Export diversification and the S-curve effect in a resource-rich state: evidence from Azerbaijan Mohsen Bahmani-Oskooee • Rustam Jamilov Received: 14 January 2013 / Accepted: 26 June 2013 Ó Springer Science+Business Media New York 2013 Abstract Resource-rich states often miss out on diversified export-led growth opportunities due to their overreliance on resource-generated revenues. One strategy to boost non-resource exportation is to temporarily devalue the domestic currency and to provide exporters with some price competitiveness. This paper applies the notion of currency devaluation to the issue of export diversification via the S-curve principle. A comprehensive analysis of aggregate, bilateral, and industry-level trade is employed for Azerbaijan—a country-model for resource-abundant states with underdeveloped non-oil sectors. Consistent and strong evidence in favor of the S-curve effect is found in all stages of our analysis. In particular, a depreciative shock to the exchange rate correlates positively with the balance of trade on the aggregate and bilateral levels, as well as in 16 of the 20 industries examined. Results confirm previous literature findings. Azerbaijan’s non-oil exportation responds to a depreciated Manat in a systematically positive way, which adds further value to the argument of using currency devaluations for export diversification in resource-rich economies. Keywords Resource curse Export diversification S-curve JEL Classification F14 F31 F43 Opinion presented in this paper does not reflect the views of the Central Bank of Azerbaijan and belongs solely to the authors. M. Bahmani-Oskooee (&) Department of Economics and the Center for Research on International Economics, University of Wisconsin-Milwaukee, Milwaukee, WI 53201, USA e-mail: [email protected]R. Jamilov Department of Research, Central Bank of Azerbaijan, 1014 Baku, Azerbaijan e-mail: [email protected]; [email protected]123 Econ Change Restruct DOI 10.1007/s10644-013-9145-8
Transcript
Export diversification and the S-curve effectin a resource-rich state: evidence from Azerbaijan
Mohsen Bahmani-Oskooee • Rustam Jamilov
Received: 14 January 2013 / Accepted: 26 June 2013
� Springer Science+Business Media New York 2013
Abstract Resource-rich states often miss out on diversified export-led growth
opportunities due to their overreliance on resource-generated revenues. One strategy
to boost non-resource exportation is to temporarily devalue the domestic currency
and to provide exporters with some price competitiveness. This paper applies the
notion of currency devaluation to the issue of export diversification via the S-curve
principle. A comprehensive analysis of aggregate, bilateral, and industry-level trade
is employed for Azerbaijan—a country-model for resource-abundant states with
underdeveloped non-oil sectors. Consistent and strong evidence in favor of the
S-curve effect is found in all stages of our analysis. In particular, a depreciative
shock to the exchange rate correlates positively with the balance of trade on the
aggregate and bilateral levels, as well as in 16 of the 20 industries examined. Results
confirm previous literature findings. Azerbaijan’s non-oil exportation responds to a
depreciated Manat in a systematically positive way, which adds further value to the
argument of using currency devaluations for export diversification in resource-rich
Although no conclusive empirical evidence on either the short- or long-run
reactions of the trade balance to currency innovations has been found, some
research has revealed interesting results. For example, currency depreciations can
indeed positively affect the balance of trade in the long run. Moreover, this effect
works for resource-rich states in particular, which is quite relevant to our purposes
(Bahmani-Oskooee and Kandil 2007). The J-curve literature has been equally
extensive. However, results vary considerably across studies, regions, and time
periods in question. In addition, the J-curve research stream differentiates based on
the methodological approach. The sphere consists of three fundamental compo-
nents: an aggregated method, a bilateral approach, and the relatively new
proposition—industry-level analysis.1 Research shows that aggregated J-curve
studies typically suffer from the so-called aggregation bias. A bilateral approach,
proposed by Rose and Yellen (1989) is therefore more desirable. However
consistent the bilateral results for any particular set of parameters may be, it turns
out that further disaggregation of the data (industry-level approach) produces highly
heterogeneous results which vary considerably across industries.
The most recent phenomenon, which has received arguably less attention than the
other relevant areas of empirical trade, is the S-curve effect. The pioneering work by
Backus et al. (1994) has claimed that there is no single simple structural relationship
between the trade balance and the exchange rates. Originally, it is believed that a
contemporaneous relationship between the two variables (trade balance and the
exchange rate) is positive. However, the Backus et al. (1994) finding is that cross-
correlation is positive only between the current value of the exchange rate and the
future values of the trade balance. It is negative, however, between the current
1 Examples of the aggregated approach include Bahmani-Oskooee (1985), Narayan (2004), Halicioglu
(2007), and Hsing (2008). Some of the papers belonging to the bilateral approach are Rose and Yellen
(1989), Bahmani-Oskooee and Brooks (1999), Bahmani-Oskooee et al. (2006), Halicioglu (2008),
Bahmani-Oskooee and Kutan (2009), Perera (2011). The industrial approach includes such titles as
Ardalani and Bahmani-Oskooee (2007), Bahmani-Oskooee and Wang (2008), Bahmani-Oskooee and
Hajilee (2009), Bahmani-Oskooee and Hegerty (2009), Bahmani-Oskooee and Mitra (2009), Soleymani
and Saboori (2012). A review of the J-curve literature is provided by Bahmani-Oskooee and Ratha
(2004).
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123
exchange rate and past trade balances. When collecting the cross-correlation
coefficients and plotting them over time, we should get the S-shaped figure.2 The
S-curve is, conceptually, an extension of the forward-looking cointegrating J-curve.
The peculiarity and usefulness of the S-effect is that we accept the attenuating
reality that the structural relationship between terms of trade and the balance of
trade is not consistent. It is therefore possible to apply the S-curve approach to the
study of empirical trade and, indirectly, to the export diversification discourse.
Diversification—at least in principal—can be obtained via an intervention into the
exchange rate market. And this paper will attempt to test this idea from the S-effect
angle.
Although the literature on currency depreciation and its impact on the balance of
trade is extensive, this is one of the first papers which deliberately and explicitly
connects the issue of the S-curve and export diversification in a non-diversified
resource-rich state. In this paper, we will apply the trade balance narrative to the
issue of export diversification in the case of Azerbaijan. Azerbaijan is selected
basically as a country model for small open economies with significant reliance on
the resource sector and an underdeveloped non-resource economy. Azerbaijan fits
well into the role of a typical economy transitioning from resource-dependence to
diversified growth, and a lot of countries could be used in its place. Indeed, the
methodology adopted in this paper should be extrapolated and applied to many other
oil-exporting states in the future. Results should have very important policy-relevant
implications.
Azerbaijan has managed to grow in double digit percentage rates from 2004
through 2008, posing a real oil-driven economic miracle. Although the overall
national stance in competitiveness is robust (Fig. 2), the dominating reason for this
stability is macroeconomic might, affected largely by the oil factor. The economy is
practically debt-free with the proportion of gross external debt to GDP being
minutely small. However, it is the substantial oil revenues which are stored and
managed in the State Oil Fund of Azerbaijan (SOFAZ) that have created a natural
buffer against macroeconomic turbulence. It is clear that this stability is not
sustainable in the long run, since oil is a finite source. Today, Azerbaijan’s economy
is practically 50 % oil-driven (Fig. 3). 95 % of exports are oil related, with just 5 %
in the non-oil sphere (Fig. 4). As a result, the non-oil trade balance of the country is
on a dangerous long-run negative slope (Fig. 5). The urge to seek for export
diversification strategies, and the importance of this paper, is therefore rather
obvious. The picture is quite alarming, considering both the BP oil outlook and the
national predictions that Azerbaijan’s oil production will continuously decline in the
nearest future (Fig. 6). The reality has urged Azerbaijani policy makers and
economists to come up with plans on how to diversify the oil-dependent economy.
This paper proposes to consider the currency-depreciation principle as one of such
potential plans.
In addition to Azerbaijan being, in our opinion, a perfect country-model for our
analysis, it has already been confirmed by previous studies that a currency
2 Examples from the S-curve literature include Senhadji (1998), Parikh and Shibata (2004), Bahmani-
Oskooee and Ratha (2007a), Bahmani-Oskooee and Ratha (2011).
Econ Change Restruct
123
depreciation in case of Azerbaijan would not be a pointless endeavor. In particular,
the bilateral Marshall–Lerner condition is found to be functional, and the volume
effect is proven to be the driving factor of trade balance improvement in response to
a currency depreciation (Jamilov 2012). In addition, an industrial analysis using the
ARDL methodology has revealed that trade balances of most of Azerbaijan’s largest
non-oil industries respond positively to a drop in the currency value (Bahmani-
Oskooee et al. 2013). Both studies highlight that both short-run and long-run
empirical results are theoretically correct. All in all, since the precedent has already
been set, the risks of conducting this investigation and failing to reveal any plausible
result are quite small. In other words, we expect a priori that at least somewhere in
this analysis depreciation of the currency will indeed positively affect the non-oil
trade balance. Whether the short-run dynamic will resemble the S-curve is,
however, an empirical question yet to be answered.
The basic design of this paper is threefold. Respecting the literature stream, we
will target aggregate, bilateral, and industrial approaches to the S-curve estimation.
First, we look at Azerbaijan’s aggregated trade turnover against the rest of the
world. We also look specifically at the non-oil component. Second, we adopt a
bilateral framework vis-a-vis Azerbaijan’s major trading partner—the Euro-area.
Fig. 2 Azerbaijan’s competitiveness summary. The figure is adopted from the 2012’ World EconomicForum’s global competitiveness report
Econ Change Restruct
123
Azerbaijan’s bilateral trade with Europe accounts for more than 50 % of the
country’s overall trade turnover. Once again we will also look at the non-oil sector,
now in bilateral format against the concrete partner. Third, we estimate the S-curve
Fig. 3 Azerbaijan’s gross domestic product by sector
Fig. 4 Azerbaijan’s foreign trade composition
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123
for 20 specific industries of Azerbaijan’s economy and provide an industrial angle to
the study. Not only is this paper among the first ones to apply the S-effect narrative
to the discourse of export diversification in oil-rich states, but it also enriches the
empirical S-curve literature and empirical trade in general with a comprehensive
aggregate, bilateral, and industrial investigation. Of course, the paper also adds to
the literature on Azerbaijan’s exchange rate and trade dynamics.
The remaining parts of this paper are structured as follows. Section 2 will
describe the data and the estimation strategy employed in this study. Section 3
Fig. 5 Azerbaijan’s non-oil trade balance. Trade balance is defined as the ratio of exports to imports.Any value below 100 % indicates balance of trade deficit
Fig. 6 Azerbaijan’s forecasted domestic oil production. Based on the state oil company of the Republicof Azerbaijan forecasts as of January, 2011
Econ Change Restruct
123
reports the empirical results. Section 4 offers a policy discussion of our findings.
Finally, Sect. 5 offers some final concluding remarks.
2 Data and estimation issues
For the purpose of our estimation strategy we use data at the aggregate, bilateral,
and industry levels. However, data limitations do not allow us to conduct a perfectly
homogeneous analysis. For the cases of aggregated total and non-oil trade balances
with the rest of the world, we use quarterly data for the period 2001:1-2009:4. For
total and non-oil bilateral trade with the Euro-area we use monthly trade data
between 2006:01 and 2009:01. For the industry level data, the same quarterly
framework of 2001:1-2009:4 as in the case of aggregate trade is adopted. These
periods are selected based on availability of data.
The two variables for which cross-correlations are constructed are defined as TBt
which refers to the trade balance at time t, and REXt, the real exchange rate. The two
variables should be defined in a manner where contemporaneous correlation should be
positive. As such we define the trade balance as the difference between exports and
imports deflated by the GDP of Azerbaijan to set it in real term. All variables are in
nominal values. REXt will be defined in a fashion that an increase reflects depreciation
of the Manat. All variables in the study have been de-trended using the Hodrick-
Prescott filter (Hodrick and Prescott 1997). Data has been taken from the Azerbaijan
State Statistical Office (AZSTAT). Figure 7 depicts Azerbaijan’s exchange rate
dynamics and Table 1 summarizes main data on Azerbaijan’s exports and imports.
Following the literature (e.g., Bahmani-Oskooee and Ratha 2007a, b), we defined
the correlation coefficient (qK) between the two variables as follows: Where
qK ¼PðREXt � R �EXÞðTBtþk � T �BÞ
ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiPðREXt � R �EXÞ2ðTBtþk � T �BÞ2
q ð1Þ
R �EX and T �B are arithmetic means of the real exchange rate and the balance of trade,
respectively; k is the lag operator. When qK is plotted against k, we get the graph of
Fig. 7 Exchange rate dynamics
Econ Change Restruct
123
Tab
le1
Tra
de
dat
asu
mm
ary
stat
isti
cs,
2000–2009
Mea
nS
tan
dar
der
ror
Med
ian
Ran
ge
Min
imu
mM
axim
um
Co
un
t
Aze
rbaij
ani
export
sadd
tota
l,nonoil
,and
expand
indust
ries
To
tal
exp
ort
s2
49
,48
21
72
4,8
16
1,0
20
,943
21
,17
5,0
04
30
6,7
89
21
,48
1,7
94
40
No
n-o
ilex
po
rts
19
1,2
38
20
,22
61
81
,79
93
94
,97
8.9
37
,90
74
32
,88
64
0
Pla
nts
and
veg
etab
les
31
,53
64
,89
92
3,0
36
.40
10
7,8
45
2,8
85
11
0,7
30
40
An
imal
and
pla
nt
oil
s1
4,5
23
1,8
56
14
,30
1.7
34
0,0
19
32
40
,34
54
0
Fo
od
and
bev
erag
es2
1,9
64
2,9
60
12
,86
4.1
06
2,5
48
3,9
26
66
,47
54
0
Ch
emic
alp
rod
uct
s1
9,8
45
2,2
01
15
,72
2.6
04
9,7
32
2,9
08
52
,64
14
0
Po
lym
er,
rub
ber
,an
dre
late
dp
rod
uct
s1
5,0
25
1,6
02
13
,31
6.1
04
0,8
28
52
64
1,3
55
40
Wea
vin
gpro
duct
san
dm
ater
ials
11,1
18
838
10,6
16.0
520,2
85
174
22,0
35
40
Sem
i-pre
cio
us
met
als
and
rela
ted
arti
cles
28
,95
25
,12
22
5,5
69
.80
19
7,5
96
28
71
9,7
88
40
Mac
hin
es,
mec
han
ism
s,an
del
ectr
ical
equip
men
t8,4
47
464
8,2
35.3
014,4
69
642
15,1
12
40
Lan
d,
air
and
wat
ertr
ansp
ort
faci
liti
es2
4,6
19
7,9
85
3,8
41
.80
26
4,6
89
72
72
65
,41
74
0
Inst
rum
ents
and
app
arat
us
1,4
05
18
61
,114
.10
5,1
26
24
15
,368
40
Aze
rbaij
ani
import
s
To
tal
imp
ort
s1
,04
1,3
62
85
,91
59
95
,16
01
,87
3,4
33
26
7,6
69
2,1
41
,106
40
No
n-O
ilim
po
rts
93
9,4
04
85
,61
68
67
,32
41
,84
9,0
09
20
8,5
20
2,0
57
,529
40
Pla
nts
and
veg
etab
les
57
,59
35
,93
44
2,6
11
15
6,0
49
15
,77
71
71
,82
74
0
An
imal
and
pla
nt
oil
s9
,121
98
97
,397
25
,20
67
38
25
,94
54
0
Fo
od
and
bev
erag
es5
8,5
26
7,2
24
34
,84
41
37
,47
99
,24
41
46
,72
44
0
Ch
emic
alp
rod
uct
s5
2,0
76
5,5
23
37
,12
01
28
,81
21
5,5
00
14
4,3
13
40
Po
lym
er,
rub
ber
,an
dre
late
dp
rod
uct
s2
7,0
13
2,8
47
24
,74
26
2,9
54
4,0
46
67
,00
04
0
Wea
vin
gpro
duct
san
dm
ater
ials
11,9
61
708
12,1
68
15,1
30
4,3
31
1,9
46
40
Sem
i-pre
cio
us
met
als
and
rela
ted
arti
cles
12
2,0
00
9,7
65
12
7,6
80
21
0,2
13
22
,94
52
33
,15
84
0
Mac
hin
es,
mec
han
ism
s,an
del
ectr
ical
equip
men
t297,0
10
30,2
22
269,3
35
680,2
66
50,4
20
73,0
68
40
Econ Change Restruct
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Tab
le1
con
tin
ued
Mea
nS
tan
dar
der
ror
Med
ian
Ran
ge
Min
imu
mM
axim
um
Co
un
t
Lan
d,
air
and
wat
ertr
ansp
ort
faci
liti
es1
29
,20
41
7,5
30
92
,54
63
97
,37
81
2,1
15
40
9,4
93
40
Inst
rum
ents
and
app
arat
us
25
,50
13
,26
21
8,1
30
93
,94
25
,03
39
8,9
76
40
All
val
ues
,unle
ssoth
erw
ise
spec
ified
and
exce
pt
for
the
last
colu
mn
label
edco
unt,
are
inA
zerb
aija
ni
Man
at
Econ Change Restruct
123
the cross-correlation function. It is predicted that the cross-correlation coefficients
will be positive for positive lags (i.e., leads) and negative for negative lags. If the
contemporaneous correlation (when k = 0) is negative, then the unanticipated
permanent deterioration in the terms-of-trade leads to a current account worsening
via the rise in aggregate expenditure, or the so-called Harberger-Laursen-Metzler
(HLM) effect takes place (Harberger 1950; Laursen and Metzler 1950).
3 Results
3.1 Aggregate trade
We begin to report the results of the cross-correlation function estimations with the
most basic case of Azerbaijan’s aggregate total trade with the rest of the world. The
exchange rate employed here is the real effective exchange rate of Manat (REER).
By way of construction, since a decrease would reflect Manat depreciation, we use
the inverse 1/REER in (1) so that an increase in 1/REER, which now reflects
depreciation, yields a positive correlation if the trade balance is to improve.
Figure 8 presents the plot of the cross-correlation coefficients qK’s against k using
the aggregate trade balance and the inverse of REER. The graph resembles the
S-curve quite strongly. The contemporaneous cross-correlation is practically equal
to 0 which negates the HLM prediction of negative cross-correlation at k = 0. The
exchange rate is correlated positively with the positive (future) lags of the aggregate
trade balance, and negatively with its past values, just as the S-curve theory would
predict. It’s important to note briefly that one lag refers to one quarter of a calendar
year.
Fig. 8 S-curve for aggregate total trade
Econ Change Restruct
123
For the purpose of this paper’s theme of non-resource export diversification,
analysis of the non-oil trade balance carries strategic importance. Therefore, Fig. 9
carries a lot of value and relevance for the policy-makers of Azerbaijan as well as of
all similar resource-rich states. Figure 9 depicts the dynamic of cross-correlations of
the aggregate non-oil trade vis-a-vis the rest of the world, and the dynamic clearly
supports the S-curve effect hypothesis; indeed even more vividly than in Fig. 8. The
most important take-away point is that the balance of trade correlates positively
with a positive shock to the exchange rate, which is defined as the reverse of the
non-oil REER. In other words, non-oil exportation in Azerbaijan can be potentially
improved via a depreciated domestic currency. The HLM effect is not supported
again as the contemporaneous correlation is positive, not negative.
3.2 Bilateral trade with the Euro-area
In order to eliminate any aggregation bias which is potentially present in any
aggregate S-curve analysis, we look at the bilateral trade case. Figure 10 represents
the cross-correlation function between the bilateral trade balance vis-a-vis the Euro-
area (Azerbaijan’s major trading partner) and the REER calculated specifically
using the weights of the European trading partners of Azerbaijan. Just as in the
aggregated case, the S-curve effect is quite clearly traceable. There is minor
evidence in support of the HLM hypothesis of negative contemporaneous cross-
correlation. In our bilateral Euro-area trade analysis, one lag constitutes one
calendar month.
Continuing this paper’s emphasis on diversification of non-oil exports, we
present the graph of the cross-correlation function of the bilateral Euro-area non-oil
trade balance and the non-oil Euro-specific REER in Fig. 11. The graph resembles
S-shaped behavior once more, providing more evidence in support of the presence
of the S-effect in Azerbaijan’s bilateral trade dynamic with Europe. The potential
Fig. 9 S-curve for aggregate non-oil trade
Econ Change Restruct
123
aggregation bias seems not to have affected our baseline conclusion, or not in any
substantial way at least, since the bilateral conclusion is the same as in the aggregate
trade case.
3.3 Industrial trade
Having established the presence of the S-curve effect in the cases of aggregate and
bilateral trade dynamic, as well as for total and non-oil trade balances, we now
extend our analysis to disaggregated data, i.e. to the industry level. These are the
industries that trade between Azerbaijan and rest of the world. Thus, the same
REER that was used when we generated the S-curve in Fig. 8 is also used here.
Fig. 10 Bilateral total trade with the Euro-area
Fig. 11 Bilateral non-oil trade with the Euro-area
Econ Change Restruct
123
Overall, 16 of the 20 industries analyzed exhibit either strong or considerable trace
of the S-curve effect. For ‘works of art’, ‘food and beverages’, ‘polymer, rubber,
and plastics’, ‘chemical products’ there is very little support for the S hypothesis. In
almost all industries, however, there are some negative cross-correlation values for
negative lags and positive values for the positive lags of k. Included among the
industries that conform to S-curve are small as well as large industries. The largest
industry which has 68 % of the market share supports the S-pattern. It could be said
comfortably that the S-curve is very well supported for Azerbaijan at the aggregate,
bilateral, and industry-level analyses. This is not surprising considering that
previous studies have confirmed the existence of the similar phenomena—the
J-curve and the Marshall–Lerner condition—in the case of Azerbaijan. Furthermore,
this is another confirmation of the benefit that currency depreciation can bring to
export diversification in oil-rich states (Fig. 12).
Fig. 12 Industry-level S-curve analysis
Econ Change Restruct
123
4 Policy discussion
Based on the results of this paper, it is clear that Azerbaijani exports, and
particularly the non-oil sector, can benefit mightily from a little boost in
competitiveness provided by a depreciated currency. A weaker Azerbaijani
currency—the new Manat—will make exportation to the neighboring states seem
more attractive (and profitable), which will drive domestic production volumes up
by considerable amounts just several months after the policy intervention. It’s
established that the concept of the ‘‘long run’’ is quite diluted, and policy
adjustments get completely transferred into the real economy just 9 months after the
shock (Jamilov 2012). So, we are expecting an improvement in the balance of trade
just 3 quarters after the exchange rate alteration.
Broadly speaking, additional revenues generated from the expanded exportation
base will allow for more investments to flow back into the domestic non-oil sector
Fig. 12 continued
Econ Change Restruct
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via the privately retained earnings channel. Those investments can improve the
technological base of the country’s non-oil production, thus creating a platform for a
real, productivity-based long-term comparative advantage. With such prospects in
mind and assuming a good quality of governance which will have an impact of
Fig. 12 continued
Econ Change Restruct
123
effectiveness of investment, it is not necessary to keep the exchange rate policy
loosened for too long, since non-oil producers won’t require any additional stimulus
several years after the sector starts flourishing ‘‘from within’’. As a result, we will
also see a decline in the need for state intervention to promote industrial
diversification, as the private sector will have a natural, market-driven incentive to
‘‘price-up’’ the non-energy segment.
In addition, the average gain in the non-oil area of the economy will start
increasing, causing the general public to perceive the oil and non-oil sectors as
equally competitive from the remunerative point of view. And not only will the non-
oil entrepreneurs and producers become wealthier and more influential macroeco-
nomic-wise, the export-led expansion will provide more jobs to the economy. It’s a
well known fact that the oil sector is extremely capital intensive, while accounting
for just over 2 % of total employment provision, at least in the case of Azerbaijan.
This is true for Azerbaijan as well as for almost all resource-rich states around the
world. A more competitive non-oil sector will thus create more jobs with a good
market salary and potential for future growth and development.
Consider that unlike many other previous papers on the S-curve effect, this study
is analyzing a country with a fixed exchange rate regime. For example, Bahmani-
Oskooee and Ratha (2011) look at the industry-level S curve of Australia and
mention that an excessive devaluation of the Australian dollar, although positive for
export competitiveness, could trigger currency attacks and/or capital flights. The
structural peculiarity of Azerbaijan is such that the Azerbaijani currency is tightly
controlled by the Central Bank of Azerbaijan. In a theoretical scenario of a Manat
devaluation, any potential consequent downward pressures on the currency will be
counter-balanced by Central Bank interventions, which happen in any case due to
the pegged regime itself. Moreover, incoming money from the oil-generated sales
constitute the big bulk of the capital inflow, which constantly puts appreciation
pressures on the Manat. In practice, any iterative depreciation of the Manat initiated
by the Central Bank will be naturally compensated by the appreciative tendencies
associated with being the resource-rich state. In other words, for as long as
Azerbaijan remains an energy resource exporter (and we can comfortably expect
this to last for another three decades or so), domestic currency will always be under
upward pressures due to the design of the country’s growth model—an ideal
environment for export diversification via a currency depreciation.
In this study, Azerbaijan has been used just as a single case study for applying a
trade balance prism to the industrial diversification narrative. The model can be
applied equally well to other similar resource-rich countries of the region like
Russia or Kazakhstan. The idea is very simple in both its set-up and computation,
and provides a real foundation for an argument for letting the national currencies of
resource-rich states temporarily lose a bit of value. Whether the national
government of Azerbaijan, or any other regional state for that matter, will actually
decide to embrace currency depreciation is, of course, a slightly different issue.
There are, at least, three potential obstacles for this proposal.
First of all, devaluation or depreciation typically goes against the principle of
inflation control, as a weaker currency might lead to higher prices in the medium-
long run. Against this claim we would counter argue that it is a proven case that in
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Azerbaijan inflation, especially the very high double-digit values of the pre-crisis
period, was driven largely by the fiscal apparatus and the massive influx of oil
money into the real economy via the fiscal policy arm; not really by aggressive
monetary policy and/or loose exchange rate control. Second, weakening the
currency, which also means letting all the other vis-a-vis currencies to strengthen,
may shaken the population’s trust in domestic money, force people to hold more US
dollars, and eventually revive ‘‘dollarization’’—an old decease very much common
to many developing states of Azerbaijan’s caliber. It’s difficult to assess whether
this claim is legitimate or not, but basic statistics show that the local population has
increased its belief in the national monetary and financial system, evidenced by the
rapid growth of deposits held by physical entities. Similarly to the previous point of
discussion, depreciation may also play the wrong card with the attempts to improve
the functioning of domestic financial institutions and capital markets. In particular,
saving and deposit accounts which are denominated in the local currency will
instantly drop in their relative value, thus forcing savers to consider relocating their
funds abroad or at least converting to a stronger currency for storage. This is indeed
a legitimate concern, and the importance of Central Bank communication with the
public becomes the key factor here: policy-makers must effectively communicate
the newly adopted strategy and convince the population of their motives of
promoting Azerbaijani products and national exporters, and that a weaker Manat
signals international competitiveness and not a loss of trust by any means.
Export diversification really is an existential strategic concern for all resource-
rich states. Allowing for a temporary depreciation of the currency should, according
to our and many previous research results, act as a price-driven booster for non-oil
exports. With time, retained investments will initiate a build-up of technology- and
productivity-based competitive advantage, kick-starting sustainable growth from
within. While there are several potential drawbacks to this policy recommendation,
there seem to be very few other alternatives capable of delivering fast, value-added
results. With careful and effective management, it’s more than probable that
currency depreciation can be a reliable tool in the hands of policy-makers in their
attempt to revive non-resource exportation.
5 Conclusion
This paper enriches the literature on export diversification in resource-rich states
with an argument for currency depreciation. Azerbaijan has been selected as a
country-model for economies with a strong oil sector and largely underdeveloped
non-oil industries and exports. Following recent literature trends, a comprehensive
three-phase application of the S-curve effect is employed for the case of aggregate
trade with the rest of the world, bilateral trade with Azerbaijan’s major trading
partner—Europe—and an industry-level analysis. Specific emphasis has been
placed on the non-oil sector. Cross-correlation functions between trade balances and
variations of the REER have been constructed and plotted over a set of positive and
negative lags. In the case of both aggregate and bilateral trade, there is clear support
for the S-curve phenomenon. In particular, both aggregated non-oil trade balance
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and the bilateral non-oil trade balance vis-a-vis Europe respond positively to a
depreciation shock to the exchange rate. In the case of specific industries, evidence
in support of the S-curve is found in 16 of the 20 industries analyzed. Overall, all
stages of our investigation confirm the presence of the S-curve effect in
Azerbaijan’s trade and exchange rate dynamic. In particular, the non-oil sector
seems to consistently react positively to currency depreciation. This result confirms
previous studies on Azerbaijan’s empirical trade, supports the existence of the
S-curve, and provides a claim in favor of using currency depreciation as a tool for
export diversification in resource-rich states.
Acknowledgments We are thankful to Taleh Ziyadov for insightful discussions on the resource curse.
We also appreciate the valuable comments from Salman Huseynov and Ramiz Rahmanov from the
Department of Research, Central Bank of Azerbaijan.
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