Developments since independence Azerbaijan was among the poorer Soviet republics at the time of independence from the Soviet Union in 1991. In the early 1990s, Azerbaijan faced many of the challenges that confronted other Commonwealth of Independent States (CIS) countries in transition, including contraction of economic activity, deterioration in social services and infrastructure, and a rise in poverty. In addition, an armed conflict with neighboring Armenia over Nagorno-Karabakh led to an influx of about one million refugees and internally displaced people, and disrupted key regional trade and transport links. By 1994, a ceasefire was achieved; currently parties to the conflict are making efforts to find a peaceful solution to the dispute through mediation of the Minsk Group, co-chaired by France, Russia and the US. For Azerbaijan, economic recovery began in 1995 when, with greater political stability, the Government embarked on a program to stabilize the economy and introduce structural reforms. These reforms, aimed at stabilization and laying foundations for a market economy, were largely successful and ushered a period of sustained growth. The factors that led to sustained growth, were as follows: - First, in late 1994, Production Sharing Agreements (PSAs) were signed with foreign oil companies under which these companies agreed (i) to help develop oil and gas deposits in the Caspian Sea, and (ii) to construct the Baku-Tbilisi-Ceyhan (BTC) pipeline and the South Caucasus Gas pipeline, to transport oil and gas to Turkey through Georgia. Following a significant amount of Foreign Direct Investment (FDI), oil production started in 2006, while gas production started in 2008. The PSAs were the cornerstones of Azerbaijan’s forthcoming development as they generated a significant amount of FDI in the country, raised demand in the economy, and generated confidence for future investments. In order to safeguard prospective oil revenues, the State Oil Fund of Azerbaijan was created in December 1999. Its purpose was to perform both stabilization and savings functions. Its assets reached US$11.2 billion at end 2008.
- Second, the Government launched a wide-ranging reform program supported by quick-disbursing World Bank credits and an IMF program starting from the late 1990s. The early programs supported the stabilization of the economy while the later ones include oil revenue management, establishing institutions to develop the private sector, strengthening governance in the banking sector, enhancing transparency in the utility sectors, enacting a modern budget systems law, enacting a modern tax code, ensuring more transparent budget execution and accounting, and strengthening internal and external audit capacity. While the agenda is still under implementation, important strategic directions were set early on and important changes were made in legislation.
Recent economic developments and impact of the global crisis Starting in 2006, as new oil flowed into the BTC pipeline, Azerbaijan entered a new chapter in its development. Higher oil revenues allowed the government to embark on a large scale infrastructure modernization program aimed at improving the environment for non-oil sector development and the quality of social services, The reform efforts before 2006, and the ambitious modernization programs since then, have had a significant impact on poverty reduction. The government estimates that the poverty rate declined to about 20 percent in 2006 (nearly half the rate in 2003), and that it has continued dropping in subsequent years. In 2007 and 2008, Azerbaijan’s economy grew at 25 percent and 10.8 percent respectively. The oil sector grew at 36.8 percent and 7 percent respectively in both years, while the non-oil economy grew at 12 percent and 17 percent in the same years. In 2008, non-oil growth came primarily from construction (36 percent growth) and from services (13.7 percent growth), while agriculture grew a respectable 6 percent. The sources of aggregate demand in Azerbaijan have been oil exports and domestic consumption and investment, which have been supported by rising public spending. Azerbaijan ’s fiscal policy has sought to capitalize on the oil boom and to support the modernization of the economy by improving outdated public infrastructure and by adjusting the very low public sector salaries and pensions. Total public spending reached AZN 12.4 billion in 2008, up from AZN 5.1 billion in 2006. Between 2006 and 2008, Azerbaijan more than doubled the wage bill and social transfers, in efforts to adjust salaries and pensions to more meaningful levels. In 2008, public investment reached about AZN 4.7 billion, up from AZN 1.7 billion in 2006. Education, utilities (especially power) and the transport sector were declared priorities early on, while the health sector and the environment have also increased in importance. Azerbaijan ’s fiscal policy came at a cost, as inflation reached 19.7 percent in 2007 and decreased to 15.3 percent in 2008. By end 2008, Azerbaijan’s real effective exchange rate had appreciated by more than 40 percent relative to the pre-boom period. At the same time however, credit in Azerbaijan expanded significantly, growing by 97 percent in 2007 and 35 percent in 2008, alleviating some of the credit constraints that plagued the private sector and allowing Azerbaijan’s financial sector to expand. Azerbaijan ’s current modernization efforts are geared towards building foundations for greater diversification and sustainability of the economy. Important reforms have been completed in social assistance, are underway in the general education sector, and are being designed in the health sector. Efforts to improve the business environment (especially in business registration, labor market flexibility, protecting investor rights, and in tax administration) resulted Azerbaijan being named top reformer in improving business regulations among 185 assessed countries in Doing Business 2009. Azerbaijan is also a frontrunner in the Extractive Industry Transparency Initiative (EITI), and received the UN Public Service Award in June of 2007. The Global Crisis The global crisis has not hit Azerbaijan as severely as other countries in Europe and Central Asia. The impact of the crisis on Azerbaijan in 2008 was mostly through lower oil revenues. The country still managed to end 2008 with a double-digit growth rate. In 2009, GDP is expected to maintain positive, though oil revenues, remittances and non-oil exports are expected decline significantly. The country’s measures to overcome the global crisis, primarily on the side of monetary policy and in support of the private sector seem to have had a positive impact. Challenges ahead Azerbaijan’s medium term challenge is to diversify its economy. It needs to use its oil revenues to strengthen the institutional foundations for market economy and to develop a human capital base that is flexible and that will enhance the country’s prospects during and beyond the oil boom. This involves: - Effectively managing the country's finite oil and gas resources. In the coming years, Azerbaijan will have to assure that oil revenues are managed prudently and that they are being put into efficient use. The country will have to strengthen its economic management institutions to ensure that a sustainable fiscal policy becomes the hallmark of its macroeconomic policy making, that its budgeting institutions (including project appraisal) are strengthened, and that internal and external review of public expenditures meet international standards. Azerbaijan will also have to make sure that macroeconomic policies are supportive of the diversification of the economy.
- Improving living standards and tackling poverty. With about 20 per cent of the population still living in poverty, Azerbaijan needs to improve social services and infrastructure, generate employment, and develop the non-oil economy. As Azerbaijan’s oil sector occupies less than 1 percent of the labor force, the overwhelming share of employment needs to come from agriculture, non-oil industry, and services. Developing competitive products in these areas requires improved infrastructure and utilities, but also continued gains in the operating environment for the private sector, in improving public administration, in maintaining human capital with skills that match the needs of the private sector, and in addressing environmental challenges.
- Strengthening governance. Although Azerbaijan has made some important gains in political, regulatory, and legal reform, and there are important signs of improvement in the business environment, a significant agenda for reform remains. This agenda includes improving public-sector efficiency and transparency, enhancing the ability of citizens and communities to utilize information and hold the government accountable, strengthening the relatively weak legislative and judicial branches of government, and ensuring orderly electoral processes at all levels.
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The World Bank Group is a major development partner of Azerbaijan and as such has always been ready to support its both immediate and longer term needs. The World Bank’s operations in Azerbaijan have produced tangible and far-reaching results. Within the framework of its Country Partnership Strategy covering the fiscal years 2007-2010, the Bank has been assisting Azerbaijan in supporting sustainable and balanced growth of the non-oil economy by helping expand access of people to financial services; improve the business environment and develop essential infrastructure and services including roads, irrigation and water supply and sanitation. Special attention has been paid to the rural economy. World Bank assistance has been used to support the poor through the Targeted Social Assistance System and has helped rural communities to build local infrastructure and produce goods of common use. Bank support has also been used to improve the general education system by introducing changes to the curriculum and financing system. The World Bank is also helping Azerbaijan to build an effective health care system that will provide better quality services. The World Bank has been providing high quality and timely advice on strategic reforms, such as health financing, social protection, food security, and public investment programming. Major analytical work includes the Country Economic Memorandum, Programmatic Poverty Assessment,and various studies and assessments.
Azerbaijan has almost finished the transition from International Development Association (IDA) to International Bank for Reconstruction and Development (IBRD) financing due to its rapidly growing economy and creditworthiness. Its first IBRD loan was approved in May 2005. Since that time country received eight more IBRD loans totaling to US$ 1.65 billion which makes 81% of the overall commitments for active projects. In 2008, the World Bank portfolio was tripled with approval of eleven projects for a total amount of US$ 1. 26 billion. With two more projects approved in FY08, it is the largest in Europe and Central Asia region (ECA) in value terms. The overall commitments for active projects total US$ 2.18 billion. Going Forward The current Country Partnership Strategy for 2007-2010 is close to completion and the World Bank will embark on developing a new framework for its engagement in Azerbaijan later this year and complete the process of shaping it towards the middle of 2010. The institution will continue to help the country meet its most important priorities in the spirit of partnership and cooperation. |
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