Azerbaijan’s Devaluation in Disguise

Feb 2015
Azerbaijan, February, 17 2015 - On Monday 16 February, the Central Bank of Azerbaijan stated that it had abandoned its currency peg between the Azerbaijan New Manat (AZN) and the US dollar (USD) and replaced it with a dual-currency basket weighted at 70% USD and 30% in Euro.

This was conducted under the pretext of reflecting the trade flows of Azerbaijan, but it is actually the devaluation in disguise.  A source quoted by Reuters at the Central Bank stated that it seeks parity between the Euro and the Manat by year’s end.   The currency peg to the dollar became untenable in December when it lost one billion USD defending its peg.  While many economists would have argued for this policy change much earlier, it is better late than never in the oft-ossified political apparatus in Baku. Nonetheless, the policy of inflation targeting at 5-7% as well as a more diversified basket of currencies to which the AZN will be pegged should have a useful impact on the competitiveness of the Azerbaijani economy outside of the natural resources sector.

The Central Bank of Azerbaijan governor Elman Rustamov stated in an interview with the Financial Times that “we consider that we should transit to a more flexible exchange rate regime and gradually we will transit to an inflation-targeting regime.” This policy prescription has been stated by other Central Bank officials before, such as in an interview with October 8, 2013 interview with deputy-governor Khagani Abdullayev conducted by your correspondent. Thus, it was the drop in oil prices that drove the near-term goals to being enacted immediately.

Though Azerbaijan is not as tied to the Russian economy, it still is facing difficulties driven by the drop in oil prices.  Government finances are based on a $90 a barrel price of oil while currently it is a fraction of that. Thus one of the moves is to tap the $37 billion oil fund – State Oil Fund of the Azerbaijani Republic (SOFAZ).  While some of the investment that will proceed is for prestige projects including that of the May 2015 European Games, much of it will be spent on infrastructure that should in the long-term boost the economic potential of Azerbaijan.

There is a great opportunity for Azerbaijan to re-balance its economy. Even before the drop of the currency peg, the oil sector grew by 3.1 percent while the non-oil sector grew by 5.5 percent in 2014. Governor Rustamov stated in the same Financial Times interview, “the is to diversify the economy and decrease resource dependency”.  The devaluation of the currency will allow for other products of Azerbaijan, notably its agriculture and foodstuffs to be more competitive.  Azerbaijan’s non-oil sector balance of trade will continue to benefit from this devaluation following a short-drop as the J Curve predicts in the balance of trade model.

The risks to this change in monetary policy include inflation driven by the weakening AZN as well as social disruption from groups dependent on fixed incomes of the elderly, state-employees, as well as the disabled. Moreover, the muted fillip to non-resource sector is dependent on increased cross-border trade, something that the European Bank for Reconstruction and Development has noted is lacking throughout the region. Thus, if trade-facilitation, border simplification, and de-concentration of certain industries is not promoted, Azerbaijan may simply trade inflation and unrest for the preservation of its foreign currency holdings.


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