A STABLE EXCHANGE RATE

Azerbaijan's economy has continued to develop for about a year now in very difficult conditions linked with the fall in global oil prices and world economic problems. In these circumstances, various experts have expressed their views regarding the stability of the country's monetary policy next year and for the period after that. However, neither the Ministry of Finances nor the Central Bank of Azerbaijan sees any need for a further devaluation in the near future.

2015 has turned out to be a very difficult year for countries exporting energy commodities in the post-Soviet region and the neighbouring oil-producing countries. A reduction in world prices and, accordingly, revenue from the export of energy resources has had a negative impact on the economy in general, forcing governments to review budget expenditure and impose serious restrictions in the sphere of monetary policy. The region has encountered a serious wave of devaluation of national currencies and growing rates of inflation and so many countries have been forced to tighten financial regulation.

And Azerbaijan is no exception. The negative impact of the raw-materials crisis was negated to some extent by the devaluation of the manat in February. Experts from the International Monetary Fund (IMF) gave a very positive assessment of the flexibility of the Central Bank's monetary policy. They believe that this has helped to appreciably replenish the treasury's revenues and maintain the bar of the state budget deficit at a level of 6 per cent of GDP.

However, the Central Bank's efforts to maintain the stability of the manat have so far led to an appreciable reduction in its own currency reserves. Thus, since the beginning of the year their volumes have been reduced by 7.998bn dollars, or more than 53 per cent, and the CBA's remaining currency reserves by the end of September were estimated at 7.044bn dollars.

"Since mid-September the country's currency market has become realigned, the Central Bank is not selling currency and this process has been halted," Xagani Abdullayev, deputy chairman of the board of the CBA, said. However, in the current circumstances, the Central Bank needs to draw up mechanisms as soon as possible to minimize the risks of a reduction in reserves and to ensure macroeconomic stability in the country. This is extremely important, because having a sufficient volume of reserve capital is an essential requirement for the CBA to carry out its regulatory functions within the context of monetary policy.

One of the positives of February's devaluation was the easing of the Central Bank's burden in regulating the country's foreign currency market. With the weakening of the exchange rate of the manat, relatively smaller volumes of funds had to be spent on currency interventions to maintain its stability. The cheaper manat to some extent strengthened the competitiveness of home-produced output which, among other things, is quite important for the expansion of non-oil exports. However, the positive effect here was not so significant, bearing in mind the relatively small proportion of the non-oil sector to the country's foreign trade.

Among the downsides of devaluation has been the negative impact of this process on the country's financial sector, especially the banking sphere. This negative has had a disastrous effect on the operational environment, the quality of bank assets and their capital, profitability and funding. According to the Fitch Ratings agency, the process of the dollarization of deposits, which has intensified since February, is putting extra pressure on the banking sector. Foreign currency deposits accounted for 67 per cent of the sector's deposits at the end of June. The quality of banks' assets suffered from the devaluation of manat loans. On the other hand, additional depreciation will be linked with risks of non-payments on foreign currency loans, which made up 43 per cent of the whole credit portfolio of banks by the end of the first half of this year. The latter is due to the majority of borrowers having restricted access to foreign currency revenues.

Experts from the Standard & Poor's agency hold a similar view, believing that the dollarization indices of Azerbaijan's banking sector will continue to remain high. "The proportion of people's foreign currency deposits amounted to 70 per cent of the deposits of the banking system, which were a significant increase on the 50-per cent level at the beginning of the year, and this will increase even more the dependence of the funding base on the effect of this factor. In our view, these processes could put extra pressure on the financial indices of the sector and cash flow management," the S & P report said.

So, while in many ways inevitable and having a positive impact on state treasury revenues and maintaining a low level of state budget deficit, the February devaluation still carries considerable risks to the stability of the financial sector.

Awareness of this was the reason for the very cautious policy of the government, which excluded the possibility of any sharp change in the exchange rate of the national currency in the follow-up period. Of course, the possibility of another devaluation cannot be ruled out if there is a sharp reduction in the demand for energy resources in the coming months. However, if oil prices can be maintained within the 40-50-dollars a barrel corridor the government will be able to hold back exchange-rate parameters from sharp fluctuations. In the opinion of some experts, we should not expect a sharp fall in oil prices in the near future, especially in the light of events in Syria and the Middle East. Moreover, Fitch Ratings predicts that roughly by the end of next year OPEC will adopt a decision on a gradual reduction in production so that the oil price can return to a figure of 70-80 dollars a barrel within a couple of years. In other words, one can expect a final stabilization of demand and an increase in world oil prices only in a few years' time. However, the general trend here is a positive one.

That is possibly why in the package of documents of Azerbaijan's state budget for 2016 the government stipulated that the average annual rate of exchange of the manat against the dollar and the euro would remain unchanged for the next four years. Thus, in the medium term, the country's monetary policy will be aimed towards maintaining the stability of the exchange rate of the national currency.

"The Central Bank sees no grounds for sharp fluctuations in the exchange rate of the manat: there is stability on the currency market, the supply and demand for the national currency have stabilized and the country's balance of payments is now also fairly well balanced," Abdullayev believes. "Significant fluctuations in the exchange rate are possible in those countries where there is the likelihood of a sharp reduction in currency receipts or a switch to a deficit. Our balance of payments is currently well balanced." The deputy chairman of the CBA also pointed out that in the medium term the CBA plans to increase the flexibility of the exchange rate of the manat, but this year and next there is unlikely to be a need for a sharp change in the exchange rate of the national currency. For the time being the Central Bank is committed to the practice adopted in February of targeting the exchange rate of the manat on the basis of the dollar-euro dual currency basket. 

The country's Finance Ministry holds similar views of the country's monetary policy. "Azerbaijan's balance of payments is sensitive to changes in oil prices on the world market, but nevertheless currently no serious problems have been detected in this sphere, and therefore we see no risks in the exchange rate of the national currency." Finance Minister Samir Sarifov said. "At the same time, it should be borne in mind that Azerbaijan's economy is based on market principles and this makes the impact of negative external factors on it inevitable, and so no country in the world, whatever its level of development, can confidently claim that its national currency will remain stable for ever." He also added that it was too early today to speak about the likelihood of a swift transition to a floating exchange rate. But it is well known that the Central Bank is working in this direction and the relevant research is being carried out. And judging from what the finance minister says, new decisions on this will be drawn up taking into account all the factors of their impact on the socio-economic situation of the population.