INVESTMENT DIVERSIFICATION

The new economic realities of the existing energy crisis have made certain adjustments to the development of the non-oil sector of Azerbaijan. Today, foreign investors provide a significant portion of funds for the capitalization of national economy. Yet a significant portion of the investments is canalized to the production projects and other segments of the real economy. The new trends led Switzerland, Russia and Turkey to become leaders in terms of investment activity: by the results of the past year, the volume of investments from these countries increased by 20 plus times.

The start of large-scale reforms aimed at the development of the non-oil sector in Azerbaijan dates back to 2004, when the State Program of Socio-Economic Development of the Regions, which contributed to the improvement of farms, agrarian processing enterprises, development of small industries, logistics, service companies, etc. started. Since 2009, projects for the development of diversified technology parks, business incubators and industrial quarters have started, which served as a basis for the establishment of large and medium-sized industrial enterprises, as well as for the development of high-tech industries.

All these efforts have radically changed the structure of the national economy: if some ten years ago the share of the non-oil sector in the country's GDP was about 40%, today this indicator reaches 70%.

Direct budgetary inflows, funds of state organizations and foundations provided in 2004-2014 reached two thirds of the total volume of financing for energy, transport, communal, agrarian, communication and other infrastructures, as well as the implementation of a number of industrial projects. In particular, during the pre-crisis year of 2013, a record volume of aggregate investments was recorded (over $28 billion), and more than two-thirds of this amount was the share of budget and state entities.

However, the low prices for energy resources established in recent years have markedly limited the investment opportunities of the state budget, and therefore the government's policy is aimed at attracting domestic private and especially foreign investments, which should save the economy from dependence on raw materials and increase non-oil exports. The latter is extremely important, as due to the narrowness of the domestic market, the policy of import substitution implemented in recent years has objective limitations, and in the long term, the export of industrial non-primary products can become the main driver for production expansion.

In fact, the roadmap for the national economy development until 2020, as well as the special economic zone created in the settlement of Alat, which was actually adopted a year ago, are fully focused on attracting investment capital to export-oriented industries. For the same purposes, the government has carried out a series of legislative and administrative reforms in recent years, and the business climate has been optimized.

A new stage in the development of the non-oil sector, shifting its priorities in the export direction, led to significant changes in the structure of investment. Among the most important changes in the last three years has been a reduction in the financing of infrastructure projects, as well as the construction of social and residential facilities, which accounts for almost 40% of all investments, mostly state-owned. This trend implies the government's desire to optimize budget expenditures - a number of non-priority investment projects, as well as projects with a long payback period (road construction, reconstruction of communal infrastructure, etc.) have been stopped.

On the contrary, the investments in the industrial sector and partly in the service sector have increased. Thus, according to the State Statistics Committee of Azerbaijan, during the first half of 2017 about ₼5.611 billion of capital investment (78.6% of the total volume of investments, ₼7.138 billion) was directed to production facilities. The construction of facilities in the sphere of services is ranked the second in the structure of investments: over ₼1.142 billion (16% of all investments) were invested in January-June 2017. At the same time, the sphere of housing construction could attract only ₼385.5 million (5.4% of investments).

The proportion of domestic and foreign investment has undergone significant changes: a few years ago, public and private domestic investment accounted for almost three quarters of all investments. Today, we can see a fundamentally different situation. According to the results of the first half of 2017, the volume of foreign investments in fixed assets exceeded ₼4.283 billion (60% of all investments), while the share of total domestic investments is 40%, or ₼2.855 billion.

It is noteworthy that the prevailing ratio of external and internal investments is associated not only with the reduction of financial potential of the state budget. Thanks to the optimized regulations, establishment of positive business climate, introduction of fiscal preferences regime for investors and encouraging mechanisms for the exporters, it was possible to increase significantly the volume of national external capitalization. Moreover, the structure of investments has changed, both sectorally and geographically. Until recently, almost four-fifths of all foreign investments were directed to the extractive industry, as well as to the development of oil and gas infrastructure (transportation, storage, etc.). The dominant role here was played by the UK (through the participation of BP in the projects for the extraction of mineral resources, the UK accounted for about half of all external investments), the Netherlands, Norway and a number of other countries involved in the extraction industry.

Nevertheless, the statistics of 2016 shows a certain shift in priorities among foreign investors: the vector of foreign capitalization has shifted in the direction of the non-oil sector. In general, according to the State Statistics Committee of Azerbaijan, foreign investments in the non-oil sector of Azerbaijan increased by 98.3% in 2016, exceeding $1.706 billion. At the same time, some countries increased investment rates by more than 20 times. In particular, companies from Switzerland invested $370.5 million (an annual growth of 23.6 times) in the non-oil sector of Azerbaijan, and Russian investments in the non-oil sector of Azerbaijan in 2016 increased by 22.8 times - up to $363.2 million. In terms of investment growth, Turkey ranks the third ($307.5 million with growth of 39.5%). The United Kingdom ($174.4 million) and the Netherlands ($127.9 million) shared the fourth and fifth place in investments in non-extractive industries.

In this context, the activity of Swiss business that has intensified in recent years is very interesting. The necessary legal framework between Azerbaijan and Switzerland has already been created long time ago: more than 20 bilateral agreements have been signed, including mutual encouragement and protection of investments, trade and economic cooperation, and elimination of double taxation. Nevertheless, over a relatively long period of time (1995-2013), Swiss investments in the non-oil sector of the Azerbaijani economy amounted to only $185.3 million. Over 80 companies with Swiss capital were created in Azerbaijan over this period: they are represented in the spheres of services, industry, trade, construction, communications, transport, finance, etc. A breakthrough in relations with Switzerland in the investment sphere dates back to 2014 after the establishment of a joint venture in Ganja for the production of wagons with the famous Swiss company Stadler Rail Group. The implementation of this capital-intensive project has become a catalyst for increased investment in our non-oil industry, and judging by the recent interest of a number of Swiss companies in investing in agriculture and tourism, this growth will continue also in the future.

Even more promising is the noticeably increased activity of Russian business. Azerbaijan occupies the fifth place in Russia's foreign trade with the CIS countries, and in the pre-crisis year of 2014, the bilateral trade reached a record $4 billion. "The investment cooperation between the two countries is progressing quite stably: more than 600 joint companies with Russia work fruitfully," said the Russian Foreign Ministry Sergei Lavrov.

According to Shahin Mustafayev, the Minister of Economy of Azerbaijan, Russian business as a whole invested $3 billion in the national economy. $2.8 billion of this volume of investments is in the oil sector of the economy. At the same time, the profits of Russian companies from investments in the oil sector have already reached $2 billion.

The past year has become a breakthrough in the investment activities between Baku and Moscow: joint and foreign investments of Russian companies from Russia to Azerbaijan increased from $15.9 million in 2015 to a record $363.2 million. To expand industrial investments, the Russian-Azerbaijani Business Council (RABC) was established in last May, which included, in particular, 30 Russian companies representing the oil and gas sector, the food industry, information and communication technologies, banking and insurance segments. According to Chairman of RABC Petr Fradkov, fifteen joint projects have been developed in automotive and railway transport industries, agrarian sector, metallurgy, etc.

One of the first initiatives of the Council was the project to create a joint venture between the Russian company R-Farm and pharmaceutical company Hayat Pharm in Pirallahi district of Baku. The project, implemented since last year, will be invested $74 million. It is noteworthy that the Pirallakhinsky Industrial Park has become a sort of hub, attracting investments in pharmaceutical production from a number of other countries. In January 2017, the establishment of the Azerbaijani-Iranian joint venture Caspian Pharmed also took place in here, where $20.6 million will be invested at the first stage. Another investor, Diamed Co. will invest $4 million and will soon start building a plant for the production of disposable syringes, which will be commissioned in the first half of 2018. Apparently, the potential for growth is huge, as currently the Ministry of Economy is negotiating with companies from Turkey, UAE, Japan and South Korea to organize joint production of pharmaceutical products.

Azerbaijan is also actively developing relations with Turkey - traditionally the largest investor in the non-oil sector of Azerbaijan. Today, there are about three thousand Turkish companies in the country, which employ about 150 thousand of our nationals. More than three quarters of Turkish investments are in the non-oil sector of the economy. Basically, this includes agriculture and food industry, tourism, hotel business and services, telecommunications, production of construction materials and household appliances, sewing and furniture production. Turkish business is also active in the financial and credit sectors. In particular, five banks with the Turkish capital were established in Azerbaijan. In recent years, the largest Turkish industrial holdings (for example, MKEK, Roketsan, etc.) cooperate in the development of the defense industry of Azerbaijan. According to the Ministry of Economy of Azerbaijan, Turkish investments in Azerbaijan are estimated at about $10.1 billion, including $2.6 billion invested in the non-oil sector.

"Information and communication, financial and insurance sectors, public catering sector, soft drinks and tobacco products, as well as the industrial and construction sectors are of the greatest interest to Turkish investors in Azerbaijan," said the Turkish Deputy Prime Minister Nurettin Canikli recently. According to him, the new stage of the reforms initiated in Azerbaijan to encourage investments and development of export-oriented production attracts the Turkish business to expansion of investments in our country. This interest is mutual, believes the Chairman of the State Customs Committee of Azerbaijan Aydin Aliyev. "The existence of a free trade agreement between Baku and the CIS countries opens up wide opportunities for Turkish business to localize production in Azerbaijan and subsequent export of products that will be exempted from customs duties when it is delivered to CIS countries," said Mr. Aliyev.

Given the increased activity of the Turkish business in 2016 (the businessmen from the neighboring country invested $307.5 million (39.5% growth) in the non-oil sector of Azerbaijan), it can be expected that Turkey maintains a stable leading position of the leading investor in Azerbaijan's non-oil sector in the near future.