TOPIC OF THE WEEK: What is "Wrong" with Azerbaijan? - A slide presentation

CAUCASUS / CENTRAL ASIA - Report 29 Sep 2023 by Ivan Tchakarov

Azerbaijan may be enjoying the spoils of victory over Nagorno Karabakh, but its economy has little to celebrate. GDP growth has expanded by a mere 0.8% YoY Ytd, rendering Azerbaijan the worst-performing economy in the Caucasus and Central Asia. In this week's report, which is a slide presentation, we delve into the sectors that are driving growth, and those that are inhibiting growth.

Underperformance can be ultimately linked to the oil sector, which has been in steady decline since 2011 when oil deposits started to get depleted. The Shah Deniz gas field, discovered in 1999, and the start of production in 2007 helped offset declining oil production as 2021 marked the first year when Azerbaijan produced more gas than oil. Nevertheless, this has only helped keep overall oil/gas production constant, and the government sees total oil/gas output declining at an average of 1.8% per annum over 2024-2027.

However, there is more diversification than meets the eye. The structure of real GDP over 2007-2022 reveals non-trivial rotation away from oil into trade and, in particular, transport and communication. The energy share of the economy declined from 57.4% in 2007 to 35.8 percent in 2022, and the government plans to reduce it further, to 28.8 percent by 2027. At the same time, transport and communication has now become the second-largest sector of the economy, having raised its share of GDP from 6.9% in 2007 to 17.1% in 2022. The recovery in the economy over 2021/2022 has been primarily driven by transport, communication, and construction, which contributed 37 percent and 74 percent to 2021 and 2022 GDP growth, respectively. Indeed, it has actually been the nonoil economy that has been driving growth in the last decade and so far in 2023.

Azerbaijan already enjoys the highest sovereign rating among peers (ARM, GEO, UZB, TAJ, KGS), but we see good prospects for the country to re-attain its investment grade status over the next 3 to 5 years. Baku has already made notable progress in increasing diversification and reducing dollarization, while its FX buffers are large and public indebtedness low. Reducing the outsize reliance on energy exports may represent the key challenge to address.

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