Economic monitor: Central Asia’s unpegged post-crisis drift

Azerbaijan’s thinly-traded eurobond sold off sharply as the central bank followed through on its early year pledge to float the currency after initial devaluation, and it promptly fell 30% overnight against the dollar. The pattern mirrored peg adjustment in Central Asia’s other major oil exporter, Kazakhstan, with world prices half the budgeted level and the Russian ruble also recovering against the local unit, putting international reserves under unprecedented strain to maintain previous exchange rates.

Baku, Azerbaijan towers

Baku, Azerbaijan towers

Authoritarian President Ilham Aliyev blamed western actions for lower oil and gas values, which account for 95% of exports and 40% of GDP, after Washington and Brussels also criticized recent parliamentary elections. The reserve level had fallen by half from the start of 2015 in October to under $7 billion, and the $35 billion sovereign wealth fund was tapped for the first time to aid in currency defense as well as fiscal deficit coverage. The state-owned oil company, with dollar earnings, will gain from the switch, but the banking system already suffering from a major scandal will be further battered as deposit flight from the manat currency accelerates. With salaries and savings eroding, popular discontent could prompt rethinking of political and economic direction, but officials in Baku have not offered concrete initiatives beyond “compensation for negative consequences.”

Both GDP growth and inflation will end 2015 around 4%, but the former could be halved in 2016 as authorities vow to “stabilize” devaluation induced double-digit price increases. Moody’s estimates the budget deficit at 9% of GDP, and the sovereign wealth fund will continue to bridge the gap without near-term tax hikes and spending cuts to accompany higher dollar-denominated oil revenue. Non-oil agricultural and metal exports remain in a slump, and foreign direct investment slipped 2% through the third quarter on construction and tourism decline after June’s European Games. The lifting of Iranian trade sanctions in the next phase of the nuclear deal could offer a minimal boost, but WTO accession under negotiation for the past decade has been a slow process, according to the EU which backs the bid. Although Azerbaijan surpasses the level in per-capita income terms, it has applied as a developing country enabling subsidy continuation on the basis of hosting a million refugees from the Nagorno-Karabakh border conflict with Armenia.

The World Economic Forum’s latest Global Competitiveness Report ranked Azerbaijan 40 out of 140 countries, two spots above Kazakhstan, with decent marks for growth and labor markets offset by poor anti-corruption and financial sector development progress. Before the devaluation banks were criticized for lack of non-lending services and small business access. Capital markets are in their infancy and the World Bank recently provided funding to modernize Baku Stock Exchange trading. The former head of state-owned International Bank of Azerbaijan, which controls one-third of system assets, was arrested in December on embezzlement charges. Foreign currency deposits are 75% of the total, and the nonperforming loan ratio was 7% in November. Fitch Ratings predicted “debt servicing deterioration” leading to capital and earnings losses after the peg collapse, as several institutions suspended consumer credit.

Kazakhstan currency

Kazakhstan currency

Fitch also noted additional banking system distress from Kazakhstan’s currency free float muddied by regular central bank intervention, as 1% GDP growth and double-digit inflation may threaten the investment-grade sovereign rating. The MSCI stock market index is at the frontier bottom with a 40% loss, despite a revived privatization program announced by President Nursultan Nazarbayev to unload stakes in sixty government-held companies in the coming years. Interest rates remain punishing at 15%, and the tenge recently settled below 300 to the dollar as the monetary authority withdraw liquidity facilities. The 2016 budget gap will be financed by $2 billion in World Bank and Asian Development Bank loans, after the sovereign wealth fund had to inject $5 billion into the main oil and gas company for debt repayment. The president recently fended off speculation that capital controls would also be introduced to support the flailing currency and economy, as heavy-handed Central Asian leaders continue to throttle their financial system lifeblood and reject investor-recommended strengthening formulas.

Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.

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