MANAT'S DOING WELL

The exchange rate of Azerbaijani Manat to the US Dollar has been stable for the third year. Even sharp fluctuations in the currencies of neighbouring countries, and periodic panic in the oil market throughout 2018 could not push it out of the $1/±₼1.7 corridor. Viewing such persistence as harmful, some local experts and economists occasionally suggest the Central Bank (CBA) to ensure low volatility for the sake of exports.

Chairman of CBA, Elman Rustamov, believes that manat will remain stable provided that the macroeconomic situation in Azerbaijan is favourable. In general, Mr. Rustamov recommends both the population and experts shifting the focus of discussions to global factors affecting economic processes than the exchange rate. 

Increased public sensitivity to fluctuations of the national currency is quite understandable. To make things worse, the recent forecast of S&P Global Ratings has suggested that the exchange rate of manat to USD would fall to 2-to-1 ratio in the next three years, triggering a new wave of rumours and comments. Fortunately, a few days later, Fitch has reported that the manat would remain stable in the coming years.

Shortly after, CBA denied the likelihood of devaluation, at least in the short term: "Today there are no indicators of exchange rate fluctuations. Any rumours about the devaluation of the manat are not serious," Elman Rustamov stated.

According to Mr. Rustamov, the macroeconomic situation in Azerbaijan is stable, the balance of payments has a surplus. Thus, in general, the year of 2019 will not differ from 2018.

"When we are asked about the possibility of devaluation, we always refer to fundamental reasons. With an increase in foreign exchange reserves, a 15% surplus in the balance of payments in 2018, a 10% surplus forecast for this year, and promising oil price forecast exchange rate fluctuations are not expected," E. Rustamov said.

It is true that CBA has introduced a partial free-floating exchange rate, but it is important to realise that the bank has a whole set of tools to keep the situation under control until a certain moment. For example, maintaining the currency balance in the market. In this case, CBA makes sure that the money supply in manats and dollars is maintained at a level that is not dangerous for the exchange rate of the national currency. In 2018, CBA initially planned to inject about $6.5 billion to the foreign exchange market, but in reality a little more than $100 million was not sold at foreign exchange auctions. This money remained in the state budget and was used to pay external debts and for other tasks. In general, the foreign exchange market remained balanced and stable, hence ensuring the stability of the manat. "It was not an easy task for us. In April and August 2018, we observed strong volatility in the exchange rates of the neighbouring countries and major trading partners, which had a certain impact on Azerbaijan. But we managed to restore the balance and prevent strong fluctuations in the exchange rate," Mr. Rustamov said.

Previously, CBA used to use its reserves for these purposes, but last year the whole process included only foreign exchange auctions conducted by the State Oil Fund of Azerbaijan. Therefore, although Azerbaijan’s foreign exchange reserves increased by approximately $300 million in 2018, this was not connected with the purchase of currency by CBA.

Moreover, CBA is not intended to increase reserves, as it means an additional injection of manat to the market, which may increase inflation risks. "The volume of foreign exchange reserves of the Central Bank should be sufficient to cover the country's imports for several months. Presently, this volume fully meets the requirements," E. Rustamov added.

Another tool to ensure the stability of the manat is a new budget rule applied in Azerbaijan from this year. According to the rule, the volume of transfers of SOFAZ funds to the state budget will not depend on oil prices. "This significantly limits the volatility in the currency market. We insist that stability will be ensured in the future," Mr. Rustamov said.

In general, Mr. Rustamov recommends focusing more on inflationary expectations than devaluation ones. "Apparently, our population is more interested in the stability of the exchange rate, considering it the cause of inflationary fluctuations. But in world practice, inflationary expectations usually prevail over all other macroeconomic forecasts by degree of demand," E. Rustamov noted.

In fact, this index forms the degree of confidence of the business community in the national economy and the competitiveness of national currency. In 2018, the average annual inflation rate in Azerbaijan set a good record becoming lower than the initial forecast of the CBA—2.3% against the expected 6-8%. "It is believed that inflation is the most ruthless tax. After all, it affects the level of welfare in any country. Therefore, such a significant decrease in inflation rate compared to 2017 (almost 13%, R+) is the most significant indicator of the ongoing processes in the national economy," Mr. Rustamov said.

In general, CBA has focused its monetary policy on maintaining the inflation rate stable, using the available tools to maintain the target indicator. In 2019, CBA forecasts the inflation rate at 3.8%, which is 0.2 points lower than the government forecast. However, the bank is mindful of the possibility of fluctuations within ±2%.

Thanks to the low inflation rate, CBA decided to reduce the discount rate to 9.25% in 2019. "Inflation risks have somewhat decreased, which allows us to continue the normalisation of our monetary policy. Given the number of internal and external inflation factors and risks, we prefer to preserve the anti-inflationary nature of the monetary policy," Elman Rustamov said. CBA has so far reduced the discount rate four times during the last year: from 15% to 9.75%.

This factor is more of a macroeconomic nature, which does not directly affect banking activity in Azerbaijan, but Rustamov promises that the situation will change in the future, taking into account the reform package aimed at enhancing business development in the country. "Reforms in the tax, customs and other areas have a significant effect on reducing the level of the shadow economy, which has a positive effect on the overall macroeconomic situation," E. Rustamov said.

At the same time, regardless of all positive changes in macroeconomic situation, one may ask why then CBA does not introduce full free-floating rate for the manat? According to Rustamov, although maintaining low inflation rate is the main priority to ensure stability in the national economy, the economy always needs an alternative anchor to maintain economic balance. This alternative tool is the exchange rate of manat, although, in principle, it is the value of money or the purchasing power of the currency that are usually used for this purpose. "Currently we are only creating such fiscal conditions. One of the main goals is to limit the cash supply in circulation. To make the economy responsive, it is necessary that the money be in banks, otherwise managing the situation is much more difficult. We have a program recommended by the International Monetary Fund. It is quite realistic, but requires precise coordination between the financial institutions of the country, which will be ensured by the Council for Financial Sustainability," Rustamov said, adding that this process is not short-term and difficult.

Regarding the feasibility of ensuring, say, conscious volatility of manat within 3-5 qapiks for regulating panic devaluation sentiments in the society, on the one hand, and stimulating the exports, as many local experts insist, CBA has a completely different view on this issue. Mr. Rustamov invited the experts to study the research of the head of the IMF, Christine Lagarde, which quite convincingly proved that there is no relationship between the trade balance of any country and its currency. However, the ongoing global processes most clearly illustrate this conclusion — why do countries, which can influence exchange rate processes in many other countries choose not this mechanism, but trade wars? Because, contrary to theory in reality, the competitiveness of exports does not depend on the exchange rate.

In other words, given the existing conditions in the national economy, CBA is set to maintain the rate of manat and inflation at stable levels. After all, stability is the most important factor for the development of business and trade opportunities of any country including Azerbaijan.