Proposal for a Council Decision providing exceptional financial assistance to Azerbaijan
Date: 1998-04-03
Institutions: European Commission
Subjects: Azerbaijan, International Development Association, International Monetary Fund, economic reform, financial aid

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 03.04.1998 
COM(1998) 205  final 

98/0129(CNS) 

Proposal for a 

COUNCIL DECISION 

providing  exceptional financial  assistance 

to  Azerbaijan 

(presented by the Commission) 

EXPLANATORY  MEMORANDUM 

General economic situation of Azerbaijan 

Azerbaijan  suffered  a  severe  economic  decline  from  the  outbreak  of  the  Nagorno-
Karabakh  conflict  in  1988. This still  unresolved  conflict  has destroyed  infrastructure,  and 
led  to  the  occupation  of  twenty  percent  of  Azerbaijan's  territory  by  Nagorno-Karabakh-
Armenian  forces.  As  a result,  around  one  million  people,  about  one  seventh  of  the  total 
population  of  the  country,  were  obliged  to  leave  their  homes  and  seek  refuge  in  other 
regions  of  Azerbaijan.  This  situation  was  compounded  by  the  disruption  of  trade  and 
financial  links with the other  former  Soviet republics  in  1991-1992, by  soaring  prices  for 
imports, and  by the partial  closure  of the  Azeri  borders, not  only  with  Armenia,  but  also 
with Russia because of the Chechen conflict.  The effect  was catastrophic  for  Azerbaijan's 
economy  which  contracted  by  some 60 %  from  1992 to  1995 and reached  hyper-inflation 
levels. 

Under  such  critical  circumstances,  living  standards  of  60  % of  the  population  fell  below 
poverty  levels. Moreover,  the  strict  budgetary  policies  implemented  from  1995 prevented 
the  Azeri  Government  from  providing  as much  funding  as  necessary  for  social  purposes 
and prevented any significant  improvement in the very difficult  situation of the population. 
Currently, the monthly  average  salary  is not higher than 40 US$ and the monthly  average 
pension  is  less  than  15 US$, while the  income  of 20 % of  the population  represents  only 
40 % of the minimum consumption basket. 

Political  instability  prevented  Azerbaijan  from  embarking  early  on  economic  and 
structural  reforms  in the  years  after  indépendance.  However,  in  1995,  supported  by  IMF 
Arrangements,  the  Government  initiated  a  largely  successful  macroeconomic  reform 
programme  and, at present, economic  recovery  has started:  a GDP  growth  of about  1.5  % 
was  recorded  in  1996,  while  a  growth  of  5  %  was  reached  in  1997;  annual  average 
inflation  declined  from  1700 % in  1994 to 4 % in  1997 and the budget  deficit  from  12 % 
of  GDP  in  1994  to  2  %  of  GDP  in  1997.  However,  tight  fiscal  policies  have  led  to 
substantial sequestration of budgetary expenditure, in particular, in the social sectors. 

Largely  reflecting  oil  investments,  the  current  account  deficit  soared  to  around  22  %  of 
GDP in  1996 and  1997, and is expected to grow further  up to some 34 % of GDP in 2000. 
As  a result  of  investment  into  the  oil  sector,  external  financing  gaps  will  appear  in  1998 
and  1999, while the gross reserves of the Azeri National  Bank  are not expected  to  exceed 
16 weeks  of  imports  in the coming  years. Concerning  structural  reform,  after  a slow  start 
which  left  Azerbaijan  lagging  well  behind  most  other NIS,  important  steps  were  taken  in 
1996 and the reform  process, although slower than expected  in  1997, is now considered  as 
being under way. The public external  debt is expected to remain  stable at around  15-20 % 
of GDP in the years to come. Despite the difficult  circumstances, Azerbaijan  has remained 
current  on  most  of  its  external  debt  obligations,  in  particular  towards  the  Community 
whose MECU 51 loan granted in  1994, was fully  repaid on time (29 September  1997). 

In  order  to  cover  its  basic  needs  over  the  last  five  years  Azerbaijan  has  had  recourse  to 
international  humanitarian  assistance,  out  of  which  the  Community  has  provided  the 
biggest  share  (under  ECHO  and  exceptional  food  aid  programmes).  However,  so  far,  the 
level  of  international  assistance  to Azerbaijan  has been  proportionally  lower  than  to  other 

I 

countries  in  the  Caucasus,  as  a result,  in particular,  of the  United  States  being precluded 
under its domestic legislation from  providing assistance to this country. 

Status of IMF programmes on Azerbaijan 

Supported  by  a  first  Structural  Transformation  Facility  (STF)  (US$  46  milllion)  in  April 
1995, the comprehensive  stabilization and reform  program that Azerbaijan  launched  at the 
start of  1995 has been very successful  in achieving macroeconomic  stabilization. 

In  December  1996, the  IMF  approved  the  new economic  programme  of  the  Government 
for  the  1996-99  period,  and  supported  it  by  three-year  combined  facilities:  a  US$  135 
million  Enhanced  Structural  Adjustment  Facility  (ESAF) and  a US$  84 million  Extended 
Fund  Facility  (EFF).  This  economic  programme  is  addressing  the  key  structural  reform 
issues. The  IMF Board  approved  the completion  of the first  review under these  combined 
facilities  in July  1997. 

The proposed  exceptional  assistance 

the  Azeri  macro-economic  programme  as  being 
The  Commission  considers 
comprehensive  and ambitious. This programme, if fully  implemented,  should reinforce  the 
current macro-economic  stabilisation and, by the means of structural  reforms, establish  the 
core frame of a market economy. 

that,  without  additional  budgetary  support, 
The  Commission  considers  however 
Azerbaijan  will  not be able to pursue the very tight  macroeconomic  policies  implemented 
so far  in the  context  of  its reform  programme.  Indeed,  a very  restrictive  budgetary  stance 
has  already  put  a  strain  on  the  very  difficult  social  situation  and  has  led  to  budgetary 
sequestration,  in particular  of much needed  social  expenditures, which  can not be  delayed 
any  longer.  The  improvement  in  the  social  situation  which  would  result  from  additional 
assistance  targeted  to the  social  safety  net would  be an essential  element  for  political  and 
social  stability  in this  strategic but politically  unstable  region  and  would  contribute  to  the 
sustainability  of continuing economic and structural  reforms. 

Azerbaijan,  as  a  low  income  country,  is  eligible  for  World  Bank  lending  at  highly 
concessional  IDA  (International  Development  Association) conditions, as well  as for  IMF 
ESAF  lending,  the  concessional  facility  of  the  Fund.  In  the  circumstances,  the  country 
should, in the Commission's  view, be supported with highly concessional  assistance. 

Throughout  the  1993 -  1997 period,  the bulk  of the  Community  assistance  to  Azerbaijan 
was  provided  in  the  form  of  grants  under  humanitarian  programmes,  in  particular  in  the 
context  of  the  two  important  food  aid  operations  of  the  Winter  periods  1994-1995  and 
1995-1996. 

In January  1997, the Parliament  urged  the European  Union  to develop  an active  presence 
in Transcaucasia,  a region of strategic importance, both politically  (proximity  of the  Black 
Sea)  and  economically  (trade  corridor  from  Europe  to  Central  Asia,  energy  resources  -
TRACECA  and  INOGATE  initiatives).  Recommending  to  encourage  the  economic 
development  of  this  region,  it  underlined  also  the  necessity  of  equitable  treatment  of 

3 

Armenia, Georgia and Azerbaijan and advocated consideration of exceptional financial aid 
to these three countries in the context of IMF agreements. In November  1997, the Council 
adopted  the  Commission's  proposal, for  exceptional  financial  assistance  to  Armenia  and 
Georgia, which is now in the process of implementation. 

Owing to the exceptionally harsh political, economic and social conditions presently faced 
by Azerbaijan, the Commission considers that exceptional assistance in the form of grants 
targeted  to  social  safety  net  budgetary  expenditures  is  required  to  alleviate  the  social 
hardship resulting from  the austerity measures accompanying thé implementation  of IMF 
supported  stabilization  programmes,  notably  by  securing  implementation  of  adequate 
levels of budgetary expenditures, in particular in the social sectors* and to help Azerbaijan 
to cope with its refugees problem. 

Against  this  background,  the  Commission  is  now  proposing  that  consistent  with  the 
present ceiling of Category. 4 of the financial perspective, the Community makes available 
to  Azerbaijan  exceptional  financial  assistance  in  the  form  of  grants  of  up  to  ECU  30 
million to be financed from the general budget. 

The  Commission  considers  that  this  exceptional  assistance  to  be  financed  through 
redeployment within the existing limits of Category 4 of the financial  perspective should 
have to be implemented in three successive annual instalments from  1998 to 2000. 

The Commission accordingly requests the Council to adopt the attached proposal. 

U 

Proposai for a 

COUNCIL DECISION 

providing exceptional financial assistance 

to Azerbaijan 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  establishing  the  European  Community,  and  in  particular 
Article 235 thereof, 

Having regard to the proposal from the Commission1, 

Having regard to the opinion of the European Parliament2, 

Whereas  Azerbaijan  is  undertaking  fundamental  political  and  economic  reforms  and  is 
making substantial efforts to implement a market economy model; 

Whereas trade, commercial and economic links will develop between the Community and 
Azerbaijan  within the framework of the Partnership and Cooperation Agreements signed 
on 22 April 1996; and whereas an Interim Agreement was signed on 8 October 1997; 

Whereas Azerbaijan  agreed with the International Monetary Fund (IMF) in April  1995 on 
a first  set of stabilisation and policy reform  measures which was supported by the IMF's 
Systemic  Transformation  Facility  (STF),  and  whereas  the  IMF  Board  approved  in 
November  1995 a Stand-by Arrangement and a second drawing under the STF Facility in 
support of further  ambitious stabilisation and structural adjustment  reforms, for the period 
November  1995 - November  1996; whereas the IMF board approved in December  1996 a 
combined  three-year  Enhanced  Structural  Adjustment  Facility  (ESAF) /  Extended  Fund 
Facility (EFF) at concessional terms in favour of Azerbaijan; 

Whereas, so far, the level of international assistance to Azerbaijan has been proportionally 
lower  than  to  the  other  countries  in  the  Caucasus  and  whereas  the  Council  adopted  in 
November  1997  a  Decision  providing  exceptional  financial  assistance  to  Armenia  and 
Georgia (O.J. L 322 of 25.11.1997, p. 37); 

Whereas Azerbaijan  is a low income country  and  is facing  particularly  critical political, 
economic  and  social  circumstances;  and  whereas  the  country  is  eligible  to  highly 
concessional loans from the World Bank and the IMF; 

1 

2 

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Whereas  this  assistance  is  exceptional  and  only justified  on account  of  the  particularly 
harsh  political,  economic  and  social  conditions  presently  faced  by  Azerbaijan,  and,  in 
particular, on account of the large number of refugees living on its territory; 

Whereas  the  authorities  of  Azerbaijan  have  formally  requested  exceptional  financial 
support from the Community; 

Whereas concessional financial assistance from the Community in the form of a grant is an 
appropriate measure to help the beneficiary  country at this critical juncture by supporting 
the policy objectives attached to the governments' reform efforts  and alleviating the social 
cost of adjustment measures; 

Whereas the maximum amount of this assistance is without prejudice to the competences 
of the budgetary authority; 

Whereas this assistance should be managed by the Commission; 

Whereas the Treaty does not provide, for the adoption of this decision, powers other than 
those of Article 235, 

HAS DECIDED AS FOLLOWS : 

Article 1 

1.  The  Community  shall  grant  to  Azerbaijan  exceptional  financial  assistance  of  a 
maximum amount of ECU 30 million in the form  of straight  grants, with a view to 
alleviating  the  social  hardship  of  the  austerity  measures  accompanying  the 
implementation  of  IMF  supported  adjustment  programmes,  notably  by  securing 
implementation  of  adequate  levels  of  budgetary  expenditures,  in  particular  in  the 
social sectors, and to helping the country to cope with its refugees problem. 

2.  The Community exceptional assistance shall be managed by the Commission in close 
consultation with the Monetary Committee and taking into account the provisions of 
any agreement reached between the IMF and Azerbaijan. 

Article 2 

Subject  to the provisions of Article  1, the Commission  is empowered  to agree with 
the Azeri authorities, after  consultation with the Monetary Committee, the conditions 
attached to this assistance. These conditions shall be consistent with any agreement as 
referred to in Article 1  (2). 

The Commission  shall verify  at regular intervals, in consultation with the Monetary 
Committee, that the policies  in Azerbaijan  are in accordance  with  the  objectives  of 
this assistance and that its conditions are being  fulfilled. 

<o 

Article 3 

1."  The  assistance  will  be  made  available  in  three  successive  annual  instalments  from 

1998 to 2000, subject to the provisions of Article 2. 

2.  The funds  shall be paid to the National Bank of  Azerbaijan. 

Article 4 

All related  costs incurred by the Community  in concluding  and  carrying  out the  operation 
under this Decision shall be borne by Azerbaijan. 

Article 5 

At  least once a year, the Commission  shall  address to the European  Parliament  and to  the 
Council a report, which will include an evaluation, on the implementation of this Decision. 

Done at Brussels, 

For the Council 

The President 

n-

FINANCIAL MEMORANDUM 

1.  Title of Operation 

Exceptional financial assistance to Azerbaijan. 

2.  Budget heading involved 

Article  (B7-53...)  Exceptional  financial  assistance  to  Azerbaijan  (to  be  created 
through an amending and/or supplementary Budget). 

3.  Legal basis 

Article 235 of the Treaty 

Proposal  for  a  Council  Decision  providing  exceptional  financial  assistance  to 
Azerbaijan. 

4.  Description and Justification for the action 

a)  Description of the action 

Provision  of a Community  grant of up to ECU 30 million  (to be financed from the 
General  Budget)  to  Azerbaijan  with  a  view  to  alleviating  the  social  hardship  of 
austerity measures associated with the implementation of IMF supported  adjustment 
programmes,  notably  by  securing  implementation  of  adequate  levels  of  budgetary 
expenditures,  in particular  in the  social  sectors, and to  helping  the country  to cope 
with its refugees problem. 

b)  Justification for  the action 

The  sustainability  of  Azerbaijan'  economic  reforms  heavily  depends  on 
complementary budgetary assistance; from official  sources, at concessional terms. 

5.  Classification of the Expenditure 

Non compulsory,  differentiated. 

6.  Nature of the expenditure 

-  a grant (100% subsidy), which would be released in three successive annual 

instalments. 

7.  Financial impact 

a)  Method of calculation 

-  The evaluation of the amounts of the assistance  deemed necessary  is based 
on  the  present  estimates  of  Azerbaijan's  budgetary  financing  needs,  in 
particular in the social sectors 

f 

. b) 

Effect of the action on intervention credits 

-  The  budget  entry  corresponding  to  the  grant  will  be  activated  subject  to 
compliance  with  a  nurhber  of  conditions  to  be  agreed  with  Azerbaijan's 
authorities 

c) 

Financing of intervention expenditure 

The  financing  of the  expenditure  will  be  secured  in  three  successive  annual 
instalments  from  1998  to  2000  through  redeployment  within  the  limits  of 
Category 4 of the present Financial Perspective. 

The  following  schedule  of  appropriations  is proposed  (in  million  of  current 
ECU): 

Commitment 
appropriations 

1998 

1999 

2000 

10 

10 

10 

Payment  appropriations 

10 

10 

10 

8.  Fraud prevention measures 

The  grant  will  be  paid  directly  to  the  National  Bank  of  Azerbaijan  only  after 
verification  by the Commission  Services, in consultation  of the Monetary  Committee 
and  in  liaison  with  the  IMF  and  World  Bank  Services,  that  the  macro-economic 
policies  implemented  in the  country  are  satisfactory  and  that  the  specific  conditions 
attached to this assistance are  fulfilled. 

9.  Elements of cost-effectiveness  analysis 

a) 

Grounds for  the operation and specific objectives 

The  improvement  in  the  social  situation  which  would  result  from  assistance 
targeted  to  the  social  safety  net  and  complementing  financing  by  the 
International  Community  provided  to  the  country  in  the  context  of  an  IMF 
agreed  programme  would  be  an  essential  element  for  political  and  social 
stability in this strategic but politically unstable region and would contribute to 
the sustainability  of continuing economic and structural  reforms. 

The  specific  objectives  are  to  alleviate  the  social  hardship  of  austerity 
measures  associated  with the IMF  supported  adjustment  programmes,  notably 
by  securing  implementation  of  adequate  levels  of  budgetary  expenditures,  in 
particular in the social sectors, and to help the country to cope with its  refugees 
problem. 

9 

10 

. b)  Monitoring  and evaluation 

This exceptional assistance is of macro-economic  nature and its monitoring  and 
evaluation  are  based  on  a  satisfactory  track  record  of  the  IMF  supported 
adjustment  and reform programme that Azerbaijan  is implementing. 

The monitoring of the action by the Commission services will take place on the 
basis  of  a  genuine  system  of  macro-economic  and  structural  policy  indicators 
to be agreed  with the authorities  of Azerbaijan.  The  Commission  services  will 
also  remain  in close  contact  with the  IMF  and  World  Bank  services  to  benefit 
from their assessment of Azerbaijan's  stabilization and reform  achievements. 

An annual  report  to the European  Parliament  and to the Council  is foreseen  in 
the  proposed  Council  decision,  which  will  include  an  evaluation  of  the 
implementation of this operation 

10.  Administrative  expenditure 

This action  is exceptional  in nature and will not involve an increase in the number  of 
Commission  staff. 

/o 

ISSN 0254-1475 

COM(98) 205 final 

DOCUMENTS 

EN 

11  01  09 

Catalogue  number  :  CB-CO-98-219-EN-C 

ISBN  92-78-32964-9 

Office  for Official  Publications of the European  Communities 

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