MANAT STABLE FOR NOW

One of the pillars of economic stability in any country is the status of its national currency. In many countries, the market responds to various changes or crises by depreciating or strengthening its exchange rate. In Azerbaijan, the Manat's exchange rate has been stable for almost six years after a rather painful devaluation in 2015-2016. Since March 7, 2018, the Central Bank of Azerbaijan (CBA) has maintained the exchange rate of Manat at ₼1.7 per 1 US Dollar.

Azerbaijani government wanted to ensure a free floating regime for the Manat, but the pandemic postponed these plans for quite a while. Is this really the price of the Manat or does the Central Bank still have to support it? It definitely has to even through its own reserves, especially when the external pressure on Azerbaijan increases. But today, market regulators note, the positive effects of such tight control over the Manat outweigh the negative side effects.

Weaknesses of a strong Manat

In early November, CBA reduced the discount rate from 9 to 8.5%. It explained the decision by external and internal factors affecting inflation, as well as a significant excess of supply and demand in the foreign exchange market. CBA also stated that the annual inflation rate fell to 5.1 per cent in September 2023, which is still within the target range (4±2 per cent). Its annual rate is more than 3 times lower than the rate recorded in September last year (15.6%). Baseline inflation rate also fell to 5.2% in September. The key achievement is the reduction of inflationary import mainly because of strengthening the nominal effective exchange rate of the national currency by 21.6% and simultaneously maintaining balance in the local foreign exchange market.

Thus, amid foreign trade surplus, at 99% of currency auctions held by CBA from the beginning of the year till September, the supply exceeded demand. Therefore, the total volume of the currency purchased during CBA's interventions in the currency market over 10 months reached $1.3 billion. 95% of this amount was purchased in September-October. What does this mean? The growing pressure on the Manat in the first place. Thus, CBA has to buy currency to maintain a stable exchange rate. But in the end, as CBA Chairman Taleh Kazimov has repeatedly noted, the monetary base is growing, leading to higher consumer prices. However, as Kazimov assured, the fears of growth do not concern this year. By the end of 2023, as promised by the CBA and the government earlier, it will drop to a single-digit number. "The goal of monetary easing is to level the impact of excess demand over supply in the foreign exchange market. According to our plan, the monetary base will increase by about 20% by the end of this year. This also creates sufficient risks in terms of macroeconomic stability in the future. Therefore, we reduce our discount rate to prevent negative consequences in the future," Kazimov said.

The discount rate has only recently started to influence monetary processes in Azerbaijan. As Kazimov stated, for almost a year since the introduction of the new operational framework for determining the discount rate, there are significant positive developments. In particular, the interbank foreign exchange market has been formed, the volume of repo transactions has doubled, even a market of corporate repo transactions has been created. Most importantly, the market began to react to CBA's decisions on the discount rate, while previously it was only a certain indicator for investors. But it is too early to ascertain its determinant role in currency trading, partly due to the Manat being under strict control of the CBA.

Anti-records in neighbouring countries

The exchange rate of the Turkish lira is breaking new records, which is affecting Azerbaijani economy as well, as Türkiye is one of Azerbaijan's key trading partners. According to the Financial Times, it was the new forecast of the Central Bank of Türkiye, which caused the recent fall in lira's exchange rate. Thus, the forecast predicts the rise of the annual inflation rate in 2026 to 6.5%. According to experts, the devaluation of the lira will continue for some time. Today, 1 Turkish lira is already cheaper than 6 Azerbaijani cents. While the local shoppers welcome such a decline, it is a serious problem for exporters from Azerbaijan to Türkiye. "Azerbaijan implements a policy of fixed exchange rate. This means Azerbaijani exports to Türkiye have less chance to compete with Turkish products," economist Rashad Hasanov said.

Things are different, but also unfavourable for Azerbaijan's other trading partner, Russia. Political problems, which eventually led to a decline in exports and excessive growth of domestic demand, have also seriously weakened the exchange rate of the Russian Rouble. In a macroeconomic survey conducted by the Bank of Russia, the largest Russian banks and investment companies worsened their forecasts for the rouble exchange rate both for the end of 2023 and for the next three years. Russian rouble and Turkish lira lost 27% and 52% this year.

However, the expectations of international analysts are not so pessimistic. Experts polled by Reuters believe that emerging market currencies will start to show a noticeable growth next year against the falling US dollar, despite the view that the interest rate cycle has reached its peak.

At least for another three years

Is strong Manat the optimal choice for Azerbaijani economy today? Yes, primarily because it is one of the most important instruments for regulating inflationary processes in the country, which affect the welfare of every citizen. "By strengthening the nominal effective exchange rate, we can reduce inflation. According to our forecasts, by the end of this year, the share of imported inflation will be 7.2% of the total rate. By strengthening the nominal exchange rate, we are reducing it by 5.3%. Therefore, with the consumer price index, etc. in mind, the annual inflation, is projected at 4.3% by the end of 2023," Kazimov said.

We already noted above that the pressure on the monetary base is quite significant. Moreover, the existing limit of $20,000 on foreign currency sales by commercial banks prevents the population from buying it. In other words, it is the CBA that undertakes most of the burden. Kazimov said that for the first time since 2015 the positive balance of cash purchase-sale of foreign currency by commercial banks reached $100m. "It is wrong to say that people cannot buy dollars because of the limit, the figures do not confirm it. Today every citizen of Azerbaijan has the right to buy foreign currency above the limit of $20,000, indicating the source of origin of this money," Kazimov said. He believes that the weakening of interest in foreign currencies is related to the growing confidence in the Manat, increase in the popular income in the national currency and predominance of supply over demand. To confirm this, for 9 months of 2023, the deposits of Azerbaijani population in the national currency grew by 15.6% (64.9% of all deposits) amid decreasing deposits in foreign currency (by 3.3%).

The currency market is also strongly influenced by the current account surplus on the back of higher energy prices and growth of non-oil exports.

As a result, CBA's foreign exchange reserves increased by 16.8% (to $10.5b) in 10 months, while the assets of the State Oil Fund increased by 12.3% (to $55.1b).

Will the policy of maintaining the exchange rate of the manat be continued? According to Kazimov, one of the alarming factors today is the CBA's purchase-oriented intervention in the currency market: "With such intervention, the money supply may increase and sterilisation operations will need to be expanded to prevent inflation growth in the future. This in turn will increase costs."

He noted that reforms are planned next year to improve monetary policy and liquidity management system, develop the interbank money market, and strengthen the impact of short-term interest rates on medium- and long-term interest rates.

In macroeconomic forecasts of the Ministry of Economy, the exchange rate of the Manat against the US dollar for 2024-2027 is set at 1.7 manat. This is in line with what the experts of Fitch Solutions believe: Manat will remain stable until 2027, and in 2028 will fall to 1.80 and remain at this level until 2033. Earlier, ING Corp. reported that the Manat exchange rate will remain stable until 2026.

Such forecasts create a comfortable environment for internal and external investors. Therefore, we believe, they should have a positive impact on the growth of capital investments in the economy in the coming years.