TIME FOR PRUDENT CONSOLIDATION

The International Monetary Fund (IMF) has concluded its annual consultations with Azerbaijan in accordance with Article IV of the IMF's Statute, issuing a concluding statement following the visit of its mission to Baku.

According to IMF estimates, Azerbaijan's economy is projected to grow by 3.5% in 2025, which is still above the European average. However, starting from 2026, growth is expected to slow down and fall to 2.5%. It is estimated that the average annual growth rate for the 2025-2029 period will be 2.66%.

This is due to a number of factors, but primarily to the stagnation of the hydrocarbon sector. Given the importance of the fuel and energy sector to both export revenues and the national budget, any limited growth in this area has a detrimental effect on the wider economy. Secondly, the implementation of large-scale infrastructure and social projects financed from the state budget and the State Oil Fund of Azerbaijan (SOFAZ) provided a short-term boost to the economy in 2023-2024. However, as these projects reach their conclusion and new comparable initiatives are not yet available, the economic effect is diminishing. Thirdly, the non-oil export sector remains dependent on a limited number of product categories and markets, and its growth rate does not adequately compensate for losses from a potential decline in oil and gas revenues.

Financial Cushion

The IMF has observed that Azerbaijan has substantial foreign exchange reserves. The combined assets of SOFAZ and the Central Bank total $73 billion, which is equivalent to over 40 months of imports. In the coming years, it is anticipated that the volume will remain stable at around $71-72 billion. This creates a robust macro-financial cushion, enhancing confidence in the currency policy.

However, the IMF highlights the importance of a careful management of oil and gas revenues. In the long term, it is vital that strategic reserves not only cover short-term budget needs, but also serve as a foundation for the transition to a new economy, with a focus on the private sector and innovative production.

The budget is now dependent on SOFAZ transfers, with their share of state budget revenues set to rise to 37.75% in 2025 (up from 34.4% in 2024). The IMF has highlighted the need to diversify and expand private investment in order to reinforce this.

In this regard, the Fund recommends that Azerbaijan start a gradual fiscal consolidation from 2025. This process entails a systematic decrease in the non-oil primary deficit (NOPD), with a target reduction of 1.5-2 percentage points of non-oil GDP on an annual basis over the next decade.

According to IMF estimates, the target level of the NOPD should be 6-6.5 per cent of non-oil GDP. This will ensure a more equitable allocation of resources, help contain the growth of expenditures in the context of a possible decline in oil and gas revenues, preserve fiscal sustainability and help avoid overheating of the economy and loss of competitiveness of the non-oil sector.

The Fund issues a warning that the postponement or deviation from fiscal adjustment could potentially compromise confidence in the fiscal rule and hinder the preservation of assets for future generations. In light of the impending changes to the budget legislation, the government is advised to define more clearly the conditions for possible deviations from the fiscal rule, implement an automatic adjustment mechanism, and strengthen the assessment and management of fiscal risks.

The fiscal rule, a mechanism that limits excessive budget expenditures and is designed to reduce dependence on oil price fluctuations, was introduced in Azerbaijan in 2018. Many international experts consider it to be a highly effective tool for resource-rich countries. Abandoning it would result in an increase in transfers from SOFAZ to the state budget, which would in turn increase vulnerability to external shocks. The application of the "golden rule", i.e. the exclusive use of these transfers for investment purposes, will mitigate the impact of oil and gas price fluctuations, strengthen confidence in the national currency and ensure the sustainability of economic growth.

According to IMF forecasts, a 20-25 per cent drop in oil and gas prices from current levels could significantly reduce fiscal revenues. This is an undesirable trend in the context of growing state obligations, including in the social sphere and for the restoration of liberated territories. It has been calculated that a decrease in oil prices of $10 would result in a reduction of oil and gas revenues by approximately ₼1.1-1.3 billion per year. Similarly, a decrease in gas prices by $50 would lead to losses of up to ₼400-500 million per year.

According to the fund's estimates, the cost of natural gas in 2025 is projected to be $517.4 per 1,000 cubic metres. It is anticipated that the figure will decline steadily to 424.7 in 2026, 342.2 in 2027, and $290.2 in 2028 and 2029.

Transition Time

In order to achieve sustainable fiscal consolidation, the IMF suggests that Azerbaijan implement a wide range of measures, including broadening the tax base. The annual budget deficit resulting from tax exemptions is more than ₼2 billion, which is equivalent to approximately 1.5% of GDP. In order to enhance the efficiency of revenue collection, it is essential to strengthen tax discipline and to assess tax administration using the TADAT methodology. This will identify weak links in the system and improve the efficiency of tax control.

The Fund's recommendations include the rationalisation of the subsidy system and a gradual reduction in public investment, with a focus on enhancing efficiency. In order to minimise fiscal risks and stimulate economic growth, the government is encouraged to continue to create a favourable environment for attracting private investment.

Among the main reforms, the IMF highlights the reduction of state involvement in the economy and increasing the efficiency of state-owned enterprises. In this regard, the establishment of the Azerbaijan Investment Holding Company (AIH) in 2020 and the Azerbaijan Transport and Communications Holding Company in 2024 is noted. The Foundation's experts also favourably regarded the measures taken over the years by AIH. These include the establishment of supervisory boards, independent audits and the enhancement of financial reporting quality, as well as the refinement of corporate governance within state-owned enterprises.

It should be noted that Azerbaijan has pursued an expansionary fiscal policy in recent years, in which the growth of budget expenditures was ensured through investment programmes. These measures have contributed to the maintenance of employment levels, the development of infrastructure, and the revitalisation of regions. Consequently, labour remains relatively inexpensive in these regions, creating opportunities for the establishment of labour-intensive clusters. However, achieving sustainable growth requires strategic choices that prioritise productivity improvements. In order to achieve this, it is necessary to establish a high-quality institutional environment, to gain access to sources of finance, to ensure proper segmentation and specialisation of businesses, and to provide priority training to highly skilled human capital.

In this context, foreign investors play a key role in economic diversification. Their contribution lies not only in the investment of fixed capital, but also in the introduction of new technologies, the transfer of expertise and the creation of networking opportunities needed to tap new industries and develop competitive value chains. Expanding sources of finance will eventually lead to diversification of exports (not only through goods, but also by expanding the range of services), which in turn will reduce dependence on oil and gas prices, ensuring a stable inflow of foreign currency.

Improving Access to Finance

The IMF also considers it necessary to improve the private sector's access to finance. According to the fund's economists, despite the stability of the banking system, financial and stock markets remain underdeveloped, which limits the growth of business and private investment. In this regard, the fund recommends improving corporate governance in the private sector, enhancing the quality of accounting and auditing, and modernising the legal framework. The Financial Sector Development Strategy 2024-2026, according to the IMF, is properly oriented towards removing these barriers.

The Fund considers the financial stability of the banking sector of Azerbaijan to be high, while emphasising the persistence of certain risks. According to the results of the Financial Sector Assessment, the stress tests confirmed the banks' adequate level of capitalisation in both baseline and adverse scenarios. However, it should be noted that some banks with limited capital buffers may not meet the minimum regulatory requirements under stress conditions.

Furthermore, the significant proportion of large corporate deposits, which are contingent on the fluctuations of the oil and gas sector, introduces liquidity risks. The high level of dollarisation is also a risk factor, and the accelerated growth of unsecured consumer lending may intensify pro-cyclical risks.

The authorities' efforts to strengthen regulation and supervision are commended. The IMF mission has observed that the Central Bank of Azerbaijan (CBA) has made significant progress in developing new regulatory norms, macroprudential policies, and corporate governance and risk management standards. Specifically, the CBA has implemented an additional countercyclical capital buffer of 0.5 percent of banks' regulatory capital, effective from 1 March 2025. This measure aims to mitigate the impact of rapid credit growth and the credit-to-GDP gap. Provisioning requirements for banks with high deposit concentration have also been strengthened.

The IMF has identified the strengthening of systemically important banks as a priority area for enhancing the banking sector's resilience.

Should inflation stabilise as predicted, the fund advises the CBA to maintain the current monetary policy, while remaining ready to respond promptly to changes based on leading indicators. Therefore, analysts are confident that the inflation rate will remain within the CBA target range (4 ± 2 per cent) in 2025-2026.

In view of the aforementioned points, it is important to note that since 2006, cooperation between Azerbaijan and the IMF has been based on regular consultations under Article IV of the IMF's Articles of Agreement and technical support in the area of macroeconomic policy. Due to stable revenues from energy exports, Azerbaijan has no need for IMF financial resources and has no credit obligations to the Fund. In this regard, the Fund's recommendations are advisory in nature, providing valuable expertise and guidance for further sustainable economic development of the country.