Of the five Caspian states, Azerbaijan is the country most vulnerable to the collapse in the price of crude oil as the country lacks the minerals and other natural wealth of others in the region. After spending much of its foreign currency reserves last year to support a peg to the U.S. Dollar, the central bank moved to allow the currency to free float on global markets. The Manat promptly saw its value decrease by fifty percent against the greenback as the price of crude oil slumped 70% in the face of ruthless overproduction in America and elsewhere.
In response, Azerbaijan has recently raised its benchmark interest rate to 5% from 3%. The rate had been lowered to 3% from 3.5% last July in a futile bid to diversify its economy away from hydrocarbon production. The upper rate of the bank’s rate corridor was increased from 5% to 10%. The government is aware of the challenges it faces to wean Azerbaijan off of oil and natural gas as are multi-national institutions.
The World Bank stated in 2015, Azerbaijan now faces some new challenges as the income generated from oil exports is decreasing and the fallout from Russia’s economic downturn damages Azerbaijan’s immediate growth prospects. To help mitigate these risks, the government of Azerbaijan is looking at economic diversification to reduce the country’s dependency on the oil sector, boost private sector growth and competitiveness, and foster new and better paid jobs in the economy. The financial sector remains relatively small and bank-centric, with the state playing a dominant role in ownership and financing. Gaining access to finance, therefore, has often proved challenging for micro, small and medium enterprises (MSMEs), especially entrepreneurs and young businesses; thus the SME sector remains small (10 percent of GDP).
The problem, as with many CIS countries, is that this is the wrong time to attempt this transformation. Access to finance, reducing corruption, removal of government interference in private markets, although desirable, is much easier to do during the boom times. Now, as in Russia and elsewhere, the lack of success in these areas is coming home to roost.
Going forward, the central bank will be in survival mode to support the currency in any way possible. Unfortunately, the price of oil is going to languish well below $50 for years. Even with Russia, Iran, and Saudi Arabia attempting to talk markets out of the doldrums by discussing a freeze (at record high levels), U.S. producers will fill any gaps opened by a cut in production in the Middle East and Asia. OPEC knows this. That is why there have not been any production cuts to date as everyone is concerned about losing market share.
Inflation in Azerbaijan is rampant, estimated at 15% in 2016 by Standard & Poor’s. With inflation holding in the 2% range for since the turn of the century, policy makers had grown complacent.
We are seeing some relief in the value of the manat as oil rebounds in a dead-cat bounce from the mid $20s on rumors of a production cut deal among the major producers outside North America. However, this is just a small respite in a growing wave of financial stress that is coming due to the basic fundamentals of supply and demand in the oil market.
Simply put, there is too much oil by record amounts. Additional storage capacity is non-existent. American producers can turn on the taps at any point if prices rise, keeping a lid on revenue for hydrocarbon dependent states. Therefore, the downward pressure on the manat will continue as Azerbaijan is especially vulnerable. Currency speculators are circling like sharks smelling blood in the water, looking for an easy meal.
Opinion: The Coming Azerbaijan Currency Crisis