Azerbaijan: Transformation task ahead

Azerbaijan: Transformation task ahead

Baku, Azerbaijan, Sept. 20

Trend:

Azerbaijan, having emerged from an economic crisis that began just a few years earlier, now faces another formidable challenge: how to transform its economy into one where growth and job creation is driven by a dynamic private sector, reads the article byInternational Monetary Fund Mission Chief Natalia Tamirisa and the IMF Senior Economist Kevin Ross for Azerbaijan, Trend reports.

On Sept. 6, the IMF Executive Board announced the completion of 2019 Article IV consultations with Azerbaijan.

As discussed in a recent report, in 2014-15, a slide in oil prices, along with a banking crisis and a regional downturn, shrank Azerbaijan’s budget revenues and triggered a prolonged economic slowdown. Meanwhile, the country’s non-oil sector, which had been expanding at a fast clip in 2011-14, came to a standstill.

To halt the slide, the authorities tightened the public purse, adjusted the exchange rate, closed many unviable banks, and took steps to improve the business environment. Thanks to this robust response and firming oil prices, the country has started to turn the corner.

So, what lies ahead for Azerbaijan’s economy?

First, the good news: fiscal and external surpluses have risen, inflation has declined, and the banking sector, while still fragile, has stabilized. With the hydrocarbon sector revitalized by new gas exports, the economy expanded at a 2.5 percent clip through the first half of 2019. A recently announced bad loan resolution program and increases in wages and pensions have boosted consumer demand.

However, with oil production now in a long-term decline, the country needs to ween itself off its dependence on hydrocarbons. This requires diversifying sources of economic growth and government revenues, creating a viable and competitive private sector, and improving resilience to shocks. Without such a transformation, the economy will not be able to achieve sustainable growth and create the jobs needed for Azerbaijan’s young population.

Economic policies should play an important role in creating incentives for this transformation.

A key building block is fiscal policy. Weening the budget off oil requires saving exhaustible hydrocarbon wealth for future Azerbaijani generations. But fiscal consolidation needs to be growth-friendly. To this end, the efficiency of public spending needs to be improved, transfers and subsidies should be better targeted to those who need them most, and state-owned enterprises need to be restructured to become self-sustainable. Improving the efficiency of tax policy and administration should also remain a priority. A well-designed fiscal rule, along with stronger public financial management and greater fiscal transparency, can help guide fiscal policy and promote discipline.

A second crucial plank is the central bank’s planned transition to inflation targeting. Greater exchange rate flexibility under such a regime would help the economy to absorb external shocks without losing competitiveness. It would also encourage better management of exchange rate risks and help prevent a build-up of future vulnerabilities. Together with greater exchange rate flexibility, increased issuance of government securities in domestic markets would foster financial market development by providing a benchmark for corporate bonds and an investment asset for the private sector.

The third building block is a well-functioning financial system, which can direct savings to their most efficient uses. Further upgrading of financial sector supervision and phasing out of regulatory forbearance, along with an independent asset quality review, are essential to improve confidence and prevent a build-up of future vulnerabilities.

Finally, for a private sector-led growth model to take hold, the government needs to step back and focus on creating an enabling environment for the private sector to flourish.

Azerbaijan has already started to put the pieces of this new policy framework together. Recent announcements of reforms are positive steps. Effective implementation of these measures is now essential to ensure that the underlying goal of improving Azerbaijan’s economic prospects and inclusiveness is realized.

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