- The economy’s high dependence on hydrocarbons output has revealed vulnerabilities. Economic growth slowed considerably in the past year due to some oil output disruptions. Growth outside the hydrocarbon sector continued, propped up by government spending. Inflation has remained subdued, while external and fiscal surpluses slowly narrowed.
- Azerbaijan tapped international capital markets. Two Eurobond placements in 2014, by the government and state-owned bank, were well received by investors and increased the country’s visibility in international financial markets.
- Challenges in diversification of the economy remained. Diversification efforts were largely limited to fiscal and credit incentives, rather than improving the business environment and ensuring a level playing field.
Key priorities for 2015
- Diversification of the economy remains a key priority for the authorities. To reduce dependence on the hydrocarbon sector, further progress should be made in improving the country’s business climate, reducing corruption and strengthening competition policy. Completion of the World Trade Organization accession could increase international investment and encourage development of the non-oil sector over time.
- The authorities should continue to improve conditions for development of the financial sector and capital markets. Restructuring and transparent privatisation of the major state-owned bank – the International Bank of Azerbaijan (IBA) – would help strengthen the banking sector and commercialise, and eventually unwind, state-directed lending.
- The government should strengthen policies concerned with managing oil wealth. Present and future generations would benefit from the introduction of a fiscal policy rule that would aim to smooth the intergenerational allocation of oil wealth and promote fiscal discipline during periods of high oil prices. Future public investment projects should be designed to increase growth potential and to complement private sector investments.
THE ECONOMY’S HIGH DEPENDENCE ON HYDROCARBONS OUTPUT HAS REVEALED VULNERABILITIES
AZERBAIJAN TAPPED INTERNATIONAL CAPITAL MARKETS
CHALLENGES IN DIVERSIFICATION OF THE ECONOMY REMAINED
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.
Main macroeconomic indicators %
|Current account balance/GDP||28.0||26.5||21.8||16.7||14.6|
|Credit to private sector/GDP||17.9||17.6||20.1||25.5||n.a.|
Growth has been volatile. The high pace of economic growth in 2013, enabled by the election-related credit and public spending boom and the stabilisation in oil output, petered out in 2014. Growth slowed from 5.8 per cent in 2013 to a preliminary 2.5 per cent year-on-year in the first nine months of 2014. The unexpected decline in oil output at the start of 2014 weighed on growth. The non-oil sector continued to grow fast, albeit at a slower pace than before. A substantial fuel price increase in December 2013, the first since 2007, did not have a lasting effect and inflation has remained low, at 1 per cent year-on-year in July 2014, constrained by stable food prices.
The external position is strong, but slowly deteriorating. With the oil price relatively stable, revenues from hydrocarbon exports remained virtually flat. Non-oil imports continued to surge, boosted by rising incomes and consumer credit. As a result, the overall current account surplus narrowed further from 22 per cent of GDP in 2012 to 17 per cent of GDP in 2013. The ban on some used car imports that do not meet the Euro 4 fuel standard requirement, introduced in April 2014, could temporarily reverse this trend, as evident from the preliminary imports data for the second quarter of 2014. The external buffers remained ample, with foreign exchange reserves and oil fund assets amounting to US$ 49.1 billion (65 per cent of GDP) as of the end of June 2014. The Central Bank of Azerbaijan (CBA) continued to maintain its policy of a stable exchange rate against the US dollar.
While the near-term outlook remains positive, long-term growth prospects hinge on progress in reforms. Oil price shocks and output disruptions remain the biggest challenges in the short term. At the same time, large foreign exchange reserves give the authorities room for mitigating risk. Over the last decade, the government has been successful in leveraging the country’s hydrocarbon potential, and hence in promoting growth and reducing poverty. In the last couple of years the limits to resource-led growth have become evident. While the dependence of the economy, budget and exports on hydrocarbons is slowly decreasing, the ability of the non-oil sector to grow sustainably without constant government stimulus is unclear. Sustained structural reforms aimed at encouraging competition, and facilitating economic openness and trade, are needed to secure sustainable development in the long term.
Major structural reform developments
Some progress has been made in structural reforms, but many challenges remain. In the World Economic Forum’s Global Competitiveness Report 2014-2015 Azerbaijan maintained its relatively high position – 38th out of 144 countries – which is the second-highest ranking among the former Soviet countries. This high ranking is largely due to a stable macroeconomic environment. At the same time, corruption is still a serious concern despite some steps taken by the authorities in recent years to reduce it and to improve governance in public services. In Transparency International’s Corruption Perception Index, Azerbaijan ranked only 127th in 2013, up from its 139th position in 2012. The overall business environment outside the oil sector remains difficult, as evidenced by the country’s relatively low ranking for ease of doing business (80th out of 189 countries in the World Bank’s Doing Business 2015 report). Consequently, foreign investments in the non-oil sector are limited.
The presence of the sovereign and of corporates in international capital markets has increased. In March 2014 Azerbaijan placed its first sovereign Eurobond, raising US$ 1.25 billion for a 10-year issue. The bond attracted significant investor interest and was reportedly more than three times oversubscribed. The final yield was set at 5 per cent, about 220 basis points above the 10-year US treasury yield. The successful sovereign placement paved the way for other deals. In June 2014 the IBA placed a debut 5-year US$ 500 million Eurobond at a 5.625 per cent yield. The local capital market has continued to develop. The first initial public offering of a local IT company is expected to take place by the end of 2014.
Diversification of the economy is progressing slowly. Diversification of the economy is recognised by the government as being an urgent priority. In its Azerbaijan 2020 vision, rolled out in late 2012, the authorities viewed enhancing competitiveness and export growth as necessary steps towards developing the non-oil sector. The government’s approach to developing the non-oil sector of the economy mainly included pursuing government-sponsored infrastructure projects linked to the use of oil wealth, as well as directly intervening to stimulate product diversification, as testified by its drive to build industrial parks. So far, this has not translated into pronounced non-energy exports growth, which was a meagre 6 per cent in value terms in 2013, or into a significant increase in the private sector share of employment. A new competition code has long been pending in parliament and the timeline of its adoption and implementation is unclear.
Major infrastructure projects are on track. In 2013 Azerbaijan determined the Trans-Anatolian (TANAP) and Trans-Adriatic (TAP) pipelines as being the main routes for Caspian gas to European customers. In May 2014 TANAP awarded a construction management contract to the Australian firm WorleyParsons. The 1,841 km TANAP, which should initially pump 16 billion cubic metres of gas annually, will cost an estimated US$ 10 to US$ 11 billion and should be completed in 2018. With regard to the TAP pipeline project, shareholders plan to initiate a construction tender in late 2014 or early 2015. Contracts for the development of the Shah Deniz II project have been actively awarded over the last year. At the same time, there have been delays in construction of the new port near Baku (the first phase of which was postponed from June 2014 to the start of 2015) and of the Baku-Tbilisi-Kars railway.
Financial sector intermediation continued to expand. Since mid-2012, when the CBA announced new minimum bank capital requirements of AZN 50 million (US$ 64 million equivalent), commercial banks have been increasing capital. In November 2013 the CBA postponed the deadline for compliance with the new requirements from 2014 to 2015. As of July 2014 the capital position of banks appears to be strong, with the average capital of all 44 banks being some 70 per cent above the minimum threshold. Despite the high capitalisation and low NPL ratio, official NPL figures include only an overdue portion of interest and principal, and hence do not fully reflect the quality of loans on the banks’ balance sheets. The state-owned IBA represents around one-third of the system-wide loans. In early 2014 the CBA decided to curb the accelerating shift of commercial banks to retail lending by tightening consumer loan requirements and limiting the loan-to-value ratios for car loans. Provisioning rules and NPL classification requirements were also strengthened. Cashless payments by households continued to grow steadily as the CBA improved infrastructure for non-cash transactions, including plastic cards, point-of-sale terminals and automatic teller machines.