Currency inflows: what can Azerbaijan expect in 2023? Review by Caliber.Az

One of the noteworthy achievements of the past year was a more than twelve-percent growth in the total gold and foreign exchange reserves of Azerbaijan. Rising income from oil and gas exports, a high level of balance of payments, and a trade surplus allowed increasing the country's "rainy-day fund" to some $60 billion. Moreover, the foreign exchange reserves of the Central Bank of Azerbaijan (CBA) replenished most rapidly: according to recently published data, they increased in 2022 by more than 27%, exceeding $8.995 billion, and almost approached the record levels of seven years ago. According to expert forecasts, the favourable foreign trade environment will allow the high level of reserves to be maintained this year as well.

The instability in the gas market observed back in 2021 has developed into a full-blown global energy crisis due to the war in Ukraine and the subsequent anti-Russian sanctions. In 2022, the EU almost refused to buy Russian "blue fuel", a similar situation occurred with regard to oil supplies. Among other things, EU restrictions on crude oil exports from Russia came into force on December 5, setting a price cap on Russian oil of around $60 per barrel. From February 5, 2023, a price cap will also be imposed on Russian oil products. The refusal to buy Russian oil and gas, and the imposition of restrictive price caps on such raw material supplies, had a very negative impact on the fuel market of the energy-intensive industry in Europe as well, becoming the key background that determined the subsequent negative trends on the financial and stock markets around the world. At the peak of the crisis, the prices for natural gas in the European market exceeded $4,000 per 1,000 cubic meters. And the price of a barrel of Brent oil rose to $120, the last time such prices were recorded in early 2014, before the onset of the multi-year energy downturn.

The huge demand for gas, oil and other energy resources in the Old World has contributed to an unprecedented growth in liquefied gas supplies from the US and the Persian Gulf, while pipeline gas exports from Norway and North African countries have increased. Such large-scale energy diversification enabled many other countries to increase their supplies to the large European market, and Azerbaijan became one of the beneficiaries of these processes. Moreover, one of the advantages of our country is the relatively lower cost (compared with offshore supplies of liquefied gas) of pipeline gas deliveries through the Southern Gas Corridor (SGC) system. As a result, Azerbaijani gas exports to the southern European region of Italy, Greece, and Bulgaria alone rose to 11.3 bcm (billion cubic metres) in 2022, almost a quarter more than a year earlier. In general, for the eleven months of last year, all exports of Azeri gas amounted to 20.1 bcm, and given the high world prices its value exceeded $15 billion with more than a three-fold increase in profitability.

Quite impressive profitability indicators were observed also on the oil track: in January-November last year the republic exported over 24.318 thousand tons of oil raw materials for over $18.318 billion, which ensured income growth by 49.1%.

Oil and gas products accounted for 92.6% of total national exports and the increased foreign exchange earnings were a key factor in the build-up of the country's foreign exchange reserves. The average price of Brent oil in January-November 2022 was $100.9 per barrel, compared to the average price of $71 per barrel a year earlier, which increased by 42%. Thus, the global average price of hydrocarbons was noticeably higher than the projected oil cut-off price ($70 per barrel Brent) in Azerbaijan's last year's budget, and this difference was accumulated in the country's reserve funds.

The country's strategic foreign exchange reserves consist of CBA reserves, assets of the State Oil Fund (SOFAZ), and treasury funds of the Ministry of Finance. As a result, in January-November 2022, amid a high surplus of 30.7% of GDP and thanks to a trade surplus of over $23.454 billion (2.5 times growth) currency reserves of the country grew by 12.3%, reaching an impressive amount of $59.8 billion.

The bulk of the reserves, about 85.5%, are accumulated in the SOFAZ, the next largest financial cushion held by the Central Bank, with the CBA holding record reserves last year. At the end of December, the central bank's foreign exchange reserves exceeded $8.995 billion, an increase of $1.920 billion, or 27.1%, from the end of 2021. The last time the country's financial regulator had such a high level of savings (just over $9 billion) was in March 2015. But then the CBA was forced to spend the lion's share of its foreign currency reserves to bail out the collapsing manat under the weight of devaluation and support local banks drowning in the credit crisis.

Fortunately, today the situation in the financial market is qualitatively different from seven years ago: during 2022 the currency market of Azerbaijan remained stable, and the exchange rate of the manat against the dollar did not change. At joint currency auctions with the CBA, the SOFAZ fully satisfied the demand of banks for the dollar, and thus the Central Bank did not have to use its currency reserves. Moreover, during the year, in order to stabilize the exchange rate of the national currency (preventing its excessive appreciation), excessive foreign exchange was sterilized from the market, and this also replenished the reserves of the financial regulator.

What will the year 2023 look like in terms of currency inflows and will the country manage to keep the positive trends in the reserves sphere?

In particular, experts of the International Monetary Fund (IMF) forecast an increase in SOFAZ assets by 82.3% - to $82.076 billion in 2022-2028. In turn, in a recent report of the Asian Development Bank (ADB), CBA foreign exchange reserves growth by 2023 is estimated at $10.2 billion. It is obvious that without steady high oil and gas prices, the IMF and ADB estimates of the growth of our country's foreign exchange reserves simply would not be possible.

The country's central bank is also looking at the current year in a fairly positive light for foreign exchange earnings growth: based on forecasts by leading analytical centres for the price of Brent oil, the regulator estimates the average annual oil price at $92 per barrel. And these estimates are quite in line with OPEC+ and International Energy Agency (IEA) forecasts, where they believe that as a result of the anti-Russian embargo in 2023, Russian oil production will decrease by 1,4 million barrels, which will support demand and oil prices, including those for diesel fuel. In their turn, analysts of leading world rating companies and banks (Fitch, JPMorgan, Bank of America, Goldman Sachs) see the price per barrel of Brent in the range from $80 to $110 this year, which is more than acceptable for Azerbaijan, where oil revenues of the state budget for 2023 are calculated on the average price of $50 per barrel. Thus, the expected dynamics of hydrocarbon prices will significantly outpace the cut-off price, contributing to the growth of oil and gas revenues for SOFAZ this year and probably in the future.

The importance of this fact can hardly be overestimated: on the one hand, a surplus of reserves, if necessary, will allow for an increase in financing of the most important areas in the economy, including rehabilitation and infrastructure projects in the Karabakh region, on the other - it expands the country's opportunities for external borrowing. Finally, the growth of foreign exchange reserves, the amount of which is now many times higher than the country's external debt, forms a reliable "rainy-day fund" and allows for an adequate response to possible external shocks and monetary risks.