DIRECTION - EAST

With the growth of the foreign currency reserves of Azerbaijan, the issue of their diversification is becoming increasingly important. The importance of this problem has increased in recent years in view of the growing crisis in the economies of the United States and Europe, the volatility of the dollar and the euro and the falling profitability of the securities in these currencies. The recent decisions of the Central Bank of Azerbaijan (CBA) and the State Oil Fund (SOFAR) indicate that the country intends to diversify its strategic currency reserves, involving the resources of the dynamically developing Asian region.

For a relatively long time, the government of Azerbaijan adhered to a very cautious stance on the issue of forming a multi-currency basket of the reserve funds of SOFAR and the CBA. The key role in shaping the structure of foreign exchange reserves was played by the American dollar and the euro, and to a small extent, by the British pound. Such an approach is quite objective, since the structure of savings proportionally reflected the foreign trade of Azerbaijan, most of the exports of which fell to European countries and partly America.

Relatively recently, in 2010, the Central Bank decided to include a new asset - gold - in the basket of currencies: Some of the precious metals produced from an Azerbaijani field in Gadabay were accumulated in the reserves of the Central Bank.

In 2012, the State Oil Fund, which adopted a new investment policy, also moved away from the decade-long conservative approach to the formation of the investment portfolio by expanding the list of financial instruments and the geography of investment. Today SOFAR invests its assets not only in the long-term obligations of G7 member states, but also of other countries participating in the European Monetary Union, as well as Russia and Turkey. At the same time, the Fund has included gold and real estate in its assets by making them suitable for the diversification of foreign exchange reserves in the long-term. The new strategic approaches of SOFAR and the CBA were associated to a large extent with the negative trend of recent years, which led to a marked decline in profits from the management of assets in US and European currencies and securities.

At the same time, in recent years, Azerbaijan has effectively expanded the geography of oil trade, advancing to the dynamically developing region of Southeast Asia and Indochina, forming at the same time a stable base of sales in some countries of the Middle East. Interestingly, the regions we listed now account for nearly half of the foreign trade balance of Azerbaijan. First of all, in this context it is worth mentioning Indonesia, Thailand, and to some extent, South Korea, Vietnam and other neighbouring countries, actively acquiring Azerbaijani energy through oil terminals of SOCAR Trading created in Singapore and Korea.

By the way, the change of global benchmarks towards the booming Asian region has long become a leading trend for most countries of the world. Despite the fact that trade in China and other countries is carried out in the world's major reserve currencies - the dollar and the euro, the recent period has seen the yuan included in the trade turnover. A fundamental change in China's position in the world economy took place literally in front of the eyes of one generation: China now ranks first in export worldwide and second - in terms of GDP and the total volume of foreign trade. In this regard, China's monetary policy has undergone significant changes, having a major impact on the international monetary system. For example, according to the report of the Bank for International Settlements published once every three years, in 2010, operations in yuans accounted for less than 1 per cent - 77.1bn dollars of the total turnover of foreign exchange markets. According to the forecasts of the world's largest bank HSBC published in 2013, over the next three years 30 per cent of the total trade flows of China will be carried out in yuans, which will make it one of the three most commonly used currencies - after the dollar and the euro.

At the same time, the International Monetary Fund also calls for reform in the global monetary system, for emerging market currencies, particularly the yuan, to be added to the IMF basket and for the use of securities and other assets of Asian states to be expanded in every possible way, thereby stimulating the stability of the global financial system. This trend is a stable dominant in the policy of China, Russia and other BRICS members. In particular, Moscow and Beijing are considering using national currencies in mutual trade, and in the future, expanding the reserve assets of the Russian reserve funds in Chinese securities.

It is noteworthy that in the recent period, the need for the diversification of the currency reserves of Azerbaijan has significantly increased. To this end, a few years ago the Central Bank developed a new strategy for improving the management of the reserves, providing for their instrumental, currency and geographic diversification. This process has already begun, and now about 400m dollars have been transferred under the control of external managers, and over time, their volume will consistently increase to 1-1.5bn dollars. As the centres of economic activity gradually move to China and Southeast Asia, the Central Bank plans to gradually place a significant part of their foreign assets here.

 "The novelty of the strategy is to diversify foreign exchange reserves on the Asian securities markets. And along with the huge Chinese market, it is very important to place our assets in Singapore, Malaysia, Indonesia and South Korea. These promising financial markets will also be accessed via external asset management," says CBA Deputy Chairman Aftandil Babayev.

The CBA is already conducting another tender for the selection of foreign managers to manage the portfolio of Asian stable income securities as part of its foreign exchange reserves. And recently, the CBA applied to the Central Bank of China for permission to participate in the interbank bond market of the country. In general, to create a multi-currency investment portfolio, the Central Bank plans to place about 600m dollars under foreign management in Asia, investing these funds in stable and highly liquid papers.

According to most experts, the thriving and stable economy of China makes the currency and securities of this country very promising for the reservation of assets of third states. However, until now the main obstacle to this has been the lack of the free-market conversion of the yuan. Its rate is regulated by the government, and, until recently, the Chinese government sought to artificially lower the rate of its currency to boost exports. Recently, however, Beijing has been thinking of allowing the exchange rate of the yuan to float freely, which will significantly increase the investment attractiveness of Chinese securities.

However, in other countries of Southeast Asia, the system of regulating the exchange rate is much more liberal, and their securities markets have long been actively involved in the global financial system.

Actually, it is for this reason that the State Oil Fund of Azerbaijan has started to develop promising Asian destinations. "SOFAR is in talks with Chinese regulators on the subject of access to assets in the yuan and plans to invest up to 1.8bn dollars in this currency during the current year. The yuan is gaining global significance, and our country is interested in keeping some of its foreign exchange reserves in that currency," SOFAR head Sahmar Movsumov told the Financial Times recently. According to him, at the end of last year, the Fund decided to increase the share of world currencies (except the traditional dollar, euro and pound sterling) in its portfolio from 5 to 10 per cent. "It is planned to invest additional 5 per cent, or about 1.8bn dollars in other currencies. We will invest the amount that will be available by the end of the year in the yuan and any other assets in the Chinese currency," Movsumov said.

The need to diversify the country's international reserves is dictated not only by the need to increase the return on assets, it is also a question of the long-term security of the state, the need to protect the savings for future generations against possible devaluations of world currencies and crises on the global securities markets. The price of the issue is quite considerable - after all, today the volume of total foreign exchange reserves exceeds 54bn dollars, which is almost equal to 70 per cent of annual national GDP.