TOPIC OF THE WEEK: Azerbaijan gets a well-deserved IG status
In some of our recent writings (from last year), we conjectured that Azerbaijan was on pace to re-attaining IG status as early as within the next 3 years. Fitch has been the fist of the rating agencies to do that by assigning the country an IG rating on Jul 26th. Not unexpectedly, Fitch justified its decision by referring almost exclusively to the country's very robust sovereign balance sheet, including steady and copious CA surpluses, larger FX buffers, low debt levels and enhanced resiliency to external shocks.
While these advantages are much to envy and well known, Azerbaijan enjoys other fortes that are worth discussing. In particular, while the energy focus naturally attracts the greatest attention, we have been consistently pointing to the significant structural shifts in the economy, as well.
For example, there is more diversification than meets the eye. The structure of real GDP over 2007-2023 reveals a non-trivial rotation away from energy (oil) into trade and, in particular, transport and communication. The energy share of the economy declined from 57.4% in 2007 to 34.8 percent in 2022, and the government plans to reduce it further, to 28.8 percent by 2027. Moreover, transport and communication has now become the second-largest sector of the economy, having raised its share of real GDP from 6.9% in 2007 to 16.2% in 2023. The recovery in the economy post-2020 has been primarily driven by transport, communication and construction.
In contrast to peers (save for Uzbekistan), which benefited from appreciating currencies in 2021-2023, Azerbaijan’s fixed exchange rate prevented inflation from falling more appreciably during that period. A high base (and later transition to easing) have now helped, bringing inflation down significantly in 1H24.
Since the start of the rate-cutting cycle last Nov, the monetary authorities have eased cumulatively by 175bpts to 7.25%. While the balance of risks is neutral, one needs to monitor the expansion of budget expenditures and the effect of lending on inflation in the medium term. Real policy rates are in the middle range vs peers and we have estimated (using three different methodologies) that Azerbaijan is the only country in the space that still maintains a neutral policy stance (the rest are still pursuing tight monetary policy).
The CA surplus is moving with oil prices. The small 0.5% of GDP deficit in 2020 transitioned into strong surpluses in the years 2021 (15.1% of GDP), 2022 (29.8 percent of GDP) and 2023 (11.5). We estimate the CA will decrease to a still robust 9.5% of GDP this year. The CA position is almost exclusively driven by the goods balance, with the share of oil & gas exports running at 90 percent. Increasing nonenergy exports will be key in attaining an even higher investment grade status.
Flow fiscal position is run prudently, with deficits kept at about 2 percent of GDP in the last couple of years. There are some risks of a more aggressive fiscal policy in the next couple of years related to fresh spending in the newly acquired territories. The 2024 deficit is estimated at 2.8% of GDP.
This week, we present slides of the economic and fiscal factors leading to Azerbaijan's attaining IG status.
Now read on...
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