BACKGROUND: On February 21, 2015, the Central Bank of Azerbaijan (CBA) announced a devaluation of the manat by 33 percent against the US$ and 30 percent against the euro. The bank rate for the manat was set at 1.05 manat for US$ 1 from 0.7860 manat. The CBA justified the devaluation as a necessary step to maintain Azerbaijan’s international competitiveness, reduce pressure on public finances, balance payments and protect its sovereign wealth fund reserves.
Kazakhstan has already indicated that expenditures will be cut by around 1 trillion tenge (around US$ 5.4 billion). There is a likelihood that the National Bank of Kazakhstan (Central Bank) may have to devalue the tenge (Kazakh currency) in 2015 as well, either in a one-off devaluation similar to last year’s, or gradually over a longer period.
Oil exports make a large share of Azerbaijan’s and Kazakhstan’s total export earnings. According to the Economist Intelligence Unit’s estimates, oil exports account for US$ 26 billion (86 percent of exports) in Azerbaijan and US$ 54 billion (69 percent of exports) in Kazakhstan. Also, natural gas and petroleum products make up a significant portion of the export basket of both countries. Gas exports account for additional 6 percent of exports. As a result, Azerbaijan is one of the most oil-dependent countries in the world. Kazakhstan is also heavily reliant on oil and gas for its economic well-being, with petroleum products and natural gas constituting about 6 percent of exports.
According to many economic forecasts, oil prices will remain subdued throughout 2015. Prices for petroleum products and natural gas will likely fall as well. Natural gas pricing is not as transparent as oil pricing; natural gas is sold on the basis of long-term contracts indexed to the oil price but with a lag, and can therefore be expected to decrease. Total export revenue may decline by about 40 percent in Azerbaijan and 35 percent in Kazakhstan.
IMPLICATIONS: The total export revenue drop has put immense pressure on both countries’ currencies and balance of payments. For the time being, the Kazakh central bank has kept the tenge’s peg to the U.S. dollar. The sharp fall in the Russian ruble contributed to pressure on Kazakhstan’s currency in particular, due to close trade ties between Kazakhstan and Russia. Decreased oil prices and the lower ruble have increased speculation that the Kazakh central bank will be forced to devalue the tenge again along the lines of the February 2014 19 percent devaluation, despite repeated denials by government officials prior to the devaluation. Financial and economic analysts expect that, based on economic analysis taking into consideration the fall in oil prices and the steep depreciation of the Russian ruble last year, there will be a devaluation of the tenge by 15-20 percent. The tenge is also undergoing a liquidity crunch as the Kazakh population converted most of their savings into U.S. dollars. The liquidity shortage has increased the cost of borrowing and decreased lending, leading to an economic slowdown. The expected devaluation will likely preserve Kazakhstan’s foreign reserves.
Last year’s devaluation caused public anger and rare protests in Almaty. In addition, it triggered a run on three banks and a flight to the dollar by Kazakhstani citizens, and inflation increased significantly as a result. Due to the upcoming presidential and parliamentary elections in 2015 and 2016, authorities may delay the devaluation of the tenge or implement it incrementally over a longer period. Kazakhstan has a small currency exchange market and the central bank has sufficient foreign reserves to maintain the tenge’s peg to the dollar for the foreseeable future. The Central Bank’s external reserves and the national oil fund total more than US$ 100 billion, twice the value of money in circulation in the country at the current exchange rate.
Although Azerbaijan’s CBA in January indicated its commitment to maintaining the manat’s peg to the dollar in 2015, the CBA conducted a one-off 33 percent devaluation of the manat against the US$ on February 21. Because Azerbaijan’s trade surplus has been so large in the past, even a 40 percent fall in dollar export revenue can keep Azerbaijan in surplus for the short to medium term. The manat has been supported by fiscal transfers from the Azerbaijan’s State Oil Fund (SOFAZ), with a value of approximately US$ 13 billion in 2015. Payments into SOFAZ have been higher in recent years and transfers from SOFAZ can be funded by drawing down on foreign currency assets, thereby creating further demand for the manat. However, the Azerbaijani government and the CBA chose to preserve the foreign currency assets by devaluing the manat against the US$.
The significant decline of the Russian economy due to the oil price drop and the Western sanctions has impacted Azerbaijan’s and Kazakhstan’s economies due to close trade ties, particularly between Kazakhstan and Russia. The low Russian ruble has negatively impacted Kazakhstan’s economic competitiveness.
Unlike Russia, which faces western economic sanctions in addition to low prices, Azerbaijan and Kazakhstan do not have major financing pressures and there is sufficient scope to use assets in the sovereign wealth funds to offset revenue shortfalls in 2015. Both countries transfer the bulk of their fiscal revenue from the oil and gas sector into oil funds. The oil funds are then transferred to their national budgets. Transfers will likely be maintained in 2015 despite a decline in foreign reserves, affecting particularly Kazakhstan after Azerbaijan’s devaluation earlier this year. Although both countries have a financial cushion in the form of oil funds, low oil prices and weaker economic growth reduce revenues from the overall economy.
There are reports in Kazakh media that the government has cut its forecast for non-transfer income by 1 trillion tenge (US$ 5.4 billion), which could create a deficit of 4 percent of GDP. Revised expenditure plans and cuts are due to the projected fall in revenue. Kazakhstan’s President Nursultan Nazarbaev urged the government and public to brace for an economic slowdown albeit keeping the promise to continue spending on social areas like healthcare and education.
CONCLUSIONS: The sudden yet sustained decrease in oil prices has put oil-producing countries under fiscal pressure. Azerbaijan and Kazakhstan are not exceptions. Both countries established sovereign wealth funds to accumulate oil and gas export revenue as an insurance policy against challenging economic times like these. So far, Azerbaijani authorities have chosen to devalue the manat in order to protect its sovereign wealth fund reserves. In contrast, Kazakh authorities have chosen to maintain the peg to the U.S. dollar. However, if the lower oil price environment continues for more than a year, Kazakhstan will face a stark choice to either deplete its foreign reserves by maintaining the peg to the U.S. dollar, or devalue the tenge, which will have far-reaching implications for its economy.
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