SETTING THE RECORD STRAIGHT

The whole of last week the fluctuations in the exchange rate of the manat against foreign currencies were being tensely monitored in Azerbaijan. However, there was no turmoil at the banks and currency exchange offices: after minor changes in the Central Bank's exchange rate policy many people adopted a wait-and-see position.

President Ilham Aliyev, who was on a visit to Mingacevir, made a number of important statements on the situation, after which the government institutions tightened control over inflationary processes and instances of speculation on the currency market.

An anticipated measure

"The tension on the neighbouring CIS landscape over the past year has in some ways affected the Azerbaijani economy," President Aliyev said, commenting on recent events on the country's currency market. He said the main aim of the decision to devalue the manat is a desire to protect the Azerbaijani people from possible risks and to strengthen stability in Azerbaijan. He recalled that the last monetary reform in the country had been carried out in 2006, as a result of which the manat was equated with the dollar. However, over the next ten years, in the context of the economic reforms, the national currency grew stronger and its stability was maintained by the CBA [Central Bank of Azerbaijan]. The positive outcome of this process was a reduction in inflation, an upturn in the well-being of the population and the rapid development of the banking and insurance sectors and other segments of the financial market, the services sphere, infrastructure, and so on.

"The sharp fall in the exchange rate of the national currencies of our neighbouring countries began, in one way or another, to have a negative impact on us, too. On top of that, the sharp fall in world oil prices also had a negative effect on our revenues. At the same time, the gradual appreciation in the exchange rate of the manat did, of course, have a negative impact on our economic development. Given that, the decision was taken to slightly cheapen the manat," Aliyev noted, adding that in January this year he expressed the view about the negative impact of the excessive strengthening of the manat on the economy. "Thereafter, our Central Bank stated that the exchange rate of the manat would gradually fall before the end of the year. This was also a signal that the people were ready for this."

At the same time, turmoil could not be avoided and eventually people rushed to buy up dollars. The speculators, too, soon twigged how they could make a killing over the fluctuations in the exchange rate and began to besiege the bureaux de change.  The result was that a fairly dangerous situation built up for the CBA's currency reserves: every day over the course of a few days at least 500m dollars were bought up. So that's why the decision on "shock" devaluation was taken. "The manat has been virtually reduced to its previous level. In other words, when the reform began one manat was equal to one dollar, and now one manat is equal to approximately one dollar," the head of state summed up.

Let us recall here that our currency reserves have suffered enough from the urge to maintain the exchange rate of the national currency against the background of a sharp fall in oil prices and the devaluation of currencies in neighbouring states who are Azerbaijan's trading partners.  For example, in the fourth quarter of 2014 the country's currency reserves were reduced by 2.3bn dollars, or by 4.3 per cent.

At the same time, of course, we are still a long way from the danger level and, the CBA assures us, the current volume of the country's reserves (51.4bn dollars as of 1 January 2014) is sufficient to cover three years of goods and services imports and exceeds eightfold the size of Azerbaijan's external debt.

Meanwhile, foreign experts also believe that the fall in the manat's exchange rate was anticipated and was an economically sound decision. In the opinion of Professor Wilfried Furman of Potsdam University, who was commenting on the recent events in the Azerbaijani economy on the Vestnik Kavkaza website, if the manat's exchange rate had not been reduced, all the efforts and success of previous years in building a diversified Azerbaijani economy - i.e. strengthening the non-oil sector (agrarian, tourism, service and industrial sectors) - would have been in vain. "These sectors, surrounded by countries that have depreciated their currencies, would have lost their competitiveness and their export capacities would have been restricted. Increased unemployment would have put the Azerbaijani economy back years," the expert pointed out. Furman claims that national currencies are being devalued against the dollar all over the world and this usually happens by a decrease in interest rates by national banks, as happened in Mexico, India, Australia and many other countries, or by other means, as in Japan, China, Singapore, Denmark, and so on. "For example, for a long period of time, right up to now, the Chinese currency exchange rate has been understated, which was one of the key factors in China's economic boom. In the past the rate of the Estonian kroon was understated in order to ensure Estonia's development after it gained independence; or the rate of the deutschmark in Germany to rebuild the country after the war. The devaluation of the manat is, therefore, a kind of industrial policy," the expert noted. According to Ruslan Grinberg, a corresponding member of the Russian Academy of Sciences and director of the Institute of Economics of the RAS, currencies will increase if the oil markets recover. "This should have happened in a country whose economy is based on energy resources. After the collapse of the rouble it was expected that there would be devaluation in the CIS countries," he said.

A statement by the Fitch Ratings agency also notes that devaluation will assist fiscal and external adjustment to the lower oil price. "The sharp appreciation of the manat's real effective exchange rate as a result of the depreciation in 2014-15 of the Russian rouble and Turkish lira would, if sustained, have hampered efforts to develop the non-oil economy in Azerbaijan," the agency points out.

However, the rather restrained manner in which international capital markets reacted to the news of the devaluation of the Azerbaijani manat is shown by the fact that the quotations of Azerbaijani sovereign Eurobonds and two issues of Eurobonds by SOCAR almost completely recovered the losses which occurred on 23 February. According to the Stuttgart stock exchange, on Tuesday, 24 February the republic's 10-year Eurobonds with a redemption in 2024 were trading at 100.15 per cent of the rate, whereas on Friday evening, 20 February, the price of securities was equal to 100.16 per cent. On Monday, 23 February securities quotations were reduced to 99.87 per cent of the rate. In the opinion of experts of Interfax-CEA [Centre for Economic Analysis], the original fall in the price of Eurobonds was caused by fears of a destabilization in Azerbaijan's monetary sphere, but it soon transpired that the rate of exchange was stabilizing at a new level and these fears dispersed, and so prices recovered. Generally speaking, the devaluation of the manat, which was carried out distinctly and decisively, did not cause the owners of Azerbaijani sovereign bonds any fears about the financial insolvency of the issuer.

The banks take measures

However, sound and anticipated though the devaluation of the manat may have been, there is no denying the fact that this process brings with it a number of negative consequences for certain sectors of the economy and the population.

First of all, as has been mentioned several times in the media, the sectors that are suffering are the bank, insurance, tourism and services sectors. Despite the gloomy predictions that first appeared about the possible bankruptcy of a number of companies and organizations in these spheres, we have had no real information in this regard.

However, the Fitch Ratings agency issued a statement that devaluation will have a negative impact on the capitalization of the country's banking sector. "Banks in Azerbaijan have large numbers of foreign currency loans and are exposed to losses on short foreign currency positions. Greater dollarization of the economy and banks' balance sheets means that foreign currency risks are likely to be significant for the sector over the medium term," the agency's report points out. The agency stresses that several banks have booked considerable losses as a result of the devaluation. "We estimate that some banks could have breached their regulatory capital adequacy ratios, but we believe the authorities may introduce some regulatory forbearance to support banks' formal compliance, as was the case with Russia," the press release states. The agency believes that a gradual deterioration in asset quality is likely, especially as exposures are largely to borrowers with limited access to foreign-currency revenue.

Here we should point out that last week the Azerbaijan Deposit Insurance Fund (ADIF) adopted a decision to increase from 24 February this year the maximum interest rate on insured deposits from 9 per cent to 12 per cent. The main objective here is, naturally, to try to maintain people's trust in the banks and to prevent the outflow of deposits of individual citizens. At the same time, some banks have already announced various campaigns and new incentive measures for depositors, including a commitment to reimburse profit tax on deposits.

However, the situation with borrowers' obligations is more difficult to understand. For example, up to now there has been no single opinion regarding which rate payments on dollar loans should be made. Even the CBA has said that this question is not clearly defined in the country's legislation: "The clause in the Civil Code on this question may be interpreted in different ways. Therefore it is hard to give a single answer to the question as to against which rate loans should be surrendered." As regards the question as to how relations between a bank and its clients should be regulated, the CBA has advised clients to refer to the courts because this question may be resolved only as follows: "The Constitutional Court may possibly comment on this question."

In the opinion of economic expert Vuqar Bayramov, it would be advisable if the CBA chose one of three possible ways worldwide in resolving this question, "First, the Central Bank could itself compensate for the difference in the exchange rate taking into account the fact that it has the reserves for this. This would rescue both the borrower and the lender from any losses. The second option is to use the principle of average rate of exchange for the indexation of dollar loans in the national currency, which enables the additional exchange-rate burden to be shared between the parties. And, finally, the CBA could introduce benefits for borrowers by recommending that banks review their existing loan agreements," Bayramov said. In any event, it is clear that the solution should satisfy both parties in order to avoid tension in the banks and for borrowers. 

Slowing down of inflation

As far as the main negative result of devaluation is concerned - the increase in consumer prices - in this case it is important that this process is also economically sound, and not indiscriminate. It has already been reported that many retail outlets, literally on the day the "shock" devaluation was announced, began to overprice goods regardless of whether they had been brought into the country against the old exchange rate or were locally produced.

However, President Ilham Aliyev set the record straight in a fairly sharp statement on this subject. "All the relevant structures have been instructed to prevent artificial overpricing.  The situation is being monitored and tough punishments will be imposed on those who wish to artificially increase prices. During recent years the basic foodstuffs consumed in the country have been produced in Azerbaijan. Therefore, any increase in the price of these goods is out of the question. If anyone artificially increases prices the state will punish them," the head of state pointed out.

After this, the prices of medicinal products, which had increased after the sharp devaluation of the national currency, were reduced to their previous level and reports appeared about penalties being imposed on firms importing food products and creating an artificial shortage of them on the market or increasing their prices. Currency exchange offices involved in speculative operations on the currency market were also punished.

Here I would like to draw attention to the example of neighbouring Russia, which is now experiencing serious inflationary processes as a result of the sharp devaluation of the rouble. There, the operators of grocery stores that are part of the Association of Retail Companies (ACORT) took the decision to freeze prices on a basket of not less than 20 staple commodities for a period of two months. By fixing prices, the retail chains are committed to preventing their increase, but will lower prices if the purchase value is reduced. This is a decision that is worth copying.

However, social departments have already stated that if the cost of the consumer basket in Azerbaijan goes up, the negative impact on pensions and benefits will be removed by indexation. The Azerbaijani Tariff (price) Council has also stated that the question of increasing energy tariffs (including petrol), as well as passenger transportation, is not currently being considered by the council, which is also a sign that the inflationary processes will slow down and moderated by all means available to the state.

In other words, for the time being the negative consequences of the sharp cheapening of the manat have been cut short and the second week of devaluation has passed more or less quietly.