Rapid Credit Growth in Azerbaijan: Convergence or Boom? Macroeconomic Implications of Fast Credit Expansion


Master's Thesis, 2010

55 Pages, Grade: A-


Excerpt

Table of Contents

CHAPTER 1: INTRODUCTION

CHAPTER 2: RECENT ECONOMIC OVERVIEW IN AZERBAIJAN

CHAPTER 3: LITERATURE REVIEW

CHAPTER 4: CREDIT BOOM
4.1 MAIN REASONS OF CREDIT BOOMS
4.2 EMPIRICAL INDENTIFICATION OF CREDIT BOOMS

CHAPTER 5: DATA ANALYSIS AND THEORETICAL FRAMEWORK
5.1 DATA ANALYSIS OF THE DETERMINANTS OF EQUILIBRIUM LEVEL OF CREDIT
5.2 THEORETICAL FRAMEWORK

CHAPTER 6: EMPIRICAL ANALYSIS AND RESULTS
6.1 FINDING THE CREDIT BOOM LEVEL
6.2 UNIT ROOT TESTS
6.3 COINTEGRATION TESTS
6.4 VECTOR ERROR CORRECTION MODEL
6.5 MODEL CHECKING

CHAPTER 7: CONCLUSION AND DISCUSSION

REFERENCES

APPENDIX

TABLE OF FIGURES

Figure 1: Structure of banking sector’s assets, % (Source: Central Bank of Azerbaijan Republic, 2008)

Figure 2: Quality of loan portfolio, % (Source: Central Bank of Azerbaijan Republic, 2008)

Figure 3: HP filter for Credit per capita (in AZN)

Figure 4: Credit per capita

Figure 5: Credit to GDP ratio

Figure 6: Real interest rate

Figure 7: GDP per capita

Figure 8: Real effective exchange rate

Figure 9: Oil prices (monthly average)

Figure 10: Inflation

Figure 11: Openness of trade

LIST OF TABLES

Table 1: Long-run equilibrium equation that for the credit to GDP ratio

Table 2: Cointegration Analysis

Table 3: Long-run equilibrium equation that for the credit to GDP ratio

Table 4: Weak Exogeneity Test

Table 5: Error Correction Equations for Credit Level and Oil Prices

Table 6: Error Correction Equations for GDP per capita, REER and RIR

Table 7: Diagnostic tests for residual autocorrelation

Table 8: Unit root tests

Table 9: Johansen (1995) Cointegration Test

Table 10: Cointegration Analysis

Table 11: Literature Survey.

CHAPTER 1: INTRODUCTION

A good introduction to the work is almost the half of the success.

Haydar Aliyev

This thesis contributes to the detection and identification of credit booms in Azerbaijan in the period of 2000-2009 years. This issue has been the primary topic of many empirical researches in the last decade. Gourinchas et al. (2001) and Mendoza and Terrones (2008) discuss this issue in more detailed form and get interesting results though their methods of finding credit booms are different. In this study, I apply simple Hodrick-Prescott (HP) filter used by Mendoza and Terrones (2008) to analyze the difference between ordinary credit expansions and credit booms. Employing all their methods I find that Azerbaijan faced credit boom conditions in the May-October of 2008. This period is consistent with the period of significant fluctuations in macroeconomic aggregates, where these changes are typical for credit booms.

This paper also studies the macroeconomic implications of rapid credit expansions, determines the long-run and short-run equilibrium of credit level. The data for this study is obtained from the Central Bank of Azerbaijan Republic (CBAR). I take the sample of 120 monthly observations of the period 2000-2009 years. Here, I use credit/GDP ratio which is the primary indicator of financial deepening process that causes credit booms. Hofmann (2001), Duenwald et al. (2005) indicate credit to GDP ratio as the equilibrium level of credit and discuss the implications of the expansions in credit to the private sector on the main economic indicators. To discuss macroeconomic implications of fast credit growth, Cottarelli et al. (2003) exploit this fundamental in their model based on a panel estimation from the developing and industrial countries of Central and Eastern Europe and Balkans. As a main determinants of the equilibrium level of credit I employ real GDP per capita (PPP-based), real effective exchange rate, real interest rate, inflation, oil prices and the openness of trade (proxy for the tradable sector) to learn the association of these fundamentals with the credit level. To identify the stationarity conditions of these fundamentals I make use of the unit root tests, both Augmented Dickey-Fuller (ADF) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) tests. Estimations allow us to say that all the variables are integrated of order one, that is, we get the non-stationary conditions for these aggregates. Then I switch to cointegration tests to investigate the long-run relationships of the variables and identify the long run equation for credit to GDP ratio. Based on Johansen’s (1995) approach to cointegration analysis it turns out that the long-run development of credit can not be explained by all the fundamentals that intuitively could be considered as the determinants of credit level. But once inflation and openness variables are excluded from the model I am able to identify the long-run equilibrium of credit. Moreover, I find that there is a one cointegration among the variables, so I decide to set up a VECM (Vector Error Correction Model) to learn the short-run dynamics of credit expansion. VECM framework provides estimates of both the short-run equilibrium value of the credit to the private sector and the dynamic adjustment path to its long-run equilibrium. The coefficients of the error terms in VECM imply that credit converges to its long-run equilibrium.

This research about credit expansions in Azerbaijan also links the rapid credit growth to the financial crisis happened in 2008. There are several studies that discuss this issue with the empirical approaches. For instance, Kaminsky and Reinhart (1996) analyze the Mexican and Asian case and conclude that credit bubble is an important preceding factor causing banking and currency crises. Schadler et al. (2004) also argue the risk of banking crisis after rapid credit expansions in Central and Eastern Europe. This thesis also reemphasizes the findings of Mendoza and Terrones (2008) who find a large likelihood of financial crises with the credit booms, as my study also shows a significant connection between the credit bubble found in 2008 May-October period and the financial crisis in 2008.

Reiner et al. (2007) discuss the issue of appreciating domestic currency in the countries facing credit booms. This thesis also shows the similar results in the case of Azerbaijan in 2000-2009 years, especially in the period of financial crisis in 2008. This should also be mentioned that CBAR pursues the fixed exchange rate policy in Azerbaijan; hence nominal interest rates do not change as a result of credit booms, just real effective exchange rate slightly decreases (the domestic currency appreciates).

CHAPTER 2: RECENT ECONOMIC OVERVIEW IN AZERBAIJAN

Azerbaijanproduced more than half of the

world’s oil supply at the beginning of the 20th century[1]

Azerbaijan is located in the South Caucasus region, bordering Caspian Sea from the east, between Iran and Russia, with a small European portion in the north of the Caucasus range. Historically, Azerbaijan has been in the interest of the big countries because of its strategic-geographical position. After gaining independence in 1991, Azerbaijan became a member of the International Monetary Fund (IMF), the World Bank, the European Bank for Reconstruction and Development, the Islamic Development Bank and the Asian Development Bank. Country encompasses lots of different natural resources; in particular it is rich in oil-gas sector. Oil and gas serve as a large part in Azerbaijan’s industry, it accounts for more than 80% of exports and 50% of GDP. Oil production was about 450 million barrels in 2008. GDP is also growing every year; it was estimated at 10.8% in 2008, including 7% in the oil sector and 15.7% in the non-oil sector. The national currency, Azerbaijani manat[2]was established in 1992, since then all kind of monetary transactions have been conducted in this currency.

The banking system’s portfolio did not face any kind of negative changes during the financial crisis period, in 2008. Despite of unfavorable surroundings, Azerbaijan’s banking system demonstrated its ability to withstand the emerging risks. Progress in banking sector is essential for Azerbaijan, because an efficient banking system is crucial for the development of non-oil sector of the country and it plays a pivotal role in reducing the country’s dependency on the oil. Banking sector includes more than 40 commercial banks, 2 state owned banks, and assets in this sector are estimated at about 4.4 billion USD. Banking sector in Azerbaijan has undergone significant changes and improvements; combined with favorable investment climate, it is posed for further growth and enhancement.

illustration not visible in this excerpt

Figure 1: Structure of banking sector’s assets, % (Source: Central Bank of Azerbaijan Republic, 2008)

The total bank assets increased by AZN 3547.9 million or 52.7% totaling to AZN 10273.5 million as of January 1, 2009. This is a quite considerable amplification in bank assets for Azerbaijan. As it is seen from above figure, a huge division (67%) of whole assets is the loans given to customers. That indeed shows the significance of credit loans in Azerbaijan’s banking sector. Given loans played a substantial role in the increase of profit for small firms and organizations, as well as for individuals. Therefore, The Central Bank of the Azerbaijan Republic, henceforth CBAR, pursued policy about keeping the banking systems harmless from the negative impact of the misbalance at the international financial market. During the reported period, the banks’ loan portfolio increased in scope in addition to continuing to improve in terms of quality.

illustration not visible in this excerpt

Figure 2: Quality of loan portfolio, % (Source: Central Bank of Azerbaijan Republic, 2008)

Because of the rigid asset classification, quality of loans increased in 2008. The possible loan loss provisioning requirements were increased. As of January 1, 2009 the possible loan loss provisions amounted to 6.2 % of loan portfolio (5.7% as of January 1, 2008).

CHAPTER 3: LITERATURE REVIEW

Knowledge is a treasure – the more you use

the more it increases, the less you use the more it diminishes.(A Chinese proverb)

A quite large number of empirical researches and studies have been conducted both to identify credit booms and analyze the effects of credit booms on macroeconomic indicators. Identifying credit expansions and characterizing economic fluctuations through the comparison of emerging and industrial economies were the main interests of these studies. Gourinchas, Valdes and Landerretche (2001), were the first who introduced threshold methods to the analysis of credit booms. Their method also encompasses the introduction of thresholds that are common to all the countries of interest in their study. Moreover, Gourinchas et al. (2001) analyze relationship of boom episodes with the financial crises. They compare the probability of having a banking crisis before and after a boom episode with the probability of experiencing such a crisis during tranquil periods.[3]The authors use basic information from Caprio and Klinguebiel (1997) who construct a large database on banking crisis episodes. According to Caprio and Klinguebiel (1997) a banking crisis occurs when the net worth of the banking sector has been almost completely eliminated.

Another approach to the identification of credit booms is made by Mendoza and Terrones (2008). Their method for determining credit booms is different from the one used by Gourinchas et al. The fundamental that they use to measure a credit boom and the ways of detecting the booms are quite different in their study. I talk more briefly about this issue in Chapter 3.

[...]


[1]From the report of the Chairman of the Central Bank Management Board

[2]On 1 January, 2006 a new manat, AZN was introduced (at a value of 5000 old manat) with the denomination due to inflation. 1 USD = 0.8036 AZN, 1 EUR = 1.0164 AZN

[3]For more information see “Lending Booms: Latin America and the world”

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Details

Title
Rapid Credit Growth in Azerbaijan: Convergence or Boom? Macroeconomic Implications of Fast Credit Expansion
College
Central European University Budapest
Grade
A-
Author
Year
2010
Pages
55
Catalog Number
V155027
ISBN (eBook)
9783640678174
ISBN (Book)
9783640678105
File size
574 KB
Language
English
Notes
Tags
Rapid, Credit, Growth, Azerbaijan, Convergence, Boom, Macroeconomic, Implications, Fast, Credit, Expansion
Quote paper
Rashad Karimov (Author), 2010, Rapid Credit Growth in Azerbaijan: Convergence or Boom? Macroeconomic Implications of Fast Credit Expansion, Munich, GRIN Verlag, https://www.grin.com/document/155027

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