AZERBAIJAN: IMF READOUT ON ECONOMY IN LATE 2005

C O N F I D E N T I A L SECTION 01 OF 02 BAKU 000219

SIPDIS

SIPDIS

E.O. 12958: DECL: 02/14/2016
TAGS: ECON EFIN PREL PGOV AJ
SUBJECT: AZERBAIJAN: IMF READOUT ON ECONOMY IN LATE 2005
AND EARLY 2006

REF: BAKU 205

Classified By: Ambassador Reno L. Harnish III, Reasons 1.4 (b)(d).


1. (SBU) SUMMARY: According to the IMF resident
representative, the slowdown in inflation during the last
quarter of 2005 was due primarily to a combination of nominal
appreciation in the manat and a deceleration in money growth.
In addition, it appears that many businesses did not raise
prices in late 2005, following through on a Presidential
Decree of May 2005 ordering a delay in price increases. The
Consumer Price Index in January 2006, however, increased 1.3
percent, indicating that prices have started to rise. The
IMF noted that the GOAJ had still not yet prepared a list of
capital expenditure projects, although a mysterious
government decree has allowed spending on a select number of
projects to begin. The IMF warned that GOAJ spending plans
for 2006 were a direct threat to the competitiveness of the
non-oil sector and could lead to currency appreciation. END
SUMMARY.


2. (SBU) At the February 2 meeting of the Revenue Management
Group, the IMF reported that recent monetary data, which
showed a sharp slowdown in the rate of growth of the broad
money supply, confirmed that the slowdown in inflation in the
last months of 2005 was related to a combination of nominal
appreciation in the manat and a deceleration in money growth.
The IMF noted that these factors may have been associated
with political uncertainties connected with the November
parliamentary elections and the expectation among some
members of the public that the manat would depreciate to
5,000 to the U.S. dollar on January 1 following the
redenomination. There was also the likelihood that President
Aliyev's May 2005 instruction to monopolists to delay price
increases may have carried over through the pre-election
period. The Consumer Price Index in January 2006, however,
increased 1.3 percent, indicating that prices have started to
rise.


3. (C) On the fiscal front, the IMF reported that the capital
budget for 2006 had not yet been established and discussions
continue between the Cabinet of Ministers and the
President,s office. The approved amount of possible capital
expenditures could total close to USD 1 billion. A contact
at the National Bank told EconOff that this "free" money
represented a serious threat to the balance of the economy.
The IMF also noted that a mysterious decree had been issued
by the Cabinet of Ministers in mid-January that allowed
spending on selected projects to commence. The IMF and
Embassy have not been able to locate this decree and a
contact at the National Bank told EconOff that he had not
heard of the decree.


4. (C) The IMF resident representative commented that Fitch's
recent long-term rating report on Azerbaijan (which confirmed
the BB (stable) sovereign rating) must have come as something
of a disappointment to the GOAJ as it had been expecting an
upgrade, as evidenced by GOAJ interest in a Euro-bond issue
later this year and the rapid build-up of foreign assets by
the State Oil Fund (SOFAZ) and the National Bank. There are
rumors that Moody's is planning to come to Azerbaijan shortly
to perform a sovereign debt rating. In previous discussions,
Minister of Economic Development Babayev had told Ambassador
Harnish that the GOAJ wanted to receive an "investment grade"
sovereign debt rating in order to attract more international
capital.


5. (SBU) The IMF representative also discussed the potential
for manat appreciation and the impact on the competitiveness
of the non-oil sector. He indicated that the spending plans
of the GOAJ were a clear threat to the competitiveness of the
non-oil sector and could lead to excess demand which would
appreciate the real effective exchange rate. This real
appreciation would put pressure on both the nominal exchange
rate and on prices. The split between the two would depend
on the National Bank policies - but in either case the
competitiveness of the non-oil sector would be undermined.
Experience suggested that the nominal appreciation of the
manat is limited by political factors to about 10 percent per
year and that remaining demand pressures would spill over
into inflation.


6. (SBU) The IMF will send a technical assistance mission to
Baku in late-February to review the appropriateness of the
mid-2005 change in CPI methodology. There are suspicions
that this change may have resulted in a systematic downward
bias in the headline inflation numbers. This visit this will
be followed by an Area Department mission in mid-April. At

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that time there may be a better indication of the GOAJ,s
intentions for a possible precautionary stand-by arrangement.
HARNISH