Is the Central Bank preparing for devaluation?

115 to regulate an increase in the amount of the ratio of cash in circulation to the monetary base, decrease in the velocity of money in manat, as well as the increase in foreign exchange reserves outside of  banks, the Central Bank decided to apply strict control rules in the foreign exchange market. In this regard, the instruction addressed to commercial banks states[1] that they should collect more detailed information from customers who receive foreign currency during exchange transactions. After that, customers who receive foreign currency, along with the name and surname, must disclose the source of funds and the purpose of the foreign currency received (i.e., for what purpose it was received and how it will be spent). For this purpose, customers must fill out a special form for transactions over $ 500.

If the amount of currency received during the year exceeds 20,000 AZN, the client must also document the information provided in accordance with the rules of the Financial Monitoring Service. For example, if a customer wants to convert the manat he/she received from the sale of any property into dollars, he/she must submit a notarized purchase agreement on the source of the manat he/she wants to convert into dollars. In this case, the customer will be able to exchange manats for dollars in the amount specified in the contract. If the salary is indicated as the source of the manat that the customer wants to convert to dollars, he/she must submit a stamped certificate of salary for the last year.

After that, if customers receive more than the limit of foreign currency in several places in a day, then the person will be asked the source of funds. The income of a customer who is unable to document the source of the funds will be investigated, and the funds of which source cannot be identified will be considered as proceeds from non-entrepreneurial activities and will be taxed in accordance with Article 101.2 of the Tax Code[2]. Article 101.2 of the Tax Code states that non-entrepreneurial activity is taxed at the rate of 14 percent of annual income.

Let’s see why the Central Bank sets monetary policy, which is contrary to the government’s plans to attract foreign investment into the economy, its liberalization, capital and property amnesty as the main activities of the future. What is happening? What are the concerns? In this article, we will look for answers to these questions.

First of all, the Central Bank is already trying to take measures to prevent the evasion of accumulated foreign capital from the country during the post-pandemic. This concern stems from the rapid deterioration of the political situation and the socio-economic situation in the country. Therefore, in order to prevent economic sabotage in such a vulnerable period, the Central Bank tries to control the movement of cash outside the banks, especially foreign currency. According to the Central Bank[3], as of May 1 this year, the ratio of cash in circulation to the monetary base was 80.5 percent. As of that date, the amount of cash (M0) outside banks was 8.705 billion AZN, which is an increase over the same period last year and the previous month. The recent increase in the level of dollarization of deposits also raises the Central Bank’s concerns.

While the beginning of the economic downturn in May (according to the State Statistical Committee, in January-May 2020, GDP decreased by 1.7 percent compared to January-May 2019[4]), the negative foreign trade balance in May (according to the customs statistics of foreign trade of the Republic of Azerbaijan, the foreign trade balance in May amounted to $ 117.024 million[5]), and deficit in the balance of payments according to the results of the 1st quarter of this year (the total balance of the central balance of payments was $ 1,343.5 million[6]) required from the government to take different steps in response to the challenges of the new era, the Central Bank’s tight regulation of the foreign exchange market serves more political purposes and aims to control the capital, to control those with foreign exchange reserves, and to put pressure on them through the tax authorities. In fact, the instruments of economic policy acceptable for the post-pandemic period are the liberalization of currency, taxation, customs regimes, and fiscal decentralization reforms. Otherwise, it will be difficult to attract foreign investment. It seems that in the post-pandemic period, the government, which predicts that it will not be able to stand out in the current competitive environment, will prefer to prevent the inflow of foreign capital.

Secondly, with this decision, the Central Bank is trying to reduce the risks of future devaluation that it will pursue and intends to achieve this by tightening the rules in the foreign exchange market.

According to the Central Bank’s monetary review report[7], the manat’s current velocity  rate has reached its lowest level in five years – 4.08. For comparison, I would like to note that the lowest rate of velocity of the manat for the last 20 years was recorded in January 2015, i.e. on the eve of the first devaluation, and amounted to 2.68 points.

At the same time, according to the Central Bank[8], in the first quarter of 2020, the purchase and sale of dollars in Azerbaijan increased by 60.8%.

Third, the Central Bank, the Financial Monitoring Service, and the State Tax Service are identifying new sources to attract additional funds to the budget. Thus, the basis for taxation of passive capital is formed.

As a result of all this, first, a black market for foreign exchange transactions can be formed, informal foreign exchange transactions with high margins can be stimulated, a double exchange rate system can be formed, in short, the scale of the shadow economy can expand. Secondly, and worst of all, this decision will be a serious obstacle to attracting foreign investment to the country in the post-pandemic period. Azerbaijan’s economy, which already has high investment risks, will suffer. Therefore, the Central Bank should reconsider this decision, which contradicts economic liberalization.

Gubad Ibadoglu











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