PREVENTING OVERHEATING

For some years now the Azerbaijani government's economic policy has won the approval of the leading ratings agencies. In their reviews and reports they have given a fairly objective opinion of what is happening in various sectors of the country's economy, and this in turn has had a very positive impact on the republic's image in general and some businesses in particular, which at the end of the day substantially improves their investment appeal.

The international Fitch Ratings agency recently published its findings and forecasts on the economic situation in Azerbaijan, and in the banking sector in particular, and in its opinion the country's economy will grow by 3.5 - 4 per cent this year.

Stability the main thing 

In the view of Charles Seville, the agency's director for the sovereign ratings of Europe's developing countries, which he expressed at Fitch Ratings' third annual conference in Baku, the key aspects of the development of the Azerbaijani economy are the effective management of oil revenues and diversification. Specifically, he noted the commitment towards improving the business climate for the development of the non-oil sector. Besides this, the reduction in the amount of transfer from the State Oil Fund of Azerbaijan (SOFAZ) to the state budget from 11.35bn manats in 2013 to 9.337bn manats in 2014 may be regarded as a positive factor.

"The level of foreign debt is not a 'worrying' factor for Azerbaijan, either. The country's economy has not been so strongly subjected to world trends as other developing markets," the agency's analyst said. In Seville's opinion, the manat remains stable compared with the national currencies of other developing countries. A result of the stability of the manat is the continuation of a reduction in the level of dollarization in the Azerbaijani economy. "Dollarization in Azerbaijan is higher than, say, Russia or Kazakhstan, but its level continues to go down," he said. Seville also noted the low level of inflation in Azerbaijan. "In general, inflation has been low in the region and this is linked with the reduction in food prices on world markets," he said.

In sum, the overall economic situation in Azerbaijan is stable which, of course, also impacts on an assessment of its individual sectors. For example, at the centre of attention of Fitch Ratings on this occasion was the country's banking sector which, in the opinion of the agency's experts, is currently generally stable and is being maintained by respectable economic indices, although structural questions continue to affect the quality of assets and the profitability and capitalization of the sector.

CBA's actions justified

"Azerbaijani banks are currently shifting the focus of lending growth on to the retail segment in order to compensate for inherent problems with the depreciation of credits in the corporative portfolio and to improve the return on equity through higher mark-up. The increase in retail lending (44 per cent in 2013) is proceeding at a higher rate than the increase in nominal household income (8 per cent), which is leading to a rapid increase in the debt burden of the population," the report emphasizes.

However, Fitch believes that the quality of retail lending is acceptable and there is some margin for future growth bearing in mind the still moderate level of penetration of lending (the ratio of the volume of retail credits to GDP was just 11 per cent at the end of 2013) and the attraction of potential clients yet to embrace the banking system. And, on the other hand, the corporate lending market is close to saturation, as shown by the shortage of good-quality borrowers (the growth in corporate lending was 15 per cent in 2013 after an increase of 25 per cent in 2012).

Fitch junior director Dmitriy Vasilyev said "Azerbaijani banks are finding it more difficult to find good corporative borrowers because of certain problems with transparency and accountability among a number of companies. And secondly, retail lending is more profitable because the interest here is higher, which is more beneficial to the banks. And, thirdly, the penetration of retail credits has historically been lower than corporative; i.e. there is a significant section of the population which has still not embraced banking services and, accordingly, they are potential clients."

We should also point out that literally the other day Elman Rustamov, chairman of the board of the Central Bank of Azerbaijan (CBA), approved the "Regulation of Management of Exposures to a Single Borrower or group of Connected Borrowers". According to the regulations, risks whereby a borrower or groups of connected borrowers have been issued with credit of over 10 per cent of the size of a bank's tier 1 capital are considered to be high credit risks. These regulations also extend to vehicle loans. Besides this, the regulations define the conditions whereby borrowers are considered inter-connected and the size of the credit risks.

In Vasilyev's opinion, it is the CBA's task to limit risks and to prevent the overheating of the banking market. "This is normal practice which is adopted in many countries. For example, in Russia consumer credit is also becoming more intense and the Central Bank is intervening in this process and adopting quite tough measures," he said.

Meanwhile, Fitch's report points out that the qualitative indices of the assets of Azerbaijan's banks point to an improvement in the situation in the sphere of overdue loans. According to Fitch's research into the ratings-listed banks, loans overdue by 90 days went down to 9.6 per cent at the end of 2013 compared with 13.1 per cent a year ago. Although at the same time the agency believes that the quality of assets could be somewhat weaker than the report figures indicate, taking certain factors into account.

Positive growth of capital

As regards the question of raising capital to the normative minimum of 50m manats before 1 January 2015, this decision by the regulator was approved by Fitch Ratings' experts. Dmitriy Vasilyev said that in absolute terms capital growth was positive for the banking system. "At the same time, we believe we must look at rates of growth and how quickly capital is required by the banks. Banks grow faster than profits, and so new capital is needed to support their growth," the expert said. He believes that there are questions regarding the quality of the assets of Azerbaijan's banks. "The credit portfolios of the banks are quite 'long'. It is difficult to say to what degree the quality of the assets is pertinent to the banks' reserves. There are still questions here," Vasilyev said. Meanwhile, according to Fitch, "the banks are maintaining an acceptable liquidity cushion in their balances, but in the event of stress this liquidity could be vulnerable in view of the slow depreciation of credit portfolios".

As far as other problems in the banking sector are concerned, in particular the need for a demonopolization of the market, which was pointed out in previous years by ratings agencies and international financial institutions, Vasilyev said that progress has also been made in this sphere: "In recent years the International Bank of Azerbaijan has experienced problems with capital. Although this was before the decision on recapitalization was announced. Nevertheless, in this period the IBA was unable to build up its assets, whereas despite this situation other banks grew and this impacted on a reduction in the IBA's share of the Azerbaijani banking market. Whether this factor had a positive or negative influence on the market is hard to say at the moment, but, of course, the lower the level of monopolization in the market the better." It will be recalled that in October 2013 the IBA's shareholders adopted a concept of increasing its authorized capital to 500m manats over a period of four years (today it is 368m manats).  

In short, judging by the assessments of Fitch's experts, an improvement in the situation on Azerbaijan's banking market in recent years has been evident, which can also be seen when compared with the markets of the CIS countries, which were not very successful in standing up to the financial crises of 2008-2009. At the same time, being rather vulnerable to external and internal structural risks, this sector demands a more thorough approach to existing problems and defects than is justified by the at times rather tough measures by the regulator.