Azerbaijan allows national currency to float freely

On Monday the Central Bank of Azerbaijan stopped binding the national currency, the manat, to the dollar-euro basket, instead introducing a floating exchange rate mechanism. At the same time, the Central Bank reduced the official exchange rate of the manat to the US dollar. As of December 21st it was 1.55 manats/$1 compared to 1.0499 manats/$1 on December 18th. Thus, the rate dropped to 47.6%. Taking into account the devaluation carried out in February this year, the official exchange rate of the Azerbaijani currency from the beginning of the year halved compared to the dollar. The Central Bank notes that now the exchange rate will be determined "on the basis of supply and demand."

CAUSES OF DEVALUATION

The Central Bank explained its decision to abandon the binding of the manat and reducing the official rate "by increasing of negative external influence", as well as the necessity of maintaining the balance of payments, foreign exchange reserves and preserving the competitiveness of the national economy.

An adjustment of the manat was expected. In September the Asian Development Bank (ADB) noted that the preservation of low oil prices on world markets and a reduction of foreign exchange reserves might provoke a new devaluation in Azerbaijan.

"Oil prices, the key to the stability of the local currency, have fallen sharply over the last year. The decline in foreign exchange reserves and oil prices put additional pressure on the manat. This can provoke a new devaluation if the past trends continue in the coming months,'' ADB noted in the September review.

According to statistics, foreign exchange reserves of the Central Bank of decreased by 2.2 times up to $ 6.2 billion Azerbaijan in January-November 2015. The GDP for the 11 months increased by 3.1% (in January-November 2014 by 2.2 %), in industrial production by 3% (in January-November 2014 decreased by 1.5%), in agricultural production by 6.7% (decreased by 2.9%).

Azerbaijan's trade surplus in January-October declined by 5.1 times in comparison with the same period in 2014. In January-November 2015 the reduction was 5.2 times.

Azerbaijan's oil production, including gas condensate in January-November 2015 amounted to 38.3 million tonnes (decreased by 0.5%), gas production was 27.1 billion cubic meters (decreased by 0.2%).

The International Monetary Fund (IMF) forecasts a drop in the oil sector by 0.9% in 2015 and expects zero growth in 2016.

According to the World Bank (WB), the decline of oil production will continue in Azerbaijan in 2015-2017. "The fall of oil revenues will limit capital expenditure of the state in the medium-term perspective," the World Bank's report informed.

The Azerbaijani government expects that the country's GDP will grow by 3.3% in 2015. In 2014 the economic growth was 2.8%. The IMF expects that the GDP growth is be to 4% in 2015. According to the World Bank, it will be about 2.4%.

The European Bank for Reconstruction and Development predicts a surplus of Azerbaijan's payment balance at the end of 2015 at the level of 3% of GDP compared to 14.1% of GDP in 2014.

FIRE SAFETY MEASURES

"Such a devaluation will certainly lead to an increase in inflation, as well as a deterioration of some macroeconomic indicators. In such circumstances the Government needs urgent short-term measures in order to neutralize the negative shock from the devaluation," Interfax-Azerbaijan cites a source close to the government.

According to him, the lead role in these matters should be played by the Ministry of Economy and Industry. "Devaluation is not a tragedy, many countries have passed, or are passing through it now. Moreover, it was an anticipated, although belated decision. But the Ministry of Economy and Industry, the Ministry of Finance and the Central Bank of Azerbaijan should take joint steps to improve the situation,'' he said.

According to the source, above all, the government should take measures to encourage the development of entrepreneurship. "We need to actively pursue a policy of import substitution, especially in the food industry. It will help to prevent a sharp rise in inflation," the source reports.

In addition, the country needs to create a Development Bank. "We have different funds, such as the National Entrepreneurship Support Fund, the State Fund for Development of Information and Communication Technologies, the State Agency for Agricultural Lending. We need to unite all of these agencies into a single structure – the Bank development. In addition, there is a need to establish a Coordinating Council for Enterprise Development under the President," the source underlined.

According to him, the devaluation of the manat will require adjustments and macroeconomic indicators of Azerbaijan for 2016. "Certainly, an adjustment of macroeconomic indicators is needed in such circumstances. On the other hand, a revision of parameters of the state budget for 2016 is not necessary, as the devaluation of the manat will provide additional revenues to the state budget," the source noted.

IMPACT ON BANKS

"I think the new devaluation of the manat will have a severe impact on the banking sector of Azerbaijan. After the first devaluation, many banks were forced to resort to the financial assistance of the Central Bank. In addition, the Central Bank gave banks additional time to improve the indicators of the open currency position on the solution to the problems of capital. Now these banks' problems will only worsen," a source in the banking sector said in an interview for Interfax-Azerbaijan.

According to the source, banks will face growth of non-performing loans, especially loans in foreign currency. "It is difficult to evaluate all the negative effects of devaluation now, but we can say that the impact on the banks will be very strong," he added.

International rating agency Moody`s previously predicted that by the end of the year the share of problem loans in total loan portfolio of Azerbaijani banks would increase at least from 11.4% to 15% in 2014.

According to ADB estimates, increased dollarization [increase in the share of foreign currency loans and deposits – IF] is the major problem for the banking sector of Azerbaijan. "After the devaluation of the manat [February – IF] the volume of deposits in US dollars almost doubled,'' the bank noted earlier.

The IMF believes that the high level of dollarization, as well as the deterioration of banks' capital indicators, the economic slowdown and the February devaluation are the causes of the vulnerability of the financial sector of the country.

WHAT'S NEXT?

The devaluation of the manat will lead to an acceleration of inflation, a leading economist of the ADB Baku Office Nail Valiyev believes.

"Certainly, the sharp devaluation has a major impact on the country's macroeconomic indicators, primarily on the level of inflation. The same situation was observed in Kazakhstan, Kyrgyzstan and other countries that passed through devaluation," he said in a interview for Interfax-Azerbaijan.

However, according to him, the government and the Central Bank of Azerbaijan have monetary tools to maintain inflation below 10%.

"After the February devaluation the structure of bank deposits has changed. Today the majority keep their money in dollars. Loans in manats were also reduced. Accordingly, the manat monetary base has decreased in the country. In addition, the state budget for 2016 involves reducing costs, primarily for infrastructure projects. It will affect the income of those who might be involved in these projects. All of this eventually leads to a decrease in consumer spending.These factors will exert downward pressure on inflation,'' Veliev believes.

He noted that the continuing decline in oil revenues, new devaluation and the reduction of costs for investment projects in the budget for 2016 are likely to lead to a slowdown of economic growth in the country in 2016 of 1-2%.

According Veliev, the decision to move to a floating exchange rate of the manat was 'ripe'.

According to Azerbaijani MP, member of the Parliamentary Committee on Economic Policy, Enterprise and Industry Vahid Ahmedov, the devaluation of the manat may continue,

"The manat has not yet found its low yet," he said in an interview to Interfax-Azerbaijan.

Commenting on the possible impact of the devaluation on the budget adjustment, the deputy noted that the revision of the budget figures will depend on oil prices. "We hypothesised the price of oil at $50 a barrel in the budget for 2015. If the price remains at a level significantly below this estimate, then adjustment is possible. Now oil is $36 a barrel. However, I expect that the oil price will rise to $50 a barrel at the beginning of next year,'' the deputy said.