Impacts of the depreciation of oil prices on Azerbaijan’s economy in 2014.
The objective of this proposal is to determine whether the continuous declining oil prices can create some types of financial crisis in a country which’s economy is based on the oil revenue. The depreciation of oil prices began in mid-2014 and continue until the end of the 2015. The impacts of the depreciation of oil prices are currency crisis, which have 2 phases, and banking crisis.
Keywords: Oil prices; economy of Azerbaijan; currency crisis; banking crisis.
The depreciation of oil prices began in June 2014 and continue until the March 2015, then the prices relatively increased until May 2015 but after the June 2015 it depreciated again until the end of the year. After 5 years of stability oil prices fall more than 40% since June 2014 because of Organization of Petroleum Exporting Countries(OPEC), which controls nearly 40% of the world market, failed to reach agreement on production curbs. As it can be seen from Figure 1, the price of one barrel of Azeri Light crude oil was approximately $113.2 in the June 2014 and then the price started to decline and at the end of March, the price of one barrel of crude oil was $57.3. Moreover, Figure 1 shows that at the end of the January 2015 the price of one barrel of crude oil was $49.4, so the February 2015 might be mentioned as the date when the first and main effect of the depreciation of oil prices took place, because the first phase of currency crisis out of 2 phases happened in Azerbaijan. “A currency crisis can be defined as a speculative attack on a country’s currency that can result in a forced devaluation and possible debt default” (Abbigail J. Chiodo and Michael T. Owyang, p.7,2002).
Source: State Oil Company of Azerbaijan Republic and CESD calculations, August 2015
As mentioned above the currency crisis in Azerbaijan can be divided into 2 phases. The first phase of the currency crisis in Azerbaijan began on 21st February 2015, just 2 days after the declaration of the governor of Central Bank of Azerbaijan that there wouldn’t be sharp depreciation in the value of currency after continuous depreciation of prices of Azerbaijan crude oil. The crisis began after the devaluation of manat (AZN, National Currency of Azerbaijan) by the Central Bank of Azerbaijan. The AZN depreciated in value against US dollar by 33% and had been set at 1.05 manat while it was set at 0.78 against US dollar before devaluation and this devaluation of AZN was first since 2006.
After the March 2015, the price of Azerbaijan oil increased in comparison with the previous months but in June 2015 it started to decline and at the end of the year the one barrel of Azeri Light crude oil was approximately $39.2. This decline leads to the second phase of the currency crisis which is the second effect of the declined oil prices on the economy of Azerbaijan.
The second phase of the currency crisis in Azerbaijan began on 21st December 2015. The Central Bank of Azerbaijan decided to change their policy from fixed exchange rate to the floating exchange rate, because of the continuous declining of oil prices. Following this change in policy by Central Bank the manat depreciated in value against US dollar second time by 47.6% and had been set at 1.55 per 1 US dollar. After 21st December AZN were depreciating almost every day because of 2 reasons. The first and the main reason of depreciation is because of the oil prices continue to depreciate and second reason of depreciation is because of the policy change, it means that before the floating exchange rate when Central Bank of Azerbaijan were supporting the fixed exchange rate, they were spending money in order to take AZN stable.
The third and last effect of depreciation of oil prices was the banking crisis. “Banking crisis refers to actual or potential bank runs or failures that induce commercial banks to suspend the internal convertibility of their liabilities” (Marek Dabrowski, p.303,2016). There were 44 commercial banks in Azerbaijan before the depreciation of oil prices and this is the large number because the population of the country is not high. Many experts state that the optimum number of banks for Azerbaijan is 20-25 banks. After the depreciation of oil prices and also because of the Central Bank of Azerbaijan which adopted new regulation on 1st January 2015 and set higher capital requirements for banks bringing the capital floor up to 50 million manats ($64.1 million) to force banks strengthening and reduce risks, the 2 out of 44 banks closed because they failed to meet Central Bank’s regulation, next year 11 more banks also closed.
The main contribution of proposal is that it shows how the falling of oil prices can affect the economic and financial conditions of a country which’s economy mainly based on oil export and import while creating some types of financial crisis, particularly currency and banking crisis. In other words, the main endowment of this proposal to the knowledge is to demonstrate which types of the financial crisis can occur after the depreciation of oil prices.
The objective of this proposal is to determine whether the continuous declining oil prices can create some types of financial crisis, currency and banking crisis, in a country which’s economy is based on the oil revenue.
Up to now, very little research has been carried out on the impacts of declining oil prices because before mid-2014 there wasn’t any sharp and continuous depreciation of oil prices, so it can be said that there is a gap in the literature.
Marek Dabrowski (2016) advocated that sharp decline of oil prices in July 2014 was affected by the different factors such as slowing progress in emerging-market economies, energy-saving policies in developed and developing countries, and the improvement of renewable energy sources reduced demand for oil. Francesco Grigoli, Alexander Herman and Andrew Swiston (2017) discover that the countries which have more macroeconomic policy space, fiscal and monetary policy, weathered depreciation of oil prices in 2014-2016 better, moreover they found that countries with flexible exchange rate regime got less damage rather than countries with fixed exchange rate regime.
The policy reactions to the depreciation of oil prices by countries depend on several factors and according to Aasim M. Husain, Rabah Arezki, Peter Breuer, Vikram Haksar, Thomas Helbling, Paulo Medas, Martin Sommer, and an IMF Staff Team (2015) these factors are the exchange rate regime, exchange rate valuation, the output gap, inflation and so on.
As mentioned above the depreciation of oil prices in mid-2014 lead to some consequences in the economy of Azerbaijan, such as currency and banking crisis. The main reason why the depreciation of oil prices created currency and banking crisis is because the economy of Azerbaijan is based on oil revenues. So, the decrease in oil prices directly decrease the budget revenue of country, because almost 60% of the budget revenues of Azerbaijan Republic is based on oil revenues. That’s why the depreciation of oil prices lead to the currency crisis in Azerbaijan, because until the 21st December 2015 the Central Bank of Azerbaijan Republic supported the fixed exchange rate regime and the decrease in budget revenue lead to the first phase of currency crisis because when a country uses fixed exchange rate regime, they spend money in order to take currency stable. Moreover, the depreciation of oil prices leads to the banking crisis because of the same reason. Throughout the Great Recession in 2007-2008 the banking sector of Azerbaijan not affected with the state support because the oil prices were high, but now the budget revenues decreased and that’s why the Central Bank of Azerbaijan Republic adopted new regulation.
This phenomenon cannot be generalized to all oil exporter countries. If the countries non-oil sector revenues would constitute big portion of the budget revenues then the decline in oil prices wouldn’t affect them like in Azerbaijan.
The continuous depreciation of oil prices stopped and the prices become more stable nowadays but the impacts of those rapid depreciation on Azerbaijan don’t over. The currency exchange rate is not stable and fluctuates between 1.68-1.72 per 1 US dollar. Moreover, the crisis in the banking sector is not over and at the end of December one of the biggest banks of Azerbaijan Demirbank closed because the aggregate capital of the bank is currently below the minimum level established for banks, as well as the lack of possibility to perform obligations to creditors.
In my opinion, in order to prevent these type crisis in the future, the state should decrease the portion of revenues from oil sector in the budget, it means that to develop non-oil sector. The government of Azerbaijan Republic relatively decreased the portion of revenues from oil sector after the crisis but I think this portion should be decrease until the minimum level and also oil export should be decreased to the minimum level, in order to keep the oil reserves for the future generations as in Norway.
There are a few countries which’s economy based on oil revenues, basically it is the post-Soviet countries such as Azerbaijan, Russia, Kazakhstan and Turkmenistan, and in the literature there are a few researches about the impacts of the depreciation of oil prices and almost all of them describe the effects of the declining oil prices in general but this proposal describe it for the particular country. That’s why I think this proposal will fill the gap in the literature.