Our Analytics 22 september — 15:00

Headache for Central Bank: Foreign exchange reserves put pressure on manat (Our analysis)



Board of the Central Bank of Azerbaijan made a decision to reduce the discount rate from 6.75% to 6.5% from 18 September. The lower threshold of the interest rate band has been reduced from 6.25% to 6%, the upper threshold from 7.25% to 7%. The parameters of the interest rate band will be aimed at maintaining an optimal balance between keeping inflation within the stated target range (4±2%), supporting financial stability and economic activity. At the same time, it is emphasised that the Central Bank will continue to take all possible measures to maintain macroeconomic and financial stability in the country and keep inflation within the stated target.

Central Bank again lowered the discount rate

Yes, the Central Bank is a conservative structure and does not hide it. Its head Elman Rustamov sees his main goal in maintaining macroeconomic and financial stability in the country and keeping inflation within the stated target. And, apparently, he had reasons to cut the discount rate during the difficult period of the coronavirus pandemic, although many central banks of the leading countries of the world are in no hurry with this. When the chief banker announces the now traditional discount rate cut at press conferences, journalists are meticulously investigating the reasons for this step. But the latest decline was reported by the bank's press service in a short press release, in which it is difficult to find answers to all questions. Therefore, let's try to figure it out ourselves.

Despite low oil prices, since the beginning of the year, the country's foreign trade balance remains in surplus, which creates conditions for the growth of the country's strategic foreign exchange reserves, which are formed from the reserves of the Central Bank, the assets of the State Oil Fund and the Treasury of the Ministry of Finance. Azerbaijan's strategic foreign exchange reserves have increased by 3.7% since the beginning of this year and amounted to $51.4 billion, while at the end of 2019, the country's strategic foreign exchange reserves amounted to about $ 50.9 billion. And compared to the same period last year, the reserves grew by 0.6%.The presence of multibillion-dollar strategic foreign exchange reserves is, of course, a favourable factor. But, on the other hand, this creates a headache for the Central Bank, as it increases pressure on the national currency, the manat. Suffice it to note that only the transfer from the Oil Fund to the budget is $ 6 billion, which are preliminarily sold at auctions, since the budget accepts receipts in manats.

Strategic foreign exchange reserves put pressure on manat

And if appropriate measures are not taken in time, the manat exchange rate may be under threat, which can lead to its devaluation, to an increase in inflation, and to violations of macroeconomic and financial stability.

Let's take this illustrative example. Following the results of eight months from the beginning of the year, the cost from the sale of products and services rendered in order to meet the needs of Azerbaijani consumers amounted to 29.4 billion manats. According to the State Statistics Committee, this figure is 7.5% less compared to the same period last year. At the same time, the cost of products sold and services rendered by non-state sector entities amounted to 28.3 billion manats, which is 7.1% less than the same period last year. Of these, 48.6% was formed due to the activities of individual entrepreneurs. And the cost of products sold by public sector entities amounted to 1.05 billion manats. At the same time, for this period, the average monthly cost of each consumer was estimated at 368.7 manats, which is 21.1 manats less in nominal terms compared to the same period in 2019.

The market is crying: people's wages have dropped significantly, therefore, their purchasing power has also decreased. And then there's the pandemic with its tough restrictions, which also hit not only production, but also the retail market. Closed markets, boutiques, shopping centres, celebration houses, service and catering facilities have long been displeasing both traders and the population. In general, the current situation causes uncertainty among the population, which is in no hurry to make large purchases. Yes, and other goods that are not of first importance are sold poorly.

This is just what we see. But it is not hard to guess that all this directly affects the budget and inflation. And it is no coincidence that since the beginning of the year the Central Bank has provided liquid support to the banking sector in several directions for 1 billion manats. This was announced by the chief banker himself at an online meeting of the Council for Cooperation with Entrepreneurs under the Board of the Central Bank.

According to Rustamov, in a pandemic, the Central Bank provides support to banks, which, in turn, help entrepreneurs.

Elman Rustamov announces liquid support for manat

So, during this period, mortgage and business loans increased, while consumer loans decreased, which was difficult to achieve even in more favourable times, when the country's economy was not threatened. Since the beginning of the year, the regulatory requirements for loans for entrepreneurs engaged in export activities have been relaxed, and regulatory requirements have been tightened to reduce consumer lending.

In order to minimise the negative consequences of the pandemic, a number of prudential standards of banks were relaxed, recommendations were made to increase capital reserves and restructure loans to economic entities affected by the pandemic. In addition, loans to 49,000 borrowers in the amount of AZN 886 million were restructured. Moreover, the restructuring of the loan portfolio was actively carried out on the initiative of the banks themselves. In addition, under the self-employment program, banks provided various assets to vulnerable groups. And to expand access to financial resources in rural areas, the Central Bank launched a joint project with the relevant departments.

In short, the regulatory easing measures adopted by the Central Bank turned out to be so effective that President of the Association of Banks of Azerbaijan Zakir Nuriyev called for their extension. Although financial support and the introduction of appropriate incentive mechanisms in the areas that have suffered the greatest damage from the pandemic are significant, banks find it difficult to take on additional risks of these business entities.

But the desire of banks to achieve comfortable conditions for themselves is easy to understand. And all this is difficult. With the total loan portfolio of banks and other credit organisations in the country at 14 billion 585.3 million manats, the amount of overdue loans amounted to 1 billion 62.4 million manats (7.3% of the total portfolio). And how to repay the loan if the population and entrepreneurs have suffered great damage. On the other hand, deposits are withdrawn from banks; since the beginning of the year, savings have decreased by almost 1 billion manats. So the discount rate is going down. The goal is to reduce the cost of loans and revive the economy.

And the Central Bank is optimistic, according to its updated forecasts, by the end of the year inflation is expected in the range of 3-3.2%, which is below the centre of the target range. And for this it has reason. Suffice it to note that in conditions of weak aggregate demand, according to official statistics, prices in August fell by 0.2%, while annual inflation was 2.8%. Under the influence of seasonal factors, food prices in August fell by 0.5%. Prices for non-food products and service tariffs have not changed. In general, the dynamics of actual inflation is in line with forecasts. In addition, until the end of the year, the Central Bank intends to maintain economic activity, counter-cyclical fiscal policy, monetary easing and synchronised anti-crisis measures.

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