Recent macroeconomic
performance
Azerbaijan is one of the fastest growing economies in
the world. The GDP annual surplus in 2003 was above 11%. The
growth for the year 2004 is 10.2%. A record growth of circa 17%
is expected in the year 2005. As per some forecasts (ADB 2005)
growth in 2007 may be as much as 26%! It is highly probable that
the country will be the global leader in economic growth in the
coming next 2-3 years. GDP per capita is growing respectively
although from a very low base. In 2004 it was USD 1042 per
capita. Nominal wages grew by 26%. Almost all other major
economic indicators point out a similar growth pattern.
The GDP growth forecast for the years to come
look even brighter (see the chart). As illustrated the Gross
Domestic Product is expected to nearly double in the next four
years. It is noteworthy that Azerbaijan managed to sustain
economic stability even during the period of fluctuation of oil
prices in late 90-s of the XX century and general economic
downfall of early 2000-s.
Bright FDI statistics
Plus to the general economic growth with circa 5,000 million USD
actually invested by foreign companies in the economy in 2005,
Azerbaijan is now living through an investment boom. The boom,
however, is largely conditioned by the ongoing development of
the oil & gas industry which accounts for approximately 90% of
inward investments registered. Most of the flow goes into 3
major projects: Azeri-Chirag-Guneshli oil field, Shahdeniz gas
field and Baku-Tbilisi-Ceyhan pipeline. The development phase
for these projects is due to end by 2008 and consequently the
investment flows is expected to decline sharply unless new major
oil field discoveries occur or investments in other sectors of
economy are approved. Interestingly, in all of the above oil &
gas projects the lead violin is being played by the British
Petroleum as the major stakeholder and investor, which
apparently is another risk of depending on one single large
investor.
Mixed FDI attractiveness picture
The Government has not managed so far to secure any
substantial inflows of investments in other segments of economy,
though a number of state sponsored initiatives aimed at
improving attractiveness of the economy as the location to do
business outside the oil & gas were announced or are underway.
One can name such government endorsed mechanisms as Regional
Development State Programme and Poverty Reduction State
Programme. The both have undoubtedly shaped up the agenda and
the workload of the various Government Bodies during the last 2
years. A number of achievements have been reported, including
openings of new enterprises, infrastructure improvements, new
schools and hospitals in the regions outside Baku etc.
The country has undergone a major legal reform in
early 2000-s. A number of vital legal acts were adopted in order
to stimulate easier business conduct. Interestingly, however,
that practically no specific measures targeting foreign
investors as such have been taken lately. The legal regime for
foreign businesses considering starting up in Azerbaijan has not
been changing in essence for approximately a decade. The new
draft Law on Investments which is now going through the
Parliament approval stage does not contain any basic reform
agenda and is merely a better legal technics compared with 1992
and 1994 laws. The Government continues to adhere to formal
“non-discrimination” principle in respect of foreign capital.
The practical trends, however, show that there are some
indications that the Government lately is falling under
increasing pressure from the developing local business community
as regards to more protectionist policy for foreigners who wish
to do business in the country. The Government is formally
continuing the liberalization policy (e.g. the average weighted
customs import tariff went down by 1% in 2004 to 5.8%) while a
number of practical difficulties are being created by various
pressure groups to outcast local and international competitors.
The situation described above does not stimulate a
better general business environment as it artificially boosts
the “informal” side of regulation while making the “formal”
regulatory framework less efficient. The phenomena that come
together with “informality” such as corruption, red tape and
arbitrariness of officials do not make the picture brighter.
As one might have gathered from the above Azerbaijan
at the moment has two parallel stories to tell in respect of
attraction of FDI. On one part Azerbaijan is the number one
performer in the region of Central and Eastern Europe in respect
of FDI attracted per GDP unit as well as one of the top
performers as per this indicator globally. The country by now
has an Oil & Gas business which is regarded as one of the best
models internationally. Despite all the existing problems it is
still the most liberal market among those of the Caspian region.
The country is also perceived as a rapid grower with the wealth
growth practically secured for the next 2 decades.
On the other hand Azerbaijan is not on the
international investment maps of the largest TNCs outside oil
business as it is regarded as the location outside traditional
markets. There is also a perception of Azerbaijan as a generally
“difficult” or “unknown” place for trade and investment. As the
country is relatively small, it also does not attract extra
attention compared with neighboring Russia, Ukraine or even
Kazakhstan.
In short, Azerbaijan is a mixed picture when it comes to FDI.
There are apparent strengths as well as actual and perceived
weaknesses. The future flows of investments in the country is
very likely to depend largely on whether the Government will
implement an efficient strategy to capitalize on the
abovementioned strengths and compensate for some of the
weaknesses.
Variables for future FDI in Azerbaijan
The complexity of the issue might be better
apprehended if we would try to identify the most possible
scenarios as well as the factors and decisions that are most
likely to happen and if so, to make the strongest impact on the
FDI attractiveness of the country (or in other words “Variables”
for future FDI flows in Azerbaijan)
The following factors are, in our opinion, the most
important Variables for the inflows of FDI in Azerbaijan in the
next 3 to 5 years:
New oil & gas discoveries
So far the Azerbaijani Government signed 23 oil
contracts with a number of oil corporations from dozen of
leading economies. To the moment only few of the contracts
reached full scale development phase. There were few
disappointments when SIPCO (Italian led consortia) and JAOC
(Japan led consortia) have stopped operations due to
unsuccessful exploration and drilling attempts. However, it can
not be ruled out that new discoveries of oil or gas in
Azerbaijan as well as opening up of the neighboring Caspian
countries for foreign investors may give another boost to the
sector in the years to come. In any case, Azerbaijani oil & gas
industry is likely to remain the strongest part of the economy
and the largest attraction for foreign companies due to its
openness and modernity.
Liberalization of
business climate
The previous 5 years were the period of steady
liberalization of the business climate in Azerbaijani albeit
from a very low base as the governmental policies of mid 90-s
were to some extent oppressive in respect of private sector
development. So, the positive trend is certainly existing,
however, one may argue that the pace of reform and
liberalization is too slow. In general, the government of the
last decade has been pretty conservative in respect of
introducing any major steps in order to ease environment for
both foreign and domestic investors, apart from few cases
(reform of licensing system, introduction of “revision”
registrars, abolishment of a large number of revisions of
businesses etc.).
Another potential conflict is arising from the recent
trend when the local companies, in particular, large holdings
and state owned enterprises openly and discreetly lobbying
against new arrivals to the economy. A clear agenda by the
Government where it states which sectors will be genuinely open
for FDI as well as a clever protectionist policy for local
producers and financial groups will be a useful instrument to
resolve this potential conflict of interests.
Introduction of FDI
incentives, free zones or industrial platforms
There are no sector or territory specific incentives
for doing business in Azerbaijan for local business. Neither
there are any FDI oriented incentives. Few years ago the
Government came very close to introducing tax incentives for the
regions outside Baku in order to stimulate regional development
there. However, the initiative was seriously opposed by the
international financial institutions such as IMF and was later
put away. UNDP office in Baku and the Government of Azerbaijan
have been also long discussing establishment of a Free Economic
Zone in Sumgayit, an industrial town of 200 thousand population
north of Baku with strong traditions in chemicals and
metallurgy. The idea was buried alive as well at the time.
The most recent developments in this area include
announcement of establishment of an Industrial Town (industrial
platform of 300 ha, 25 km north of Baku), which is at the moment
at the stage of going through approvals in the Government as
well as the recently revived discussion on the establishment of
the first Free Economic Zone in Azerbaijan, and probably in the
Caspian Region.
Introduction of incentive schemes might boost few
sectors of the economy as well as potentially the re-export and
regional trade (in particular, in the case with Free Economic
Zones).
The ongoing negotiations with the WTO on accession of
Azerbaijan is another factor that might affect its international
competitiveness.
Change to the perception of the country as a
difficult place to do business outside oil & gas
Azerbaijan traditionally ranks very low in the
international rankings devoted to such topics as corruption,
economic freedom, governance. E.g. TI ranks Azerbaijan 140 (6th
place from the bottom), Heritage puts Azerbaijan in a raw with
“predominantly unfree economies” (rank 103 in 2005). This may be
attributed to both reflections on the reality in Azerbaijan and
somewhat distorted perception of Azerbaijan in the international
media as a country that went through a military conflict,
located in a complex part of the world and that never really
made any targeted efforts to remedy such perception. Obviously,
the Government may potentially launch an international campaign
aimed at improvement of the international perception of the
country. The clever design of the campaign, the correct
positioning of the country might become a factor behind the
future success in getting FDI or else.
Development of
Azerbaijan’s strategy and policies towards FDI
As mentioned above the strategy of the Azerbaijani
Government in respect of FDI went through a certain evolution.
The first and so far the most decisive step was taken in mid
1995 with opening of the oil & gas industry for foreign
companies. Since then the Government has undergone some
evolution to realizing the need to diversify the investment
stock and to attract businesses in the non mining projects.
However, to the moment, not much has been done to provide for
really competitive environment for FDI.
The Government is preaching the so called “equal
playing field” approach, according to which no sector or
territory should receive special treatment or enjoy exemptions
from the general legal regime. This concept, however, has a very
serious weakpoint in Azerbaijan specifically, as a number of
businesses to the moment have managed to break the principle by
securing near monopolistic positions in many segments of the
local market, or enjoying more liberal administrative regime
through the so called “informal” instruments. The resolution of
this mere problem in the local business climate requires a
number of decisive and maybe even unorthodox steps.
It is likely that the Government will be forced to
take a number of decisions in the area of policy making as well
as reform continuation if it is genuinely interested in removing
the obstacles for investments.
In our opinion a sound strategy towards FDI would
include the following necessary elements:
- prioritization of sectors in which the Government is
welcoming the investors in particular, though the “umbrella”
principle remains in place that all sectors remain open
-
introduction of incentive schemes with emphasize on such
criteria as sector, export element, jobs creation etc.
- further liberalization of the general business climate or
creation of “red tape free” zones such as special economic zones
or industrial platforms
-
support to targeted country promotion campaign
This approach has been to some extent reflected in
the INOTIS 2003 study prepared by the World Bank team in form of
the sector prioritization proposal. The sectors that have been
picked up by WB experts and that they believe to be potentially
competitive internationally are Fruit and Vegetable processing,
Oil & Gas related industries, Trade and Transport, Telecom and
IT.
It is also vital for the Government to design an
efficient public investment programme which will boost the
business development including FDI projects. The current
strategy of the Government aimed at construction of high class
transport infrastructure is seen as the major tool. One can only
reiterate the importance of establishment of the international
legal infrastructure for businesses including system of
international agreements on such issues as double taxation,
investments protection, free trade zones as well as introduction
of international certification and quality standards in
Azerbaijan, harmonization of FDI approval procedures and better
Government services to investors.
WTO accession process speed up, more efficient
utilization of existing bilateral trade and investment treaties,
improvement of customs policies and practices, upgrade of the
critical infrastructure, need for bonded warehouses and free
zones, reform of investment law, business start up procedure
streamlining, simplified land titling and access to land for
projects, improve application of IP laws, strengthen
competition, access to financing, public private partnerships,
market info dissolution, development of industry clusters;
exchange of data etc. are other supplemental factors that would
help Azerbaijan to overcome a number of apparent weaknesses such
as, small market, mixed image and lack of positive record in
non-oil FDI.
Conclusion
The development of the Azerbaijani economy during the
last decade and the set of policy instruments that has been used
by the Government so far is to some extent determining the
future of this line of business in Azerbaijan. It is safe to say
that unless major oil & gas discoveries take place in Azerbaijan
in the near time the structure of FDI inflow will change
dramatically. Should even the most efficient non oil FDI policy
be implemented in Azerbaijan it is unlikely that the country
will be able to secure so much capital in the economy. However,
the stock may be diversified in future, and include other
segments of business. We might point out few sectors which are
likely to be the next targets for investors in Azerbaijan. They
include telecom and logistics, construction, food processing and
maybe some segments of tourism.
A non proactive Government stance will end in the
minimal or no FDI inflow after the oil projects expansion phase
is over and should be avoided by all means.
1) Current
environment for investments in the Republic of Azerbaijan
Inventory of “Investment Climate” related initiatives.
Azerbaijan Investment Promotion & Advisory Foundation (AIPAF) /
Mayer & Foch Baku
2) Doing business in Azerbaijan 2004. The World Bank Group
survey;
3) Overview of the investment legislation of Azerbaijan.
InterJurService 2004;
4) World Bank’s Integrated Non Oil Trade and Investment Study (INOTIS).
Draft;
5) FIAS FDI Diagnostic Study for Azerbaijan 2002;
6) Ten obstacles to Enterprise Development. EU Support to MED
project. Donald Wills. 2004;
7) Legal framework for foreign investments in Azerbaijan.
Omniconsultants. Baku 2003;
8) Statistical yearbook of Azerbaijan 2004. SSCA
9) Doing business in Azerbaijan. March 2004. Baker & McKenzie
10) State Programme on Poverty Reduction & Economic Development.
Annual report 2003
11) WTO accession group. Additional Questions and replies. 2004
12) Doing business in Azerbaijan 2005. AIPAF
(pp. 42-48)