Azerbaijan: MLT political risk rating upgraded from 5/7 to 4/7


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Stable political situation but risks arising from generation overhaul and unresolved dispute with Armenia

Nearly since Azerbaijan’s independence from Russia in 1991, the country’s political scene has been dominated by the Aliyev family. In 2003, President Ilham Aliyev succeeded his father who had ruled the country with an iron fist since 1993. Since his first election in 2003, Ilham Aliyev abolished the two-term presidential limit and was re-elected several times (in 2008, 2013 and 2018). His party and independents (close to the power) control a vast majority in parliament. A generational overhaul is underway and the post of Prime Minister was created in October 2019.

President Aliyev exercises strong control over the political, economic and social life. Recently, some signs of growing social unease have emerged amid deteriorating socioeconomic conditions. In this context, the parliamentary elections scheduled in February this year could be marked by a resurgence of the opposition. Full destabilisation is not the baseline scenario but soviet history has shown that reforms (cf. the generation overhaul) can raise public hopes and then cause a backlash.

The Nagorno-Karabakh dispute with Armenia dates back to 1991 when the region dominated by Armenians declared its independence from Azerbaijan. It was followed by an armed conflict between Armenia and Azerbaijan that ended by a UN ceasefire agreement in 1994. Since then, negotiations with Armenia on the status of the Armenia-supported breakaway republic of Nagorno-Karabakh have made very slow progress, with events such as the presidents of Armenia and Azerbaijan meeting in 2019 (which is already progress in itself). Even if it has diminished recently, the risk of an armed conflict with Armenia remains given Azerbaijan’s sharp increase in military capabilities over the past years and Russia’s military presence in Armenia. Relations with other neighbours (Turkey and Iran) are good. That being said, the recent escalation of tensions between the US and Iran could have a negative spillover impact on the Caucasus region.

High reliance on oil and gas…

Azerbaijan is highly reliant on oil and gas. Hence, the Azerbaijani economy was hit hard by the sharp drop in oil prices that started mid-2014. Real GDP growth contracted in 2016. It has partly recovered thanks to the development of hydrocarbon resources and a rebound in oil prices as of 2017. This year, real GDP growth is expected to be slower than in 2019. 

The dynamics of the balance of payments is also heavily influenced by energy prices and production fluctuations. After having posted a deficit in 2015-2016, the current account reached a surplus as of 2017 even if current account receipts in 2018-2019 are still far below the level reached in 2011-2014. Looking ahead, the current account receipts are expected to remain broadly stable. Indeed, hydrocarbon production is expected to stabilise as the expanding production from the Shah Deniz 2 gas project and the Azeri Central East oil project compensate for the declining production in other oil fields. It should be noted that oil reserves are expected to be depleted in 20-25 years whereas the gas production horizon is large and equivalent to more than 100 years.

The oil and gas sector also has a large influence on the financial account. Indeed, following years of large FDI inflows (related to gas projects), FDI are expected to remain muted as no other major projects are foreseen and foreign investors are deterred by the poor investment climate in a country where the state dominates the economy. Since years, Azerbaijan’s financial account has been marked by large capital outflows that are driven by the strategy of the country to constitute a sovereign wealth fund – the State Oil Fund of Azerbaijan (SOFAZ) – which equalled nearly 90% of GDP in 2019. Thanks to this large sovereign wealth fund, Azerbaijan is a net external creditor. Looking ahead, the country is likely to remain an external creditor. Of course, energy price fluctuation has a large influence on the international investment position as shown by the 2014 experience when external debt surged and SOFAZ dropped by about 10%.

Liquidity is adequate but still below its pre-crisis level

The gross foreign exchange reserves dropped by almost 60% in 2015 (cf. graph 3) as the authorities tried to defend the fixed exchange rate in relation to the USD. It resulted in two sharp devaluations in 2015 and a lower level of liquidity. Since then, the gross foreign exchange reserves have slightly increased but they remain low compared to their historical level. Still they are adequate as they cover more than 3 months of imports. Should the oil prices drop sharply, gross foreign exchange reserves are likely to be under renewed pressure as the central bank continues de facto to maintain a fixed exchange rate even if the de jure exchange rate arrangement is classified as free-floating.

Public finances in better shape following double shock of oil prices and banking sector crisis

Public finances were also hit hard by the sharp drop in oil prices – as oil revenues accounted for a large share of public revenues – and by the banking sector crisis. Public debt including guarantees surged form 11.2% of GDP in 2014 to around 50% in 2019. The surge is largely explained by the 2015 devaluations and the surge in guarantees is related to banking sector restructuring, the construction of the Southern Gas corridor and other infrastructure projects as public debt excluding guarantees equalled about 20% in 2019. Since 2014, the authorities have approved a public financial management reform that includes the adoption of a fiscal rule in 2019 and a public-debt management strategy. The large number of State-Owned Enterprises (SOEs) (more than 5,000) could represent an additional fiscal burden. Indeed, past devaluations, sluggish growth and poor governance have weakened the financial position of most SOEs, which required larger budget support. Despite the authorities’ effort to monitor SOEs and strengthen financial accounting practices, more progress is needed to reduce the contingent liabilities arising from SOEs.  

Following the drop in oil prices, non-performing loans surged leading to a banking sector crisis. The authorities had to intervene to close some banks and recapitalise other banks. The International Bank of Azerbaijan (IBA) was one of the banks that had to restructure its debt, which led to losses among its creditors. IBA still does not have a viable business model. That being said, the situation in the banking sector has stabilised and de-dollarisation is ongoing. Nevertheless, the banking sector remains fragile. Weaknesses in banks’ balance sheets persist as some banks remain undercapitalised with high NPL and related-party lending. Hence, some banks might still be closed and others might still be recapitalised.


The sharp drop in oil prices hit the Azerbaijani economy hard. Real GDP growth was in negative territory in 2016, the current account balance turned into a deficit, external debt increased sharply and the banking sector was seriously hit. Moreover, gross foreign exchange reserves plunged as the central bank tried to avoid a(n) (unavoidable) devaluation. That being said, despite the somehow long-lasting impact of the lower oil prices on the Azerbaijani economy, Credendo decided to upgrade the country’s MLT political risk to category 4/7 (from 5/7). Indeed, although public finances and the financial situation are worse than in 2014, they have been improving since the oil price shock of 2015. Last but not least, Azerbaijan is a net external creditor.

Analyst: Pascaline della Faille -


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