Following 20 years of a fixed exchange rate policy, Azerbaijan awoke on Saturday 21 February 2015 to news of a 33.4% devaluation of the AZN against the US$. Since start of 2014 only Russia and Ukraine experienced greater devaluations than Azerbaijan among the country’s immediate neighbors, while Georgia and Turkey, at 31.8% and 15.4%, respectively, experienced milder weakenings. We believe that falling central bank (CBAR) reserves were the main reason for the immediate radical devaluation. We also believe that the devaluation will pose short‑term challenges, but will lead to benefits in the medium to long term by saving international reserves at both the Central Bank and in the State Oil Fund of Azerbaijan Republic (SOFAZ). It is probable that demand for US$ surged right after the devaluation in the ensuing panic. However, we believe that eventually the policy will help to balance the budget, precluding the need to tap international debt markets.
End of a stable currency?
For 20 years, Azerbaijan pursued a fixed exchange rate policy with the AZN, the local currency, which was pegged to the US$ or a US$-EUR basket. Thanks to massive oil revenues, the CBAR was able to retain this policy and increase its reserves, which passed US$ 15bn in mid-2014. During this period, the US$/AZN rate ranged between 0.7712 and 0.9878, with an overall tendency towards appreciation of the local currency. Oil revenues meant that foreign exchange inflows remained strong, feeding not only CBAR reserves, but also reserves at the SOFAZ, boosting budget revenues and expenditure and improving living standards.
Collapsing oil prices and steadily declining output strained CBAR’s exchange-rate policy. Elevated public expenditure and falling revenues meant that Azerbaijan faced its first budget deficit of the decade (double digits), tapped SOFAZ reserves for the first time, and resorted to international debt markets. Declining CBAR reserves, which fell by US$ 2.5bn in December 2014-January 2015, was the first major indicator of looming problems. Retaining the same policies would have risked eating reserves and been unsustainable in the medium to long term if low oil prices persisted.
International reserves – one of the most important pillars of stability for Azerbaijan in the medium to long run. SOFAZ’s reserves increased by US$ 1.2 bn to US$ 37.1bn in 2014. Along with CBAR’s US$ 13.8bn reserves at the end of 2014, consolidated international reserves equaled 67.7% of GDP, making them one of the main factors guaranteeing Azerbaijan’s investment grade rating. The previous exchange rate presented the risk of SOFAZ losing US$ 6.0bn in 2015, along with a fall in CBAR reserves. We estimate that with the devalued AZN, reserves will decline by just US$ 2.4bn in 2015 and last longer, supporting both Azerbaijan’s ratings and fiscal policy in the longer time span.
