• The economy is coming out of stagnation. This year, the economy will grow by 1.5%. The key drivers include recovering external demand for a basic export commodity and growing non-primary economy as a phenomenon of delayed activity. However, until 2022, no significant growth drivers are expected to emerge, and the annual growth will be within 3.2%.
  • The regulator has managed to cap the inflation, which reached double-digit values in 2016 and 2017. The surge was caused by a shock in the exchange rate dynamics and a high level of import dependence. According to ACRA estimates, in 2018–2022, the inflation will be in range 4–6%, following the counter-cyclical regulatory policy and the end of the translation of the exchange rate shock into price formation.
  • Significant dependence of the economy on mineral resources remains the main risk. At the same time, the basic forecast scenario implies a low probability of worsening demand; the trade balance will remain positive, provided that price for Azeri Light is $45 per barrel or higher. In this case, manat will demonstrate stability; the probability of devaluation is low.
  • The share of mining sector in the industry of Azerbaijan is growing again. The recovery in industrial production has occurred solely due to growth in mining industries, and the share of manufacturing sector has fell to 28% of the industrial production volume (63% in 1997). Negative dynamics of lending activity aggravates this trend.

 Table 1. Key indicators of Azerbaijan and other economies in 2015–2022

Source: national agencies, ACRA estimates

Recovering economy and growing oil dependence

This outlook is drawn up in line with ACRA’s General Principles of Socioeconomic Indicators Forecasting.

After the recession in 2016 and the 0.1% growth in 2017, the economy of Azerbaijan began to show a gradual recovery at the turn of 2017-2018. At the same time, the growth in real terms in non-primary sectors amounted to 1.9% in January-May, outperforming similar indicators in aggregate terms (1.1%).

In the real sector, the decline started in 1Q2016 and lasted exactly a year. In 2017 transport, retail trade, agriculture moved into the growth zone, other segments of the real sector, remaining in the red, still stagnated rather than sagged. A different picture was observed only in the construction sector: the sector started to sag (y-o-y) in early 2015, and it was this segment of the real economy where the fall was most drastic (25% in early 2016).

In January-May this year, economic growth strengthened in virtually all segments of the real sector, which showed significant positive dynamics in real terms, except for construction sector that showed an 11.2% decline. The most significant growth was observed in agriculture (8.5%), the least significant — in freight transport (0.9%). At the same time, due to the significant influence of the oil sector on both the country's industry and the GDP, as well as due to the restrained dynamics in the oil industry, the overall economic growth (y-o-y) in January-May was more modest: from 1.1% to 2.3% in different months of the current year.

Against the background of the restoring economic activity, oil dependence is also restoring in Azerbaijan. The share of oil industry in the GDP was 43% in 2017. Due to the absence of significant drivers for growth, the GDP trend (almost a half of the commodity segment of the economy) will continue throughout the forecast horizon.

Figure 1. Azerbaijan's GDP by segment, %

Source: national agencies, ACRA estimates

Translation of the exchange rate shock onto inflation has dried up. Inflation has stabilized

See also: Among CIS oil exporters, only Kazakhstan will evade the risk of slowing down economy dated April 9, 2018.

After reaching 12.9% in 2017, the y-o-y consumer inflation in Azerbaijan stabilized in 1H2018. By the end of May, the y-o-y CPI growth was 3.2%, significantly lower than the target level of 6-8% for 2018. ACRA expects an average annual growth of consumer prices in the range of 4-6% in 2018-2022, because by the end of 2017, the inflationary surge caused by the revaluation of the exchange rate of manat exhausted its potential.

Since the beginning of this year, the CPI has been largely driven by fundamental factors: inflation in the economies of key trading partners of Azerbaijan, inflation expectations and money supply. Apparently, the Central Bank of Azerbaijan no longer expects significant inflationary outbursts, since the beginning of the year, the refinancing rate of the Central Bank has been decreased three times already, by 5 p.p. in total, having reached 10% by mid-July, with the corridor at +/-2 p.p.

Among the main expected effects of the moderate inflationary background for the Azerbaijani economy are the continued growth of real incomes of the population and the potential revival of lending to the real sector, which is still in the shrinking zone since the end of last year.

However, the banking sector problems, including low public confidence, a sharp reduction in the number of commercial banks1, lower volume of investments in fixed assets, can hinder the development of the real non-primary sector of the economy. These difficulties forced the government to offer 100% guarantees for retail deposits and to accelerate the restructuring of IBA.

1 In 2016, 11 banks failed to satisfy the minimum regulatory standards; 30 out of 43 commercial banks operating in Azerbaijan survived the year of 2017.

Figure 2. Nominal rate of manat and CPI dynamics

Source: national agencies, ACRA estimates

In the absence of further shocks in external demand, the AZN exchange rate will be stable

The devaluation of manat and the relevant shock effects of inflation and disposable incomes of households came to naught at the turn of 2017-2018, but the question remains: will the regulator be able to maintain the current flexible monetary regime, with interventions minimizing the exchange rate fluctuations caused by non-fundamental factors?

On the one hand, the improvement in the external situation indicates a decrease in the tension in the balance of payments, which moved to the positive zone in 1Q2017, due to lower payments on primary incomes. The basic forecast scenario of ACRA implies a stably positive current account at the level of 5-5.7% of GDP, which is formed due to the prevalence of a positive trade balance over negative primary income and neutral secondary income. To enter the positive zone, the threshold price for Azeri Light should be $45 per barrel.

On the other hand, new significant fluctuations in the hydrocarbon market, with the planned stable oil production levels in Azerbaijan for the forecast period, may affect the exchange rate of the national currency, while the balance of payments may be subject to risks of deterioration in case of new external economic shocks. In 1Q2018, oil and gas exports and exports of petroleum products comprised about 89% of the national exports.

In general, due to a decrease in inflation expectations, a reduction in the intensity of price increases, and international reserves going up to the level of the country's total imports for 8–9 months (or up to $8.5 billion at the end of 2022), the main expectation is a relatively stable exchange rate of the national currency, with a fluctuations corridor of 1.66–1.73 against the US dollar, with the prospects for strengthening to 1.66 at the end of the forecast period.

Figure 3. The effective rate of manat went down after oil prices

Source: national agencies, ACRA estimates

Growth of Azerbaijani economy will be limited

See also: Six investment drivers in Russia dated April 4, 2018.

After the recession in 2016 and stagnation (a growth of 0.1%) in 2017, the economy of Azerbaijan showed a real growth of 2.3% in 1Q2018. ACRA expects the economic activity in Azerbaijan to recover to 2.2–3.2% in 2019–2022, but real growth rates will not be able to reach a more significant trajectory. In general, the Azerbaijani economy will not demonstrate such impressive real economic growth, as it was before 2014 (see Fig. 4). Even taking into account recovering oil prices and expected rates of oil production, the annual growth of the oil component of Azerbaijan's GDP will be limited by 2%, leaving the initiative to form a long-term trend of real growth in the economy to the non-primary sector.

The real sector lacks funding, which, in many respects, is due to certain difficulties in the financial sector of the country. In 1Q2018, the loan portfolio of the Azerbaijani banking system declined by 27% y-o-y. In the absence of increase in the production of basic export commodities, the presence of such impressive difficulties in the financial infrastructure is a clear inhibitor for the economic recovery.

Figure 4. The economy of Azerbaijan recovers after recession and stagnation of 2016–2017, demonstrating growth since 2H2017

Source: national agencies, ACRA estimates

Absence of long-term growth drivers is a key problem of the economy

See also: Kazakhstan’s accelerating economy will also support inflation dated December 12, 2018.

In 2H2017–2018, the basic impetus for economic activity in Azerbaijan is occurring exclusively on the wave of deferred growth in the non-primary sector of the economy and due to the increase in export earnings. In 2H2018, some revival will also be observed in the primary sector. The Southern Gas Corridor has already been put into operation, through which gas will be supplied from Azerbaijan to Turkey and further to Europe via the TANAP gas pipeline. This will allow Azerbaijan to improve its balance of payments and to strengthen the indicators of growth in the primary sector of the economy.

It should be notes that in the long term, on the backdrop of weak lending activity in the country and poor quality of assets of the banking system2, the mineral extraction industry may not serve a full-fledged long-term source of economic growth. Real incomes, although growing now, are not a source of stable domestic demand, but are rather of a temporary nature, since they are more likely to translate the short-term combination of lower inflation and a growth of incomes deferred since 2016.

The main structural problem of Azerbaijani economy is the absence of long-term drivers of growth, and in 2018-2022, the economy will continue to be highly dependent on external conditions, and therefore, chronic macro-risks will remain strong. ACRA believes that there are no grounds for systemic improvement of credit quality in Azerbaijan, and a potential event that may lead to a more positive assessment is the privatization of the largest state-owned bank, IBA, expected in 2018.

2 The most prominent event was the default of the International Bank of Azerbaijan on its external debt in mid-2017; the total amount of restructured loans reached $3.3 billion.

Figure 5. Starting from 2015, there were no clear growth drivers in the economy of Azerbaijan

Source: national agencies, ACRA estimates

The share of mining is growing in the industry sector

The PMI of manufacturing industries showed a 39% decline in production in 2016 against 1990. In general, since 2003–2004 (the beginning of the oil boom in the country), the share of manufacturing industries has been invariably declining in the structure of industry. The only exception was the period of 2014–2015, when the share of refining sector grew on the background of the reduction in oil and gas production in monetary terms, but the previous trend was resumed as early as in 2016. At the same time, the total volume of industrial production has not recovered in full, and the relative increase observed since 2004 was caused by the mining component.

In the outlook period, ACRA does not expect that the manufacturing sector will recover to pre-crisis levels in view of extremely low volumes of loans to the real sector of the economy. The annual lending trend in the main segments of the real sector of the economy is negative, with the most decrease recorded in the construction sector (–75% y-o-y) and manufacturing industries (–44% y-o-y).

Figure 6. Lending to Azerbaijani economy is in a deep crisis (trends in real terms

Source: national agencies, ACRA estimates

Figure 7. Azerbaijani manufacturing sector has revived due to deterioration in the industry structure

Source: national agencies, ACRA estimates


Zhannur Ashigali
Director, Project Manager for Central Asian Cooperation, Sovereign and Regional Ratings Group
+7 (495) 139 03 02
Natalia Porokhova
Senior Director, Head of Sovereign Ratings and Forecasting Group
+7 (495) 139 04 90
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