An International Monetary Fund (IMF) mission headed by Ms. Nienke Oomes visited Baku during February 18-March 3, 2010 to conduct the 2010 Article IV Consultation discussions with the Republic of Azerbaijan. Ms. Ratna Sahay, Deputy Director of the IMF’s Middle East and Central Asia Department, joined the mission for the policy discussions.

An International Monetary Fund (IMF) mission headed by Ms. Nienke Oomes visited Baku during February 18-March 3, 2010 to conduct the 2010 Article IV Consultation discussions with the Republic of Azerbaijan. Ms. Ratna Sahay, Deputy Director of the IMF’s Middle East and Central Asia Department, joined the mission for the policy discussions. The mission exchanged views with the government, central bank, parliament, private sector, diplomatic community, and civil society, and would like to thank the authorities and the Azerbaijani people for their warm hospitality. To conclude the 2010 Article IV Consultation with Azerbaijan, the IMF mission will prepare a staff report, scheduled to be presented to the IMF’s Executive Board in early May.

The Azerbaijani economy has withstood the impact of the global financial crisis well, but has not been immune to it. Overall GDP grew at an impressive 9.3 percent during 2009, but non-oil GDP growth fell from 16 percent in 2008 to 3 percent in 2009. The most direct impact of the crisis was through a large drop in the price of oil and lower external demand, which caused fiscal and export revenues to fall by nearly 30 percent. In addition, commercial banks cut back their loans to the private sector because of lower access to foreign financing, and a number of state-owned enterprises experienced refinancing difficulties. As international commodity prices fell, average annual inflation dropped dramatically from more than 20 percent in 2008 to 1.4 percent in 2009.

The Azerbaijani authorities successfully responded to the crisis. As fiscal revenues fell, the government appropriately cut non-priority spending and financed only ongoing capital investment projects. The Central Bank of Azerbaijan (CBA) successfully maintained financial stability by keeping the exchange rate stable and injecting liquidity into the banking system. The stability of the exchange rate reduced inflation, reversed the temporary increase in dollarization, and avoided a negative impact on households’ and banks’ balance sheets. CBA foreign exchange reserves declined, but remained comfortable at US$5.5 billion at end-2009.

Non-oil GDP is expected to recover to 4.2 percent in 2010, but downside risks remain. Oil production is projected to grow by only 1.3 percent, implying overall GDP growth of only 2.7 percent. Along with the recovery of the non-oil sector and the rise in international commodity prices, inflation in 2010 is expected to increase slightly to 4 percent. Growth will be lower if businesses remain pessimistic or external demand recovers only modestly.

The IMF mission welcomes the conservative 2010 budget and encourages the authorities to improve the quality, efficiency, and transparency of public spending. Even if oil prices turn out to be higher than budgeted or growth turns out to be lower than expected, additional resources from the oil fund should not be used to increase government spending. This is because the government (i) has ample room to improve the quality and efficiency of its spending and (ii) needs to significantly reduce the non-oil deficit in the coming years to secure fiscal sustainability in line with its Long Term Oil Revenue Management Strategy. A first step to enhance expenditure efficiency is to publish on the government’s website the detailed breakdown of the budget, which will improve the monitoring, selection, and review of public investment and social sector projects. In addition, the authorities should develop a stronger medium-term fiscal framework that explicitly recognizes the provision of financial support to state-owned enterprises as quasi-fiscal costs, and includes a strategy to gradually reduce this support.

The mission supports the CBA’s intention to keep the exchange rate stable in the near term. However, more flexibility will become beneficial when the economy becomes more diversified and more integrated with international capital markets. The mission will continue its constructive dialogue with the authorities on the timing, modalities, and preconditions for increasing exchange rate flexibility in the medium term.

The mission agrees with the authorities that they should continue to closely monitor and improve the health of the financial sector. As the economy recovers, excess liquidity should gradually be withdrawn so as to limit inflationary pressures. The mission welcomes the CBA’s plans for consolidating the banking system and increasing competition between banks. Given the recent fall in inflation, these efforts should help bring down the high interest rates, as well as the spread between lending and deposit rates. To further improve debt statistics, the presidential decree on authorizing the CBA to compile private and public debt data from relevant agencies should be approved as soon as possible.

Given that oil production will no longer be the main source of growth, there is an urgent need to accelerate economic diversification. In this regard, the mission welcomes the government’s commitment to develop a non-oil export strategy and to continue working towards joining the World Trade Organization. The authorities are encouraged to achieve these goals by stimulating private sector development through trade facilitation, tax and customs modernization, and reducing monopolies. To this end, it is disappointing that important anti-monopoly and investment legislation were recently withdrawn from Parliament. Finally, the impact of the crisis highlights the need to improve financial discipline and accountability in large state-owned enterprises