Public Information Notices
Republic of Azerbaijan and the IMF
IMF Concludes Article IV Consultation with Azerbaijan Republic
On June 30, 1999, the Executive Board concluded the Article IV consultation with Azerbaijan Republic.1
Throughout 1998 and into early 1999, the Azerbaijan Republic continued to implement firm financial policies in the context of an economic program supported by the Fund's Enhanced Structural Adjustment Facility and Extended Arrangement. Policies have also been supported by a World Bank Structural Adjustment Credit. As a result of these policies, economic activity continued its revival, while inflation was kept well under control. Public finances were adversely affected by the persistence of low oil prices and problems with revenue collection. Low oil prices also adversely affected the external accounts. These factors and the effects of the Russian financial crisis created major challenges for the formulation of economic policy. Implementation of structural reform was mixed.
Real GDP growth during 1998 was 10 percent, higher than expected, reflecting a rapid expansion of oil production, and of construction and service industry activities associated with the oil sector. However, nonoil manufacturing activities declined by eight percent in 1998. Agricultural production grew by only four percent. Both manufacturing and agriculture faced intensified pressure from increasingly competitive Russian imports after the steep devaluation of the ruble in midyear. The persistence of low international oil prices in 1998 led to the postponement of some planned oil sector investment. Although oil prices have recovered from their lows, these trends continued into 1999, and overall growth has tended to slow, with real GDP increasing by about six percent in the first four months of the year compared to the same period in 1998.
Consumer prices declined by about 7½ percent in the 12 months to December 1998 and disinflation has intensified in 1999, with consumer prices falling by nearly 11 percent in the 12 months to April 1999.
Fiscal performance deteriorated in the second half of 1998, reflecting lower than expected revenues and some unplanned off-budget expenditure. Low revenue reflected both the effect of oil prices but also poor tax collection, especially excise taxes. Lower revenue was offset by some expenditure compression and a rise in arrears, and the cash fiscal deficit for 1998 was 4¼ percent of GDP, broadly as expected. Owing to lower oil prices and despite implementation of new and stricter tax administration, revenue performance in the first quarter of 1999 continued to be poor, and further expenditure cuts had to be made and additional arrears were incurred.
The external current account deficit was larger during 1998 as export revenues were lower (despite higher oil export volumes) and import values higher than envisaged. However, weak oil prices have led to some postponement of direct investment plans. Although other capital flows were slightly larger, gross international reserves declined by about US$ 20 million, and represented 10 weeks of imports. By end-May 1999, gross international reserves had increased to about US$630 million (14 weeks of imports), reflecting additional oil bonus payments and disbursements of the second tranche of the SAC.
The exchange rate became a major concern for the authorities in 1998. Throughout most of 1998, they maintained the exchange rate of the manat against the US dollar broadly constant. This had beneficial results in terms of helping curb inflation and maintaining public confidence, especially in the light of sharp devaluation in neighboring economies, but adversely affected growth in the non-oil economy. Since December 1998, the authorities have intervened less in the foreign exchange markets and the exchange rate against the U.S. dollar depreciated by about 3 percent between then and end-May.
Monetary policy has been tighter than envisaged with manat reserve money declining by about 20 percent during 1998, and by a further 11 percent in the first quarter of 1999. Real interest rates have risen sharply and there has been little increase in bank credit to the private sector. Liquidity problems have worsened, in part due to slow progress in restructuring the state-owned banks.
Executive Board Assessment
Executive Directors commended the authorities' firm policy response to external shocks experienced in 1998, which had allowed Azerbaijan to maintain financial stability in a difficult and uncertain environment. However, with non-oil output and prices falling, Directors urged the authorities to ease macroeconomic policies to support activity in the near term, while intensifying structural reforms to ensure that growth is sustained over the longer term.
Regarding financial policies in the near term, Directors supported the authorities' decision to increase cash budgetary expenditures and ease monetary conditions. They welcomed, in particular, the use of government deposits at the Azerbaijan National Bank (ANB) to reduce pension arrears, noting that this had provided a helpful injection of liquidity and assisted directly one of the poorest groups in society.
While favoring an easing of fiscal policy in the near term, Directors emphasized the importance of determined measures to strengthen the underlying structure and transparency of public finances. They urged the authorities to strengthen tax administration and budgetary management, and to avoid further arrears on wages, pensions, and utilities payments. The authorities were encouraged to build on recent progress in addressing these issues and to make effective use of the available technical assistance. Directors noted that improved cooperation between the Ministry of Finance and the ANB was an important step toward establishing a strong treasury bill market, which could facilitate both budgetary management and monetary policy operations.
Directors recognized the merit of the authorities' reasons for maintaining a stable exchange rate during 1998. However, with substantial real depreciation having taken place in key partner countries, they considered that it would now be appropriate for exchange rate policy to be geared toward restoring the competitiveness of the non-oil sector. In conjunction with the easing of other financial policies, this would help support economic growth without jeopardizing price stability. Directors encouraged the authorities to continue to monitor developments in the exchange market closely. A number of Directors considered that a flexible exchange rate regime would be appropriate. Directors welcomed the authorities' intention to accept at an early date the obligations of Article VIII, Sections 2, 3, and 4.
While acknowledging the progress made, Directors considered that an intensification of structural reform efforts was needed to improve the climate for foreign direct investment and private sector development, and to promote broad-based and sustainable growth. They encouraged the authorities to revitalize their privatization program as quickly as possible. Regarding the banking system, Directors commended the progress that has been made toward privatization of the International Bank and Savings Bank, and urged the authorities to be prepared to take quick and decisive action to resolve the growing problems of the other two state-owned banks, as well as to strengthen the remainder of the banking system. Noting the weak condition of many private banks, Directors recommended more rigorous enforcement of prudential standards, establishment of a clear legal framework for the closure of nonviable banks, and further relaxation of the limits on foreign participation in the banking system. Directors encouraged the authorities to undertake a careful review of the reform strategy in consultation with the Monetary and Exchange Affairs Department of the Fund and with the World Bank.
Directors considered that, provided economic reforms were pursued vigorously, Azerbaijan's medium term prospects were strong. They stressed that, in the long run, Azerbaijan's oil wealth could not provide a substitute for determined reform. Directors welcomed the authorities' intention to tackle problems of governance and corruption, and encouraged them to intensify their efforts in this regard, including through a strengthening of the legal and regulatory framework, a reorganization of government and the civil service, improved fiscal transparency, and reduced government intervention in the economy.
|Azerbaijan Republic: Selected Economic Indicators|
|(Changes in percent)|
|Money and credit|
|Manat reserve money||33.6||35.1||-21.3||10.0|
|Manat broad money||25.8||29.2||-21.7||14.8|
|Credit to the economy||22.9||7.6||7.8||16.7|
|(In percent of GDP, unless otherwise stated)|
|Expenditure (including net lending)||20.4||21.4||21.5||24.1|
|General government balance||-2.8||-1.7||-4.2||-4.0|
|Balance of payments|
|Debt service ratio (in percent of exports)||9.7||7.4||5.3||5.3|
|Gross international reserves2|
|In millions of U.S. dollars||214||467||449||605|
|In weeks of next year's imports||6||10||10||12|
|Exchange rate regime||Managed floating|
|Manat per U.S. dollar (end-period)||4,098||3,888||3,890||...|
|Real effective exchange rate (1995=100)||105.3||105.4||115.8||...|
Sources: Azerbaijan authorities and IMF staff estimates.
1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
IMF EXTERNAL RELATIONS DEPARTMENT