Gradually recovering but vulnerabilities remain substantial


HIGH RISK for entreprise

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

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GDP USD46.9bn (World ranking 89, World Bank 2018)
Population 9.94mn (World ranking 90, World Bank 2018)
Form of state Republic
Head of state Ilham ALIYEV (President)
Next elections 2020, legislative
  • Ample natural resources in the hydrocarbon sector
  • Substantial foreign currency assets in the State Oil Fund of Azerbaijan (SOFAZ)
  • High regional political instability
  • Relatively poor regional relations, in particular the conflict with Armenia over the Nagorno Karabakh enclave
  • Authoritarian political regime
  • Government effectiveness and slow progress of structural reforms
  • Significant level of perceived corruption and weak protection of property rights
  • Huge dependence on oil and gas sector, creating substantial external vulnerability
  • Exchange rate risk
  • Weak banking system, with very high level of non-performing loans

How oil dependency triggered a currency and banking crisis

With ample natural resources in the hydrocarbon sector, Azerbaijan is highly dependent on mineral products, which account for about one third of GDP, half of fiscal revenues and nearly 90% of goods exports. As a result, the economy is very vulnerable to external shocks. Between 2014 and 2016, two such shocks hit  Azerbaijan’s economic growth, budget revenues, the balance of payments, the manat (AZN, the local currency), foreign exchange (FX) reserves and, in 2017, the banking sector hard.

The first was the sharp drop in global oil prices, which combined with a loss of competitiveness as neighboring countries, notably Russia, depreciated or devalued their currencies. The two shocks led to downward pressures on the AZN, which was for long pegged to the USD. In trying to defend the peg, the Central Bank of Azerbaijan’s (CBA) FX reserves fell from a peak of USD16.7bn in May 2014 to a low of just USD5.3bn in April 2016. Eventually, the CBA devalued the AZN substantially in two steps in 2015 and subsequently shifted from a pegged to a floating exchange rate regime. On average, the AZN fell by -31% against the USD in 2015 and -55% in 2016. This currency crisis triggered a banking crisis in 2017. As risks related to the servicing of corporate and bank debt denominated in FX had increased substantially, the CBA closed or merged a few small banks in 2015-2016, before the International Bank of Azerbaijan (IBA) – a largely state-owned bank, holding some 40% of total bank assets at the time – had to file for a large-scale restructuring of its debt in 2017. As of mid-2019, Azerbaijan’s banking sector is still struggling to crawl out its crisis. Officially reported non-performing loans (NPLs) stand at around 13% of total loans, but when including all problem assets, the ratio should be well over 20%. The IMF suggests that improved financial sector regulations and supervision are urgently needed to avoid future vulnerabilities.

Growth and inflation have normalized but are not risk-free

Following the crisis-related recession in 2016-2017, Azerbaijan’s economic activity recovered moderately in 2018, with real GDP expanding by +1.4%. Increased gas exports from the Shah Deniz Phase II field, thanks to the Southern Gas Corridor pipeline becoming operational, as well as strengthening domestic demand on the back of lower inflation and interest rates, have lifted economic growth to +2.4% y/y in H1 2019. We expect this moderate dynamic to continue and forecast full-year GDP growth of about +2.5% in both 2019 and 2020. However, global uncertainties, including the rise in trade tensions and potentially lower oil prices, pose downside risks to this forecast.

In April 2017, the CBA shifted back from the floating exchange rate regime to a “stabilized arrangement”, with the AZN trading at 1.70:1.00 versus the USD. So far, the real effective exchange rate indicates that the AZN is not overvalued. Coupled with base effects, the currency stabilization contributed to a significant deceleration in consumer price inflation from an average of 12.8% in 2017 to 2.3% in 2018, allowing for already materializing monetary easing (the CBA’s policy interest rate was cut from 15% at the start of 2018 to 8.25% in July 2019). Inflation has picked up slightly to 3% y/y in June 2019 but we expect it to remain in check in the near future, averaging about 3% in 2019 as a whole and 3.5% in 2020. However, the potential impact of global uncertainties on emerging market currencies in general, as well as ongoing domestic banking sector vulnerabilities, pose upside risks to this forecast.

Debt levels have increased but buffers remain

As a result of sharply lower oil revenues and the IBA FX debt restructuring, Azerbai-jan’s fiscal balance shifted to manageable annual deficits in 2015-2017 (between -4.8% and -1.1% of GDP) after eight years of large surpluses before that. Thanks to rising revenues from hydrocarbon production, the fiscal balance moved back to a +4% of GDP surplus in 2018. Slightly smaller surpluses are forecast in 2019-2020.
However, total public debt, including guarantees, has surged from 13% of GDP in 2013 to around 50% currently, mainly for two reasons: First, the sharp AZN devalua-tion led to a substantial rise in FX-denominated public debt if measured in local cur-rency. Second, government injections into IBA and new sovereign securities issued in exchange for IBA debt pushed up public debt and guarantees.

Meanwhile, assets held by the State Oil Fund of Azerbaijan (SOFAZ) – which had declined in the wake of both the oil price slump in 2014-2015 and the IBA debt re-structuring – have recovered and increased to a new record high of USD42bn in mid-2019 (approximately 85% of GDP). This means that the sovereign will remain a solid net creditor for now.
Azerbaijan’s external position also deteriorated following the oil price crisis. After nine years of double-digit surpluses (in % of GDP) the current account balance shifted to manageable deficits in 2015-2016. However, since 2017 it has posted an-nual surpluses again (+12.6% of GDP in 2018), thanks to the partial recovery in oil prices and the overall positive effect of the AZN depreciation on the economy’s ex-port competitiveness. We forecast annual surpluses of around +8% of GDP in 2019-2020.
Meanwhile, gross external debt rose from just 14% of GDP in 2013 to 33% in 2018 and is forecast to stabilize in the next two years. While this is still a moderate ratio, there are some doubts about data accuracy with regard to external debt.

Official FX reserves of the CBA (USD6.7bn in mid-2019) cover only a modest 3.5 months of imports. However, combined with the assets held by SOFAZ they cover over 20 months of imports, providing a sufficient buffer for standard trade finance.

Trade structure by destination/origin

(% of total)

Exports Rank Imports
Italy 17%
19% Russia
Turkey 12%
14% Turkey
China, Taiwan Province of 9%
8% China
Israel 7%
6% United Kingdom
Germany 7%
6% United States

Trade structure by product

(% of total)

Exports Rank Imports
Petroleum, petroleum products and related materials 86%
12% Other industrial machinery and parts
Vegetables and fruits 2%
9% Iron and steel
Sugar, sugar preparations and honey 2%
8% Road vehicles
Plastics in primary forms 1%
8% Specialised machinery
Gas, natural and manufactured 1%
5% Electrical machinery, apparatus and appliances, n.e.s.

  • Low

  • Medium

  • Sensitive

  • High

  • Payments

  • Court proceedings

  • Insolvency proceedings


Euler Hermes

Economic Research Team

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