Russia is currently curbed by the international sanctions imposed in response to the invasion of Ukraine, leaving both economies with limited external financing options. The invasion will also make filling sizable investment needs more difficult in neighboring ECA economies. In the economies of the South Caucasus and Central Asia, which are closely linked to Russia, weaker economic growth in Russia will likely dent investment prospects, including through reduced inflows of foreign direct investment (FDI).

Across ECA’s economies, recent headwinds—including pandemic-related increases in government debt, negative spillovers from Russia’s invasion of Ukraine, and tightening global and domestic financing conditions, as well as lingering structural issues, mean that strengthening the growth of investment, public or private, faces severe challenges. Reforms are needed to confront the shocks from the pandemic and the invasion, to address longstanding structural challenges, and to set the stage for sustained recovery.

# 6.2 Evolution of regional investment

In 2011-21, ECA experienced the second sharpest slowdown in investment growth, relative to the preceding decade, among EMDE regions. Investment growth fell from an average annual rate of 7.3 percent in 2000-10 to 3.1 percent a year in 2011-21, with the pace of growth in the second decade weaker in most ECA economies. Weakening investment growth in large part reflected the effects of several adverse shocks, including the global financial crisis (2007-8), Russia’s domestic financial crisis (2008-09), spillovers from the European debt crisis (2009-11), Russia’s annexation of Crimea in 2014 and associated sanctions, the 2014-16 oil price plunge, the COVID-19 pandemic, and financial stress in Türkiye. As a result, investment had not recovered to the levels observed prior to the global financial crisis in 90 percent of the ECA sample by 2019. Related to the weakening of investment growth, net FDI inflows fell from nearly 5.5 percent of GDP in 2007 to 1.8 percent of GDP in 2018-19.

In the aftermath of the European debt crisis of 2009-11, there was a significant weakening of prospects for economic growth in the EU, ECA’s largest trading partner.<sup>4</sup> The associated weakening of prospective growth in demand for ECA’s exports and in financial flows from the EU to ECA reduced prospective returns on investment in ECA and increased financing costs. With ECA countries heavily reliant on financial flows, including FDI, from the EU, there were significant negative spillovers from deteriorating EU growth prospects to ECA investment (figure 8.A).<sup>5</sup> Just as investment growth was starting to firm after 2016, the external environment deteriorated again, as a spike in policy

> 4 Ten-year-ahead GDP growth forecasts for the EU produced by Consensus Economics fell from 1.9 percent in 2007 to 1.2 percent in 2019.

> 5 Data available for the following ECA economies: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Georgia, Hungary, Kazakhstan, Kosovo, Kyrgyz Republic, Moldova, Montenegro, North Macedonia, Poland, Romania, Russian Federation, Serbia, Tajikistan, Türkiye, and Ukraine.