**CHAPTER 2: ECONOMIC PROFILE**  

 

 

The Azerbaijani economy declined significantly afterindependence in 1991 due to war with Armenia, disruption of trade ties withinthe former Soviet Union, and the collapse of large parts of the statemanufacturing sector that stemmed from supplier disconnects. The economy beganto recover in the second half of 1996, with real GDP growing 5.8 percent in1997 and 10 percent in 1998 (official Azerbaijani estimate). This growth issupported by a highly skilled workforce, abundant oil, a strategic location inthe Caspian region, and above all by massive foreign investment in oil andrelated services sectors.  

 

As impressive as Azerbaijan’s economic recovery has been,the country is heavily dependent on oil revenues and, beginning in the fall of1998, these revenues have fallen along with world oil prices. 

 

**RECENT DEVELOPMENTS**

 

Azerbaijan was minimally affected by the 1998 Russian rublecrisis, and the falling world oil prices in the second half of 1998 severelycurtailed investment by oil and oil related companies. Nevertheless,January-March 1999 showed a growth in GDP of 6.2 percent and an increase of 4.1percent in industrial production over the same period in 1998.

 

Economic reform moved forward in 1998, with various estimatesplacing GDP growth between 8.5 percent and 10 percent. Inflation stood at lessthan 1 percent, and the manat remained a stable currency. Foreign exchangereserves were healthy. Fourteen production-sharing agreements (PSAs) weresigned with foreign oil companies by December 1998, resulting in $1.6 billionin foreign investments and contract bonuses. Basic laws for the terms andprotection of foreign investment were in place. A new tax code, currently indraft form, should improve collections and tighten overall tax administration.New oil and gas related legislation was enacted in February 1999 providingbasic regulation of the country’s oil and gas operations. 

 

Privatization has been slow, with most medium and largeenterprises remaining in the state sector. However, the Azerbaijanigovernment’s privatization program raised about $36.6 million in 1998. Byyear-end 1998, 6,654 small state enterprises were privatized, and 967 jointstock companies were established from medium and large state enterprises, 211from the Ministry of Agriculture. About 90 percent of the nation’s farmland wasprivatized, although agricultural production is only half its Soviet-eralevels, and virtually all small companies are private. The state oil companySOCAR, remained a state-owned enterprise. 

 

**The Oil Sector**

The oil sector has played a crucial role in Azerbaijan’srecovery since the mid-1990s, with 74 percent of foreign direct investment. Oiland oil products exports in 1998 accounted for $418 million of the total $606million in Azerbaijani exports, about two-thirds of the total, in part due tothe startup of several new offshore wells. Oil equipment imports made up $435million of the almost $1.1 billion in total Azerbaijan imports in 1998.Oil-related revenue brings in nearly 50 percent of budget revenues, including57 percent of total indirect taxes. 

 

Seventeen PSAs have been signed, three in 1999. Three of the17 are for onshore development and the rest offshore. Two of the PSA consortia,CIPCO and NAOC, were terminated in 1998 for lack of yield. Three new PSAs weresigned in late spring 1999 in Washington.

 

Azerbaijan produced 70 percent of the Soviet Union'soilfield equipment, and is trying to attract foreign investment into thissector so that it can become the dominant supplier both domestically and forexport. Agronomic potential is strong, but economies of scale are lacking andthe domestic market is undeveloped.

 

**Non-Oil Sectors**

Outside of oil exploration and production, the growth ofBaku's expatriate community and a monied class of Azerbaijanis are generatingtax revenue and a demand for recreation, entertainment, and retail services inBaku (temporarily curtailed by the fall in oil prices). 

The national infrastructure, however, is in poor condition.It was built in the Soviet period. Since independence, there has been inadequate public investment in, andmaintenance of, public infrastructure. Roads are inadequate and deteriorating.The electrical generation and distribution system is in poor condition. Eightypercent of arable land is irrigated, but the irrigation system is collapsing.Baku experiences shortages of gas, water, and electricity. Elsewhere in thecountry electricity supply is inadequate, and gas is almost nonexistent. Publicutilities are financially crippled by their inability to secure payment fromtheir customers.

 

**ECONOMIC STATISTICS**

 

**Currency Manat (AZM):**3.869/$l average exchange rate for 1998, up from 1997's 3.985, and 1996's4.298  

 

**GDP: **15,930 AZM ($4.1 billion). Growthrate in 1998 was 10 percent as a result of strength in fourth quarter, with theconstruction sector, linked to oil growth, dominating recovery. Agriculturerecovered after a 1997 decline. In 1998, industrial production = 22.3 percentof GDP, construction (16.4 percent), transportation & Communications (12.9percent), trade (5.7 percent), agricultural production (20.3 percent).

 

**Industrial Production**:2.2 percent growth in 1998, up from .3 percent and -6.9 percent in two prioryears.

 

**AgriculturalProduction:** 3.9 percent growth in 1998, up from -6.9 percent and 3 percentfrom two prior years. 

 

**Private sector:**represented 55 percent of 1998 GDP. 141.7 billion manats ($36.6 million) camefrom all forms of privatization in 1998. 

 

**Inflation:** 1998was negative (-7.6 percent), grew 4 percent in 1997.

 

**Foreign debt**: Inthe first three quarters of 1998, loans to the Azerbaijani economy were lessthan half those received in 1997 ($81 million versus $194 million), and adecreasing part came from the IMF. These were loans made to the government, andconstitute only 12 percent of FDI.

 

**Total InternationalReserves:** $448.7 million in January 1999 (January 1998 were $467.5million). Net international reserves decreased from October to December 1999mainly due to Russian crises leading Azerbaijani National Bank to sell U.S.dollars for AZM to avoid a depreciation of the AZM. 

 

**Oil/Gas Production:**Crude production fell from 12.5 million tons in 1990 to 9 million tons, 1997,and grew to 11.4 million tons in 1998, of which roughly 85 percent was offshore.Production of natural gas continued its gradual decline from 1998's 5,963.9 mcmto 5,589.6 mcm of which roughly 94 percent was offshore. 

 

**Exports:** 1995:$637 m, 1996: 631 m, 1997: $781 m, and 1998: $606m. Principal exports wereoil/oil products, cotton, chemicals/petrochemicals/plastics, foodstuffs, andmachinery. Main destinations of exports were Turkey (22 percent), Russia (18percent), Georgia (12.4 percent), Iran (7 percent), and Ukraine (2 percent).

 

**Imports:** 1995 -$668 m, 1996 - $961 m, 1997 - $1.2 b, 1998 - $1.077b. Principal Imports weremachinery & equipment, foodstuffs, metals, oil products,chemicals/petrochemicals, and tobacco products (No. 1 export in 1998 fromU.S.). Exports came from Turkey (20 percent), Russia (18 percent), Ukraine (9percent), UAE (4 percent), and Iran (4 percent).

 

**INVESTMENT **

 

The Government of Azerbaijan’s policy is to encourage andwelcome foreign investment, with legal, tax, and regulatory reforms tofacilitate this investment. Experts have estimated that around $15 billion ininvestment is needed for modernization of the country’s outdated industry overthe next 20 years. Because the annual income of the state budget is around$600-650 million, the Government of Azerbaijan will not be able, with foreigninvestment at current rates, to make the full volume of needed core industrialrevamps within the next two decades. 

 

In 1998, Azerbaijan signed economic cooperation agreementswith the United Kingdom, Austria, France, the OSCE, and Kazakhstan. It alsocontinued to sign and ratify new PSAs with world oil companies (3 new ones sofar in 1999), and on November 24, 1998, passed a Law on Energy. Total loansfrom international financial institutions and foreign countries amounted to$1.444 billion by October 1998, of which 43.8 percent has been used. The bulkcame from the IMF and IDA ($535 million), followed by ICEF and EBRD ($170m and$111.6m, respectively). About $884 million has been assigned to investmentprojects, mostly in infrastructure and environment.

 

**FOREIGN DIRECTINVESTMENT**

 

Foreign participation is possible through joint ventureswith local companies, wholly owned enterprises, and representative offices.Foreign direct investment (FDI) was estimated at a cumulative $2.1 billion atend 1998. FDI in 1993 totaled $15m, 1994 - $30 million, 1995 - $155 million(6.4 percent of GDP), 1996 - $591 million (18.6 percent of GDP), 1997 - $1051million (27.3 percent of GDP), and 1998 - $1077 million. 

 

At 3Q 1998, FDI was only $674 million (24.1 percent of GDP).Growth in FDI since 1995 has been largely due to investment by foreign oilcompanies. The oil sector accounted for 74 percent of total FDI in 1997 and 81percent in 3Q 1998. Therefore, total FDI was affected heavily by the 1998decrease in world oil prices.

 

During January-April 1999, $370 million was invested intothe Azerbaijani economy, pointing to an investment year exceeding even 1997.Oil and gas investment amounted to 77.4 percent of the total, as opposed to49.5 percent in 1994. 

—90 percent of this amount was directed to production units.

—75 percent of this amount was foreign investment. 

—Only 1 percent of this amount came from the state budget. 

 

Investment of Azerbaijani citizens in 1998, and duringJanuary-April of this year, has fluctuated between 14 and 16 percent, mainly toconstruction sector. 

 

**INVESTMENT IN THE OILSECTOR**

 

Since 1994, 17 production-sharing agreements (PSA) have beensigned, with 7 in 1998 and 3 in 1999.

 

**1998 INVESTMENT BY FOREIGN OIL COMPANIES(NEW PROJECTS)**

 

Projects                                 TotalAmount of Investment ($ billions)    ForeignParticipation (percent)

1. Kurdashi field                                                            2                                                     50

2. South Gobustan field                                             0.8                                                       80

3. Kyursangi and Karabahli fields                              n/a                                                       50

             4. Inam                                                               3.8                                                                               50

             5. Muradkhanli, Geferli, Zerdab                        1.2                                                             50

             6. Araz, Alov, Sherg                                          9                                                                                 60

             7. Ateshgah, Yanantava                                      n/a                                                      50

 

**FOREIGN TRADE**

 

Azerbaijanhas consistently run a negative trade balance mainly as a result of imports ofoil and oil related (including construction, telecommunication, medicalservices, transport, hotels) machinery, products and services. The currentaccount deficit is expected to continue until oil export revenues rise tosignificant levels, around 2005. 

 

Onethird of Azerbaijan’s exports went to the CIS, and Azerbaijan bought 37.6percent of its imports from the CIS. Turkey is its largest single trade partnerwith Russia second, and, outside the CIS, Iran.

 

U.S.turnover with Azerbaijan almost doubled in 1998 to a total $127.3 million from$67.7 million in 1997. Azerbaijan broadened its negative balance ($117.5m) importing$122.3 million worth of goods and selling $4.9 million. U.S. machinery andparts exports mostly bound for oilfields or oilfield sites amounted to $26.2million, up from $21.9 million in 1997. But the big U.S. products werecigarets, cigars and other tobacco products, which captured first place amongU.S. exports at $66.5 million up from 1997's third place ($7.2 million). Otherexports were meat, and tools/cutlery which grew, and electrical machinery andoptical/medical equipment which fell.