Republic of Azerbaijan: Fifth Review Under the Poverty Reduction and Growth Facility Arrangement and Request for Waiver of Performance Criteria

The staff report for the Fifth Review Under the Poverty Reduction and Growth Facility for the Republic of Azerbaijan focuses on the short-term macroeconomic outlook and monetary and exchange rate policies. Domestic demand has been increasing much faster than GDP partly on account of large oil sector-related and other investments. There was broad agreement that greater exchange rate flexibility is essential for reducing inflation pressures. Azerbaijan has had an excellent track record in servicing its external debt.

Abstract

The staff report for the Fifth Review Under the Poverty Reduction and Growth Facility for the Republic of Azerbaijan focuses on the short-term macroeconomic outlook and monetary and exchange rate policies. Domestic demand has been increasing much faster than GDP partly on account of large oil sector-related and other investments. There was broad agreement that greater exchange rate flexibility is essential for reducing inflation pressures. Azerbaijan has had an excellent track record in servicing its external debt.

I. Recent Developments and Performance under the Program

1. Political tensions are rising in the run-up to the November 2005 parliamentary elections. The current government, although committed in principle to market-oriented reforms, has faced difficulties advancing the reform agenda in a timely manner. While the authorities understand the risks of pursuing expansionary policies in the current environment of double-digit inflation, political pressures for increased spending and high credit growth, as a means of reducing social and political tensions ahead of the elections, remain high.

2. Buoyed by rapid domestic demand growth, the economy has continued to expand at double-digit rates since 2003 (Figure 1). In 2004, real GDP grew by 10.2 percent, with non-oil GDP growing by 13.4 percent (Table 1). Preliminary estimates for the first quarter of 2005 suggest that year-on-year growth rates of oil and non-oil GDP were in double digits as well. Domestic demand increased much faster than GDP in 2004, mainly on account of investment. Foreign direct investment in the hydrocarbon sector has financed a significant share of gross domestic investment and has stimulated rapid growth in construction, transportation, and services since 2003. An expansionary policy mix and a loosening of wage policies have also added to the domestic demand expansion (Figure 1).

Figure 1.
Figure 1.

Azerbaijan and Selected CIS Countries: Real Sector Developments, 2000–05

Citation: IMF Staff Country Reports 2005, 260; 10.5089/9781451931099.002.A001

Sources: Azeri authorities; and Fund staff estimates.
Table 1.

Azerbaijan: Selected Economic and Financial Indicators, 2001–05

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Sources: Azeri authorities; and Fund staff estimates and projections.

Excludes fuel, energy, transportation, water, and communications from consumer price index.

Excludes the increased revenues and expenditures from including SOCAR’s quasi-fiscal activities in the budget.

In percent of beginning of the year broad money (M3) stock, unless otherwise specified.

In terms of non-oil GDP.

For 2002 and 2003 includes investments of US$50 million and US$121.5 million, respectively, for the government’s share in BTC, equivalent to 0.8 percent and 1.7 percent of GDP, respectively.

Calculated by deducting Oil Fund, AIOC, and SOCAR revenues from the consolidated government budget balance.

In percent of exports of goods and services.

Excluding Oil Fund assets.

3. As a result of rapid economic growth and increased social spending, poverty declined to 40.2 percent in 2004 from 49 percent in 2001. A poverty reduction conference, held in Baku on May 12, 2005, opened a dialogue on a new 10-year program of poverty reduction, which will succeed the current three-year State Program of Poverty Reduction and Economic Development (SPPRED) expiring in 2005.

4. Inflation has been rising since the beginning of 2004. Demand pressures, exacerbated by expansionary macroeconomic policies, contributed to an increase in the headline 12-month CPI rate to 15.5 percent in April 2005 compared to 3.6 percent in December 2003.1 The administered energy and utility price increases implemented in November 2004, and January and March 2005 only added about 1.5 percentage points to the headline inflation rate. Therefore, the 12-month core inflation rate reached about 14 percent in April 2005, well above the year-end program target of 5 percent.

5. Strong domestic demand contributed to an increase in the current account deficit in 2004, but the external position remains sustainable. The positive impact of higher oil prices on exports was more than offset by rapid growth of imports, including those related to oil projects (Table 6). This, together with a significant increase in the repatriation of profits by foreign oil companies, led to an increase in the current account deficit to 30.3 percent of GDP in 2004 from 27.7 percent in 2003. Since the current account deficit was largely financed by FDI, external public and publicly guaranteed debt increased modestly to $1.6 billion (18.6 percent of GDP) by end-2004. The external liquidity position remains comfortable: gross official reserves amounted to about $1 billion (3½ months of non-oil imports) and the Oil Fund accumulated about $1 billion in foreign assets by end-March 2005.

Table 2.

Azerbaijan: Monetary Survey, 2001–05 1/

(In billions of manats, unless otherwise indicated)

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Sources: Azerbaijan National Bank; and Fund staff estimates.

Accounts are valued at program exchange rates of 4,606 manat per U.S. dollar and 1.26 U.S. dollar per SDR through end-March 2005.

Quarterly figures are cumulative changes year to date.

Velocity is defined as nominal non-oil GDP divided by average broad money.

Table 3.

Azerbaijan: Summary Accounts of the Azerbaijan National Bank, 2001–05 1/

(In billions of manats)

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Sources: Azeri authorities; and Fund staff estimates and projections.

Accounts are valued at program exchange rates of 4,606 manat per U.S. dollar and 1.26 U.S. dollar per SDR through end-March 2005.

Table 4.

Azerbaijan: Consolidated Government Operations, 2003–05

(In billions of manats)

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Sources: Azeri authorities; and Fund staff estimates and projections.

The program column reflects the initially approved 2005 budget on the basis of earlier WEO oil price projections (US$42.75 per barrel), and staff’s estimates of non-oil revenues. The revised budget column reflects the 2005 budget (based on a US$25 per barrel oil price) with proposed amendments on which detailed data on the economic classification of expenditures are not available yet. Expenditure numbers in this column do not reflect the authorities’ commitment to save about 300 bln. manats presented in the SLOI, paragraph 18. The projection column reflects the March 2005 WEO oil price projections (US$49.5 per barrel), staff’s estimates of non-oil revenues, and the authorities’ commitment to save about 300 bln. manats presented in the SLOI, paragraph 18.

Starting from 2004 includes contingent revenues accrued on the “deposit account”rdquo; of budgetary organizations.

Includes profit oil, acreage fees, and income earned on Oil Fund assets. Oil bonuses also enter in the Oil Fund, but these are treated as a financing item.

Tax credits for SOCAR energy subsidies for the third and fourth quarters of 2004 were allocated in the 2005 calendar year. Tax credits for the first quarter of 2005 have not been allocated yet.

Statistical discrepancy of 189.2 bln. manat in the first quarter of 2005 is eliminated assuming that expenditures during the rest of the year will be less by the same amount.

Excludes SOCAR tax credits for energy subsidies.

Including grants.

Table 5.

Azerbaijan: Selected Fiscal Indicators, 2001–05

(In percent of non-oil GDP, unless otherwise indicated)

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Sources: Azeri authorities; and Fund staff estimates and projections.

Program column ratios for oil revenues, non-oil revenues, and primary non-oil balance have been corrected. Nominal values for these items remained unchanged.

The program column reflects the initially approved 2005 budget on the basis of earlier WEO oil price projections (US$42.75 per barrel), and staff’s estimates of non-oil revenues. The revised budget column reflects the 2005 budget (based on a US$25 per barrel oil price) with proposed amendments on which detailed data on the economic classification of expenditures are not available yet. Expenditure numbers in this column do not reflect the authorities’ commitment to save about 300 bln. manats presented in the SLOI, paragraph 18. The projection column reflects the March 2005 WEO oil price projections (US$49.5 per barrel), staff’s estimates of non-oil revenues, and the authorities’ commitment to save about 300 bln. manats presented in the SLOI, paragraph 18.

Starting from 2002 includes SOCAR tax credits for energy subsidies.

Investment expenditure increases by 1.2 percent of non-oil GDP (0.8 percent of GDP) in 2002 and by 2.4 percent of non-oil GDP (1.7 percent of GDP) in 2003 due to an equity investment by the government in BTC Azerbaijan.

Calculated by deducting Oil Fund, AIOC and SOCAR revenues from the consolidated government budget balance.

Table 6.

Azerbaijan: Balance of Payments, 2002–05

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Azeri authorities; and Fund staff estimates and projections.