Azerbaijan country assessment

• The authorities should continue to pursue policies needed to support diversification of the economy. The business environment should be further improved to remove obstacles to private sector development. Opening the country to cross-border trade, which includes completing accession to the World Trade Organization (WTO), should open access of non-oil sectors to the international markets.
• Competition policy should be further strengthened. Sector regulators should be made independent and encourage greater competition (especially in telecommunications, transport and the financial sector) and stimulate the entry of foreign strategic investors. Redress procedures in the cases involving anti-competitive practices should be further clarified.
• The financial sector requires significant reform. The recent decision to recapitalise the state-owned IBA highlights the need to reduce its role in the banking system and ultimately privatise the bank in a transparent manner with a view to strengthening competition in the sector and reducing its quasi-fiscal activities.

The non-oil economy continued to expand as oil output contracted further. The 10 per cent contraction of the oil sector in 2011 was almost fully offset by the rapid increase of the non-oil sectors, in particular construction and services, mainly stimulated by rising budget expenditures. Real GDP grew by 1.3 per cent year-on-year in the first eight months of 2012, again led by the non-oil sectors. Growth of consumer prices decelerated to -0.2 per cent in August 2012 after peaking at 9.7 per cent in May 2011, with the decline largely due to favourable base effects and lower international food prices. The policy of maintaining a stable exchange rate of the manat against the US dollar has complicated the central bank’s ability to maintain price stability. External debt remains low, and the public sector balance sheet is supported by a large oil fund. However, the non-oil fiscal deficit remains very large in light of the finite oil production, raising concerns about the long-term sustainability of the government’s fiscal policy. Nevertheless, exports of oil and gas will likely ensure that the current account remains in surplus and the exchange rate remains stable.
 

Economic growth is expected to remain subdued as energy output stabilises and non-oil sectors reached capacity. As gas fields operate at full capacity and reviving oil output requires investment and time, hydrocarbon production should stay below the pre‑crisis levels in 2012‑13. Non-oil output growth is expected to reach around 8 per cent, for an overall rate of growth of 3.5 per cent in 2012. If the authorities avoid further fiscal expansion and non-oil sector capacity constraints are not binding, inflation should remain moderate but volatile as long as the central bank is unable to effectively utilise interest rate tools. Export of oil and gas will continue to account for around one half of GDP and ensure a current account surplus and a stable exchange rate.
 

Risks stem mainly from a possible decrease in the oil price or extended disruption of oil export flows and their knock-on effects. In particular, risks are generated by real estate prices, a fall in which would affect the collateral value and portfolio quality of banks, undermining their lending capacity and hence growth in the non-oil sector. Further risks to forecasted growth derive from uncertainty regarding oil and gas production and potential political and external instability. Also, increasing global risks and the looming prospect of medium-term economic growth can affect oil and gas prices through decreasing global demand for hydrocarbons. This in turn will have a negative effect on the oil sector in Azerbaijan, making economic growth even weaker.

Although the authorities continue to improve the business environment, corruption remains a serious problem. Azerbaijan’s ease of doing business score in the 2012 World Bank’s Doing Business Report improved last year by three places to 66th, as the authorities lowered some tax rates and simplified the process of paying corporate income tax and value added tax. Azerbaijan ranked 46th in the global competitiveness ranking released by the World Economic Forum in September 2012, climbing up by nine places. Access to credit was aided by an online platform allowing financial institutions to provide information to, and retrieve it from, the public credit registry. The new customs code, which came into effect in January 2012, includes strengthened provisions in various areas that are expected to bring regulations into line with international standards (including verification of the country of origin, valuation methods, single-window principle in customs administration, customs audit and electronic submission of information on goods to the customs authorities).
 

The dominant state bank was recapitalised, but its long-term future is yet to be decided. Following an audit, in February 2012 the government injected new capital into the majority state-owned International Bank of Azerbaijan and the central bank provided liquidity. The recapitalisation increased the share of the state in the bank to 50.2 per cent, thus raising concerns about the authorities’ commitment to its privatisation. An international consortium of companies has been advising the state property fund on IBA’s privatisation since mid-2011, although little actual progress has been made so far to begin implementing the privatisation. The authorities have made a decision on an export route to the European hydrocarbon markets. In June 2012 the Shah Deniz consortium chose the Nabucco West pipeline as a potential export route to Europe. This is a shorter version of the Nabucco pipeline and it will connect the Shah Deniz field to Austria. Also, Azerbaijan signed an inter-governmental agreement with Turkey on the construction of the TANAP pipeline, which is expected to start at the end of 2013 and will carry gas to Europe and Turkey. The new route should diversify Azerbaijan’s export routes to the international markets and Europe’s access to energy imports.
 

Large infrastructure projects to increase trade and capitalise on the country’s strategic location are continuing. In March 2012 the government announced a tender for construction works and supply of goods and services for a new international sea port, to be located 65 km south of Baku. Construction of the port, the largest in the Caspian region, is expected to cost around US$ 1 billion. The first of the port’s three stages is expected to begin to function in 2014. If successfully completed and run commercially, the port should help strengthen the country’s role as a trade link between Europe and Asia.
 

The National Bank of Azerbaijan (NBA) continues to strengthen the regulatory framework and build capacity for inflation targeting. In July 2012 the NBA increased the threshold of aggregate capital of operational banks, as well as authorised capital for newly established banks to AZN 50 million. The new norm on the minimum capital requirement is to take effect from January 2014. Once implemented, the new norms should help strengthen the capital position of Azerbaijani banks. The central bank has also continued developing analytical skills and capacity to pursue the policy of inflation targeting over time, although it has continued to target the exchange rate as a nominal anchor.
 

The capital market is expected to be affected by recent changes of the insurance legislation. The law “on compulsory insurance” regulating the principles and basis for mandatory insurance came into force in September 2011. In November 2011 the authorities established a Compulsory Insurance Bureau with the purpose of stabilisation and development of the system of compulsory insurance and fulfillment of duties prescribed by the law. These reforms are expected to increase the size of the insurance market and, over time, increase the stock of assets in the local capital market.
 

Negotiations continue on WTO accession. In February 2012 at the ninth meeting of the working party on the accession of Azerbaijan, members reviewed Azerbaijan’s trade-related reforms, examined legislative developments and evaluated the progress made in the bilateral negotiations on market access for goods and services. Azerbaijan is currently negotiating with 10 members and the next meeting of the working group is scheduled for late-November 2012. The progress in negotiations should pave the way for reforms in tariff policy and trade liberalisation.