Our Analytics 27 march — 13:01

How to save Azerbaijani economy (Our analysis, Article one)

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BY ELNUR MAMMADOV AND MAMMAD EFENDIYEV, ECONOMICS SECTION

Azeri Daily has repeatedly been noting the importance of the Strategic Roadmap for the Azerbaijani Economy approved by President Ilham Aliyev at the end of the last year. However, recently state officials and the media seem to have forgotten about this document: from the stormy campaign about its prospects for all spheres of the country's economy, which developed as if by someone's instruction, there was no trace left. And unjustly so, for it is in this conceptual document that the entire economic program of President Aliyev for the next five to ten years and a vision for the future are clearly reflected. And analysing it, you are convinced that there was no such a large-scale economic document in the history of the country. Moreover, we have not yet seen such a long-term development program in world practice.

What is Ilham Aliyev's program?

Yes, it would seem that only a year ago the head of state instructed the newly appointed assistant on economic reforms Natiq Amirov to develop a Strategic Roadmap for the country's economy within six months. And today we can say that this task has been accomplished at a very high level. It is felt that a lot of work was carried out by a group of specialists in a new reform team - the experience of leading countries was studied, the current situation and the reasons that led to it were analysed, and concrete ways of development of the country's economy were indicated.

Moreover, in separate provisions it is possible to see what mistakes were made in modelling the main directions of macroeconomic indicators. True, either because of bureaucratic solidarity these problems are noted in passing, or maybe the head of state has more serious approaches to this matter (up to the personnel), which will appear, we think, in the near future, but they are not named specifically with name of persons and departments guilty of these mistakes.

Natiq Amirov's map

The only mistake of the reformers, in our opinion, is that the voluminous document was developed in the cabinet quiet, without discussion with the general public. Moreover, such secrecy is observed today too. But the essence of it must necessarily be brought to the public, for which it is, properly speaking, developed. To do this, it was not necessary to spare the efforts, it was necessary to use all media resources, hold presentations for specialists. But this was not the case, not everyone will read hundreds of pages of boring economic text, even experts today find in this text only those provisions that directly interest them. Speaking of the available presentations with visual slides, graphics, tables is not worth at all. Yes, the document requires a serious approach, the people should realise its essence as soon as possible, and Azeri Daily decided to provide all possible assistance in this to the presidential team of reformers.

So, the main strategic goal of the president, as the analysis of the strategic map shows, is to transform the economy from low level to high, from low efficiency to high, from small volume to large, which involves high technological and innovative research. There are four main ways to achieve this goal.

First and foremost, we need to achieve macroeconomic stability by improving and linking monetary and fiscal policies (for the former, Azeri Daily has a slightly different view, which we will discuss below). It is also necessary to ensure the dynamics of economic efficiency by increasing the level of management of state enterprises and continuing their privatisation, and improving the quality of human capital to achieve the development of the labour market, which is necessary for the development prospects of the national economy.

And, of course, it is necessary to improve the existing business climate in the country. These four factors are the pillars, on which the main burden of development of the national economy lies. They also rely on the basic priorities for the development of eleven major spheres of the economy, for each of which a sectoral strategic map has been developed.

Notorious macroeconomic stability

And clearly, in order to achieve the goals set in the document, it is necessary first of all to overcome the shortcomings in the monetary policy, in order to improve the financial and banking system of the country, which is quite justified. The population too is more concerned with problems in this area than other issues today. And the basis of this sphere is the monetary and credit policy, which the Central Bank of Azerbaijan (CBA) has been conducting for more than two decades, and which the government adhered to in general. But such a policy in recent years in a difficult period of crisis needed revision.

Until now, the monetary policy of the Central Bank has been aimed at targeting (manipulating) the exchange rate of the national currency in order to achieve macroeconomic stability. But the events of the last crisis years forced the CBA to drastically change its policy. It completely refused to ensure the stability of the manat, its main goal today is to target inflation by adjusting the discount rate. The CBA as a whole voluntarily refused the function of the regulator of the currency and financial market. And the CBA, with a long delay copying the actions of the Bank of Russia, moved to a full (ultra-) liberal monetary policy. How much this approach is acceptable for the current state of the economy, let head of the CBA Elman Rustamov think about.

Central Bank of Azerbaijan lost time

But we want to note that the policy of his Russian colleague Elvira Nabiullina meets with hostility even in Moscow. Moreover, our chief banker outstripped her on such an important issue as the currency position of commercial banks, where he simply 'liquidated' this position immediately after the first devaluation of the manat, which could lead to an increase in the speculative factor in the local market. And now it remains only to wait whether Nabiullina will take such a step.

Shadow of Elvira Nabiullina

Rustamov, a week before the first devaluation, almost assured the public of the country that there would be no devaluation, which he, we think, really did not want, at least in the near future and on such a scale, but he could not keep his word. And if then many were surprised at this, later the people got used to such empty statements of the chief banker - it became a habit for him. True, it was clear that during the year the manat persistently went to its devaluation, caused by a number of objective and subjective factors - a decrease in the revenues of petrodollars, which in turn reduced the balance of foreign trade turnover of goods and services and the current account of the balance of payments, the growing rate of dollarisation of the economy and stable trend of reducing foreign exchange reserves.

According to the Law on the Central Bank, the head of the CBA could conduct monetary policy at his own discretion, regardless of the requirements of the executive bodies, but he apparently did not withstand the pressure from the more influential executive structures. Although it is generally accepted that concern for the stability of the national currency should always be one of the main functions of the chief banker.

But the first devaluation broke out. It would seem that the CBA had to take urgent measures to prevent further decline in the manat rate, for which there were opportunities that were concentrated precisely in the hands of the chief banker. But even after the devaluation, the CBA adopted a number of steps, in our opinion, inadequate to the current state of the economy, which led to further aggravation of the situation.

For example, it is still unclear why the CBA immediately after the devaluation simply 'liquidated' the currency position of commercial banks, which opened up wide speculative opportunities for players in the local currency market. Although he could have made another decision, to close currency positions, not to expand refinancing and raise the discount rate. To make it easier for the reader to understand these arguments, we will reveal the essence of all three factors.

Saving manat is the work of manat itself?

Closing currency positions, the CBA could have prevented the process of buying up the banks' currency and selling it after a certain time with the aim of speculative gain. Such a position would have allowed them to sell as much currency as they bought during the same day. The CBA could have switched to daily currency trading on the exchange, which could have prevented the artificial build-up of rush among the population and currency shortages. For legal entities, it would have been rational to set a certain limit for withdrawing funds available in bank accounts in manats in order to prevent their entry into the cash currency market, to raise the discount rate for commercial banks and to attract their deposits to the CBA. It was possible to gradually reduce also the volume of refinancing for commercial banks, especially since during this period, as can be seen today from statistics, the liquidity of the banking sector of the country was quite high - up to 1 billion manats. Besides, the main banker of the country, using his authority and as a 'banker of banks,' had to bring to the heads of commercial banks all the responsibility that was to be realised. In our opinion, the use of a combination of all these instruments could have then positively affected the complex situation that developed in the local market.

But the absence of the above actions and the almost twofold increase in this period of refinancing of banks (or some of them?) - from 3.2 billion manats to 6.2 billion manats - with a low discount rate led to a larger December devaluation, the consequences of which were more severe. And at that time the regulator somehow lowered the discount rate from 3.5 to 3.

The main banker's goal, as he himself repeatedly said, was to contain inflation, but why initiate it by reducing the discount rate. It turned out that with the efforts of the CBA the market was flooded with cheap manats. Wishing it or not, the CBA created the conditions for the banking community (possibly only to selected banks) for speculative activity in the future. And this future was not so far away. All this led to a paralysis of the banking sector, which had no other way, but to curtail its main activity aimed at lending to the economy. On the other hand, the hands of banks have been completely unleashed for the transition to simple currency speculation.

Due to the insolvency of the adopted steps, the CBA, after the second devaluation, completely refused to regulate the manat rate, letting it float freely. In fact, there is no central bank in the world that could afford it. Yes, in developed countries the exchange rate is free, but they also have a leverage on the exchange rate of the national currency, albeit not directly, through stock exchanges, which we do not have. And in this situation, we think, it was not entirely right for the CBA to abandon its main function, as it did not meet the state, in which the economy of the country found itself to be. And today it is not entirely clear how the goals set in the strategic map will be fulfilled with the floating rate.

Suppose that today's manat rate found its market value. What will the Central Bank do if, in the short and medium term, world oil prices rise to the level of optimal for both exporters and oil importers - to about $ 80 per barrel.

But if the flow of petrodollars rises again?

It is clear that the growing inflow of petrodollars will simply bring down the current rate, manat will become more expensive, which again leads to an imbalance in the economy. Let's consider another possible scenario: manat has reached the equilibrium rate and it is stable, for the development of the economy, money is needed. How will the economy's need for money be satisfied? Credit issuance should be carried out by banks. To raise the economy, cheap and long-term loans are needed, but the current situation in the banking sector will not allow this.

Banks do not have such resources - the volume of manat deposits has decreased so much that it takes a lot of time to restore it. The multiplicative effect of lending by our banks is very low, and for the expansion of the money supply, profound reforms in this sector will be required. Another scenario is also possible, when the population, having lost interest in the accumulated dollars, will start selling them. Of course, the rate of manat will start to grow, which will not help to lower prices in the market. It is clear that such scenarios can be observed both separately and in aggregate. But how will the CBA adhering to the floating rate behave in such scenarios is not clear.

It is well known that if you raise the discount rate after a sharp devaluation, then commercial banks will gradually transfer the economy into a mode of expensive money. The real sector falls into a serious condition, as enterprises will have to curtail production due to expensive credit resources that will form part of their working capital.

Most enterprises will either have to repay the loans they have already taken, since the next stage of lending will not be in their power, or they will raise prices for manufactured goods. Over time, the possibilities of both steps are exhausted, it becomes more difficult to raise prices, because the effect of appreciation of imports after devaluation also exhausts itself. And to expand production is impossible because of expensive loans, the economy enters a stagflation trap that combines a decline in production and inflation. This is the result of a policy of expensive money. For each economy there is an optimal level of monetarisation, if the economy deviates from this level, inflation is growing. But the monetary view takes into account only one part of this picture, when inflation is generated by an excess of money with the invariability of other economic factors, so they look at money as a regular commodity.

And this leads to the conclusion: if the goods become cheaper, that is, inflation rises, it is necessary to reduce the supply of this product. Like, then prices will go up, money will become more expensive, and inflation will decrease. But the essence of inflation is to reduce the purchasing power of money. With a decline in the production of goods, there are fewer, higher prices - this is also a fact. If the level of monetarisation falls below the optimal one, then this, in turn, will lead to an increase in prices. In other words, in a non-monetarised economy, to which Azerbaijan belongs, the amount of money is always less than it is necessary for simple reproduction. In such a situation, the reduction in the amount of money is automatically accompanied by a fall in investment, and, consequently, production.

When the economy is re-monetarised, when all capacities and resources are loaded, the amount of money simply goes off scale, and then, indeed, an increase in the money issue leads to an increase in prices. With a non-demonetarised economy, a reduction in the money supply also leads to higher prices, because the costs of enterprises are rising. They are shifted to prices, production is declining, which causes a reduction in the supply of goods on the market. As a result, prices are rising, and this situation is very favourable for speculators, they have ample opportunities to manipulate the market.

How to stop the decline? A sharp decline in the purchasing power of the national currency leads to the fact that people begin to save on essential goods. Hence, the incomes of the population fall below the normal level.

After all, the drop in incomes is drowning the economy

The fall in income entails a fall in demand, and then everything continues as if by a chain reaction in a confined space. Decrease in demand entails a fall in production, which leads to an increase in costs, and this fuels inflation, which in turn aggravates the fall in real incomes of the population and business. And as a consequence, the spiral twists all the same.

The only way out of this situation is not to let the national currency rate 'hang out' in wide ranges, to start targeting the national currency. You need to fix (establish a closed position) currency position for banks, which will reduce the pressure on the national currency from the currency exchange with the aim of narrowing speculative opportunities. Finally, it is necessary to lower the discount rate to the level of inflation, which will give an incentive to the revival of the economy. Only then should we wait for the slowdown in the economy's recession and the beginning of a decline in inflation. Once again, we note that all this follows from well-known economic laws.

In addition to the Central Bank, the global financial regulator - the IMF - also participates in the regulation of the national currency rate of almost all the countries of the world. To this end, the mission of this organisation comes to Azerbaijan twice a year. The last time it visited Baku in early March. But because of the lack of complete information it is difficult to say which macroeconomic levers the IMF recommended to the government to overcome the current situation.

One thing is well known: the IMF noted quite strong financial resources of our country and expressed readiness to render technical assistance to the Azerbaijani side if necessary. Strictly speaking, Azerbaijan does not need IMF loans, but whether the country needs its technical assistance, let's think about it.

Is it worth being guided by the IMF?

For Russia, its assistance is reduced to unchanged recommendations that the Bank of Russia should not interfere in regulating the rouble's exchange rate by letting it float freely, raising the discount rate for slowing the inflation process, and the Ministry of Finance cutting back on social payments and government spending. Like, the invisible forces of the market will adjust the balance of the economy and smooth out all the errors. These standard proposals, which the IMF recommends to all post-Soviet countries, are similarly suggested by the representatives of this structure in Baku. But we remember how the former Moscow economic bloc led by Primakov in 1998 came against the recommendations of the IMF, which practically saved the same Russia from the imminent economic collapse.

By the way, even today in Moscow there is a great confrontation between the public economic bloc and the official economic policy of the government, conducted in accordance with the recommendations of the IMF. It is evident that the financial leaders of our country also follow these recommendations. This allows the IMF to easily forecast macroeconomic indicators in these countries.

Both for Russia and Azerbaijan, according to the IMF forecasts, in the coming years the average GDP growth will be 2-3%. In other words, such a growth rate can lead to a doubling of the domestic economy in only 30-35 years, which, of course, is not enough to meet the growing needs of the population, not to mention other factors. And this pace is not enough to achieve the goals set in the strategic plan, in particular, to ensure employment with high population growth.

But, perhaps, the IMF could play a much greater role for the Azerbaijani public, if through its technical assistance it can achieve  bringing the national statistics to a level consistent with the recommendations of this structure. It is enough to note the completeness of the information provided by the CBA and the rules for the periodicity of its dissemination. And maintaining the balance of payments does not even deserve criticism. Today, the lack of harmony in the conduct of national statistics does not allow us to closely monitor the processes taking place in the economy and build an adequate macroeconomic policy.

Also a theorist, Elman Rustamov

Criticising the activities of the CBA, we do not intend to question the ability of Elman Rustamov to give a true assessment of the situation. Thus, even before the crisis in Azerbaijan, in his research article 'Financial Crises: Sources, Manifestations, Implications' published in the Russian journal 'Voprosy Ekonomiki,' Elman Rustamov very skillfully revealed the essence of all previous large-scale crises in the world economy.

We can proudly say that our chief banker has revealed the whole essence of the cause-and-effect factors that lead to a crisis. He really showed a deep understanding of all the macroeconomic processes taking place in the world economy. In his article he, in particular, emphasises the specifics of the economic policy of the government and monetary authorities. And he refers 'to this group of factors as permanent rules (for example, the regime of exchange rate policy or rules for managing oil revenues), and decisions taken before or during the crisis.'

And it creates a strange impression: why did Elman Rustamov fail to implement his deep theoretical knowledge in practice before the crisis that began in 2014? And where could have all this led us, if not for the timely intervention of President Ilham Aliyev?

(to be continued)

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