BY MAMMAD EFENDIYEV, ELDAR ALIYEV, ELNUR MAMMADOV, ECONOMICS SECTION
In our opinion, the state of the foreign exchange market could be exacerbated by the errors committed by the Central Bank. So, after the first devaluation, the regulator liquidated the banks' currency position, explaining its step by the fact that this position was at odds with the rules prescribed by the CBA itself.
The question arises, where did the regulator look?
After all, banks and bank administrators, who have committed a violation of these rules, should be held accountable in accordance with the law. In addition, the CBA simultaneously reduced to a minimum the reserve requirement for commercial banks - to 0.5%. And, in addition, it began to increase the volume of crediting banks (over 3 billion manats before the second crisis) at the then low interest rate of 3-3.5%.
But all this could lead not only to an increase in the liquidity of the banking sector and to the expansion of the money supply, but also to the inflated demand for currency and possible manipulation by banks in the currency market during the crisis period.
The statistics are disclosed once a month, showing its results for the end (or beginning) of the month. But what happens in the interval from the beginning to the end of each month, we do not see, and therefore do not know. Banks could quite well at this time themselves and/or through front companies or firms issue loans, stock up currency, creating an artificial compression of the offer when demand grows, and at the end of the month sell the reserve currency legally or illegally with a good margin and close the loan.
Such an operation cannot affect the overall trend of declining or growing of loans. This is nothing more than a speculative profit to the detriment of economic stability in general. Moreover, all the conditions for such speculative manipulations were created by the regulator. For banks, it would simply be a sin to miss this opportunity. Why did it happen? Probably, in pursuit of a momentary decision to straighten out the situation, the CBA, apparently, did not take into account a number of factors that could really interfere with the implementation of measures taken by it in the longer term.
Thus, without taking into account all possible factors, our officials confidently led the economy to another devaluation. And at the end of 2015, the official rate of the manat again began to diverge from the ratio of the monetary base to foreign exchange reserves by 15%. Then, the leaders of the monetary authorities acknowledged the failure of the steps they took and announced the second devaluation, taking a decision simultaneously on the transition to a freely floating exchange rate.
And they explained their act by the myth that such a decision was the most accurate, the market itself would settle the cost of the manat, and the economy would transform in accordance with market laws, so it was not worth it to waste the currency reserves, especially since they had approached the minimum mark - 3 Month import volume. (Due to the lack of statistical data, we do not know the structure of the foreign exchange reserves, but judging by the latest data, on the eve of the second devaluation - by early October 2015 - there were other assets in the structure of foreign exchange reserves in the equivalent of about 2.9 billion US dollars. However, most likely, they were kept in less liquid assets, and it is not entirely clear in what currencies these reserves were kept and whether they remain in the structure of the current foreign exchange reserves)
In principle, one can agree with the CBA's arguments on switching to a floating exchange rate, but it all depends on how developed the country's economy is, how well its institutions are, how vulnerable it is to external shocks, and consequently to internal shocks, and will it be able to absorb such shocks.
Distorted currency regime
And it is no coincidence that at the end of 2016 again, against the background of changes in the ratio of money supply to currency reserves, the rate of the manat again began to fall. This process could be influenced by budgetary expenditures, which in December amounted to AZN 3.8 bn and exceeded the average monthly budget expenditures by 2.6 times; this factor could be strengthened by the imbalance of the ratio of money supply to foreign exchange reserves. It is clear that the budget had to fulfill its expenses, fulfill its obligations, and by the end of the year to balance on the basis of the adopted budget law for the current year. But at that time there were still great opportunities for cashing in all senses too.
And after the adoption of a new regulation on withdrawing cash from bank accounts and limiting their spending, the manat rate began to stabilise and even strengthen. And the ratio of the monetary base to foreign exchange reserves became adequate to the rate of the manat. It is not profitable for players in this situation to deal with currency speculation, since the factor that directly influenced the growth in demand for currency was already blocked. This can be called the main achievement for us, and the economy as a whole, which the crisis 'presented' to the country. The deepened crisis forced the government to take such a step; it only remains to wish the authorities not to change this course. Then we will be able to transform the economy.
To eradicate corruption mechanisms at the expense of budgetary funds, it would be logical to create structures for the purchase of services and goods, as well as investment technologies produced both in the country and abroad, on the basis of transparency and competition. Moreover, we already have such experience. In 2016, by decree of President Ilham Aliyev, JSC 'Procurement and Supply of Foodstuffs' was created with the goal of providing the state's (that is, society's) needs with the food products, which works successfully.
The new structure would ensure the purchase of services and goods, as well as investment technologies. And the necessary foreign technologies and equipment could be acquired on the basis of leasing (for this purpose it is possible to create a state leasing company whose assets can be formed at the expense of the Oil Fund). Thus, each year the budget expenditures for investments would be made partially and for a longer period of time. And most of the remaining amount, which was fully intended for the purchase of such investment technologies, could be sent to the National Entrepreneurship Support Fund on the basis of targeted lending. And such loans certainly could not be cashed.
Target loans are something like an advance for goods produced in the future. Such a mechanism would positively affect the work of the banking sector, eventually our banks would be tightened up and begin to lend to the real sector at reasonable rates.
Now it remains to answer the main question: which monetary system and which course are acceptable for us?
The current currency regime is wrongly called a floating exchange rate, it is rather some kind of a hybrid of currency regimes. A real market price of a dollar (commodity) at an auction cannot be determined if only one seller is on it - the Oil Fund! In general, auctions are held somehow wrong, and most importantly, prices are determined not by the seller, but by the buyers - by banks.
Even during the collapse of the USSR, when exporters were allowed to sell part of the currency proceeds at auctions, the price of the currency was set by the seller of the currency. They could still do that now. Take, say, the current rate as a basis, and tie it to the dollar, with an increase in oil prices by 1% to adjust the dollar to manat by 0.001 manat, and with a decrease in oil prices, on the contrary. In fact, the market price can only be achieved on the market (exchange), where there are many buyers and sellers. Unfortunately, in the current situation, the Oil Fund has a monopoly in the sale of currency, whether state or quasi-public, it does not matter.
But if the fund is a monopolist, then the prices for the goods that it represents on the market should be regulated logically by the state in the person of the Tariff Council. After all it regulates prices for goods and services of other monopolists (state and quasi-public). And such a situation, when the prices of some monopolists are regulated by the TS, while others are not, contradicts the usual logic. The difference between them is that one monopolist sells its natural gas to the population, business and the state, and the other monopolist sells the product in the form of money to the same persons - the population, business and the state. We have previously had a currency exchange, and we remember how it managed its task at the very least. One also remembers that on this site there was a mass of both sellers and buyers, and the regulator acted as a seller or a buyer, depending on its goals. So the CBA is disingenuous when it says that the current rate is the market one.
And now let us consider a different scenario. In recent months, the volume of loans from the CBA has been sharply reduced. Suppose that our banks start borrowing abroad, and in the auction sell the foreign currency for manats together with the Oil Fund (this will not be an auction, but rather an exchange). In this case, if only the Oil Fund does not stop selling the currency or reduces the volume of its sale, the manat rate will begin to strengthen because of the surplus foreign currency. Another option is possible, when the banking community, in order to somehow ease the situation of its credit currency debtors, conspires and establishes in its bids the price of the dollar at the level of 1.5 manat. What, in this case, will the fund stop selling dollars? It also has obligations to the budget, it must sell the currency and transfer manats to the budget according to the established schedule. Maybe in this case the CBA will also say that this is the market rate of the manat?
If the government had made timely decisions on cash withdrawal restrictions and limited spending, had not liquidated the currency positions of banks and had not increased refinancing, the exchange rate after the February devaluation could still be in the range of 1.05-1.2 manats per dollar. And even if for some reason the regulator would have adopted the current currency system, the rate could still have stabilised in this range. It is likely that if all these steps were taken on time, the regulator would not abandon the fixed exchange rate regime at all, but continued to steer still.
So we should deceive neither ourselves, nor the economy, on the whole, the economy cannot be fooled anyway. Either the former fixed regime, or the managed currency regime suit us, but not in its classical version, only with some reservations.
What kind of rate do we need?
The exchange rate confusion has led to the fact that one but insignificant category has profited from currency races at the expense of the rest of the overwhelming majority of the population, as well as business, the banking sector and the state as a whole. In our opinion, the country needs such a fixed rate, which would suit both importers and exporters, and the population, and the state.
It is likely that this level of the exchange rate in relation to the dollar is in the range of 1.5-1.6 manats. But the population is mostly concerned with one question: will such a rate lead to lower prices? It is difficult to answer this question unequivocally. After the February 34% devaluation, prices rose, but insignificantly.
Perhaps this was influenced by the president's calls, and business' expectations in the uncertainty that has arisen. But after the second devaluation, prices immediately went up. The CBA did not give explanations, as if all this was done not for the general public, but for a narrow group of bankers. Numerous experts, however, did not shy away from giving the most unexpected forecasts, predicting the collapse of the national currency almost to 3-5 manats per 1 dollar. The reduction in prices will depend on their elasticity in the direction of lowering. Much depends on how much after the devaluation the costs of business have grown and what the price structure is.
We must also take into account the level of monopolism and competition in the market, as well as the possible level of the state's dialogue with business. Over time, prices will decline, but not at the pace that they grew. If this happens, the real effective exchange rate of the manat will also remain stable.
It should be taken into account that all our analysis is conducted in the conditions of extreme shortage of statistical data, the provision of which the CBA limits every year. In general, the CBA expands the page volume of its bulletins, but the full coverage of statistical data narrows. Basically, our reasoning is based on the logic that flows from the economic theory and the real state of the domestic economy. And this logic shows that the transition of the CBA to the floating rate of the national currency was a premature and unrealistic step taking into account the state of the country's economy.
We, in turn, propose to consider the possibility of switching again to a fixed or managed currency regime (with reservations), which we consider more acceptable for the current situation of the economy and for economic agents. At the same time, the large-scale economic reforms initiated by President Ilham Aliyev should be more deepening and accelerating.
(to be continued)