Azerbaijan, the host of this year’s Asian Development Bank annual meeting, is suffering from lower oil prices, but its prudent fiscal policy offers some lessons to other Asian governments.
Azerbaijan is a country under pressure. Oil and gas accounts for 95% of its exports and the near 50% slump in crude prices in the second half of 2014 has roiled its current account surplus. The central bank devalued the manat by over 30% against the US dollar in February, underlining the stresses on the country’s finances. Now, economists worry another devaluation may be on the cards after foreign exchange reserves tumbled 14% in March.
Relative to other oil exporters, however, Azerbaijan is well placed to weather the storm.
“To some extent, the pressures have evaporated,” said Klaus Gerhauesser, director general for Central and West Asia at the Asian Development Bank. “The government has been very forward-looking in terms of its reserves and has taken a very prudent view in keeping foreign debt below 10% of GDP.”
“Given the outlook for oil revenue, public investment in other sectors should increasingly be financed through taxes, not transfers from Sofaz.”
Having intervened in the currency markets on several occasions in the previous six months, Azerbaijan’s central bank abandoned a peg to the US dollar on February 16. By the end of the next week, it fixed the manat 34% lower against the dollar and 30% down against the euro. The switch itself was poorly managed amid government promises that there would be no dramatic drop.
Weeks after the devaluation, the Ba1/BB+/BBB– rated State Oil Company of the Azerbaijan Republic (Socar) was back in the capital markets with a US$750m 15-year bond via Deutsche Bank and JP Morgan, pricing at 6.95%.
Standard & Poor’s has kept its BBB– rating on negative watch since January. Fitch, however, affirmed Azerbaijan’s BBB– rating in March, noting that the devaluation would reduce the impact of a lower oil price in local currency terms.
“Azerbaijan has a solid track record and a good credit history. The concession in the exchange rate was needed. There is no reason why the market wouldn’t support it,” said Gerhauesser.
Azerbaijan has used its oil exports to build a US$37bn sovereign wealth fund, Sofaz, and is expected to draw down on the fund in 2015. While some non-essential spending has been cut from the budget, Sofaz can provide counter-cyclical funding to take up some of the slack.
Economists warn, however, that the Azeri government will have to adjust its budget of 4.4% GDP growth this year, as a result of the lower oil price. Brent crude has recovered from its January lows of below US$47 a barrel, but is still trading at around US$59, down 45% from a year earlier. Azerbaijan’s budget contained assumptions of US$90.
The IMF expects Azerbaijan’s economy to expand at a real GDP growth rate of just 0.6% in 2015, before rebounding to 2.5% in 2016. The ADB, however, has a more upbeat assessment. It predicts GDP growth of 3.0% in 2015, on the back of public spending, before it moderates to 2.8% in 2016.
“Planned investment in infrastructure should offset declines in the oil sector, aiding non-oil growth in 2015 and 2016,” wrote the ADB’s Nail Valiyev in the bank’s Asian Development Outlook 2015.
The ADB expects Azerbaijan’s service sector to grow 8.0% in 2015 and 6.5% in 2016, largely due to trade and tourism. Azerbaijan, which hosted the Eurovision Song Contest in 2012, is to host the first European Games, an athletics event organised by the European Olympic Committee, in June and a Formula 1 Grand Prix in 2016.
However, it echoes warnings that the government needs to diversify the economy beyond the oil sector, since the Sofaz oil fund accounts for half of budget revenue.
“Given the outlook for oil revenue, public investment in other sectors should increasingly be financed through taxes, not transfers from Sofaz,” said Valiyev.
The ADB agreed a partnership strategy with Azerbaijan in September 2014 aimed at broadening the country’s economy through expanded transport links and a greater focus on renewable energy and energy efficiency. In keeping with the government’s Azerbaijan 2020 strategy, the ADB is also providing technical assistance and advice on a shift from 10 to 12 years of education.
Still, policymakers need to be careful not to burn through their fiscal reserves in search of a quick fix.
“The immediate response is to keep the macro framework sound because, without that, any further development of the non-oil sector would be much more difficult. The development of the non-oil sector is a long process. It doesn’t happen overnight,” said Gerhauesser.
“It’s a structural reform, which is necessary, and it’s something that will show a much bigger share of GDP in five to 10 years’ time.”
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