On September 6, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Azerbaijan.

The economy is continuing to recover from a banking crisis and recession. Real GDP growth reached 1.4 percent in 2018 and 2.4 percent in the first half of 2019, supported by increases in natural gas production and activity in the services sector. Higher oil prices have helped improve internal and external balances. Lower food prices and a stable exchange rate have kept inflation subdued, below the midpoint of the target band (4±2 percent). With inflation expectations well anchored and the fiscal position strengthening, the Central Bank of Azerbaijan has started to ease monetary policy. The business environment has been improving as bank lending and manat deposits have picked up.

Looking ahead, economic growth is expected to reach 2.7 percent in 2019 on strong hydrocarbon production and robust domestic demand, benefitting from new spending measures. In the medium term, economic growth is projected to settle at 2½ percent, as hydrocarbon expansion stabilizes at about 1¼ percent, and nonoil growth gradually rises above 3 percent. Inflation should remain under control, given low projected food price inflation and continued fiscal consolidation envisaged under a new fiscal rule. With oil prices expected to hover around $60 per barrel, the current account surplus is forecasted to remain sizeable. Public debt is set to decline relative to the size of the economy. Challenges remain, however, including fragilities in bank balance sheets, structural rigidities, governance weaknesses, and lack of transparency. Risks to the outlook are tilted to the downside, but Azerbaijan has room to respond to adverse shocks, given its strong net foreign asset position.

<strong>Executive Board Assessment</strong>

Executive Directors agreed with the thrust of the staff appraisal. With the economy recovering from a banking crisis and a prolonged downturn, they commended the authorities for their policy response to the recent economic challenges. Going forward, Directors encouraged the authorities to continue their efforts to diversify the economy, raise its potential, and improve its resilience to shocks. They also emphasized the importance of economic inclusiveness and sharing the exhaustible hydrocarbon wealth with future generations.

Directors saw continued fiscal adjustment as necessary for ensuring long term debt sustainability and intergenerational equity. To mitigate the impact on economic growth, they recommended that fiscal consolidation proceed at a gradual pace and rely primarily on mobilizing nonoil revenues, improving the efficiency of public spending, reforming SOEs, and better-targeting transfers and subsidies.

While welcoming the introduction of a fiscal rule, Directors recognized that recent spending packages make compliance with the fiscal rule challenging. In this context, they underscored the importance of complementing the fiscal rule with stronger public financial management, greater fiscal transparency, and better management of fiscal risks.

Given still tight financial conditions and economic slack, Directors broadly encouraged the authorities to continue normalizing monetary policy with a carefully calibrated and data driven approach based on incoming evidence about the impact of recent fiscal measures. They agreed that greater exchange rate flexibility would improve competitiveness, foster diversification, facilitate adjustment to shocks, and enhance risk management. Directors also encouraged the authorities to step up preparations for modernizing monetary and exchange rate policy operations and transitioning to an inflation-targeting regime.

Directors agreed that strengthening financial supervision and fostering competition in the banking sector is crucial for ensuring its health and enabling it to play an effective role in intermediating resources for economic growth. While recognizing that the recent program for nonperforming loan resolution is set to improve bank balance sheets, they expressed concern that the program risks worsening moral hazard and repayment culture. Directors encouraged the authorities to conduct an independent asset quality review, phase out regulatory forbearance, and improve transparency.

Directors emphasized the importance of pressing ahead with structural reforms to foster diversified, private sector led and inclusive economic growth. In this context, they welcomed the progress in improving the business environment and encouraged the authorities to make further efforts to reduce the economic footprint of the state and open the economy to greater international trade and investment. Directors also emphasized the importance of addressing governance weaknesses, including by strengthening the AML/CFT and anti-corruption frameworks. In addition, Directors stressed that better data and transparency would improve decision making, promote private sector participation, and reduce vulnerabilities to corruption.
<table class="financial" border="0" cellspacing="0" cellpadding="0">
<tbody>
<tr>
<td colspan="7" valign="top" nowrap="nowrap" width="100%">
<p align="center"><strong>Azerbaijan: Selected Economic Indicators</strong></p>
</td>
</tr>
<tr>
<td colspan="7" valign="top" nowrap="nowrap" width="100%"></td>
</tr>
<tr>
<td valign="top" nowrap="nowrap" width="52%">Population (2018 est.): 9.9 million</td>
<td colspan="6" valign="top" nowrap="nowrap" width="47%">Literacy/Poverty rates: 100.0 (2017)/5.4 (2017)</td>
</tr>
<tr>
<td valign="top" nowrap="nowrap" width="52%">Quota (in SDR million): 391.7</td>
<td colspan="6" valign="top" nowrap="nowrap" width="47%">Per capita GDP (in US$, 2018): 4,742</td>
</tr>
<tr>
<td valign="top" nowrap="nowrap" width="52%">Main products and exports: Oil, gas, and fruits.</td>
<td colspan="6" valign="top" nowrap="nowrap" width="47%">Key export markets: Italy, Indonesia, Germany</td>
</tr>
<tr>
<td colspan="2" rowspan="2" valign="top" nowrap="nowrap" width="63%"></td>
<td colspan="3" valign="top" nowrap="nowrap" width="22%"></td>
<td colspan="2" valign="top" nowrap="nowrap" width="14%">Projections</td>
</tr>
<tr>
<td valign="top" nowrap="nowrap" width="7%">2016</td>
<td valign="top" nowrap="nowrap" width="7%">2017</td>
<td valign="top" nowrap="nowrap" width="7%">2018</td>
<td valign="top" nowrap="nowrap" width="7%">2019</td>
<td valign="top" nowrap="nowrap" width="6%">2020</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Output</strong></td>
<td valign="top" nowrap="nowrap" width="7%"></td>
<td valign="top" nowrap="nowrap" width="7%"></td>
<td valign="top" nowrap="nowrap" width="7%"></td>
<td valign="top" nowrap="nowrap" width="7%"></td>
<td valign="top" nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Real GDP growth (in percent)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-3.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-0.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">1.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">2.7</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">2.1</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Real non-oil GDP growth (in percent)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-4.9</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">2.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">1.8</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">2.8</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">2.7</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Real oil GDP growth (in percent)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-0.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-4.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">0.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">2.5</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">1.2</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Employment</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Unemployment rate (in percent)</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.0</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.0</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.0</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">5.0</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Prices</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Consumer price index (period average)</td>
<td nowrap="nowrap" width="7%">
<p align="center">12.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">12.8</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">2.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">3.2</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">3.3</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>General government finances</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Revenue (including grants, in percent of GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">34.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">34.2</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">38.8</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">39.1</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">37.8</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Expenditure (in percent of GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">35.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">35.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">33.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">34.7</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">34.4</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Current expenditure</td>
<td nowrap="nowrap" width="7%">
<p align="center">24.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">25.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">19.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">22.9</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">25.8</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Capital spending and net lending</td>
<td nowrap="nowrap" width="7%">
<p align="center">10.8</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">10.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">14.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">11.9</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">8.6</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Fiscal balance (in percent of GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-1.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-1.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">4.4</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">3.4</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Non-oil primary fiscal balance (in percent of non-oil GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-26.7</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-30.9</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-32.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-31.1</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">-30.0</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">General government gross debt (direct borrowing)</td>
<td nowrap="nowrap" width="7%">
<p align="center">20.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">22.5</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">18.8</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">19.7</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">18.6</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">General government gross debt including guarantees</td>
<td nowrap="nowrap" width="7%">
<p align="center">50.7</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">53.2</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">48.4</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">51.5</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">47.8</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Money and credit</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Broad money (including foreign currency deposits,

percentage change)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-1.9</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">9.0</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">11.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">7.2</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">6.0</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Bank credit to the private sector (percentage change)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-24.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-28.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">14.9</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">11.1</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">8.2</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Balance of payments</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Current account balance (in percent of GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-3.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">4.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">12.9</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">9.7</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">10.0</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Foreign direct investment (in percent of GDP)</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">0.7</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">-1.7</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.0</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">4.7</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">Gross international reserves (in months of non-oil imports)</td>
<td nowrap="nowrap" width="7%">
<p align="center">4.2</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.1</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">4.7</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.9</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">6.3</p>
</td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%"><strong>Exchange rate</strong></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="7%"></td>
<td nowrap="nowrap" width="6%"></td>
</tr>
<tr>
<td colspan="2" valign="top" nowrap="nowrap" width="63%">REER (average, percentage change)</td>
<td nowrap="nowrap" width="7%">
<p align="center">-27.0</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">3.3</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">5.6</p>
</td>
<td nowrap="nowrap" width="7%">
<p align="center">…</p>
</td>
<td nowrap="nowrap" width="6%">
<p align="center">…</p>
</td>
</tr>
<tr>
<td colspan="7" valign="top" nowrap="nowrap" width="100%">Sources: Azerbaijani authorities; and IMF staff estimates and projections.</td>
</tr>
</tbody>
</table>