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Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : Central Asian Republics

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Azerbaijan

With improved performance in the non-oil sector, the economy maintained strong momentum in 2001, but overall GDP growth fell slightly as world oil prices declined. Growth prospects remain positive for 2002–2003 as major investments in the oil and gas sector are expected. Policy commitment to developing the non-oil sector through deepening structural reforms remains key to achieving sustained growth and poverty reduction.

Macronomic Assessment

GDP growth for 2001 is estimated at about 9.9%, a slight decrease from the 11.1% in 2000 (Figure 2.21). Agriculture increased by around 11% because of higher grain production resulting from an expansion in the area under cultivation. The oil and gas sector, the most important part of the economy and accounting for almost 30% of GDP, continued to grow only slowly, due mainly to a sluggish rise in production.

Domestic investment recovered in 2001. Preliminary data point to improved foreign investment. Foreign investment inflows (primarily in the oil and gas sector), which currently account for 56% of total gross domestic investment, are estimated to have climbed to about $700 million, or 13% of GDP, during the year. Despite strong economic growth and improved investment, there is no indication of improvement in the employment situation: unemployment is now estimated to have risen to 18%, because much of the economic growth has been in capital-intensive areas that create few jobs.

Government revenues (excluding the State Oil Fund), which rose in nominal terms on account of the strong GDP growth, still fell short of budget targets. As a result, revenues relative to GDP declined to 18% in 2001 from 18.6% in the previous year. Although government expenditures rose by 10% in nominal terms, the expenditure-to-GDP ratio fell to 20.1% from 20.8% in 2000. As a result, the fiscal deficit slightly improved from 2.2% of GDP in 2000 to 2.1% in 2001. Foreign capital remained the major source of deficit financing.

Broad money supply increased by 9.7% in 2001. Much of the increase was due to financial deepening, as total money supply, including foreign currency deposits, is currently only 12% of GDP. Annual inflation, measured by the consumer price index, remained modest at 1.5%. The exchange rate depreciated by 4.4% against the dollar to AZM4,748 by the end of the year.

Exports strengthened by 7.9% in 2001, lifted by strong oil exports. With falling imports, this resulted in an improved trade balance and a surplus equivalent to 9.6% of GDP. As a result, the current account deficit narrowed to 2.3% of GDP from 3.4%, despite the growing deficit on the nonmerchandise account.

On the capital account, gross foreign investment recovered, mainly in the form of FDI in the oil and gas sector. Despite rising debt repayments and growing funds in the State Oil Fund, gross international reserves improved from $680 million in 2000 to $744 million at the end of 2001, or equivalent to about 5 months of non-oil imports of goods and services. Total public and public-guaranteed external debt rose from $1.16 billion in 2000 to about $1.27 billion in 2001, but as a proportion of GDP remained stable at 22%.

Policy Developments

A mix of a tight fiscal policy and a looser monetary stance was pursued in 2001. In view of the growing accumulation of spending arrears and worse than expected revenue performance, the fiscal deficit target of 2% of GDP was not met. The loosening of the monetary stance reflected the policy intention of supporting the development of the non-oil sector. But credit availability in this sector remained limited because of the underdeveloped banking sector and poor financial intermediation. The Government continued with its flexible exchange rate policy with the objective of maintaining currency stability and of supporting the non-oil sector.

The Government demonstrated a renewed commitment to structural and institutional reform, including the launching of a new privatization program and the streamlining of governnment organization. Preparation of a national program for poverty reduction, which emphasizes non-oil sector development, also began. A new reform program—introduced with the assistance of IMF—aimed at deepening trade liberalization; promoting good governance, especially financial discipline in the energy sector; and improving the legal and regulatory environment for private sector development.

Outlook for 2002–2003

The growth prospects for 2002–2003 are positive, provided that, as expected, oil investments increase and the world economy begins to recover in the second half of 2002. With agricultural performance likely to be stable, overall economic growth is forecast at around 10% in 2002 and 11% in 2003. Some major investment activities are expected to begin in 2002, which will help boost economic activity. They include the start of phase one of the full development of the Azeri-Chirag-Guneshi oil field and the construction of the Baku-Tbilisi-Erzurum gas pipeline. The inflation rate is expected to be fairly stable at 1.8% and 2.0% in 2002 and 2003, respectively.

The Government’s current tight fiscal and looser monetary policy mix is expected to continue. However, a challenge for the Government is to increase much-needed social expenditures while keeping the fiscal deficit under control. Higher investment, which is closely associated with oil equipment imports, is expected to increase pressure on the current account, which is projected to swing to a deficit of 3% of GDP in 2002 and to 5% of GDP in 2003. To promote non-oil trade activities, the Government will likely allow a quicker depreciation of the manat. Debt service is expected to rise, reaching about 8.5% of exports of goods and services in 2003.

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