Twin track Azerbaijan

By bne IntelliNews April 29, 2010

Clare Nuttall in Baku -

It seems unfair to criticise an economy that managed to grow by 9.3% during the depths of the international economic crisis in 2009. But while on the surface everything appears to be going well in Azerbaijan, the headline statistics mask some inefficiencies and obstacles to investment.

Already among the world's fastest growing economies, Azerbaijan is expected to get a further boost when the second stage of the Shah Deniz oil and gas field comes online. The European Bank for Reconstruction and Development (EBRD) forecasts GDP growth of 9% this year, which while well below the peak of 31% posted in 2006, still outperforms all other countries in the region.

Azerbaijan also benefited from government investments into public infrastructure programmes, as well as from the Central Bank of Azerbaijan Republic's (CBAR) response to the crisis. Back in 2008, the central bank's chairman, Elman Rustamov, was already urging banks to take a prudent approach. International borrowing remained low and distressed loans today are a mere 8% of the total.

Once the crisis started to have an impact on the Azeri market, the central bank stepped in to avert problems within the banking sector, as well as supporting the real sector with liquidity injections. Further action on the same scale is unlikely to be needed. "We will continue our easy monetary policy this year," Azer Aleskerov, director of the central bank's monetary policy department, tells bne. "Since other sources of liquidity have recovered, we expect that the demand for CBAR liquidity support will be much lower than it was in the previous year. It is also possible that such demand will not exist this year."

Indeed, thanks to rising oil prices Azerbaijan's economy is once again on a strong growth path. But there remain questions over how quickly revenues from the energy sector are trickling down to the wider population.

Potholes on the way

Even in Baku itself, it's easy to turn a corner from the immaculately clean buildings, gilded fountains and designer shops onto potholed streets lined with ramshackle apartment blocks. Supplies of gas and other utilities are poor in these districts, residents say. The standard of living for rural dwellers - many of whom have moved to the cities - is also lower.

As in other resource-rich countries, the Azeri government frequently talks about the need to diversify the economy and provide for the future after oil and gas reserves are depleted. There has been a relatively high level of investments into sectors such as construction, processing and food production. Some current investments include Azersun Holding's plans to open factories to produce iodised salt and milk in Azerbaijan this year and AzMeCo's ongoing construction of a modern methane plant. Other companies such as Garadagh Cement are investing into more efficient and environmentally friendly technologies at existing facilities. "The government has made economic diversification a cornerstone of its development strategy to reduce Azerbaijan's dependence on oil and gas, create employment and lay the foundations for long-term sustainable growth," says the EBRD's country manager for Azerbaijan, Francis Delaey. However, he adds, that "to do this, the government needs to create a business enabling environment for domestic and foreign investors."

The need to diversify has receded somewhat since Azerbaijan's oil production is now not expected to peak until 2020 at the earliest. "Previously, we expected peak production to end in 2011 or 2012, but we now plan to keep production at Azeri Chirag Gunashli (ACG) level at a minimum of 50m tonnes of crude, which in addition to Socar's own production at other fields and joint ventures, will allow us to maintain production of 60m tonnes a year at least until 2020," says Vitaliy Baylarbayov, deputy vice president of Azerbaijan's state oil and gas company Socar.

According to Baylarbayov, there is also further potential at ACG, Shah Deniz and other fields, which could make it possible to maintain this level of production after 2020, as well as the possibility of new offshore discoveries. "In the medium term, Azerbaijan will continue to experience strong growth driven by oil and gas revenues and the spill-over effects in the construction and service sectors," says Delaey. "To achieve long-term sustainable growth, Azerbaijan needs to maintain its efforts to develop its non-oil economy."

Reforms required

Azerbaijan has made some strides in improving its business climate in recent years. It was the top reformer in the World Bank's "Doing Business" 2009 report. In 2010, it rose an additional two places to 38th on the ranking of 183 countries. However, issues of transparency and corruption remain; Azerbaijan had a considerably lower ranking of 143rd out of 180 on Transparency International's June 2009 corruption perceptions index

According to Delaey, "the government should promote deregulation, dismantle informal barriers and simplify licensing and permit requirements. Creating a level playing field and upholding the rule of law would encourage the entry of new players and promote competition." He also hopes to see ongoing reforms to customs and tax administration speeded up. "Cumbersome procedures and arbitrary practices encourage companies to stay small and operate in the grey economy," he warns.

The executive director of the American Chamber of Commerce (Amcham) in Azerbaijan, Nargiz Nasrullayeva-Muduroglu, also reckons the country would benefit from further reforms to the legal framework. "Azerbaijan needs to change its legal framework to make it more transparent and efficient. [World Trade Organisation] accession would help with this, since it would provide an imperative to move forward with legislative changes," she tells bne. "Another priority is investments into the country's road infrastructure, which are desperately needed. Azerbaijan is in a perfect location to act as a transit state, but the roads are very bad. Introducing a single travel document for Azerbaijan and Georgia would also help."

Despite improvements in the business environment, foreign investors say it's become more difficult to find large-scale investment opportunities in Azerbaijan in recent years. "Azerbaijan is a small and highly monopolised market, so it is more difficult to find niches to invest in than, for example in Russia or Kazakhstan," says Nasrullayeva-Muduroglu. "The investment environment was more open before the opening of the [Baku-Tblisis-Ceyhan oil] pipeline and the increase in oil prices in recent years. Previously, Azerbaijan needed [foreign direct investment]. Now, foreign companies tend to enter the market as contractors working for the major Azeri companies rather than as investors."

On a more positive note, Nasrullayeva-Muduroglu says the government has been receptive to input from Amcham on how to improve the business environment. Other investors note the seeds of a change in atmosphere within government offices and enterprises as the foreign educated sons and daughters of the elite return home with western ideas for management and improving efficiency.

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