An International Monetary Fund (IMF) staff mission, headed by Raja Almarzoqi, visited Baku during November 8-15, 2013 to discuss recent economic developments, government policies and future prospects for the Azerbaijani economy.¹The discussions also paved the ground for the next Article IV Consultation mission, tentatively scheduled for March 2014. The IMF team met with senior government officials and representatives of the private sector, civil society, and the diplomatic community. The following statement reflects the views of the IMF mission.

The near-term growth prospects are generally favorable, reflecting strong non-oil growth and a successful stabilization of oil output. With the mission projecting non-oil growth of 9.3 percent and 8.4 percent in 2013 and 2014, respectively, overall gross domestic product (GDP) growth should be about 5 percent in both years. Favorable oil sector developments will help maintain double-digit current account surpluses in percent of GDP and a solid external position. Headline inflation is projected to hover around 3 percent on the back of softer pressures from both food and non-food prices. Risks of a fall in oil prices emanate mainly from a potential deterioration in the global outlook and the performance of key emerging markets. The impact of the tapering of quantitative easing in the United Stated on Azerbaijan is limited, given the low reliance on external savings and capital inflows.

The draft 2014 budget signals a welcome start in fiscal consolidation. Preliminary information suggests that the non-oil consolidated fiscal deficit could shrink by about 5 percent of non-oil GDP next year relative to the estimated deficit of 50 percent in 2013, but would still remain above the estimated sustainable level of 35 percent. Both non-oil revenue-enhancing measures and restraint on non-priority investment spending will help support the consolidation efforts, which should continue in the medium term. The envisaged adjustment—while slightly weakening non-oil growth next year—will help reduce risks to macroeconomic stability, begin to address medium-term fiscal sustainability, and provide room for private sector activity. The mission encourages the authorities to safeguard the consolidation efforts by managing increasing fiscal risks from state activities outside the budget, primarily from SOCAR and the International Bank of Azerbaijan (IBA). The mission also supports ongoing efforts to improve the efficiency of public spending, particularly by undertaking the public expenditure and financial accountability assessment (PEFA) with development partners. Plans to place the finances of the pension system on a sustainable path are also well placed. The IMF stands ready to continue supporting the authorities’ efforts in these two areas.

The Central Bank should continue with efforts to address the strong consumer lending growth and strengthen banking supervision to reduce vulnerabilities in the banking system. Soft food prices and a large import component of public investment have helped keep consumer prices low, but this trend could suddenly reverse. Monetary policy tools are limited, and thus strengthening the interest rate transmission mechanism while allowing greater exchange flexibility will help better control inflation volatility over the long term. Accelerating the strengthening of asset classification and provisioning rules will be crucial to ensure the correct capital needs, ahead of the deadline for the new capital requirement in early 2014. These rules will also help to slow the rapid pace of credit growth. Macro-prudential measures are also needed to reduce the high loans to deposits ratio and discourage banks from taking on foreign-exchange exposure to un-hedged borrowers.

The capitalization plan of IBA in absence of a restructuring of the bank is a serious source of concern and creates risks to the system. An unreformed IBA undermines the development of the banking system and could result in high costs for the shareholders, including the government. The mission urges the government to take decisive steps to combine the capitalization of the bank with a plan to restructure its operations and governance in line with internationally accepted practices.

Further improvements in the business climate will be key in opening up new markets and developing a more diversified growth strategy. A competitive private sector will require speeding up the efforts to implement the new customs code, finalize World Trade Organization (WTO) accession, ease barriers to competition, and generally improve governance. The recently enacted inspection law is a welcome step in this direction and builds upon the achievements of other initiatives, including e-Government and “one-stop” windows, to reduce the costs of doing business. As the law currently applies to all inspections, the mission supports the authorities’ plans to amend this law to exclude the the supervision of the banking and insurance sectors from the law’s purview.

The mission thanks the authorities for their hospitality and the constructive discussions.