RaboResearch - Economic Research

Country Report Azerbaijan

Country Report


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The Azerbaijani economy is expected to slow in coming years, and fiscal policy will be more restrictive in 2014. Meanwhile, the increase in social unrest over the past year is a worrying trend. 

Strengths (+) and weaknesses (-)

(+) Strong external position

Azerbaijan has a vast amount of FX-reserves - which cover ten months of imports - and it has an acceptable external debt burden of 14% of GDP in 2013.

(-) Weak business environment  

A corrupt business elite controls the important energy sector, while investment opportunities outside this sector are scarce. The weak judiciary system further deters foreign investment.

(-) Weak governance and weak rule of law

President Alliyev rules in an authoritarian manner, corruption is deeply embedded and the country lacks an independent legal system.

(-) High dependence on single commodity export revenues

The oil and gas sector dominates the economy, making up 94% of total exports and accounts for the lion’s share of government revenues, which makes the country highly susceptible to global oil price fluctuations. 

Key developments

1. Economic growth expected to slow in coming years

Azerbaijan’s economic growth is estimated at 5.7% in 2013, and is expected to slow down in the coming years. The latest available data is from the period of January-September 2013, which shows that the non-oil sector grew by 10.4% year-on-year (yoy), while the oil sector, which accounts for 40% of GDP, declined by 0.4% yoy over the same period. The trend that the non-oil sector is outperforming the oil sector has been visible since 2010 and is likely to continue. In past years, problems at the country’s largest oilfield, Azeri-Chirag-Guneshli (ACG), weighed on oil production. These have been resolved last year, but oil production growth is likely to be flat going forward nonetheless, as the oil production will be deliberately lowered in order to  prevent excessive depletion of the existing oil fields. Also, foreign companies are likely very cautious to engage in contracts for new exploitation rights with Azerbaijan’s government, after it accused British Petroleum (BP) in 2008 of stealing oil revenues on multiple occasions still threatens serious action. Risks of this forecast are firmly tilted toward the downside, as no new oil fields will be launched. The West Chirag field (part of ACG), due to come on stream in early 2014, is the only exception.

In the non-oil sector, the highest growth - 30% yoy in the first nine months of 2013 - was recorded in construction. The agricultural sector, which accounts for around 5% of GDP but employs nearly half the population, grew by 4.9% yoy in January-September 2013. The government has made diversifying the economy a priority of its policy agenda up to 2020. However, we remain sceptical if the pace at which the non-oil sector can expand will be sufficient to compensate for slowing growth in the oil sector, as the rapid growth of the non-oil sector in 2013, which was underpinned by a rapid expansion of the construction sector, is unlikely to be sustainable in years ahead. Construction-led booms not always produce sustainable growth, especially if they lead to overcapacity in the property market. Key to the success of Azerbaijan’s plans for economic diversification will be making the right choices in future construction policies. Finally, there are indications that fiscal policy will be significantly less expansionary in the coming years, which will dent domestic demand. As such, we expect economic growth to slow to around 5% in 2014.

2. Fiscal policy more conservative in 2014

Fiscal policy has become more conservative this year, as the Azerbaijan government has become increasingly aware of its high dependence on revenues from the oil sector. According to the draft budget for 2014, the Azerbaijani government will increase spending by 1.1% in 2014, while revenues are forecast to be 4% lower. Although fiscal policy remains rather loose, it is more conservative than last year, as the spending increase of 1.1% is the smallest increase since 2009.

Figure 1: Slower-economic growth
Figure 1: Slower-economic growthSource: EIU
Figure 2: More restrictive fiscal policy
Figure 2: More restrictive fiscal policySource: Bloomberg

The estimate of lower revenues is based on a conservative assumption of an average oil price of USD 90 per barrel (p/b) in 2014, compared with USD 100 p/b last year. Furthermore, transfers from the State Oil Fund of the Republic of Azerbaijan (SOFAZ) next year will make up 50.8% of total budget receipts, down from 59% in 2013. SOFAZ collects most of the country’s energy revenues, and the more conservative budget is a sign that the government is aware of the risks associated with the growing dependence on transfers from SOFAZ to the budget. The IMF has encouraged Azerbaijan to establish a fiscal rule to limit transfers from SOFAZ, which is intended to act, in part, as a sovereign wealth fund to conserve the windfall from oil production for future generations. At current oil production rates, the proven oil reserves of Azerbaijan could last well over two decades. However, by then, the economy needs to be well-diversified and have a developed non-oil sector. The key risk of a continued high dependence on these transfers is a reduced sense of urgency to diversify the economy. If tax receipts will remain structurally too weak to cover a reduction in SOFAZ transfers, this will be a problem for the longer term.  While the more conservative fiscal policy is a positive development, it only is a very small start towards a reduction of dependence on the oil sector.  

3. Social unrest has increased in 2013

Social unrest has risen and several fairly large-scale protests have been held last year over a range of issues, including poor conditions for soldiers in the military that resulted in several deaths, as well as over socioeconomic disparities. The wider population is dissatisfied with its living standards, while Azerbaijan’s political and business elite enjoy significant wealth. Their wealth is enabled by an authoritarian rule of President Alliyev: a small business elite controls the most important sectors of the economy, such as the energy sector and the political system is practically closed from opposition parties. The government cracked down on the protests swiftly and violently on every occasion. It has installed further legislation which limits freedom of speech on the internet and which reduces the freedom of religion. This is a worrying trend. Since the weaker outlook for the economy will make it harder for the Alliyev regime to maintain order, there is a risk of further protests in 2014. 

Factsheet of Azerbaijan
Factsheet of AzerbaijanSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank

Background information

Azerbaijan is formally a presidential republic, but the regime of President Ilham Alliyev exercises near-absolute control over the country's political, economic and even social life. The parliament has effectively become a rubber-stamp institution, and remains nearly totally compliant to the president while the country lacks an independent legal system. Despite rivalries among the several powerful "clans" that try to influence the ruling regime and several instances of rioting, the regime is likely to continue to successfully suppress any potential domestic challenges thus appears set to remain in place. The Azerbaijani economy is highly dependent on oil revenues from the country's long-known and exploited reserves. Oil exports constitute a very large 94% of the country’s total exports, although Azerbaijan's oil output is very small in global terms. A strong inflow of foreign investment into the country were instrumental in facilitating skyrocketing GDP growth in the boom years of 2005–2007, when GDP expansion averaged 29% and was among the strongest in the world. Per capita income has grown rapidly in the preceding years, from USD 1,570 in 2005 to USD 7,861 in 2013, thereby surpassing per capita income of its direct neighbours. Income surged as both the production and the prices of hydrocarbons grew rapidly. In 2007, with the opening of a new oil-export pipeline from Baku through Georgia and Turkey, Azerbaijan increased its strategic importance as a thoroughfare for the export of Caspian oil and gas, mainly from Kazakhstan and Turkmenistan, through non-Russian networks. However, the country needs to diversify the economy away from the energy-sector to ensure sustainable long-term growth. 

Economic indicators of Azerbaijan
Economic indicators of AzerbaijanSource: EIU

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