IFIS WEIGH IN ON EFFECT OF GLOBAL FINANCIAL CRISIS

C O N F I D E N T I A L BAKU 000023

SIPDIS

EEB FOR TIM GILMAN
EUR/ERA FOR BENJAMIN ROCKWELL
TREASURY FOR JEFF BAKER

E.O. 12958: DECL: 01/12/2019
TAGS: ECON EFIN ETRD EXIM EINV AJ
SUBJECT: IFIS WEIGH IN ON EFFECT OF GLOBAL FINANCIAL CRISIS
IN AZERBAIJAN

REF: 08 BAKU 863

Classified By: Political-Economic Counselor Rob Garverick, Reasons 1.4
(b and d).


1. (C) Summary: In early December, EconOffs met separately
with representatives of the EBRD, IMF, and World Bank in
Azerbaijan who unanimously expressed confidence that the
Azerbaijani economy and banking sector would be able to
absorb the twin shocks of the global credit crisis and the
sharp decline in energy export prices with only a modest
decline in economic growth over the near term. They did
express some concern that the housing and construction
sectors were vulnerable to a sharper downturn in the longer
run if commercial banks continue to curtail real estate and
consumer lending. The financial experts noted that
Azerbaijan may find budget implementation tricky this year.
Inflationary pressures, which have been strong, may ease
because of lower commodity prices. The manat (currency) is
likely to be stable, as Azerbaijan runs a current account
surplus, has large reserves, and few debt instruments exist
for potential speculators. Weaker currencies in neighboring
states, particularly Russia and Ukraine, could lead to
cheaper imports, putting a hurt on Azerbaijan's non-energy
sector. End Summary.

International Monetary Fund (IMF)
--------------


2. (C) On December 2 EconOffs met with IMF Resident
Representative Koba Gvenetadze to discuss the economic
outlook for Azerbaijan and other key issues. The IMF expects
some slowdown in Azerbaijan's economic growth due to the
global credit crunch, as domestic commercial banks have cut
back on providing consumer credit. Gvenetadze indicated that
the real estate market is particularly vulnerable, and has
heard anecdotal reports that inventories of unsold apartments
in Baku are on the rise. He noted that because of the global
credit crisis domestic banks will not be able to roll over
outstanding external lines of credit, but that the total
external credit currently held by Azerbaijani banks is small
at 2.6 billion USD, of which 1 billion USD is due next year.
Meanwhile, Azerbaijan claims its reserves exceed 18 billion
USD, thanks to windfall oil profits.


3. (C) Gvenetadze said that the National Bank of
Azerabaijan's December 1 decision to reduce reserve
requirements was the third policy adjustment this year. He
believes the NBA has perhaps acted too quickly and might have
been better off waiting to see the next set of inflation
figures before injecting additional liquidity into the
banking system. He suggested that the reason for these
proactive efforts might be due to pressure from commercial
banks or because, as th central bank, the NBA has access to
confidentia banking information which suggests the sector is
under more stress than the GOAJ has been willing t admit.


4. (C) Regarding the budget, Gvenetadz opined that the GOAJ
has not yet decided exactl how it will implement the budget
in 2009, partiularly in terms of transfers to the budget
from the State Oil Fund (SOFAZ) even though a notional amount
had been announced. (NOTE: The official budget was published
on December 11, details reported septel. End Note.) He
indicated that GOAJ officials are aware that budget
flexibility in the year ahead will be necessary to handle the
uncertainties related to fluctuating oil prices and the
global financial crisis. He said that non-oil economic
growth will also be slowed by the reduction in government
spending increases in 2009. The key question will be what
programs GOAJ will choose to cut.


5. (C) Gvenetadze anticipates that the fall in global
commodity prices will allow 12-month inflation to register
near 17 percent, down from an earlier estimated 21-22
percent, for 2008. However, he acknowledged that
inefficiencies in the customs office are also likely to
produce some stickiness in prices and will impede the
transmission of lower import prices to domestic consumers.




6. (C) Gvenetadze stated that the IMF considers official
GOAJ statistics on key macroeconomic variables such as GDP
and inflation to be fairly accurate and worth using as
indicators, although he commented that the data is by no
means perfect. He conceded that some data, such as that on
labor and balance of payments are less reliable.
Specifically, unemployment information is not particularly
dependable because of the challenges of conducting surveys on
a regular basis. Balance of payments data is thought to be
less reliable in part because remittances are difficult to
estimate.

European Bank for Reconstruction and Development (EBRD)
-------------- --------------


7. (C) EconOffs met with EBRD Senior Banker and Head of
Office Francis Delaey on December 4 to discuss banking and
business conditions in Azerbaijan. Delaey noted that the
EBRD works directly with 9 banks in Azerbaijan, some of which
are more vulnerable than others. He confirmed that Unibank
took out a 50 million ANZ loan from the NBA, and suggested
that it may still need to borrow additional funds in 2009 to
address liquidity issues. He noted that other banks are in a
better position but may need some help meeting liquidity
needs. Delaey does not consider the problems threatening
Azerbaijan's economy and banking sector to be a direct result
of the global financial crisis, but rather a peripheral
development. He expects the biggest threat to come from a
sharp downturn in the real estate market, which would have
repercussions on the banking sector.


8. (C) He remarked that most banks have become much more
conservative, especially in consumer lending and mentioned
rumors that obtaining consumer credit is increasingly
difficult. He suggested that, if true, this could negatively
impact companies which rely on consumer credit for "big
ticket" sales, such as car dealerships. He also noted that
many bank loans are secured by real estate and suggested that
this could trigger a fall in real estate prices, as banks cut
back on lending "perhaps exacerbated by the global credit
crunch," which could precipitate a decline in housing prices.
Delaey said he expects the property market in Baku to
undergo a substantial correction but suggested that even if
that were to happen, the GOAJ could be in a position to buy
up unsold apartment blocks from private developers and then
offer this housing to civil servants andothers. While not
recommending complacency regaring the potential for a
downturn in Azerbaijan'seconomy, Delaey implied that the
situation wouldnot be as challenging as that in Kazakhstan,
Ukrine, or Russia. He flagged the potential for econmic
issues in neighboring economies to affect Azebaijan's
competitiveness and suggested that local non-oil sectors were
already struggling because, with the ruble's depreciation,
imports from Russia are now more competitive. He offered
milk as an example of a product where imports were more
competitively priced than local products.


9. (C) According to Delaey, the EBRD plans to allocate 50
million USD to the banking sector in 2009 and is interested
assisting Azerbaijan's infrastructure development, but there
are no such projects in the pipeline. Part of the difficulty
in winning project bids is that EBRD financing tends to be
more expensive than commercial bank loans and the EBRD has
conditionality requirements for procurement, etc. In light
of the global financial crisis, however, he expects that
investors will find it more difficult to raise money from
commercial sources and this may be an impetus for Azerbaijan
to increase its engagement with IFIs like the EBRD.
Nonetheless, Delaey said he doesn't think the GOAJ has yet
fully realized how much the lending environment has changed
because of the global financial crisis.

World Bank
--------------


10. (C) On December 15 EconOffs met with World Bank Country
Manager Gregory Jedrzejczak and Senior Operations Officer
Saida Bagirli to discuss recent macroeconomic developments
and economic reforms. World Bank officials say that they

have been working with MoED, MinFin and NBA on modeling
macroeconomic indicators, highlighting the difficulty
theuncertainty of future oil prices adds to that task. They
believe GOAJ officials understand the 70 USD per barrel price
assumption in the 2009 budget is likely overly optimistic.
They commented that the oil price assumption really only
influences how much of the budget is raised through taxes and
that any decline in the flow of tax revenues into the
budget will be offset by transfers from the oil fund, and
that the GOAJ budget staff is really only concerned with
planning expenditures. They noted that the war in Georgia,
the drop in oil prices, and global credit conditions have led
to some confusion within the GOAJ about prudent macroeconomic
policy. Some officials have questioned them why GOAJ should
curb fiscal spending when places like the US and Europe are
embarking on massive fiscal stimulus packages. World Bank
officials stressed that as long as there is money in the oil
fund, GOAJ has the luxury of keeping public spending high.


11. (C) The World Bank expects inflationary pressures in
Azerbaijan to decrease as global prices for oil, steel,
concrete and other commodities decline. Jedrzejczak
suggested that there is likely to be a struggle within GOAJ
as some officials and influential business-people may be
interested in keeping some of these prices artificially
high. He noted that there is an unofficial freeze on new
construction in Baku although GOAJ officials are not likely
to acknowledge this. He said there have been anecdotal
reports that some construction firms are having difficulties
raising financing for projects, noting a collapse in the real
estate sector would probably prompt GOAJ to buy up new,
unsold apartments and essentially bailout housing developers.


12. (C) According to the World Bank, Azerbaijani banks are
on relatively soundfooting, having largely relied on local
sources f capital, and therefore are not significantly
vlnerable to external exposure. It does not forese a
steep drop in the value of the manat as thereare no local
public debt instruments which investrs could use for foreign
exchange speculation. he financial sector is not expected
to experience problems in the near term. However,
there are risks in the real sector from a number of factors.
These include oil prices, lower foreign remittances, and an
increasingly uncompetitive environment where technology is
weak and there are many informal, artificial monopolies.
World Bank experts noted that a ruble devaluation could
facilitate the importation of cheap Russian products which
could prompt GOAJ to implement additional non-tariff measures
at the borders. All of these factors, they noted, could lead
to notable increases in unemployment.

Comment
--------------


13. (C) The Azerbaijani economy is well-positioned to avoid
a sharp contraction but growth is likely to experience some
slowdown particularly in the non-oil sector. However, there
are considerable risks to this assessment as oil prices
continue to be a significant point of uncertainty. The
near-term risks faced by the financial sector are limited but
the real estate and construction sectors are in a more
vulnerable position. Although public expenditures in the
2009 budget show a more modest 15 percent increase over last
year, the reserves held by the State Oil Fund provide a
funding source that GOAJ will probably increasingly rely upon
to compensate for the decline in oil export revenues.
SOFAZ's strong financial position will insulate the GOAJ from
having to cut back drastically on planned expenditures in the
near-term but ongoing transfers from SOFAZ to the general
budget will probably continue to undermine the Fund's
function as a reserve for future generations
LU