Azerbaijan floats the manat

Azerbaijan floats the manat
By bne IntelliNews December 21, 2015

The Azerbaijani central bank (CBA) was forced to float the national currency on December 21, prompting the immediate devaluation of the manat by 50% against major international currencies such as the dollar.

This is the second devaluation of the manat in 2015, after the currency lost 34% of its value in February. The manat now trades for $0.64, from $0.95 on December 18, and €0.59, from €0.88 on December 18.

The move will help safeguard CBA's FX reserves, which dropped from $15.2bn in August 2014 to $6.2bn in November. It had been largely anticipated by international analysts and feared by domestic bankers, especially after an early December meeting of the Organisation of Petroleum Exporting Countries (Opec) decided to maintain current production levels, leading to a 20% drop in oil prices.

The Azerbaijani currency and economy are heavily dependent on oil prices, with oil contributing more than 90% of export revenues and over 30% of GDP. As a result of the steep drop in oil prices in the last 18 months, the Azerbaijani economy contracted by 6.7% in nominal terms to AZN50.1bn ($47.9bn at pre-devaluation exchange rate, $32.5bn at the December 21 exchange rate) in January-November.

Analyst Tim Ash from Nomura International wrote in a December 21 email note that the devaluation echoes that of regional peers, such as Kazakhstan, Russia, Turkey and Georgia, which are also Azerbaijan's leading trading partners. "The only real surprise is that they waited for so long, blew scarce foreign exchange (FX) reserves in the process, and thereby undermined the sovereign balance sheet and credibility and confidence in the process," Ash writes.

"They never had enough reserves at the CBA to defend the exchange rate and sovereign wealth funds were either invested in illiquid assets or earmarked for priority real investment projects. In making this move, the Azeris are following the Russians and Kazakhs in allowing much more FX flexibility to help rebalance and insulate their economy in the face of what now seems likely to be an extended period of low energy and commodity prices. The fact that the CBA moved is credit positive in my view now as scarce FX reserves can now be used to counter potential fallout amongst banks and corporates and for development purposes in terms of anti-crisis measures," he added.

The second devaluation will help Baku protect its foreign currency reserves, and balance its macro-economy in the light of the oil price volatility, by using the dollar-denominated oil revenues to increase budget revenues and the country's current account surplus.

However, the devaluation will deal a blow to the banking sector, one of the worst performers in Azerbaijan this year. Its profit margins and asset quality plummeted after the February devaluation, while the rate of dollarisation of its deposits and loans reached 75% and 45% respectively.

With banks still dealing with the effects of the first, more modest devaluation, the new wave is likely to take a few victims among the country's smallest banks. Baku has already bailed out its largest bank, International Bank of Azerbaijan (IBA) this year, by injecting AZN3bn ($2.9bn at pre-devaluation exchange rate), and it is unlikely to use significant amounts of public funds to prop up other banks.

Dmitri Vasiliev, director for financial institutions at rating agency Fitch, told bne Intellinews in a December 21 interview that " the devaluation will negatively affect the banking sector in terms of asset quality and capital. Dollarisation of sector loans is high and most borrowers do not have access to dollar-denominated revenues, meaning that the devaluation will impair their debt servicing capacity. Inflation of FX-denominated assets will bring down capital ratios and some banks may fail to comply with regulatory capital adequacy rules. Additionally, some smaller banks have large open currency positions, hence devaluation will result in considerable one-off currency translation losses for such banks".

That said, CBA is likely to provide hedges and swaps to support banks, just like it did after the February devaluation. Ash believes that the sector's small size "means that problems can be managed to avoid systemic problems damaging the sovereign balance sheet... the only nagging question in my mind is why they waited so long after the modest earlier devaluation in February. I guess therein there were concerns still over social stability, and the level of popular support for the [Ilham] Aliyev regime. Perhaps the recent upsurge in violence across the border with Nagorno-Karabakh is now seen as rallying the nation behind the regime and the external threat, sufficient to ensure political and social stability in the face of this FX move," he writes.

Sources in the banking sector told bne Intellinews that "banks maintaining long dollar positions will profit from the devaluation before the end of the year, but the devaluation will affect all banks in 2016, and especially those with a high level of balance sheet dollarisation. The entire economy will suffer as a result of the devaluation in 2016, and we expect banks to suffer as well, and the rate of non-performing loans (NPLs) to increase".

On December 18, the regulator moved to reinstitute a policy capping the banks' FX positions in preparation for the devaluation, in order to avoid FX speculation. It is unclear which banks have benefitted from the devaluation, but many were prepared in advance and maintained limited amounts of manat-denominated liquidity.

Economist Vugar Bayramov from the Centre for Economic and Social Development (CESD) was quoted by as saying that the business sector was not prepared for a second devaluation, and that it will put "psychological" pressure on consumption patterns in 2016.

"Businesses, households, banks were used to having a stable currency exchange rate," he said, referring to the four-year peg with the dollar and decade-long stable exchange rate that the manat had prior to the February devaluation. "Salaries and pensions will suffer, and prices could increase steeply, particularly for imported products. But the government is likely to contain inflation in order to avoid social tensions," he said.