IMF Executive Board Concludes 2014 Article IV Consultation with the Republic of AzerbaijanPress Release No. 14/256
June 2, 2014
On May 29, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Azerbaijan1 and considered and endorsed the staff appraisal without a meeting.2
Recent economic developments have been favorable. In 2013, a stabilization of oil output and strong non-oil growth at nearly 10 percent helped lift overall GDP growth to 5.8 percent. Inflation remained low, averaging 2.4 percent, restrained by soft food prices and a stable exchange rate. High oil prices helped keep the current account in significant surplus. The impact of regional market turbulence in early 2014 has been limited, with few signs of lower manat demand or capital flight. Financial indicators of the banking system excluding the largely state-owned public bank, the International Bank of Azerbaijan (IBA), appear stable.
Since last year, the authorities have begun to unwind the supportive macroeconomic policies put in place during the 2008/09 global crisis. Preliminary data suggest that the 2013 non-oil primary deficit in percent of non-oil GDP remained at the 2012 level, below the announced target, reflecting some spending restraint. The approved budget for 2014 would contribute to consolidate further the non-oil primary deficit. On monetary policy, the Central Bank of Azerbaijan (CBA) kept the refinancing rate steady until end-April 2014, when it lowered the rate by 50 basis points. The CBA has also reduced its direct lending to the real economy, and early this year tightened consumer loan conditions to cool down the acceleration of private sector credit.
Economic prospects over the near and medium term are positive, if underpinned by fiscal consolidation and supported by reforms to spur non-oil private sector activity. Growth of non-oil GDP is projected to remain strong at about 8 percent in 2014–15, before declining to 5 percent through 2019. With the non-oil economy hitting capacity constraints, inflation is set to rise, but tighter fiscal policy and soft food prices would allow it to stay at low single digit levels. High oil prices will help sustain comfortable sovereign foreign assets. Prospects could be affected by a disruption in oil production, slippages in the fiscal adjustment, and further weakening of the financial situation of the IBA. Risks from a potential deterioration in the global outlook emanate mainly from a fall in global oil prices but large sovereign foreign assets provide a buffer to help mitigate the impact of any shocks.
Executive Board Assessment
In concluding the 2014 Article IV consultation with Azerbaijan, Executive Directors endorsed staff’s appraisal, as follows:
The government’s recent achievements provide an impetus to advance toward the goal of becoming a dynamic emerging market. Recent agreements in the gas sector will help transform Azerbaijan into a strategic gas supplier for the European market. In addition, the government’s successful debut Eurobond, issued amid market turbulence in the region, is testimony of investors’ confidence in the prudent management of the oil revenues as reflected in large buffers and macroeconomic stability. This vote of confidence, along with the benign environment of high oil prices, provides an opportunity to build on the recent progress in changing the course of macroeconomic policies and take decisive steps to improve governance and the business climate. Actions in these areas will be crucial to fostering sustainable and diversified private sector-led growth that will ensure a sustained improvement in living standards.
Continued efforts to rein in government spending are needed to reduce fiscal vulnerabilities and achieve sustainability of the non-oil fiscal position in the medium term. Staff welcomes the approved 2014 budget that contains government spending, and encourages the authorities to complement their plans to improve public investment efficiency with decisive business climate reforms to create opportunities for private investment. Moving ahead decisively with the planned reform of the pension system, along with the adoption of a rules-based fiscal framework and sound fiscal risk management, will also help safeguard the consolidation efforts and preserve fiscal sustainability over the medium term. Given the prospects of flat oil production and softer oil prices, public announcement of and strict adherence to the informal fiscal rule would help build a track record for the adoption of a formal fiscal rule.
The current monetary policy stance is appropriate if supported by prudent fiscal and financial sector policies. Inflationary pressures are likely to remain subdued if the authorities’ plans to tighten fiscal policy and cool down consumer credit growth are fully implemented. Monetary tightening would be warranted if demand pressures arise in the event of slippages in the fiscal consolidation plan or a reversal in soft global food prices due to regional tensions. Going forward, strengthening the role of monetary policy as anchor for inflation expectations requires discontinuing the CBA’s direct lending on a permanent basis and decisive progress to develop the interbank money and foreign exchange markets in line with past IMF technical assistance. These actions would facilitate a move toward inflation targeting and pave the way for adopting greater exchange rate flexibility over the medium term when the costs of the current exchange rate regime will increase as Azerbaijan further diversifies its economy and increases its financial integration.
Enhancing the regulatory framework while promoting financial deepening is critical for the development of the non-oil economy. Recent measures by the CBA to strengthen banking regulations will help ensure correct capital needs; but increasing the resilience of the banking system also requires reducing the exposure of banks to connected lending and to un-hedged borrowers. Strengthening the banking system to facilitate a sustainable and broad-based growth led by the private sector will require actions aimed at encouraging market-led consolidation of banks without extending the new deadline to meet the capital requirement; creating a private bureau to promote competition in interest margins; protecting creditors’ rights to help banks reduce their costs; and ensuring a level playing field in the banking system by further reducing the IBA’s dominance in the system. Restructuring the IBA is also needed to help strengthen the monetary transmission mechanism and contain the associated fiscal risks.
Achieving sustainable growth of the non-oil output and export diversification in the medium term also entails accelerating reforms to attract private investment. Building on recent efforts to reduce corruption, including the introduction of e-government and “ASAN” public services, the authorities could broaden the anti-corruption efforts beyond small-scale corruption, strengthen the rule of law, and reduce formal and informal constraints to business environment in the non-oil sector. Such efforts will be crucial to foster a competitive economy and reap the full benefits of complementary efforts aimed at developing the domestic capital market and opening up new export markets.