Azerbaijan: Azerbaijan Economy Profile 2012

Azerbaijan Economy Profile 2012

Statement by the IMF Staff Visit to the Republic of Azerbaijan

February 15, 2011

An International Monetary Fund (IMF) staff mission, led by Mr. Nadeem Ilahi, visited Baku on February 7-15, 2011. The mission met with senior government officials and representatives of the private sector, civil society and the diplomatic community, and the discussion paved the ground for the 2011 Article IV consultation, expected in the second half of 2011. The mission issued the following statement at the end of the visit:

“The Azerbaijani economy continues to recover from the world economic crisis. Non-oil economic increase was strong in 2010, largely spurred by high public investment spending, though inflation rose rapidly in 2010, driven largely by rising world food prices. There are increasing signs of inflation forecasts becoming entrenched.

“Prospects for 2011 are as well promising, but rising inflation, expected to reach 10 % by end-2011, pose macroeconomic challenges. The major challenge for policymakers would be to contain inflation forecasts, while fiscal policy would as well need to contain request pressures.

“Fiscal expansion, financed by oil revenues, has been the major driver of non-oil increase in recent years, but the increasing risk of overheating calls for moderation in 2011. Spending restraint in 2010 appears to have resulted in a lower-than-expected non-oil deficit, which, in turn, helped with restraining inflation. The mission advocates spending restraint again in 2011, and welcomes the authorities’ intention to undertake spending in line with absorptive capacity. Efforts to ensure medium term fiscal sustainability are warranted, even if the prospects for additional hydrocarbon resources materialize. This could be achieved through raising non-oil revenues, making government spending additional efficient and allowing space for sustainable private non-oil sector to develop further.

“The signs of overheating in 2011 call for monetary policy to be tightened. The recent policy rate increase and the move to better exchange rate flexibility are appropriate steps, and should be accompanied with better policy coordination, transitioning to an inflation targeting framework, and enhancing banking system’s ability to transaction with exchange rate risk. The Central Bank’s plan to sterilize liquidity is welcome.

“The economy has weathered the world crisis and the authorities have recently taken some steps to improve supervision. While system-wide liquidity and capitalization appear adequate, private sector credit increase is sluggish. The mission supports the authorities’ intention to privatize the International Bank of Azerbaijan, after restructuring it, and urges prompt action to start the resolution process to preserve financial stability.

“The sharp rise in world food prices warrants additional , well-targeted social transfers to the poor, who tend to bear a heavy burden of rising inflation. The authorities’ recent campaign to target monopoly practices and public sector corruption is welcome, and needs to be pursued in a comprehensive manner to remove economic distortions and public sector inefficiencies.

“The mission wishes the authorities well in their efforts to maintain macroeconomic stability, improve governance, and pursue a broad-based, high increase path.”

Azerbaijan is an economy in transition in which the national continues to play a dominant role. It has significant oil reserves and a significant agricultural potential based on a wide variety of climatic zones. During the late 1990s, in cooperation with the International Monetary Fund (IMF), Azerbaijan pursued a successful economic stabilization program, with annual increase exceeding 10% since 2000. In 2009 Azerbaijan's gross domestic product increased by 9.3%, with increase in 2010 estimated at 9.8%. Output expansion has been largely driven by oil-sector foreign direct many(FDI) and related spillover effects in the construction and transportation sectors, although there have as well been substantial gains in agriculture. Inflation remains a major risk that could accelerate in the context of further increases in fiscal spending, high oil prices, and an inflexible exchange rate. Factors attributable to the world financial crisis may mitigate some of the inflationary trend, however. Importantly, the higher inflation as well reflects customs restrictions that are in place due to supply constraints that limit import competition and monopolies that continue to control a lot of sectors of the economy. The national currency, the Manat (AZN), is artificially stable and was allowed to appreciate against the dollar by 6.1% in 2005, 5.4% in 2006, 3.4% in 2007, and 1.1% in 2008. By early 2009 AZN was worth $1.24, which is its current worth.

The 2009 consolidated national budget set spending at $14.8 billion, an increase of about 16% over 2008. The IMF has expressed concern about the impact on inflation and macroeconomic stability inclunding governance if the capital budget is not well managed. The National Oil Fund (SOFAZ) was established as an additional -budgetary fund to ensure macroeconomic stability, transparency in the management of oil revenue, and the safeguarding of resources for next generations. Amount oil revenue profits from the development of new oil fields now flow into SOFAZ, and are held offshore. The National Oil Fund continues to play a critical role in promoting macroeconomic stability and in dampening the impact of massive energy revenues upon the economy. SOFAZ, as of January 2010, reported assets of 12 billion Manat ($14.9 billion). These assets constitute a 32% increase over SOFAZ's January 2009 reported assets ($10 billion). In 2007, the United Nations awarded SOFAZ a public service award for its transparency, accountability, and responsiveness in the public sector. Nevertheless, SOFAZ's sterilization effect is limited since it does not cover SOCAR, the National Oil Company. Both the IMF and the World Bank continue to emphasize the need to coordinate the budget planning process to integrate a medium-term spending framework with financing plans and the government's broader oil-revenue management strategy.

Azerbaijan has made efforts to modernize and reform its economy. The World Bank named Azerbaijan “Top Reformer” in its “Doing Business 2009” statement, reflecting its significant efforts to simplify its domestic regulatory requirements. The government has undertaken regulatory reforms in some areas, including substantial opening of trade policy, but inefficient public government, in which commercial and regulatory interests are co-mingled, limits the impact of these reforms. The government has largely completed privatization of agricultural lands and small and medium-sized enterprises. Azerbaijan is still plagued by an arbitrary tax and customs government, a court system lacking independence, monopolistic regulation of the market, and systemic corruption.

Azerbaijan is considered of the majority significant spots in the world for oil exploration and development. Proven oil reserves in the Caspian Basin, which Azerbaijan shares with Russia, Kazakhstan, Turkmenistan, and Iran, are comparable in size to North Sea reserves several decades ago.

Azerbaijan has concluded 28 production-sharing agreements with various oil companies. Azerbaijan celebrated first oil for the Baku-Tbilisi-Ceyhan (BTC) pipeline in May 2005, and the official completion ceremony was held in Turkey in July 2006. The BTC pipeline is now operational and has a maximum capacity of million barrels per day. A parallel Baku-Tbilisi-Erzurum gas export pipeline opened in September 2006. In October 2008, the first tanker carrying oil from Kazakhstan’s Tengiz field departed for Azerbaijan. New pipeline and delivery route systems for natural gas through the southern corridor to Europe are currently being considered and negotiated.