Azerbaijan

major macro economic indicators

(e): Estimate (f): Forecast *SOFAZ transfers included **Not including the guaranteed debt of public enterprises

Risk assessment

Growth driven by natural gas and domestic demand

After the sharp economic slowdown of 2023, the gas industry (+3.3% year-on-year) is expected to drive a recovery in activity in 2024. Hydrocarbon exports, boosted by strong European demand, will make a positive contribution to growth. Since Russia's invasion of Ukraine in 2022, EU members have largely replaced their Russian gas imports with those from Azerbaijan in order to reduce their energy dependence on Moscow. By 2027, the Azeri government has even pledged to double its natural gas exports to the EU (20 billion cubic meters per year compared with the current 10). To comply with its part of the agreement, the government is counting on BP to develop 12 new gas wells in the Azeri-Chirag-Gunashli (ACG) field in the Caspian Sea, some of which will be operational as early as 2024. However, the European Parliament is hostile to the EU-Azerbaijan gas deal, citing human rights violations. Following the Azeri offensive in Nagorno-Karabakh in September 2023, forcing the exodus of over 100,000 Armenians, MEPs adopted a text calling for the suspension of this agreement and for targeted sanctions against the Azeri state in October 2023. Unlike natural gas, oil production has been on a downward trend since 2010 (-7.7% year-on-year in 2023) due to the depletion of oilfields in the southern Caspian Sea. However, BP's investment in its new Azeri Central East offshore oil platform on the ACG field, scheduled to start up in April 2024, could eventually stabilise crude production: 100,000 barrels of oil per day would be added to the 474,000 (excluding 124,000 of condensate) produced in January 2024, while the OPEC+ quota for 2024 is 551,000. In addition, the government's allocation of USD 2.25 billion in 2024 for the reconstruction of the Nagorno-Karabakh region should stimulate the construction sector. At the same time, resilient domestic demand will once again boost economic activity. Rising wages and social spending, together with falling inflation, will keep private consumption strong (42% of GDP in 2022). Although high levels of corruption and cumbersome bureaucracy will curb the appetite of non-hydrocarbon investors, private investment will still benefit from the easing of credit conditions. The Central Bank, which ensures that the manat is pegged to the dollar (1.7 AZN per USD), is set to lower the Fed's key rates in the second half of 2024. Public investment (+10.4% in 2023) will increase, boosted by the development of the agricultural and security sectors. Azeri roads, railroads and ports will continue to attract foreign investment to provide an alternative transit route to the Russian route. As part of the Middle Corridor linking China and Europe, Azerbaijan represents a strategic gateway for Europeans and Chinese (Silk Road), especially as international sanctions against Moscow and Teheran make the region even more attractive.

Current and public surpluses fuelled by hydrocarbons

The current account surplus contracted considerably in 2023. This was due to a fall in exports (-30% year-on-year for hydrocarbons, despite strong European demand due to lower gas and oil prices), while imports rose moderately, despite lower international food prices. The non-hydrocarbon current account showed a high deficit (10.1% of GDP for the first 9 months of 2023). By contrast, the services deficit narrowed. Increased trade along the Middle and Southern corridors between China and Europe boosted logistics and transport services. Imports of hydrocarbon-related services remained high. Similarly, the deficit on the primary income account halved, as the gas boom encouraged foreign companies to reinvest their profits rather than repatriate them. In addition, the surplus on the secondary income account fell due to the Russian economic slowdown (-64% of remittances sent by expatriates to Russia). In 2024, the current account balance is expected to remain largely in surplus, bolstered by the expansion of natural gas sales. Despite net outflows of FDI and portfolio investments, foreign exchange reserves fuelled by the current account surplus (equivalent, in February 2024, to 8.5 months of non-oil imports), will be sufficient to continue financing the manat's peg to the dollar, as well as to combat any external headwinds.
On the fiscal front, the public balance widened in 2023 due to the country's dependence on oil and gas (51% of revenues). Public revenues, which fell during the year with the drop in oil and gas prices, did not offset the 9.2% increase in social spending and public investment. The non-hydrocarbon public deficit has also increased (25% of GDP in 2023), so much so that the government has decided to postpone the -17.5% of GDP target to 2027. For 2024, the deficit is expected to resume its downward trend. In addition, the 9% increase in transfers from SOFAZ, the sovereign wealth fund dedicated, among other things, to diversifying economic activity, to the state budget compared with 2023, should help offset the fall in oil revenues and absorb some of the expenditure linked to the reconstruction of Karabakh. Fueled by oil and gas revenues, SOFAZ's assets should stabilise at around USD 56 billion by 2023, reflecting continued high energy revenues and record returns on its investment portfolio. Lastly, the public debt burden, of which just under half is external, held steady in 2023 and will not vary in 2024, as the deficit is kept low thanks to SOFAZ payments.

President's power strengthened by victory over Armenia

The takeover of the whole of Nagorno-Karabakh following the lightning attack on Armenia in September 2023 strengthened the authoritarian regime of President Ilham Aliyev. After the fall of the Soviet regime and the end of the first war (1992-1994), Karabakh declared its independence under Armenian protection, but was still considered by the international community as an autonomous region of Azerbaijan. Heydar Aliyev's mandate centred on the reconquest of this enclave, and he took advantage of this war to come to power in 1993. In September 2020, Azerbaijan resumed hostilities with the support of its Turkish ally and succeeded in recapturing a third of Nagorno-Karabakh. Inheriting the presidency on the death of his father in 2003, Ilham Aliyev took advantage of his renewed popularity, stemming from his military victories, to bring forward the presidential election from April 2025 to February 2024. Faced with a muzzled opposition, Aliyev was unsurprisingly re-elected for a fifth consecutive term with 92% of the vote. The integration of Nagorno-Karabakh into the national territory is a major challenge. Given that it was never really part of independent Azerbaijan, Aliyev will have to resort to substantial public spending to open up the region. It will encourage Azeri repopulation of the region. Moreover, given the country's heavy dependence on imported wheat, securing food supplies is a priority. To address the problem, the government has limited grain exports and allocated a budget of USD 114 million to create a food reserve while encouraging the development of the agricultural sector through subsidies. Finally, Aliyev is seeking to rapidly develop the natural gas sector on which the country is increasingly dependent due to the decline in oil production.
Relations with Armenia have somewhat improved recently. After 30 years of conflict, the two countries agreed to an exchange of prisoners of war in December 2023. Better still, Armenia has declared that it will not block Azerbaijan's bid to host COP29, even before it wins. For his part, Aliyev pledged to support Armenia's bid to head the regional bloc at the same summit. The EU is seeking to advance negotiations on a peace agreement between the two countries even if they do not start on an equal footing. Azerbaijan is in a strong position vis-à-vis Europe, which is seeking to secure a gas supply, and Armenia, still reeling from its defeat in 2023. However, the risk of renewed hostilities remains high. Skirmishes at the border will continue, while its new route is under discussion. The opening of the Zanguezour corridor, which would link Azeri territory to its exclave of Nakhchivan through the extreme south-east of Armenia, is also a source of tension. While this link would provide an additional alternative for the movement of people and goods between Europe and Asia, the extraterritoriality sought by Azerbaijan is disliked by Armenia. Iran is also opposed, as the corridor would hinder exports to its Russian and Armenian neighbors. Relations with EU countries have become strained. The EU has taken steps to dissuade Aliyev from appropriating the Zanguezour corridor by increasing the presence of its observers along the Armenian border. Similarly, in November 2023, the United States announced that it would cease military aid to Azerbaijan. Relations with the Afghan Taliban have also been normalized, with plans to open an embassy in Kabul. Finally, Serbia and Azerbaijan signed a trade agreement in November 2023 under which Baku undertakes to supply Serbia with gas for the 2024-2027 period.

Last updated: May 2024