Abstract
This Article IV Consultation reports on policies of the Republic of Azerbaijan. These policies contain inflation and measures to strengthen the resilience of the banking system to promote the development of the financial sector. Non-oil GDP continued to expand rapidly, pushed by large increases in public expenditure, including wages and pensions. The authorities intend to continue with their expansionary fiscal plans in 2008, in line with their strategy to pursue fast improvements in living standards and infrastructure to set the basis for long-term non-oil growth.
May 23, 2008
1. On behalf of our Azerbaijan authorities, we would like to thank the staff for the constructive discussions and the candid staff report. In these for Azerbaijan exciting but challenging times, the staff’s policy advice provides valuable input to the authoritiess’ efforts to address the populations’s manifold expectations. The authorities are committed to preserve macroeconomic stability and agree that, going forward, fiscal moderation will be needed. Managing a sudden surge in oil wealth, however, is and remains a challenging balancing act.
2. Azerbaijan has experienced spectacular growth during the recent years, with GDP per capita more than doubling over the last three years alone. The authorities are determined to use this unique opportunity for the rapid development of the country and to make fast progress in the living standards of the population. Given the still large needs and expectations of the population, the authorities have scaled up development spending. Not only infrastructure, but also such sectors as health and education are receiving necessary increases in funding.
3. The authorities are fully aware of the macroeconomic challenges that the oil boom creates. In 1999, in anticipation of the oil boom, the State Oil Fund of the Republic of Azerbaijan (SOFAZ) was established to save energy-related windfalls both for future generations and to avoid excessive spending. In 2003, the government established a Committee on Extractive Industries Transparency Initiative (EITI) to implement its obligations under the initiative, and Azerbaijan has since then published annual and semi annual EITI reports. The authorities have also made significant improvements in increasing non-oil revenues and are putting policies in place to support the development of medium-sized companies and the diversification of the economy.
4. The authorities are also aware that the rapid scaling up of public expenditure is testing the absorptive capacity of the country. They agree that the quality of public investment is crucial and are committed to improve project selection and monitoring to avoid wasteful, inflationary spending. The government is building up domestic capacity to conduct cost-benefit analysis for project proposals, and the adoption of IFRS accounting starting in 2008 will enhance the transparency of SOEss’ operations and their financial discipline.
5. Rising food prices and energy price increases are contributing to the inflationary pressures. In March, the authorities replaced the crawling peg to the US dollar with a peg to a dollar/euro currency basket, whereby the weight of the euro will be adjusted in light of experience with the basket arrangement. Moreover, in April the National Bank of Azerbaijan (NBA) raised the refinancing rate by 1 percentage point to 14 percent. Both measures should help to contain inflation. Moreover, the introduction of a new system which requires VAT taxpayers to maintain a sub-account with the ANB is expected to raise VAT collection above projections and should thus have a cooling effect on aggregate demand. The establishment of a macroeconomic coordination committee with the aim to improve policy coordination is also expected to help preserve macroeconomic stability.
6. Our Azerbaijan authorities consider the development and strengthening of the financial sector a priority. Azerbaijans’s banking sector has grown substantially over the last years, with private banks now accounting for a larger share of total assets than state-owned banks. Soundness indicators and compliance with prudential regulations have improved in 2007, and the ANB is taking several measures to contain the risks stemming from high credit growth.
7. Measures on the structural front to develop entrepreneurship and improve the business environment are expected to boost competitiveness. The organization of entrepreneurship under the “one window” principle, loans given to investment projects of entrepreneurs by the National Fund on Support of Entrepreneurship, and preferential loans to farmers play a significant role in the development of the private sector. The establishment of special economic zones is also one of the major initiatives of state support to entrepreneurship. Efforts are made to create the first industrial city, business incubators and a network of business centers in the country to establish a market infrastructure of entrepreneurship. A new State Program is expected to be adopted that will cover the state policy on the development of entrepreneurship and the methods of its implementation. The Program will cover 2008-2013. WTO accession is now a top priority of the government of Azerbaijan, and the harmonization of legislation with WTO rules is expected to provide additional impetus to the efforts to improve the business environment.
8. The authorities would finally like to thank the Fund for the recently concluded CPI ROSC mission. Concerns about the CPI methodology have repeatedly been the subject of discussions between the authorities and stakeholders in past years. The authorities are currently studying the draft ROSC paper, but they appreciate the preliminary finding that there are no issues with their CPI methodology. Of course, the authorities will be keen on further improving their assessments of prices, based on the finding of the report.