A pump jack lifts crude oil near Baku, Azerbaijan. The country is taking steps to adjust to slumping oil       prices and weaker growth, says the IMF (photo: Danil Shamkin/NurPhoto via Getty Images)

Azerbaijan's Opportunity to Reboot, Diversify Economy

September 15, 2016

  • Lower oil prices, weak regional growth impair economic prospects
  • Authorities tighten monetary policy to reduce inflation
  • Structural reforms needed to diversify, boost non-oil private sector growth

Growth in Azerbaijan fell to 1.1 percent in 2015, and is expected to decrease further in 2016 as the country copes with the large decline in oil prices, cuts in public investment, currency depreciations, and the slowdown in trading partners’ economies, said the IMF in its latest assessment.

The government has started to implement policies in response to the weak external environment—but the country needs to step up structural reforms and find ways to diversify its economy from oil to reap faster growth.

Speaking to IMF News, IMF Mission Chief for Azerbaijan, Mohammed El Qorchi, talks about the current economic outlook for the country.

IMF News: Can you provide an update on Azerbaijan’s economy?

El Qorchi: We expect growth to be in negative territory at -2.4 percent in 2016, as public investment fell, credit activity stagnated and oil production remained flat. Inflation averaged 4.1 percent in 2015 and is expected to jump to 10 percent in 2016.

In response, the authorities have adjusted the policy mix. Monetary policy has been tightened sharply over the last year to address inflation and support the currency. At the same time, fiscal policy has been slightly relaxed, to accommodate more spending to stimulate growth and protect vulnerable populations.

A key issue has been the banking sector. The devaluations and recession have hurt bank profitability and brought to the fore a host of bad debts. Fortunately, the authorities are now taking steps to address the high incidence of non-performing loans, with a number of non-viable banks being closed.

IMF News: Can you talk a little bit more about the impact of the oil price shock on Azerbaijan?

El Qorchi: During the boom years, oil activity accounted for about three-quarters of GDP and government income, and 90 percent of exports.

Declines in oil prices quickly and directly translate into lower export revenues, reduced hydrocarbon profits, less foreign direct investment, fewer budgetary transfers from Azerbaijan’s main sovereign wealth fund to the state budget, and lower related public investment. At the same time, the oil price shock put pressure on the exchange rate and foreign exchange reserves—particularly under the old pegged exchange rate regime.

The ensuing devaluations in 2015, which were needed to restore competitiveness and preserve reserves, also negatively impacted bank balance sheets and led to increased dollarization pressures (whereby citizens shift from the domestic currency towards loans and borrowing in U.S. dollars). In the end this lowers non-oil sector growth, which then reverberates back through the economy with indirect negative second round effects.

IMF News: What role do exchange rates play in stabilizing Azerbaijan’s economy?

El Qorchi: Exchange rate adjustments have played a crucial part in stabilizing the economy after the oil price shock. The devaluations of the currency, which were basically in line with oil price reductions, helped to avoid an excessive buildup of external imbalances, restored competitiveness, and preserved dwindling foreign exchange reserves.

Thus far in 2016, the authorities have allowed for greater exchange rate flexibility under the new regime to more fully absorb shocks.

IMF News: The government has made progress in implementing their "2020 Development Strategy"—such as improving public construction tenders and extending agriculture and business environmental reforms. What other reforms can help diversify the economy away from the oil sector?

El Qorchi: Shifting to a new economic model, one based more on non-oil private sector growth, will require implementing a broad-based structural reform agenda. This would range from measures as diverse as boosting competition among firms, making it easier to start a business, to rules on hiring and firing and investing in human capital and education. Perhaps the most pressing need right now, however, is a rapid and well-organized cleanup of the banking system so that credit to the real economy flows efficiently.

The IMF can help primarily by working with the authorities to create first rate macroeconomic institutions, frameworks, and policies—key ingredients in their    reform process.