19 pandemic, EaP countries quickly adopted measures to work towards its containment. Considering their proximity to Iran, an epidemiological hotspot, Armenia, Azerbaijan and Georgia introduced restrictions on travel and public gatherings, and closed schools. However, the spread of Covid-19 withinthe region prompted most EaP countries to declare stricter quarantine measures, and, in some cases, states of emergency.

New restrictions have included closure of places of business except for those deemed essential (e.g. grocery stores and pharmacies), adoption of self-distancing and self-quarantine, limits on intercity and interregional transport, and penalties for violators. Moreover, international travel has been restricted (or banned). Detailed information on EaP countries’ containment efforts is presented in Annex 1.Economic and social impactMost EaP governments have already implemented measures to mitigate the negative economic impact of Covid-19.

While it is difficult to estimate the magnitude of the effect of the crisis on EaP economies and their SMEs, it is clear that this crisis will cause a sharp contraction in domestic output, household spending and international trade. Taking into account the strong containment measures implemented by five of the six EaP countries, together with the disruption in global value chains and the structural characteristics of the EaP economies, this section outlines the anticipated economic fallout from the crisis, with a view to informing related policy responses.
Financial market reactions Financial markets are usually the first to react to economic uncertainties and are a good indicator of how much investors trust markets. Trends in government bond yields and local exchange rates indicate falling investor confidence in the region’s economies. All EaP countries except Azerbaijan have experienced significant currency depreciation (the Azerbaijani manat is subject to currency controls) and growing yields on government bonds, signalling heightened concern about the stability of public finances in the EaP countries.

Several service sectors, such as those related to tourism and proximity services that require direct contact between customers and service providers, will forgo virtually all of their revenues as a result of the restrictions on movement and the requirements of social distancing.

Most retailers and restaurants are closed, and increases in their online and take-away sales will not compensate for the resultant massive drop in demand, particularly in places where internet penetration is lower and cyber-commerce less developed.

Moreover, non-essential construction work is likely to be adversely affected by limited labour mobility and reductions in investment. Altogether, the most-affected sectors account for 30-40 % of total output in the EaP economies.

Assuming a total or partial shutdown of their activity, Figure 4 shows the estimated impact of the containment measures on the output of EaP countries, following the introduction of stringent containment measures. The impact on annual GDP growth would depend on how long these measures remain in place.

However, it is critical to note that this estimate does not take into consideration the speed or magnitude of policy responses, activity in other sectors of the economy, changes in the terms of trade, or any indirect/second-round effects of the drop in sectoral output. It also does not consider the role of sub-sectors that might not be negatively affected by the crisis and are prominent in some countries (e.g. gambling in Armenia). In addition, estimates for Belarus are included for comparison although the government has not introduced any significant containment measures to date.

Based on the assumption of complete or partial shutdowns in selected sectors, the immediate impact on an y given economy for the duration of the shutdown is estimated to be between 20 and 30% of GDP depending on the structure of economy. For example, Georgia’s economy, which is mostly driven by the service sector, can be expected to contract by around 30%, while economies driven more by extractive (Azerbaijan) and manufacturing sectors (Ukraine) will be confronted with a smaller direct impact of containment measures. However, developments in external markets will add to the impact, particularly in Azerbaijan – the estimate above does not include the effects of lower oil prices.

Slowdown of global economic activity and its economic impact on EaP economies.

The impact of the pandemic on international trade will be severe, given partial or complete border closures, restrictions on the movement of goods, labour and even capital, a drop in global demand and disrupted value chains. The contraction of trade and other economic activity in major markets will directly affect smaller economies on the periphery.

Domestic demand and investment in Armenia, Georgia, Moldova and Ukraine are significantly supported by personal remittances from abroad, equivalent to more than 10% of GDP. The anticipated economic contraction in the EU, Russia and the USA will most likely result in increased unemployment in these economies, which in turn might lead to reduced inflows of personal remittances to the EaP region.

In addition, the Covid-19 crisis has also affected energy markets and has caused a sharp decrease in oil and gas prices.

This will have implications in particular for Azerbaijan where the extractives sector generates around 35% of GDP and over 90% of exports. Social impact of the COVID-19 crisisThe prevalence of informal economic activity in the region might exacerbate the socio-economic impact of the crisis and complicate efforts to mitigate it. Armenia, Georgia and Moldova have comparatively large informal sectors.

IMF estimates the size of the informal economies in the EaP region to range from around 30% of GDP in Belarus to 50% of GDP in Georgia, while International Labour Organisation estimates suggest that the informal share of total employment exceeds 20% across the region, rising above 50% in some countries. It can be difficult to provide support to households and firms that operate in the informal economy.

Quite apart from informality, some other employment patterns also point to an unusually high number of vulnerable workers in some EaP countries. Around half of those in Azerbaijan and Georgia are own-account workers (self-employed individuals without hired workers) 

Many of them rely on seasonal work related to tourism, are severely affected by the containment measures, and have only limited access to traditional forms of income support. Low saving rates, particularly in Armenia, Georgia and Moldova, further undermine the ability of households and individuals to absorb the economic shock related to the pandemic (Figure 8). Moreover, the global economic recession will exacerbate the social situation in EaP countries, as migrant workers might be unable to support their families back home. Returning migrants may also carry the risk of transmitting the virus from place to place.