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Unsatisfactory level of development of the non-oil sector of Azerbaijan despite numerous state programs of support and encouragement of business indicates the need for a targeted approach to the problems of SMEs and large industrial companies. Despite the obvious positive changes in the development of many industries, the conclusion of major investment agreements to form export-oriented industrial capacities, as well as the level of capital investment in this sector is still far from the desired goal. Therefore, the government will take further measures to solve the problem.

According to the State Statistics Committee, in January-September 2019, the growth rate in the non-oil industry is nine times faster than the general dynamics of the industrial sector (1.5%, including the raw materials segment) and five times faster than the country's GDP growth rate, which increased by 3% over this period. This suggests that the capitalisation of the industrial sector gives quite tangible returns. Whereas in 2015 the share of industry in the GDP of Azerbaijan reached 32.9%, in the first half of 2019 this indicator increased to 46%.

Low investment level

No matter how optimistic the numbers look like, the volume of investments in the non-oil sector has decreased in the last few years, although investments in the production segment dominate in the structure of overall investments. In January-July 2019, almost ₼7.4 billion was invested in the national economy (64.3% in production sector). The latter is extremely important, because in contrast to investments in infrastructure, capital construction, services and trade, the growth of industrial capitalisation has a great multiplier effect and gives a significant return in terms of GDP and the creation of new jobs.

The government is now focused on solving the problems with the low level of investment, including the recently announced set of comprehensive measures in fiscal and customs sectors to promote investors. The government's expectations are quite positive: the nominal volume of investments in fixed assets in 2020 is projected at ₼18.3 billion. More than half of this amount (₼10.6 billion) will be directed to the non-oil sector, with two-thirds of domestic investments (the private sector will provide about 60% of the capital), and one-third from external sources. In other words, there will be funds available for the development of the industry but again, largely thanks to internal and state investments, which means that the efforts to attract foreign investors to the industrial sector of Azerbaijan are insufficient.

Recently, President Ilham Aliyev highlighted the predominance of state funds in investment projects and the relatively low level of foreign investment in the non-oil sector. "Half of the investments made this year are foreign investments. But they are investing in oil and gas operations, and not in the non-oil sector. Our main task is to link economic growth directly with the development of the non-oil sector," Mr. Aliyev emphasised.

New benefits

In the past few years, the most serious challenge to the development of the non-oil industry will be the extremely passive investment policy of the country's banking sector. In recent years, bank lending to the real economy has significantly decreased: the ratio of loans to non-oil GDP decreased from 51% in 2014 to 27.8% at the end of August 2019.

To correct this imbalance, the government can take measures in the near future to help the increase the share of foreign and local private capital invested in non-oil production. One of such measures should be the adoption of amendments to the Tax Code, which assumes that tax and customs benefits for residents of industrial quarters and technology parks will be increased from 7 to 10 years from the date of registration. This means a ten-year exemption for income tax, land, property, customs duties when importing machinery, plants and technological equipment.

Investment Promotion Certificate (IPC) issued to entrepreneurs since 2016 also helps to increase the interest in the development of non-oil production. It exempts entrepreneurs from paying land tax, which provides a 50 percent discount on income tax and income tax, and also completely exempts from VAT and customs duties when importing machinery, processing equipment and installations. During nine months of 2019, the Ministry of Economy issued 75 IPCs to projects worth ₼807.6 million. In general, over the past few years, IPCs have been issued to 346 business entities, and the total investment in 407 investment projects is estimated at ₼3.9 billion. It is planned to expand this practice to next year and beyond encouraging investors to increase the capitalisation of non-oil production.

Export orientation

One more important feature of the industrialisation policy of the past few years has been the readiness of almost all industrial enterprises (built or planned) to export their produce. The latter is extremely important, since the comparative narrowness of the domestic market deprives investment projects of quick payback, hence reducing interest in their implementation. In general, as the experience of Japan, South Korea, China, and a number of Southeast Asian states shows, the emphasis on the development of export-oriented industry makes it possible to implement industrialisation programs relatively quickly and efficiently. The same approach is true for the government of Azerbaijan.

A good example is the large companies launched in early 2019 including SOCAR Carbamide and SOCAR Polymer, with a lion's share of the production capacity exported to foreign markets. Also, a Chinese company China National Electric Engineering is preparing to invest $450-500 million in the construction of a tire plant at the Sumgayit Technology Park to establish supplies to the post-Soviet region. It is planned to expand the supply of rolled metal products at the new steel mill agreed between Baku Steel Company LLC of Azerbaijan and CAMC Engineering of China. Diamed Co. syringe plant launched in May 2019 plans to make deliveries to Russia, Georgia, Iran and the Central Asian countries. Water-heating systems manufactured by the Azerbaijani-Chinese joint venture Elektrogaz launched in September will be supplied to these countries and to Ukraine.

The above examples are only a part of the industrial enterprises put into operation and under construction in the current year. In the near future, the number of industrial enterprises with export potential will increase even more, taking into account projects implemented in technology parks and industrial districts of Azerbaijan. In recent years, these clusters have served as analogues of classic industrial free economic zones. Due to fiscal and tariff preferences, preferential rental terms and a number of other advantages, the volume of local and partly foreign capital gradually increases contributing to the establishment of a new industrial cluster in the country.

Currently, five industrial parks operate in Azerbaijan, i.e. in Sumgayit, Garadagh, Mingachevir, Pirallahy and Balakhany. In general, $3.4 billion have been invested in them since 2009, which made it possible to create over 9 thousand permanent jobs. In is assumed that residents will invest another $395.9 million in industrial parks and open an additional 1,500 new jobs. Over the nine months of 2019, industrial parks produced goods worth ₼564 million, while slightly less than half (₼233 million) of these products were exported. This clearly confirms the availability of wide export opportunities, which should serve as yet another factor attracting investors to Azerbaijan.

Industrial clusters have been also established in Neftchala and Masalli. The ones in Hajigabul and Sabirabad will be launched before the end of the year. The total investment in industrial quarters is estimated at $31.6 million. It is planned that the residents will invest another $53 million bringing the total number of jobs to 3,400.

In a word, the government is ready to make additional preferences to attract investment in Azerbaijan's industry. At the same time, we must admit that developing a project in the industrial sphere with export potential and effective returns in the future requires a lot of time. Therefore, one should not expect too quick results here. Nevertheless, it is necessary to carefully consider the requests of potential investors to eliminate existing gaps in the legislation, bureaucratic obstacles, and the introduction of more specific tax benefits. All these measures will make the non-oil industry of Azerbaijan be more attractive for investors ensuring stable growth.