INCENTIVES FOR BUSINESS

In early April, the Central Bank of Azerbaijan (CBA) lowered the interest rate by 2% for the second time this year. Currently, it is 11% with minimum (floor) and maximum (cap) rates established at 8% and 14%, respectively. In parallel with international experience, CBA’s decision was mainly based on macroeconomic situation in the country, specifically, low inflation, positive dynamics of GDP growth and positive trends in foreign trade.

At the same time, as the President of Azerbaijan, Ilham Aliyev, noted in his speech at the meeting of the Cabinet of Ministers on the results of the first quarter of 2018 and forthcoming tasks, economic reforms will continue this year, despite the stabilisation of oil prices. Therefore, it is very likely that CBA will further reduce the interest rate.

Quarterly growth

How does the reduction of the CBA interest rate benefit the national economy? An interest rate is defined as a percentage of loans lent by central banks to commercial banks, which in turn distribute these loans among their customers at higher interest rates considering their own benefit. The interest rate has long become an important macroeconomic factor. Even the smallest fluctuations in interest rates of developed economies are closely watched all over the world. The lower is the refinancing rate, the more stable is the national economy. In the U.S., EU, and Japan, interest rates usually do not exceed 0.5-1%. In fact, the interest rate is a consequence rather than a cause of the current state of any economy, because by manipulating it, one can say stop inflation processes. Thus, constant or falling income leads to the increase in prices of goods and services. Then the Central Bank raises the refinancing rate making the loans of commercial banks more expensive and less demanded same as the purchasing power of population. This, in turn, makes goods and services less attractive and eventually stops the growth of prices. In other words, if, on the one hand, the increasing interest rate stabilises the economy, on the other hand, it indicates problems in it. When this indicator decreases, the reverse process take place.

In fact, there is no direct link between the CBA interest rate and commercial banks in the banking sector of Azerbaijan. The reason is simple: commercial banks do not use the resources of the Central Bank. Therefore, decreasing interest rates signal the investors about stabilising economic processes and encourage them to make investments in existing or new projects.

The interest rate in Azerbaijan has not been revised since September 15, 2016. CBA expected to lower the interest rate in 2017 but due to high average annual inflation (12.9%) it was impossible. Therefore, at a press conference, the CBA Chairman of the Board, Elman Rustamov, highlighted inflation as one of the main reasons for the recent decision. By the end of March 2018, the average annual inflation rate in Azerbaijan fell to 4%, for food products - 4.5%, non-food - 4.3%, services - 2.9%. At the same time, Elman Rustamov believes that the trend towards lower inflation rate continues. “By the end of the first quarter, Azerbaijan’s trade turnover grew by 31%, and the growth of non-oil exports reached 37%. These facts show that the diversification of the national economy is progressing well and we predict that the balance of payments will continue to grow,” said Rustamov. Current account surplus in 2017 was $1.7b compared to $1.36b deficit in 2016.

National GDP also showed a stable growth rate of 2.3% in January-March 2018, while the growth of non-oil GDP in the reporting period was within 3%. The situation is similar in industrial production, which increased by 2%. The main positive factor was the growth of non-oil industry by about 10%, which, as President Ilham Aliyev noted, can be considered a record indicator.

The foreign exchange market, as another instrumental component of macroeconomic position, also shows quite a decent progress. The banks have no problems with liquidity; Azerbaijan's currency reserves increased by $2.2b and now reach $44.2b. "This shows that, on the one hand, we economically use our reserves, and on the other hand, we implement a successful oil policy, as these funds also contain a $450m bonus received from the agreement signed last year on the extension of the development of the Azeri-Chirag-Guneshli field".

Economic incentives

In general, the existing economic situation suggests that the activity of entrepreneurship in Azerbaijan should grow. However, as Elman Rustamov admitted, banks are still reluctant to lend to business and prefer investing to securities. Some experts believe that this is due to devaluation expectations from banks. But Mr. Rustamov assures that such expectations are groundless even considering significant currency fluctuations in Azerbaijan’s trading partners, Russia and Turkey. "Oil prices remain stable and in comparison with the past period even increased by 25%. Any rumours about the devaluation of Manat have no serious arguments. We monitor the situation in neighbouring countries. Changes in their exchange rates psychologically can create volatility at the level of 0.2 or 0.3%. However, these are not serious fluctuations – Manat’s official exchange rate is stable," said E. Rustamov.

In theory, this should encourage financial institutions for more extensive credit injections into the economy. However, Azerbaijani entrepreneurs can obtain loans at interest rates even lower than the CBA interest rate. National Fund for Entrepreneurship Support (NFES) has been working on this for the past year and provides its agent banks with loans at 7% annual rate. Thus, the total amount of NFES lending is growing gradually and by 2018, it reached at least ₼170m and can increase to ₼200m in the future. The main thing is that these funds are provided at the expense of loans granted in due time and repaid. "This demonstrates the success of our policy, as loans issued in the past (more than ₼2m) are returning today and are serving new loans," said President Ilham Aliyev.

On the other hand, this is a clear example of the demand for low-interest loans, which should be an additional incentive for joining to such programs and loan portfolios of banks. After all, NFES has provided ₼50m-worth preferential loans to businessmen since the beginning of 2018.

In addition to NFES loans, another mechanism for promoting business activity in Azerbaijan is a mechanism to encourage investments. 28 documents that encourage investments were issued only in the first quarter of this year. 229 entrepreneurs have used this opportunity until now. The volume of investments to be invested and already invested in these projects reach ₼2.3b. "It is important that these large funds are being invested. According to preliminary estimates, 17 thousand new permanent jobs will be created under this program. These investments will be used to produce competitive products. State authorities closely monitor all these issues. I am sure that a significant part of these products will be exported," said President Ilham Aliyev.

All these factors, as well as the elimination of negative aspects in the relationship of businesses with government agencies, in particular the Ministry of Taxes, State Customs Committee, etc. should result in a significant revival of business environment. Furthermore, CBA also promises to continue reducing the interest rate and will do so on June 14, 2018. "In the first quarter, we could increase Manat’s monetary base by 11%. We believe that given the existing liquidity in the banking sector, this growth is optimal. If such conditions remain, the interest rate may be further reduced," said E. Rustamov. He also believes that the average annual inflation rate in 2018 will not exceed 6-8%.

"We must attract the most progressive practices in Azerbaijan, test and apply them," said President Aliyev in his recent speech summarizing the processes aimed at the business development in Azerbaijan.

Apparently, all state authorities have already joined this process and we can expect new real and statistical progress by the end of this year.