THE GLOBAL CRİSİS AND FİNA NCIAL STABILITY İN AZERBAIJAN

1. NATIONAL BANK OF AZERBAIJAN KHAGANI ABDULLAYEV, EXECUTIVE DIRECTOR THE GLOBAL CRİSİS AND FİNANCIAL STABILITY İN AZERBAIJAN

2. Contents • Recent Macroeconomic Developments • The Global Crisis and the Banking System • Prudential Regulation and the Monetary Policy • Policies for 2009

3. 1. Recent Macroeconomic Developments High economic growth has been driven by the oil industry expansion and active fiscal policy The average annual growth rate stood at 24% in 2004-2007 Rising public expenditures (investments) has been the main force behind booming non-tradable activities. Up to 75% of new jobs have been concentrated in the non-tradable sector.

4. 1. Recent Macroeconomic Developments Given the large scale use of the oil revenues, the money supply almost tripled in 2006-2008 The non - oil GDP monetization reached almost 40%; Aggregate demand expansion has been followed by rising inflation, while the real income growth staying positive (10-15%) ; Declining real interest rates stimulated “consumer credit boom”.

5. 1. Recent Macroeconomic Developments The current account surplus reached 40% of GDP. Given the growing demand for credit, banks increased externalsources of borrowing The ratio of loans to individuals to consumption expenditures increased from 3% to 22% in 2001-2007 Banks’ loan portfolio increased 5 times in 2004-07. 2/3 of the loan portfolio has been concentrated in the non-tradable activities Ratio of bank assets to the non-oil GDP approached 60% Growth rate of external loans Current account/GDP Banks’ foreign borrowings, million manats (right scale)

6. 1. Recent Macroeconomic Developments: Growth Stabilization in 2008 As the oil extraction approached its peak level, the growth of the industry started stabilizing, inflation rate showed signs of declining With the world financial crisis turning into global recession, Azerbaijan was not under its heavy impact Inflation did not grow as high as in 2007 due to 1) falling commodity prices at the world markets 2) the Nominal Effective Exchange rate appreciation at more than 12% (AZN is pegged to basket) The money supply growth has been twice lower than in 2007, but the non-oil GDP continued growing at two digit level as a result of sufficient fiscal stimulus to economy

7. 1. Recent Macroeconomic Developments: Global Crisis, External and Fiscal Sustainability • Strategic foreign exchange reserves (State Oil Fund, Central Bank and Treasury) of Azerbaijan - 18.1 bln. USD 1. Reserves/ gross foreign debt ratio: 200% 2. In months of the non-oil imports of goods and services: 27 months • International Investment Position, net claims: 13 bln. USD • Share of bank’s external liabilities in total liabilities : 25% • Forecast for the State Oil Fund reserves with the oil prices of 30$ per barrel, in percent of GDP (transfers to state budget excluded)

8. 2. The Global Crisis and the Banking System Banks’ reaction to global crisis was quite rational: over 1 bln. USD out of outstanding foreign debt was paid back. In addition, under psychological impact of global crisis and prudent risk management policies of the central bank, banks switched to conservative credit policies . The growth rate of credits moderated

9. 2. The Global Crisis and the Banking System • Because of squeezing schedules on the foreign debt service, banks accumulated enough liquid assets as a precautionary step to safeguard against any unexpected events • Ratio of liquid assets to the foreign debt stock is 99%, while its ratio to total assets is 21%

10. 3. Prudential Regulation and the Monetary Policy:Main Steps in 2008 PRUDENTIAL REGULATION: 1. Strict Provisioning Policy and Tight Lending Standards: • increased risk classification of assets • increased LTV (from 120 to 150%) 2. Risk Management requirements - private action plans on individual banks MONETARY POLICY: • Reduction of the main refinancing rate from 15% to 8% • Reduced required reserves from 12% to 6% • Abolition of a 5% reserve requirement on external borrowing • The resulting impact: liquidity injection equivalent to 10% of the monetary base

11. 3. Prudential Regulation and the Monetary Policy:Policy Results Main policy outcome in 2008: Stability, High Liquidity, Adequate Portfolio Quality

12. 4. Policies for 2009 Risks in 2009: • Uncertain oil prices and global demand; • Decline in investment flows around the globe; • Impact of crisis in neighbors (Russian Federation: ruble depreciation, falling money remittances etc.) Main Policy Task: Smoothing the impact of global crisis on domestic economy and prevention of the sharp demand contraction Supporting Policy of the National Bank of Azerbaijan: • Sound Prudential Policy (strengthening the capital position, maintaining adequate level of the asset quality , liquidity and risk management) • Liquidity Support to banks through activating the refinancing facilities • Allow for More Exchange Rate Flexibility to Absorb External Shocks and to Focus More on Liquidity, Demand Management and Inflation Targets • Confidence measures: Central Bank”s guarantee on lending at the interbank money market and further increase of the deposit cell covered under the current deposit insurance scheme

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