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Economy

Over the past few years, the Government of Azerbaijan has sought to integrate the country more fully into the global marketplace, attract foreign investment, diversify its economy, undertake needed market economic reforms, and stimulate growth. However, the Azerbaijani economy is heavily dependent on oil and gas output, which account for roughly 91 percent of export revenue. Real GDP grew 1.4 percent in 2018 as oil prices increased.

While the oil and gas sector has historically attracted the majority of foreign investment, the Azerbaijani government has targeted four non-oil sectors to diversify the economy: agriculture, tourism, information and communications technology (ICT), and transportation. Measures taken in recent years to improve the business climate and reform the overall economy include eliminating redundant business license categories, empowering the popular “ASAN” government service centers with licensing authority, simplifying customs procedures, suspending certain business inspections, and reforming the tax regime. These measures helped Azerbaijan rise from 57 to 25 in the World Bank’s Doing Business Report. However, progress on structural reforms required to create a diversified and competitive private sector is mixed. A small group of government-connected holding companies dominate the economy, intellectual property protections are insufficient, and judicial transparency is lacking.

Since early 2016, the government has introduced tax and investment incentives for entrepreneurs and legal entities in non-oil export sectors as part of the overall economic reform/diversification effort. These measures include certain partial, temporary exemptions from corporate and property taxes; favorable tax treatment for manufacturing facilities and imports of manufacturing equipment; and subsidies for certain exports.

Access to capital is a critical impediment to business development in Azerbaijan. An effective regulatory system that encourages and facilitates portfolio investment, foreign or domestic, is not fully in place. Though the Baku Stock Exchange opened in 2000, there is insufficient liquidity in the markets to enter or exit sizeable positions. Non-bank financial sector staples such as capital markets, insurance, and private equity are in the early stages of development.

The country’s financial services sector – of which banking comprises more than 90 percent – is underdeveloped, which constrains economic growth and diversification. The drop in world oil prices in 2014/2015 and the resulting strain on Azerbaijan’s foreign currency earnings and the state budget exacerbated existing problems in the country’s banking sector and led to rising non-performing loans (NPLs) and high dollarization. NPLs accounted for 12 percent of all outstanding loans as of January 2019. President Aliyev signed a decree in February 2019 to provide partial relief to retail borrowers on foreign-currency denominated loans that meet certain criteria.

In Azerbaijan, state-owned enterprises (SOEs) are active in the oil and gas, power generation, communications, water supply, railway, and air passenger and cargo sectors, among others. There is no published list of SOEs. While there are no SOEs that officially have been delegated governmental powers, companies such as the State Oil Company of Azerbaijan (SOCAR), Azerenerji (the national electricity utility), and Azersu (the national water utility) – all of which are closed joint-stock companies with majority state ownership and limited private investment – enjoy quasi-governmental or near-monopoly status in their respective sectors. SOEs are, in principle, subject to the same tax burden and tax rebate policies as their private sector competitors. However, in sectors that are open to both the private and foreign competition, SOEs generally receive a larger percentage of government contracts or business than their private sector competitors.

Azerbaijan depended heavily on trade with Russia and other former Soviet republics. Azerbaijan's overall industrial production dropped in the early 1990s, although not as drastically as that of Armenia and Georgia. The end of Soviet-supported trade connections and the closing of inefficient factories caused unemployment to rise and industrial productivity to fall an estimated 26 percent in 1992; acute inflation caused a major economic crisis in 1993.

Azerbaijan did not restructure its agriculture as quickly as did Armenia and Georgia; inefficient Soviet methods continued to hamper production, and the role of private initiative remained small. Agriculture in Azerbaijan also was hampered by the conflict in Nagorno-Karabakh, which was an important source of fruits, grain, grapes, and livestock. As much as 70 percent of Azerbaijan's arable land was occupied by military forces at some stage of the conflict.

In spite of these setbacks, Azerbaijan's economy remains the healthiest among the three republics, largely because unexploited oil and natural gas deposits are plentiful (although output declined in the early 1990s) and because ample electric-power generating plants are in operation. Azerbaijan has been able to attract Western investment in its oil industry in the post-Soviet years, although Russia remains a key oil customer and investor. In 1993 the former Soviet republics remained Azerbaijan's most important trading partners, and state bureaucracies still controlled most foreign trade. Political instability in Baku, however, continued to discourage Turkey, a natural trading partner, from expanding commercial relations.

Azerbaijan is an economy in transition in which the state continues to play a dominant role. It has important oil reserves and a significant agronomic 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 growth exceeding 10% since 2000. In 2007 Azerbaijan's gross domestic product increased by 24.7%, with growth in 2008 estimated at 18.6%. Increases in oil production have largely driven this rapid growth as the oil sector accounted for 52.8% of GDP in 2007 and more than 50% again in 2008. Output expansion has been largely driven by oil-sector foreign direct investment (FDI) and related spillover effects in the construction and transportation sectors, although there have also 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, although factors attributable to the global financial crisis may mitigate some of the inflationary trend. Importantly, the higher inflation also reflects customs restrictions that are in place due to supply constraints that limit import competition and monopolies that continue to control many sectors of the economy. The national currency, the manat, is artificially stable and was allowed to appreciate against the dollar by 6.1% in 2005, 5.4% in 2006, and 3.4% in 2007.

The 2009 consolidated state budget sets spending at $14.8 billion, an increase of about 16% over 2008. More than 40% of revenues will be provided by transfers from the State Oil Fund (SOFAZ), based on an estimated oil price of $70 per barrel. The IMF has expressed concern about the impact on inflation and macroeconomic stability as well as governance if the capital budget is not well managed. The State Oil Fund was established as an extra-budgetary fund to ensure macroeconomic stability, transparency in the management of oil revenue, and the safeguarding of resources for future generations. All oil revenue profits from the development of new oil fields now flow into SOFAZ, and are held offshore. The State 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 currently has assets in excess of $10 billion, with assets expected to grow to approximately $12 billion in 2009. 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 State 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" report, 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 administration, 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 administration, a court system lacking independence, monopolistic regulation of the market, and systemic corruption.

Azerbaijan is considered one of the most important 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 21 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 one 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.