INDICATIVE INCENTIVE

The results of 2017 along with favorable outlook for 2018 indicate that the negative impact of the global energy crisis on Azerbaijani economy is weakening gradually. The recent decision of the Central Bank of Azerbaijan (CBA) to reduce the discount rate from 15 to 13 per cent was an explicit manifestation of these positive processes. This measure is also in line with the post-oil economic policy of the government trying to stimulate investment activity and reduce the cost of borrowed resources.

Justified by time

One of the most important tasks for Azerbaijan in the next five or six years is increasing the volume of non-oil GDP and expand agricultural and industrial exports. It is planned to support the actors of the non-oil sector by expanding access to low-interest long-term bank loans.

Unfortunately, the situation over the past three years has not contributed to the expansion of bank lending. Unfavorable state in foreign trade, which has cut the positive trade balance, decreased the balance of payments, and led to the devaluation of manat had the most negative impact on the banking sector. The crisis of non-payments, efforts of the government and the Central Bank to sterilize excess money supply, reduce the level of dollarization of the financial system and measures to strengthen the national currency made the embodiment of a conservative scenario in the field of bank lending unavoidable.

In 2016-2017, CBA repeatedly made decisions on increasing the discount rate (refinancing rate), and also revised the parameters of the interest corridor for liquidity transactions. As a result, the discount rate has gradually increased from 3 to 15%. This decision, which became the most important step to stabilize the circulation of money and strengthen the position of the national currency, contributed to the growth of the volume of manat deposits, ensured the stability of consumer prices in the medium term, as well as basic macroeconomic indicators.

In fact, the measures implemented two years ago was the same scenario used to overcome the implications of the 2008 global crisis. At that time, CBA was also forced to raise the refinancing rate to 15%. It is obvious that the measures to stabilize the circulation of money have led to a significant increase in the cost of funds borrowed in manat. In the difficult conditions that prevailed two years ago, choosing between macroeconomic stability and the economy's need for "cheap" money, the government preferred the first, which is already justified by time.

Stable assumptions

In 2017, Azerbaijan managed to maintain macroeconomic stability. The foreign exchange market stabilized significantly, and the manat’s exchange rate strengthened by 4%, the Central Bank's currency reserves grew 24.4%, reaching $5.4b by January 2018. "Last year, the balance of foreign trade surplus amounted to $5b, which is ten times higher than in 2016. The volume of exports increased by 52%, and non-oil exports by 23%. Along with the trade balance, improvements are also observed in the balances of primary and secondary incomes, as well as in the balance of services. There is also a positive balance in the movement of capital and finance," said CBA chairman Elman Rustamov.

As we see, despite the persisting negative processes in the global economy and the decline in business activity in the region, Azerbaijan managed to stabilize its macroeconomic indicators. Apparently, the above positive trends are based on changes in the world energy situation. "The rise in oil prices in early 2017 supported stabilization of the Azerbaijani economy," reports the international rating agency Moody's. Oil prices of $65-70 per barrel will support the economic development of Azerbaijan and the level of fiscal revenues also this year, believe Moody’s experts. According to their forecasts, in 2018 Azerbaijan's GDP may grow by 1.5%, while the current account surplus of the balance of payments will be 1% of GDP.

"Balancing the external balance creates the conditions for continued stability in the foreign exchange market. The monetary situation is formed in the context of the economy's needs for money, including the liquidity needs of the fiscal sector, as well as the level of liquidity in the banking sector, "the CBA said in a statement.

All of the above has created the prerequisites for gradual liberalization of a rigid monetary and credit policy conducted by the government and the Central Bank in the past two years. It is noteworthy that the main obstacle to cheapening borrowed funds in recent years has been the relatively high level of inflation, which reached 12.9% in the last year. However, the growth rate of consumer prices was reduced to 7.9% in December last year and to 5.5% - in January 2018. The Azerbaijani government expects an average annual inflation of 6.8% in 2018, while the European Bank for Reconstruction and Development forecasts that inflation remains unambiguous at 5-9%. A similar opinion is shared by other experts. "Given the lack of pressure on the Azerbaijani manat, you can expect that in 2018 and 2019, the inflation rate will be 6% and 5% respectively. Confidence in the stability of the exchange rate also reduces inflation expectations. Taking into account the above factors, one can count on the fact that the Central Bank of Azerbaijan will most likely continue to soften monetary and credit policy, "Moody's experts believe.

Actually, the first step in this direction was made on February 12, 2017, when the Central Bank decided to reduce refinancing rate from 15 to 13%. The CBA Board also decided to lower the lower limit of the interest corridor from 10 to 8%, and the upper limit - from 18 to 16%. "Depending on positive trends, the Central Bank considers it possible to further reduce the discount rate while maintaining it in the positive zone if there are no external shocks and risks within a year and the inflation rate be even lower than the forecasted figure of 6-8%," said Rustamov, adding that next time the parameters of the percentage corridor will be discussed in April 2018.

Indirect influence

As an instrument of the money market, the parameters of the interest corridor, including the discount rate, are adequately regulated by the state depending on economic cycle and the situation in financial markets. Of course, one should admit that in Azerbaijan the change in the refinancing rate for the most part plays an indicative role: its correction affects the financial markets and business indirectly; therefore the change in the discount rate is interesting, first of all, as a trend, sort of a CBA’s message to the actors of the financial market. Expert economist Farhad Amirbayov hinted in November 2017 a possibility of slight reduction in the discount rate in the event of stabilization of inflationary processes. Speaking about the impact of a high discount rate in Azerbaijan’s money market, the expert noted that at present this influence is insignificant. Actually, only a small part of banks is refinanced at the discount rate, and this process does not affect the economy in a broad sense. Therefore, the impact of a high CBA discount rate on money market is relatively small and is felt only in the form of high interest on bank loans, believes F. Amirbayov.

At the same time, the preservation of existing situation with "expensive" bank loans is completely unacceptable, if we take into account that according to the Strategic Roadmap, credit institutions should channel ₼27b by 2020 in various sectors of the national economy. It will be very difficult to hit this indicator, since lending to projects in the sphere of industry, agrarian sector, construction, etc. at bank rates exceeding 20-30% is prohibitive for Azerbaijani entrepreneurs, while a business operating abroad has access to loans that are several times cheaper.

Therefore, CBA’s decision to reduce the discount rate should be unequivocally considered as a positive move. The Central Bank believes that a decline in the level of refinancing, a gradual transition to a neutral monetary policy and an intensification of the money supply dynamics will allow the state to further soften monetary policy, and this will positively affect economic activity in Azerbaijan.

Restoration begins

Today it is quite difficult to know how well such forecasts are done. Even considering the very successful experience with overcoming the implications of the 2008 crisis. Incidentally, from December 2012 to July 2015, the CBA decided five times to reduce the discount rate from 15 to 3%. Then, the reduction in the refinancing rate, coupled with favorable external conditions, ensured the growth of the bank lending market and provided tangible support to the development of the national economy, including the diversification of its non-oil segment.

Of course, the current conditions are not exactly the same as it was six years ago: oil prices are still very far from pre-crisis indicators, and the banking sector suffered much more damage than after in 2008. Indicators show that the banking sector is still at risk.

Nevertheless, experts of Fitch Ratings expect the restoration of bank lending in Azerbaijan in 2018: the country gradually reduces the dollarization of loans and deposits, which reflects the increase of confidence in the national currency. An equally important factor for the early recovery of the banking sector may be a reduction in the cost of banking services. In particular, a decrease in interest rates on loans will lead to the stimulation of lending to the real sector of the economy, which will increase the banking turnover and stabilize the level of liquidity.

If the upcoming steps to liberalise monetary policy reduce the average level of bank loans and improve the investment environment in general, they will be the main argument justifying the February decision of the CBA to reduce the discount rate.