Azernews.Az

By Gulgiz Dadashova

2015 has become another volatile year for energy producing countries, with the oil prices collapsing to new seven-year-lows and Brent falling below $40.

The worse news is that low prices will put even more burden on oil-exporting countries, as crude prices unlikely to recover anytime soon.

Oil prices are collapsing for several reasons, the main of which, according to analysts, is OPEC’s refusal to intervene into stabilizing crude markets, as the cartel members seek higher prices without having to cut their own output.

On the demand side, it has not risen as much as expected because United States domestic production has nearly doubled over the past years and economies of Europe and developing countries are weak for consuming the produced crude.

Third, Iran, encouraged with a nuclear deal signed this summer, seeks to return to global markets, even with the prices decreasing below $30.

Meanwhile, others claims existence of conspiracy theories; the United States wants to hurt Russia with forcing down prices, while the de-facto leader of OPEC Saudi Arabaia seeks to hurt Iran. But, none of these theories have been proved yet.

The South-Caucasus nation of Azerbaijan can be justly proud of the economic growth figures it achieved so far mostly thanks to its energy revenues. The country was among the few that could resist the 2008/2009 financial crisis. However, the low crude prices have hurt the country’s economy, which relies on hydrocarbons for 60 percent of its state budget.

Mercy Tembon, the World Bank's Regional Director for the South Caucasus has shared her views with Azernews regarding the challenges Azerbaijan faced this year:

'Stability ratio of economy'

Overall, Azerbaijan is undergoing a major process of adjustment to low oil prices. Macroeconomic challenges caused by low oil prices entail adjustments to fiscal spending and exchange rate administration. The government has already taken steps in both directions by devaluing the manat by 33.6 percent in February and by significantly cutting the spending for 2015 and 2016.

Fortunately, Azerbaijan has a large buffer against any unanticipated external shocks in the size of $37 billion saved in the State Oil Fund. The 2016 budget assumes a significant reduction in transfers made from the Oil Fund to the State Budget which indicates that the government wants to keep the buffer size. This effectively protects the Azerbaijani economy from major fluctuations coming from the global markets.

However, fiscal tightening and exchange rate uncertainty will affect the growth outlook adversely. The non-oil sector of the economy was mainly driven by public investment in the recent past hence a substantial reduction in public investment spending will negatively affect non-oil sector growth.

In addition, policy uncertainty regarding the exchange rate erodes private investors’ confidence, which adds concerns to the already challenging growth outlook. Therefore, clarity in exchange rate management would make the situation for the investors more predictable. On the other hand, strong reforms aiming to ease the business environment to allow better access to finance and increase in the efficiency of public spending would boost non-oil private sector growth. This can potentially compensate for the fiscal spending cuts in the near future.

'Possibility of devaluation'

The exchange rate of manat is strongly linked to the price of oil and overall developments with regard to the regional currencies.

Low oil prices mean low oil revenues, which is the major source for foreign exchange supply in Azerbaijan. In addition, regional currencies such as Russian ruble, Kazakh tenge and Turkish lira have been depreciating strongly in the past year. This forces market participants to sell off their manats. Furthermore, because of manat’s appreciation in real terms, competitiveness of Azerbaijan goods in the regional markets becomes challenging. All these factors trigger the authorities to react to the external developments and adjust the manat exchange rate accordingly.

Consequently, the interplay of oil price, regional currencies and the Fed’s interest rate decisions will create an environment in which the Azerbaijani authorities will shape their responses. It is also extremely important that this response is well communicated, so that the exchange rate administration should be adequately understood by the markets. Also, greater flexibility should be given to manat to help investors position themselves in a constrained environment. Lack of clarity will contribute to low investor confidence and market speculation, which is harmful for economic growth in general.

'Non-oil sector to help'

Non-oil sector has the potential to compensate for the growth slowdown, but it critically depends on many factors, including creating a business environment conducive to the private sector.

For the private sector to increase investment and start to tap into potential sources of growth, it is important to have efficient business regulation, developed infrastructure, competitive environment, highly skilled labor and strong institutions. The government has already started addressing some of these by implementing reforms in easing issuance of construction permits and by delegating most of the license and permit functions to the ASAN service. These efforts should certainly be continued but the scope of the reforms should be broadened.

'WB advices'

From the supply side, devaluation of currency pushes up domestic prices through import prices. The higher the share of imported goods in the consumer basket, the bigger will be the impact of devaluation. If domestic manufacturers can produce competitive goods which can replace imports, it will lower the sensitivity of domestic prices to exchange rate fluctuations. This again requires a conducive business environment for the private sector.

On the other hand, allowing for more competition among the companies involved in import market can also dampen the markups on imported goods which can bring the prices down, eventually. Manat has contracted by nearly 40 percent since the beginning of the year, which is instrumental in keeping inflation under control. However, growth outlook in the medium term is quite weak and this reduces pressures on inflation from the demand side.

Overall, external conditions remain challenging and lower oil prices have highlighted the need for economic diversification. The government's strategic vision aims to support skills, infrastructure development, and improved governance and accountability, as does the World Bank's partnership strategy for Azerbaijan. This is indeed the right path for the country to find new and resilient sources of growth and a better future for its people.

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