NEW TRENDS OF FINANCIAL POLICY

In the recent period, Azerbaijan has launched a number of mechanisms designed to ensure the stability of the national currency and macroeconomic stability in general. At the same time, a radical reform of the institutions responsible for the regulation of monetary and insurance spheres, as well as the securities market is being carried out. These steps are designed to ensure the long-term stability of the exchange rate of the manat and minimize the losses of local banks and other financial market participants.

Azerbaijan finished 2015 in a rather difficult economic environment: the three-fold fall in oil prices led to a noticeable drop in foreign exchange earnings from the export of energy resources. These circumstances forced the Central Bank of Azerbaijan (CBA) to spend over 8bn dollars of reserve funds to stabilize the national currency rate last year. However, the stable trend of falling oil prices forced the Central Bank twice - in February and December last year - to reduce the rate of the manat, and the last time a floating exchange rate of the national currency was put in place.

Despite the fact that February-March this year saw a slight increase in world oil prices, negative processes in the banking sector of Azerbaijan and inertial pressure on the foreign exchange market forced the CBA to spend reserves to stabilize the exchange rate of the manat again. For example, as of 1 March, the volume of foreign exchange reserves of the Central Bank amounted to 4.026bn dollars - down by almost a billion dollars in two months.

These negative developments did not go unnoticed by international expert entities: the rating agency Fitch Ratings downgraded the country's long-term issuer default rating (IDR) in foreign and national currency from BBB- to BB+. This assessment is due to a marked fall in revenues from the export of oil and the growing budget deficit. Fitch experts believe that the policy of protecting the manat contributed to a drop in official foreign exchange reserves of the Central Bank to a level that provides 3-4 months of import. This is unfavourable compared with the median level for the BBB rating category, where the reserves cover at least 5-6 months of import. On the other hand, the weakness of the banking sector estimated by Fitch at B level will deteriorate as devaluation and economic downturn continue.

Due to the continuing unfavourable situation in foreign trade, the government and the Central Bank of Azerbaijan have taken a number of steps since the beginning of the year to minimize the impact of the devaluation of the manat on the country's economy. Despite a sizeable fall in the reserves of the Central Bank, foreign exchange intervention still remains the main tool to adjust the floating rate of the manat. At the same time, the CBA also uses a number of other mechanisms that stabilize the currency market of the country. In particular, in February and March of this year, the Central Bank twice made a decision to increase the discount rate of refinancing and revise the parameters of the percentage corridor for liquidity operations. As a result, the level of the discount rate increased from 3 to 7 per cent. This decision was a major step to stabilize the currency and strengthen the position of the national currency. This measure should help to increase the volume of manat deposits as well as to stabilize consumer prices in the medium term and ensure the stability of basic macroeconomic indicators. Another advantage of the increasing discount rate will be an increase in the yield of government bonds in manats compared with foreign currency bonds. It is equally important that this measure contributes to attracting foreign short-term capital into the country, and as a result, the balance of payments will become active and the supply of foreign currency will increase.

Increasing the refinancing rate makes access to the national currency more expensive and thus helps to establish a balance on the currency market. Buying manats from the Central Bank at an increased price, local banks will have to set a higher interest rate on deposits, and this will have a positive impact on the use of the national currency as a store of value. The latter is extremely important, as 85 per cent of bank deposits today are in dollars, euros and other foreign currencies. This leads to increased dollarization in the economy and an increase in inflation and finally, significantly impairs the performance of the banking sector assets.

In order to change the proportion between manat and foreign currency deposits, the regulations of the bank deposit insurance fund were recently amended. Manat deposits in banks are provided with full insurance at a rate of 12 per cent per annum, while for foreign currency deposits, this level was reduced to 3 per cent, and this advantage is also intended to strengthen public confidence in the national currency.

However, the flip side of the growth of the CBA discount rate is a rise in the cost of bank loans, but this negative aspect is quite admissible, since at this stage the policy of "cheap" money is not the top priority for getting the financial sector out of the crisis. Moreover, the Central Bank is doing its best to hold back the excess pressure of the manat mass on the market, since it is fraught with a growth in consumer inflation.

What the government's policy will be with respect to the rate of the manat in the future in many respects depends on world energy prices: their steady growth and a fall in market volatility will ensure an inflow of foreign currency, and as a result, provide the opportunity to spend some of the reserves on foreign exchange intervention. "In the new year, indicators of the state budget have been revised and optimized, and although the price of oil is not high, it is stable, and it affects the improvement of the trade balance of the country," the chairman of the Central Bank, Elman Rustamov, said in late February. "These factors have contributed to the preservation of the stability of the floating exchange rate of the manat, and thus talk of devaluation expected in late March is unfounded."

At the same time, the artificial retention of the national currency exchange rate through currency intervention and reducing the money supply affects other parameters of macroeconomic stability. Specifically, this limits state investment and leads to higher prices for private investment in the non-oil sector, especially in the sphere of production. Thus, with the help of dollar injections or an increase in the discount rate, it will be difficult to regulate the monetary system in the long-term.

Therefore, the government decided to form new institutional mechanisms for monetary policy regulation in the country. This work has already begun: the country is creating a Chamber of Financial Market Supervision, which will combine the functions of three financial institutions. A public legal entity - the Chamber of Financial Market Supervision - is being formed on the basis of the State Securities Committee, the State Insurance Supervision Service under the Ministry of Finance and the Financial Monitoring Service under the Central Bank. The duties of the Chamber include licensing, regulation and control over the activities of the securities market, investment funds, insurance companies and credit institutions (banks, micro-finance organizations and postal operators) and payment systems. Its duties also include the development of an appropriate regulatory framework, the introduction of new management tools, stress testing and analysis of market scenarios. Among other things, the new entity will have to counter money laundering and prevent the financing of terrorism.

It is important that the activities of the Chamber will lead to qualitative changes in the regulation of monetary policy and the securities market. Its work will be done in a collegial form and is aimed at protecting healthy competition and the liquidity of all participants of the banking, insurance and stock market. It is expected that the Chamber will focus on gradual transition from fiscal to monetary methods of stimulating the economy, which, in particular, will increase the amount of domestic and foreign investment.

According to recent amendments to the law "On the Central Bank of Azerbaijan", the powers of the Central Bank will include only the regulation of interbank payment systems, as well as the function of a lender of last resort. So, at the request of the Chamber, the Central Bank will issue short-term loans (6 months) in order to maintain the solvency of banks and their liquidity. Thus, having acquired the status of a "public legal entity", the CBA will be able to participate in the formation of the monetary and foreign exchange policy of the country only with the Chamber of Financial Market Supervision and the Ministry of Finance.

"The need to ensure the stability of the banking system is the most important task against the background of the redistribution of functions of the Central Bank," said the chairman of the board of the Chamber of Financial Market Supervision, Rufat Aslanli. "In this regard, a specific mechanism with three basic elements has been proposed: the first one involves the rehabilitation of systemically important banks, the second one - a solution to the short-term problems of banks regardless of their systemic importance, and the third one - system risk management as a whole." According to him, within the framework of improvement measures, a definition has been proposed for the criteria of systemically important banks and lending institutions that meet these requirements. A special regulatory regime will be introduced for such entities, and if there are problems, the Ministry of Finance and the Central Bank shall ensure public participation in addressing them. In order to solve short-term liquidity problems of small banks, the lending institution will be able to seek the assistance of the CBA, while the Chamber of Financial Market Supervision, in cooperation with the Central Bank and the Ministry of Finance, will be engaged in addressing systemic problems. In order to coordinate this activity, Azerbaijan plans to form a tripartite committee on financial stability in the near future.

It is hoped that the creation of new institutions and mechanism of monetary regulation of the market will bring the national currency to the desired level of exchange rate stability, strengthen the position of credit institutions and at the same time provide the real economy with the necessary amount of investment.