SEPARATING THE RISKS

The main task of the current stage of economic reforms in Azerbaijan is to find new forms and mechanisms for financing small and medium-sized enterprises (SMEs). The trends of the post-oil reforms show that relatively expensive bank loans are often not suitable for business development, especially in the agrarian sector and industry. The loans from foreign donors cannot always meet these goals. Moreover, due to a painful experience after the recent devaluation, there is an extremely low demand for loans in foreign currency. Under these circumstances, the state funds and, above all, the National Fund for Entrepreneurship Support (NFES) were expected to play a key role in financing SMEs. However, taking into account the new tasks concerning the development of the non-oil sector, it was decided to abolish NFES by replacing it with a new entity, the Entrepreneurship Development Fund (EDF) established by a recent presidential decree.

Credit donors

The increase in oil prices and the establishment of favorable foreign trade conditions since the end of 2017 created prerequisites for gradual liberalisation of the hardline monetary policy conducted by the government of Azerbaijan. In 2018, the Central Bank (CBA) lowered the interest rate twice – from 15% to 13%, and subsequently to 11% to stimulate investment activities and to make the borrowed resources cheaper.

However, inertial processes in the banking sector, which is still dealing with the liquidation of problem loans trying to adhere to a conservative policy in the issuance of loans with relatively high interest rates (on average more than 20%) due to serious risks associated with them, prevent speeding up the process of loan disbursement as expected.

This is not surprising given the scale of the previous decline in bank lending. As noted in a recent Moody's report, the share of loans in the total assets of Azerbaijani banks fell from 74% (2014) to 41% (2017).

According to the CBA, in the first half of this year, the growth rate of lending in the country reached 2.95% thanks to trade and consumer lending with a relatively small share of loans granted to the industrial and agricultural sectors. In turn, the volume of overdue loans since the beginning of the year increased by 7.3%. In general, the share of overdue loans increased from 13.8% to 14.4% during the same period, which indicates that risks remain in the banking system.

Although Moody's changed the outlook for Azerbaijan's banking system from "negative" to "stable", the insignificant growth in the loan portfolio does not promise that local banks are now ready to meet the financial needs of the real economy.

Therefore, the state funds are the main donors that provide entrepreneurs with low-interest loans and long-term money.

NFES of the Ministry of Economy has played an instrumental role in the financing of SMEs in the last two decades. Over these years, the institution has distributed over ₼2 billion of soft loans to about 35,000 SMEs, which makes more than half of all concessional state financing. About 69% of soft loans were credited to farmers, processors of agricultural products, and also allocated to special projects for the development of agrarian infrastructure. The key activity of the NFES has recently been the financing of agro-parks, poultry and livestock farms. According to Shirzad Abdullayev, the Executive Director of NFES, it was planned to commission 15 agro-parks. It was also supposed to increase the crediting of tourism projects five times by providing concessional loans of ₼10 million in 2018.

"The state renders great support to the development of entrepreneurship. Thanks to NFES, entrepreneurs were granted concessional loans for ₼2.2 billion, which created 163 thousand new jobs in Azerbaijan. This year, it is also planned to provide ₼170 million of loans, and a significant part of them has already been issued in the first half of the year," President Ilham Aliyev said at a recent Cabinet meeting on the results of socioeconomic development in the first half 2018.

New Fund Equals New Challenges

However, despite the high efficiency of financing under the NFES, in recent years there has been a certain decline in the credit activity of the organization. Thus, in the relatively prosperous pre-crisis year of 2014, the fund allocated ₼295 million for the implementation of investment projects with a forecast of ₼280 million. In the following years this amount decreased reaching ₼146 million in 2017. The forecast for 2018 was approved at the level of ₼170 million.

The decline in the fund's activities during the recent years was explained by the general situation in the economy and, in particular, in lending sector. The slowdown in production and capital construction in the non-oil sector did not contribute to the growth of demand for borrowed funds. The closure of some banks and non-bank credit organisations, which were partners of the NFES, has also had a negative impact on the process of issuing concessional loans. This is an important moment given the fact that the fund uses the funds coming from the repayable loans to issue new loans.

Thus, according to Shirzad Abdullayev, 12 banks, which were authorized organizations of the NFES and were provided ₼200 million of the NFES funds, were closed Azerbaijan in recent years. About ₼40 million of preferential loans serviced by liquidated banks have already been returned to the Azerbaijan Deposit Insurance Fund (ADIF). Another ₼10 million were directly transferred to the treasury account of the NFES. "We have already applied to the ADIF and the Financial Market Supervision Chamber of Azerbaijan to permit the transfer of loans under these projects to other banks." All these projects are working with payments on loans returned to ADIF in a timely manner," said the Executive Director of the NFES.

On the other hand, in the peak of problems in the banking sector and considering the increased risks, authorised agent banks carried out a more rigorous selection of business plans and strengthened the requirements for borrowers' financial responsibility. Obviously, this imposed significant obligations on the entrepreneurs applying to the Fund to prepare a detailed business plan, calculate profitability, loan repayment terms, and also to demand experience and property guarantees in the event of force majeure.

Either way, this is an objective circumstance limiting the activities of the Fund only by issuing loans and preventing undue risks in its activities.

At the same time, considering the specifics of the local market, there is not a considerable number of traditional loan organizations in Azerbaijan that provide preferential loans in demand, rather investment structures with broad rights to carry out entrepreneurial activities and aimed at investing in industry, agriculture, etc.

Unlike banks and credit funds, such an institution should have greater risk tolerance, independently investing in certain production projects, as well as co-financing SMEs not through loans, but on the basis of equity participation. Moreover, such an investment structure should not only be limited to providing financial resources to entrepreneurs, but directly participate in the management of companies and through experience and advisory support to assist entrepreneurs in achieving success.

In fact, the Entrepreneurship Development Fund (EDF) is a public entity recently established in accordance with a presidential decree to improve the mechanism of state support for the development of entrepreneurship in Azerbaijan. That is the reason why the NFES was liquidated.

The general management and control over the work of the fund will be carried out on a voluntary basis through a Supervisory Board composed of nine people. Five members of the Supervisory Board are appointed by the Ministry of Economy, four more represent the ministries of finance, taxes, labour and social protection, as well as the Financial Markets Supervision Chamber. The board will manage the fund. The Minister of Economy will be responsible for the appointment and dismissal of the board members, who, in agreement with the President of Azerbaijan, determines the structure and staffing of the fund, the number of employees, their salaries, etc.

Low interest rates

As noted in the preamble of the decree, the objective of the new fund is to improve the mechanism for supporting the development of entrepreneurship, the establishment of new industrial, processing and infrastructure enterprises in the non-oil sector, based on innovative technologies, financing export operations, accelerating investment in the real sector and expanding access of individuals operating in the private sector to financial resources.

The fundamental difference between EDF and its predecessor is that the new institution can independently engage in entrepreneurial activities, which is stipulated in the organization's charter. At the same time, EDF's business activities can be carried out to achieve strictly specified tasks, which primarily include the creation or participation in business entities. Also, EDF will be able to develop sectoral and regional programs for the development of entrepreneurship, as well as to create new jobs. In addition to the main task, which is the provision of preferential lending to businesses, the Fund will assist Azerbaijani entrepreneurs in expanding their activities abroad, providing them with consulting services, in particular, studying market conditions, preparing investment projects for them, helping them to form market infrastructure, trainings, various events etc.

For comparison, the NFES had limited opportunities due to its charter and provided loans for specific projects only. Expansion of the EDF's functions is extremely important, as it will allow financing a number of promising industrial and agriculture programs not yet mastered by local businesses. Ultimately, co-financing and partnership with businesses will significantly reduce the level of risks for entrepreneurs, help to implement the most advanced and complex technologies, ensure the development of effective business strategies, the use of advanced know-how, and attract qualified consulting services. Thus, greater flexibility and availability of investment functions will allow EDF to involve businesses on the development of certain sectors and directions of the economy, increase profitability and expand production towards external markets.

It is also important that the crediting function of the new fund has also undergone significant changes: firstly, the terms of preferential financing have become cheaper. Thus, according to the Rules for the Use of EDF funds approved by the president, the annual interest rate on loans of the new fund will be only 1%, another 4% is the rate of the authorized credit institution. Prior to this, NFES loans were issued at an annual rate of up to 7%.

The minimum size of the EDF soft loans will be ₼5,000, and the maximum – ₼10 million. Small loans granted to SMEs - from 5 to 50 thousand Manats - will be provided for a period of up to three years, average loans - from 50,001 to 1 million Manats - for 5 years, large loans - over 1 and up to 10 million Manats - for a period of up to 10 years.

The decrease of the interest rate and the possibility of long-term borrowing, coupled with the prospect of the fund's participation in the capital of new enterprises, will help to overcome the inertia in the business environment and will increase the interest of SMEs in expanding activities and increasing production.

Looking at the volume of capitalization, the scale of the EDF activities will be very significant. The statutory fund of EDF is defined as over ₼1.094 billion and is a product of the property provided to it, as well as funds allocated from the state budget. To increase the capitalization of the new fund and increase the volume of its operating capital, the Cabinet of Ministers was instructed to draft a bill within a month to ensure the exemption of the Fund from tax liabilities on loans returned from agent banks (loans from the former NFES), and to solve all issues related to the security and technical base of the new fund.

Financing through the EDF will start in the coming months, and we hope that it will multiply all the achievements of its predecessor - the NFES and will be able to achieve real advancement in the development of entrepreneurship in Azerbaijan.