Our Analytics 2 september — 14:35

Give us weak manat! (Our analysis)



Which is better - a strong or weak national currency? For all its apparent simplicity, it is difficult to answer this question unambiguously. On the one hand, a strong currency is the pride of the country, which testifies to its power. But this is only at first glance. In any country, there are two large groups of people, who want to strengthen or weaken their national currency. In a closed economy that we have experienced, this problem is not particularly evident, but with the transition to an open economy it acquires a fundamental character.

Here this tendency has especially amplified recently, when the external economic relations began to play, it is possible to say, the decisive role in development of economy. And since the economy has long ceased to focus only on seeming, but not always effective external factors, we will dwell on the other side of this issue.

Manat is not a dogma, but a commodity

In today's world there is one generally accepted standard of money - the American dollar. And, in different countries the dollar has different purchasing power. In one country for every dollar you can buy less goods, and in another - more. That is, the rate of one or another currency to the dollar does not always show its true price. And in this article, we want to analyse this problem under the conditions of Azerbaijan.

Azerbaijan in the world economy is not a separate island. We, as in all other countries, have certain social groups and business groups, whose interests on this issue are diametrically opposed. At the same time, in general, there are some national interests in the society, the most important of which can be called the announced state course of economic and social policy. And the rate of the national currency (manat) in any case (even if for this it is necessary to use indirect ways) should meet these interests.

Theoretically, the exchange rate of the national currency should be determined on the exchange, in practice this also happens on the exchange. In the market, supply and demand determine the true price of any product, and money is the same commodity. But if we adhere to such a dogma, then in the fat years the rate of our manat (without the intervention of the Central Bank) could be kept at about 20-30 qepiks per dollar - the dollar in the market was much more prevalent over manat.

Or let's take the beginning of this year, when the manat rate could drop below $1.9. But again, if there was no CBA intervention. It is clear that the CBA always tries to maintain some stability of the manat, which is generally true even for an open market economy. Hence, in some situations, the official exchange rate of manat may deviate from its market rate, and sometimes, significantly. But in this case the question arises: how much is our manat estimated or undervalued against the dollar in a particular period of time? And the solution of this issue can become already one of the most important factors for the domestic economy.

How to establish the degree of manat's evaluation?

This can be determined by purchasing power parity (PPP) of our national currency, which is calculated for all states, including for Azerbaijan, by the International Monetary Fund and the Organisation for Economic Cooperation and Development. These calculations are based on the baskets of goods and the proportion of the prices of these baskets.

In the United States, the exchange rate is by definition 100%. For Western countries, or the so-called 'golden billion,' exchange rate is higher than PPP, and for all developing countries, including Azerbaijan, it is below PPP. Somewhere it is 20% lower, and somewhere twice, like ours, in neighbouring Russia and a number of CIS countries. In fact, undervaluation of national currency characterises the weakness of the economy, and says that the country is even more plunged into a quagmire of economic backwardness.

For the average reader, all this, maybe, is somewhat difficult. To facilitate his work, we try to explain this theory with the simple and all accessible concept of 'Big Mac,' which has already been fully established in the international economic community.

Calculations based on the index of 'Big Mac' began to run The Economist since 1986. On this index, you can compare purchasing power and national currency rates of countries where there are McDonald's restaurants, in relation to the US dollar. For example, today the price for 'Big Mac' in the US is 5.2 dollars, and in Azerbaijan - 3.95 manats or 2.32 dollars. And if we calculate by this principle, the fair rate of manat today should be 76 qepik (3.95 manats: 5.2 dollars). Thus, according to the 'Big Mac' index, our manat is underestimated by 55% (the Russian rouble, about which we spoke above, is underestimated about the same).

Although 'Big Mac' calculations in some circles may be considered very illiterate, in practice this indicator is very close to the purchasing power parity of different countries, which is calculated by international organisations. The fact is that for the manufacture of 'Big Mac' in all countries the same ingredients are used. And when calculating the purchasing power parity, all types of goods and services are taken into account. But the ingredients used in 'Big Mac' (bread, onions, meat, cheese, pickled cucumbers, lettuce, sesame, etc.) are just the most popular foods that are used in all countries. Therefore, experts often resort to the services of 'Big Mac,' as this indicator can be calculated at any desired time and in general to judge the state of the market. And PPP, which is a very labour-intensive process, is calculated by international organisations every 2-3 years.

Theoretically, the exchange rate of the national currency in an open economy should approach the PPP over time. At the same time in practice such a 'dogma' is rare. In some countries, the exchange rate of the national currency is understated, in others it is too high. Although these deviations must somehow be motivated. In particular, in Azerbaijan, the rate of manat, as noted above, is underestimated by more than two times.

It would seem that there is nowhere else to be worse. At the same time, such an underestimation of manat allows the country's economy to reorient itself to import substitution in a short time. And President Ilham Aliyev in this situation chose the right way - to use the lowered rate of the national currency as a powerful tool for achieving his strategy. If we manage to take advantage of the incident and raise labour productivity, then import substitution itself will simultaneously lead to an increase in exports. Thus, developing import substitution, we will develop the domestic economy as a whole.

If it were not for devaluation...

Import substitution, in general, is important. In the fat years, we spent on importing a half dozen billion dollars a year. True, today this amount has decreased significantly, but still measured in billions of dollars a year.

Where did the huge volume of imports come from, which today the authorities want not only to curb, but also to achieve with it the replacement of a breakthrough in the economy? In the years that followed, we developed through oil exports, for ten years the country built its economy under one-sided export, and not to meet domestic needs through the development of domestic production. That's why we got such huge amounts of import - the super profits were so high that the authorities to some extent ignored the need for the development of those domestic industries that are aimed at meeting domestic needs.

Underestimation of manat also has the opposite side. Today, many criticise the authorities for the conducted devaluation of the manat, which, indeed, hit the population and the economy as a whole. But what could happen if the authorities did not do this - unfortunately, very few people think about this. And what would have happened is this.

Our traditional partners, already having managed to devalue their national currencies, would flood our market with their cheap goods, which could inflict an irreparable blow to the real economy in the short and medium term. We are not so ardent supporters of the devaluation of manat and do not intend from the height of today to indicate possible ways for a less painful exit from that situation. But it must nevertheless be noted that after taking preliminary measures, the government could still go on a devaluation, but with much less loss of the CBA's currency reserves.

On the other hand, for broad import substitution, the same broad industrialisation is required. But with an understated exchange rate of manat, imports, including imports of machinery and equipment, are becoming more expensive. However, even the more expensive investments in such conditions justify themselves, since under the understated rate of manat, domestic production becomes more competitive. As a result, we can win more on competitive products than lose from the increased import of machinery and equipment.

In addition, the understated rate of manat gives Azerbaijani exporters ample opportunities for obtaining the so-called 'invisible subsidies.' This is a kind of currency dumping, when exporters receive a certain subsidy, additional competitive opportunities. But this 'subsidy' is paid not by the state, but by individuals and legal entities that are not only not participants in this export activity, but have absolutely nothing to do with it. In a word, these are local companies oriented to the domestic market, and all citizens of Azerbaijan.

The decline in the manat rate is essentially inflation, which is an invisible tax for all citizens of the country. But the trouble is that such 'invisible' subsidisation of exports is not in the interests of the population, it only serves the interests of a small group of oligarchs.

The latter often manage to return to the country the minimum export earnings only for paying some taxes, paying salaries and covering certain services. And multimillion-dollar revenues are deposited in off-shores, not bringing any benefit to the people. The same mechanism is used in principle by the oligarchs of Russia, where this process has taken on a wider scale.

As can be seen from the graph, last year, between the ratio of the monetary base in a narrow definition (issued by the CBA for cash, taking into account the balances of funds in the cash departments of credit institutions plus the balances of mandatory reserves on funds raised by banks in the national currency deposited in accounts with the CBA) to foreign exchange reserves of the CBA and the official exchange rate of the manat showed a large and dramatically changing deviation. But since the beginning of this year, the CBA has managed to equalise this picture. Moreover, the CBA succeeded in increasing the foreign exchange reserves to achieve an adequate ratio of the monetary base to its foreign exchange reserves. Thanks to this kind of monetary policy, the CBA managed to achieve a stabilisation of the national currency rate.

Our resume

With all this said, one can come to this conclusion: regardless of underestimation or overestimation of manat, the government and the CBA should direct their main efforts to maintain its stability and stability. For the economy, the worst option is the fluctuating exchange rate. In this situation, nothing can be planned, including investment.

It is no mere chance that in the last 2-3 years investments in the real sector are experiencing the same crisis as the economy as a whole. But, strange as it may seem, nobody is responsible for the stability of the manat under the Azerbaijani Constitution, although the Central Bank of Russia is responsible for this in that country. Therefore, it is doubly gratifying that since the beginning of this year the manat has stabilised thanks to the efforts of the CBA, which is not formally responsible for this area of work. And the current exchange rate of the manat, according to our forecasts, will not change until the end of this year. And this forecast is not taken from the air.

First, oil futures contracts are already concluded at the current price level by the end of the year. And secondly, since the beginning of the year the ratio of the monetary base to the CBA foreign exchange reserves is adequate to the established official rate of manat.

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