PRAGMATIC SANATION

Stability in the oil market and the measures to develop the non-oil sector have significantly encouraged the Azerbaijani government in overcoming stagnation in the near future. A similar opinion is shared by international organizations. For example, Fitch Ratings forecasts 0.2% and 1.7% GDP growth for the national economy in 2017 and 2018, respectively.

In fact, the government of Azerbaijan forecasts the GDP growth of 1% only in 2017. President Ilham Aliyev believes that Azerbaijan will experience economic growth this year. During the first two months of 2017, GDP growth had an increase of 0.4%, while it was 5.3% in January-February in the non-oil sector. The decline in global oil markets in 2014-2016 caused serious damage to the national economy. "Our revenues declined by 3-4 times, which was a serious challenge for us but we have nevertheless managed to rebuild our economy under these harsh conditions," said the president.

However, one should not expect the adjustment of budgetary indicators due to stabilized oil prices. After all, the existing budget was developed based on three scenarios in order to protect against possible risks: worst-case (if the oil price drops to $35 per barrel), basic ($40) and best-case ($45). Although the chairman of the parliamentary committee on economic policy, industry and entrepreneurship, Ziyad Samedzadeh, allows for adjusting budget figures in the event of oil price increase to $50 per barrel, the Finance Ministry has clearly stated: no preparatory work is being implemented in this direction.

It is still too early to expect the end of existing financial crisis. International and local experts predict that the number of actors in banking sector will decrease due to bankruptcy. "We expect that the purge in this sector will continue due to insufficient capital, low asset quality and currency risks," Fitch analysts say. At the beginning of last year, the ratings of five of the eight banks assessed by Fitch, including the largest bank of the country, have declined. In addition, the regulator revoked the licenses of 10 banks not rated by the agency. There are 32 banks in the banking sector today. Despite the regulator's attempts to rectify the situation, the devaluation of manat still pushes the banking sector of Azerbaijan, and banks are facing continued capital decline.

At the 6^th annual meeting of Fitch in Azerbaijan, the analysts of the agency stated that last year net losses of the sector amounted to 1.7 billion manat, while about 1.3 billion of them accounted for net losses of IBA, which are related to losses from exchange rate differences. And the trend continued in the first month of this year - only in January 2017, net losses of banks, according to the Financial Markets Supervisory Chamber (FMSC), amounted to 496 million manats.

According to Fitch, a high level of dollarization of deposits (80% by the end of 2016) continues to remain one of the main problems of Azerbaijan's financial institutions, which, naturally, limits the flexibility of monetary policy and creates a lack of liquidity in national currency.

This, in turn, is reflected in the main source of bank profits, the loan portfolio. According to international experts, it will decrease by 5% in 2017. As a result, banks may face an increase in the number of new risky loans due to capital constraints. For comparison, in 2016, the loan portfolio of the national banking sector decreased by 26.6%. "The share of non-performing loans (overdue more than 90 days) in the total portfolio reached 21%, as of the end of 2016, and we expect that foreign currency loans, which account for 48% of the loan portfolio, will put additional pressure on portfolio quality in 2017", said Fitch’s Director of financial institutions analytical group, Dmitry Vasiliev. According to him, in 2017, this sector will need support through transfers from the State Oil Fund of Azerbaijan (SOFAZ) and state guarantees.

However, the problem of dollarization has affected not only the national banks. According to experts of another influential rating agency, Moody's, the majority of banks in the CIS countries are still exposed to high currency risks. However, it is alarming that Moody’s has listed Azerbaijan as one of the countries with the highest risks - along with Ukraine, Tajikistan and Belarus.

The agency believes that the reduction in the volume of foreign currency loans in the CIS countries is mainly due to prohibitions by regulators: "Regulators in a number of CIS countries, including Kazakhstan, Azerbaijan and Ukraine, have banned temporarily the issuance of loans in foreign currency to individual and corporate clients that do not have export earnings. This is a reasonable but rather late decision, which is clearly visible in terms of the volume of loans issued in foreign currency. In addition, many banks have restructured foreign currency loans and transferred them to the national currency. This process includes extending the maturity of loans. But monthly payments remained unchanged," note Moody’s analysts.

However, the government of Azerbaijan is highly optimistic as far as the prospects of the national financial sector is concerned. According to Prime Minister Artur Rasizadeh, the situation was stabilized thanks to "targeted measures taken in 2016 and the appropriate use of strong economic potential accumulated in previous years." "The sharp decline in hydrocarbon prices in world markets has led to a significant reduction in the country's export earnings and caused a large deficit in the balance of payments. The unsatisfactory progress of a number of banks, as well as the criminal activities of the former leadership of a systemically important International Bank of Azerbaijan have further complicated the situation," said Mr. Rasizadeh.

The Financial Markets Supervisory Chamber (FMSC) believes that the situation has stabilized on overdue loans: the most serious problem of the banking sector. According to the head of the FMSC department, Rustam Tahirov, first of all, the banks have established a framework for healthy borrowing and responsible lending, which has brought a qualitatively new stage in relations between banks and customers. In addition, the assets of banks were assessed and the requirements for capitalization were set: "The licenses of banks that failed to fulfill the capitalization requirements have been canceled, some banks increased their capital, in others this process is ongoing. We expect an early completion of the capitalization process," said R. Tahirov.

According to Tahirov, sufficient funds to create reserves for problem loans eventually leads to reduction of bank profits and often leads to capital losses. As for liquidity, it is now in excess in banks. "Our Chamber periodically conducts stress tests, and the liquidity situation became more stable compared to September 2009. During this time, banks were able to reduce external liabilities, and foreign debt decreased by about 20%," R. Tahirov said.

According to experts, the weakening of the dollarization of financial market can be expected after the long-term stabilization of manat’s exchange rate. However, contrary to local experts, international analysts are more optimistic. Thus, Fitch believes that the average annual rate of manat to the dollar for 2017 will be around 1.76 manats, in 2018 - 1.7 manats, which is close to the current rate (1.72 manats / $1). That is, there are no shocks or a new devaluation on the horizon. Consequently, we can expect activation of the recovery process in the banking sector, as well as business revitalization, and, in general, rectification of the majority of macroeconomic indicators, including lower inflation.