Enjoining a massive oil-boom
Overview:
Azerbaijan is enjoying an extraordinary period of economic growth related not only to high oil and gas prices but to sharp increases in production. It has benefitted hugely from the opening of key pipelines and its geo-political standing remains strong given the ongoing struggle for the commitment of Caspian hydrocarbon resources to competing pipeline projects. This continues to have the unfortunate side-effect of drawing attention away from the weak democratic credentials of the Aliyev regime. However, there are significant economic challenges too. The authorities wish to use the oil and gas bonanza to reduce poverty levels directly but their efforts to do so mean that monetary and fiscal policies are too loose, as demonstrated by rising inflation. Also, oil and gas production is expected to fall from 2015 and there are doubts that this temporary windfall is being spent efficiently.
Recommendation:
Nominal interest rates are relatively high but real interest rates are still too low. The currency may be moderately undervalued but the authorities are cautious to let it appreciate quickly given the temporary nature of the oil and gas boom. Fiscal policy is also too loose. Financial markets are thin and under-developed and the banking sector may well also be growing at an unsustainably fast rate. We are therefore neutral on local interest rates.