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Azerbaijan: dealing with foreign exchange inflows Emin Huseynov The National Bank of the Republic of Azerbaijan Recent macroeconomic performance Inflows Outflows Net inflows Specific features of Azeri case Demand management policies Structural reforms Outline strong overall economic growth modest non-oil growth intensified demand pressures real exchange appreciation Recent macroeconomic performance 160 135 120 % 98,3 80 57,6 31,6 34,5 Czech Republic Hungary 40 62,3 26,8 0 Azerbaijan Kazakhstan Ukraine Russia Poland GDP growth during the 20002006, % 7500 6000 4500 2383 3000 1500 665 714 774 897 1610 1060 0 2000 2001 Kyrgyz Republic 2002 Armenia 2003 2004 Azerbaijan 2005 Kazakhstan 2006 Russia GDP per capita in selected CIS countries, USD 40 35 30 % 25 20 15 10 5 0 2000 Agriculture 2001 Mining 2002 Construction 2003 Trade 2004 2005 Transport, communication Sector’s contribution to GDP growth, % 2006 GDP growth 10000 12% 8000 10% 6000 8% 4000 6% 2000 4% 0 2000 2001 2002 2003 2004 2005 2006 2% -2000 -4000 C onsumption Investment Net exports Demand pressures annual inflation 0% 5 100 90 4 80 70 3 60 50 2 40 30 1 20 10 0 0 2006 2005 2004 2003 2002 2001 2000 1999 Total deposits (in percent of GDP; left) FOREX deposits (in percent of total deposits; right) Confidence in banks improved, dollarization declined Export of goods and services, mostly oil related FDI’s, mostly oil related Remittances Bank borrowing Inflows 14 12 10 8 6 4 2 0 2000 2001 Oil exports 2002 2003 Non-oil exports 2004 FDI Inflows, bln. USD 2005 Bank borrowing 2006 Remittances Imports of goods and services Capital repatriation Profit repatriation Outflows 0 -1 000 -2 000 -3 000 -4 000 -5 000 -6 000 -7 000 -8 000 -9 000 2000 2001 2002 Improts of goods and services 2003 2004 C apital repatriation Outflows, mln. USD 2005 2006 Profit repatriation 4000 3500 3000 2500 2000 1500 1000 500 0 -500 2000 2001 2002 2003 2004 Net inflows, mln. USD 2005 2006 Significant oil revenues Short horizon of production profile various estimates indicate $140-$200 billion until 2024, which is about 10-fold of GDP in 2006 proven hydrocarbon resources would almost be depleted at end-2024 Existing pipeline infrastructure to the world market completion of BTC opens up prospects of continued revenue base even after oil and gas dries up Specific features of Azeri case 16000 14000 12000 10000 8000 6000 4000 Profit tax Government's share Oil revenues, mln. USD 2024 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 2012 2011 2010 2009 2007 0 2008 2000 Transparent and best practice governance framework established but not fully operationalized Effective coordination of macroeconomic policies of demand management is lacking Underdeveloped domestic financial markets and low initial level of financial intermediation Unfinished agenda of structural reforms, especially in the non-financial corporate sector Specific features of Azeri case 1600 1400 1200 1000 800 600 400 200 0 2000 2001 2002 Taxes from AIOC 2003 2004 Taxes from SOCAR 2005 2006 Transfers from SOFAZ Oil revenues accruing to Government Budget, mln.$ 2007 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 Non-oil overall balance to Non-oil GDP Budget expenditure growth (right scale) Expansionary fiscal policy framework 2000 1600 1200 800 400 0 2000 2001 2002 2003 Change in SOF assets 2004 2005 2006 2007 Change in NBA assets Excess FX sterilization, mln. USD 2500 (mln.AZN) 2000 1500 1000 500 0 2000 2001 2002 NFA 2003 2004 Reserve money Monetary impact 2005 2006 I. Handling monetary impact Partial FX sterilization Efforts to liberalize capital outflows Limited appreciation Partial sterilization by ANB notes These measures have not been sufficient to constrain demand so far Demand management policies 300 250 200 150 100 50 0 2003 2004 2005 Monetary Sterilization NBA’s paper, mln. AZN 2006 2007f 0.9900 120 0.9800 0.9700 100 0.9600 0.9500 80 0.9400 0.9300 60 0.9200 0.9100 40 0.9000 0.8900 20 0.8800 0.8700 0.8600 0 2 000 2 001 2 002 2 003 Ex. Rate USD/AZN 2 004 2 005 NEER Limited X-rate flexibility 2 006 II. Constraining fiscal expansion A rule-based cap on maximum oil revenues to be used in one year: PIH, non-oil GDP growth, real productivity growth, model-based estimates consistent with low and stable inflation, etc. Nominal growth of expenditure to be limited to under 10% for the period of 2008-2024 Non-oil revenue growth to match that of current expenditure Ineffective public investments to be minimized Demand management policies III. Adopting inflation targeting in the mediumterm Inflation target to be set for medium-term Operational independence of the monetary authority to be ensured Flexible X-rate policy to be adopted Macroeconomic coordination to be strengthened Gradual switch from monetary targeting to interest rate targeting Demand management policies Reduction of the role of state in the economy Completion of reforms in the utilities sector Introduction of corporate governance principles in state enterprises Deepening and expansion of financial sector Improving tax administration Structural reforms