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FEDERATION OF EURO-ASIAN STOCK EXCHANGES SEMI ANNUAL REPORT OCTOBER 2006<br />
BAKU INTERBANK CURRENCY EXCHANGE<br />
ECONOMIC AND POLITICAL DEVELOPMENTS<br />
Economic and Political Environment<br />
It is expected that Mr. Aliyev will continue to<br />
consolidate his position over the forecast<br />
period, by sidelining potential rivals and<br />
placing loyalists in positions of power.<br />
Azerbaijan's growing oil wealth will enable<br />
Mr. Aliyev to increase expenditure on wages<br />
and infrastructure–thereby allowing him to<br />
claim that he is distributing the benefits of<br />
the oil boom.<br />
Azerbaijan will continue to balance its foreign<br />
policy orientation, seeking to maintain stable<br />
relations with the West at the same time as<br />
developing military and economic ties with<br />
Russia and keeping relations with Iran on an<br />
even keel. Prospects for a resolution of the<br />
conflict with Armenia over the disputed<br />
region of Nagorny Karabakh have receded,<br />
following the failure of presidential talks in<br />
February 2006 to reach consensus over a<br />
framework peace agreement. Further<br />
progress is unlikely in the forecast period,<br />
given the approach of a parliamentary<br />
election in Armenia in 2007 and presidential<br />
elections in both countries in 2008.<br />
Economic policy will focus on the challenge<br />
of maintaining macroeconomic stability<br />
during a period of rapid economic growth.<br />
Budgetary spending on welfare and<br />
infrastructure projects will rise, with the aim<br />
of alleviating poverty (particularly among<br />
those displaced from Nagorny Karabakh).<br />
In conjunction with a large increase in<br />
foreign-currency inflows from oil exports, the<br />
rise in government spending risks sparking<br />
an acceleration in inflation. Official debt, both<br />
domestic and external, will remain low, but<br />
the issuance of domestic debt will increase<br />
as a way of mopping up excess liquidity<br />
linked to hard-currency inflows. Greater<br />
reliance on hydrocarbons resources will<br />
adversely affect the structure of Azerbaijan's<br />
economy. Together with increasing concerns<br />
about the business environment, the weak<br />
banking sector and poor legal framework,<br />
the growing dependence on hydrocarbons<br />
will exacerbate the differences between the<br />
oil and non-oil sectors.<br />
Economic Performance<br />
A surge in hydrocarbons output will support<br />
Azerbaijan's economic expansion in 2006-07.<br />
Production came on stream at the Azeri-<br />
Chirag-Guneshli (ACG) oilfields in February<br />
2005, and crude oil has now filled the Baku-<br />
Tbilisi-Ceyhan (BTC) export pipeline, with the<br />
first tanker leaving Ceyhan in early June.<br />
Crude oil production will increase steadily<br />
over the next few years, reaching just under<br />
1m barrels/day by 2007. Gas from the Shah<br />
Deniz field is expected to come on stream in<br />
September-October 2006, which will provide<br />
a further boost to economic growth.<br />
The main factors fuelling consumer price<br />
inflation will be the rapid growth in budget<br />
expenditure and continued strong foreign<br />
exchange inflows associated with the oil and<br />
gas sector. Robust private consumption,<br />
owing to sharply rising wages in the oil and<br />
oil-related sectors, will also exert inflationary<br />
pressure. In response, the authorities will<br />
tighten monetary policy slightly and will allow<br />
the manat to appreciate. However, because<br />
of the dominance of foreign currency in the<br />
money supply, and a continuing lack of<br />
public confidence in the manat, the<br />
strengthening of the local currency will<br />
have only a limited impact on inflation.<br />
We therefore expect annual average inflation<br />
to remain at around 6.5% in 2006-07,<br />
although the lack of monetary policy tools<br />
available to the authorities could result in a<br />
somewhat higher rate.<br />
Hard-currency inflows from oil exports will<br />
strengthen the manat in both nominal and<br />
real effective terms over our forecast period<br />
and beyond. The National Bank of Azerbaijan<br />
(NBA, the central bank) will attempt to<br />
sterilize foreign-currency inflows through<br />
the sale of Treasury bills and the use of<br />
Azerbaijan's overseas oil fund, the State Oil<br />
Fund of the Republic of Azerbaijan (SOFAZ).<br />
However, the amount of short-term paper<br />
involved will be small. As Azerbaijan's rate<br />
of inflation will remain high compared with<br />
those of its trading partners, this will produce<br />
a real effective appreciation of around<br />
10-15% between end-2005 and end-2007.<br />
Nevertheless, the manat will still be some<br />
15% weaker in real effective terms than its<br />
rate in 1997. This will mitigate the impact of<br />
the real effective appreciation on the export<br />
competitiveness of Azerbaijan's non-oil<br />
sectors.*<br />
* The Economist Intelligence Unit Ltd., July 2006<br />
Key Information Contacts<br />
National Bank www.nba.az<br />
State Committee for Securities www.scs.gov.az<br />
Ministry of Finance www.maliyye.gov.az<br />
National Depository Center www.mdm.az<br />
Ministry of Economic Development www.economy.gov.az<br />
2003-MAIN ORIGINS OF GROSS DOMESTIC PRODUCT (%)<br />
2003-MAIN COMPONENTS OF GROSS DOMESTIC PRODUCT (%)<br />
Agriculture Industry Construction<br />
Transport & communications Other<br />
Public consumption<br />
Gross fixed investment<br />
Private consumption<br />
Net exports of goods & services<br />
49.9<br />
12.1<br />
10.6<br />
13.1<br />
14.3<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
10<br />
0<br />
-10<br />
-20<br />
-30<br />
11.7<br />
63.2<br />
50.8<br />
-24.0<br />
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