Catalog

	Table of Contents
p. 41 of 69 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia Azerbaijan Kazakhstan Kyrgyz Republic Tajikistan Turkmenistan Uzbekistan The Pacific III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia : Central Asia

---

Azerbaijan

Macroeconomic performance remained strong in 2003, with double-digit GDP growth, low inflation, and rising international reserves. The medium-term prospects are good, as the ongoing investment boom in the oil sector is expected to continue through 2004, leading to rapid expansion of oil production and exports until about 2010. A challenge for the Government will be to translate this oil boom into sustainable economic growth and enduring poverty reduction.

Economic Assessment

GDP growth accelerated to 11.2% in 2003 from 10.6% in 2002, boosted by substantial FDI inflows into the oil and gas sector (the“oil sector”), which reached $2.8 billion (39.4% of GDP). The full development of the Azeri-Chirag-Gunashli oil fields and the construction of the associated Baku-Tbilisi-Ceyhan (BTC) oil pipeline proceeded apace, despite delayed approval of loans by international creditors. In addition, two new large-scale gas projects-namely, the development of the Shah-Deniz gas field in the Caspian Sea and the construction of the South Caucasus Pipeline, which will deliver gas from Shah-Deniz to Turkey-were launched in early 2003.

On the production side, construction, which benefited most from the growing investment demand, surged by 61.0%, contributing an estimated 5.8 percentage points to GDP growth (Figure 2.21). Other industrial subsectors relating to hydrocarbon development, such as metallurgy and the production of construction materials, also performed well, while oil production itself remained flat at about 310,000 barrels a day. Agriculture, the economy’s largest sector in terms of employment, recorded robust growth of 5.6%, notwithstanding relatively unfavorable weather conditions. The services sector expanded by an impressive 8.0%, led by communications and domestic trade.

Rapid output growth does not appear to have been accompanied by a commensurate increase in employment. According to official labor statistics (based on reports by enterprises and labor exchanges), total employment increased by 0.5% and the unemployment rate rose from 1.3% to 1.4% between end-2002 and end-2003. These statistics, however, underestimate the true unemployment level because only a fraction of the unemployed register with labor exchanges. Results of a recent labor market survey, conducted by the State Statistical Committee, suggest that the actual unemployment rate was 10.7% in mid-2003.

The consolidated budget, including the State Oil Fund of Azerbaijan Republic (SOFAZ), recorded a small surplus of 0.2% of GDP, compared with a surplus of 1.3% of GDP in 2002. Although the non-oil deficit-defined as the deficit of the consolidated budget excluding hydrocarbon-related receipts and outlays-widened to 8.2% of GDP in 2003 from 7.7% the previous year, it remained well below the estimated long-term sustainable level. Assets of SOFAZ, which accumulates and manages most of the Government’s revenues from production-sharing agreements in the oil sector, reached $817 million at end-2003.

Inflation remained subdued, with the average annual CPI rising by 2.2%, compared with 2.8% in 2002. While the nominal exchange rate of the national currency (the manat) against the dollar remained virtually unchanged, the real effective exchange rate depreciated by an estimated 13.1%, giving domestic producers a competitive edge. Remonetization of the economy continued, albeit from a low base, with broad money supply increasing by 29.8%, and the monetization ratio-as measured by the ratio of broad money to GDP-rising to 14.5% in 2003 from 13.0% in 2002. At the same time, a high degree of dollarization persisted, with foreign exchange deposits accounting for about half of broad money. Real interest rates as well as the spread between deposit and lending rates stayed high (more than 4% and 6%, respectively). This primarily reflected underlying weaknesses of the financial sector, such as the lack of public confidence in banks and weak competition, although tight monetary policy is seen as a contributing factor.

Preliminary data suggest that the current account deficit more than doubled to 28.3% of GDP in 2003 from 12.3% in 2002. Strong performance of both oil and non-oil exports was more than offset by a sharp rise in imports of capital goods and services for the oil sector. The current account deficit was fully financed by inflows of FDI and other capital inflows such that the overall balance of payments recorded a surplus of $236 million. Consequently, gross official international reserves, including SOFAZ assets, increased from $1.4 billion at end-2002 to $1.6 billion at end-2003. The external debt burden remained moderate, with the end-of-year stock of public and publicly guaranteed debt standing at $1.6 billion (22.0% of GDP) and the ratio of debt servicing to exports of goods and nonfactor services amounting to 5.0%.

Policy Developments

Fiscal policy was moderately expansionary. Several taxes, including the enterprise profit tax and the payroll tax, were lowered to reduce the tax burden on the non-oil sector. Moreover, sector and regional variations in the enterprise profit tax rate were introduced in an attempt to stimulate non-oil sector growth and more balanced regional development. At the same time, salaries of public sector employees were raised considerably to reduce the gap between wages in the public and private sectors, and SOFAZ expenditure was increased to finance high-priority social and infrastructure projects.

Nonetheless, the consolidated budget was kept in surplus, in part due to an increase in oil-related revenues. Moreover, part of the revenue windfall arising from higher than anticipated world oil prices was saved as a cushion against possible future declines in oil prices and, consequently, oil-related budgetary revenues. In this way, the Government effectively established a stabilization oil fund separate from SOFAZ. (Unlike, for example, Kazakhstan’s oil fund, SOFAZ does not perform the stabilization function in that its receipts and outlays are not directly linked to world oil prices and the domestic budgetary situation.)

Monetary policy remained tight, with the primary goal of maintaining domestic price stability. The National Bank of Azerbaijan Republic (NBAR) kept its refinancing rate unchanged at 7% per annum. NBAR also continued with its policy of informal exchange rate targeting, frequently intervening in the foreign exchange market to smooth out fluctuations of the nominal exchange rate and to ensure continued depreciation of the real exchange rate of the manat vis-à-vis the dollar. Reserve money grew by 23.5%, mostly resulting from a buildup of NBAR’s net foreign assets.

Considerable headway was made in structural reform, though it was uneven across various reform dimensions. A wide range of fiscal reforms was introduced to enhance efficiency, transparency, and accountability of public financial management. Most notably, the Budget System Law was amended in May to integrate SOFAZ more closely into the consolidated budget and to strengthen parliamentary oversight of the fund. A timetable for privatization of the two remaining state-owned banks-the International Bank of Azerbaijan (IBA) and the United Universal Joint Stock Bank-by end-2004 was announced, and the 50% ceiling on foreign participation in the domestic banking system was lifted, with effect from 1 January 2004. However, the planned sale of 20% of IBA shares from the Government’s holding to the European Bank for Reconstruction and Development was delayed. While the domestic prices of natural gas and most oil products were raised to estimated long-term import or export parity levels to reduce implicit energy subsidies, the amount of explicit energy subsidies to the electricity and gas sectors included in the 2003 budget exceeded the target level because of increased oil consumption by these sectors.

Progress in some other key areas of structural reform was limited. Agricultural reform had lost momentum following the distribution of 1.3 million hectares of land to rural households in the second half of the 1990s. The implementation of the Second Privatization Program adopted in 2001 was slow, with only about one tenth of some 350 SOEs included in the program having been privatized by end-2003. Despite the Government’s recent efforts to improve the business environment in the non-oil sector, formidable obstacles to the development of the non-oil private sector remain. These include weak protection and enforcement of property and contractual rights; cumbersome licensing procedures; corruption; and limited access to, and high cost of, bank credits. Many sectors of the economy continue to be characterized by a high degree of market concentration and weak competition, with incumbent companies using their dominant position to prevent potential competitors from entering the market.

The Government recognizes that structural reform is essential to fostering the development of the non-oil sector, creating productive job opportunities, and enhancing the economy’s long-term growth potential. Thus, following his election victory in October 2003, President Ilham Aliyev issued decrees that called for initiating the second phase of agricultural reform, tightening financial discipline in the energy sector, accelerating privatization of SOEs, enhancing competition, and stimulating the development of the non-oil private sector.

Outlook for 2004-2005

The macroeconomic outlook for 2004-2005 is positive. GDP is projected to grow by 9.0% in 2004 and by 12.5% in 2005, on the baseline assumptions that the key oil sector projects will be implemented on schedule and that the benchmark price of Brent crude oil will average $28 per barrel in 2004 and $26 per barrel in 2005. Growth will be driven by a continuing investment boom in the oil sector in 2004 and by rapid expansion of oil production and exports in 2005. Pushed by the considerable rise in public sector wages in 2003, average annual consumer price inflation is forecast to accelerate to 4.0% in 2004, before moderating to 3.0% in 2005. While the nominal exchange rate of the manat will remain fairly stable against the dollar, its real effective exchange rate will continue to depreciate. The current account deficit is expected to widen further to 32.5% of GDP in 2004 due to anticipated modest declines in world oil prices and the volume of oil exports, and a further rise in imports related to hydrocarbon development. The deficit will shrink to 18.1% of GDP in 2005, as a rebound in the volume of oil exports will more than offset continued weakening of world oil prices, and oil sector imports will start to decrease. The deficit will continue to be financed by FDI inflows.

No significant shift in macroeconomic policies is expected in 2004-2005. The consolidated budget is likely to remain in surplus in both years. The reduction in the number of VAT exemptions and the unification of the enterprise profit tax at 24%, effective 1 January 2004, will broaden the tax base and mitigate the negative impact on budget revenues of the anticipated decline in oil production and exports in 2004. Likewise, the planned further increase in capital expenditure in 2005 will be offset by a recovery in oil-related revenues. A challenge for monetary policy will be to accommodate growing demand for money while preserving price stability. It will also become increasingly difficult for NBAR to counter upward pressure on the exchange rate stemming from large oil-related foreign exchange inflows.

These projections are, however, very sensitive to changes in the underlying assumption about world oil prices. A 1 dollar rise (decline) in the assumed average annual price of Brent crude oil in 2004 raises (lowers) the projected GDP growth rate by about 1 percentage point and reduces (increases) the forecast current account deficit by more than 1% of GDP, with the opposite impact on the consolidated budget surplus. The projections for 2005 are also dependent on the timely implementation of the key investment projects in the oil sector. For example, a considerable delay in the completion of the BTC oil pipeline, which is scheduled to become fully operational in early 2005, would have a major adverse impact on GDP growth and the budgetary situation in 2005. This simple sensitivity analysis highlights Azerbaijan’s vulnerability to a sustained decline in world oil prices and possible delays in the implementation of a few oil sector projects, and underscores the need to diversify the economy to reduce its dependence on the oil sector.

Back Central Asia	Next Kazakhstan