Moody’s: US tariff policy may open new opportunities for transit transportation via Azerbaijan

US tariffs have limited direct impact on Central Asia and the South Caucasus, but create indirect risks for the region's banking and corporate sectors, while global changes in trade flows may open up new opportunities for Azerbaijan, especially in the transit sector, Report informs via Moody's.

"Along with the tariffs being moderate, the US accounts for only a small fraction of the countries' total exports, most of which will avoid the new tariffs. Nonetheless, an escalating trade war between large economies would pose broader economic challenges for banks and corporates in the region through three main risk channels: trade; weakening confidence and macroeconomic conditions; and financial markets. In particular, low prices for oil and other commodities, potential trade disruptions, currency volatility, reduced investment inflows, inflationary pressures, tighter credit conditions and sector-specific effects would weaken the performance of certain companies. This would hinder local banks' loan growth, weaken asset quality and strain their profitability. A potential trade war would however also present some opportunities for the region.

The US tariffs will have indirect economic effects on the region. Economies and certain sectors in Central Asia and the Caucasus would be indirectly affected by the US tariff policy if it leads to slower economic growth globally, especially for the region's key trade partners, such as Russia, China and the EU. Lower commodity prices would affect the main exports of many Central Asia and Caucasus countries, while an overall decline in economic and investment activity would lead to reduced demand for their exports.

Fluctuating commodity prices and a more competitive environment for domestic manufacturers would also challenge sectors such as manufacturing, textiles and mining. Companies outside of the region facing high tariffs may redirect their sales to non-US markets, potentially driving down prices and increasing competition for domestic producers. This scenario is particularly relevant for Uzbekistan, whose textile sector accounts for around 11% of its total exports, according to the country's statistics agency. Banks lending to these sectors would face greater risks if businesses struggle with lower revenues and higher costs, potentially leading to tighter credit conditions and increased credit cost.

Conversely, the shift in global trade flows could create regional opportunities, such as more favourable pricing on local markets for some goods such as various equipment, metals and building materials, that may be redirected from the US market. A global trade war ignited by the sweeping US import tariffs could also push affected countries to seek new trading partners, potentially increasing interest in the resource-rich Central Asia and Caucasus region. The region also has significant transport and logistics potential, as a link between north and south, and east and west. In particular, the cargo rail sectors in Kazakhstan and Azerbaijan could get a boost from rail transit operations between Asia and Europe. The boost could drive up investment and the need for new bank lending in attractive and rapidly growing sectors. However, risks remain high amid the heightened economic uncertainty and volatility."

Low oil prices have knock-on effects for the broader economy. Concerns over a potential trade war because of the US trade policy could reduce global economic growth and, consequently, demand for oil. Additionally, OPEC-plus has decided to increase oil production, adding supply to the market. As a result, crude prices have fallen significantly in April, with Brent and WTI benchmarks around $65 and $62 per barrel, respectively, as of April 16. Crude prices will likely remain low but volatile in 2025. Even if oil demand remains steady, the crude market is well supplied and is likely to experience inventory build-up in the second half of the year if OPEC and OPEC-plus maintain plans to unwind production cuts," Moody's noted.

"Low oil prices primarily affect the oil and gas sectors in Azerbaijan and Kazakhstan by reducing revenues and profitability, as well as investment in new projects and exploration. While local banks are not directly exposed to large state-owned oil companies, the slowdown in the oil sector could affect the broader non-oil economy, hitting banks that have become increasingly exposed to small and medium-sized enterprises, and the retail sector.

In recent years, however, both countries have made substantial progress in diversifying their economies and bolstering their reserve buffers. These initiatives are vital for reducing their dependence on primary commodities and enhancing their economic resilience. Both countries proved such resilience through the pandemic shock, when the average oil price fell to $40 a barrel in 2020. Exports from Uzbekistan, Tajikistan, Armenia and Kyrgyzstan are heavily reliant on gold. The overall economic conditions in these countries will be supported by strong growth in gold prices during 2024 and the first quarter of 2025, mitigating the potential indirect impact of the US tariffs."

"Depreciation of local currencies increases credit risks for companies in the Central Asia and Caucasus region, especially those servicing domestic markets, engaging in imports or holding significant foreign-currency debt without matching cash flows. Levels of foreign- currency debt exposure differ among countries, however. After experiencing multiple currency shocks over the past two decades, Kazakhstani companies with no export operations have consistently reduced their foreign-currency debt, thereby mitigating revenue-debt mismatch risks.

Exporters, on the other hand, may benefit from weaker currencies aiding their top line and providing a hedge for foreign debt. In particular, weaker currencies could support the revenue and profitability of commodity exporters, including oil and gas companies, amid the significant drop in prices. However, foreign currency expenses, dollar-pegged investments and inflationary pressures on costs may temper these benefits."