1. Azerbaijan: dealing with foreign exchange inflows Emin Huseynov The National Bank of the Republic of Azerbaijan

2. Outline  Recent macroeconomic performance  Inflows  Outflows  Net inflows  Specific features of Azeri case  Demand management policies  Structural reforms

3. Recent macroeconomic performance  strong overall economic growth  modest non-oil growth  intensified demand pressures  real exchange appreciation

4. GDP growth during the 2000- 2006, %

5. GDP per capita in selected CIS countries, USD

6. Sector’s contribution to GDP growth, %

7. Demand pressures

8. Confidence in banks improved, dollarization declined

9. Inflows  Export of goods and services, mostly oil related  FDI’s, mostly oil related  Remittances  Bank borrowing

10. Inflows, bln. USD

11. Outflows  Imports of goods and services  Capital repatriation  Profit repatriation

12. Outflows, mln. USD

13. Net inflows, mln. USD

14. Specific features of Azeri case  Significant oil revenues  various estimates indicate $140-$200 billion until 2024, which is about 10-fold of GDP in 2006  Short horizon of production profile  proven hydrocarbon resources would almost be depleted at end-2024  Existing pipeline infrastructure to the world market  completion of BTC opens up prospects of continued revenue base even after oil and gas dries up

15. Oil revenues, mln. USD

16. Specific features of Azeri case  Transparent and best practice governance framework established but not fully operationalized  Effective coordination of macroeconomic policies of demand management is lacking  Underdeveloped domestic financial markets and low initial level of financial intermediation  Unfinished agenda of structural reforms, especially in the non-financial corporate sector

17. Oil revenues accruing to Government Budget, mln.$

18. Expansionary fiscal policy framework

19. Excess FX sterilization, mln. USD

20. Monetary impact

21. Demand management policies I. Handling monetary impact  Partial FX sterilization  Efforts to liberalize capital outflows  Limited appreciation  Partial sterilization by ANB notes These measures have not been sufficient to constrain demand so far

22. Monetary Sterilization NBA’s paper, mln. AZN

23. Limited X-rate flexibility

24. Demand management policies II. Constraining fiscal expansion  A rule-based cap on maximum oil revenues to be used in one year: PIH, non-oil GDP growth, real productivity growth, model-based estimates consistent with low and stable inflation, etc.  Nominal growth of expenditure to be limited to under 10% for the period of 2008-2024  Non-oil revenue growth to match that of current expenditure  Ineffective public investments to be minimized

25. Demand management policies III. Adopting inflation targeting in the medium- term  Inflation target to be set for medium-term  Operational independence of the monetary authority to be ensured  Flexible X-rate policy to be adopted  Macroeconomic coordination to be strengthened  Gradual switch from monetary targeting to interest rate targeting

26. Structural reforms  Reduction of the role of state in the economy  Completion of reforms in the utilities sector  Introduction of corporate governance principles in state enterprises  Deepening and expansion of financial sector  Improving tax administration