Public Information Notice No. 02/24

Public Information Notice: IMF Concludes 2001 Article IV Consultation with the Azerbaijan Republic

March 8, 2002

On February 20, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Azerbaijan Republic.¹

Background

On July 2, 2001, the Executive Board approved a new three-year program under the Poverty Reduction and Growth Facility, in an amount equivalent to SDR 80.45 million (50 percent of quota). The first semi-annual loan under this program was disbursed in July 2001 (see Press Release No. 01/33).

Azerbaijan's 2001 economic performance was strong. Real GDP growth is estimated at 9 percent, exceeding the 8.5 percent program target for the year. Both the oil and the non-oil sector, including agriculture, experienced strong growth. Consumer price inflation for the year ending December was 1.3 percent, below the 2001 inflation target in the program of 2.5 percent.

Financial policies remain on track, with money and credit growth somewhat faster than programmed and net international reserves of the Azerbaijan National Bank (ANB) well above program targets. The fiscal deficit was well within program ceilings, notwithstanding a shortfall in revenues. Revenue from state owned enterprises declined due to the switch from pre-negotiated tax targets to payments according to the tax code. Expenditures were adjusted by reducing expenditures on goods and services and domestically financed investments relative to budget projections.

Throughout 2001, the exchange rate of the manat continued its gradual nominal depreciation. The current account registered a slight deficit in the first half of 2001, compared with a small programmed surplus, as larger than projected service imports more than offset the better than programmed trade balance. Net direct investment increased sharply in the second half of 2001 and is projected to increase further over the medium term, as major energy sector projects are being developed.

On the structural front, reforms continued across a wide range of activities. Progress was made in spelling out rules for Oil Fund asset management and spending. The Customs Committee has been evaluated by an external auditor, and the government has agreed on a reform program on the basis of this evaluation. Steps that were taken to make the Chamber of Accounts operational included appointing a head, submitting a revised law on the Chamber of Accounts to parliament, and inclusion in the 2002 budget of adequate funding for this institution. The ANB eliminated its deposits at the International Bank of Azerbaijan (IBA), thus contributing to the creation of a level playing field in the banking sector. Other important reforms in this sector in 2001 included the revocation of Agroprom's banking license and the adoption of operating principles for the state-owned United Universal Joint Stock Bank.

Combating arrears and non-payments in the domestic energy sector is a key focus of Azerbaijan's economic reform program. In the second half of 2001, a long-term management contract for the Baku Electricity Distribution Network was signed, and the authorities decided to eliminate all preferential consumer tariffs for electricity, gas heating, and transportation effective January 2002. In February 2002, the government adopted a comprehensive plan to strengthen financial discipline in the energy sector. An important element in this plan is the decision to include subsidies to the utility companies in the 2003 budget, and to include these subsidies in quarterly public reports on the execution of the consolidated government budget throughout 2002. The plan also contains a commitment to gradually eliminate the spread between domestic and export prices for oil.

Executive Board Assessment

Executive Directors commended the authorities for Azerbaijan's continued strong economic performance in 2001, and noted that, despite the slowdown in the international economy and the reduction in oil prices, real GDP growth has been sustained at a high level. The authorities' economic policies contributed to low inflation and a positive consolidated government budget balance. Directors felt that the prospects for broad-based economic growth and low inflation are encouraging. However, in light of the continuing uncertain prospects in the energy sector, Directors stressed that economic diversification over the medium term should remain a crucial policy objective of the authorities in order to sustain a lasting reduction in poverty.

Directors agreed that the authorities' fiscal stance for 2002, which is somewhat tighter than originally envisaged, remains appropriate in the present circumstances. Nevertheless, they advised the authorities to carefully monitor revenue developments, and to be prepared to adjust the budget if developments—particularly those related to the oil sector—turn out to be less positive than currently expected. They also urged the authorities to take steps to improve revenue collections and expenditure management, and welcomed the increase in the share of expenditures going to education, health and social protection.

Directors welcomed the adoption of a comprehensive plan to strengthen financial discipline in the energy sector, noting that failure to reduce the large quasi-fiscal subsidies in this sector would threaten both the economic stability already achieved as well as the further broadening of economic growth. Directors were particularly encouraged by the decision to incorporate into the state budget the subsidies provided by the State Oil Company of the Azerbaijan Republic (SOCAR) to the utility companies, which they consider a crucial step toward fiscal transparency and enhanced financial discipline. Directors emphasized the importance of the authorities' commitment to develop a timetable for the gradual elimination of the spread between domestic and export prices for natural gas, crude oil and oil products.

Directors were encouraged by the adoption of regulations and procedures to ensure the integrated planning, execution and monitoring of the oil fund and state budgets in the context of a consolidated budget. Directors urged the authorities to develop a prioritized Medium Term Expenditure Framework and Public Investment Program to guide the utilization of oil fund assets, stressing that the oil fund, if used wisely, can make a crucial contribution to combating poverty in Azerbaijan.

Directors considered that monetary policy should continue to target a low rate of inflation, and that the exchange rate should remain market-determined. They welcomed the ongoing efforts to strengthen the banking system, including through improved banking supervision and raising the share of foreign banks, and the progress in the rehabilitation of the state-owned United Universal Bank. They encouraged the authorities to complete the privatization of the IBA in order to create a competitive banking system in Azerbaijan. Directors praised the measures the authorities have taken to eliminate funding sources for international crime and to prevent money laundering.

Directors commended the authorities for the progress made in improving governance in 2001, with the expansion of the authority of the Chamber of Accounts, the passage of an improved procurement law, and the commitment to public reporting and auditing of the activities of the oil fund. Directors also welcomed the completion of the external evaluation of the Customs Committee and the adoption of a reform program on the basis of that evaluation, and encouraged the authorities to move forcefully with its implementation.

Directors noted the progress made in the preparation of the Poverty Reduction Strategy Paper, and urged the authorities to make every effort to develop a high-quality poverty reduction strategy in a fully participatory manner.

Directors stressed the need to improve macroeconomic and social data. They welcomed the steps that the authorities have taken in this regard in recent years, and urged them to continue their efforts to strengthen the statistical system and to ensure the timely dissemination of statistics. Directors welcomed the authorities' intention to accept the obligations of Article VIII, Sections 2, 3, and 4.