Rising Food and Energy Pricesin Europe and Central Asia

Copyright © 2011 Europe and Central Asia Region The World Bank1818 H Street, NWWashington, DC 20433, U.S.A.All rights reservedManufactured in the United States of AmericaFirst Printing: April 2011

Europe and Central Asia RegionThe World Bank

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Rising Food and Energy Pricesin

Europe and Central Asia

Europe and Central Asia RegionThe World Bank

Preface

G l obal markets are again witnessing a period of rising commodity prices. Part of

the current increase is attributed to temporary factors, while a portion is attributed

to longer term trends in commodity markets. Of immediate concern has been the

impact of rising fuel and food prices on global incomes, macroeconomic imbalances and

national poverty. Countries that are large net food and fuel importers in global markets

are particularly vulnerable to world price changes, as are countries where there is high

food and fuel price inflation affecting the poor. This paper presents the possible impact of

rising food and fuel prices on ECA countries’ macroeconomic and poverty outcomes. Its

purpose is to illustrate the possible short run consequences of rising prices and the coun-

tries that are most likely to be significantly affected, both adversely and positively, while

noting the importance of medium-term policy and non-policy related factors that could

mitigate adverse consequences of commodity price increases. In ECA, low and lower

middle income countries tend to be more vulnerable to rising food and fuel prices, while

a handful of ECA countries export substantial amounts to world wheat and fuel markets.

The paper presents an initial assessment of a still evolving situation. Further analysis at

the country level will be undertaken as the situation evolves. Should the need arise, and

collaborating with partners, the World Bank stands ready to assist clients in ensuring that

food and finance reach the most affected countries, to work with countries in developing

their social assistance systems as needed, and to develop and rationalize their agriculture

and energy sectors.

Philippe Le Houerou

Vice President

Europe and Central Asia Region

The World Bank

Acknowledgements

T his paper was prepared through a cross-sectoral collaborative effort across departments of

the World Bank’s Europe and Central Asia Region. Substantive inputs were received from

the Human Development (HD), Poverty Reduction and Economic Management (ECSPE),

and Sustainable Development Network (SDN) with the overall coordination of ECSPE. The rapid

response and effort of managers and staff in the Region are gratefully acknowledged.

Contributors: Roumeen Islam led the writing of the report with contributions from Nicolas

Ahouissoussi, Mohamed Ihsan Ajwad, Benu Bidani, Dina Umali Deininger, Sebastian Eckardt, Lire

Ersado, Boryana Gotcheva, Mattias Grueninger, Jesko Hentschel, Aylin Isik-Dikmelik, Theo Janse

Van Rensburg, Irina Kogay, Holger Kray, Alexander Kremer, Ranjit Lamech, Nadezhda Lepeshko,

Kathy Lindert, Yulia Mironova, Snjezana Plevko, Clelia Rontoyanni, Yadviga Semikolenova,

Alexander Sharabaroff, Kenneth Simler, Victoria Strokova, Victor Sulla, and Ramya Sundaram.

Ricky Ubee and Olga Vybornaia provided excellent research assistance. Suggestions from Chiara

Bronchi, Indermit Gill, Ronald Hood, Takuya Kamata, Elena Karaban, Andrew Kircher, Matija Laco,

Sanja Madzarevic-Sujster, Martin Raiser, Pedro Rodriguez, Mark Roland Thomas, Eskender Trushin,

Willem van Eeghen, Claudia Ines Vasquez, Salman Zaidi, Juan Zalduendo and Sally Zeiljon are

deeply appreciated. Bruce Ross Larson edited the Summary. Susana Padilla formatted the docu-

ment. This report was initiated and produced under the general guidance of Yvonne Tsikata.

Country level data and information provided by: Marina Bakanova, Farid Bakshiyev, Oleksiy

Balabushko, Iaroslav Banclajanschi, Zeljko Bogetic, R. Sudharshan Canagarajah, Souleymane

Coulibaly, Mariam Dolidze, Bakyt Dubashov, Gohar Gyulumyan, Borko Handjiski, Ronald Hood,

Stella IIieva, Faruk Khan, Vladimir Kolchin, Ewa Korczyc, Tigran Kostanyan, Matija Laco, Erjon

Luci, Sanja Madzarevic-Sujster, Dino Merotto, Evgenij Najdov, Catalin Pauna, Ruslan Piontkivsky,

Pedro Rodriguez, Kaspar Richter, Pablo Saavedra, Ilyas Sarsenov, Afsaneh Sedghi, Emilia Skrok,

Mark Roland Thomas, Stepan Titov, Eskender Trushin, Sergei Ulatov, Ekaterine Vashakmadze,

Danijela Vukajlovic-Grba, Marina Wes, and Cihan Yalcin.

­�

Table of Contents

Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Section.1 ...World.Commodity.Markets.and.Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Section.2 ...Macroeconomic.Channels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

. 2 .1 .. Food.and.Energy.Price.Inflation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

. 2 .2 .. Current.Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

. 2 .3 .. Output.and.Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

. 2 .4 .. Fiscal.Impact. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Section.3 ..Poverty.Impacts.and.the.Response.of.Social.Assistance.Systems . . . . . . . . . . . . . 21

Section.4 ..Vulnerability.and.Policy.Interventions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

. 4 .1 .. Vulnerability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

. 4 .2 .. Policy.Interventions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Section.5 ..Agriculture.in.ECA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Section.6 ..Energy.in.ECA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Annex.1 ..World.Bank.Support.to.Clients . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

. A-1 .1. World.Bank.Support.for.Fiscal.Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

. A-1 .2. World.Bank.Supported.Reforms.in.Social.Protection . . . . . . . . . . . . . . . . . . . . . . . 38

. A-1 .3. World.Bank.Support.to.Agriculture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

. A-1 .4. World.Bank.Support.to.the.Energy.Sector. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Annex.2 ..Terms.of.Trade.and.Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

Annex.3 ..Simulating.Poverty.Impacts.of.Food.and.Energy.Inflation . . . . . . . . . . . . . . . . . . . . . 43

References:. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

List.of.Boxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii

List.of.Figures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii

List.of.Tables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

List.of.Acronyms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv

��

List of Boxes

Box.1:. Channels.through.which.Food.and.Energy.Prices.Affect.Economic.Conditions. . . . . . . 7

Box.2:. Variation.in.Evolution.of.Food.Prices.in.Selected.ECA.Countries. . . . . . . . . . . . . . . . . . 12

Box.3:. Modeling.an.Increase.in.the.Price.of.Oil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Box.4:. The.Hidden.and.Rising.Fiscal.Cost.of.Cheap.Energy.in.Belarus . . . . . . . . . . . . . . . . . 19

Box.5:. Global.Food.Price.Crisis.and.Safety.Nets.Response:... . Experience.of.IDA.Countries.in.ECA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Box.6:. Policy.Initiatives.in.Selected.ECA.Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Box.7:. Community.Seed.Funds.in.the.Kyrgyz.Republic. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Box.8:. Export.Restrictions.Damage.Food.Security.in.the.Long.Run. . . . . . . . . . . . . . . . . . . . . 33

Box.9:. Reducing.Volatility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

List of figures

Figure.I:. High.Trade.Deficits.in.Food.and.Energy.in.Some.Countries... Accompany.High.Current.Account.Deficits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Figure.II:.Some.Countries.Are.Vulnerable.in.Both.Macroeconomic.and.. Poverty.Outcomes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Figure.1:.Energy.and.Food.Price.Indices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Figure.2:.Wheat.Prices.Are.Still.Rising. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Figure.3:.High.Food.and.Energy.Price.Inflation.in.many.ECA.Countries,.2010. . . . . . . . . . . . . 11

Figure.4:.Poorer.Countries.Have.Higher.Food.Price.Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Figure.5:.Some.Countries.Have.Large.Trade.Deficits.in.Food.and.Energy. . . . . . . . . . . . . . . . 13

Figure.6:.High.Trade.Deficits.in.Food.and.Energy.Accompany... High.Current.Account.Deficits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Figure.7:.Some.Countries.with.a.Substantial.Dependence.on.Energy.Imports.. . . . . . . . . . . . 16

Figure.8 .1:. Coverage.of.Poverty.Targeted.Programs.is.Very.Low... in.Some.ECA.Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Figure.8 .2:. Targeting.Accuracy.of.Poverty.Targeted.Programs.in.ECA... Varies.among.Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Figure.8 .3:. Generosity.of.Poverty.Targeted.Programs.in.ECA... Could.be.Strengthened.in.Some.Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Figure.9:.Some.Countries.are.Vulnerable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

(cont�nued­on­page­���)

­���

Figure.10:.ECA.Countries.Use.Various.Policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Figure.11:. Fertilizer.Use.per.Hectare.in.Selected.Countries. . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Figure.12:. Some.ECA.Countries.May.Expand.their.Wheat.Production.Significantly. . . . . . . . . 31

Figure.13:. An.Increase.in.the.Long.Run.Marginal.Cost.of.Electricity.Generation. . . . . . . . . . . 36

Figure.14:. Some.ECA.Countries.Subsidize.Households.and.Others.Tax.Them. . . . . . . . . . . . 36

List of taBLes

Table.1:. The.Impact.of.Increased.Food.and.Energy.Prices.on.the.Trade.Balance... May.Be.Significant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Table.2:. Oil.and.Gas.Revenues,.%.Share.in.Total.Fiscal.Revenues . . . . . . . . . . . . . . . . . . . . . 18

Table.3:. Oil.and.Gas.Revenues,.%.of.GDP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Table.4:. The.VAT.Effect:.Increased.Tax.Revenues.from.Food.and.Energy.Imports . . . . . . . . . 18

Table.5:. Poverty.Impact.by.Sub-Regional.Groupings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Table.6:. Simulation.Results.for.Poverty.Increases.Resulting.from.Higher.Food... and.Fuel.Price.Inflation.(US$2 .5/Day):. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Table.7:. Energy.Use.(kg.of.oil.equivalent).per.US$1,000.GDP. . . . . . . . . . . . . . . . . . . . . . . . . 35

List of figures­(cont�nued­from­page­��)

�v

List of acronyms

AAA. Analytical.and.Advisory.Activities

ARD. Agriculture.and.Rural.Development

CASAREM. Central.Asia/South.Asia.Regional.Electricity.Market

CIS. Commonwealth.of.Independent.States

CPI. Consumer.Price.Inflation

CSF. Community.Seed.Fund

CTF.. Clean.Technology.Fund

DEC. Development.Economics.Group,.World.Bank

DPO. Development.Policy.Operation

EBRD. European.Bank.for.Reconstruction.and.Development

ECA. Europe.and.Central.Asia

ECAPOV. Poverty.in.Europe.and.Central.Asia.(Data.Bank)

EU. European.Union

EU.CAP. European.Union.Common.Agriculture.Policy

EU10. New.Member.States

FAO. Food.and.Agriculture.Organization

FBP. Family.Benefits.Program

GDP. Gross.Domestic.Product

GFRP. Global.Food.Crisis.Response.Program

IBRD. International.Bank.

IDA. International.Development.Association

IMF. International.Monetary.Fund

KOE. Energy.Use.per.Capita

LLMIC. Low.and.Lower.Middle.Income.Countries

LRSA. Last.Resort.Social.Assistance

OECD. Organization.for.Economic.Co-operation.and.Development

OGE. Oil.and.Gas.Exporters

TA. Technical.Assistance

TOT. Terms.of.Trade

TSA. Targeted.Social.Assistance

VAT. Value.Added.Tax

WEO. World.Economic.Outlook

WB. World.Bank

­�

SummARy

1. Non-energy commodity prices rose for eight consecutive months through February, crude oil prices for seven.TheWorldBankfoodpriceindexhasmatcheditspeakof2008withtheenergypriceindexstillbelowtheJuly2008peak.Theincreaseinfoodpricesin2010-11representsageneral-ized increase in the prices of several commodities. Thesecommoditymarketdevelopmentsreflectacombinationoftemporary andpermanent factors.Rising incomes aroundthe world, and particularly in emerging and developingcountries, have increased demand for food and fuel. Inaddition, supply factors, related to fuel supply constraintsandinventories,haveaffectedpricesbothintheshortandlonger runs,whilepolicies supportingbio-fuelproductionhaveaffectedgrainprices.Intheshortrun,volatileweatherconditions(suchasthedroughtinRussiaandthefloodsinAustralia)haveaffectedworldwheatpriceswhiletemporarypolicychangesbymajorexportersorimportershavetendedtopushglobalmarketpricesabovelongerruntrends.

2. The purpose of this paper is to illustrate the channels through which rising food and energy prices might affect countries in the Europe and Central Asia Region (ECA) in the short run and to indicate which countries are most likely to be significantly affected. While thefocus is mostly on short run effects, the paper notes theimportanceofmedium-termpolicyandnon-policyrelatedfactorsthatcouldmitigateormagnifytheconsequencesofcommodity price increases. The paper presents an initialassessmentofastillevolvingsituation.

3. As the Region recovers from the effects of the global economic crisis, the global food and fuel price increases represent a boon and an opportunity for commodity exporters but an additional source of vulnerability for many net importers.

• Pers�stently­h�gh­and­r�s�ng­commod�ty­pr�ces­w�ll­com-pl�cate­ econom�c­ management­ for­ some­ ECA­ countr�es­recover�ng­ from­ the­ global­ cr�s�s.­ During the 2008-09global economic crisis, growth declined, unemploy-ment increased and wages fell in most ECA countries.Throughout the region, fiscal revenues also fell whilecountries struggled to contain macroeconomic imbal-ances and protect the vulnerable. In the recovery from

the crisis, governments are trying to rationalize fiscalexpenditurestocontaindeficits,preventthelargeexternaldeficits of the pre-crisis era, and support growth, whilecontinuingtoprotectthepoor.

• In­ECA­overall,­an­add�t�onal­5.3­m�ll�on­people­could­become­ poor.­ Five low and lowermiddle income coun-tries,Armenia,Georgia,theKyrgyzRepublic,Moldova,andTajikistancouldseepotentiallyhighincreasesintheirpovertyratesasaresultofhighfoodandfuelpriceinfla-tion.Theymayneedtoexpandcoverageandadequacyoftheirtargetedsocialassistancesystemsinordertoprotecttheadditionalpoor.

•­Some­ countr�es­ could­ face­ add�t�onal­ external­ f�nanc-�ng­ needs­ or­ may­ need­ to­ constra�n­ domest�c­ demand­to­ conta�n­ external­ balances.­ The same five countriesandKosovohave an average foodand fuel tradedeficitof around 16% of GDP and will see current accountbalances deteriorating with rising food and fuel prices.Among middle income countries, Albania, Belarus,Bosnia-Herzegovina and Montenegro also have doubledigit food and fuel deficits or double digit currentaccount deficits, or both.These countries may need tofindadditionalexternalfinancingfortheirhighercurrentaccountdeficitsorhavetoreducedomesticdemand,forexamplethroughtighterfiscalpolicy.

•However,­ commod�ty­ exporters,­ part�cularly­ large­ o�l­and­ gas­ exporters­ such­ as­Azerba�jan,­Kazakhstan­ and­Russ�a,­are­benef�t�ng­substant�ally­from­h�gher­commod-�ty­pr�ces­wh�ch­are­boost�ng­growth,­current­account­and­f�scal­balances.­

•­On­average,­the­�mpact­of­the­current­food­and­fuel­pr�ce­�ncreases­ on­ the­EU­member­ and­access�on­ countr�es­ �s­small.­

•ECA’s­food­and­fuel­sectors­are­�mportant­�n­world­mar-kets. Moreover, wheat production has the potential todoubleover themedium-term.Tomeet theirpotential,ECAcountrieswillneedtoinvestinandreformpoliciesin their agro-food sectors.Food, andparticularlywheatproducers,canexpandproductionandexports inasus-tainableway,withoutencroachingonforestsandprotect-

�

edareas.Intheenergysector,aconcertedeffortbygovernmentis needed to further improveenergy efficiency, to encourageclimatesmartinvestments,andtocontainfiscalrisks.

macroeconomic and Poverty impacts 4. The short run impact on domes-

tic food and fuel inflation, cur-rent account balances, and fiscal balances is large for some coun-tries. The medium-term growth impact of higher oil prices is likely to be small as long as prices remain at current levels.

• Thefirstroundoffoodandenergypriceinflationishigh-est among the lowand lowermiddle incomecountries.Inthisgroup,foodinflationaveraged13%in2010andenergy inflation averaged 15%. The Kyrgyz Republichadfoodinflationof27%in2010andGeorgiaof23%.Forbothcountries,theweightoffoodintheCPIisover40%.Energyinflationisalsothehighestamongthelowandlowermiddleincomecountries.

•Countries that have net food and fuel trade deficits ofclose to10%ofGDPoraboveand thatalsohave sub-stantial current account deficits are considered vulner-able to rising food and fuel prices in terms of externalbalances (shaded area in the lower left-hand section ofFigure I). Most of them also have high fiscal deficits.Amongthelowandlowermiddleincomecountries,theseare Armenia, Georgia, Kosovo, the Kyrgyz Republic,MoldovaandTajikistan.Othermiddleincomecountries,Albania, Belarus, Bosnia-Herzegovina and Montenegromay also face additional financing needs as they haveeitherdouble-digitfoodandfueltradedeficitsordoubledigit current account deficits, or both. However, theeffect of rising food and fuel prices on the currentaccountsofnet importerswillbemitigatedbyincreasesinthepricesoftheirexports.Externalandfiscalbalancesoftheoilandgasexportersareshowinganincreasingsur-

plus.Azerbaijan’scurrentaccountsurpluswasover25%ofGDPin2010,Kazakhstan’s8%andRussia’s5%(thesecountriesarerepresentedintheupperrighthandcornerof Figure I).1The EU member and accession countriesarelessaffectedthattheothergroupsandarenearertheorigininthefigure.

•Oil price increases are likely to have higher adverseeffects on output over the medium-term for large netcommodity importers which also have high energyintensity of production, though these effects will besmall if prices remain at current levels. Countries thatfall inthiscategoryareBelarus,andfourlowandlowermiddleincomecountries,theKyrgyzRepublic,Moldova,TajikistanandUkraine.

5. Measured at the US$2.5 level a day, an additional 5.3 million people could be made poor in ECA because of the higher food and fuel inflation; most of the higher poverty is due to the food price increase.Thepotentialoverallincreaseinthepovertyrateis1.3percentagepointsforECA,intheabsenceofcountervailingmeasures,growthin wages and incomes, or changes in household behavior.The countries in which poverty could increase the mostare a group of low and lower middle income countries:potentialincreasesare9percentagepointsforArmeniaandGeorgia,11fortheKyrgyzRepublic,around5forMoldovaand8percentagepointsforTajikistan.

1AzerbaijanisnotvisibleasitscurrentaccountbalancerelativetoGDPisextremelylargecomparedtoothercountriesinECA.

Figure I: High Trade Deficits in Food and Energy in Some Countries Accompany High Current Account Deficits

­3

Vulnerability and Policy responses6. Countries that are the most vul-

nerable in terms of both macro-economic outcomes and poten-tial poverty increases are all low and lower middle income countries: Armenia, Georgia, the Kyrgyz Republic, Moldova and Tajikistan (in Figure II).Inaddi-tion,Albania,Bosnia-Herzegovina,Kosovo and Montenegro, are vul-nerableintermsoffacingadditionalexternal financingneeds,but theirpotentialpovertyincreaseresultingfrom high food and fuel prices, issmallornegligible.Intheabsenceofadditionalfinancing,thesecountriesmayneedtocontainaggregatedemand.At the same time,vulnerablecountrieswill need to find additional fiscal resources toprotect thepoor,while expanding their targeted social assistancepro-grams.The policy response to inflation in ECA countrieswilldependonthepersistenceofinflationandtheoutlookforothermacroeconomicvariables.Tightermonetarypolicymay be warranted in some countries if inflation pressurespersistoverthemedium-term.

7. The effect of the price shocks on the poor in most ECA countries could be offset by relatively modest increases in fiscal resources which could be distributed through cur-rent social safety net programs. MostECAcountrieshaveatleastonefairlywelltargetedsocialassistanceprogram.Byincreasing the fiscal resources allocated to these programs,theycanincreasecoverageofthepoorandtheadequacyofbenefits.Overtime,astheadministrativecapacityofthesesystemsimprovesandoverallexpendituresarerationalized,there can be fiscal savings. Fully compensating the poor-est 20% forhigher inflation in the low and lowermiddleincomecountrieswherepovertyisexpectedtoincreasethemost (Armenia, Georgia, the Kyrgyz Republic, Moldova,andTajikistan),couldrequireupto1%oftheirGDP.

8. ECA countries responded to the 2007-08 increase in food and fuel prices in a number of ways, but some poli-cies they adopted have negative long term consequences. Amongthemostusedpoliciesin2007-08weretraderestric-tionsonfoodexports,reducedvalue-addedtax(VAT)rates

onfoodimports,relianceonstateprocurementanddistri-bution to ease prices, price controls and staggered energypriceadjustments.In2010-11,allofthesepossibilitiesareback.However, thesepolicies aremostlynotwell targetedto the poor. In addition, reductions in VAT rates reduceimportpricesandraisethefiscaldeficit,butdonotensurelowconsumerprices.Energysubsidies,implicitorexplicit,are often not well targeted and worsen the government’sfiscalposition.Exportrestrictionsandinappropriatepricingpolicies(suchaspricecontrols)intheagricultureandenergysectorshinderlongtermadjustmenttoglobalmarketcondi-tions.Totheextentpossible,expansionofsocialassistancesystems shouldbe thepreferredmethodof protecting thepoor.

9. ECA’s medium-term response to higher prices in global food markets should be to expand its agro-food sector in a sustainable way and improve distribution; many countries have already embarked on this process. ECA’sagro-food sector affects both regional and global markets;wheataccountsfor25%ofworldexportsonaverage.ECAcoulddouble itsproductionby increasing the land that iscurrently under cultivation and increasing yields throughbetteruseofinputsandservices.Distributionaswellaspro-duction inefficiencies have further exacerbated food pricevolatilityandinflationinlocalmarkets.Importantreformsincludeinvestingininfrastructureandirrigation,improvingpost harvest logistics and waste reduction, and eliminat-inggovernment interventions thatprecludeadjustment tochangedprices.

Figure II: Some Countries Are Vulnerable in Both Macroeconomic and Poverty Outcomes

�

10. Exports from ECA’s three largest oil exporters account for around 15% of world oil supply and 25% of non-OPEC oil supply. To contain fiscal pressures, sustainoil and gas production and to be climate smart, manyECAcountrieswillneedtorationalizetheirenergysectorpolicies.Risingfuelpricesmakereformofpricingpoliciesandreducingenergyintensitymoreurgent.Theproblemis pressing for countries with large energy trade deficitssuchastheKyrgyzRepublicat20%ofGDP,followedbyGeorgia(14%)andUkraine(11%).InallECAcountries,the energy intensity of GDP has declined significantlysincetheearlypartofthe lastdecade,butcanbefurtherreducedifECAadoptspoliciestoenhanceitsenergyeffi-ciencyandencourageclimatesmartinvestments.

Bank support to clients11. The World Bank supported ECA countries during the

last commodity price hikes and during the global crisis; it is already involved in measures that will help contain country vulnerabilities to global developments. ECAcountriesarefacingamorechallengingexternalenviron-ment than before the global crisis.The Bank supportedcountriesintheireffortstoputinplacesustainablemac-roeconomicpoliciesandtoimplementmeasuresaimedatshorttermprotectionofthepoor.Lending,policyadviceand analytical work are being used in tandem to meet

thegoalsofmacroeconomicstability,growthandpovertyreduction.TheBankisworkingwithclientson:

•­ Rat�onal�z�ng­ publ�c­ f�nance­ and­ adm�n�strat�on. InmanyECAcountries, theBank is supportingsustain-able fiscal planning, rationalization of overall expen-ditures to ensure fiscal sustainability, and tax reformincludingimprovementoftaxadministration.Itissup-porting clients in implementing structural reforms invarioussectorsinordertoenhancefiscalsustainability.

•Enhanc�ng­soc�al­ass�stance­systems.TheBankiswork-ing with clients to provide greater coverage of thepoor,increasetheeffectivenessofpublicspendingandimprovetargetingofoverallfiscalexpenditures.

•­­Enhanc�ng­ product�v�ty­ and­ real�z�ng­ potent�al­ �n­agr�culture.­ The Bank is supporting improved watermanagementinagriculture,enhancedaccesstoinputsorextensionsservicesandbetterlandadministrationaspartofeffortstoenhanceproductivity.Ithasalsosup-portedeffortstoincreaseaccesstofinanceforfarmersandtoreducevulnerabilitytoshocks.

•Energy­sector­reform­and­susta�nable­energy.­TheBankis supporting improvements in energy efficiency,pro-motionofprivateinvestmentintheenergysector,andsupport for renewable energy production and climatechangemitigationinitiatives.

­5

InTRoduCTIon

1. The ECA region was hit hard by the global economic cri-sis and countries are facing the commodity price hikes of 2010-11 from a different situation than that prevailing at the time of the 2006-2008 commodity price increases. ECAcountrieswereinamuchstrongereconomicsituationbefore the global crisis with growth averaging almost 7%during 2005-08. Fiscal deficits were falling, as was publicdebt.Capital,availableatunprecedentedlylowrates,allowedmany ECA countries to finance large current accountdeficitsastheygrew;remittancesbufferedtradedeficitsandprovided income support for many. ECA’s strong growthwas accompanied by decreasing unemployment and wageincreases.Povertydeclineddramaticallyduring the2000s.Rising commodity prices2 added substantially to com-modity exporters’ incomes.The negative impacts of highcommoditypricesonnetimporters’macroeconomiesweremitigatedby thepositiveexternalenvironmentandgloballiquidity.However,therewerewithincountrynegativedis-tributionalimpactsofrisingpricesandthepoorsufferedariseinthecostoftheirconsumptionbasket.

2. Today, in the changed global and domestic economic conditions, both macroeconomic and within country distributional impacts are potentially more severe, par-ticularly for the poorer countries in ECA. In2009mostof the ECA countries experienced negative growth ratesaveraging -3.8%. For many, 2010 was the beginning ofthe recovery, and the average growth ratewas around3%compared with a world average of 5.1% Recessions haveleftECAcountrieswithmuchhigherunemploymentratesandlowerwages.Fiscalaccountshavebeenputundersig-nificantpressures asdeficits anddebthave increased.Theaveragefiscalbalancein2007was1.3%ofGDPcomparedto -5.8% in 2010 (with a maximum deficit of over 9%).TheaveragedebttoGDPratiohasjumped10percentagepointsofGDP.Forlowandlowermiddleincomecountries,thefiscaldeficitjumpedfrom-1.8%to-5.8%ofGDP,thesecountriesarealsomorevulnerabletothe2010-11commod-

itypricehikes.Governmentaccountshavebeenstrainedbydeclines in revenues, the need to rationalize expendituresandeffortstoprotectthepoor.Globalfinancialmarketsarealsolessliquid;andexportsformanyECAcountriesarejustbeginningtopickup.

3. In this context, the adjustment to higher commodity prices for many net commodity importers may be harder than it was previously.CountriesinECAwillcontinuetorationalizefiscalspendingandmanagevolatilityinaworldinwhichfinancialmarketsandgrowthprospectsaremoreuncertainandriskperceptionsarehigh.Theglobalincreasein food and energypriceswill havedifferentiated impactsacrossECAcountriesdependingon (a) their status asnetcommodityexportersorimporters;(b)demandandsupplyresponses over time (e.g., for foodproduction and energyefficiency investments) in each country; and (c) initialeconomic conditions. Internal redistribution from foodandenergyconsumerstoproducersisexpectedtoresultinincreasedpovertyatatimewhenunemploymentishigh.Atthetimeofthe2008commoditypricehikes,countrieshadadopted measures to insulate their economies and/or thepoor from these global market developments. Additionalpolicieswereadoptedtoadjusttothe2009downturn.Notall of these policies were sustainable. ECA countries needto takemeasures inpublic finance,demandmanagement,agriculture and energy that prepare them for higher andmorevolatilefoodandfuelprices.

4. The purpose of this paper is to illustrate the channels through which rising commodity prices might affect countries in the Europe and Central Asia Region (ECA) in the short run and to indicate which countries are most likely to be significantly affected.While the focusismostlyon short runeffects, thepapernotes the impor-tanceofmedium-termpolicyandnon-policyrelatedfactorsthat could mitigate the consequences of commodity priceincreases.Thepaperpresentsaninitialassessmentofastillevolving situation in which commodity market develop-mentsareuncertain.Theeventual impactsongrowthandpovertywilldependonthemacroeconomicpolicyenviron-2Commoditiesincludefood,rawmaterials,energyproducts,metalsand

minerals.

�

ment,thedurationandvolatilityofthepriceincreases,socialassistancepoliciesandotherdomesticpolicies thatchangethestructureofdomesticmarkets.Dependingonthenatureoftheimpactsandtheinitialconditions,appropriatepolicyresponseswilldiffer.Countrypolicyresponsesintheregioncanhavesignificantimpactsonworldmarkets.Forexample,inthelastfoodpricecrisismajorexportingcountriesintro-duced export taxes, export bans or other restrictions onexportsofagriculturalproductsor increasedhoardingandthesepoliciesaffectedworldasmuchasnationalmarkets.

5. This paper discusses the effects of the global food and energy price increases on ECA countries from two per-spectives: (a) impacts on the macro-economy through inflation, the trade balance, fiscal accounts and growth and (b) distributional impacts within countries (Box1).Itaimstohighlightvulnerabilitiestorisingcommodityprices and discusses some policy interventions to mitigate

the impactof risingprices. Itputs theECAexperience inthecontextofthelastcommoditypriceincreaseaswelltherecent global economic crisis. Section 1 summarizes thestateofglobalcommoditymarkets.Section2discussesthemainmacroeconomicchannelsthroughwhichcommodityprice increases affect theeconomy.Section3discusses thepotential poverty impacts of the price increases and theabilityofcountries’socialassistancesystemstodealwiththeheightenedneedforsocialassistance.Italsodiscussescoun-tryresponsestothecrisistodatewithreferencetopoliciesfollowedduring the2008pricehikes. Section4 examinesECA’sagriculturesectorandpotentialresponsestothecom-moditypriceincreaseandpricevolatility.Section5discussestheenergy sector.Banksupport toECAcountries tohelpdealwithcommoditymarketdevelopments isdiscussedinAnnex1.

­�

macroeconomic and PoVerty effects

Impact on inflation: Nationalinflationlevelsareaffectedby rising world prices for commodities. The direct firstroundeffectsonoverall consumerprice inflationdependon theweightof these commodities in the consumptionbasket;thisishigherforlowerincomecountries.Whetherthese price changes affect core inflation rates (inflationmeasured without food and energy prices)depends on anumberoffactors,amongthempersistenceofworldinfla-tion, domestic policies and expectations of future pricedevelopments. Allowing the first round effects of com-moditypriceinflationtobeaccommodatedwouldhelptheadjustment to the jump in commodity prices. However,inflationexpectationsneedtobeconsidered;totheextentthatthefoodandfuelpriceinflationraiseexpectationsoflong term inflation, monetary policy would need to betightened.Thelongtermincreaseincommoditypriceswillfeed into domestic inflation depending on the exchangerateandmonetarypoliciesfollowedbycountries,thetaxesandsubsidiestheyimposeonthesegoods,howintegratedorisolatedtheirdomesticmarketsarefromworldmarkets,andthenatureofdomesticproduction.3

Impact on external balances: Net food and energyimporters will see deterioration in their current accountbalances4 with the magnitude depending on the impor-tance of net food and fuel imports in the economy.5Current account deficits will need to be financed by aninflow of foreign funds or a reduction in demand. Forsome vulnerable countries that are adversely affected intheshortrun,additionaldonorfinancingmaybeneeded.

Box 1: Channels through which Food and Energy Prices Affect Economic Conditions

6SeealsoIMF2008.

Alternatively,domesticdemandwillneedtodecline.Netfood and energy exporters will face improved externalbalances.Theeffectonthecurrentaccountovertimewilldependonhowoveralltermsoftradeevolvebutalsotheresponsetothepriceincreaseinnationalmarkets(suchassubstitutiontoother,nonimportedenergyorfoodsourc-es,ordeclineinenergyconsumptionandthusimports,orincreases indomesticsupply),andexpectationsregardingthe permanence of the shock. Diversification of energysourcesoverthelongerruncouldhelpreducetheimpactsof price volatility in oil markets. Similarly, the nationalagriculturesectorshouldrespondtopermanentchangesinfoodprices.Actualresponseswillbedeterminedinpartbycountrypoliciesinthesesectors.

Impact on fiscal balances: Most immediate in termsof nondiscretionary effects are the tax revenue increasesthat will result from higher energy related income orprofits made by oil and gas corporations. Azerbaijan,Kazakhstan and Russia have various taxes on oil and/orgasrelatedincome.AnothershortrunpositiveimpactonfiscalaccountscomesfromrisingtaxrevenuesonfoodandfuelimportswhicharesubjecttotheVAT.Increasesinthevalueofimports,giventaxrates,willraiserevenues,giveninelastic demand in the short run. However, as demandandsupplyadjustovertime,theserevenuescoulddecline.Countries face fiscal pressures because of the rising costofexistingsubsidiesintheagricultureandenergysectors.Discretionarychangesinfiscalpoliciessuchasreductionsor increases in subsidies have usually accompanied com-moditypriceincreases.Theseincludeareductionintaxes(e.g. VAT rates) to cushion the impact on consumers.6These tend to worsen fiscal balances.To the extent thatGDPgrowthisaffected,itwillalsoaffecttaxrevenues.

Impact on growth: Sustainedchangeinthetermsoftrade(TOT) affects growth as does volatility in the terms oftrade. Countries facing an increase in the terms of tradewould see higher growth; higher volatility in the termsof trade can be expected to have a dampening effect ongrowth.SeveralempiricalpapershaveassessedtheimpactofchangesintheTOTongrowth(Annex1).InadditiontotheincometransferrelatedtoTOTchanges,theenergy

3 Impacts of inflation on other macroeconomic variables such aslongterminterestratesortheshorttermimpactonthefinancialsectorarenotdiscussedhere.Factorsconstrainingpass-throughofinternationalprices lowerthepriceelasticityofdemand.SeealsoIMF2008/02.

4Totheextentthatfoodandfuelpurchasesaredeterminedbylongtermcontracts, theeffectof risingpricesonexpenditureswillbemuted.

5Shorttermpriceelasticitiesofoildemandaregenerallybelievedtobelow.IMF(2005),estimatesittorangefrom0.03-0.08.Thusincomeeffects tendtodominateoilmarkets.Evensmallchangesinsupplycanhavelargeeffectsonshorttermprices.Iflongertermpriceelasticitiesarehigherthanshorttermones,thenshorttermpriceswilltendtoovershootlongertermone. (cont�nued­on­page­8)

8

priceincreaserepresentsasupplyshock.Fuel,beingafac-tor of production, also affects growth/GDP through thefollowingchannels.Thehighercostofoilwillreducetheuseofoilandproducerswillsubstitutetootherfactorsaspossible,butwillalsolowertheiruseoflaborandcapital.Onthedemandside,oilpriceincreaseswilltendtoreducenon-oildemandandlowerinvestmentinimportingcoun-tries. In addition, oil price changes affect inflation andexchangeratesandtherefore(givenmonetarypolicy)affectaggregatedemand.7Estimatesof the effectsofoil shocksvarybut the effects havebeen found tobe asymmetrical

betweenoilpriceincreaseswhichtendtobecontraction-ary and oil price decreases which are less expansionarythanincreasesarecontractionary.Theshortruncontrac-tionary effects of oil price increases are enhanced whenfactorsofproductioncannotbeeasilyreallocatedbetweensectors.8

Poverty effects: Inflation in foodand fuelprices lowersthe purchasing power of poor people as food is often alarge share of the poor’ s consumption basket.Theimpactwilldependverymuchonthetypesofcopingmechanismsthatareavailableintheshortrun.

Box 1 (cont�nued­from­page­�)

7For example, higher oil prices may mean higher money demand(realbalancesfallwithinflation)andthereforehigherinterestratesandlowereconomicgrowth.(BrownandYucel,2002). 8Hamilton,(2009).

­�

6. Non-energy commodity prices rose for eight consecutive months through February, crude oil prices for seven.Figure1belowshowstheevolutionofworld food and energyprices since 2005.The energy priceindex is still below its July 2008peak,thoughtheWorldBank(WB)food price index had matched thepeakofJuly2008byJanuary2011.The increase in foodprices in2010represents a generalized increase inthepricesofseveralcommodities.IntheECAregion,wheatisanimpor-tant staple. Wheat prices are stillbelowtheir2008peak(Figures1-2).

7. Commodity market developments reflect a combination of temporary and permanent fac-tors. Risingincomesaroundtheworld,andparticularlyinemerginganddevelopingcountrieshaveincreaseddemandforfoodandfuel.Inaddition,supplyfactors,relatedtofuelsupplyconstraintsandinventorieshaveaffectedpricesbothintheshortandoverthelongerrun,whilepoliciesregarding

SECTIon 1. WoRld CommodITy mARkETS And PRICES

biofuelshaveaffectedgrainprices.Intheshortrun,volatileweatherconditions(suchasRussia’sdroughtandAustralia’sfloods)have significantlyaffectedworldwheat supplyandprices while temporary policy changes by major exportersor importershave tended topushprices above longer runtrends. To the extent that many commodities substituteforeachother(e.g.cornversuswheatorrice),increasesin

thepriceofonegoodhavetranslatedintoincreasesinthepricesofothergoods.Inthelongrun,thesupplyelasticityoffoodcouldbe substantial both in the ECA regionitself andglobally, and larger than thatofconventionalenergyforms.9,10Intermsof

Figure 2: Wheat Prices are Still Rising Wheat,Canada,US$/mt,current

Figure 1: Energy and Food Price Indices FoodPricesHaveSurpassedTheir2008Peak 2000=100,constant2000US$

9 Commoditypriceboomsareusuallyfollowedby periods of falling prices as supply condi-tions adjust, but the substantial decline incommodity prices during 2009 was due inlarge part to the global economic crisis andslowdownineconomicactivity.Inthecaseoffood,theweatherwasalsofavorable.

10 IMF,2008,Chapter5

�0

11 Azerbaijan, Kazakhstan, Russia,Turkmenistan and Uzbekistan ben-efitedthemostfromtermsoftrade(TOT)changesin2006-08whileTOTworsenedforcountriessuchasArmenia,andTajikistan.

volatility, both food and energy prices have become morevolatiletodaythantheyhavebeenintherecentpast.

8. Among ECA countries, fuel is a principal source of export earnings for Azerbaijan, Russia, Kazakhstan and Turkmenistan. For Tajikistan and Ukraine non-fuelcommodityexportsareimportant.Russia,Kazakhstanand

Ukraine are also significant wheat exporters that have thepotential to affect world markets. However, due to poorweatherconditions,Russiawasanetimporterthisyear.11

­��

2.1.FoodandEnergyPriceInflation9. Food price inflation varies

substantially among ECA countries with poorer coun-tries tending to experience higher inflation rates. Foodprice inflation was over 20%in two countries in 2010- theKyrgyz Republic and Georgia.For another nine countries, itwas over 10% (Figure 3). Foralmost a third of ECA coun-tries, the weight of food inthe consumption basket usedto estimate the CPI is around50%.12,13 For another 20% itaccounts for around 40% oftheCPI.Thus, any changes infoodprice inflationhave a sig-nificantimpactonoverallinfla-tion rates. Ukraine had foodprice inflation of 10.6% andthefoodweightintheCPIwas53.5% while Armenia’s foodprice inflation was 15.2% andthe share of food in the CPI48%.Asagroup,theCaucasusexperienced the highest food

SECTIon 2. mACRoEConomIC ChAnnElS

12 Amongthelowerincomedecilesfoodaccounts for a larger share of con-sumption than for the upper incomedeciles.InAzerbaijan,foodaccountedfor 66% of the consumption basketof the two lowest income deciles; inArmeniaitaccountedfor63%.

13 Some importing countries did notallowfullpass-throughofinternation-alpricesintodomesticprices(in2007,anIMFsurveyshowedthatlessthanhalfasampleof43developingand emerging market countries allowed for full pass-through). In2007,foodpriceinflationaccountedforalmost70%of2007headline

Figure 3: High Food and Energy Price Inflation in Many ECA Countries, 2010

Figure 4: Poorer Countries Have Higher Food Price Inflation

inflationinemergingeconomies.Thefirstroundeffecton2007cur-rentaccountbalancesexceeded1%ofGDPindevelopingcountries(IMF,2008).

��

priceinflationwhiletheBalkansfaced the lowest (see also Box2). Figure 4 shows that poorercountries tended tohavehigherfoodprice inflation.The reasonfor this pattern may be relatedto differences in the abilities ofmarkets in these countries torespond to supply or demandchanges. For example, suppliersinrichercountriesmayhavebet-terstocksordistributionsystemsandcanmoderatetheimpactofpriceshocks.

10. Energy price inflation also var-ies substantially across coun-tries, being highest in the low and lower middle income country group (LLMIC), on average.14 Energypriceinflationis25%ormoreinMoldovaandUzbekistan and around 10% ormore in another 13 countries(Figure3) including theBaltics,andHungary aswell as,Russia,Uzbekistan and Tajikistan.Uzbekistan,whichhad the low-estfoodpriceinflationrate,hadthe highest energy price infla-tion rate, whereas the KyrgyzRepublic suffered high inflationratesonboth(27%infoodand15% in energy). Montenegro’sdecline in energyprices is strik-ing and is the result of a sub-stantial increase in domestichydro-energyproduction aswell as adecline inbusinessdemand reflecting the fall in overall economic activity.15Though the increases in food and energy price inflationare large formany countries, not all countrieswith veryhighinflationrateshadoverallhighinflationasthecom-binedweightofenergyandfoodintheCPIisnothigh.Estonia forexample,hadhigh foodandenergy inflation

14 TheLLMICgroup includesArmenia,Georgia,Kosovo, theKyrgyzRepublic,Moldova,Tajikistan,UkraineandUzbekistan.

15 Inaddition,regulatedpriceswereloweredin2010,tocompensateforlargeincreasesin2009.

Foodpricesreflectvaryingconsumptionbasketsindifferentcountries,thoughbreadisamajorstapleinallECAcountries.BreadpriceincreasescanhavequitesignificanteffectsontheoverallCPI,andsignificantsocialeffects.InTaj�k�stan,whichimportssubstantialamountsofwheat,wheatpriceswere37%higherinDecemberthaninJune2010.IntheKyrgyzRepubl�cbreadpriceshavenotrisento their 2008peaks, thoughdifferent cities are facing varying inflation rates.The most noticeable increase in food prices in Azerba�jan was for importedbreadgrain.SinceSeptember,flourhasbecomeupto20%moreexpensiveandinBaku, thepriceof loafhas risenbyone-third. Thebreadprice increase isobservedparticularlyinurbanareaswhereimportedflourplaysagreaterroleinmeetingdomesticdemand;wheatismostlyimported.In2010,importsofgrainfromKazakhstanhavedoubledreplacingimportsfromRussia.

InUzbek�stan,foodpricesareregulatedanditimports1/3ofdomesticwheatconsumptionneeds.Russ�ahasexperiencedtheworstdroughtindecades,con-tributing toa largedrop in theharvest andhigher foodprices. In theperiodJune-December2010,foodpricesrose7.7%.InAlban�a,contrarytotheexpe-riences of many other ECA countries, recent concerns have mostly centeredaround weather-related increases in the prices of vegetables; bread prices arebeginningtoincreasebuttheyarenotaroundprevioushighs.Foodprices,espe-ciallybreadandcerealsprices,beganclimbingrapidly inKosovo fromAugust2010.ThebreadandcerealsCPIinDecember2010stoodat169.0comparedto160.4inMay2008.Otherfooditemswithlargepricehikesareoilsandfats.InFYR­Macedon�a,­overallfoodinflationwasonly3.2%in2010.Thismasksrelativelylargedifferencesbetweenproducts.Pricesof“oilsandfats”increasedby 35% and fruits were almost 13% more expensive. In contrast, bread andcereals prices only increased by 0.7%, while prices of vegetables actually fellby4.6%.LowwheatyieldsinSerb�athisyear,combinedwiththeincreaseinwheatpricesglobally,mightleadtoasharpincreaseinflourandbreadprices.ProductionofsugarbeetandsunfloweriswithinaveragesforSerbiaandshouldhavenoimpactonpricesofsugarandoil.

Box 2: Variation in Evolution of Food Prices in Selected ECA Countries

of12.1%and11.6%respectivelybutoverallinflationwasonly5.4%.

11. The impact of world commodity price changes on domestic inflation is affected by several policy related factors.Policiessuchastaxes,pricecontrolsandsubsidies,limit thepass throughof internationalprice increases todomestic inflation. In the past for example, some ECAcountries temporarily reduced taxes on food/energy, inorder to limitprice increases.Changes in exchange ratesrelative to the dollar, and the currency in which com-

­�3

modity prices are quoted, couldhaveasubstantialeffectoninfla-tion. Many ECA countries haveexchange rates pegged to theeuro;iftheeurodepreciatesrela-tivetothedollar,thesecountrieswillseeanincreaseinfoodpriceseven if world prices do not rise.Countrieswith flexible exchangerates, if their exchange ratesdepreciate relative to the dollar,will face the same fate. If mon-etary policy remains or becomesexpansionary, then inflation infood prices may be sustained. Itis important to remain alert toinflation risks particularly in thecontextofbothvolatileandrisingcommodityprices,but the infla-tionrisksofmonetaryeasinginECAcountrieshavetobeweighedagainstthenegativeeffectofmonetarytighteningonthenascenteconomicrecoveryandoncountries’finan-cialsystems.

2.2.CurrentAccount12. The immediate impact of changes in commodity prices

on the current account will vary according to whether the country is a net exporter or importer of food and energy products, and the volume of trade in these com-modities. Overthelongerrun,quantitiesdemandedandsupplied change in response to price changes; however,in the short run, it is assumed that quantities importeddo not adjust as the demand for food and energy tendsto be inelastic in the short run.16Themagnitudeof theinitialdeficitsinfoodandfueltradebalanceshelpprovideanestimateof themagnitudeof the initial impactof anincreaseincommoditypricesonthecurrentaccount.

13. Five LLMIC countries, Albania, Armenia, Kosovo, the Kyrgyz Republic, and Tajikistan have food trade defi-cits around or above 5% of GDP.Amongmiddleincomecountries (MIC), Bosnia-Herzegovina and Montenegroalso fall intothehighdeficitcategorywherenet importsaccountfor7.1%and-21.7%ofGDPrespectively.SeveralECA countries were net exporters of food in 2010; the

topexportersintermsofGDPwereUkraine,BelarusandSerbia. Neither Russia nor Kazakhstan, both top grainproducers,werenetfoodexporters;theseveredroughtin2010hasledRussiatobeawheatimporterthisyear.

14. Seven LLMIC countries in ECA have energy trade deficits of 7% or more of GDP. In addition, Ukraine,Belarus and Bulgaria are very dependent on energyimports.17Apartfromtheoilandgasexporters(OGE)18

andUzbekistan,mostEUmemberandaccessioncountriesare less dependent on energy imports, with exceptionsbeingBulgaria,andLithuania,bothofwhichhaveenergytrade deficits above 6% of GDP. As food production iswidespreadbutenergyproductionislessso,thevariationin the food trade balance is between 2.7 and -8.2% ofGDPwhilethatforenergyisbetween44.8and-20%ofGDP (reflecting standard deviations of 2.96 and 12.40respectively).

15. Some ECA countries have high combined food and energy trade deficits and their external balances are sensitive to commodity price changes. Five LLMIC,Armenia, Georgia, Kosovo, the Kyrgyz Republic and

16 Theremaybesubstitutionbetweenproductsandtonon-tradeditemsintheshortrunbuttheseeffectsarenotconsidered.

17 Insomecountries,suchasBelarusandUkraine,energypricesarenotmarketdeterminedbuttheresultofagreementsbetweenthecountriesandRussia.However,thesepriceshavebeenadjustedasworldpriceshaveincreasedinrecentyears(seeEnergySection).

18 CountriesthatareoilandgasexportersincludeAzerbaijan,KazakhstanandRussia.

Figure 5: Some Countries Have Large Trade Deficits in Food and Energy; a Few Have Very Large Surpluses

��

Tajikistan,andtwoupperMICsBosnia-HerzegovinaandMontenegro,havethehighestfoodandfueltradedeficitsatover10%ofGDP.Bycontrast,Polandhassubstantialcoal reservesandalso imports fuel fromRussiabasedonlong term contracts which limit price volatility. Polandalsohasasmallsurplusonitsfoodaccount.ThusPolandis lessvulnerabletoa foodandfuelpriceshockthanarethe countries mentioned above.19 As Figure 5 shows,Azerbaijan, Kazakhstan and Russia have large combinedtrade surpluses because of the surplus in energy trade.Overall,theimpactofenergypricestendstobehigheronthecurrentaccountthantheimpactoffoodpricesbecausetheproductionoffoodtendstobewidespreadwhilepro-ductionoffuelismuchmoreconcentrated;consumptionoffuelislinkedmorecloselytotradeinfuel.

16. Estimates of the impact of rising food and fuel prices on the trade balance shows substantial potential deterioration for a few countries.Whileeachcountry’soverall food and fuel balancedependson theprices andshares of individual commodities in the trade basket, afirst approximation of the impact of price increases onthetradebalanceisdoneassuminganaverageincreaseof30%inthepricesofimportsforallcountries.20Increasesin food prices have a positive trade impact on exportersoffood.ThenumberspresentedinTable1showpossibleimpacts.Thetableshowsthata30%increaseinthevalueofthenetfoodandfuelimportbasketraisesthetradedefi-citforfiveLLMIC,Armenia,Georgia,Kosovo,theKyrgyzRepublic and Tajikistan by over 3 percentage points ofGDP.Bosnia-HerzegovinaandMontenegroamongMICs,alsohavepotentiallylargeimpactsontheirfoodandfueldeficits.21However,totheextentthattherearesimultane-ous increases in theprices of commodities exported, theimpactofrisingfoodandfuelpricesontheoverallcurrentaccount balance would be reduced. For example, risingcottonpricesmeanhigher export revenues forTajikistanwhileFYRMacedoniabenefitsfromhigherpricesformet-alsthatitexports.

19 The terms of trade decline in 2010 is estimated to be 3% for theKyrgyzRepublic,and3.5%forTajikistan.Georgiasawanimprove-mentof2.6%.

20 ThecorrelationbetweenfoodandfuelpriceshasalsoincreasedovertimeIMF(2008).

21 Totheextentthatpricesandquantitiesaresetbylongtermcontracts,theywillnotbeaffectedimmediately.Itisassumedinthisstatementthatpricesadjustfastbutquantitiestakelongertoadjust.

Food and Change in Energy Food and Food and Trade Energy Energy Balance, Trade Trade % GDP, Balance, Balance, 30% price % GDP, 30% Country % GDP increase price increase

Azerbaijan 45.3 58.9 13.6

Kazakhstan 22.9 29.7 6.9

Russia 15.6 20.3 4.7

Uzbekistan 9.6 12.5 2.9

Poland -1.7 -2.2 -0.5

Estonia -2.1 -2.7 -0.6

Romania -2.5 -3.2 -0.7

Hungary -2.9 -3.8 -0.9

Serbia -3.0 -3.8 -0.9

Turkey -3.6 -4.7 -1.1

Czech.Republic -3.9 -5.0 -1.2

Croatia -4.8 -6.2 -1.4

Latvia -4.8 -6.2 -1.4

Slovenia -5.1 -6.6 -1.5

Lithuania -5.1 -6.7 -1.5

Slovakia -5.7 -7.4 -1.7

Belarus -7.2 -9.4 -2.2

Albania -7.6 -9.8 -2.3

Ukraine -8.3 -10.8 -2.5

Bulgaria -8.4 -10.9 -2.5

Moldova -8.6 -11.1 -2.6

FYR.Macedonia -8.6 -11.2 -2.6

Armenia -11.4 -14.8 -3.4

Bosnia-Herzegovina -12.7 -16.5 -3.8

Tajikistan -16.3 -21.2 -4.9

Kosovo -16.5 -21.4 -4.9

Georgia -17.8 -23.1 -5.3

Montenegro -17.8 -23.1 -5.3

Kyrgyz.Republic -25.2 -32.8 -7.6

Source: World Bank staff estimates based on National Sources

Table 1: The Impact of Increased Food and Energy Prices on the Trade Balance May Be Significant

­�5

17. If the combined deficit in food and energy trade is large and the country already has a sub-stantial current account defi-cit, then its external account is vulnerable to increases in prices. Countries with highfoodandfueltradedeficitsandhigh current account deficitsmay face external financingneeds/constraints. In contrast,if the country is running acurrent account surplus, anincreaseinthefoodandenergytrade deficit will reduce thesurplus (or if large enoughturnitintoadeficit)butthesecountries are not consideredvulnerableasthesechangeswillnotstrainexternalbalances.Acountrythatisalreadybor-rowing large amounts of funds from abroad to financedomesticdemand,may find itdifficult toborrowmore.Thus, the increase in food and energy prices, assumingthatothergoodspricesareconstant,couldhaveasignifi-cantimpactonthosecountriesthatarelargenetimportersof food and energyproducts and alsohave large currentaccountdeficits.22InFigure6,thelowerthecountriesareinthebottomleftquadrant,themorevulnerableistheirexternalaccounttoatermsoftradeshock.AmongthesecountriesaresixLLMIC,Armenia,Georgia,Kosovo,theKyrgyzRepublic,MoldovaandTajikistan.ExceptfortheKyrgyz Republic and Tajikistan, they all have currentaccountdeficits of 10%ormore in2010.However, theKyrgyz Republic andTajikistan have among the highestdeficits in food and fuel (-25.2% and -16.3% respec-tively). In addition, four other MICs, Albania, Belarus,Bosnia-Herzegovina, and Montenegro have vulnerabilityon external accounts.23The EU10 on average will showmuchsmallerimpactsontheirexternalaccountsandthe

22 TableA1intheAnnexliststhecountriesintermsofincreasingdeficitsin food and energy trade and also in terms of their overall currentaccountdeficitsatend2010.Thethirdcolumnordersthemaccordingtothesizeoftheircurrentaccountandfoodandenergytradebalances.Thatis,thecountrywiththesmallestdeficit(largestsurplus)onfoodandenergyandthatalsohasthesmallestcurrentaccountdeficit(larg-estcurrentaccountsurplus)istheleastvulnerable.

23 AlbaniaandMontenegrohaveobtained financingon theEurobondmarkettomeetfinancingneeds.

OGEwillreapfurtherbenefitsfromrisingfuelprices;twooftheOGEalsoproducesubstantialamountsofwheat.

2.3.OutputandGrowth18. There have been substantial changes in the terms of

trade of ECA countries in recent years. Commoditypricechangeshave ledto large incometransfersbetweencommodity exporters and importers that have differedsubstantiallyfromyeartoyear,particularlyduring2007-2010. In 2008-09, the effect of the downturn in theglobal economy overtook the underlying trend of risingcommodity prices. In 2010, these trends are again vis-ible. In addition, increases in energy prices represent asupplyshocktofirmsasenergyisanimportantfactorofproduction.24 Estimates indicate that Albania’s terms oftrade improved12%in2009(thusbufferingthedeclineineconomicactivityresultingfromtheglobaldownturn)butdeteriorated12%in2010.Ukraine,ametalandwheatexportersawtheopposite:a12.6%declineintheTOTin2009wasfollowedbyanimprovementof2.9%in2010.FortheOGEexporters,theimpactoftheTOTimprove-ment was muted by the extent of food imports; Russia,traditionally awheat exporter, became anet importerofwheatin2010.Theextentandnatureoftheresponseineconomiesdependsonhowmuchoftheoilpricechangeisperceivedtobepermanentortemporaryandhowmuchthe

Figure 6: High Trade Deficits in Food and Energy Accompany High Current Account Deficits

24 While there are other explanations for the impact on GDP andgrowth,thissectionfocusesonthesetwochannels.

��

32 This statement reflects the importance of oil in their economies but does not account for compensating TOT effects.

increased uncertainty in global markets (reflected in price vola-tility) will deter investment. Though it is often hard to distinguish between temporary and permanent components of shocks, the recent upsurge in oil (and overall food and fuel) prices is believed to have a strong permanent component due to the factors discussed in Section 1.

19. ECA countries’ growth impacts will be differentiated by the particular commodi-ties they export and import, the value of exports and imports and the evolution of market conditions over time, and, in the case of energy, on the energy intensity of GDP. For example, even if the rise in the price of oil has a negative immediate impact on importers, many of them export commodities such as metals or cotton whose prices are also rising; the rise in these prices would mitigate the negative effects for food and fuel importers. The longer run impacts may differ from the immediate or shorter run impacts. Box 3 examines the impact of an oil price shock on the GDP of ECA countries. Models examining the effect of oil price shocks give varying results because of the different assumptions they make and the magnitude of the price changes they examine. The two most important (non-policy) channels considered are the TOT effect and the importance of energy in production. The net trade in fuel (in this case oil) reflects the magnitude of the overall effect on income from energy price changes.25 The energy intensity of GDP reflects the importance of GDP in the production process and thus the magnitude of the shock to production.

20. The energy intensity of GDP has declined over time for ECA countries on average, but some still have high energy intensity, reflecting countries’ different economic structures, energy pricing policies and tech-nological efficiency in energy use. Countries that are more energy intensive are more vulnerable to an oil price shock, as the effect on production from high oil prices will

25 The net trade in food and fuel would be a wider proxy for the magni-tude of the overall commodity TOT effect on growth.

be greater in these countries. In addition, the larger the net energy trade deficit, the greater the TOT impact. Taken together, these two aspects are important determinants of fuel price increases on output. Kazakhstan, Ukraine, Turkmenistan and Uzbekistan have energy use per value of GDP, far above the other ECA countries. Figure 7 shows ECA countries along two dimensions: net trade in energy as a ratio to GDP and energy intensity. Among the OGE, Azerbaijan, Kazakhstan and Russia are very energy intensive (they are not shown as they are energy exporters. The further down countries are in the lower right hand corner, the more vulnerable they are to a negative GDP from the oil price increases.32 These countries are Belarus, the Kyrgyz Republic, Moldova, Tajikistan, and Ukraine. On average, the EU 10 countries are the least vulnerable.

2.4. Fiscal Impact21. The fiscal impact of the food and energy price increases

is large and positive for energy exporters. The fiscal impact of food and fuel price increases depends on some non-discretionary (or automatic) changes in revenues: however, usually governments adopt fiscal policies to mitigate the impact of rising prices in revenues. This sec-tion will briefly consider both aspects. The most obvious sources of fiscal impacts are three: taxation of profits/rev-enues of energy companies, subsidization of consumption of food and energy, income support in production (e.g.

Figure 7: Some Countries With a Substantial Dependence on Energy Imports also Have High Energy Intensity

Energy Intensity, 2007Sources: World Development Indicators, World Bank World Bank staff estimates based on National Sources

Note: Net trade Figures are for2010; energy intensity for 2007.

­��

in agriculture), or tax revenues arising from increased/reduced VAT on consumption. Tables 2 and 3 on thenext page show the amount three oil and gas export-ers have collected in revenues over the last decade fromenergy exports. Azerbaijan’s dependence on oil revenuesis remarkable as three-fourthsof its fiscal revenues come

from the taxation of energy. Energy’s share in revenuesincreased dramatically during the energy price boom in2006-2008 for Azerbaijan and more moderately for theothertwo.Thevolatilityinrevenuesisvisible:revenuesfelldramaticallyasashareofGDPinallthreecountriesduring2009,buttheincreasein2010isalsosubstantial.Withoil

AWorldBankmacroeconomicmodelwasusedtoexaminethe impactofanoilprice shockonGDPandgrowth inECAcountries,assumingthat this isapermanentshock.Oil prices averaged US$79 a barrel in 2010, up fromaround US$62 a barrel in 2009. In this scenario it isassumedthatoilpriceswillrisefurthertoaverageUS$85in 2011 and vary between US$90 and US$95 during2011-2015,26 compared to a baseline view that sees thelong run equilibrium price of oil at US$83 /bbl in realterms.Thebaselineprojectionsforthetermsoftradeinthemodelassumethatothercommoditypriceswillalsoevolveaccording to trend.27 The impact of an oil price shockdepictsascenariowherethebaselineoilpriceincreasesbyUS$10 over and above the projected baseline trend overtheentireperiod;i.e.itisapermanentshock.Themodelislinearinitseffects.28SimulationsindicatethatboththeimpactandlongertermeffectsonGDPandGDPgrowthare relatively small, with GDP levels in the ECA regiondeclining by about 0.06% in 2012; the effects rise to acumulative0.12%by2015.Animplicationofthelinearityof themodel is thatanotherUS$10increase inthepriceofoil coulddouble the impactonGDPand soon.Theeffects are negligible as oil exporters such as Azerbaijan,Kazakhstan and Russia make up for GDP losses in oil-importingcountrieselsewhereintheregion.

TheimpactontheEU12(EU10plusCroatiaplusTurkey)is alsomarginal,while the impacton theoil exporters ispositiveand larger, the impacton largenetoil importersnegative.Thebaselinesimulationsalsoprojectanincreaseinothercommodityprices,notjustoil.Thus,theoilshock

26 Baselineassumptions,DEC,WB.

27 BaselineprojectionsaretakenfromtheWB(2011a).

28 RecentevidenceusingnonlinearspecificationsforOECDcoun-triesfoundlargeimpactswhenoilpricesdoubled.

Box 3: Modeling an Increase in the Price of Oil

occurs in a context of rising commodity prices overallwhich is amore realistic scenario than assuming that allother prices are constant.These model outcomes reflectthe impact of changes in the respective country’s overallTOT and the global (trade) transmission mechanisms.29

TheimpactoftheoilpriceshockontheECAregionisonparwithwhathappens indevelopingcountries inaggre-gate. Other estimates show much larger effects because(a) theyassume that thepricesofother commoditiesdonotchange;(b)theyassumemuchlargerincreasesintheprice of oil; and (c) some take account of asymmetricadjustmentcosts.Inaddition,someestimatesincludethecostsofvariabilityintheTOT.Estimatesoftheeffectofa similar increase in oil prices have been around 0.4%of GDP for the US. Another paper (Jimenez-RodriguezandSanchez,2004)estimatesthatinthepre-2008periodoutput losses resulting from a doubling of oil prices30

wouldbe in the rangeofup to3-5%in individualeuroareacountries.However,atpresent,indicationsarethatoilpricesareunlikelytodoublefromtheir2009levels,eveniftheyhaverisensubstantiallyin2010.Someotherstudies(conductedpriortothe2006-08boom)havefoundGDPwouldbe0.4%lowerinayearinOECDcountriesifoilpricesincreasedUS$10abarrel.31Inaddition,someesti-matesincludethecostsofvariabilityintheTOT.

29 Itisimportanttonotethatintheoilshockscenarioanalysis,itwasassumed thatoilpriceschangebyUS$10/barrel above theexpected baseline trend increase in the price of oil and othercommodities. Inreality,manycommodityprices tendtomovein tandem, and the impact on a respective country’s terms oftrade could be exacerbated/softened depending on how otherpricesrespondwhenoilpricechange.Also,itwasassumedthatexchangeratesremainunchangedfromthebaselinescenario.

30 Thisstudyusesbothlinearandnon-linearestimation.

31 IEA,(2004).

�8

Table 2: Oil and Gas Revenues, % Share in Total Fiscal Revenues

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Azerbaijan 22.0 12.9 39.9 44.3 38.0 39.2 49.3 53.1 73.9 65.8 75.5

Kazakhstan 14.8 18.8 15.5 21.4 26.3 33.1 35.0 27.6 42.8 35.2 41.4

Russia — 16.2 15.1 15.0 31.2 24.3 27.5 26.5 26.8 22.1 25.0

Average 18.4 16.1 23.5 26.9 31.7 32.4 37.6 36.0 45.8 41.7 44.7

Source:.World Bank staff; National Sources

Table 3: Oil and Gas Revenues, % of GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Azerbaijan 4.5 2.4 10.8 12.3 10.2 9.9 13.4 15.2 38.3 27.4 36.6

Kazakhstan 3.2 4.7 3.5 5.3 6.2 9.4 10.0 8.1 12.3 8.1 11.4

Russia — 6.5 7.5 6.0 12.4 10.2 11.1 10.6 10.4 7.6 8.6

Average 3.8 4.5 7.3 7.9 9.6 9.8 11.5 11.3 19.8 14.3 17.8

Source: World Bank staff; National Sources

34 Thiscouldbeduetoanincreaseindollarpricesoracombinationofacurrencydepreciationrelativetothedollarandanincreaseinthedollarpriceofimports.

nextpageshowshowanincreaseof30%inthevalueofimportscouldhaveasubstantialincreaseinVATrevenues.Inthetablebelow,itisassumedthatimportsareattheir2010levelsbutthatcommoditypricesincreaseby30%.34

Thisisnotaslargeanincreaseasitmayseemgivencur-rent commodity price increases.The price of oil was aslowasUS$62abarrelin2009andisalreadyexpectedtoaverage around US$85 in 2011.The table shows that a30%increaseinthefoodandenergyimportvaluecould

pricescontinuingtorise,themajoroil exporterswillhaveachance toreplenishthereservestheyhadputaside from oil revenues before theglobal crisis.33 They may also usetheserevenuestomitigatethenega-tivedistributional impactof risingoilpriceswithin thecountries.Allthreecountrieswillneedtoensurethattheiroilfundsareusedstrate-gically and that reserves are builtup to handle volatility in marketswhen needed. In these countries,animportantissuewillbepotentialcurrencyappreciationanditseffectonotherexports.

22. Higher prices for food and fuel, whose demand is relatively inelastic in the short run, mean higher VAT revenues. InECAcountries,VATrevenuesincreasewithincreasesinthevalueofimports;thequantitiesimportedoffoodandfuelareassumedtobemostlyunchangedintheshortrun,butasimportsadjust,the“VATeffect”declines.Overthelongerrun,thepricechangesareexpectedtobemoderatedbychangesindemandorsupply.Table4onthe

Table 4: The VAT Effect: Increased Tax Revenues from Food and Energy Imports

2010 Increase of value of imports by 30%

Imports of Food Increase in VAT Increase in VAT and Energy, collection, % of collection, VAT rate, % % GDP total 2010 revenue % of GDP

Armenia 20 13.07 3.3 0.78

Bosnia-Herzegovina 17 18.82 2.2 0.96

Bulgaria 20 19.00 2.9 1.14

Georgia 18 19.89 3.7 1.07

Ukraine 20 17.60 2.4 1.06

Source: World Bank staff estimates based on National Data

33 InRussia’scaseforexample,theoilstabilizationfundwasusedtofundthelargefiscalstimulusduring2008-09.

­��

raiseVATrevenuesbyaround1% of GDP in the countriesbelow. The larger the initialimportbill,thegreaterwillbethe potential positive impacton revenues, all else given.However,changes indemandand supply conditions willchange imports over time; ifthey are reduced, then the“VAT effect” declines. Somecountries have reduced VATratesinpreviousyearsinordertomitigate the impactof ris-ing food and fuel prices onconsumers. In that case, thetable reflects the loss in rev-enuesresultingfromadeclinein taxes proportionate to thepriceincrease.AnyincreaseinVATrevenuescouldbebetterused to increase transfers topoor households in targetedsocial assistance systems, andtoraisecoverageandadequa-cyofthesesystems.

23. The fiscal impact of subsi-dies and transfers based on current prices will increase and adjustments will be needed to maintain a neutral fiscal impact. Governmentsin many countries providesubsidiesandtransfersinvari-ousformsforfoodconsump-tion, agricultural productionandenergyconsumption.Thecostofmaintainingconsump-tionsubsidies(preventingpassthrough of prices) increaseswhenthemarketpriceofthecommodity increases.35 This

InBelarus, the energymarket is substantially affectedby risingprices for energyimportsfromRussia.BelarusisheavilyreliantonnaturalgasimportsfromRussiawhichitobtainsatbelowmarketprices.Belarusgeneratesabout97%ofitselectric-ityfromnaturalgasbasedthermalpowerplants,while87%ofitsheatgenerationis based on natural gas.While import prices for natural gas and oil continue tobebelowEuropeanmarket prices, as a result ofRussia’s drive to introducemar-ket-basedprices for its energy exports to theCIScountries (Albania,Azerbaijan,Belarus, Georgia, Kazakhstan, Kosovo, Moldova, the Kyrgyz Republic, Russia,Tajikistan,Turkmenistan, Ukraine and Uzbekistan), import prices of natural gasmore than tripled over the past 5 years, presenting the sector with significantchallenges.

Reluctancetopassthroughincreasesinproductioncoststoresidentialconsumershasledtoadeteriorationofcostrecoverylevelsonelectricity,gasandheatsuppliedtoresidentialconsumersandhasunderminedthefinancialviabilityof thesector.Energytariffsforresidentialconsumershaveremainedflatinrealtermssince2005keepinghouseholdexpendituresonutilityservicesinBelarusbelow10%ofhouse-hold income,much lower than inmostcountries in the region.Lowpriceshaveunderminedthefinancialviabilityandsustainabilityofthesector.Operatinglossesincurredbyutilitycompanieshavegrownto1.7%ofGDPin2009.Theyarecom-pensated for these losses througha complex,non-transparent systemof subsidiesaccountingfor0.3%ofGDPand,toa largerextent,crosssubsidizationbetweencommercialandresidentialconsumers,accountingfor2%ofGDPin2009.

While imposing a rising fiscal cost, energy subsidies are untargeted and largelyinequitable.Theybenefitthehigherincomepopulationthathashigherpercapitaconsumptionofenergy.45%oftotalenergysubsidiesforutilitiesflowstothetop30%householdsintheincomedistributioncomparedto15%forthepoorest30%ofhouseholds.Householdsinurbanareasreceive82%ofthesubsidy.Inaddition,persistentunder-pricinghasdeprivedenergysuppliersof the financingneededtocarryout routinemaintenance activities and investments reducing efficiency andreliabilityof energy supply.Lowenergypricesalsodistortprice signals tohouse-holds leading to energy inefficient consumption patterns while cross-subsidiesbetweencommercialandresidentialconsumersimposeanimplicittaxonthebusi-nesssector,addingtoanalreadylargetaxburden

Respondingtogrowingfiscalpressures,theGovernmenthasbeguntoaddressthesechallenges. With energy costs expected to rise, the importance of higher energypriceshasbeenwellrecognizedinBelarus.Torestorethefinancialviabilityofthesector, the State Program for the Development of the Belarusian Energy System(2011-2015) inAugust2010calls for a comprehensive tariff reformandgradualeliminationofcross-subsidizationinnaturalgassupplyby2013,andinelectricityandheatsupplyby2014.If implementedasplanned,thesereformswillgeneratesignificantfiscalsavings,buttheywillrequiresteepincreasesintariffsthatwillhurtthe poorer households, necessitating compensating increases in the coverage andadequacyoftargetedsocialassistance.

Box 4: The Hidden and Rising Fiscal Cost of Cheap Energy in Belarus

35 In2008,theIMFestimatedfoodandfuel subsidies to amount to around2% of GDP in Ukraine and 6% ofGDP in Turkmenistan (IMF 2008,Chapter3).

�0

is a source of fiscal strain. In some ECA countries forexample,consumptionofenergyissubsidized,particularlyforhouseholds.Box4illustratesthenatureofsomeofthequasifiscalissuesintheenergysector.

24. Additional discretionary measures to protect consum-ers (or agriculture producers) will raise fiscal costs. Another source of fiscal strain is the adoption of newpoliciestoprotectdifferentgroupsinresponsetofoodandfuel price increases. For example, countries may reducetaxes on food and fuel. Also, more people may becomeeligibleforgovernmentsuppliedfoodatpricesthatdonotreflectcostsofpurchasingandstoringfood,whenmarketprices rise. Many ECA countries increased public sectorwagesandpensionsduringthelastcommoditypricesurge(2006-08),anactionthatwasasourceofunsustainablefis-calexpansion.Intheensuingglobalcrisis,fiscalrevenuesplummeted. These policies strained fiscal budgets whentax revenues fell in 2009 and many are being reversed.

ManyECAcountriesareunderpressuretocontainexpen-ditures.

25. Countries with the largest fiscal deficits/debt will be under the greatest strain to rationalize fiscal systems, (for example, by reducing subsidies) when fuel prices rise or if GDP rises less than expected. Georgia, theKyrgyzRepublic,Tajikistan, andUkrainehavehaddefi-cits close to6%ofGDPorabove in2010. Inaddition,Albania (arounda5%deficit), and theKyrgyzRepublichave debt to GDP ratios over 60%, while Armenia andGeorgiahave ratiosof40%and45%respectively.Someof the highest deficit countries are in the EU but theireconomiesarelessvulnerabletooilpriceshocksand,thesecountrieshavesmallersubsidies toenergyandfoodthandosomeofthelowerincomecountries.Amongthefiscallyvulnerable countries, countries as diverse as the KyrgyzRepublic and Ukraine both have high fiscal deficits andsignificantsubsidies,oftenimplicit,forfuel.

­��

26. The food price increases are exacerbating the weakened conditions of many households affected by unemploy-ment and lower wages in the global crisis. The2010-11foodandenergypriceincreases,ifsustained,couldhaveastrongernegativeimpactonpovertythandidthe2006-08priceincreasesastheyareoccurringatatimewhenECAcountriesarejustbeginningtorecoverfromtheglobaleco-nomiccrisis.ThefirstroundofpriceincreasesoccurredatatimewhenGDPgrowthhadbeenstrongforawhile,labormarketsweretight,wageswererisingandremittanceswerehigh.In2009-10,thesituationhasbeenverydifferent.Inorder to copewithunemployment,wage cuts and lowertransfersfrommanysources,householdsreducedsavings,increased borrowing, or reduced consumption (of bothgoods and services such as health). Food consumptiondeclined- either in quality or quantity. Crisis ResponseSurveys in six countries indicate that food expenditureswerecutduringthe2009crisis)36andhouseholdsputoffexpendituresthatcouldbedelayed(e.g.healthvisits,extraexpendituresforeducation,andsoon).

27. At the same time, governments used fiscal measures to protect households against income losses. In theperiod prior to the crisis, during the 2006-08 food andenergypriceincreases,manyECAgovernmentswerealsoincreasing pensions and public sector wages. Given thesignificantweightofthepublicsectorintheseeconomies,and the prevalence of poor pensioners, these measures,though untargeted for the most part and unsustainable,didalleviate thepotentialpoverty impactsof rising foodprices.ManyECAcountriesalsotooktheopportunitytobegintorationalizetheirsocialassistancesystems,improv-ingtargetingandcoverageofthepoor(seeBox5onnextpageandBox6inSection4).Theprogramsofparticularinterest are the Last Resort Social Assistance programs(LRSA).37 The reforms initiated will take time to beimplemented fully. Against this background, rising food

SECTIon 3. PovERTy ImPACTS And ThE RESPonSE oF SoCIAl ASSISTAnCE SySTEmS

36 WorldBank(2011),Forthcoming.

37 Thisisthelargestprogramthatistargetedinacountryandwiththeprimaryobjectiveofpovertyalleviation.

38 SeeAnnex2foradescriptionofthesimulationmethodologyanddataused.Theseestimatesdonotdifferentiatebetweennetproducersandconsumersoffood:poornetproducersmaygain.Thepovertyimpactsaregreateriftheyarenetconsumersofcommodities,andifothercop-ingmechanismsfail(e.g.theydonothavesavingsorcannotborrow),andtheydonotsubstitutetowardscheaperalternatives.

and energy prices constitute a further negative shock toalready poor households and strained fiscal systems. Inaddition,by lowering real incomes, they are expected tothrowadditionalpeopleintopoverty.

28. Simulations based on the most recent household survey data in each country indicate that average household consumption in ECA may have fallen by as much as 5.3% in real terms.38 Food prices account for a largepartof that shock(4.1%of the5.3%),withthebalancecoming from higher energy prices (Table 5). Becausepoor people allocate a larger share of their budgets tofood,thesimulateddeclineinrealconsumptionfromthefoodprice increase isapproximately5.7%inthepoorestquintile,with losses reaching7.0%whenboth foodandenergypriceincreasesareconsidered.Unlesscounteractivemeasuresare taken, thecombinedfoodandenergypriceshockshavethepotentialtoincreasetheextremepovertyrate(belowUS$2.5/day)inECAfrom5.5%to6.7%.Ifthisoccursitwouldtranslatetoanadditional5.3millionpeopleinECAlivingonlessthanUS$2.5perday.Growthin incomesandwages in2011willmitigate this impact.AsshowninTable5, the foodprice shock is responsibleformostof the increase inpovertyacrossall sub-regionswithin ECA, as food is a much larger share of the con-sumptionbasketofthepoorestthanisenergy.

29. The projected impact across ECA countries is hetero-geneous, reflecting not only the differences in food and energy price inflation but also the differing conditions across countries. The negative impacts are expected tobe most pronounced in the low-income CIS countriesof Central Asia and the Southern Caucasus, which areamong the poorest in ECA, with people having highfoodbudgetsharesandwhererelativelylargesharesofthe

��

The implications of higher food prices for low-incomeECA countries, where food represents a substantial partof the household consumption basket (50-60 %), havebeen significant.The impact of the food crisis has beenmost severely felt in the three poorest countries in theregion – Moldova, the Kyrgyz Republic, and Tajikistan.In2007,foodpriceinflationintheKyrgyzRepublichitarecordhighamongECAcountriesat31.5%;inTajikistan,it reached 27.5 %. With 28 % of its population livingin poverty, a sudden increase in food prices by 24 % inMay2008comparedto2007ledtoseriousfoodsecurityandsafetynetconcernsinMoldova.Thegovernmentsofall three IDA countries requestedWorld Bank assistanceon an emergencybasis andobtained financing for safetynets andnutritional supplementsunder theGlobalFoodResponseProgram(GFRP).39

TheresponseoftheWorldBankinMoldova,TheKyrgyzRepublic, andTajikistanbuilt on active programs agreedwith the governments. The approach to addressing theissuewas the same ineachcase: adding financing toon-going Health and Social Protection projects. Since theseprojectswerealreadyinplace,theyprovidedaconvenientway todeliveradditionalandrapid financing tomitigatetheimpactofthecrisis.Inaddition,existingclientrelationsand the extensive knowledge base that had already beendevelopedwiththeseoperationsfacilitatedtheprocess.

The Kyrgyz Republicalreadyoperatedamoderatelywelltargeted program, the Unified Monthly Benefit (UMB).

Box 5: Global Food Price Crisis and Safety Net Response: Experience of IDA Countries in ECA

39 The program was set up by the Bank in 2008 following theapprovalofUS$1.2billioninfundsforthemostvulnerableandpoorestcountries.ThisinitiativecomplementedtheeffortsoftheUnitedNationsHigh-TaskForceonfoodsecurity.

In June 2008, the World Bank rapidly mobilized addi-tionalfinancingofUS$6millionundertheactiveHealthand Social Protection Project (SWAP) to assist KyrgyzRepublic in two ways: (i) to protect and improve thehealthandnutritionalstatusofvulnerablepopulationsbyproviding nutritional supplements and nutrition educa-tiontopregnant/lactatingwomenandinfantsandyoungchildren;and(ii) tohelppoorfamiliesmitigatethefoodpriceshocksandprotectconsumptionbyscalingupandstrengthening targeted cash transfers. The cash transfercomponent was designed to “top up” the monthly pay-mentsundertheUMBprogramtocompensatethepoorforthelossofpurchasingpowerlivingduetorisingfoodprices. The European Commission supported this pro-gram. Higher institutional safety net capacity in KyrgyzRepublic,duetotheexistingUMB,greatlyfacilitatedtheGFRPinvolvement.

In contrast, the state of existing safety net system inMoldovadidnotofferthesameopportunitiesforscalingup.Atthetimeofthecrisis,Moldovawasspendingnearly1.4 % of GDP on 15 cash transfer programs, none ofwhichwerewelltargetedtothepoor.However,Moldovaoperatedanetworkofspecializedinstitutionsthatprovid-edsocialservicestovulnerablegroups;thisnetworkservedas a basis for leveraging the GFRP response.The WB’sHealthServicesandSocialAssistanceProject receivedanadditionalfinancingofUS$7millionundertheFoodPriceCrisisResponseTrustFund.Thoughtoppingupatargetedprogramwouldhavebeenpreferable, thisalternativedidsucceed in providing additional funding for nutritionalsuppliesreachingvulnerablegroups,suchasorphans,thedisabledandelderly.Moldovahasalsobeguntheprocess

(cont�nued­on­page­�3)

populationareveryclosetothepovertyline.Thisisalsothesub-regionthathasseenthesharpestincreaseinfoodprices.TheKyrgyzRepublic isprojected tobe theworstaffected country. In 2010 the price of wheat—whichprovidesapproximately40%ofcaloriesconsumedinthatcountry—increased by 54%. In the absence of counter-vailingmeasures, food and fuelprice inflationof15.1%couldincreasetheextremepovertyrateby11.4percentagepoints, increasing the number of extremely poor people

by600,000(Table6).WheatprovidesmorethanhalfthecaloriesintheaveragedietinTajikistan.InTajikistan,foodandfuelpriceincreasescouldincreasetheextremepovertyrate by 8.4 percentage points, as an additional 586,000people fall below the extreme poverty line (US$2.5 perday). In Georgia simulations show that extreme povertycouldincreaseby9.1percentagepoints,whileinArmenia,extreme poverty could rise by 9.4 percentage points at2010inflationratesforfoodandfuel.

­�3

10%,butwere still substantially lower than those in theSouthernCaucasusandCentralAsiancountries.Becausepoverty rates are much lower in these countries, theproportion of the population vulnerable to falling intopoverty or extreme poverty from a price shock is muchsmaller,rangingfrom0.2to1.6percentagepoints.Despite

the small impact in proportionalterms, these populous countrieswouldcontributelargenumbersofthe“newpoor.”Itisestimatedthatthenumberofextremepoorcouldincrease by 1.2 million inTurkey,600,000inRussia,and100,000inUkraine.40 However, these effectswould be muted as wages andemployment grow. For example,for Russia, there are indicationsthatgrowthinwagesandpensionshave mitigated the potential pov-ertyimpactofhighprices.

Box 5 (cont�nued­from­page­��)

ofestablishinganLRSAprograminresponsetothe2008crisis.Thenumberofhouseholdscoveredinthepilotpro-gramhasincreasedfromaround20,000to50,000during2010.TheWBisplanningtechnicalassistanceforexpan-sionofthisprogram.

Tajikistan did not operate an effective safety net thatcould be leveraged to protect the poor when the foodcrisis hit in 2008 andTajikistan was only spending lessthan 1 % of GDP on safety nets. The benefits mainlyincludedgas/energysubsidiesandacashtransferprogram.None of the programs were well-targeted or could tracedistribution of benefits. Lack of a functional safety netsystem presented a challenge for the implementation ofthe GFRP response. However,Tajikistan received US$4million in additional financing for the Community andBasicHealthProjectinJuly2008tosupporttheprovision

ofnutritionsupplementsandnutritioneducation,andtoimprovethemonitoringofchildrenunderfiveinprimarycarecenters.Decadesofmalnutritionofwomenandchil-drenhadalreadyledtowidespreadmicronutrient,vitaminA, and iodine deficiencies. The food crisis raised fearsthattheextentanddepthofthisproblemcouldintensify.The additional financing thus focused on the provisionof maternal and child nutritional supplements and theinvolvement proved effective. Moreover, 1,200 primarycare facilities received weighing equipment. To improvethe effectiveness of the existing safety net system, theGovernmenthasjustlaunchedapilottestingthescoringformula(proxy-meanstest),andconsolidatedthetwolarg-estsocialassistanceprogramsintoasingleone,targetedtothepoorest20%ofthepopulation.

Source:WorldBank(2011)

30. Higher food and energy prices may also lead to sub-stantial increases in the number of poor people unless countervailing actions are taken, though the poverty rate increase would be small in large middle-income countries such as Ukraine, Turkey and Russia. Foodand energy price increases in these countries exceeded

40 Allthepovertyreferencesareforpov-ertymeasuredatpeoplelivingbelowtheUS$2.5adaylevel.

Table 5: Poverty Impact by Sub-Regional Groupings

Low- Middle- All income income Western ECA EU-10 CIS CIS Balkans

Baseline Poverty rate at US$2.5/day (%) 5.6 1.9 32.9 1 8.8

Foodinflationonly Increase in poverty rate at US$2.5/day (% pts) 1 0.3 7.8 0.4 0.7

Foodandenergyinflation Increase in poverty rate at US$2.5/day (% pts) 1.3 0.4 9.4 0.5 0.9

Source:.ECA Databank (ECAPOV), World Bank; WB Simulations

EU-10.countries.are: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia

Low.income.CIS.countries.are: Kyrgyz Republic and Tajikistan

Middle.income.countries.are: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kosovo, Moldova, Russia, Turkmenistan, Ukraine, Uzbekistan

Western.Balkans.countries.are:.Albania, Bosnia-Herzegovina, Croatia, FYR Macedonia, Montenegro, Serbia, Kosovo

��

31. The poverty impacts in the EU New Member States and Western Balkans are expected to be modest in comparison to the effects on their neighbors. Ingeneral,foodpriceinflationhasbeenmuchlowerinthesecountries: lessthan5%inabouthalfof the countries, and surpassing10%onlyin Estonia (11.6%) and Serbia (10.7%).Compared to other ECA countries, theEU-10, and to some extent the WesternBalkans, tend to have lower food budgetshares,lowerinitialpovertyrates,andlowershares of the population that are onlyslightlyabovethepovertyline.Amongthesecountries the most negative impacts areexpectedtohaveoccurredinEstonia,wherehigherfoodandenergypricescouldincreaseextreme poverty by 1.5 percentage points,and Romania, where the correspondingestimateis0.9percentagepoints.

32. In the aggregate for the ECA region, the amount required to compensate poor households for the losses associated with energy and food price shocks is marginal, but there are large differences across countries. The compensation needed tooffset thenegative shockson thepoor is afunction of the effectiveness of the socialassistance programs and the proportion ofthe increase in the aggregate poverty gap.It is estimated thatapproximately0.1%ofthe ECA region’s overall GDP would beneeded to compensate the poor based onthemagnitudeofthepriceshocksandeffec-tivenessoftheexistingprograms.Inmostofthecountries,theeffectofthepriceshockson the extreme and moderate poor couldbeoffsetbymodest transfersandcouldbedistributedby the current social safetynetprograms.TheECAaveragemonetary lossmaskssignificantregionalandcountryleveldifferences.InadditiontheUS$2.5povertylineimpliesdifferentlevelsofpovertyindif-ferentECAcountries.Forexample, in lowincomecountries,amuchlargershareofthepopulationwillbedefinedas “poor”using

Table 6: Simulation Results for Poverty Increases Resulting from Higher Food and Energy Price Inflation (US$2.5/Day)

Food and Energy Price Increases Food Price Increases

Increase Increase

Headcount Number Headcount Number Ratio of poor in Ratio of poor in (% points) 1,000s (% points) 1,000s

Albania 1.8 57 1.15 36

Armenia 9.4 290 8.36 258

Azerbaijan 1.56 137 1.41 124

Belarus 0.12 11 0.12 11

Bosnia.Herzegovina 0.06 2 0.06 2

Bulgaria 0.57 43 0.42 32

Croatia 0.07 3 0 0

Estonia. 1.46 20 1.22 16

FYR.Macedonia 0.31 6 0.31 6

Georgia 9.11 388 8.22 350

Hungary 0.21 21 0.12 12

Kazakhstan 1.47 233 1.47 233

Kosovo 2.09 38 1.92 35

Kyrgyz.Republic 11.37 605 10.69 569

Latvia 0.39 9 0.24 5

Lithuania 0.28 9 0.15 5

Moldova 4.85 175 2.4 86

Montenegro 0 0 0.17 1

Poland 0.14 54 0.08 31

Romania 0.92 198 0.72 155

Russian.Federation 0.42 603 0.37 518

Serbia 0.75 55 0.63 46

Slovenia 0 0 0 0

Tajikistan 8.43 586 6.01 418

Turkey 1.6 1,193 1.22 909

Ukraine 0.24 111 0.2 93

Source: ECA Databank (ECAPOV), World Bank

Note:.Simulations reflect the increase in poverty rates from food and fuel price inflation at the rates experienced in 2010.

­�5

this measure as opposed tohigherincomecountries.Inthe low and lower middleincome countries wherepoverty is expected toincreasethemost(Armenia,Georgia, the KyrgyzRepublic, Moldova, andTajikistan), the additionalfiscal cost of compensatingthe poorest 20% of house-holds forthefoodandfuelpriceincreaseswouldbeupto1%oftheirGDP.

33. In ECA countries, the capacities of social assis-tance programs to help buffer the price shocks vary widely.Safetynetscanbe leveraged as importantcrisisresponsemechanisms.However, the ability ofcountries to respond withspeed depends critically onthe capacity of core socialassistance systems beforea crisis hits. Three aspectsof social assistance systemsthat determine their abilitytoprotectthepoorarecov-erage, targeting and gener-osity. Coverage in this caserefers to theportionof thepoorest quintile receivingtransfers. Generosity refersto how much the transferrepresents of post transferconsumption. Targetingrefers to the portion of fis-calexpendituresreachingthepoorest.TheseareshowninFigures8.1-8.3.Fortunately,mostcountriesinECAhaveat least one well targetedsafety net program, andmany also have additional

Figure 8.1: Coverage of Poverty Targeted Programs Is Very Low in Some ECA Countries

Figure 8.2: Targeting Accuracy of Poverty Targeted Programs in ECA Varies among Countries

Figure 8.3: Generosity of Poverty Targeted Programs in ECA Could Be Strengthened in Some Countries

��

programs to protect vulnerable groups such as childrenandthedisabled.

34. Among the ECA countries that are expected to be the most affected by higher food prices, Armenia and Georgia are best positioned to provide safety nets for the poor. Both countries have well-established targetedcash transfer programs – the Family Benefits Program(FPB) in Armenia, and the Targeted Social Assistance(TSA) program in Georgia.The Armenia FPB programcovers about40%of individuals in thepoorest quintile,whiletheGeorgiaTSAprogramcoversabout20%(Figure8.1). In addition, both programs have good targeting

accuracy, transferring more than 55% of total socialassistancebenefitstothepoorestquintile(seeFigure8.2).Finally,bothprogramsalsohavereasonablegenerosity.Alittlemorethan50%oftheconsumptionofbeneficiariesofGeorgia’sTSAprogramcomes fromtheTSA transfer,while about30%of the consumptionofbeneficiariesofArmenia’s FRB program is from the transfer (see Figure8.3). Both Armenia’s FPB program as well as Georgia’sTSAprogramrespondedrobustly to the food-fuel-finan-cial crisis of 2008.The Kyrgyz RepublicUMBprogramhas reasonable coverage and targeting accuracy, but verylowgenerosity.

­��

4.1.Vulnerability35. Countries in ECA are con-

sidered most vulnerable to the food and energy price shocks if they could have large increases in poverty rates due to high inflation and if, at the same time, the impact on their macroeco-nomic accounts is potentially significant. In ECA, currentaccount imbalances precedingthe last crisis magnified theregion’s vulnerability to exter-nal shocks. During the globalcrisis, current account imbal-ances improved inECAcoun-triesbecauseconsumption(andtherefore imports) tended tofallsosharplythattheyoutweighedthedeclineinexportscausedbylowerexternaldemand.AstheECAeconomieshaverecovered,sohasconsumption.Currentaccountdefi-citshaveremainedlowerthaninthepre-crisisperiod,buttheyhavebeenrisinginmany.Thefoodandenergypriceincreaseswillhaveanegative impactonmanycountries’external balances; the higher the overall deficit to beginwith,thegreaterthevulnerabilitytoshocksandthegreatertheadditionalfinancingneed.41Intermsoffiscalvulner-abilities,countrieswithhigherdeficitsareconsideredmorevulnerablefromamacroeconomicperspective,particularlycountries with higher deficits that also may have highpotential increases in poverty rates. The distribution of

SECTIon 4. vulnERAbIlITy And PolICy InTERvEnTIonS

41 Even if the food and energy trade balance is in deficit, the currentaccountmaybe in surplus (andvice versa).Ahigher food and fueldeficitmayreducethesurplus;however,itisassumedthatacountryfacing a lower overall surplus is much less vulnerable to externalshocks(e.g.theriskofcapitaloutflows)thanacountrywithadeficit.InTable A1 in Annex 2, the countries that will face the strongestexternal financing pressures are listed at the bottom of the columnCombinedOrdering.Totheextentthatthesecountriesexportpricesincreasealongwithfoodandfuelprices,theirpotentialvulnerabilityisreduced. 42 TheMacroVulnerabilityIndicatorisbasedonWBstaffestimates.

Figure 9: Some Countries Are Vulnerable in Both Macroeconomic and Poverty Outcomes

ECAcountriesalongmacroeconomicandpovertydimen-sionsisshowninFigure9.42

36. In assessing vulnerabilities, it is important to differ-entiate among three groups of countries: EU member and accession countries, some particularly vulnerable low and lower middle income countries, and the OGE. Countriesthataredeemedthemostvulnerabletothefoodandenergypriceincreasesfromanoverallmacroeconomicanddistributionalperspectivearethelowandlowermiddleincomecountries:Armenia,Georgia,theKyrgyzRepublic,Moldova, and Tajikistan. They are represented in theshadedupper righthand segmentofFigure9.Therearecountriesthatarepotentialvulnerableontheirmacroeco-nomicoutcomesbutarenotexpectedtohavehighpovertyincreases.TheseareAlbania,Bosnia-Herzegovina,Kosovoand Montenegro. If food and fuel prices continue toincreasesubstantially,theycouldfacedeterioratingexter-nalbalances.EUcountriesaretheleastvulnerable.Theirmacroeconomicpositionreflectsmostlymanyof theEU

�8

member and accession countries’largerfiscaldeficits,buttheimpactof additionalprice increases is onaveragesmall.TheOGEcountriesaretheleastvulnerable,andare,infact,outliers.

4.2.PolicyInterventions37. Governments in ECA countries

tried to soften the impact of food prices through a range of inter-ventions in response to the 2008 commodity price hikes. Thesewereaimedatprotectingdomesticconsumers of food and energy.43These include export quotas (forfoodexportingcountries),domes-tic (formal and informal) pricecontrols, greater use of state pro-curement at lower-than-market prices, and topping upexisting social assistance andother transfers. In a coupleof countries, however, importVAT was reduced to helplowerimportedgrainprices.Forenergypriceincreases,thefavoredresponsebyGovernmentswasprimarilytostaggerdomesticpriceincreases.

38. In response to the current hike in commodity prices, some, but not all governments have adopted new poli-

43 WorldBank(2008).

Figure 10: ECA Countries Used Various Policies to Contain the Impacts of Food and Energy Price Increases in 2008

Armenia has had an Energy Efficiency Action Plansince2010andanewtaxationsystemwasintroducedtoenhance efficiency in 2010. Additional fiscal resourceswereallocatedtopensionsandtofamilybenefitstooffsetgastariffincreasesin2010.

Azerbaijan has had subsidies for fertilizers, fuel, seeds,seedlings,hectaresunderwheatandricecultivationdur-ing 2007-2010. In Dec 2010 it temporarily suspendedtheVATonwheatimportsandtheexemptionisprovideduntilAug2011.

Belarushascontrolsoverpricesoffoodstuffsandregulatesagriculturalproducts.InAug2010,agovernmentresolu-tionsettargetsforenergyefficiencyanddiversification.The

Box 6: Policy Initiatives in Selected ECA Countries

cies (at the time of writing) to manage the effects on their economies. However, the situation is still evolvingand countries may adopt policies to protect the poor orcontainmacroeconomic impacts.Anumberof countrieshave adoptedplansor strategies to improveproductivityand/or efficiency in the agriculture and energy sectors(Section4and5);someofthesestrategies/plansbeganinconnectionwithEUaccessionor in response to fast ris-ingfoodandenergypricesinthepre-crisisperiod.Box6belowsummarizessomeinitiatives.

governmentenvisionsreducingenergyintensityofGDPby50%in2015relativetothe2005levelandtoreducetheshareofrenewableenergyfrom20%in2009to32-34%in2020.Theaveragegasimportpriceincreasedby25%;household tariffsdidnot increasebut industrial consum-erssawanincreasehigherthantheincreaseinprices.Forheating,subsidiesareprovidedfromlocalbudgetsamount-ingto0.25%ofGDPonaveragep.a.during2007-2010.10.7%ofhouseholdsreceivedafoodsubsidyin2010.

Bulgariahasanenergyefficiencystrategyinplacein2010.Meanstestedheatingallowancesandsocialassistance forindividualsandfamiliesexist.

(cont�nued­on­page­��)

­��

Croatiahasundertakenseveralenergyefficiencymeasures.Italsohasasubsidyondieselforfarmers,andhasreducedtheexcisetaxonderivatives.

Georgia. The Tblisi municipality has opened groceriesgivinga20%discountonbasicproducts for thevulner-able. Subsidies were estimated at 11.1 million for 2011;this isaone time transferofUS$11perpersontocovertheenergybill.

Kazakhstan imposed a ban on exports of selected fooditems on Oct 2010, excepting exports to Belarus andRussia;anewlawgivesgovernmentthepowertosetpricecapsonsocially important food itemsforaperiodofupto90days.Theyhaveadoptedsomereformstoenhanceenergyefficiencyinpublicinstitutions.

The Kyrgyz Republichascompensationpaymentstothepoorforhighfoodpricesandisplanningotherinterven-tions.

Latvia has adopted some energy efficiency initiativesrelated to EU accession; it has a subsidy on diesel usedbyfarmersandotheragricultural subsidies,a subsidyforbiofuelandfoodsubsidiesinplace.

FYR Macedonia reducedtheimporttariffonsugarfrom30%to5%;ithasaGEFprojectrestructuredtofocusonenergyefficiency;agriculturesubsidieswereincreasedfrom0.3%ofGDPin2006to1.5%in2010.

Moldovahasbannedwheatexportsuntilthenextharvest;compensationforenergyexpenditureswere0.5%ofGDPand recently another .35% of GDP subsidy has beenaddedforatotalof0.85%ofGDP.

Poland has ongoing energy efficiency initiatives for EUcompliance; an energy subsidy for vulnerable consumershasbeenlaunchedandallocationstothegovernmentpro-gram“supportforameal”wereincreasedin2010.

Romaniameanstestedsubsidiesforresidentialconsumersforheatingremainaswellasproducersubsidiesforheat-ingbutithascutasmallsurchargeongasoline.ThereareongoingEUrelatedenergyefficiencyinitiatives.

Russia has imposed an export ban on wheat and othergrains from Aug. 15th to end-June 2011; the existing

Box 6 (cont�nued­from­page­�8)

TradeLawwasamendedtoallowgovernmenttosetpricecapsonsociallyimportantfoodproductsforamaximumperiodof90days;gasolinetaxeshavebeenraised, trans-port taxes lowered; the government is selling from itsstockpile in drought affected areas; it has adopted someenergyefficiency initiatives; andhouseholdenergy tariffsslowlybeingraisedtocovercosts.

Tajikistan. An export restriction of locally producedwheat to neighboring countries was introduced by oneregion;thereareenergyefficiencyinitiativesinplaceanditaimstocovercostsforgasby2011;oneregionhasbeenexemptedfromVATpaymentonadeliveryofcoal;energytariffincreasesareplanned.

Turkmenistan prohibited fertilizer exports; the state hasestablishedmonthlyquantitiesofwater,salt,gasandelec-tricity to be delivered free of charge to poor householdsuntil2030.

Turkeytemporarilyeasedthebeefimportduty;alawonfooddistribution is tobeenacted inMarch2011whichaims to reduce volatility and improve distribution; theconsumptiontaxonoilproductswasraisedinJan2010;effortstoenhanceenergyefficiencyareunderway.

Ukraine has adopted quotas on grain exports throughMarch 2011; the list of socially important food whosepricesarecontrolledwasextendedtoincludebuckwheat;theexciseongasolinewasincreasedandthetransportationduty reduced; began increasing tariffs for gas, electricityand heat, introduced fines for nonpayment; householdsreceivedanadditional0.5%ofGDPforgascosts.

Uzbekistan doesnot allowgrain/flour/rice exports since1994,thoughoccasionallythegovernmentmaydecidetoexport some grain and flour; export of locally producedcookingoilissuspended;governmentiskeepingpriceslowby sellingmore flour from state resources; for2011, thegovernment adopted a program of farmland reservationforgrain,vegetables,fruits,andforageforcattlebreedingtoensureself-sufficiencyinfood;heatingtariffscontinueto be increased; there is a 2011-15, program aimed atpowersectormodernization.

30

39. Agricultural prices in ECA are spiking upwards for the second time in three years; not only are prices rising but the variance of price levels for grains, sugar and rice has increased substantially. At the beginning of2011, foodpriceswereback to the2008peak levels. Interms of individual commodities, the world wheat priceis still below its2008peak and themaizepricehas sur-passedit.Asin2008,the2011thepricepeakforfoodisrelatedtotheevolutionofenergyprices.Energyandfossilfuel fertilizersarean important input inagriculture;alsobiofuelproductionisincreasingpressuresoninternationalfoodmarkets.In2011priceincreasesaremorewidespreadacrossa largenumberofcommodities than theywere in2008andarenotdrivenonlybycereals.InJanuary2011,shorttermfoodpricevolatilityreachedthehighestlevelssince the1970s. Increasingvolatility andmarket anxietyisduetoweatherrelatedshockswhichhamperthesupplysideofthemarketandtoenergypricevolatility.Inaddi-tion,reportednaturaldisastersareincreasinggloballyandtheimpactofclimatechangeonagriculturehasstartedtoemerge.

40. Lower agricultural production in some ECA coun-tries contributed to the 2010 global price increases.In 2010, planting intentionswere slow to materialize inmanyCentralandEasternEuropeancountriesbecauseoftheweather.44HeavyOctoberrainsinBulgaria,HungaryandPolanddelayedsowing. InBelarus,Moldova,RussiaandUkraine,aggregatecerealproductionwasabout25%lowerthaninthepreviousyearandthelowestlevelsince2005.45ThesharpestdeclinewasinRussiawherethecere-alcropfellby1/3rdcomparedtothelevelofthepreviousyear.Floodandhaildamageaffectedoutput inMoldovaand Ukraine and Russia suffered from drought and hotweather.

41. High agricultural prices do not always boost agricul-tural incomes for several reasons.Inthepreviousprice

SECTIon 5. AgRICulTuRE In ECA

44 FAO(2010).

45 TheEU’saggregatecerealoutput in2010isestimatedtohavebeen6%lowerthanthatofthepreviousyear.

hike,highcommoditypricesdidnotalwayssubstantiallyraiseagricultural incomesandthe2011responsemaybesimilar.WhilecountriesinECAdifferintermsofagricul-turalstructureandpoliciesanumberoffactorsmighthin-derfarmersfromgainingwhenagriculturalpricesrise.46,47

Theseinclude:

• Imperfect­ pr�ce­ transm�ss�on:48 High internationalgrainpricesoftentransmitonlytoa limitedextenttothe farm gate because (i) many farmers, particularlysmaller ones, do not have storage facilities and thusneed to sell their produce right at harvest timewhenpricesare the lowest,and/or (ii)policymeasures suchasexportbansmaykeepdomesticpriceslow.

• Increases­�n­pr�ces­for­farm­�nputs:­Dramaticincreasesintheprices for tradable inputssuchasenergy, fertil-izer, andpesticides increased thevariablecostof agri-culturalproductionbyanestimated20%.Farmersmaynotbeabletopayforthemorecostlyfertilizer.

• Increases­ �n­ land­use­ pr�ces: InmanyECAcountries,land rentpricesaredetermined ingrainpriceequiva-lentsandthus increasealongsidewithgrainwholesaleprices,irrespectiveofwhethertheseleadtoincreasesinfarm-gateprices.Evenwhenlandpricesarenotexplic-itlydeterminedingrainpricesequivalents,grainpriceshaveanimpactonpricespaidforthelease/purchaseofagriculturalland.

• Increases­ �n­ costs­ of­ feed�ng­ l�vestock: Increased grainpricesmeanhighercostoffeedforlivestockanddairyfarmers.

46 Forexample, small farmersmaynothaveaccess tocredit to financemoreexpensivefertilizerseveniftheirmarginalproductispositive.

47 Moreover, inmanycountries,thereisaveryunequaldistributionoffarmsize;inRomaniaforexample,lessthan10%ofthefarmsculti-vatemorethan90%oftheland.

48 The Bank’s ECA Agiculture and Rural Development group hasentered into a research partnership with the Leibnitz Institute forAgriculturalDevelopment,Germany,toassessagriculturalpriceshocktransmissionamongselectedECAcountries,amongthemthosecon-stitutingmaingrainproducersandthosemostvulnerabletofoodpriceshocks.

­31

42. Despite these weaknesses that constrain short term price responsiveness in ECA, a large untapped potential exists to respond to price increases over the medium term.ECAcouldenhance its status as a supplierof global scale and enhance itsrole as a buffer to commod-ity price shocks. It has landareas that can be brought intoagricultural production (withrelatively good infrastructure)and huge yield gaps comparedto its peers in higher incomecountries.The lower bound ofarable land expansion potential in Belarus, Kazakhstanand Ukraine, without encroaching on the forests andprotected areas, is estimated at 10-15millionhectares.49

WhilemostlandareaswouldnotrequireirrigationasECAenjoysatemperateclimatewithoutseriousenvironmentalconstraints, there will be some areas that would needinvestmentinirrigationanddevelopmentofon-farmandpost-harvestlogistics.

43. Even on current areas of cultivated land, ECA may significantly increase its grain production. Simply byan intensification of production, ECA (through opti-mized technologies, e.g.,useof fertilizers,modern seeds,agronomic skills) could more than double its outputand make it less volatile. Forexample, fertilizer use in ECAis much below that in WesternEurope (Figure 11), and farmpractices are much less sophis-ticated. These factors translateinto highly volatile productionand exports from the northernBlack Sea Region. This regionhas recently increased its exportpositions for some agriculturalcommodities, especially grains,comparedtothetraditionalpro-ducerssuchasAustralia,Canada,

49 EBRD, and FAO (2008), DeiningerandByerlee(2011).

the EU and the USA. Kazakhstan, Russia, and Ukrainehaveemergedasthreeofthetopnineexportersofwheat,currently accounting for about 25% of global exportsof wheat and wheat flour, and Ukraine has become theworld’slargestexporterofsunfloweroil.Figure12belowshowswheatproductionpotentialusingadditionallandinthethreemainexporters.MeetingECAcountries’exportpotential in agriculture means a substantial increase inworld food supply. Policies that enhance efficiency andimprovedistributionwouldsupporttheseobjectives.

44. Though stakeholders demand bold immediate respons-es to the currently emerging food price spike, in agriculture itself, there is a very limited set of short

Figure 11: Fertilizer Use per Hectare in Selected Countries

Figure 12: Some ECA Countries May Expand Their Wheat Production Significantly

3�

term remedies. Thisispartlybecauseofthelongproductioncyclesinagriculture–ECAcountriestypicallyproduceoneannualgrainharvest. The time needed for a meaningfulsupply response to price increases is also afunction of when the price increase occurs.Grainisusuallyplantedinfallwithaharvesttaking place the following summer with alimitedwindowavailableforoptimalfertiliz-erapplication.Livestockproductionactivitiestypicallyrequirepriorinvestmentsinproduc-tion technology and/or livestock. In largerscale, export oriented crop production, thetwoshortterminterventionswiththegreat-estimpactwouldbetheuse(orprovision)ofhigh quality seed and of chemical fertilizersto farmers but the application of both isonly possible at particular times, logisticallydifficult, and must be considered against aset of appropriate social and environmentalsafeguards.Insmallerscalecropproduction,whereshort-terminterventionsmainlyaimatstrengtheningtheroleoflocalagricultureasabufferagainstpriceshocks,targetedprovisionofseedandfertilizerassistancehasproventobeaneffective short termmeasureas in theKyrgyzRepublicandTajikistan(seeBox7).

45. In response to rising world food prices, many countries have adopted policies which have hindered them from realizing their potential in the past. Policiesreducingdomesticproductpricesthroughtraderestric-tions(e.g.exportrestrictionsinKazakhstan,Russia andUkraine), input availability (e.g.Uzbekistan’sfertilizerexportprovisionsthatreducedfertil-izer availability inTajikistan) and reduction in access tohigh-qualitymodern seeds (as inMoldova orTajikistan)duetooverlystringentphyto-sanitaryrequirementsactasdisincentives to a positive supply response. Investmentsin productivity-enhancing public goods are needed too,but when policies discourage private investments, thereturns of public investments are diminished. Access toservicesandmarketsdifferamongcountriesandbetweensmallandlargefarmswithincountries.Moreover,growingdemandforfoodmustbemetagainstabackdropofrisingglobal temperatures and changing patterns of precipita-tion.ECAisdevelopingstrategiesandpoliciesforclimate

Limitedaccess toquality seedsand fertilizer remainsawell recog-nized constraint to food security in the Kyrgyz Republic. UndertheGFRPadditionalfinancingfortheAgricultureInvestmentsandServicesProject (US$4.0million)wasprovidedto furtherdevelopthe Community Seed Fund (CSF) program. This has proven tobe a sustainable institutional arrangement to ensure community-drivenaccesstoqualityseedsforfarmers.NewCSFsaresupportedthroughoutthecountryunderaWB-financedprojectandincoop-erationwithanumberofotherdonorsandlocalNGOs.ANationalFederationofCommunitySeedFundswasformedandisresponsibleforcontinuedmonitoring,operationalsupport,liaisonwithdonors,andpromotionoftheinterestsoftheCSFsatthenationallevel.

Although the CSFs primary objective is poverty alleviation, theyalsodemonstrate thevalueofgoodseedand inputsandprovideasustainable, self-helpapproachwherebyfarmers,who,even if theydonothaveaccesstocash,canstillobtainseedandfertilizer.CSFsreceive improved seeds for wheat, maize, oilseeds, vegetables andfoddercropssuchaslucerne,sainfoin,barleyandoats.Eachyeartheequivalentof120%oftheseedandfertilizervaluereceivedmustbereturnedtotheCSFforsubsequentdistributiontonewmembers.Of the CSFs already established, about 80% have maintained orincreasedthevalueoftheirfunds,andmosthavenowreplenishedtheinitialseedprovidedwithnewseedand/orhaveswappedseedforotherspeciesorinputs.AnumberofCSFshavealsoestablishedsub-stantialsavingsfundsforotheractivities,andsomeofthemoresuc-cessfularenowregisteringasformalcooperatives.Overaperiodoftwoyears,thetotalnumberofbeneficiariesandtheacreagecoveredhasmorethandoubledandthe12,000beneficiaryfamilieswouldrepresentanaggregategrainproductionofabout80,000tons.

Box 7: Community Seed Funds in the Kyrgyz Republic

changemitigationthatwouldhaveaverysignificanteffecton the food system – ECA countries recognize that thechallenge of feeding a larger global population must bemetwhiledeliveringasteepreduction ingreenhousegasemissions.

47. Commitment to a framework for reform over the a medium-term in ECA would contribute to achieving both (a)asignificantlyenhancedcontributionofECAtoglobalcommoditymarketsand(b)animprovedresiliencetopriceshocksinECA’slocal/regionalfoodsystems.Suchaframeworkwouldneedtobecenteredaround:

­33

•Improv�ng­pol�c�es­and­governance­of­agro-food­systems­to­ encourage­ �nvestment.­ This means (a) eliminatinggovernmentinterventioninmarketsthatprecludemar-ketadjustmentstochangedconditions(Ukraineexportquotas), providing better public services; (b) institu-tionaldevelopment and regulatory reforms (e.g., landmarkets,riskmanagement,finance);(c)linkingsmallerfarmers to markets through infrastructure provisionor support of infrastructure provision; (d) improvingenvironmentalsustainability.

•­Invest�ng­ �n­ knowledge,­ sc�ence,­ and­ technology­ to­enhance­product�v�ty­and­reduce­y�eld­volat�l�ty­and­to­

Box 8: Export Restrictions Damage Food Security in the Long Run

OnOctober4,2010,UkraineimposedgrainexportquotasthatareexpectedtobeinplaceuntiltheendofMarch2011.Thismeasurewasmotivatedbyconcernsoverincreasinggrainandbreadpricesandtheneedtosecurefoodsupplies.However,bothonfoodsecuritygrounds as well as from an economic perspective,export quotas are not desirable. Export quotas haveproventobeoflimitedeffectincontrollingdomesticprices as producers tend to hold back grain fromdomesticmarkets if theyunderstand themeasure tobetemporary,andfarmersreduceproductioninorderto keep future prices high. In addition, processorsmaynottransmitcheaperinputpricestoconsumers,but instead, increase their profit margin. Importingcountriestendtomatchexportrestrictionsbyreduc-ingimportbarriersinordertoreducepricesfortheirconsumers.Whengovernmentskeepproducerpricesdown,producerslackincentivestoundertakeinvest-mentsnecessarytoincreaseproduction,thuslimitingthesupplyresponsethatwouldbeneededtoreducetheglobalpriceleveloverthelongerrunandreducingtheamountofgrainavailablefordomesticconsump-tionandexportsinthefuture.Exportrestrictionsalsodamageacountry’sreputationasanattractiveinvest-mentlocationandreliablesupplierofglobalmarkets,furtherreducinginvestmentsandbusinessopportuni-ties. Therefore, ironically, export restrictions basedon food security concerns reduce a country’s foodsecurity inthe longrunandcandamageacountry’soveralleconomicdevelopment.

allow­ susta�nable­ product�on­ �ncreases. Agriculture isanincreasinglyknowledgeintensivefield.Agriculturalinformation and knowledge systems (see Box 10),including advisory services and adaptive agriculturalresearch,spreadingbestpractice,promotinginvestmentinnewlong-termadaptiveagriculturalresearch(higheryield,adaptedand/orweathertolerantproductiontech-niques) arenecessary to raise the limitsof sustainableproduction,andreduceoutputvolatility.

•Promot�ng­ �nvestments­ �n­ post-harvest­ log�st�cs­ and­reduc�ng­waste.Logisticalcapacitiesandefficiencycon-stitute a critical bottleneck for reaching the potential

Box 9: Reducing Volatility

investment in irrigation and employment

The Irrigation Rehabilitation Emergency Projectin Armenia, effective since October 2009, supportinvestments in irrigation systems to enhance agri-cultural productivity, reduce production volatility,and stimulate short term employment. The projecthas been designed to improve water use efficiencybyrehabilitating83kmofirrigationcanalstoreducewaterlosseswhilefosteringimmediateruralemploy-ment. Since October 2009, 50 km of canals havealready been rehabilitated and water losses havebeen reduced by 12%; a further reduction to 20%isexpectedbytheendoftheproject.Asaresult,theincrease inthe irrigatedarea isexpectedtobeabout7,000habyJune2011.

cell-phone Based Weather forecasting

Turkey’sKastamonuProvinceinitiatedanagriculturalearlywarningserviceinspring2008tohelpfarmerscopewithchangingclimateaffectingtheproductivityofappleorchards.Inrecentyears, fruit treesseemedtobudearlierinspringwhileoccasionalfrostlingeredlater.Asaresultfrostriskwasrisingandoverallappleproductionhadbeenindecline.Protectinganorchardfrom overnight frost is a laborious task. An accu-rately-targetedinterventioncansavecropsthatwouldotherwise be destroyed. The provincial directorateof agriculture designed an information system thatprovidesfarmerswithaccurateovernightwarningsof

(cont�nued­on­page­3�)

3�

levelofproductionandexportsinmanyECAcountries.Grainstorageandtransportlogistics(e.g.availabilityofrailcars)constituteamainhurdle inbothRussiaandUkraine’sefforts toship larger amounts to international ports. InECA, waste reduction measures are neededto reduce pressure on resources needed forfoodproduction,andtolowergreenhousegasemissions.

•Invest�ng­ �n­ �rr�gat�on­ and­ land­ adm�n�s-trat�on.­ Improving the functioning of landmarkets and tenure security through LandAdministration Systems will promote invest-mentbyfacilitatingaccesstocredit.Reflectingpast collectivization and restitution processes,ECAfarmersstillhaveconsiderabledifficultiesin securing sufficient investment and oper-ational capital. In South East Europe andCentral Asia there is an increasing need toadjust production techniques and systems tomeet water resource management challenges.Manyirrigationsystemshavedeterioratedduetoinadequateoperationandmaintenance.

Box 9 (cont�nued­from­page­33)

frost risk throughSMStexts.Thesewarningsdrawon thenationalweatherforecast,ahistoryoflocaldatathatenables“tuning”ofregionalforecaststolocalconditions,andlocalmeasuringstationsthatsetoffcellphonealarmsiftempera-turesdropintothedangerzone.Withthesethreelayersofinformation, frost riskshavebeenaccurately targeted, falsealarms avoided, and farmers in the program have not lostcropssincetheprogrambegan.

Following this example, a World Bank team sought toundertake a simpler program in the Kyrgyz Republic.Normally, Kyrgyz Republic farmers must manage on one-day forecasts delivered on television. In this pilot, farmersregularlyreceivedforecasts3daysaheadbycellphone.Jalal-Abadexperiencedarainyandcoldspring,andmanyfarmershaddifficultyidentifyingwhentoplant,ordidnotsucceedinplantingatall.ButallfarmerswhowererecipientsofSMSweathermessagesundertheWBpilotsucceededinplantingtheircrops.Farmersnotoriginallyincludedinthepilothaveaskedtojoin.

­35

47. ECA countries have been facing ris-ing oil and gas prices since global economic conditions have improved. InFebruary2011,internationaloilpric-es surged past US$100 per barrel forthe first time since 2008 though theyare still below the July 2008 peak. ByJanuary 2009, they declined to onethird of their peak level. Since then,global oil prices have been increasingsteadily at an average monthly rate of1.7% over the past twelve months, toabove US$100 in early February 2011.Prices for natural gas have registereda similar evolution. The average EUpipeline import price tripled between2002 and 2008 to above US$400 perthousand cubic meters (mcm). This inturnstimulateda significant increaseofgaspricesinintra-CIStrade.Until2005,countriesintheCIShadbeenabletosecureimportedgasatbelowmarketprices.Thesubsequentdeclineingaspricesinearly2009easedCISprices.However,asEuropeangaspricesadjustto the benchmark of oil and oil product prices over thenextfewmonths,ECAcountriesarelikelytofaceincreas-ingpressures for further adjustmentsof importprices tointernational gas market levels. To the extent that theirprices move together, all countries are affected by oilpriceincreases.Somecountries,suchasMoldova,importmuchmoregasthanoil,whileothers,suchastheKyrgyzRepublicRepublicandBulgariaimportmoreoilthangas.Historically,thesetwopriceshavetendedtomovetogetherthoughsometimeswithalagorlead.

48. In ECA, high energy intensity underscores the coun-tries’ vulnerability to increases in energy prices. ThehighenergyintensityinECAcountriesimpliesthatrisingenergy prices will affect production more in ECA thanother regions. ECA countries’ level of energy intensity,thoughithasdeclinedsubstantiallyovertimeisonaveragefivetimesthatofthecountriesinWesternEurope.Today

SECTIon 6. EnERgy In ECA

thelowandmiddleincomecountryaverageenergyinten-sity in ECA is greater than in other regions and doublethehigh-incomeOECDaverage.Turkmenistan,Ukraine,andUzbekistanhavehighenergy intensities—morethan450 Kg of oil equivalent (koe) to produce US$1,000 ofGDP (constant 2005 PPP).The energy intensity in netenergy importers such as Belarus, the Kyrgyz Republic,Moldova, Tajikistan, and Ukraine was higher than 250Koe/US$1,000GDPormorein2007,farabovethe144Koe/US$1000GDPofmostcountriesinCentralEuropeandhigherthantheallECAaverage.TheBalkancountriesandtheCISshowthelowestenergyintensity,andalsoaretheonesthathavereducedenergyintensitytheleastinthelasttwodecades(Table7).TheOGEexportershavehighenergy intensities, such as Russia at 340 koe/US$1,000GDPandKazakstanat418koe/US1,000GDPin2007,thelastyearforwhichcomparabledataareavailable.

49. Energy policies in many ECA countries are not sus-tainable in view of the rising costs of energy and the need for efficiency enhancing investments. Increasinggas prices will have an impact on electricity costs across

Table 7: Energy Use (kg of oil equivalent) per US$1,000 GDP

CountryGroupAverages

Group 1992 2000 2005 2006 2007

LLMC 742.6 789.7 539.8 492.2 459.8

UMIC 403.6 277.7 254.6 254.7 240.6

Balkans 159.2 158.7 147.4 164 158

Caucasus 651.6 424.1 282.9 231.6 182.7

CIS 159.2 158.7 147.4 164 158

EU10+2 651.6 424.1 282.9 231.6 182.7

EU 163.1 140.5 134.7 130.3 125.0

AllECA 434.6 298.7 264.1 261.3 247.4

Source: World Development Indicators, World Bank

Note: The numbers are for GDP measured at 2005 PPP prices in USD. Averages are weighted by GDP. EU10+2 includes Croatia and Turkey.

3�

the region.The long runmar-ginalcostofgenerationwillrisefromroughly7.5 to8.5cents/kWh, excluding costs associ-atedwithtransmissionanddis-tribution (these are shown bythe red and dotted green linesrespectively).). This estimateis based on the constructionof a new gas fired combinedcycle power plant assuming agaspriceincreasefromUS$250to the forecasted US$350 perthousandcubicmetersin2011.Althoughmostofthecountriesin Eastern Europe were cover-ing their long run marginalcostofgenerationin2010(seeFigure13),ifthelong-runmar-ginalcostofgenerationweretoincrease, many of the countries would need to increaseelectricity tariffs to adequately cover long run marginalcosts.

50. Increasing electricity cost would threaten the financial viability of the power sector, unless consumer prices are adjusted accordingly. Duringthe2008pricehikeandtheonsetoftheeconomiccrisissomegovernmentspostponedtariffincreasesinordertoprotectcustomers.InUkraine,for example, the Governmentcapped tariffs for all customersand moved certain industrialcustomers into the subsidizedtariff category. The situationwas made worse by currencydepreciation in energy import-ing countries. Because of fall-ing revenues and rising costs,theprofitabilityofpowersectorcompaniesincountriessuchasArmenia,RomaniaandUkrainedeclinedsignificantly.Percapitaresidential electricity and heatconsumptionvarysubstantiallyacross ECA countries, partlyreflectingtheirpricingpolicies.Insomecountries,thereisalsosubstantial cross subsidization

Figure 13: An Increase in the Long Run Marginal Cost of Electricity Generation Will Require Price Adjustments for Many Countries

of household energy consumption (Figure 14). If energycompanies are not allowed to recoup the high cost ofenergy, quasi-fiscal liabilities may accumulate. In somecountries,thishasalreadybeenanissue.

51. In view of the expected increase in energy prices, some policy reforms are imperative in ECA countries and many have begun the process of reform.Keyamongthereformareasare:

Figure 14: Some ECA Countries Subsidize Households and Others Tax Them

­3�

•­­Improv�ng­Energy­Eff�c�ency. Investing inenergyeffi-ciency will reduce import dependence in ECA, lowervulnerabilitytoenergypriceincreasesandlowergreen-house gas emissions. Investment in energy efficiencycouldbehigherinECAifenergypriceswerenotkeptartificiallylowandtherewaspaymentdiscipline,therewasmore competition among contractors and servicecompaniesandfewerfinancingconstraints.

•­Industry­Responses­ –­Meet�ng­ Investment­Needs.Therevenueprojections(bothfiscalandcorporate)suggestthat the oil and gas producing countries should havethefinancialcapacitytomeetfutureinvestmentneedsintheirenergysectors.However,effectivemanagementoftheseresourcesmustbeapriorityifthesecountriesare to sustain their current levels of production. For

instance, developments to support a steady increaseoil andgasproduction in the region are estimated torequirecapitalinvestmentaveragingmorethanUS$56billion per year over the next twenty years. Althoughcapital investments increased before the economiccrisis,theyarestillwellbelowtherequiredlevels.Thishighlightsthelargefinancialchallengesforthesectorintheshorttomediumterm.

•Invest�ng­ �n­ Renewable­ Energy. ECA countries, par-ticularly the EU accession countries, have beguninvesting inrenewableenergy.Inviewofrisingpricesforfossilfuels,volatilityinthepriceofenergyandtheimperative to reduce greenhouse gas emissions, ECAcountries would benefit from exploring alternativeenergysources.

38

Bank support to clients cover several key areas such as fiscal reform, social assistance reform, agriculture and energy sector reform.

A-1.1WorldBankSupportforFiscalReformTheBankissupportingECAclientsthroughanalyticalwork,policy advice and lending to rationalize their fiscal systems.Thisinvolvesbothpolicyandinstitutionalreforms.Keyanalyt-icalworkonpublicexpendituresandfunctionalorganizationof government is aimed at identifying sustainable efficiencygains,strategicallocationofpublicresourcestosupportgrowthandenhancingeffortstoprotectthepoor.Throughacombi-nation of Technical Assistance, Development Policy Loans,KnowledgeProducts andPolicyDialogue, theBank iswork-ing with clients towards (a) more sustainable fiscal planningthrough appropriate instruments, including fiscal rules andmulti-annual fiscal frameworks, (b)makingpolicyandstruc-tural changes thatwillhelpcontainoverallbudgetsanddebtand(c)policychangesthatrationalizeexpenditureallocationsandtaxationpatternsand(d)taxadministration.TheBankhasbeensupportingclientstoputinplacesystemstobettertrackexpenditures(e.g.Treasurysystems,publicemploymentregis-ters)andachievesustainablesavings(e.g.throughoptimizationofworkprocessesandprocurementreforms).TheBankisalsoadvising clients toorganize theirbudgetsonaprogrammaticbasisandtolinkprogramstopolicyobjectivesandmeasurableresults. On the revenue side, the Bank is assisting clients inmovingtowardsmoreefficientrevenueadministrationsystems(e.g.risk-basedaudits,e-filing),whichincreaserevenuecollec-tion, while cutting administrative costs for the public sectorandreducingcompliancecostsfortaxpayers.Atthesametime,theBank,togetherwithotherpartners,hasbeenworkingwithclients to rationalize tax policies and the system of transfersandsubsidies.

a)Bankassistanceforfiscalreformhasincluded:

• Public expenditure reviews and Development PolicyOperations (DPOs) with a focus on rationalizationof public spending, sustainability of public finances,efficiency gains in public administration, and struc-

AnnEx 1. WoRld bAnk SuPPoRT To ClIEnTS

tural reforms to ensure fiscal sustainability inBosnia-Herzegovina,Croatia,Latvia,Russia,Romania,Serbia,Poland and Turkey. In Belarus, an ongoing publicexpenditurereviewsupportstheGovernment iniden-tifyingefficiencygainsinselectedareasofthebudget,and providing options for expenditure and revenuepolicies thatarebetteraligned to theenvisaged struc-turalreformagendaofthecountry.

•AnongoingfunctionalreviewinRomaniawhichana-lyzes12key sectorsof government, among these, theCabinet and General Secretariat of the Government,publicfinancemanagement,transport,education,agri-cultureandcompetitionpolicyhavebeencompleted.

•Technicalassistanceforefficiencygainsinworkprocessoptimization in Armenia; program-based budgetingand performance-oriented budgeting in Albania andtheRussianFederation;advisorysupporttotheRussianGovernment inmonitoringtheeffectivenessofpublicexpenditure through performance indicators for pro-gramsandsub-nationalgovernments.

•Investment lending/grants forTreasurymodernizationinAlbania,RussiaandUkraine.

•Technical assistance and investment lending for rev-enue administration modernization in Croatia, theCzechRepublic,Kazakhstan,Russia,andUkraine.

A-1.2WorldBankSupportedReformsinSocialProtectionWorldBanksupporttogovernmentshasfocusedonimprov-ing social assistance systems and support for employmentgeneration.

a)Socialassistancereformhasincluded:

•Supporting Albania through various lending instru-mentsfollowedbyaProgramforResults.Thereformsinclude improvingbenefits administration, improvingtargetingaccuracyand increasingcoverageamong theextreme poor for the last resort social assistance pro-gram(LRSA).

­3�

•InCroatia,Banksupportforthegovernment’sactionsto improve the targeting of non-contributory socialwelfareprograms.

•InLatviaWBsupportfortheexpansionoftheLRSAprogrambyincreasingeligibilitythresholds(leadingtoincreasedcoverageandgenerosity).

•In FYR Macedonia WB help focusing on improvingbenefits administration through the development ofan integrated database for all cash benefits with theultimategoalofconsolidationoffragmentedprograms.The WB also supports the introduction of a condi-tionalcashtransferprogram.

•InMoldova,throughtechnicalassistance,Banksupportforimprovedbenefitsadministrationandtheexpansionof theLRSAprogram,andenhanced implementationcapacityamongotherthings.

•Together with the other donors, supporting ongoingreformsthatthegovernmentofTajikistanisundertak-ingtoimprovethesocialassistancesystem.

b)Supportforemploymentgenerationoverallhasincluded:

•LendingtoArmeniaduringthecrisis.TheGovernmentprotectedor increased spendingon thepriority socialprogramssuchaspensions,last-resortsocialassistance,unemploymentbenefits,andpublicworksprograms.

• Lending to Bosnia-Herzegovina to introduce means-testing for all types of non-contributory social assis-tance. Planned support includes support to improvethe targeting accuracy of the LRSA, family and childbenefits,anddisabilityassistance.

•InLatvia,WBsupporttotheWorkplaceswithStipendsprogram.

A-1.3WorldBankSupporttoAgricultureECA’s lending program in the agriculture sector has coveredthreemainareas, enhancingagriculturalproductivity, linkingfarmerstomarketsandvaluechaindevelopment,andreducingvulnerability.

a)Enhancingagriculturalproductivity:

•Supporting access to inputs in the Kyrgyz Republicthrough the GFRP – Agricultural Investments andServicesProject.SimilarlyTajikistanalsoreceivedfund-ingthroughGFRPin2008andtheRussiaTrustFund

in2010toprovideagriculturalproductioninputsandcritical livestock-related inputs to the poorest farmersandfemale-headedhouseholds.

•SupporttotheKyrgyzRepublicforagriculturalinvest-mentsandservicesaimingtoimprovetheinstitutionaland infrastructure environment for more productive,profitable and sustainable livestock and crop produc-tionandreducingtheeconomicimpactofthezoonoticdiseaseburdeninthehumanpopulation.

•Project Support to Armenia to improve productivityand sustainability of pasture/livestock livelihood sys-temsinselectedcommunities.

•Technical assistance for improvedwatermanagement:InRomania,toachievemoreeconomicuseofirrigationresources through changes in farmers’ and the LandReclamation Agency’s behavior and increase agricul-turalproductivityinprojectarea.

•SupporttoSerbiainimplementinganirrigationprojectto address a range of interconnected sector issues byfinancingrehabilitationoffloodcontrol,irrigationanddrainage infrastructure, providing support in raisingthetechnicalcapacityofweather-forecasting,andsup-portingpreparationofwater-relatedlegislation.

•In Kazakhstan an irrigation project aims to improvewater resources management in the Kazakh part oftheSyrDaryaBasinbyincreasingthetimelyirrigationwater supply to agricultural areas, increasing fisheriesproduction,andenhancinghumansafetyandenviron-ment.TheWB also provides support to Albania andBosnia-Herzegovina topromote institutionaldevelop-ment for sustainable water management and reha-bilitationandmodernizationofirrigationanddrainagesystems.

•Supporting better land administration inRomania tocomplete the property title registration of land assetsinruralareasandtoimprovethesecurityoflandrightsandreducetransactioncostsonrurallandmarkets.

•Support to Russia to improve its land administrationaswellasArmeniaandTajikistan for sustainable landmanagement.

b) Linkingfarmerstomarketsandvaluechaindevelopment:

•ProjectsupporttoAzerbaijan,UzbekistanandKazakhstanaimstoimproveaccesstofinancetofarmers.

�0

•InTajikistanaprojectprovidesacreditlinetoginnersforpurchasingseedcotton.

•Support to government of Romania to modernize itsagricultural knowledge and information systems tocomply with the agricultural acquis communautaireandtohelptheagro-foodsectortakeadvantageofthebenefits and opportunities arising from EU member-ship. Uzbekistan’s rural enterprise support projectaims at increasing the productivity and financial andenvironmental sustainability of agriculture and theprofitabilityofagribusiness.TheWBalsoprovidessup-port toKyrgyzRepublic andMoldova forpromotingagribusinessdevelopment.

c) Reducingvulnerability:

•Under theGFRP,Moldovaprovidedcash transfers tosocialinstitutionstomeettheiradditionalfoodbudgetneedsanddistributedfoodpackagestopregnantwomenandchildrenunder2.TheKyrgyzRepublicagriculturalproductivityproject,inadditiontoimprovingaccesstofinance,supportsstrengtheninghydrometeorologyandsendingweatherforecaststofamers.

d)OtherWorldBankAssistanceincludingknowledgeproductsinagriculture

Severalknowledgeproductsprovideclientsupport:

•Impact of climate change on agriculture (South EastEurope, Caucasus) and water resources (South EastEurope,Azerbaijan);AgricultureSectorReviews (e.g.,Ukraine, Kyrgyz Republic); Price ShockTransmissionandImpactofFoodCrisisonCentralAsiaandRoleofKazakhstan,Russia,andUkraine.

•Technical assistance forTurkeyFoodSafety;MoldovaFood Security; EU CAP programming in severalECCU4/5 countries; Romania Functional Reviewtowardspolicyandinstitutionalreform;EstablishmentofEurasianCenterforFoodSecurityinRussia.

A-1-4.WorldBankSupporttotheEnergySectorTheenergysectorprogramfocusesonimprovingexistinginfra-structureinpowergenerationandtransmissionandenhancingenergy efficiency through both the supply and demand side.Several projects also aim to promote the use of renewable

energy,therebyimprovingthediversificationoftheenergymixandreducingthedependenceonfossilfuels.Atthesametime,thecurrentprogramalsoincludesemergencyprojectssupport-ingTajikistanandKyrgyzRepublicinmeetingtheirdomesticenergydemand.

a)WBactivitiescanbesummarizedasfollows:

•Supportingsupplyefficiencythroughhydroandther-mal rehabilitation (Ukraine, Turkey); transmissionand distribution upgrading to support loss reduc-tion (Kazakhstan, Turkey; Ukraine, Serbia, Georgia,Tajikistan,Azerbaijan,andGeorgia),anddistrictheatinginfrastructure(Croatia,Moldova,Belarus,Armenia).

•SupportforclimatechangemitigationprogramsusingCleanTechnologyFund(CTF)concessional resourcestopromotelow-carbonprogramsandprojects(Turkey);CarbonFinanceprograms(Russia,Uzbekistan);techni-cal assistance to financewholesale emission reductionprojectsthroughthesaleofAssignedAmountUnitsin,theCzechRepublic,Latvia,Poland,andUkraine).

•Renewableenergyandenergyefficiency initiativesarereceiving accelerated attention tomitigate greenhousegasemissions.Wholesaleapproachesthroughfinancialintermediariesandenergyefficiencyfundsaresupport-ed in Bulgaria, Croatia, FYR Macedonia,Turkey andUkraine; Global Environment Facility programs existin(Armenia,CroatiaandPoland)DevelopmentPolicyLoanssupportenergyefficiencyprograms(PolandandTurkey)whiletechnicalassistanceandreviewssupporttheWesternBalkans,Poland,andRussia.

•Loans to support the establishment of an integrat-ed regional market in the Energy Community ofSouth East Europe (Albania, Bosnia-Herzegovina,FYR Macedonia, Montenegro, Romania, Serbia andTurkey), and to support the Central Asia/South AsiaRegionalElectricityMarket(CASAREM).

•Promotingprivatesectorinvestmentthroughtheprovi-sionofPartialRiskGuarantees topromote electricitydistributionprivatization(RomaniaandAlbania),tech-nical assistance to support governments inprivatizinginfrastructure services, anddesignprivate-publicpart-nerships, andguarantees toprivate investors (Kosovo,Tajikistan,Montenegro).

­��

taBLe a1

Food and energy trade Food trade balance, Energy trade balance, CAB, % GDP balance, % GDP Combined Ordering % GDP % GDP

rank 2010 rank 2010 rank 2010 rank 2010 rank 2010

1 Azerbaijan 27.5 1 Azerbaijan 45.3 1 Azerbaijan 1.0 1 Ukraine 2.7 1 Azerbaijan 44.8

2 Kazakhstan 8.1 2 Kazakhstan 22.9 2 Kazakhstan 2.0 2 Belarus 2.6 2 Kazakhstan 23.6

3 Russia 5.0 3 Russia 15.6 3 Russia 3.0 3 Serbia 2.5 3 Russia 17.2

4 Uzbekistan 4.3 4 Uzbekistan 9.6 4 Uzbekistan 4.0 4 Lithuania 1.3 4 Uzbekistan 9.0

5 Latvia 4.0 5 Poland -1.7 5 Estonia 6.0 5 Hungary 1.2 5 Estonia -1.2

6 Estonia 3.0 6 Estonia -2.1 6 Hungary 8.0 6 Uzbekistan 0.6 6 Romania -1.7

7 Lithuania 1.4 7 Romania -2.5 7 Latvia 9.0 7 Poland 0.5 7 Poland -2.2

8 Hungary 1.2 8 Hungary -2.9 8 Poland 9.5 8 Azerbaijan 0.5 8 Albania -2.7

9 Bulgaria -0.8 9 Serbia -3.0 9 Lithuania 11.0 9 Turkey 0.4 9 Czech -3.0 Republic

10 Slovenia -1.3 10 Turkey -3.6 10 Croatia 12.0 10 Kazakhstan -0.7 10 Croatia -3.6

11 Ukraine -1.9 11 Czech -3.9 11 Czech 12.0 11 Estonia -0.8 11 Slovenia -3.7 Republic Republic

12 Croatia -2.1 12 Croatia -4.8 12 Slovenia 12.0 12 Romania -0.8 12 Latvia -3.9

13 Czech -2.5 13 Latvia -4.8 13 Romania 13.0 13 Czech -0.8 13 Turkey -4.0 Republic Republic

14 Poland -3.3 14 Slovenia -5.1 14 Bulgaria 14.5 14 Latvia -0.9 14 Hungary -4.1

15 Kyrgyz -3.5 15 Lithuania -5.1 15 Ukraine 15.0 15 Slovakia -1.0 15 Slovakia -4.7 Republic

16 Macedonia -3.5 16 Slovakia -5.7 16 Serbia 15.5 16 Croatia -1.2 16 Serbia -5.4

17 Tajikistan -3.5 17 Belarus -7.2 17 Turkey 15.5 17 Bulgaria -1.2 17 Bosnia- Herzegovina -5.6

18 Slovak -3.8 18 Albania -7.6 18 Slovakia 17.0 18 Slovenia -1.4 18 Montenegro -5.9 Republic

19 Romania -4.3 19 Ukraine -8.3 19 Macedonia 19.0 19 Russia -1.6 19 Lithuania -6.5

20 Bosnia- -5.5 20 Bulgaria -8.4 20 Albania 21.0 20 Moldova -1.9 20 Macedonia -6.5 Herzegovina

21 Turkey -6.5 21 Moldova -8.6 21 Tajikistan 21.0 21 Macedonia -2.1 21 Moldova -6.7

22 Serbia -9.3 22 Macedonia -8.6 22 Kyrgyz 21.5 22 Georgia -3.6 22 Armenia -6.7 Republic

23 Georgia -10.0 23 Armenia -11.4 23 Belarus 22.0 23 Armenia -4.7 23 Bulgaria -7.1

24 Albania -12.1 24 Bosnia- -12.7 24 Bosnia- 22.0 24 Albania -4.9 24 Kosovo -8.3 Herzegovina Herzegovina

25 Moldova -12.5 25 Tajikistan -16.3 25 Moldova 23.0 25 Kyrgyz -5.2 25 Tajikistan -8.8 Republic

26 Armenia -14.3 26 Kosovo -16.5 26 Armenia 24.5 26 Bosnia- -7.1 26 Belarus -9.8 Herzegovina

27 Belarus -16.0 27 Georgia -17.8 27 Georgia 25.0 27 Tajikistan -7.5 27 Ukraine -11.0

28 Montenegro -22.1 28 Montenegro -17.8 28 Kosovo 27.5 28 Kosovo -8.2 28 Georgia -14.2

29 Kosovo -26.2 29 Kyrgyz -25.2 29 Montenegro 28.5 29 Montenegro -11.9 29 Kyrgyz -20.1 Republic Republic

��

Severalpapershavebeenwrittenabouttheimpactofchangesinthetermsoftradeongrowth.Easterly,PritchettandSummers(1993)documentthekeyrolethattermsoftradeplayininfluencinglongrungrowthandBarroandSala-i-Martin(1995)findthatthegrowtheffectsoftermsoftradearecomparablewiththatofeducationalattainment,publicexpendituresoneducation,andhumancapital.BrodaandTille(2003)findthatimprovementsinthetermsoftradeleadtohighergrowthandconversely.Acrosscountries, it isestimatedthatabout10%ofthevariationinGDPgrowthand25%ofthevariationingrowthvolatilitycanbeexplainedbyobserveddifferencesinthevolat�l�tyoftermsoftradechanges(Easterlyetal,1993,HnatkovskaandLoayza,2005).Somepapersaddresstheimpactoftermsoftradechangesindifferentconditions.Forexample,LoayzaandRaddatz(2007)findthattheimpactoftermsoftradeshocksdependonothercharacteristicsoftheeconomy.Forexample,moreopencountriesaremoreaffectedbytermsoftradechanges,particularlynegativeones.Financialdepthindomesticmarketsservestoreducetheimpactofnegativeshocksandcomplementstradeandfinancialopenness.Inaddition,labormarketflexibilitydampenstheeffectofnegativetermsoftradeshocks;’easeoffirmentrymagnifiesthepositiveimpactoftermsoftradeshocks.Macroeconomicpoliciesalsoplayasignificantroleindeterminingtheeffectsoftermsoftradeshocks.BrodaandTille(2003)findthattheexchangerateregimehasasignificantimpactonhowchangesinthetermsoftradeaffectoutputgrowth.Theyfindthatcountrieswithaflexibleexchangeratewillhavemuchmildercontractionsintheiroutputinresponsetoanegativetermsoftradedevelopment,thancountrieswithafixedexchangerate.Forexample,inmanyoftheCISstatesthatbenefitedfromhighcommoditypricesandlittlesparecapacityin2006-08,monetarypolicywas constrained in affecting inflationand slowingoverheatingbecauseof inflexible exchange rateregimes.Mendoza(1995)estimatesthattermsoftradeshocksaccountfornearlyhalfofGDPvariability.

AnnEx 2. TERmS oF TRAdE And gRoWTh

­�3

MethodologyforsimulatingpovertyimpactsoffoodandenergypriceincreasesTheimpactoftheincreaseinfoodandenergypriceshocksonthewelfareofthepopulationissimulatedusingthehouseholdlossapproachdevelopedbyFreundandWallich(1995),whichwasoriginallydesignedforestimatingtheimpactofenergytariffsonwelfare.Inthismodel,theconsumptionlossforhouseholdsisafunctionof(1)theincreaseinthepricesofthecommoditiesinquestion,(2)theshareofhouseholdconsumptionallocatedtothosecommodi-ties,and(3)thesubstitutioneffectexpressedasanabilitytoreducetheconsumptionfollowingthepriceshocks.Theanalysispresentedhereuseshousehold-specificbudgetsharesfromthemostrecenthouseholdsurveyandcountry-specificfoodandenergypriceinflationratesfor2010.Forthepresentanalysisit isassumedthatpoorhouseholdsarenotabletosubstitutecommoditiesinresponsetochangesinrelativeprices(seeSullaandTiongson2008),andthereforethesubstitutionelasticityissettozero.Ahousehold’stotallossfromtheincreaseinfoodandenergypricesisbasedonthelossinnominalincomeduetofoodandenergyinflation.Thechangesinpovertyratesandpovertygapindicatorsareestimatedbasedonthesimulatedconsumptionaggregateequaltotheinitialconsumptionaggregatedofthehouseholds’minustheestimatedlossoftheconsumptionduetothepriceshocks.

Thelossinwelfareforeachhouseholdiscalculatedasfollows:

Loss­=­Q0(p�-p0­)(�+e­*(p�-p0­)/�p0­)­,

whereLossisthemonetarylossofthehouseholdsduetoincreaseintheprices,Qisquantityconsumed,pisprice,eisthepriceelasticityofdemand,thesubscripts0and�refertotheperiodsbeforeandafterthepricechange,respec-tively.Asquantitiesofthehouseholds’utilitiesconsumptionarenotavailableintheHBS,thelossiscalculatedusingtheexpendituresonutilities(fromtheHBS)andtheresidentialtariffs,asfollows:

Loss­=­EXP0*[(p�-p0­)/­p0]*(�+e­*(p�-p0­)/�p0­)­,

whereEXPishouseholds’expenditurefortheanalyzedutilitycomponent.Weused3alternativelevelsofelasticity(e)fortheanalysis:0,-0.4and-0.285.

Thesimulationsprovidea­ f�rst­order estimationof the impactof the foodandenergyprice shocks.Furthermore,becauseofdatalimitations,severalcaveatsshouldbenoted.Inparticular,(1)themodeldoesnottakeintoaccountanygainsinincomethatmayberealizedbyhouseholdsthatproduceandsellfoodcommoditiesthatareincreasinginprice;(2)substitutioneffects,suchasswitchingtorelativelylessexpensivecommodities,arenoconsidered;(3)secondordereffectssuchasnominalwageincreasesormitigatingpoliciesthatoftenfollowpriceshocksarenotincluded;and(4)theindirectimpactofhigherenergypricesonothergoods(whichuseenergyasanintermediateinput)arenotincluded.Becauseoflimitations(1)–(3),thesimulationmodelislikelytooverestimatetheimpactofthefoodpriceshock,especiallyinruralareas.Incontrast, limitation(4)islikelytounderstatethewelfareimpactofenergypriceincreases.

Thepoverty­headcount ratesandpoverty.gap indicatorsare themainwelfare indicatorsused in thisanalysis.Theheadcount index is the %age of the total population living in households below the corresponding international

AnnEx 3. SImulATIng PovERTy ImPACTS oF Food And EnERgy InFlATIon

��

povertyline.Thepovertygapindextakesintoaccountboththeincidenceandthedepthofpoverty.Specifically,thepovertygapistheheadcountindexmultipliedtimesthe“consumptiongap”betweentheaveragetotalconsumptionforhouseholdsclassifiedaslivinginpovertyandthepovertyline,asaproportionofthepovertyline.Thusthepovertygapissensitivetobothchangesinpovertyincidenceandchangesintheaverageincomeofthosewhoremainpoor.

DataSourcesThe microdata for the simulations come from the ECA­ Household­ Survey­ Data­ Arch�ve.­ The ECA data bankincludesstandardizednationallyrepresentativehouseholdbudgetsurveysfor25countries,coveringcloseto95%oftheECApopulation.ThestandardizedconsumptionaggregatesareconstructedbasedonthemethodologydevelopedbyDeatonandZaidi(2002),usingauniformsetofconsumptioncomponentsthataredeflatedforspatialpricedif-ferenceswithinthecountry(formostcountries),andovertimeusingtheCPI.Householdconsumptionpercapitaisconverted to internationaldollar termsusingICPconversion factorsandnationalCPIdata.ThestandardECApoverty linesofUS$2.5andUS$5.00perdayhavebeenusedforthisanalysis (seeAlamandSulla(2008)forthediscussiononthemethodofestimation).Foreachcountry,themostrecenthouseholdbudgetorLSMSsurveyhasbeenused,withthemajorityofthesurveydatacollectedin2008and2009.

­�5

Alam,Asad,SanjayKathuria,andOlgaVybornaia(2008),“RisingFoodGrainsandEnergyPricesinECA:SomeEconomicandPovertyImplications,andPolicyResponses”,m�meo,WorldBank.

Alam,AsadandVictorSulla(2009),“AnUpdateonIncomePovertyandInequalityinEasternEuropeandtheFormerSovietUnion”,m�meo,WorldBank.

Barro,Robert.andXavierSala-i-Martin(1995),EconomicGrowth,McGraw-Hill.

Broda,ChristianandCedricTille(2003),“CopingwithTerms-of-TradeShocksinDevelopingCountries”,­Current­Issues­�n­Econom�cs­and­F�nance,Vol.9,No.11.

Brown,StephenandMineK.Yucel,(2002),“Energypricesandaggregateeconomicactivity:aninterpretativesurvey”,Quarterly­Rev�ew­of­Econom�cs­and­F�nance,42:193-208.

Deaton,AngusandSalmanZaidi(2002),“Guidelinesforconstructingconsumptionaggregatesforwelfareanalysis”,L�v�ng­Standards­Measurement­Study­Work�ng­Paper:­�35.v.104,pp.xi,Washington,D.C.:TheWorldBank

Deininger,Klaus.andDerekByerlee(2011),“RisingGlobalInterestinFarmland:Canityieldsustainableandequitablebenefits?”,WorldBank.

Easterly,William,MichaelKremer,LantPritchett,andLawrenceSummers(1993),“GoodPolicyorGoodLuck,Countrygrowthperformanceandtemporaryshocks”,Journal­of­Monetary­Econom�cs.

Easterly,William,Norman.Loayza,andPeterMontiel(1997),“HasLatinAmerica’spost-reformgrowthbeendis-appointing?”,­Journal­of­Internat�onal­Econom�cs.

EuropeanBankforReconstructionandDevelopmentandFoodandAgricultureOrganization(2008),“Fightingfoodinflationthroughsustainableinvestment”,http://www.fao.org/newsroom/common/ecg/1000808/en/FAOEBRD.pdf.

FoodandAgricultureOrganization(2010),CropProspectsandFoodSituation,No.4(2010).GlobalInformationandEarlyWarningSystemonFoodandAgriculture,FAO,http://www.fao.org/docrep/013/al972e/al972e00.pdf.

REFEREnCES

Freund,CarolineandChristineWallich(1995),“RaisingEnergyPricesinPoland:WhoGains?WhoLoses?”,World­Bank­Pol�cy­Research­Paper­No.­���5,WorldBank.

Hamilton,James(2009),“CausesandConsequencesoftheOilShockof2007–08”,Brook�ngs­Papers­on­Econom�c­Act�v�ty,­Spring2009.

Hnatkovska,Viktoria,V.andNormanLoayza(2004),“VolatilityandGrowth”,World­Bank­Research­Work�ng­Paper­No.­3�8�,WorldBank.

InternationalMonetaryFund(IMF)(2008).“TheWorldEconomicOutlook2008”,IMF,Washington,DC.

InternationalEnergyAgency(2004),“ImpactofHigherOilPricesontheWorldEconomy”,http://www.iea.org/publi-cations/free_new_Desc.asp?PUBS_ID=886.

Jimenez-Rodriquez,RebecaandMarceloSanchez,(2004),“OilPriceShocksandRealGDPGrowth:EmpiricalEvidenceforSomeOECDCountries”,Work�ng­Paper­Ser�es,­No.­3��,May2004.EuropeanCentralBank.

Loayza,NormanandClaudioRaddatz(2007),TheStructuralDeterminantsofExternalVulnerability,The­World­Bank­Econom�c­Rev�ew,­Oct.2007.

Mendoza,Enrique(1995),TheTermsofTrade,TheRealExchangeRate,andEconomicFluctuations,­Internat�onal­Econom�c­Rev�ew,Feb.1995.

Roberts-Schweitzer,Eluned(2009),LeveragingSafetyNetsandNutritionalSupplementsinCrisis:InitialResponsestotheGlobalFoodPriceCrisisinKyrgyzRepublic,Moldova,andTajikistan,WorldBank,WashingtonDC.

TheGovernmentOfficeforScience(2011),Foresight:TheFutureofFoodandFarming,FinalProjectReport,TheGovernmentOfficeforScience,London,UK.

WorldBank(2011a),GlobalEconomicProspects2011:NavigatingStrongCurrents,WorldBank,Washington,DC.

WorldBank,(2011)TheJobsCrisis.HouseholdandGovernmentResponsestotheGreatRecessioninEasternEuropeandCentralAsia,Forthcom�ng.

Rising Food and Energy Pricesin Europe and Central Asia

Copyright © 2011 Europe and Central Asia Region The World Bank1818 H Street, NWWashington, DC 20433, U.S.A.All rights reservedManufactured in the United States of AmericaFirst Printing: April 2011

Europe and Central Asia RegionThe World Bank