THE BERMUDA TRIANGLE

The US trade wars based on political decisions and imposed on a number of large countries, including the nearest neighbours of Azerbaijan, are already making adjustments to the global economy. While the confrontation between the US and China is still a topic for careful observation and analysis for our government and economists, the sharp decline of the Turkish lira, as well as the opposition of Russia and Iran to the US sanctions, can hardly pass unnoticed for the Azerbaijani economy. The urgency to maintain partnership with our neighbours and to protect our own trading interests and the local currency demand for conducting a more consistent and careful economic policy.

Triple currency collapse

Since the summer of 2018, the main neighbours and trade partners of Azerbaijan, Russia, Turkey and Iran, have been targeted by the US economic sanctions. Washington’s unilateral withdrawal from the international agreement on Iran was followed by the resumption of trade and economic sanctions against Tehran. Since May, when President Trump made announcement on the withdrawal from the nuclear deal, the Iranian rial began to fall. The speed of fall suggests that Iran is in a desperate economic situation. Even though Europe and the Great Britain were categorically against the decision of their American ally and stated their commitment to the Joint Comprehensive Action Plan signed in 2015, the US is ready to launch the second package of sanctions effective from November 4 2018, if Iran refuses to negotiate with the US. According to experts, this package will be more painful for Iran due to restrictions on the import of Iranian oil.

Also in summer, just the day after the resumption of sanctions against Iran, the US announced the introduction of new measures of influence against Russia. This can be a ban preventing American banks from lending to any Russia-based company and stopping any US imports from Russia, the suspension of flights of the Russian airline Aeroflot to America and a number of other measures. Thus, in early August, the Russian ruble reached its two-year minimum against the dollar and euro. The shares of many Russian companies also fell in price.

But the Turkish lira suffered the largest currency collapse in August after the announcement of American sanctions and specifically the doubling of import duties on Turkish aluminium. The lira’s rate collapsed to historical minimums at Asian stock exchanges as well. Immediately after that, Moody’s and S&P GlobalRatings lowered the sovereign ratings of Turkey. Exactly a month later, the Turkish Central Bank, following the results of the board meeting on September 13, was forced to raise the interest rate for the third time in 2018. The rate of weekly repo transactions was increased by 6.25 points, from 17.75% to 24%.

The decision of the central bank had a positive effect on lira, and it began a slow recovery. But in general, the Turkish currency fell by almost 40% in 2018 due to a sharp increase of the national inflation rate. The growth of consumer prices in Turkey accelerated in August reaching 17.9% driving the inflation rate to the highest point since 2003.

Currency pressure

Naturally, Azerbaijan cannot remain as an outside observer in the current situation. The government has a number of measures to protect itself from the negative impacts on its neighbours.

Sberbank Investment Research’s report indicates that the weakening ruble and the recent sharp decline of the Turkish lira affected all currencies of the neighbouring states. In addition to the Russian ruble, which since the end of July has fallen by more than 6%, the currencies most vulnerable to volatility changes were the currencies of Kazakhstan, Belarus, and Georgia. "The Azerbaijani manat and the Tajik somoni were also under pressure, although their rates are still tied to the dollar," the report said. Analysts at Sberbank Investment Research believe that high oil prices support the Azerbaijani manat. According to Bloomberg, some Azerbaijani banks have restricted the sale of dollars to the population, although Sberbank Investment Research does not forecast a threat to the rate of manat as long as oil prices remain above $70 per barrel.

So, after more than a month from the last collapse of the neighbouring currencies, manat, despite external pressures, remains stable. According to the CEO of the Central Bank, Elman Rustamov,  the central bank closely monitors the situation in currency markets.

On the other hand, experts are concerned about the profitability of the currency basket of the SOFAZ's (State Oil Fund of Azerbaijan) investment portfolio, which in the first half of 2018 was $37.8 billion. 0.9% of this amount is stored in Turkish lira and Russian rubles (1% and 1.1% respectively as of the end of 2017). In August, SOFAZ made a statement that it was satisfied with its current investment strategy, which meets the expectations of real profitability for the medium and long terms. At the same time, taking into account recent geopolitical risks in Russia and Turkey, SOFAZ is conducting a serious analysis of the current state of its entire investment portfolio, market conditions and expectations. "If necessary, we make changes to our investment portfolio in an appropriate manner," reads the SOFAZ statement.

Advantages and disadvantages

Russia and Turkey are the main trading partners of Azerbaijan, especially with regard to imports. According to statistical data, following the results of the past seven months, 31% of Azerbaijan's imports come from Russia (16%) and Turkey (15%). According to economist Gubad Ibadoglu, "these figures will continue growing as long as the lower exchange rate of their currencies make purchases from them profitable. On the other hand, this means weakening of the positions of local manufacturers of non-oil products." Therefore, additional measures to support local manufactures during this period are necessary. The increase of customs duties on import of certain products, in particular potatoes, etc., is one of such measures.

According to economist Samir Aliyev, the negative impact is not so noticeable precisely because most of the Azerbaijani exports is composed of oil and oil products. "If the share of non-oil products in exports were 50%, then the processes in Russia and Turkey would have a greater impact on Azerbaijan leading to the collapse of the national currency. Devaluation of currencies in both of these countries will reduce money transfers to Azerbaijan from our citizens working there. Also, Azerbaijani tourists will be more solvent in Russia and Turkey," Aliyev said.

On the other hand, Azerbaijan is closely tied with Russia, Iran and especially Turkey thanks to a number of large regional projects. How to deal with them, will there be problems with their implementation? Experts believe that, as a rule, long-term projects of this scale are developed taking into account possible risks. Moreover, almost all regional projects on the transit of energy resources have already started. As for the transport corridors, in particular, North-South (India-Iran-Azerbaijan-Russia-Kazakhstan) and Baku-Tbilisi-Kars, there are no problems with their implementation, nor are they expected.

Also, Azerbaijan is heavily investing in neighbouring countries, in particular, a number of projects in Turkey are implemented through the state company SOCAR. For activities in Turkey, SOCAR established a subsidiary company, SOCAR-Turkey Yatirim AŞ (STYAŞ), whose investments at the end of 2017 are estimated at ₼12.2 billion. Basically, these investments cover the construction of the STAR refinery estimated at $6.3 billion.

What are the advantages and disadvantages of cheaper lira for these large scale projects? The published review by Moody's suggests that cheaper Turkish lira will extend the payback period of SOCAR's investments in the construction of the STAR refinery. "Over the past 5 years, the lira has fallen in price by 70%, since the beginning of 2018 - by 40%." The volatility of the exchange rate and the cheaper lira, which lost about half of its value over the past 12 months, will create problems for SOCAR with investment made in the US dollars," the agency reported.

In addition, cheaper lira may negatively affect the activity of another SOCAR asset in Turkey, Petkim petrochemical complex. "External liabilities of Petkim are estimated at $1.4 billion by the end of 2017. As a naphtha user, Petkim is prone to volatility in crude oil prices, which will increase the costs of raw materials possibly leading to decrease in the holding's profits," says the report.

Meanwhile, the opinion of Interfax Global Energy agency looks much more positive, the experts of which believe that the weakening of the Turkish lira can help SOCAR implement its plans to expand its business in Turkey. "SOCAR expects to increase its share in the Turkish gas market to 20%, while the decline of the lira creates the opportunity for the company to acquire assets at a lower price," the agency's experts note.

Either way, the Azerbaijani government announced that it will continue cooperation with all three neighbours and as a reliable partner will continue supporting them in joint business ventures. The crisis is a temporary phenomenon anyway, and economic relations with the nearest neighbours are built upon the foundation designed for many years to come.