Azerbaijan – Staff Concluding Statement of the 2021 Article IV Mission

• Azerbaijan was hit hard by the COVID-19 pandemic and the decline in the oil price and production. The authorities responded promptly with policy measures to mitigate the impact of the shocks.
• With vaccination ongoing and the economy gradually re-opening, growth is expected to pick up in 2021. When the recovery is firmly underway, the authorities could continue withdrawing the supportive measures gradually.
• Key policy priorities ahead include designing and implementing reforms to diversify the economy and improve its resilience to unexpected shocks. This should be accompanied by reforms to facilitate private sector development, including improved business environment, governance, and transparency, and better access to finance.

Washington, DC: An International Monetary Fund (IMF) staff team led by Natalia Tamirisa conducted a remote mission from April 19 to May 21, 2021 in the context of the 2021 Article IV consultation with Azerbaijan. At the conclusion of the mission, Ms. Tamirisa issued the following statement:

Recent Developments, Outlook, and Risks

1. Azerbaijan faced unprecedented challenges in 2020. Economic activity contracted by 4.3 percent, driven by the hydrocarbon, contact-intensive and transportation sectors. Inflation remained low, under 3 percent. Fiscal balance moved from a sizable surplus in 2019 to a large deficit, and the current account balance weakened as well. Increased health spending and a sizeable economic relief package helped save lives and livelihoods and cushion the economic impact from the pandemic and the decline in oil prices.

2. Risks to the outlook are broadly balanced, although uncertainty about the future of the pandemic remains high . Vaccination is expected to help defeat COVID-19 and support the recovery. GDP growth is projected to pick up to 2.3 percent in 2021, as the sectors affected by stringent lockdown re-open. The new Southern Gas Corridor pipeline will boost exports of natural gas, mitigating the decline in oil production. Inflation is projected to increase moderately to around 4 percent. Following a sharp widening in 2020, consolidated budget deficit is projected to remain high at 5.6 percent of GDP, owing to continued COVID-19 spending and increased reconstruction spending, before starting to narrow in 2022. Higher oil prices should improve the current account, turning it to a surplus of 2.4 percent of GDP, from a small deficit in 2020.

Fiscal Policy

3. In response to the COVID-19 pandemic, the authorities suspended the fiscal rule and rolled out a substantial fiscal package . Allowing the fiscal balance to move from a surplus to deficit in 2020-21 was appropriate, given the severity of the shocks and the need to fight COVID-19 and mitigate the adverse impact on the population and businesses. In the near term, the priority is to defeat COVID-19 and support the economy until the recovery is firmly underway. Fiscal policy would need to remain flexible in the uncertain environment, and, if downside risks were to materialize, automatic stabilizers should be allowed to operate and additional, targeted relief should be provided as needed.

4. Over the longer term, fiscal policy needs to shift to gradual and growth-friendly consolidation . Given the projected decline in oil resources, oil wealth needs to be shared with future generations to ensure intergenerational equity. Improvements in the efficiency of public spending, generalized subsidies, public employment, and taxation could support fiscal consolidation. Adequate and well-targeted social spending needs to protect the most vulnerable and improve inclusiveness and productivity. The reintroduction of the fiscal rule, and improvements in public financial management and reporting, alongside strengthened fiscal risk and SOE oversight and governance, would help underpin a sustainable and credible fiscal policy course.

Monetary and Financial Policies

5. In response to the pandemic, monetary policy has been appropriately eased . Interest rate cuts, in the context of the de facto peg to the U.S. dollar, and the easing of prudential regulation usefully complemented fiscal relief during the pandemic and kept credit flowing. However, amid weak monetary transmission, bank lending rates eased only moderately and remain relatively high.

6. Following the easing during the pandemic, gradual normalization of bank prudential and regulatory measures needs to be continued . However, this normalization should proceed carefully, in line with progress in combating the pandemic and re-opening the economy. Further improvements in the CBA’s policy frameworks and initiatives to develop financial markets and improve financial intermediation and access to finance would provide additional support to the diversification of the economy and improvements in its productivity and resilience. At the same time, the CBA’s ongoing efforts to improve financial oversight should continue, supported by cooperation with international financial organizations through technical assistance.

Structural Reforms

7. Structural reforms are needed to boost productivity and long-term growth potential . Comprehensive structural reforms in line with the recently approved national priorities for socio-economic developments would go a long way towards promoting sustainable, inclusive, and green economic growth in the coming decade. Diversifying the economy and promoting the development of a dynamic nonhydrocarbon sector is crucial for boosting Azerbaijan’s economic growth prospects and creating jobs. In this respect, recent focus on improving the governance and efficiency of state-owned enterprises is appropriate, and should be supported by steps to promote competition, improve governance and transparency and access to finance, and ensure sufficient funding for education, healthcare and social protection to help the workforce deal with the scarring from the pandemic and better prepare for the long-term challenges posed by the exhaustion of oil resources, digitalization and climate change.

The mission would like to thank the authorities for close collaboration and express its appreciation for the candid and insightful discussions.