CURRENCY: DOUBLE-EDGED SWORD

Oscillations on the world currency markets are almost as strong as the situation with the spread of the COVID-19 virus itself. This was more or less expected given a global drop in demand, production shutdowns, energy crises, etc. during the pandemic. But sometimes the events seem to go beyond all forecasts, which increasingly weakens hopes for the return to the pre-pandemic course of the economy.

Although the exchange rate of the Azerbaijani national currency, manat, seems quite stable in all this turmoil, the turbulence on the foreign exchange markets and near the borders of Azerbaijan is alarming. Amid the fierce confrontation between the Russian rouble and the American dollar, as well as a record collapse of the Turkish lira, on October 29 the Central Bank of Azerbaijan increased the benchmark interest rate again.

Abnormal growth of rouble

Russian experts admit that the first year of the pandemic was one of the worst for the rouble. In January 2020-March 2021, the Russian currency fell 26% against the dollar. According to Refinitiv, the fall in the exchange rate of rouble in 2020 (by 16.5%) was the fourth deepest after the 1998 crisis. It was worse only in 1998 (71.3%), 1999 (23.7%), as well as under the initial period of sanctions in 2018 (17.1%). Forecasts for the end of this year were also pessimistic, when suddenly... the rouble began to strengthen; regardless of the growth of the US dollar’s exchange rate in the rest of the world after the Federal Reserve System (FRS) promised to tighten its monetary policy. According to analysts, the rouble ignores global trends due to record prices for raw materials and the interest of international investors in high rouble rates.

Moreover, President Vladimir Putin has recently been rather pessimistic about the US dollar. He said that "it was losing its position as the world's reserve currency, while the volume of settlements, and personal reserves of the world's countries in dollars is also shrinking. The US national debt is growing. The Congress decided to increase the ceiling of the national debt. What does it mean? It means more emission. What is emission? This means the rise in inflation rate. And it is perhaps the first time in history that the inflation in the US is growing at such a remarkable rate. These are economic reasons, which lower the confidence in the US currency one way or another," Mr. Putin said.

But as we mentioned above, the position of the US dollar, on the contrary, began to strengthen in many other countries, threatening their economies with serious problems. The truly dramatic was the drop of the Turkish lira against the US dollar. It was more about the fall of lira rather than the strengthening of the US dollar, since the factors that provoked the situation are more related to the processes within Turkey.

Lira began to fall in price sharply in mid-October amid the news of leaving of three high-ranking Central Bank officials, including two deputy heads. All of them voted against the rate cut at the meeting of the Council on Monetary Policy held in September.

Dramatic fall of Turkish lira

On October 21, the Turkish Central Bank reduced the benchmark interest rate from 18% to 16%. After that, the lira began to fall in price again, reaching a record high of ₺9.64/$1 on October 25. Since the beginning of 2021, lira lost 26.3% in price.

It is believed that the depreciation of the Turkish national currency has a positive effect on the growth of exports from the country, which means an inflow of foreign exchange earnings. According to this concept, thanks to the created surplus in the foreign exchange market, the Turkish Central Bank will be able to further strengthen the lira.

However, as the Azerbaijani economist Elshan Baghirzade points out, we should also take into account the dependence of the local production on imported raw materials, which is quite high in Turkey. “This minimises the impact of the cheap lira on production growth and provokes inflation. The recent serious rise in prices on the domestic market confirms this once again,” Baghirzade noted.

In September, Turkish Central Bank has already lowered the interest rate by 1%, but the annual inflation in the country in September reached a record 20%. At the same time, the bank stated that it was not going to change its plans to achieve a 5% inflation rate in the medium term. “Despite the growing number of vaccinated people, new strains of the virus threaten humanity, which creates new risks for the global economy. Higher prices for raw materials, continued restrictions on production in a number of sectors and the increase of financial burdens on the transport sector increase production and consumer prices,” the statement says.

Key partners

Statistical data on trade operations is enough to clearly demonstrate how much the events ongoing in the neighbouring countries affect the Azerbaijani economy. According to the Centre for Analysis of Economic Reforms and Communications, 32.6% of Azerbaijan’s exports of non-oil products during the nine months of 2021 was a share of Russia, 25.3% - of Turkey; both countries top the list of main importers of Azerbaijani products. A similar situation can be observed in the opposite direction: Azerbaijan imports almost 17% and 16% of goods from Russia and Turkey, respectively.

Can inflation and currency processes in these countries go unnoticed for the Azerbaijani market? Of course not. The price of some Russian goods, mainly food products, have already increased. As to imports from Turkey, the drop in lira’s rate against manat did not cause a significant drop-down in the price of Turkish goods because the inflation in Turkey increased prices for local goods, hence neutralising the impact of lira’s collapse.

“On the other hand, since Azerbaijan and Turkey trade their goods mainly in the US dollars, we do not feel real changes. If we traded in national currencies, the difference would be more serious,” E. Baghirzade said.

In addition, the competitiveness of products exported from Azerbaijan is weakening in the Turkish market. That is, the cost of products manufactured in Azerbaijan, in dollar terms, is more expensive than the products locally manufacture in Turkey. Thus, Azerbaijani products are offered at a higher price, which limits them competitiveness. Therefore, Azerbaijan and Turkey have recently signed an agreement on preferential trade terms to solve exactly this problem. The goal is to create opportunities for conducting export-import operations on a number of goods on favourable terms, and expand the trade turnover between our countries. But it is still difficult to say how much this will help in the current situation.

Classical approach

At a press conference on October 29, Elman Rustamov, Chairman of the Central Bank of Azerbaijan (CBA), said that the average annual inflation in Azerbaijan was expected at 6.2-6.5% despite the forecasts of 5.4-5.8%. In annual terms, this indicator is expected at the level of 9.5-10.5%.

Mr. Rustamov also said that it were the external factors that influenced inflation in Azerbaijan the most. “What we have is imported inflation, which mainly affects food, and, unfortunately, has been more than 30% for the second year, according to the UN Food and Agriculture Organisation (FAO). This is mainly due to the pandemic, collapse of the global supply chain, rising cost of raw materials and logistic services. Therefore, the global food supply has seriously decreased," Mr. Rustamov said. In addition, there are internal factors that accelerate inflation, including the growth of utility tariffs and fuel prices. On the other hand, the economy is recovering from the pandemic crisis, including the ongoing reconstruction works on the liberated lands of Garabagh and East Zangezur. Therefore, the volume of liquidity in the market is increasing. All these factors eventually increase the consumer prices.

But unlike the Turkish Central Bank, CBA fights inflation using the classical method of increasing the benchmark interest rate. So, in the last days of October, it was increased by another 50 points reaching 7%; the lower limit of the interest rate remained at 6%, while the upper one increased from 7% to 8%.

CBA: no devaluation

As to the influence of fluctuations in the currency exchange rates in neighbouring states on the Azerbaijani manat, Mr. Rustamov was more categorical: it will not happen! “There may be some influence through the trade balance, but no direct impact, as our financial markets are not interconnected,” Mr. Rustamov said.

He denied all suggestions of a possible devaluation, calling such statements ‘incompetent’. Main arguments of CBA are a significant surplus in the balance of payments and good forecasts for oil prices. “On the contrary, there are significant factors that may strengthen the exchange rate of manat. This does not comply with our economic strategy. That’s why by the end of this year we expect this pressure on the exchange rate to decrease and manat to strengthen,” Mr. Rustamov noted.

At the same time, he re-assured that CBA did not artificially curb the fluctuations of the exchange rate: “The exchange rate is regulated by the market. As for transfers from the State Oil Fund, CBA plays only the role of an agent in this process, when we need to cover some government expenditures. This and the occasional necessity to reduce pressure on the manat are the only reasons when we buy currency.”

As we saw in the past, the devaluation crisis in Azerbaijan is in fact directly related to oil prices, rather, to their sharp drop. So, there is no reason not to believe Mr. Rustamov’s statement. At the same time, strategic currency reserves are another important guarantor of the stable exchange rate of manat. And it is nice to see them grow, by the way. So, during nine months of 2021, Azerbaijan has increased its currency reserves to $52.5 billion (by 3.4%), while the CBA reserves increased to $7 billion (by 10.4%).

Either way, we can see that manat is capable of withstanding the external influence. It is important that consumer prices do not go down and stay at least within the latest forecasts this year, while CBA promises a slowdown in the inflation rate (to 5.6%) next year. Let’s hope and wait...