Oil Currency Breaks Ranks as Azeris Can’t Quench Dollar Need

  • Manat had its worst month in June since oil’s crash in January
  • Currency diverges from peers as banks, people seek out dollars

As higher energy prices buoy currencies of commodity producers, one is swimming against the tide.

Even after losing more than half its value against the dollar in two devaluations last year, Azerbaijan’s manat is struggling to find a bottom. In fact, it just had its worst month since the height of the crisis in oil markets in January.

The currency market of the third-biggest oil producer in the former Soviet Union is failing to regain balance because the influx of petrodollars isn’t enough to meet demand by households and banks. By contrast, the challenge is the opposite among Azerbaijan’s bigger neighbors across the Caspian. An economic recovery is stuttering in Russia because of a stronger ruble, while the Kazakh central bank has been intervening to buy dollars after the tenge rebounded.

“The fundamental hurdle for the manat to sustainably recover is related to the fact that dollarization is high and not improving,” said Dmitry Polevoy, the chief economist for Russia and the Commonwealth of Independent States at ING Groep NV in Moscow.

Depositor Exodus

The manat’s swoon also shows the perils of adopting a more flexible exchange rate for an economy as reliant on oil as Iraq and Venezuela. As the currencies of the Arabian Gulf continue to face pressure to abandon their pegs to the U.S. dollar, Azerbaijan took the plunge last year, only to ignite a frenzy on the foreign-exchange market as savers fled manat deposits.

The manat lost 3.8 percent against the dollar in June after four months of gains. That was worse than all but one of its peers in the former Soviet Union, with the Russian ruble appreciating 4.3 percent. Oil had its biggest quarterly jump since 2009 in April-June. The Azeri currency was 0.2 percent weaker at 1.5572 against the dollar as of 11:30 a.m. in the capital, Baku.

Restoring trust has been an uphill struggle for Azerbaijan. ING estimates that about 70 percent of deposits are still held in foreign currency, compared with 51 percent in January 2015. The share of loans denominated in foreign currencies may account for as much as half of total credit by end-2016, almost double the level two years earlier, according to S&P Global Ratings.

Azerbaijan’s central bank didn’t respond to requests for comment.

What Now?

Policy options are limited. The central bank has little capacity to intervene after drawing more than two-thirds from its reserves to support the currency and raising interest rates twice this year to the highest since 2008.

The nation’s $34 billion wealth fund has stepped up instead, offering lenders $50 million twice a week in auctions organized by the central bank. In March, it also placed a $500 million deposit at the state-owned International Bank of Azerbaijan, the country’s biggest lender.

That may not be enough. Feeding the demand is the need by banks to repay foreign debt. The International Bank of Azerbaijan alone has $386 million due in the next 12 months. S&P puts the nation’s banking industry in its second-highest risk category, alongside Argentina, Tunisia and Vietnam.

“A tight monetary policy to bring inflation under control and increase demand for manat will be required,” the International Monetary Fund said in a June report after its mission concluded a visit to Azerbaijan.

Lenders already cut foreign obligations by 21 percent to 6.5 billion manat ($4.2 billion) in the first four months of the year, according to Samir Aliyev, an analyst at the Center for Support to Economic Initiatives in Baku.

Another hurdle is that while real rates are below zero on manat deposits, they remain “relatively high” on dollar accounts, according to ING’s Polevoy. The central bank’s benchmark is at 7 percent, compared with annual inflation above 10 percent every month this year. Price growth averaged just over 3 percent in 2015, according to data compiled by Bloomberg.

“To ease the pressure on the manat, the central bank needs to resume intervention in the market,” said Vuqar Bayramov, head of the Center for Economic and Social Development, a research group based in Baku. “The regulator is trying to hold on to its reserves for now, but this can’t continue for long as the state oil fund won’t be able to provide the dollar need in full.”

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