EURO OVERBOARD

Euro continues its downward fall.  Even the governments of EU countries, who have made the unprecedented decision to create an anti-crisis fund of almost US$ 1 trillion, have been unable to stop this.

In this situation, there is every reason to believe that the European currency is overpriced and, in the opinion of international experts, a fall in the euro's value to parity with the dollar is expected as soon as early 2011.  These forecasts are corroborated by the fact that the euro has reached record lows of late, going through different levels of support, and periods of growth are used to sell the European currency.  For now, there is no reason to expect a rise in the exchange rate of the common European currency.

The last time the euro was on a par with the US currency was in 2002.  After that, the euro appreciated noticeably, reaching a record high of $1.6 for 1 euro in 2008.

In the mean time, Dominique Strauss-Kahn, managing director of the International Monetary Fund, argues that there is no threat to the euro zone.  Jean-Claude Trichet, president of the European Central Bank, has made similar statements in the past.  He said that "rather than the common European currency, the taxation policy of some countries which need to carry out reforms is under threat."

Concerns about the stability of the euro became more prominent after the onset of crisis in Greece.  When it emerged that the Greek budget deficit in 2009 was 13.6% and the country was on the verge of default, suspicions arose that other euro zone nations would follow suit, which would jeopardize the overall stability of the common European currency.  To address the problem, the country's government introduced unpopular measures:  pay cuts, the "freezing" of pensions and increased taxes.

Countries in the south of Europe are taking similar measures, as their budget deficits also exceed the maximum level of 3% allowed by EU rules.

History of the euro in Azerbaijan

The Central Bank of Azerbaijan started to collect statistics on operations in euros in the country's domestic currency market in 2003, and of cash operations in euros from 2005.  The common European currency was introduced in 1999, but it soon became the second global currency.  The size of the economies and financial markets of euro zone countries and their level of participation in international trade and the movement of capital helped this.

In the Azerbaijani currency market, despite its considerable volatility, the euro remains the second most important currency.  Despite the fact that in May, the European currency shed 15.37% of its value and broke a psychological barrier, trading at AZN0.9796 for 1 euro.

Historically, the maximum exchange rate was AZN 1.3138, in December 2004.  In the country's domestic currency market, which is made up of the Stock Exchange Electronic Trading System (BEST), open interbank currency market and bank exchange transactions, the proportion of currency operations in euros grew until 2009.  In 7 years at the foreign currency section of the BEST, the total amount of trade in euros increased 114 times, at the interbank currency market 63.9 times, and in the banks' currency exchange operations 5 times.

However, the lion's share of the Azerbaijani currency market is taken by the US dollar, whose share of the domestic foreign currency market is 84.3%.  The domination of the dollar stems from the fact that more than 90% of Azerbaijan's exports are oil and oil products, whose prices in international markets are fixed in dollars.  Foreign trade operations are also usually in dollars.

Calm, only calm

The euro's position has not provoked alarm in Azerbaijani financial circles.  True, the unfavourable situation forces Azerbaijani financial institutions to postpone emissions of euro bonds until the situation in the international markets is stabilized, in other words, indefinitely.  Previous postponements were caused by the global financial and economic crisis.

Finance Minister Samir Sarifov said that the situation in the markets is very volatile.  Like last year, the situation in the market is also quite fragile in 2010, because of the debts of the southern European countries.  This is why Azerbaijan has no immediate need to attract funds from international markets.

Overall, the minister said, the Finance Ministry views the issue of euro bonds from the point of view of creating a "profitability curve" for Azerbaijani sovereign debt.

The country's banking sector might experience a change in the structure of deposits.  If instability in Greece continues, leading to a further weakening of the euro, some customers might change the currency of their deposits to dollars or manats, because low interest rates on savings in euros are increasingly less profitable.

Ordinary people in Azerbaijan with bank deposits will not be much influenced by the euro's falling exchange rate against the manat.  Those who are paying off their loans in euros will even benefit a little - their repayments will amount to a somewhat smaller amount in manat.  And the only sector affected is the small number of Azerbaijan's non-oil exporters to Europe, because a further weakening of the euro will result in higher prices for export goods for EU countries and, accordingly, lower demand from foreign markets.

Today, 90.7% of the country's total exports are in oil and oil products, and these are in the US currency regardless of the market.  Oil products continued to dominate exports in 2009 on the country's balance sheet, despite the fact that, compared to 2008, oil exports decreased by 32.8% to $19.1 billion.  However, exports of natural gas increased by 23.4%, to $832 million.

The fall in the euro's exchange rate will not affect Azerbaijan's strategic currency reserves either, said the head of the Central Bank.  The bank continuously monitors changes in currency exchange rates, and particularly the euro/dollar rate:  there were falls to 0.89 dollars per 1 euro and rises to 1.6 dollars per 1 euro.  However, at present the process has reversed.  The euro rose from 2001 to 2004.  And, beginning from 2005, the trend has changed.  In 2005 alone, the euro/dollar exchange rate fell by 13%.

The threat from the euro's instability does not bode ill for our foreign currency reserves because they are quite diversified, both in terms of currencies and geographically.  Some analysts say that the fall of the euro does not pose a threat because there are more dollars than euros in Azerbaijan's currency reserves.  Back in 2008, the Central Bank adjusted the currency content of its portfolio and, at present, 60% of the country's currency reserves in the main bank are in dollars, while the remaining 40% are in euros and pounds sterling.

The foreign currency portfolio is divided into two parts, investment and operations, which is why most of its reserves are in the US currency.

The investment part of the portfolio increases all the time and accounts for about 60% of the total.  The operations part is mainly used to service domestic demand and foreign debt, which is why 90% of it is in US dollars.

The investment portfolio includes different instruments.  Currency reserves in the portfolio are in the form of deposits, stocks and bonds, and some are managed by foreign institutions.

Oil money is safe

The foreign currency of the State Oil Fund of Azerbaijan is balanced in the following manner:  50% of the assets must be in dollars and up to 40% in euro.  Of the remaining 10%, half must be in pounds sterling and 5% in one of these three currencies or other currencies.  The ratio might change during the quarter but, ultimately, assets must be balanced within these limits.

Gold reserves

In view of international developments, the Azerbaijani government began to consider the effectiveness of the currency reserves' structure for the future and to think about creating gold reserves.  "The position of the Central Bank and Government is that at least the gold which is mined in Azerbaijan must be kept in the country as part of its strategic currency reserves," said the head of the Central Bank.

From the point of view of diversifying currency reserves, creating gold reserves would also be useful, in Rustamov's opinion.  Basically, gold, like all other types of reserve instruments, is also a currency, and a hard currency at that, in other words, gold is always freely sellable and buyable.

In 2009, the country's strategic currency reserves increased by $3 billion, exceeding $20 billion, and today they have already cleared $22 billion.

The strategic currency reserves are formed by the currency reserves, State Oil fund of the Republic of Azerbaijan and Government deposits.  In 2008, when the reserve structure was changed, the Central Bank and State Oil Fund adopted a conservative policy in managing the reserves, which are currently kept in the central banks of the world's leading countries and also at the World Bank, International Bank for Settlements and financial organizations with sovereign ratings.

So far, gold mining in Azerbaijan, which started in July 2009, has produced 25,022 ounces.  The first gold and silver were mined at the Gadabay mine in May 2009.  Overall, more than 300,000 ounces of gold are to be mined at the Gadabay deposit until 2015.

The Anglo-Asian Mining PLC company, the only gold miner in Azerbaijan, has the rights to develop six deposits in the country's southwest (Gadabay, Ordubad, Qosa Bulaq, Qizil Bulaq, Vajnali and Soyutluda) in accordance with the 1997 PSA agreement with the Azerbaijani Government.  According to the contract, some 400 tons of gold, 2,500 tons of silver and 1.5 million tons of copper are to be extracted from the deposits.

Euro's prospects in Azerbaijan

There are serious reasons for the further development of the euro market in Azerbaijan, says Farhad Amirbayov, head of the Baku Interbank Currency Exchange.  First, the euro is the currency of Azerbaijan's main trade partners.  In 2009, three European countries - Italy, France and Spain - accounted for 37% of the exports, and 21.3% of imports were divided between Germany, Britain, France, Italy, Sweden and Switzerland.  And these figures might increase considerably in the future, because Azerbaijan needs imports of high technology and modern equipment from the EU and a further expansion of business ties with euro zone countries.

Second, among the 10 top investor countries in Azerbaijan, two are EU members, Austria and France.

Third, demand for cash in euros has been growing in Azerbaijan.  In 5 years, Azerbaijani banks have increased their euro purchases by 5.8 times, to 63 million euro.  The lion's share of the cash market is taken by sales of euros by banks, which in 5 years increased 8.5 times to reach 737.5 million euro.  The development of the cash market in Azerbaijan is boosted by the development of business and tourism and by migration processes.  The euro's share of Azerbaijan's cash market will increase considerably after the gradual softening of the visa regime with EU countries.  Amirbayov argues that Azerbaijan is under the influence of two currency zones at the same time: the dollar zone and euro zone.  Our country accepts and pays for the currency risks and other expenses which stem from this situation.  The way out of the current position is a gradual transition to payments in euros for oil, while pricing policy remains in dollars.  This will make it possible to localize the risks in countries which buy export goods and to cut some expenses.

It also seems that accelerating the process to accede to the World Trade Organization is not worthwhile, because globalization processes in the world are beginning to slow down.

If globalization processes continue to decelerate, the risk of a dissolution of the dollar zone will increase considerably.  In that case, the vacuum will be occupied by regional currency zones and the euro's role might grow further in Azerbaijan, said the head of the currency exchange.

National currencies on the rise

 Thomas Mirow, President of the European Bank of Reconstruction and Development (EBRD), argues against the idea that the development of local currency markets can help overcome dependence on foreign-currency debts and urges greater reliance on domestic reserves.  The EBRD plans to launch initiatives in national currencies.

The idea of a transition to payments in national currencies in bilateral trade is being discussed by Azerbaijan and Turkey.  This idea was proposed back in 2008, during the visit of a delegation of the Banking Association of Turkey to Baku.  Banking Association of Azerbaijan Chairman Eldar Ismayilov said that the issue is now under discussion.  However, the current size of bilateral trade is a disincentive.  Had both countries had a 70-80% share in bilateral trade balance, the issue would have been resolved quickly.  However, trade has not reached this level yet.  Turkey's share in Azerbaijan's trade balance varies from 5 to 14%, Azerbaijan's share in the Turkish balance is even lower.  If Turkey's share in Azerbaijan's balance were 25-30%, the issue would be considered seriously, Ismayilov said.  Nonetheless, the discussion by Russia and Turkey about a transition to settlements in national currencies will have a positive effect on the discussion of the same issue by Turkey and Azerbaijan which, as a mediator country, will be influenced by any change of situation in relations between Russia and Turkey.

Let us note that Russia and Turkey are ready to discuss a transition to settlements in national currencies via joint banks when mutual trade reaches $100 billion a year.

In Azerbaijan, there is an initiative to use a mechanism of direct conversion of currencies, instead of converting via the US dollar and euro, as now.  In particular, the Azerbaijan banks propose to sell oil and gas to Turkey for Azerbaijani manat.  The introduction of a direct exchange mechanism is a serious issue, whose prospects are determined by Turkey's significant role in the financial and trade balance of Azerbaijan.

An obstacle to introducing a new mechanism is the fact that the Azerbaijani banking system is young and only recently became systematic and started to function as a dynamic equilibrium.  The issue can be decided by the leading banks of the two countries, without involving state regulatory bodies.

In the mean time, the banks of CIS member states have started to form a settlements union for national currencies.  At present, the financial and banking council of the CIS and Eastern Europe is working on proposals to promote direct payments in national currencies between banks and states of the CIS.

Trade between the CIS countries is only 15% of the total amount of their trade and economic transactions, and 85% are accounted for by export and import operations with other countries, and those transactions are in dollars and euros.