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balance sheets against financial risks. As a result, financial endurance of the banking system became stronger so that assets of the banking sector increased by 13.5%, loans to economy increased by 17%, deposits increased by 23% and the total capital of the banking sector increased by 18% in 2009.
However, despite the high capital adequacy ratio and high level of liquidity ratio of the banking sector, growing numbers of overdue credits and declining loan loss provisioning may lead to deterioration in banks’ balance sheets in the near future. The recent rising in OCR shows that the banking sector requires improving modern risk management techniques, including proper credit evaluation, development of better nonperforming loans’ management and improvement of staff quality through the training of existing personnel.
Today, Azerbaijan’s banking sector still has a significant potential for growth in addition to its higher performance as opposed to its peers. The depth and financial intermediary indicators of the banking sector, such as loans to GDP ratio or deposits to GDP ratio are still very low when compared to developed markets. Some basic financial products that have significant revenue generation potential are still in the development phase in Azerbaijan. Moreover, a large percentage of population is unbanked or potentially bankable in the medium term. All these indicators that illustrate the potential for growth have been accompanied by the CBAR’s strong and prudent management experience, which has retained a distinguished place for the banking sector throughout the crisis period in contrast to its peers.
Bahruz AHMADOV
Ph.D. candidate
at the Institute for Scientific Research on Economic Reforms, Ministry of Economic Development of the Azerbaijan Republic (Baku, Azerbaijan).
OPPORTUNITY COST OF THE CRISIS: CRISIS LOSS RANKING FOR THE CIS COUNTRIES
Abstract
This article takes a look at the opportunity cost index methodology based on deviation from the pre-crisis development trends for measuring and comparing the economic losses of different countries during the crisis. The methodology is
also used for estimating the opportunity cost index, ranking the losses the CIS countries have incurred, and assessing the reasons for the various impacts the crisis has had on different countries and its implications for the Azerbaijan economy.
I n t r o d u c t i o n
The past two years will be remembered for the economic hardships they inflicted on the world, such as bankruptcy of large banks and companies, astronomically high outstanding debts, multimillion staff cutbacks, and the decline in standard of living. The scope of the crisis and its effects differed from country to country. Whereas certain economies experienced double-digit shrinkage, others enjoyed considerable growth. Fortunately, Azerbaijan was among the few achievers, notably being a leading nation. Nevertheless, it is obvious that the crisis has affected every economy to one extent or another. However, the size of its impact on countries in terms of losses is not that easy to identify at a first glance.
1. Who Suffered Most from the Crisis...
How to Compare?
Identifying the degree to which the crisis has affected each country by means of economic growth rates alone would be an oversight, even for those at the same level of economic development. That is, a 3% decline in the economy in one country and a 5% decline in another does not necessarily imply that the latter has been harder hit. Likewise, a 7% growth rate in one country does not mean it is stronger than another that has experienced only a 2% increase. This is because the economic development prospects and pre-crisis growth rates of different countries vary. Any outcomes achieved without taking these phenomena into account appear less substantial.
The impact of the crisis on different economies can be figured out by balancing the materialized chances against the opportunity cost, which might provide a relatively better view of the picture. Namely, what growth was supposed to be achieved? And what happened instead? In other words, every country can compare its losses with the situation that might have happened had no crisis occurred. Based on the findings, it can then be determined who suffered the most.
Firstly, let us define the meaning of opportunity cost. In economics, the opportunity cost, otherwise known as alternative cost, is the cost of the goods and services or profit that must be relinquished based on the choice made among several mutually exclusive choices. For instance, the cost of an university education includes, first of all, the tuition fee and money spent on computers, textbooks, the Internet, etc. However other profits that could have been gained during the time spent obtaining a higher education are also added to the cost of a university education, what economists call the alternative cost or the opportunity cost. Indeed, in many cases (when the earnings of the highly educated are much higher than those of the not so educated), the alternative cost of not obtaining a higher education is greater.
Altogether, the alternative cost or the opportunity cost of the crisis period in an economy should refer to the difference between the cost of the goods and services produced in a non-crisis economy and the cost of the goods and services produced in a crisis economy. Clearly the occurrence or the absence of a crisis in any country or worldwide is not interpreted as a “to be or not to be” decision. Whatever the case, the crisis spills over as a consequence of the choices the individuals, actors in the economy, and regulating bodies have made. Hence, the alternative cost of those choices happens to be the sum of the revenues the economic actors would have acquired in a situation had no crisis occurred.
THE CAUCASUS & GLOBALIZATION
1.1. Opportunity Cost Measurement Methodology
The opportunity cost is determined by analyzing the pre-crisis development trend of each economy to further calculate the estimated (predicted) output value (in physical quantity index) and the consequent real growth rate:
Y = bo + V
AYt = [(Yt / Yt-1) - 1] x 100%,
where Y t —physical quantity index of the output in year t;
AYt —real growth in the output of year t (in percentage);
t —time factor;
b0 and b1 —calculated parameters.
Depending on the nature of the economic growth trends, the years 2005 and 2006 are assumed to be 100.
In the next step, the physical quantity indices calculated for 2008-2009 in the non-crisis situation are compared with the physical quantity indices calculated on the basis of the actual growth rates, the difference of which defines the cost. The cost is shown as a share of the gross domestic product (GDP) of every economy, thus enabling its scale to be counted in the ranking:
I % gdp = [(Yte + Yta)/Yta ]x100%,
where Yte — estimated (forecasted) GDP (in physical quantity index) expected for crisis year t before the crisis;
Yta — actual GDP (in physical quantity index) in year t.
The comparative calculations across the economies rely on data from the authorities—the Statistics Department and Central Bank (or equivalent authorities)—of the countries concerned, and are also compared with the IMF forecasts1 (and calculations therefrom) developed for the time before the crisis.
1.2. Opportunity Cost Index
The above methodology for estimating the opportunity cost makes it possible to rank economies according to the detriment caused by the crisis. But it goes without saying that the dimensions of the economic breakdown cannot be expressed by percentage alone. Undoubtedly, it is easy to see the economies on the extreme ends of the scale (i.e. “the loser” and “the survivor”). But for those in the middle of the ranking, another tool is required to discover whether the cost is large or small for a particular country. The opportunity cost index can be used as such a tool of measurement.
The opportunity cost index is calculated as the ratio of the share of a country’s losses from the crisis (I %gdp ) in the total losses of all the CIS countries to the share of the country’s economy (GDP)2 in the total economy of the CIS (GDP .):
1 See: International Monetary Fund, World Economic Outlook, April 2008.
2 GDP rates per economy that are used in the formulation of index are expressed in USD value of purchasing power parity. Source: International Monetary Fund.
I. = (I%gdp /I%gdp)/(GDPc /GDPas).
If the index equals less than 1, the opportunity cost of the economy is smaller than the economy itself; if it equals 1, the opportunity cost is commensurate with the size of the economy; if the index is greater than 1, the ratio is not favorable for the national economy, i.e. the opportunity cost is larger than the size of the economy.
2. Expected and Actual Economic Growth in the CIS Countries3 in 2009
Since the crisis reached its peak in the CIS countries in 2009, this year is taken as the base year for the analysis. Before the crisis, the Azerbaijani economy was predicted to be the fastest growing in the region. Despite the crisis, the Azerbaijani economy ranked first among the other CIS countries with a growth of 9.3% in 2009, thanks to timely adoption of a flexible anti-crisis policy. That rate was nevertheless 7.5 points lower than the expected rate (6.3 points lower than the IMF forecast).
According to the calculations, Armenia would have ranked second had there been no crisis. But the inability of its economy to resist the crisis and the failure of its anti-crisis policy forced it to relinquish its second place from the top and fall to second place from the bottom among the CIS countries, due to a recession of 14.4%.
The Ukrainian economy ranks last in both cases with a drop of 15.1% against the expected growth rate of 6.4%. Russia, the biggest economy in the region, experienced a decline in economic growth rates of 7.9% as opposed to the expected increase of 6.6%.
Table 1
Expected and Actual Growth Rates in the CIS Countries for 2009
Actual Growth Rate (1) Estimated Growth Rate in Non-crisis Situation (2) IMF Forecast for the Time before the Crisis (3)
2009 2009 2009
Azerbaijan 9.3 16.8 15.6
Armenia -14.4 10.1 8.0
Belarus 0.2 7.8 6.8
Georgia -5.5* 8.6 9.0
Kazakhstan 1.2 7.8 7.0
Kyrgyzstan 2.3 7.2 6.5
Moldova -6.5 6.7 8.0
3 Although it has withdrawn from the CIS, Georgia is included on the list as a country of the region.
Table 1 (continued)
Actual Growth Rate (1) Estimated Growth Rate in Non-crisis Situation (2) IMF Forecast for the Time before the Crisis (3)
2009 2009 2009
Russia -7.9 6.6 6.3
Tajikistan 3.4 6.9 7.0
Uzbekistan 8.1 8.1 7.5
Ukraine -15.1 6.4 4.2
Turkmenistan 4.0* 9.4 10.0
II * January to September.
1 (1) www.cisstat.org;
1 (2) Author's calculations;
| (3) International Monetary Fund, World Economic Outlook, April 2008. ||
The rise in the Uzbek economy draws attention to itself in the ranking. According to the development trend before the crisis, an 8.1% increase was predicted for the Uzbek economy, and unlike the rest of the CIS countries, the Uzbek economy achieved 8.1% growth, which is, inter alia, 0.6 points higher than the pre-crisis forecast IMF gave for Uzbekistan. It is therefore evident that the crisis has had almost no impact on this country (at least according to the official data). The reasons are given in the following chapter.
3. The Cost of the Crisis for the CIS Countries.
Who Suffered the Most?
Based on the calculations, Armenia is the CIS country which incurred the greatest losses during the crisis. The crisis cost this country 33.5% or one third of its GDP in 2009. Ukraine is the second most affected country with a rate of 30.5% in the ranking for 2009. Georgia rounds up the top three. The calculations indicate that its cost accounted for 22.5% of GDP.
The cost of the crisis in 2009 for the Central Asian countries was modest compared with other CIS countries, namely—Uzbekistan (0%), Tajikistan (3.4%), and Kyrgyzstan (4.8%). The other two—Kazakhstan and Turkmenistan—occupy 7th and 9th places in the ranking with 12.1% and 5.2%, respectively.
Azerbaijan, the 5th country in the ranking, sustained losses of 16.1%, followed by Russia (17.2%). The calculations inferred from the IMF forecasts (WEO, April 2008) show that Azerbaijan occupied 6th place in the ranking with an opportunity cost of 13.2%, followed by Moldova (15.3%).
As per above, Uzbekistan was the country that suffered the least losses from the crisis (to be more precise, no losses according to these measurements). There are various explanations for the
Figure 1
What the Crisis Cost the CIS Countries in 2009,
Percentage of GDP
Arm
S o u r c e: Author's calculations.
success of Uzbekistan, a country where cotton growing and grain farming account for 35-40% in an economy supported by an abundance of gold, uranium, natural gas, and oil resources, the only airplane factory in Central Asia, and the Daewoo and Chevrolet car factories. Some analysts explain its success by the effective anti-crisis measures implemented or the country’s poor integration into the global financial markets, while others say that Uzbekistan’s vast natural resources played their part.
Poor integration into the global financial markets does indeed mean that the crisis had a softer impact on the banking and currency market. The crises that hit the world in the past 10 or 15 years (especially the Southeast Asian and Latin American) indicate that the economies which “absorbed” more “hot money” before the crisis were hard put to return the money and so more likely to face dire consequences (a currency crisis, banking sector crisis, or twin crisis). Given this, it stands to reason that the Uzbek economy, which engages in only short-term borrowing, was not affected by the crisis.
The fiscal stimulus package (which included but was not limited to tax concessions) within the anti-crisis measures employed by the Government of Uzbekistan also played a significant role in keeping the economy sound.
As for natural resources, they should logically not have played a salutary part since world commodity prices dramatically dropped during the crisis, so, as a resource-rich country, Uzbekistan should have been more seriously ravaged than others. However, in spite of its rich natural resources, Uzbekistan’s economy does not rely solely on their export (the same is evidenced in the brief data above). Therefore, the country was able to outsmart the crisis not only due to its abun-
Table 2
The Opportunity Cost Ranking of CIS Countries for 2009 (Comparative Analysis) (%)
The Opportunity Cost The Opportunity Cost
Ranking according Ranking Estimated on
to the Author's Calculations the Basis of IMF Forecasts
1 Armenia 33.5 1 Armenia 29.9
2 Ukraine 30.6 2 Ukraine 26.7
3 Georgia 22.5 3 Georgia 23.1
4 Russia 17.2 4 Russia 16.7
5 Azerbaijan 16.1 5 Moldova 15.3
6 Moldova 14.1 6 Azerbaijan 13.2
7 Kazakhstan 12.1 7 Kazakhstan 7.5
8 Belarus 7.6 8 Turkmenistan 5.8
9 Turkmenistan 5.2 9 Belarus 3.8
10 Kyrgyzstan 4.8 10 Kyrgyzstan 3.5
11 Tajikistan 3.4 11 Tajikistan 3.5
12 Uzbekistan 0.0 12 Uzbekistan -1.5
S o u r c e: Author's calculations.
dant resources, but also due to its correctly structured economy, along with the above-mentioned factors.
The relatively soft impact of the crisis on the other Central Asian countries, Tajikistan, Kyrgyzstan, and Turkmenistan, is also attributed to their poor integration into global financial markets.
Interestingly enough, the leading countries of the region, Russia, Kazakhstan, and Azerbaijan with their significant development capabilities, occupied the middle positions in the ranking. These countries are in the middle, i.e. they incurred modest losses, not because they export commodities and are more deeply integrated into the world financial markets, but, on the contrary, because both of these factors were responsible for the losses.
On the other hand, those three countries were saved by their flexible and effective anti-crisis measures, which helped to mitigate the adverse effects. The reasons for the losses differ even among those countries (there could be no hope that they would entirely coincide).
The reason the Russian economy sustained more losses from the crisis than Azerbaijan and Kazakhstan can be related to its efforts to build a mixed financial system (this trend will most likely continue in the aftermath of the crisis). Currently, there are three vectors the financial system relies on:
(i) banks;
(ii) stock markets; and
(iii) a mixed system (a combination of both systems).
Russia is the only country among the others in the CIS that is pursuing parallel development of the banking system and the stock market.
This phenomenon, which is appropriate for big economies, makes it difficult to ensure help in emergencies. It becomes even more problematic in the case of a developing economy like Russia in which the transfer mechanism still does not function efficiently. This is because the transfer of monetary policy to the economy is accompanied by a certain delay (lag), and this lag is prolonged because of the immaturity of the transfer channels.
In addition, classic monetary policy is targeted at consumer prices (inflation) instead of at asset prices. The first signs of the crisis in Russia brought about excessive reductions in stock prices and, since monetary policy was unable to cope with this challenge, a large amount of funds from the stock exchange markets flowed out of the country, with all the ensuing repercussions for the economy.
The reason the cost of the crisis was less for the economy of Kazakhstan than for Azerbaijan can mainly be explained by the better, even comparatively speaking, diversification of the Kazakh economy. Indeed, Kazakhstan’s resource-related potential (both in terms of rich natural resources and human development ranking) favors diversification of its economy. The devaluation of the Kazakh currency in February 2009 contributed to softening the impact of the crisis on the real sector, pegging its impaired home industries in the domestic and foreign markets (in terms of price competition). Furthermore, this decision prevented a serious drop in the real sector’s expansion rate, so that the growth rate in late 2009 was 1.2% as opposed to 2.2% in the first quarter of 2009. At the same time, the National Bank of Kazakhstan was able to save on foreign reserves. There was no galloping inflation, as was expected, from the devaluation, and it reached a level of 6.2% by the end of the year, which is believed to be reasonable from the viewpoint of macro-financial stability.
It is still arguable what such a step might have led to in Azerbaijan at that time, because devaluation can have a number of negative effects besides the good ones cited above. A few of the negative effects are as follows: high inflation (mainly due to imported inflation); high degree of dollarization (which is bad enough in itself, but could also have other negative impacts, such as degradation of monetary policy, additional squeeze on foreign reserves, inability of the economy to cope with external shocks, losses incurred by seigniorage, etc.); greater foreign debt burden (especially risky for the banking sector during times of instability); losses faced by those who deposited their savings in national currency in banks; a drop in confidence in the banks; and the worsening of the financial situation in sectors that lend in foreign currency but earn in national currency (2/3 of the foreign loans in Azerbaijan are of this kind).4 Azerbaijan’s opportunity cost will be discussed below.
Armenia’s leading position in the ranking of crisis losses showed how vulnerable its economy is to external shocks, along with the poor, to say the least, performance of the state regulating bodies. But this degree of vulnerability is not because the Armenian financial market is well developed or closely integrated into the foreign financial markets. On the contrary, it shows attempts to maintain the economy by means of foreign aid and strong dependence on the Russian economy. Admittedly, almost all the CIS economies are more or less interrelated with the economic situation in Russia. It should be noted, however, that the present conditions of the Armenian economy denote dependence rather than interrelation.
It might seem surprising that Ukraine, the second largest economy of the CIS, with its abundant natural resources and higher level of human development, was one of the countries severely affected
4 See.: E. Rustamov, “Globalnyy krizis i antikrizisnaia politika Tsentral’nogo banka Azerbaidzhana,” Dengi i kredit, No. 1, 2010, p. 30.
by the crisis. However the reasons were not related to economic instability alone, but also to the ongoing political instability in Ukraine, which had a significant effect. Which aspect was more serious, the economic or the political, is the topic of a separate study.
Ranked third, there were also non-economic reasons behind Georgia’s losses of 22.5% in GDP. Major losses were largely incurred due to serious damage to its economic infrastructure inflicted by the Russian armed forces and the suspension of political and economic relations.
3.1. Opportunity Cost Ranking of CIS Countries:
The Opportunity Cost Index
Let us take a look at which country suffered more in relation to the size of its economy based on the ranking of crisis losses. As mentioned earlier, the opportunity cost index is intended for defining the ratio of losses from the crisis to the size of the national economy.
Figure 2
The Opportunity Cost Index of CIS Countries Calculated for 2009
As the index values indicate, the cost of the crisis was high for Armenia, Ukraine, and Georgia in terms of the size of their economies, that is, based on the ratio of their economies to the total economy of the CIS. This index value, which is equal to approximately 1 for Russia, indicates that the losses incurred by its economy from the crisis fit the size of its economy and should be considered normal. The Azerbaijani economy, with an index value of 0.9, incurred limited losses in relation to its size. As for the other seven countries, their losses were also small according to the index values.
4. Opportunity Cost of the Azerbaijani Economy during the Crisis
The structural features of the economy of Azerbaijan, and particularly its oil-driven economy, as well as the financial liberalization of recent years have made the economy more prudent against external shocks. In essence, the crisis affected the national economy through those channels.
The impacts of the crisis, such as the drop in oil prices in the world market, the large amount (at least for the Azerbaijani economy) of foreign debt recalls, and the limited sources of funding, became evident in the last quarter of 2008 and were exacerbated in the first quarter of 2009. This resulted in shortage of liquidity in the banking sector, reduced lending to the economy, and decreased budgetary revenues, and also gave rise to speculations in the manat in the currency market.
Hence, following shrinkage of the channels of aggregate demand (consumer spending, investment costs, and net exports) and rising uncertainty and pessimistic expectations, the growth rate in the real sector logically fell.
Figure 3
Economic Growth Rate in Azerbaijan:
Overall and for the Non-Oil Sector
S o u r c e: State Statistical Committee of the Azerbaijan Republic.
Based on the calculations, the crisis losses of the Azerbaijani economy for 2008-2009, in other words, unrealized gains caused by the crisis, added up to around 8.3 billion manats at the 2009 price level, 2.7 billion in 2008 (at the same price level as 2009), and 5.6 billion in 2009.
At present, the opportunity cost of the oil sector is assumed to be 5.8 billion manats (2.7 billion manats in 2008 and approximately 3.1 billion manats in 2009), whereas the opportunity cost of the non-oil sector, incurred entirely in 2009, is around 2.5 billion manats.
THE CAUCASUS & GLOBALIZATION
The opportunity cost of household incomes amounted to approximately 3.1 billion manats, which was incurred entirely in 2009.
Without timely and correct intervention in the process, the costs would have been much higher. Although the regulating bodies have no way of interfering in what happens in the world economy, in Azerbaijan, agile policymaking, a conservative attitude, and political will aimed at surmounting the crisis made it possible to neutralize the aggravated economic situation.
The role of the Central Bank was exceptional in dealing with the given situation. This institution took on greater responsibility to elaborate and implement anti-crisis measures designed to save the banking sector, which was at major risk, and stop the repercussions from spilling over into the real sector. These measures made it possible for the Central Bank to overcome the difficulties and improve liquidity in the banking system, strengthen control over the system, provide financial support to systemic businesses in the real sector, neutralize the pressure on the currency market, and restore macro-financial stability.
Certain risks remain against the background of the positive influences of these measures. How quickly the existing and emerging risks can be minimized and rapid development restored after the crisis will greatly depend on the economic policy that is implemented in the post-crisis period, as well as on the global economic situation.
In Lieu of a Conclusion
In generic measurement of the crisis losses (or the opportunity cost), the use of GDP as a major indicator of the prevailing economic situation and the employment of actual and estimated growth rates of GDP have some advantages from the methodological viewpoint. This is mainly because GDP and its growth rates implicate all types of economic activities (except for shady businesses) in the country. Therefore, the opportunity cost is what makes up an advantage.
Use of the linear trend method for calculating the estimated growth rates is as suitable as it is simple. As is known, macroeconometric models of different scales are used worldwide to forecast economic growth, which provide insight into different features of economies. An increased correlation (r=0.986) between the IMF forecasts, which are a specific output of this type of econometric computation, and the forecasts calculated as per the linear trend method justifies the use of this method as a basis for opportunity cost ranking.
It should be noted that because of its simplicity, this methodology of calculating losses and formulating the opportunity cost index and ranking enables calculations to be carried out for every country in the world and makes it possible to establish the ranking of crisis losses.
Based on the calculations and analysis, the CIS countries can indicatively be divided into the following 3 groups:
■ Group 1. Countries with a range of index values between 0 and 0.7. The countries in this group are characterized by a weakly developed financial system, relatively closed economy, and poor integration into the global financial markets, which played a key role in their minimum losses from the crisis.
■ Group 2. Countries (Kazakhstan, Azerbaijan, and Russia) with range of index values between 0.7 and 1, which are distinguished by:
(i) potential growth opportunities (evolving from rich natural resources, human capital improvement level, inclination to apply technological innovations);
(ii) deeper integration into the global financial markets;
(iii) relatively developed financial system; and
(iv) effective anti-crisis measures.
Figure 4
Correlation Between Growth Forecasts Calculated as a Per Linear Trend Method and IMF Forecasts
♦ Series 1 ----- Linear (Series 1)
While factors (i), (ii), and (iii) stipulated the losses, factor (iv) played an important role in keeping the losses at a tolerable level.
■ Group 3. Countries with index values of more than 1. In fact, the major element these countries have in common is the size of the losses from the crisis (without taking into account Russia’s influence, economically, politically and militarily, on the crisis losses of those three countries). Neither the size of their economies, nor their structural and administration traits, nor the causes of the crisis losses are same in those three countries. Being the second largest economy in the CIS and the Caucasus region, Ukraine (which could be included in Group 2 in terms of development potential) and Georgia endured crisis losses resulting from non-eco-nomic processes (the government crisis in Ukraine and the August war in Georgia), in addi-ton to economic ones. As for Armenia, the most critical reasons for its leading position in the crisis losses, among others, are occupation by Armenian armed forces of 20% of Azerbaijan’s territory and the territorial and “genocide” claims against Turkey. This is why Armenia’s borders with its neighbors (Azerbaijan and Turkey) have long been closed and economic and political relations have ceased. Armenia’s aggression is preventing it from participating in any of the major projects in the region and condemning it to accept foreign aid rather than establishing the fundamentals of a solid and sustainable economy. The crisis ultimately unveiled the problems the Armenian economy had long before the crisis happened.
The countries in Group 2—Russia, Kazakhstan, and Azerbaijan—have potential growth opportunities, institutional expertise gained from economic regulation and supervision, and sustainable and fast-developing economies that rely on solid financial systems during the post-crisis period, which, all-in-all, open up broader prospects for them.
