Information about Middle East Oriente Medio
Journal Issue


International Monetary Fund
Published Date:
December 1995
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Information about Middle East Oriente Medio
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I. Overview

Since the late 1980s, the Azerbaijan economy experienced severe external shocks resulting in an economic decline which has been among the most severe in the transition economies. First, the military conflict over the Nagorno-Karabakh region, which started in 1988 and ended with a ceasefire in May 1994, resulted in a loss of 20 percent of national territory and a large number of refugees in the country. Second, associated with the breakup of the U.S.S.R., serious disruptions in trade and financial links with Russia and other CIS countries aggravated economic problems since Azerbaijan was more dependent than many others on these markets. Third, Azerbaijan suffered from a deterioration of its terms of trade in 1994 and 1995; first as Turkmenistan moved to world market prices in its natural gas exports to Azerbaijan; and then as its transportation costs rose sharply with the disruptions of trade routes through Georgia and Chechnya. As a result, the cumulative decline in Azerbaijan’s real GDP amounted to 61 percent in 1990-94, about one third steeper than in other CIS countries on average.

In response to fundamental changes in the economic environment, the Government began to gradually implement systemic reforms. In 1992, approximately 70-80 percent of producer and consumer prices were liberalized, and enterprises were allowed greater latitude in their price and wage setting. However, price controls were applied on energy and bread prices, price markups remained controlled, and the price liberalization process was constrained by state procurement of major production items. While the coverage of the state order system was gradually reduced, it still accounted for most of the production of “strategic goods” at end-1994. Export quotas and licensing requirements remained in effect and domestic trade was largely subject to direct and indirect intervention by branch ministries and government agencies, in particular in agriculture and the energy sector.

Reforms were initiated in the financial sector by adopting a two-tier banking system in 1992. However, an annual credit plan, subject to approval by Parliament, continued to govern credit allocation. In addition, the central bank did not have control over foreign exchange reserves, which were largely allocated through the foreign exchange budget to governmental needs, including security and defense. Differentiated foreign exchange surrender requirements at below market rates resulted in multiple currency practices. Only in January 1994, did the manat, Azerbaijan’s national currency, become the sole legal tender providing a degree of autonomy for the monetary authorities. In the enterprise sector, privatization plans were drafted, but not implemented, and by end-1994, only the taxi fleet and a small part of the government owned housing stock had been privatized.

In an economic environment of systemic changes and external shocks, the financial policies pursued were largely inconsistent with achieving economic stability (Chart 1). The general government fiscal position deteriorated sharply as the revenue base shrank with declining output and an increasing shift to informal economic activities. Meanwhile, expenditures remained high. The general government fiscal balance, which was in surplus in 1992, turned into a deficit of more than 10 percent of GDP in 1993 and 1994. The absence of successful fiscal consolidation combined with accommodating central bank financing of the budget deficit led to excessive monetary expansion and high inflation, which undermined the value of the manat. In late 1994, inflation rose to more than 50 percent per month. The result was a rapid dollarization of the economy.

Chart 1AZERBAIJAN Selected Economic Indicators

Sources: State Committee of Statistics; Ministry of Finance; Azerbaijan National Bank; and IMF staff estimates.

1/ Estimate.

2/ Dollarization is the ratio of foreign currency deposits to broad money.

In the beginning of 1995, amid severe economic imbalances and rapidly falling living standards, economic policies were radically revised. Monetary stability was set as the primary goal of financial policies and the expansion of credit and money was brought under control. A precondition for this was fiscal consolidation, which was achieved by improving the efficiency of revenue collection, and, in particular, by a sharp compression of expenditures. As a result, central bank financing of the government budget deficit declined from 11 percent of GDP in 1994 to 1 1/2 percent of GDP in the first nine months of 1995. The growth of domestic broad money declined from a monthly average of 18 percent in the latter part of 1994 to 8 percent in January-September 1995 with average monthly inflation falling to 1 1/2 percent during the last six months through October 1995. The nominal exchange rate remained stable throughout 1995.

Monetary stabilization and a drastic reduction of central bank financing of the budget was greatly helped by the availability of substantial external financing for the budget. In 1995, US$91 million of the signature bonus that Azerbaijan had received for concluding an oil contract with international oil companies, was allocated to the budget. Indeed, although sterilization of the monetary effects of these foreign exchange inflows was not complete, they have provided an important source for budget financing without undermining monetary stabilization.

On the external sector, Azerbaijan’s overall balance of payments has strengthened with the disbursements of the oil signature bonus and strong inflows of foreign direct investment associated with the operations of the international oil consortium. Gross official reserves of the central bank rose from less than US$2 million at end-1994 to US$115 million by end-September 1995, equivalent to 1.6 months of imports not related to the operations of the oil consortium.

Progress on structural reforms, however, has been slower than in macrostabilization. Nevertheless, important steps have been taken. Budget subsidies have been largely eliminated, and domestic oil prices have been raised to world market levels. The exchange and payments systems were liberalized through unification of the exchange rate and discontinuation of the system of differentiated surrender requirements at below market rates in March 1995. Both domestic and foreign trade regimes have been substantially liberalized with the abolition of the state order system, export and import quotas, as well as licensing requirements. However, while the functioning of the market has improved with these measures, privatization, enterprise restructuring, and banking reform have not yet taken hold.

II. Real Sector Developments in 1994-95 1/

1. Output

Based on rich reserves of oil and natural gas, Azerbaijan was one of the first petroleum-producing regions of the world. In addition, the country has a well developed agricultural base (with cotton as the main cash crop), a large industrial sector, and an extensive transportation network. The economic downturn during the past five years affected all these sectors, with the highest declines occurring in industry. After falling by over 20 percent in both 1992 and 1993, officially recorded real gross domestic product (GDP) fell by another 21 percent in 1994 (Chart 2). Preliminary data suggest that output continued to decline during the first half of 1995, although at a somewhat lower rate.

Chart 2AZERBAIJAN GDP, Inflation, and Wages

Sources: Azerbaijan State Committee of Statistics; and IMF staff estimates.

1/ Projection.

2/ Nominal wage deflated by monthly CPI.

In recent years, the decline of real GDP was most pronounced in state owned enterprises, notably industry and construction, which were disproportionately affected by the disruption of trade routes through Georgia and--in late 1994--Chechnya. In 1994, industry and construction recorded a real decline of about 23 and 53 percent, respectively (Table 1). Agricultural output has recently been falling slower than that of industry, mainly because of two successful cotton harvests in 1994 and 1995. There are indications that economic activity has been increasingly shifting to the emerging informal sector, particularly retail trade and services which, however, remain largely unrecorded.

Table 1.Azerbaijan: Gross Domestic Product by Sector of Origin


(In millions of rubles) 1/(In millions of manat)
Gross domestic product14,85720,769229,285155,5312,078,2227,897,563
(In percent of gross domestic product)
Gross domestic product100100100100100100
(Percentage change in real terms)
Gross domestic product-11.7-0.7-22.6-23.1-21.1-16.3
Sources: Azerbaijan State Committee of Statistics; OECD; and IMF staff estimates.

GDP figures for 1990-92 are only available in rubles.

Sources: Azerbaijan State Committee of Statistics; OECD; and IMF staff estimates.

GDP figures for 1990-92 are only available in rubles.

Factor earnings of the business sector were buoyant in 1993 and 1994, reflecting a continued decline of real wages and high inflation. The terms-of-trade shock in 1994 and early 1995 (see Section V.2) and the decline of inflation in 1995 led to a marked fall of recorded business sector profits during 1995. Meanwhile, mixed household incomes increased, as private households were supplementing official wages and salaries with incomes from other sources such as in-kind pay, income from self-employment, and private farm income. Reportedly these incomes accounted for up to two thirds of total household incomes. Hence, in 1995 the real disposable income of households is estimated to have declined by about 10 percent compared with a fall of 20 percent in real wages.

On the expenditure side, the decline of GDP in the early 1990s was mainly driven by falling household consumption and a collapse of domestic investment activity (Table 2). In 1994, public consumption also started to contract, due to cuts in military expenditures after the ceasefire in the Nagorno-Karabakh conflict and, in early 1995, the pursuit of restrictive public expenditure policies. Retail turnover data suggest that real private consumption declined broadly in line with real GDP during 1994, but by less than real GDP in the first half of 1995, reflecting the above mentioned shift of real factor incomes from the business to the household sector. A lower rate of decline in private consumption may also be attributed to the sharp reduction of the inflation tax burden on households during 1995 (see Appendix I).

Table 2.Azerbaijan: Gross Domestic Product by Final Use


(In millions of rubles) 1/(In millions of manat)
Gross domestic product14,85720,769229,285155,5312,078,2227,897,563
Final consumption10,28718,754196,560150,4571,919,1537,926,500
Gross fixed capital formation2,9713,05810,79832,898432,4751,762,186
Change in inventories921-2,232-54,2481,32512,15088,663
Net exports6781,18976,175-29,148-285,556-1,879,787
(In percent of gross domestic product)
Gross domestic product100100100100100100
Final consumption6990869792100
Gross fixed capital formation20155212122
Change in inventories6-11-24111
Net exports5633-19-14-24
Percentage change of real GDP-11.7-0.7-22.6-23.1-21.1-16.3
Sources: Azerbaijan State Committee of Statistics; OECD; and IMF staff estimates.

GDP figures for 1990-92 are only available in rubles.

Sources: Azerbaijan State Committee of Statistics; OECD; and IMF staff estimates.

GDP figures for 1990-92 are only available in rubles.

As in many transition economies, the official data tend to overstate the decline in economic activity also in Azerbaijan. Poor coverage of official statistics, low response ratios to statistical questionnaires, and systematic underreporting by households and enterprises to avoid taxation are common. As can be seen in Chart 3, electricity production, often used as a proxy indicator for total output, has declined much less than officially recorded GDP. Indeed, while real GDP has fallen by about 60 percent since 1989, electricity production declined only by 25 percent.

Chart 3AZERBAIJAN Electricity Production and Real GDP (1989=100)

Sources: Azerbaijan State Committee of Statistics; and IMF staff estimates.

a. Agriculture

Agriculture continues to be organized in collective and state farms. Although these organizations have proved to be slow in adapting to the new economic environment, privatization and land reform lag far behind their initial schedules. The distinction between private and public property in agriculture is becoming increasingly blurred, however. Farm workers are using collective resources to produce and sell agricultural products on their own account. Such small-scale production appears to be widespread–57 percent of fruits and vegetables and 80 percent of domestic meat and milk supplies are reportedly produced in the private and quasi-private sectors.

At present, Azerbaijan’s main cash crops are cotton, fruits and vegetables, tobacco, and wine grapes. Wheat, meat and dairy products are mainly produced for domestic use. In these products, the country is traditionally less than self-sufficient; in particular, a large part of dairy products, wheat and flour are imported from Russia, Turkey, and the European Union (EU), the latter under the humanitarian grant and loan programs.

Output of virtually all agricultural commodities has been falling since 1990 (Table 3). Although Azerbaijan lost about 20 percent of its high quality grazing land in the conflict over the Nagorno-Karabakh region, agriculture remains a key sector in the economy, generating about 30 percent of GDP. In 1994, recorded agricultural output dropped by 13 percent in real terms, and preliminary information indicates a similar decline in 1995. The main reasons for the continued poor performance of the agricultural sector were (i) distortions in the relative price structure as producer prices of agricultural products remained low relative to other sectors in the economy; (ii) an underdeveloped rural credit market; and (iii) the dislocation of trade links with other CIS republics, which cut the country off from its traditional suppliers of fertilizer and equipment as well as from its traditional export markets.

Table 3.Azerbaijan: Agricultural Production by Major Crops


(In thousands of metric tons)
Grains (mostly wheat)1,4141,3461,3371,1481,038950
Other vegetables856805555488471420
Other fruits367498401346324300
(Percentage change)
Grains (mostly wheat)64.2-4.7-0.7-14.5-9.5-8.5
Other vegetables-6.4-6.0-31.1-12.4-3.5-10.8
Other fruits-23.535.7-19.5-13.5-6.4-7.4
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.

There are indications, however, that the decline of agricultural output may be coming to a halt as crop yields for several key products (grain, cotton, potatoes) started to pick up in 1994 (Table 4). Cotton did better than most other commodities, maintaining the same output level as in 1993. Partly this reflected the importance of cotton as a “strategic” commodity with trading organizations having well-established trade links in particular with the United Kingdom. Supply has also responded to recent, relatively rapid increases in state procurement prices (Table 5) and improvements of the irrigation system. Tea and wine grapes, on the other hand, reported further declines in 1994 after falling by more than 30 percent in 1993. These commodities, which are to a large extent produced in the enclave of Nakhichevan, were particularly hard hit by the military conflict and the related transportation difficulties. Similarly, livestock has suffered from the loss of pasture land in the aftermath of the war, and meat production declined cumulatively by 55 percent over 1990-94 (Table 6).

Table 4.Azerbaijan: Yields of Major Agricultural Commodities


(In hundred kilograms per hectare)
Grains (mostly wheat)
Other vegetables199.6195.0167.0158.0154.0155.0
Other fruits28.143.836.832.630.532.0
(Percentage changes)
Grains (mostly wheat)10.5-14.01.4-
Other vegetables-3.6-2.3-14.4-5.4-2.50.6
Other fruits-34.255.9-16.0-11.4-6.44.9
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Table 5.Azerbaijan: State Procurement Prices

(In manats per metric ton, annual average)



Agricultural crops
Potatoes1208216,796192,388- -
Vegetables605198,13369,990- -
Fruits1069568,89080,851- -
Tea leaves1771,43121,185157,545950,000
Watermelons421913,48923,430- -
Animal products
Eggs (1,000)241993,02148,687
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Table 6.Azerbaijan: Main Aggregates of Animal Husbandry

(Thousands of head)
Of which: cows716711734735712
(Thousands of tons unless otherwise indicated)
Animal husbandry products
Eggs (in millions)985958812584520
(Percentage changes)
Of which: cows-3.6-
Goats-1.5-5.63.3- --11.6
Horses-5.1-5.4- -- -- -
Animal husbandry products
Source: Azerbaijan State Committee of Statistics.
Source: Azerbaijan State Committee of Statistics.

b. Industry

The industrial sector in Azerbaijan has been characterized by a strong dichotomy between energy and nonenergy related activities, largely associated with a distorted price structure which has favored energy products. While the officially recorded output in all industrial branches has declined steeply in recent years, it appears that nonenergy related industries experienced steeper production declines than energy related industries. A comparison of Tables 7 and 8 suggest that the production of crude oil and oil products has declined much less than the production of metal, chemical, construction equipment, and consumer goods industries. 1/ The rupture of trade linkages with CIS countries hit the nonenergy related subsector particularly hard, as these industries depended heavily on raw materials and intermediate inputs imported from other CIS countries. Also, costs of these supplies have been rising steadily, as many trading partners adjusted their producer prices toward world market levels. Due to the lack of investment and know-how, Azeri suppliers have also lost ground in domestic markets as they have not been able to match the quality standards of imported goods. This has been particularly true for consumer durables (e.g., air conditioners and refrigerators), but also for industrial intermediates (e.g., pipes and construction glass). Moreover, the capital stock in these industries has become largely obsolete, not only because investment has dwindled to almost nothing, but possibly also because of asset stripping.

Table 7.Azerbaijan: Selected Industrial Production

(In thousands of metric tons, unless otherwise specified)







Electric energy
(billions Kw/year)23232019-5.318-5.317-5.6
Metal industry
Steel pipes493411260146-43.825-82.9278.0
Machinery and equipment
Oil extraction
equipment (’000)
Drilling equipment (’000)73735553-3.629-45.3303.4
Pumping equipment (’000)527462393161-59.035-78.335
Electric motors (’000)4,8603,7741,8371,355-26.2818-39.6450-45.0
(’000 kw amp.)1,9961,616651229-64.897-57.61003.1
Construction equipment
Reinforced concrete
(million m3)1,3121,190989594-39.9250-57.9
Bricks (million)1,3171,4471,062764-28.1498-34.8
Roof tiles (million)66787051-27.114-72.58-42.9
Chemical industry
Sulfuric acid603552269141-47.656-60.317-69.6
Caustic soda1601719249-46.740-18.433-17.5
Household goods
Crockery (’000)21261816-11.110-37.51-90.0
Metal goods (’000)1,948724355257-27.6135-47.5
Radios (’000)67- -303-90.01-66.7
Air conditioners (’000)309295268179-33.2119-33.550-58.0
Ventilators (’000)134934137-4.828-24.315-46.4
Bicycles (’000)130103435118.640-21.640
Children’s furniture (’000)372259
Timber (’000 m3)126874724-48.97-70.1
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Sources: Azerbaijan State Committee of Statistics; and Ministry of Economy.
Table 8.Azerbaijan: Crude Oil Production

(In thousands of metric tons)




1994 est.7,7781,7859,563-7.1
1995 proj.7,3401,7609,300-2.8
Sources: Azerbaijan State Committee of Statistics; State Oil Company; and the World Bank.
Sources: Azerbaijan State Committee of Statistics; State Oil Company; and the World Bank.

After falling by about 20 percent in 1993, recorded output in the nonenergy related sector plummeted by 50 percent in 1994, and in the first half of 1995 it was down by another 50 percent compared with the corresponding period in 1994. Meanwhile, inventory accumulation has increased, as many enterprises continued production by accumulating interenterprise arrears despite the lack of markets for their products. In general, enterprises have not adjusted their labor force to falling output, which has led to sharp declines in productivity. The deterioration of economic activity in the nonenergy related industrial sector was even more pronounced, if one abstracts from the food industry, which–being closely linked to agriculture–declined by only 7 percent in 1994.

The energy-related industrial sector, which mainly consists of power stations, refineries and petrochemical industry, has been performing better than most of the economy throughout the early 1990s. The output of refined oil dropped by only 7 percent in 1994 and 4 percent in the first half of 1995, despite the urgent need for modernization of Baku’s two refineries, Bakinsky and Novobakinsky. In part this was due to the increasing usage of fuel oil in power stations to replace natural gas previously imported from Turkmenistan but it also appears that gasoline consumption has picked up as private car ownership has increased.

In 1994, electricity production was 17.3 billion kwh, some 8 percent less than in 1993. During the first seven months of 1995 there was a further decline by 4 percent compared with the same period in the previous year. One reason why the decline of electricity production was not more in line with the drop of recorded real GDP was the fact that informal sector activities remained largely underreported in the official National Accounts. Also, high production losses in Azerbaijan’s energy plants may help explain this discrepancy. Moreover, customers have little incentive to save electricity with low user price since the State Electricity Company (Azernergo) supplies power even if consumers do not pay–indeed, collection rates of these fees have remained below 40 percent.

c. Petroleum sector

The petroleum sector in Azerbaijan is highly concentrated. Crude oil and gas production are under the responsibility of the State Oil Company of the Azerbaijan Republic (SOCAR). SOCAR also holds shares in the international oil consortium which was formed to exploit deep-water oil fields in the Caspian Sea. In addition, SOCAR oversees the operations of Azerbaijan’s oil refineries. Prices for crude oil, oil products, and natural gas are fully controlled by the Government.

Azerbaijan has a long history of producing oil and natural gas, and much of its economy (about 15 percent of GDP in 1994 1/) relies on this sector either directly or indirectly. With the exception of some hydro-energy, petroleum products are almost the only source of domestic energy. The relative abundance of cheap oil and gas has caused the industrial sector to become relatively energy-intensive, but also wasteful. During the Soviet era, Azerbaijan used to import crude oil from other republics (Russia, Kazakhstan) for processing and re-exportation, resulting in large refining facilities. As these imports have declined in recent years, the measured rate of capacity utilization in refineries has reportedly declined to around 30 percent.

Proven unexploited oil and natural gas resources are officially estimated at about 900 million metric tons, with substantial potentials below the Caspian Sea. Traditionally, oil and gas exploitation have been concentrated on onshore fields or shallow offshore areas. As productivity of these fields declined, oil exploration and production have moved increasingly to the deeper waters of the Caspian Sea (Chart 4).

Chart 4AZERBAIJAN Crude Oil Production 1980-95

(In thousands of metric tons)

Sources: Azerbaijan State Committee of Statistics; State Oil Company; and the World Bank.

(i) Crude oil

Crude oil production in Azerbaijan has declined from 11.7 million tons in 1991 to 9.6 million tons in 1994, reflecting the increasing depletion of the more mature fields (Table 8). However, in 1995 the output decline has slowed down. Many wells have been operating with technology from the 1940s; their productivity is low and environmental damage serious due to oil spills. Moreover, these facilities are characterized by overstaffing and poor management. Some of the remaining reserves in these fields could be recovered using state-of-the-art technology, but the focus of oil exploitation is clearly shifting offshore.

The “new” offshore fields have a substantial exploitation potential. Of the four deep sea fields only one, Guneshli, is currently operating and accounts for about 60 percent of domestic production. In the last two years the production infrastructure in Guneshli has been experiencing increasing difficulties, however, which partly explains the decline in crude oil output by 7 to 8 percent in 1993 and 1994.

(ii) Natural gas

Based on Azerbaijan’s extensive domestic reserves, natural gas was developed as the key fuel for domestic use. About 80 percent of all households and a large portion of industry are supplied through a vast gas distribution network which is controlled by the State Gas Company (Azerigas). As output from the large Bakhar gas condensate field began declining in the 1980s, Azerbaijan started importing gas, primarily from Turkmenistan. In 1994, some 2.5 billion cubic meters, about 30 percent of domestic consumption were supplied by Turkmenistan.

Since 1991, domestic production of natural gas has been declining at a rate of 10 percent a year. This has reflected the absence of incentives to recover gas, as producer prices were kept artificially low and imported gas was readily available. In 1993 and 1994 prices for gas imported from Turkmenistan increased sharply. Azerbaijan has been responding by curtailing domestic demand with the contraction of industrial usage and by replacing natural gas by domestically produced fuel oil as input for power stations.

In 1995, Azerbaijan’s domestic gas production is likely to increase temporarily. A new gas compressor station at the Guneshli field came into operation in late 1994 and aims at capturing 1.4 billion cubic meters of gas otherwise lost into the atmosphere. With completion of this compressor station, which was constructed and fully financed by the American oil company Pennzoil, gas production picked up slightly in the first half of 1995. Recovering gas output at Guneshli alone, however, is not sufficient to reverse the declining trend of gas production in coming years.

d. Services

Services may well be the most dynamic sector in the Azeri economy today although much of this activity is not captured in the official statistics. Services were hardly accounted for under the old concept of Net Material Product, and even in the national accounts following the SNA method coverage remains weak. 1/ An analysis of this sector is therefore extremely difficult, as one can only rely on scattered statistical information and anecdotal evidence.

Official data suggest that the value added in the service sector declined in 1994 in line with real GDP, leaving its share in GDP unchanged at about 40 percent. Recorded retail trade, transportation and public services fell by 20 to 25 percent in real terms. However, it seems that this decline was at least partly offset by increased services provided by the informal sector, especially in retail trade and catering. Preliminary data from household surveys suggest that the share of paid services in household expenditures increased from about 5 percent in 1993 to over 10 percent in 1994.

The upward trend in the value added of services appears to have continued in 1995, as inflation abated and consumer confidence strengthened. This is consistent with the observable increase of new private shops, cafeterias, restaurants, etc. in Baku. Even the official data, which mostly capture only the state-controlled sector, indicate a lower real decline of services than of real GDP. In the first half of 1995, retail trade turnover declined by 10 percent and cargo transport by 8 percent compared with the same period in 1994. Value added in the banking sector is apparently up, as both salaries and employment have risen rapidly.

2. Labor force and employment

Most of Azerbaijan’s labor force continues to be formally employed in their old jobs, which indicates that the transition from a rigid system of constitutional employment toward a market-determined process of matching labor demand and supply still lies ahead.

In 1994, Azerbaijan’s working age population (ages 16 through 59) remained almost constant at about 4 million of the total population of approximately 7.5 million (Table 9). The total labor force declined, however, due to the displacement of refugees from Nagorno-Karabakh and the emigration of many ethnic Russians, Armenians and Jews. Total employment was estimated at 2.6 million, only 4 percent less than in 1993. The strongest decline was recorded in agriculture, as employees from kolchozes and sovchozes in the Nagorno-Karabakh area lost their jobs. Industrial employment only dropped by 4 percent, despite the drastic decline of industrial output. Enterprises are not yet responding to falling output by shedding labor; instead, they retain employees without or with only nominal pay. Also, in many cases these individuals work on a part-time basis and/or have side-jobs in the informal sector. To a large extent, the adjustment of wage costs to declining output has taken place through falling real wages instead of employment reductions. This practice has also been in the employee’s interest, as they remain eligible for in-kind benefits such as housing and other social services, which they would lose if their contracts were formally terminated.

Table 9.Azerbaijan: Labor Market


(In thousands of persons)
Working age population3,9364,0133,9984,061
Outside labor force500500600622
Labor force3,4363,5133,3983,439
Total employment2,7432,7102,5872,543
Unemployment rate
(in percent)20.222.923.926.1
Registered unemployed7132226
Benefit recipients655
(Percentage change to previous year)
Working age population0.52.0-0.41.6
Outside labor force- -20.03.7
Labor force2.2-3.31.2
Total employment-1.7-1.2-4.5-1.7
Registered unemployed98.166.918.2
Benefit recipients-15.2
Sources: Azerbaijan State Committee of Statistics; Ministry of Labor; and IMF staff estimates.
Sources: Azerbaijan State Committee of Statistics; Ministry of Labor; and IMF staff estimates.

Correct accounting for unemployment is particularly difficult under these circumstances. The official number of registered jobseekers (22,000 persons or 0.6 percent of the labor force in 1994) underestimates the true extent of unemployment. Only few layoffs are registered in labor exchanges because of the social stigma associated with unemployment, tight and confusing eligibility rules, and low benefit levels. On the other hand, deriving the number of unemployed from the official data as the difference between labor force and employment (811,000 persons or 23.9 percent in 1994) may also be misleading, because many jobseekers are being accommodated by the emerging informal sector. Some of the authorities’ estimates put the number of truly unemployed in Azerbaijan at 400,000-450,000, or 12-14 percent of the labor force.

3. Prices and wages

a. Price developments and inflation dynamics

In 1992-93, prices in Azerbaijan rose rapidly with the price liberalization. However, by 1994 the inflation dynamics had changed its nature and price development showed many characteristics of hyperinflation. The consumer price index (CPI) increased by 1,664 percent, year-on-year. With the exception of a seasonal downturn in the summer, monthly inflation rates remained consistently high, with peaks in May (43 percent) and in November and December (over 52 and 55 percent, respectively, (Table 10 and Chart 2)). Another phenomenon, typical for a situation close to hyperinflation, was a rapid increase in the dollarization of the economy. Foreign currency holdings increased sharply during 1994 with a strong depreciation of the nominal exchange rate. The resulting price increases of imports immediately affected the CPI, because imported foodstuff and other goods have a high weight in the consumer basket.

Table 10.Azerbaijan: Consumer Price Index
Percentage Changes



Over Same

Month in

Previous Year


Source: Azerbaijan State Committee of Statistics.
Source: Azerbaijan State Committee of Statistics.

The high inflation in 1994 was primarily triggered by an excessive growth of monetary aggregates accommodating the Government’s need to finance its fiscal deficit. With a short time lag, the pattern of inflation mirrored the pattern of monetary expansion. Meanwhile, the rapid increase in the money velocity reflected rising inflation expectations and demonetization of the economy in an environment of high political and economic instability.

Inflation was exacerbated also by a deterioration of the terms of trade. Import prices rose as CIS suppliers moved toward world market prices and these prices spilled over to Azerbaijan’s domestic inflation. In addition, a sharp increase in transportation costs due to the closure of northern trade routes reduced the border price of exports and raised that of imports with adverse effects to the domestic price level.

In spring 1995, however, the Government’s stabilization program began to take hold. Monthly inflation declined to low single digits in line with the earlier reduction of broad money growth despite several increases in administered energy prices. The pressure on import prices was alleviated as the nominal exchange rate stabilized vis-à-vis the U.S. dollar and appreciated vis-à-vis the Russian ruble. Seasonal factors, such as lower food prices due to the new harvest, helped to subdue inflation further and resulted in virtual price stability during the summer (Table 11).

Table 11.Azerbaijan: Commodity Breakdown of the Consumer Price Index

(Monthly percentage changes)



Weight 1/
Source: Azerbaijan State Committee of Statistics.

Weights according to the 1993 household survey.

Source: Azerbaijan State Committee of Statistics.

Weights according to the 1993 household survey.

b. Wage developments

Recorded average wages in Azerbaijan have remained low by CIS standards as real wages have declined for several years. This trend continued in 1994, as nominal wage increases lagged behind inflation and real wages fell on average by almost 60 percent (see Chart 2). In dollar terms, monthly average wages dropped from about US$17 (1993 average) to US$8 in January 1995, before recovering to about US$14 in the summer of 1995.

A number of factors help explain this drastic decline in real wages. First, the tight cash flow position of many enterprises coupled with their full employment policies did not allow for significant wage increases. In fact, low average wages were “buying” low unemployment, as enterprises were dividing the available wage bill among a given number of employees, rather than releasing workers. Second, recorded wages only represent a fraction of actual pay, because many workers receive additional bonuses and in-kind payments, such as housing and social services. Third, the official employment survey probably underreports the average economy-wide wage, because it fails to adequately capture the earnings from full-time or part-time employment in the emerging informal sector.

The wage structure in Azerbaijan has remained rigid, as all wages (and social payments) in the public sector are still linked to the minimum wage by fixed coefficients. Besides directly affecting employees in budgetary institutions (which comprise about one quarter of the labor force), minimum wage increases also have strong signal function in the rest of the economy. The effect of the minimum wage hikes in June 1994 (to 2000 manats), October 1994 (to 4000 manats) and February 1995 (to 5500 manats) can be seen in Table 12, which compares nominal monthly wages in government agencies to those in the economy as a whole. On the sectoral level, however, substantial differences in average wages prevailed and even increased. The lowest salaries were paid in agriculture and social services, with average wages only slightly higher than the minimum wage (Table 13), i.e., some US$7 per month. At the other end of the spectrum were banks, insurance and the oil sector (SOCAR, Azernergo) 1/, where reported wages were 5-6 times higher than the economy-wide average.

Table 12.Azerbaijan: Average Monthly Wages
Total EconomyBudgetary Sector




in U.S.


Wage Index

(Dec. 1990=100) 1/



Wage Index

(Dec. 1990=100) 1/


June61,1028.913.866.239,729- -43.0
Sources: Azerbaijan State Committee of Statistics; and IMF staff estimates.

Average monthly wage deflated by monthly change of the consumer price index.

Sources: Azerbaijan State Committee of Statistics; and IMF staff estimates.

Average monthly wage deflated by monthly change of the consumer price index.

Table 13.Azerbaijan: Average Monthly Wages by Sector


(In manats)
National economy 1/19.531.8270.32,184.715,325.377,870
Hotel industry14.124.6162.71,640.111,206.144,967
Health and social services13.222.7240.61,294.09,982.626,679
State insurance27.161.4675.76,431.033,316.8168,920
State and government administration25.937.4345.23,478.110,134.261,357
(Annual percentage changes)
National economy8.963.1750.0708.3601.5408.1
Hotel industry11.974.5561.4908.1583.3301.3
Health and social services7.372.0959.9437.8671.5167.0
State insurance58.5126.61,000.5851.8418.7407.0
State and government administration42.344.4823.0907.6450.2505.4
Source: Azerbaijan State Committee of Statistics.

Annual data may differ from the average for the year calculated on the basis of monthly wage data.

Source: Azerbaijan State Committee of Statistics.

Annual data may differ from the average for the year calculated on the basis of monthly wage data.

III. Public Finances

1. Institutional setting

The central government budget, also referred to as the republican budget, is consolidated with the local government budgets to form the state budget (Table 14). Expenditures and revenues denominated in foreign currencies and managed through the Unified Foreign Exchange Fund (UFEF) were also included into the state budget, albeit only as single line items, until the UFEF was dissolved in March 1995. The consolidation of the extra-budgetary funds, most importantly the Social Protection Fund (Table 15) and the Employment Fund into the state budget yields a measure of general government operations (Table 16). Other smaller extra-budgetary funds, including the Road Fund, have not been reporting regularly to the Ministry of Finance.

Table 14.State Budget in 1992–1994.
1992199319941995 1/
Billions of manatsIn percent of GDPBillions of manatsIn percent of GDPBillions of manatsIn percent of GDPBillions of manatsIn percent of GDP
Individual income tax0.
Enterprise profits tax1.
Value-added tax2.
Excise taxes0.
Customs revenue0.
Strategic exports tax– –– –– –– –– –206.92.6
Forex revenue3.513.97.24.6251.612.1317.24.0
Expenditure (including net lending)9.638.372.646.2773.037.22209.728.0
Expenditure (excluding net lending)9.638.372.646.2749.136.11811.222.9
Wages, salaries86.04.1426.45.4
Purchases of goods and services4.618.538.024.2789.710.0
Reserve funds34.00.4
Settlement of refugees0.
Interest payments0.
Transfers for social protection0.
Foreign currency outlays251.112.1
Other current expendenditure1.76.817.010.8179.08.6136.51.7
Capital investment0.
Local budgets expend.149.87.2
Net lending398.55.0
Sources: Ministry of Finance and State Tax Inspectorate; and IMF staff projections.


Sources: Ministry of Finance and State Tax Inspectorate; and IMF staff projections.


Table 15.Social Protection Fund Operations in 1992–1995
1992199319941995 1/
In billions of manatsIn percent of GDPIn billions of manatsIn percent of GDPIn billions of manatsIn percent of GDPIn billions of manatsIn percent of GDP
Payroll tax2.59.815.05.896.15.7323.44.1
Transfers from the State Budget0.
Other income8.20.526.90.3
Price compensations62.43.7307.33.9
Other compensations and allowances1.
Source: Social Protection Fund; and IMF staff estimates


Source: Social Protection Fund; and IMF staff estimates


Table 16.Azerbaijan: Consolidated Operations of the General Government in 1992–1995
1992199319941995 1/
Billions of manatsPercent of GDPBillions of manatsPercent of GDPBillions of manatsPercent of GDPBillions of manatsPercent of GDP
Indivdual income tax0.
Profit tax1.
Value-added tax2.07.912.
Social security contributions2.59.715.09.579.63.8263.03.3
Excise taxes0.
Customs revenue0.
Strategic exports tax– –– –– –– –– –– –206.92.6
Forex revenue3.513.77.24.6251.612.1317.24.0
Employment Fund revenue1.
Expenditure (including net lending) 2/11.645.687.855.9860.841.42390.030.3
Expenditure (excluding net lending)11.645.687.855.9860.841.41991.525.2
Wages, salaries86.04.1339.14.3
Purchases of goods and services1.87.216.410.5120.05.8789.710.0
Reserve Fund34.00.4
Settlement of refugees0.
Interest payments0.
Current transfers to households2.911.426.016.5160.47.7569.37.2
Price compensations0.
Other allowances1.
Current transfers abroad1.50.0
Foreign currency outlays71.13.4– –– –
Other current expenditure4.115.933.221.2304.014.6135.01.7
Capital investment0.
Employment Fund expenditure1.
Financial Balance0.72.7–24.1–15.3–226.9–10.9–146.2–1.9
Net lending398.55.0
Fiscal balance0.72.7–24.1–15.3–226.9–10.9–544.7–6.9
Sources: Ministry of Finance and State Tax Inspectorate.


Expenditure breakdown in 1992–94 is not fully comparable to that in 1995 due to definitional changes.

Sources: Ministry of Finance and State Tax Inspectorate.


Expenditure breakdown in 1992–94 is not fully comparable to that in 1995 due to definitional changes.

Local governments operate autonomously in allocating their budgetary resources, which consist of local taxes and fees, transfers from the central government, all proceeds from the individual income tax, and parts of the revenue from the enterprise profits tax (41 percent in 1994) and the VAT (57 percent in 1994). Local governments can not resort to domestic bank financing and since 1992 the consolidated local government budget has been broadly balanced.

The Social Protection Fund (SPF) was established in 1992 by merging the Social Fund and the Pension Fund. Its operations are financed by employee and employer payroll contributions, and transfers from the state budget for the payment of benefits to compensate for increases in bread prices. In 1994, some 46 percent of its expenditures consisted of pensions; about 39 percent of price compensations; and 15 percent of other cash transfers.

The functions of the Employment Fund (EF) consist largely of assisting the unemployed in finding jobs, providing training, and paying unemployment benefits. Expenditures are funded by an employee payroll tax paid by all non-budgetary organizations. Noncompliance is pervasive, however, and revenues and expenditures amounted only to 0.1 percent of GDP in 1994 reflecting both the low registered unemployment and average unemployment benefits.

2. Structure of revenues and expenditures

In 1994, about 40 percent of government revenues were collected as part of the foreign currency budget. The major source of revenue was a system of surrender requirements at differentiated and highly appreciated exchange rates, which effectively expropriated a large share of export proceeds, particularly from cotton and petroleum producers. This system of surrender requirements was abolished in March 1995. To offset the loss of revenue, a temporary export tax of 70 percent of the difference between domestic and export prices was introduced on strategic goods (notably oil and cotton).

In recent years, the most important single source of tax revenues has been the enterprise profit tax, which yielded 15 percent of total government revenues in 1994. Tax rates are progressive and range from 25 to 35 percent of taxable profits. Special rates apply to a small number of sectors, such as banking and insurance for which the tax rate is 45 percent. Revenues from the individual income tax are low, reflecting weak tax administration. Also these tax rates are progressive and range from 12 to 55 percent of taxable income. Tax brackets are expressed in multiples of the minimum wage. Social security benefits and pensions are exempted from the income tax. The entire revenue from this tax is paid into the local government budget. Only 4 percent of total revenues were collected with the individual income tax in 1994.

In 1994, indirect taxes accounted for 16 percent of total government revenues. A value added tax of 20 percent is levied on the sales of goods and services by enterprises and organizations. However, most foodstuffs are exempted from the VAT and the rate of collection is low. Excise taxes are levied on specific goods, such as alcoholic beverages, cigarettes and petroleum products.

Social security contributions are collected by the SPF through a payroll tax levied on both employers and employees. The standard employer contribution is 35 percent of the wage bill (25 percent for collective, state and private farms), while employees contribute 1 percent of their wages. A payroll tax of 2 percent of the wage bill is levied on employers to finance the Employment Fund. Social security contributions yielded 13 percent of total government revenues in 1994.

In 1994, over one third of government spending was covered by the foreign exchange budget. Expenditures on wheat and flour imports, security and defence, refugees, and settlement of government obligations to abroad were typically funded through the foreign exchange budget. Another third of total outlays consisted of wages and social benefits. These expenditures have been rigidly linked to the minimum wage, which has effectively prevented restructuring the government wage structure and the social safety net. Explicit budgetary subsidies amounted to nearly 5 percent of GDP, of which the larger part consisted of bread subsidies. The implicit subsidy for bread was also substantial as the Government allocated foreign exchange to the state bread company at highly preferential exchange rates to finance the importation of wheat and flour. At the same time, the Government set the domestic procurement price of wheat at an artificially low level, imposing an implicit tax on domestic grain producers. Public investment expenditures have remained low in the 1990s, and as a result, the public infrastructure has deteriorated rapidly.

3. Fiscal policy in 1994

Since 1992, the general government fiscal position weakened continuously as the revenue base shrank with declining output and high inflation, increasing tax arrears, and inefficient tax collection. At the same time, expenditure levels remained high because of large defense outlays and increasing expenditures on the social safety net. The general government fiscal balance, which was in surplus in 1992, turned into a deficit of 15 percent of GDP in 1993.

In 1994, most revenue components continued to decline as a proportion of GDP. In particular, the collection of profit, value added, and payroll taxes lost ground as economic activities increasingly moved outside the tax network into informal sectors of the economy. Also excise tax receipts declined in real terms and revenue from customs duties remained low, reflecting lax implementation of collection procedures, and reportedly, also corruption. Meanwhile, revenues collected as part of the foreign currency budget rose from 4 1/2 percent of GDP in 1993 to 12 percent of GDP in 1994, largely due to an increased coverage of the implicit surrender taxation of strategic exports. Overall, however, budgetary revenues as a proportion of GDP declined from 41 percent in 1993 to 31 percent in 1994.

The expenditure to GDP ratio had increased by 10 percentage points to 56 percent of GDP in 1993, but it fell to 41 percent of GDP in 1994. To some extent, this reduction reflected the ceasefire of the Nagorno-Karabakh conflict as defense outlays declined. More important, however, was the Government’s attempt to improve fiscal discipline. The period of expenditure restraint lasted through the first half of 1994, resulting in a budget deficit of about 7 percent of GDP. This effort to contain expenditure growth was mainly implemented by withholding subsidy payments to the bread complex and freezing government wages and social benefits. The effort was derailed, however, as subsidies to the bread complex were increased in response to a depreciation of the manat which had raised the cost of flour imports substantially. Similarly, government wages were doubled in mid-June and again in mid-October to catch up with inflation. As a result, expenditures of the state budget alone rose from 24 percent of GDP in the first half of 1994 to 40 percent of GDP in the second half of the year. The general government’s fiscal deficit, 11 percent of GDP in 1994, was fully financed through central bank credit expansion.

4. Fiscal policy in 1995

In 1995, fiscal consolidation began to take hold. While the revenue to GDP ratio continued to decline, expenditures were compressed more. The expenditure to GDP ratio is estimated to decline to 30 percent of GDP in 1995 bringing the overall fiscal deficit down from 11 percent of GDP in 1994 to 7 percent of GDP in 1995. Meanwhile, domestic bank financing of the deficit is estimated to fall from 11 percent of GDP in 1994 to only 1.3 percent of GDP in 1995. The remainder of the deficit is mainly financed by the use of oil bonus funds, amounting to US$91 million.

Azerbaijan’s fiscal adjustment in 1995 has indeed been greatly supported by the availability of the oil signature bonus for budget financing. The agreement with an international oil consortium to develop oil deposits in the Caspian sea resulted in a first signature bonus to Azerbaijan, of which US$120 million was disbursed in 1993-95. Initially, in March 1995, US$70 million of this bonus was added to the foreign reserves of the ANB with the manat counterpart to be used for budget financing during 1995. In July, an additional US$10 million tranche of this initial oil bonus was allocated for budgetary purposes, followed by another US$11 million in October. In March 1995, SOCAR sold half of its stake in the international oil consortium to Exxon and Turkish National Oil Company and as a new signature bonus, Azerbaijan is to receive US$173 million, of which US$83 million has already disbursed; US$28 million is expected to be disbursed in 1996, and the balance during 1997-98.

The authorities took several revenue enhancing measures to improve the tax base during 1995. Administrative measures to strengthen tax collection included the reorganization of the management of the State Customs Committee and the enhanced enforcement of the collection of the VAT on imported goods. Similarly, efforts were increased to collect tax arrears from state-owned enterprises. An IMF resident expert was assigned to develop tax administration, including taxpayer registration and better control of large taxpayers. Several exemptions on value-added taxation were also eliminated, inter alia, on goods and services consumed by the Ministry of Defense and the Ministry of Interior. Exemptions on customs duties were eliminated and duties have been extended to nonlegal entities.

Nevertheless, budgetary revenues remained well below potential levels in the first half of 1995. The stock of tax arrears at the end of 1994 increased from 3 percent of annual revenue to 5 percent by mid-1995. The increase in arrears was pronounced in profit, value added, and excise taxation, and these tax ratios continued to fall relative to previous years’ levels. Receipts from customs duties remained depressed (at about 0.4 percent of GDP) despite the reorganization of the State Customs Committee. Foreign exchange revenue averaged at 8 percent of GDP in the first half of 1995, a large part of which represented the transfer of remaining balances of the Unified Foreign Exchange Fund (UFEF) to the budget at the time of its dissolution. The tax on strategic exports, designed to compensate for the elimination of the surrender requirements, became effective in late March 1995. However, with domestic prices rising rapidly toward world levels, the new tax on strategic exports has provided only a partial compensation for the elimination of the surrender tax revenue.

Expenditures were sharply restrained in the first half of 1995, reflecting the elimination of bread price subsidies, tight control over increases in wages and social benefits--the minimum wage has not been raised since February--and sharp cuts in defense and security expenditures. As a back-up device, “cash rationing” procedures were put into effect to ensure that discretionary expenditures are adjusted in line with shortfalls in revenues. 1/ Although expenditure compression led to the buildup of budgetary arrears, most of those, including arrears on wages and social benefits, were settled by the end of the second quarter of 1995.

As a result of these measures, the overall fiscal situation improved substantially in the first half of the year and the general government recorded a fiscal deficit of 2.8 percent of GDP. In the third quarter of 1995, however, the deficit rose to 16 percent of GDP, partly reflecting the loss of revenue from the surrender requirements. More importantly, however, expenditures increased temporarily with the payment of defaulted government guaranteed loans to the International Bank, amounting to US$25 million. Financing for this was available from oil bonus funds. The remaining US$9 million of the Government’s obligations to the International Bank is scheduled to be settled in the course of 1996.

5. Social safety net

Azerbaijan’s social safety net has remained broadly similar to that during the Soviet era. Expenditures in this area increased faster than GDP until 1993, but since then the efforts to consolidate the general government budget have led to a sharp decline of social transfers as a proportion of GDP. Azerbaijan’s social safety net consists of direct and indirect bread subsidies (eliminated in early 1995); subsidies on public transportation; cash compensation for bread price adjustments; pensions; unemployment benefits; child, sickness, and maternity allowances; and relief for refugees.

To cushion the impact of rising bread prices on the poor, the Government had introduced a system of targeted cash transfers in 1993. Three groups were targeted: nonworking pensioners, students, and children under 16 from low-income families. With the bread price liberalization in February 1995, the Government nearly doubled these cash transfers. Despite the initial targeting, the coverage of these cash compensations has widened, reaching about half of the population. In 1994, these cash compensations accounted for nearly 8 percent of total government expenditures.

The Social Protection Fund provides a wide range of benefits. Most of its outlays in 1994 consisted of pensions. These, as well as benefits for maternity and sick leave, are based on the recipient’s wage. The remainder of the outlays consisted of child and family allowances and other special allowances. Due to the structure of both the population and the pension system, the burden of supporting pensioners is heavy in Azerbaijan. Over 33 percent of the population is under age 15. This, combined with the population age 65 and older--the standard pension age in most industrial countries--results in a dependency ratio relative to the working-age population of over 60 percent, which is high by international standards. However, the pension system adds to the problem, as the statutory age of eligibility for old-age pensions is 60 for men and 55 for women. Applying this definition, the dependency ratio rises to nearly 80 percent. To some extent, however, this figure overestimates the support burden since many pensioners work regularly.

Expenditures on the social safety net have been rigidly tied to the minimum wage. As a result of a tight control over the minimum wage in 1995, expenditures of the Social Protection Fund are estimated to decline from 9.6 percent of GDP in 1994 to 7.2 percent of GDP in 1995. With a shift of factor incomes away from recorded wages and weak collection procedures, revenue from the payroll tax is expected to decline from 9.6 percent of GDP in 1994 to 3.3 percent of GDP in 1995.

The authorities have developed plans to implement measures to improve the cost efficiency of the social safety net. Laws have already been drafted to improve the targeting of cash compensations, including measures to combine child allowances with cash compensations for bread, and targeting those allowances only to families with two or more children. These plans also include the implementation of reform measures to reduce pensions for working pensioners, raise the eligibility age for old-age pensions, and restructure maternity and sick leave allowances. The savings derived from the latter measures are intended to be used to increase benefits to the truly needy.

IV. Money, Credit, and Exchange Rates

1. Current institutional setting

a. General

Azerbaijan has a two-tier banking system for which the legal framework was established in 1992 and which consists of the Azerbaijan National Bank (ANB) and nearly 200 commercial banks. Until recently the independence of the ANB remained limited, as its monetary policy had to be approved by Parliament. Moreover, the central bank law set out potentially conflicting objectives for the ANB as, apart from ensuring the stability of the national currency, the ANB was also to promote the interests of the state, which in practice boiled down to financing the Government and the state-owned enterprises.

A new central bank law was submitted to Parliament in September 1995. The draft law contains two key elements. First, it establishes that the overriding objective of the central bank is to achieve and maintain price stability. To this end, the ANB will have full independence to operate its monetary and exchange rate policies. Subordinate tasks are to foster the liquidity, solvency and proper functioning of a market based financial system, to promote the smooth operation of the payments system, and to license and supervise banks. Second, maximum central bank financing of the Government will be limited to a small percentage (5 percent) of the annual average of the Government’s ordinary revenue in the preceding three years.

Also, a new banking law was submitted to Parliament in September 1995. The law establishes the legal basis for the ANB to supervise the operations of commercial banks. It defines which institutions will be subject to ANB supervision, and limits the activities banks may engage in.

In the past few years, the number of banks has increased dramatically. As of August 1995, there were 188 registered commercial banks operating in Azerbaijan. Most of these banks, however, were very small, single-branch institutions, linked to one or a few enterprises. The bulk of deposit-taking and lending activities continued to be in the hands of four large specialized state-owned banks, whose traditional sectoral demarcation has been preserved. Together these banks accounted for more than 80 percent of total lending and deposit taking activities. Prominvest Bank and Agroprom Bank lend to state-owned enterprises in the industrial and agricultural sectors respectively, using funds from these sectors and the ANB. Amanatbank (formerly Sberbank), the savings bank, uses household deposits to lend mostly to other, smaller banks. It started lending to enterprises only in early 1995. International Bank continues to focus on foreign currency transactions, including domestic lending denominated in foreign currencies. Many banks--including Prominvest Bank and Agroprom Bank--redeposit their clients’ foreign currency deposits at the International Bank as they themselves lack access to the international payments network.

b. Correspondent accounts and payments system

From 1992 until late 1994, domestic transactions between banks were effected mostly through an interbank settlement system, known by its Russian acronym MFO. As opposed to the usual requirement to settle payments obligations through the transfer of banks’ deposits at the central bank, in this system banks could settle directly between themselves, through a network of mutual accounts. Most of the smaller commercial banks held correspondent accounts at Prominvest Bank or Agroprom Bank, while these two banks settled their mutual claims only once a year, in effect extending large credits to each other. The MFO system provided a channel through which credit could be extended automatically and outside the control of the ANB. In addition, Agroprom Bank and Prominvest Bank had virtually unrestricted access to central bank credit. At the end of 1994, the MFO system was replaced by a system of regular correspondent accounts and all automatic overdraft facilities were abolished.

As regards government payments, every government agency used to send its payments orders directly to the ANB, which would automatically debit the Government’s expenditure account, a practice that resulted in large overdrafts. As a result, central bank credit to the Government increased by more than 1,000 percent in 1993 and by nearly 900 percent in 1994. Toward the end of 1994, this practice was changed. The accounts of the Ministry of Finance were concentrated at the ANB, and reduced to two main accounts: a revenue account and an expenditure account, and only the Ministry of Finance could submit payment orders to the ANB. Moreover, payment orders were no longer executed when the difference between these accounts reached the credit limits agreed upon between the ANB and the Ministry of Finance within the context of the ANB’s monetary program. Thus, these accounts functioned as a normal correspondent account with a limited overdraft facility. Credit facilities at the ANB for all other government agencies were abolished. With these measures both banks and the Government were required to have sufficient balances to support payments. Moreover, it allowed the ANB to control and monitor banking system liquidity.

c. Credit auctions

Until the beginning of 1995, all refinance credit to banks other than overdrafts had been allocated directly by the ANB. In March, 1995, though, the ANB began the transition from direct to indirect instruments of monetary policy, by auctioning a portion of its refinance credits to banks. Since then, the ANB refinance rate is determined by the interest rate established in the auction. Auctions have been undertaken on a monthly basis.

The ANB’s approach to the credit auction has been different from the more usual procedure to auction a preannounced quantity of refinance credit by sealed bids. Instead, the ANB auctions its credits by open outcry in the Baku Interbank Currency Exchange (BICEX), the exchange used primarily for foreign exchange auctions. The supply of credit is adjusted dynamically as the auction proceeds, thereby allowing the ANB to retain some control over the interest rate outcome. While there is some room to adjust quantities from auction to auction in order to smooth interest rate movements, the scope is in fact quite limited as the overall amount will have to be consistent with the ANB’s credit policies. In the end, the ANB has to accept a degree of variability in interest rates.

The risk of adverse selection, that is, the possibility of a biased credit allocation due to the participation of financially weak banks in the bidding process, is countered by allowing only those banks which meet a set of prudential standards to participate in the auction. For this reason and to prevent undue domination of the credit auction, the two largest state-owned banks–Prominvest Bank and Agroprom Bank--are excluded from the auction. These banks are directly allocated a share of the total amount of refinance credit available, but are charged the refinance rate established in the auction. In the period March-September 1995 about 25 percent of total refinance credits were allocated through the auctions, while the remaining 75 percent was allocated directly to Prominvest Bank and Agroprom Bank.

d. International reserve management

Although formally the responsibility of the ANB, the management of Azerbaijan’s international reserves remained long in the hands of the Government, which managed several foreign exchange funds. In April 1994, all government foreign exchange funds were centralized in the Unified Foreign Exchange Fund (UFEF), which was managed by the Cabinet of Ministers. The UFEF included a stabilization fund which the ANB could use to support the manat, subject to presidential approval.

In March, 1995, the UFEF was abolished by presidential decree and the responsibility for managing the country’s foreign reserves was transferred to the ANB, where the official international reserve holdings were concentrated. Apart from a small Presidential Fund of less than US$1 million, the Government no longer has any foreign currency accounts. Government revenues in foreign currencies are sold in the BICEX, with the ANB acting as fiscal agent. Similarly, if the Government needs foreign exchange, for example to service its foreign debt, it purchases foreign currency from the ANB at the BICEX rate.

e. Reserve requirements

Until 1994, the four state-owned banks had not been subject to reserve requirements, which gave them an advantage over other commercial banks. Moreover, it contributed to the lack of control the ANB could exercise over the operations of these banks. The reserve requirement for other commercial banks had been unified at 12 percent for manat deposits and 5 percent for foreign currency deposits in July, 1993, with reserves continuing to be held in these banks’ correspondent accounts at Prominvest Bank and Agroprom Bank. As of January 1, 1994, though, the reserves had to be held at the ANB, and reserve requirements were extended to the state-owned banks. Compliance with reserve requirements, however, remained low. Without regular correspondent accounts, the ANB could not stop a bank’s operations if it did not comply with the regulations. As of October, 1994 the reserve requirement on foreign currency deposits was temporarily abolished.

In January, 1995, reserve requirements on foreign currency deposits were re-imposed and unified at a 12 percent requirement ratio. In April, the reserve requirement ratio for both manat and foreign currency deposits was raised to 15 percent. With the establishment of a system of regular correspondent accounts, the ANB was able to enforce compliance with reserve requirements, as well as through the imposition of substantial penalties. Because the ANB includes interbank deposits in the base for calculating reserve requirements, and most commercial banks redeposit their clients’ foreign currency deposits at the International Bank, banks increasingly complained about the high burden of the reserve requirement. In June, the reserve requirements were therefore reduced to 10 percent. This, however, loosened the stance of monetary policy and the decision was reversed in September. At the same time, though, the reserve requirement ratio for interbank deposits was lowered to 5 percent. Interbank deposits are subject to reserve requirements purely for prudential reasons.

Although banks have the option to choose whether they hold the required reserves on foreign currency deposits in foreign or in domestic currency, in practice virtually all banks hold them in foreign currency, because of the exchange rate risk. The reserve requirement is determined twice a month, and is calculated on the basis of daily average balances in the preceding 30 (or 31) day period. Reserve averaging is not permitted. Reserves are not remunerated, thus imposing a considerable tax on the banking system. Remuneration, though, would have seriously eroded the ANB’s profitability, as it earned little or no interest on a large part of its assets, i.e., credit to the government.

2. Monetary policy and developments

a. Monetary policy in 1994

Azerbaijan’s financial policies in 1994 were broadly similar to those in the preceding year, and were characterized by large fiscal deficits financed by central bank credit. In addition, strong pressures were put on the central bank to allocate directed credits to the state-owned banks, in order to meet the credit demands of state-enterprises, notably during the harvest season. Manat reserve money grew by 643 percent in 1994, and currency in circulation by 553 percent, compared with 1,137 percent and 1,475 percent in 1993, respectively (Tables 17 and 18 and Chart 5). The rapid monetary expansion in 1994, although slower than in 1993, resulted in accelerating inflation, as the public increasingly lost confidence in the domestic currency and switched to goods and foreign currencies, and consequently in a sharp depreciation of the manat. In 1992-94, the link between currency issued and inflation appears to have been stronger than that between wider monetary aggregates and price increases, suggesting that other components of these aggregates are largely held as a store of value rather than as liquid assets for transaction purposes. Notably foreign currency deposits appear to have played such a role, which is typical for a country on the brink of hyperinflation.

Table 17.Azerbaijan: Balance Sheet of the Azerbaijan National Bank

(In billions of manats, end of period stocks)



Net foreign assets–2.2–1.0–
Net international reserves (convertible)–
Gross international reserves (convertible)–
Foreign liabilities (convertible)–0.3–0.8–4.6–0.2–204.8–204.0
Required reserves held in foreign currency0.
Net claims on FSU states–2.2–1.0–0.9––0.7
Net domestic assets5.744.872.1119.9203.9322.09.8150.6394.8
Domestic credit6.744.068.8119.3209.2335.768.4236.9532.3
Credit to general government (net; incl oil signature bonus)2.123.942.167.7149.2235.1–62.765.6307.5
Credit to general government (net; excl oil signature bonus)2.123.942.167.7149.2235.1177.8235.4321.4
Manat claims on central government (net)2.324.343.968.9150.9244.7194.6239.8327.5
Manat equivalent of oil signature bonus–240.5–169.8–13.9
Claims on social protection fund (net)–0.0–0.1–0.1–0.3–0.7–0.3–1.2–1.3–1.2
Claims on local government (net)–0.1–0.3–1.7–0.9–1.0–9.3–15.6–3.1–4.9
Claims on enterprises0.
Credit to banks (including overdrafts)4.420.026.751.259.6100.2127.9165.5217.3
Other items (net)––5.3–13.7–58.6–86.3–137.5
Reserve money3.543.570.8128.1204.2323.1548.5643.0865.8
Manat reserve money3.543.570.8118.6203.6323.1455.6570.0695.7
Currency in circulation2.743.259.8103.7173.8282.3371.6467.6553.8
Bank reserves0.80.311.024.330.440.8176.9175.4311.9
Correspondent accounts0.
Required reserves0.10.110.416.612.421.4127.3105.6206.5
Required reserves in manats0.
Required reserves in foreign currencies0.
Other deposits0.
Sources: Azerbaijan National Bank; and IMF staff estimates.
Sources: Azerbaijan National Bank; and IMF staff estimates.
Table 18.Azerbaijan: Monetary Survey

(In billions of manats, end of period stocks)



Q1Q2Q3Q4Q1Q2Q3 4/
Net foreign assets–,079.1
Net foreign assets of the ANB (convertible)
Net foreign assets of commercial banks (convertible)–21.5200.4596.1
Net claims on FSU states–3.7–1.8–2.0–2.7–
Net domestic assets13.082.9128.0220.0377.5649.4464.6751.7657.0
Domestic credit15.988.2137.8249.6381.3830.0809.01,329.81,617.0
Credit to general government (net, including oil bonus)–0.917.014.738.389.3185.0–131.8–3.6256.5
Credit to general government (net, excluding oil bonus)–0.917.014.738.389.3185.0108.7166.2270.4
Manat claims on central government (net)–0.623.228.050.4117.2209.8161.7204.9320.5
Claims on social protection fund (net)–0.3–3.1–6.1–7.8–15.7–11.8–13.1–11.4–15.5
Claims on local government (net)–0.0–3.1–7.3–4.3–12.2–13.0–40.0–27.4–34.6
Manat equivalent of oil signature bonus–240.5–169.8–13.9
Claims on enterprises and individuals16.871.2123.1211.3292.0645.0940.81,333.41,360.4
Of which in foreign currency0.06.420.9106.4123.2291.5393.5535.5
Other items (net)–2.9–5.3–9.8–29.7–3.8–180.6–344.4–578.2–960.0
Broad money9.486.3130.6266.1452.61,048.1988.41,455.21,736.0
Manat broad money9.473.5111.6161.1264.2431.0580.2750.2863.5
Currency outside banks2.743.259.7103.3172.1276.1366.1460.9545.8
Manat deposits6.630.451.957.892.1154.9214.1289.2317.6
Foreign currency deposits0.012.819.0105.0188.5617.0408.2705.0872.6
199319941995 5/
Percentage changes
Reserve money63.5108.162.780.959.558.269.817.234.61136.5642.7143.5
Manat reserve money63.5108.162.767.571.758.741.025.122.01136.5642.7119.5
Currency in circulation128.738.373.467.662.531.625.818.41475.2552.9112.1
Manat broad money66.182.051.844.364.063.234.629.315.1685.9486.1108.3
Broad money 1/66.155.759.450.578.1117.
Memorandum items
Velocity of broad money (level) 1/2/3/
Velocity of manat broad money (level) 2/3/
Real broad money (Dec 1992=100) 1/3/100.065.849.536.346.932.327.232.032.7100.446.231.1
Real manat broad money (Dec 1992=100) 3/100.056.440.428.433.817.516.018.920.781.935.318.6
Manat money multiplier (level) 3/
Currency/manat deposits-ratio 3/41.0142.3115.0178.7186.9178.3171.0159.4171.989.5160.2174.6
Manat bank reserves at ANB/manat deposits–ratio 3/11.70.921.125.732.326.339.235.444.715.921.336.3
Sources: Azerbaijan National Bank; and IMF staff estimates.

In calculating these numbers, oil signature bonus funds on blocked accounts of SOCAR, which are to be transferred to the ANB are excluded from the stock of foreign currency deposits, and foreign currency deposits are valued at market exchange rates.

Calculated as annualized period GDP devided by period average broad money stock.

Annual figures are period averages.

Preliminary figures.


Sources: Azerbaijan National Bank; and IMF staff estimates.

In calculating these numbers, oil signature bonus funds on blocked accounts of SOCAR, which are to be transferred to the ANB are excluded from the stock of foreign currency deposits, and foreign currency deposits are valued at market exchange rates.

Calculated as annualized period GDP devided by period average broad money stock.

Annual figures are period averages.

Preliminary figures.


Chart 5AZERBAIJAN Selected Monetary Indicators

Sources: Azerbaijan National Bank; and IMF staff estimates.

1/ The figures for the third quarter of 1995 are preliminary.

2/ Deflated by the average monthly inflation rate (CPI) during the quarter.

Reflecting the declining confidence in the domestic currency, the velocity of manat broad money more than tripled during 1994, and demand for real money balances fell by two-thirds, reducing the authorities’ ability to finance themselves through extracting seignorage (see Appendix I). With interest rates continuing to be highly negative in real terms, the public sought ways to protect themselves from current and expected higher inflation rates by shifting out of the domestic currency. Switching to goods and foreign currencies, though, required the conversion of manat deposits into cash, as people could not pay by bank checks, and exchange restrictions severely limited the amounts of deposits that households could officially convert into foreign currencies. However, households could convert cash manats into cash dollars virtually unrestricted in the street markets. The resulting high demand for cash and an insufficient supply of banknotes made bank deposits illiquid from time to time. This further discouraged the public from building up deposits 1/. The share of currency in manat broad money--which had already risen significantly from 28 percent to 59 percent during 1993–rose to 64 percent in December 1994.

The high demand for currency was also explained by a general lack of confidence in the banking system. This not only reflected the perceived weakness of the banking system, but also the fact that banks were required to report information on their clients’ balances to the tax inspectorate. Part of household’s cash holdings were invested into financial institutions outside the control of the ANB--so called charity organizations--which offered interest rates of up to 30 percent per month. These organizations also converted the cash manats into dollars, using the dollars to finance informal trade activities, and buying back the manats later at more depreciated rates. At the end of 1994, it was estimated that households held nearly as much deposits at these institutions as they did at banks. 2/

As a result of the increasing preference for cash, the manat money multiplier declined further in 1994. In addition, towards the end of 1994, the refusal of the ANB to transfer funds for banks with inadequate balances on their correspondent accounts--a result of the elimination of automatic overdrafts–lengthened clearing delays in the payments system, and led to an accumulation of balances on banks’ correspondent accounts at the central bank. Hence, the multiplier declined from 1.7 at end-1993 to 1.3 at end-1994. With a decline in the demand for real manat balances, reflected in the increase in velocity and contributing to the decline of the money multiplier, manat broad money grew by 486 percent in 1994.

Due to the sharp decline in confidence in the domestic currency, the share of foreign currency deposits in broad money from 14 percent to 46 percent during 1994. As a result, broad money (including foreign currency deposits) increased at a much higher rate in 1994 than manat broad money.

Reflecting lax financial policies, total domestic credit increased by 841 percent in 1994, compared with 455 percent in 1993. Credit to the general government rose somewhat faster than credit to enterprises (Table 19). Funded by their clients’ foreign currency deposits, nearly half of the credits extended by commercial banks to enterprises were denominated in foreign currencies. Many of these foreign currency denominated loans were directed and guaranteed by the Cabinet of Ministers. At the end of 1994, about 16 percent of the loans to enterprises were recorded as being in arrears, down from 26 percent at end-1993. Meanwhile, interenterprise arrears continued to grow rapidly (Table 20). At the end of 1994, interenterprise arrears were slightly higher than total domestic bank credit to enterprises and households.

Table 19.Azerbaijan: Domestic Credit to Enterprises and Households

(In billions of manats; end of period stocks)



Total credit to rest of economy 1/15.379.8135.6256.8354.2678.7771.5787.6936.21,013.31,114.61,298.91,339.71,416.6
Azerbaijan National Bank0.
Industrial Investment Bank8.231.957.267.691.9132.4143.5160.3181.8206.8215.4259.5280.8292.0
Agro Industrial Bank5.021.431.246.592.1181.2188.4188.0267.2290.3298.5384.3379.9380.0
Savings Bank 2/
International Bank 3/0.05.719.596.3102.6228.3289.0264.9285.0303.7368.9401.6425.2473.5
Private banks1.617.223.540.959.6121.8134.2156.6180.7190.5204.9221.0223.0238.7
Short-term credit14.375.4127.6238.0329.2596.0693.4705.2830.7922.0985.51,160.51,149.81,226.9
Azerbaijan National Bank0.
Industrial Investment Bank7.630.054.663.585.2123.7134.2150.7171.5196.4204.1247.8265.0280.6
Agro Industrial Bank4.820.027.842.084.7168.5170.6169.3241.0263.9270.1346.6341.1339.1
Savings Bank0.
International Bank0.04.917.886.692.1167.7238.7211.6216.7249.9280.7313.0290.4336.5
Private banks1.617.123.540.659.2121.3133.7156.2180.3190.2204.8220.8222.9238.6
Long–term credit1.
Azerbaijan National Bank0.
Industrial Investment Bank0.
Agro Industrial Bank0.
Savings Bank0.
International Bank0.
Private banks0.
Memorandum items
Monthly credit growth13.112.829.9-5.723.623.
Annual credit growth968.6421.6478.0654.2675.3750.7769.0654.7590.4567.7309.5405.9413.2394.1
Real credit to rest of economy (index Dec 92 = 100)100.048.539.434.839.222.819.018.718.919.621.123.625.326.6
Source: Azerbaijan National Bank.

Data may differ from the balance sheet data used in the monetary survey due to classification differences.

Does not include lending to commercial banks.

Data for International Bank available only from December 1993 onwards. Data from that date on are therefore not directly comparable with earlier dates.

Source: Azerbaijan National Bank.

Data may differ from the balance sheet data used in the monetary survey due to classification differences.

Does not include lending to commercial banks.

Data for International Bank available only from December 1993 onwards. Data from that date on are therefore not directly comparable with earlier dates.

Table 20.Azerbaijan: Enterprise Arrears

(In billions of manats; end of period stocks)



Interenterprise arrears3.137.377.5159.0309.6736.4912.01,409.41,863.42,459.12,532.03,166.33,669.85,121.9
As reported by
Azerbaijan National Bank0.
Industrial Investment Bank1.728.056.0119.7230.6567.9701.51,098.81,447.41,921.21,887.82,333.02,742.03,958.9
Agro Industrial Bank1.36.815.027.563.8131.9163.9245.4311.4380.8449.2613.8693.1857.9
Savings Bank0.
International Bank 1/
Private banks0.
Arrears to banks0.521.520.734.849.3109.4121.7137.6210.9226.1226.3337.8360.6374.0
Azerbaijan National Bank0.
Industrial Investment Bank0.311.08.813.519.232.844.762.371.088.785.7117.3136.0151.3
Agro Industrial Bank0.
Savings Bank0.
International Bank 1/
Private banks0.
Azerbaijan National Bank0.
Industrial Investment Bank2.038.964.8133.2249.8600.7746.21,161.21,518.42,009.91,973.52,450.32,878.04,110.2
Agro Industrial Bank1.514.820.836.875.7182.5213.5290.7410.3475.3542.3772.2855.81,014.8
Savings Bank0.
International Bank 1/
Private banks0.24.48.718.027.951.159.373.9108.9147.8171.1208.1216.7280.2
Memorandum items
Real total arrears (index Dec 92 = 100)100.0114.790.486.9116.887.483.5111.1145.4178.2175.9224.8259.3352.9
Real interenterprise arrears (index Dec 92 = 100)100.085.583.883.7118.489.386.6118.9153.4191.7189.6238.5277.3386.3
Interenterpr. arrears as % of bank credit to non–government20.546.857.261.987.4108.5118.0179.8198.1240.1224.4237.5259.0343.4
Arrears to banks as % of bank credit to non–government3.626.915.313.513.916.115.717.522.422.120.125.325.425.1
Total arrears as % of bank credit to non–government24.173.772.475.5101.3124.6133.7197.3220.5262.1244.5262.8284.5368.5
Source: Azerbaijan National Bank.

Data for International Bank available only from March 1994 onwards.

Source: Azerbaijan National Bank.

Data for International Bank available only from March 1994 onwards.

b. Monetary policy in 1995

In the face of incipient hyperinflation, the authorities fundamentally changed their financial polices at the beginning of 1995. Central bank credit was tightened significantly. When abstracting from the oil bonus counterpart funds 1/, central bank net credit increased by 63 percent in the first three quarters of the year, down from 375 percent during the corresponding period in 1994. Central bank credit to the general government (excluding the oil bonus counterpart funds) increased only by 37 percent over the same period. This provided room for more credit to the banking system and credit to banks grew by 117 percent during the first three quarters. There was no significant refinancing of agricultural credits during the harvest season, as the 1995 harvest was largely financed by using the proceeds of the previous year’s harvest.

As a result of the tightening of the ANB’s credit policies, manat base money growth was brought down from a monthly average of 18 percent in 1994 to 12 percent in the first quarter of 1995. However, as the ANB did not fully sterilize the gradual drawdown of the oil bonus counterpart funds by the Government, reserve money continued to grow at a monthly average rate of 10 percent in the period May-July. In August and notably in September, the ANB stepped up its sales of foreign exchange, and consequently the growth of manat reserve money fell to an average monthly rate of 5.5 percent in August-September.

Because inflation and inflation expectations respond with some lag to changes in monetary aggregates, the velocity of manat broad money initially rose sharply. As interest rates moved to positive real levels with steadily falling inflation and the exchange rate remained stable, velocity started to decline in the second quarter of 1995. This apparently reflected in part an increase in the demand for real manat balances, suggesting a gradual recovery of confidence in the domestic currency. The increasing confidence was also signaled by a growing willingness of the public to hold manat deposits and the share of currency in manat broad money remained broadly stable at around 63 percent. With a further marginal decline in the money multiplier, manat broad money developed more or less in line with manat reserve money. In the summer of 1995, monthly average growth rates of manat broad money stayed at around 10 percent, as base money grew with foreign exchange reserves and reserve requirements were temporarily relaxed in June. As inflation had declined to zero, this amount of monetary expansion raised concerns about rekindling inflation expectations. However, with increased foreign exchange sales by the ANB and the increase of reserve requirements back to 15 percent in September, average monthly growth rates of manat broad money fell to 3-4 percent in August and September 1995.

Broad money including foreign currency deposits expanded less rapidly than manat broad money, reflecting a decline in the dollarization ratio of the economy. The share of foreign currency deposits in broad money fell from 46 percent at end-1994 to 38 percent at end-August, 1995. In line with the velocity of manat broad money, the velocity of total broad money rose in the first quarter, before it started to decline in the second quarter.

With a sharp tightening of fiscal and monetary policies, total domestic credit--excluding oil bonus counterpart funds--grew by 109 percent during the first eight months. While domestic bank financing of the general government increased by only 31 percent, credit to enterprises and households expanded at a rate of 131 percent. To a large extent, this increase reflected the capitalization of overdue interest payments on existing loans rather than the granting of new loans, as an increasing share of the banks’ loan portfolios was non-performing. In response to tighter bank credit and with a continuing lack of financial discipline, interenterprise arrears accumulated from the equivalent of 109 percent of bank credit to enterprises at end-1994 to 343 percent by end-August, or from 35 percent of GDP to 56 percent of GDP.

3. Interest rates

In 1992 and 1993 interest rates were highly negative in real terms (Chart 5). The ANB’s refinance rate remained the most important reference point for interest rates. The ANB raised this rate to 257 percent a year in July 1994 from 144 percent which had been in effect since December 1993 (Table 21) 1/. However, part of the ANB lending to commercial banks, for example agricultural credits refinanced during the harvest season, took place at rates below the refinance rate. Moreover, the Government was only charged an annual interest rate of 3 percent. Throughout 1994, real interest rates continued to be highly negative.

Table 21.Azerbaijan: Interest Rates

(End of period interest rates)



ANB refinance rate, uncompounded 1/12100100100150200237180100
Commercial bank lending rates
state enterprises, uncompounded25110110110160210260190110
private enterprises, uncompounded50–70150–200150–200150–200200–250200–250200–300180–250120–200
Commercial bank deposit rates
currenct accounts, uncompounded00–50–50–50–50–50–50–50–5
time deposits, uncompounded205050–10050–100100–150100–150100–200100–20070–110
currenct accounts, uncompounded102020202020202020
time deposits, uncompounded10–2530–10030–10050–250200–250200–250180–250160–20050–80
large one–month deposits 2/2525251510
Sources: Azerbaijan National Bank; and commercial banks.

Credit auction rate as of March 1995.

Monthly interest rates.

Sources: Azerbaijan National Bank; and commercial banks.

Credit auction rate as of March 1995.

Monthly interest rates.

In December 1994, the ANB raised the refinance rate to 406 percent, and further to 597 percent in January 1995. As a result, lending rates became positive in real terms. Since the beginning of 1995 all ANB lending to commercial banks has taken place at the refinance rate, while the Government continued to be charged an annual rate of 3 percent. In March 1995, the ANB started to auction part of its refinance credit, and since then the refinance rate is determined by the outcome of the auctions. From March to September, the refinance rate gradually declined to 144 percent. Interest rates came down slower than the rate of inflation. Annual real interest rates peaked in the second quarter, at rates slightly over 200 percent per year, before declining to slightly below 100 percent by end-September. Interest rates clearly incorporated a substantial risk premium, reflecting the lack of an effective legal structure for debt recovery, low creditworthiness of borrowers, and structural weaknesses in the financial system as a whole.

It appears that interest rates also included a significant premium for exchange rate risk. In September, the spread between interest rates on domestic loans denominated in manats and loans denominated in dollars was about 100 percent. However, such a large spread was unlikely to reflect solely the exchange rate risk. Part of the spread was obviously due to a difference in creditworthiness of borrowers in manats and in dollars, as only the less risky borrowers (for example those with government guarantees) had access to foreign currency loans.

Lending rates charged by commercial banks to state-owned enterprises were normally 10 percentage points higher than the ANB’s refinance rate, while an average spread of 50 percentage points was applied for loans to private enterprises. Interest rates on demand deposits of enterprises and households have remained very low. However, reflecting growing competition for household deposits, mostly by the charity organizations, Amanatbank raised the interest rate on large denomination one-month household deposits to 25 percent per month in the fall of 1994. Amanatbank continued to offer this rate until July 1995, while inflation rates had already fallen drastically and the charity organizations had gone under, before it lowered this rate to 15 percent, and further to 10 percent in August 1995. With the bulk of (enterprise) deposits earning little or no interest, the average spread between lending and deposit rates widened during 1994-1995. At end-September 1995, the average spread was estimated to be about 60 percentage points. Apart from the high credit risks, the high interest margins also reflected an effort to improve the banks’ capital base.

4. Exchange rate policy and developments

The manat was introduced in August 1992 but became the sole legal tender only in January 1994. Until the end of 1994, excessive monetary expansion and high rates of inflation resulted in a rapid erosion of the value of the manat (Table 22 and Chart 6). The market exchange rate depreciated from 48 manats per U.S. dollar at end 1992 to 256 manats per U.S. dollar at end-1993. During the period from November 1993 until March 1994, the authorities attempted to peg the exchange rate at a rate of 118 manats per U.S. dollar, followed by a short period of pegging the rate to the Russian ruble. With continued loose financial policies, the manat depreciated further in the parallel markets. Unable to maintain the peg, the authorities allowed the exchange rate of the manat to float again as of end-May 1994. Since then, the official exchange rate has been based on exchange rates quoted by commercial banks, but with the rapid depreciation of the manat, it lagged behind market developments during most of the year. In 1994, the manat lost more than 90 percent of its value against the U.S. dollar, and at end 1994 the exchange rate had reached 4,330 manats per U.S. dollar. As a result of the tightening of credit policies in the first quarter of 1995, the increase in interest rates to positive real levels, and the regular supply of foreign exchange to the auction by the ANB, the exchange rate has remained broadly stable since the beginning of the year. From December 1994 to September 1995, the manat depreciated only by 4.8 percent vis-a-vis the U.S. dollar. Since end-December 1994 the official exchange rate is determined by the rate established in the foreign currency auctions (see below).

Table 22.Azerbaijan: Manat/U.S. Dollar Exchange Rate
Bank cash rate 1/Official rateBICEX rate 1/
AverageEnd of

AverageEnd of

AverageEnd of

Sources: Azerbaijan National Bank; and commercial banks.

Rates used as market rates are bank cash rates until end–1994, and BICEX rates as of January 1, 1995

Sources: Azerbaijan National Bank; and commercial banks.

Rates used as market rates are bank cash rates until end–1994, and BICEX rates as of January 1, 1995

Chart 6AZERBAIJAN Exchange Rates

Source: Azerbaijan National Bank.

1/ Increase implies appreciation.

2/ Using US dollar/Russian ruble cross rates.

3/ Using total trade weights and relative consumer price developments.

4/ Average monbthly wage divided by monthly averge US dollar/manat exchange rate.

The real effective exchange rate appreciated somewhat from mid-1993 until the fall of 1994. This trend was temporarily reversed with the sharp decline in the value of the manat in the fourth quarter of 1994. In early 1995, with the nominal exchange rate stable and inflation declining, the real effective exchange rate again started to appreciate. On balance, the appreciation of the real effective exchange rate has been larger when measured in relative consumer prices than when measured using relative wages, reflecting the sharp decline in real wages in Azerbaijan in 1994. Azerbaijan’s real exchange rate as measured by relative dollar wages remains low compared with its neighboring CIS countries, suggesting a continued undervaluation of the manat.

In an effort to stimulate foreign exchange trading, the ANB revived the Baku Interbank Currency Exchange (BICEX) in August 1994, where noncash foreign exchange is traded. Only banks were allowed to participate in the auction. Noncash foreign exchange transactions outside the BICEX were prohibited, including off-auction interbank trading. At first, with the system of surrender requirements at highly punitive rates still in place, the supply of foreign exchange was limited and the frequency and volume of the auctions remained low (Table 23). With the tightening of financial policies, though, and the replacement of the system of surrender requirements by a temporary requirement to sell 30 percent of foreign exchange export earnings at the BICEX, auction frequency and turnover increased significantly in early 1995. Since April, 1995 auctions were held three times a week. Volume continued to grow during the year, reaching on average nearly US$3 million per auction in September 1995. On average, about 20 percent of the total turnover in 1995 has been supplied by the ANB.

Table 23.Azerbaijan: Baku Interbank Currency Exchange



(manats per

U.S. dollar)


(millions of

U.S. dollars)

of auctions


per auction

(millions of

U.S. dollars)
Source: Azerbaijan National Bank.
Source: Azerbaijan National Bank.

5. Banking supervision

The ANB’s supervisory capacity--in terms of regulatory framework, enforcement power, and trained staff--has been insufficient for the task of supervising an increasingly decentralized banking system. However, with the assistance of international experts, the ANB has steadily endeavored to strengthen its supervisory role. Prudential regulations were improved and in 1995 compliance with these regulations was more strictly enforced. The ANB closed a number of smaller banks that persistently failed to comply. The four state-owned banks, though, have continued to fail to meet one or more of the criteria.

On January 1, 1995 the minimum capital requirement for new banks was raised from 150 million manats (about US$35,000 at end-1994 exchange rates) to US$500,000. The minimum statutory capital for existing banks was raised from 20 million manats to 30 million manats on October 1, 1994, and further to 40 million manats on January 1, 1995 and to 50 million manats (about US$11,000) on April 1, 1995. On August 1, 1995 it was raised to the manat equivalent of US$20,000 and to the manat equivalent of US$30,000 on October 1, 1995. The capital adequacy ratio (a bank’s own funds divided by its assets) must be at a minimum 8 percent. The assets taken into the calculation of the denominator are not risk-weighted, which would seem to imply that the requirement is more stringent than international standards. However, it is likely that most assets held by banks in Azerbaijan would receive a very high risk-weighing percentage if international standards would be applied. More importantly, there is no proper classification of assets and no provisioning for loan losses, while the practices of principal rollovers and capitalization of overdue interest payments continue. Even without proper classification, the proportion of overdue loans in the total loan portfolio of commercial banks is reported to have increased from 16 percent at end-1994 to 26 percent at end-August 1995. In effect, if loans that cannot be recovered would have to be written off, a significant portion of the banks’ capital would have to be used for this. At the moment, the accounts of the banks do not reflect this. Especially the state-owned commercial banks are seriously undercapitalized.

Banks have to comply with two liquidity ratios. The first one concerns the relationship between a bank’s assets with a maturity of less than one month, and its liabilities with a maturity of less than one month. This ratio, which measures a bank’s ability to meet immediate withdrawals, must be at a minimum 60 percent. Two of the four state-owned banks failed to meet this criteria during the summer of 1995 and one of them indeed ran into serious liquidity problems early October (see Chapter VII). The second ratio concerns the relationship between a bank’s assets having a maturity of more than 12 months, and its liabilities with a maturity of over 12 months, including the bank’s own funds. This ratio, which is intended to limit the maturity mismatch, must not exceed 100 percent. Although this requirement limits the possibilities for maturity transformation, in the present conditions of lacking financial discipline in the enterprise sector it is a useful addition to the requirement for short term liquidity. The maximum exposure per borrower is 50 percent of a bank’s own funds. Many banks did not comply with this regulation as insider lending continues to be widespread. The foreign exchange exposure of banks having a license for operations in foreign currencies should not exceed 30 percent of a bank’s own funds.

V. Balance of Payments and External Debt 1/

Like most of the CIS countries, Azerbaijan has been experiencing a major redirection of its foreign trade flows. Following the dissolution of the U.S.S.R., Azerbaijan attempted to maintain centrally planned trade relationships through a network of bilateral trade arrangements with CIS countries. These trade agreements usually determine the trade volumes at prices well below world market levels. Beginning in 1992, these arrangements began to unravel as suppliers sought more advantageous prices in world markets. As a result, the share of trade with non-CIS countries has grown steadily.

1. The direction and composition of trade

Despite the redirection of foreign trade, Azerbaijan remains largely integrated with the economies of the CIS and trade with these countries consisted of nearly 60 percent of total recorded trade in 1994. Azerbaijan’s primary export products are diesel fuel and other oil products, cotton, oil drilling equipment, and light manufactures (Table 24). Although exports of diesel oil and cotton have been progressively diverted towards world markets, Azerbaijan continues to supply these goods to CIS markets, in particular to Ukraine. Russia remains the main market for equipment and light manufactures. Similarly, the bulk of wine, tobacco, and other food products are shipped to Russian markets.

Table 24.Azerbaijan: Recorded External Trade 1/

(In millions of U.S. dollars)

19931994Jan. -Jul.

By commodity
Exports (f.o.b.)697637278
Food products976412
Oil products198207120
Chemicals and plastics 2/443313
Machines and equipment669323
Imports (c.i.f.)849778319
Food products205132
Natural gas6619346
Chemicals and plastics 2/5239
Machines and equipment10242
By country
Exports (f.o.b.)697637278
United Kingdom36229
Imports (c.i.f.)849778319
CIS 3/441498117
Ukraine 3/1538610
Sources: Goskomstat; and IMF staff estimates.

Excludes unrecorded imports and exports and humanitarian imports. Data for 1993 are based on enterprise surveys. Data after 1993 are based on customs reports. Categorizations between 1993 and 1994-95 may not be strictly comparable.

Includes pharmaceuticals.

In 1993, includes imports from Ukraine of US$100 million which were recorded as domestic trade and are excluded from the official trade statistics.

Sources: Goskomstat; and IMF staff estimates.

Excludes unrecorded imports and exports and humanitarian imports. Data for 1993 are based on enterprise surveys. Data after 1993 are based on customs reports. Categorizations between 1993 and 1994-95 may not be strictly comparable.

Includes pharmaceuticals.

In 1993, includes imports from Ukraine of US$100 million which were recorded as domestic trade and are excluded from the official trade statistics.

Azerbaijan’s imports from the CIS consist mainly of natural gas from Turkmenistan, which until recently has increasingly replaced declining domestic production. In addition to natural gas, Azerbaijan imports significant amounts of food and most of its intermediate inputs from Russia. Azerbaijan also imports, refines, and re-exports crude oil from Kazakhstan, although at volumes which are insignificant compared with those in the late 1980’s. Azerbaijan also used to import large quantities of ferrous metals from Ukraine, which it processed and re-exported to Iran. These imports came to a virtual halt with the closing of the northern trade route in late 1994.

An increasing share of Azerbaijan’s commodity exports are supplied to non-CIS markets. In 1994, fuel products and cotton alone accounted for almost two-thirds of Azerbaijan’s total recorded exports to non-CIS markets. A major market for fuel has been northern Iran, where diesel supplies are relatively scarce. In 1994, cotton sales to non-CIS countries increased substantially in volume terms. Nearly all this cotton was sold to the United Kingdom. In the first half of 1995, around 70 percent of exports were sold at non-CIS markets.

Most non-CIS imports are provided by Turkey and Iran, which together accounted for 75 percent of all recorded non-CIS imports in 1994. Nearly all of these imports consisted of food, medicine, and other consumer goods. These countries also supply electricity to Azerbaijan’s Nakhichevan region. Beginning in late 1994 and continuing into 1995, Azerbaijan began importing consumer goods, mostly meat, butter, and medicine, under a humanitarian assistance loan from the European Union.

A significant volume of imported goods, mostly from non-CIS countries, remain unrecorded. Much of these imports, such as goods under humanitarian grant programs, pass through customs but due to valuation difficulties, they are not recorded in official trade statistics. Imports associated with large foreign investment projects such as Pennzoil’s Gas Utilization Project and the oil consortium investment are often unrecorded because of their duty exempt status. In addition, a large volume of trade is believed to avoid customs entirely due to smuggling and under-invoicing. Finally, a large portion of imports takes place through the so-called “shuttle trade.” The Azerbaijan National Bank estimates that personal unrecorded imports of consumer goods via charter flights alone amounted to at least US$120 million, or 15 percent of total imports in 1994. In the first half of 1995 these imports are estimated to have increased further.

While the country has historically been a large net exporter of oil products, increased imports of gas from Turkmenistan have turned this surplus into a slight deficit in energy trade (Table 25). Exports have been constrained by declining oil and gas production as Azerbaijan’s mature fields have reached an advanced state of depletion. However, the decline in production has been offset by an even greater decline in energy consumption associated with the steep fall in GDP in recent years. Between 1990 and 1994 overall energy consumption (in tons of oil equivalent) fell by 37 percent while production declined by 30 percent. As a result, while still negative the balance of energy trade improved slightly. In 1995 the balance of energy trade is estimated to record a small surplus due to special factors, such as increased natural gas rationing to users and some depletion of gas stocks held in underground storages. In addition, new facilities have allowed previously vented gas to be captured for domestic use, temporarily slowing the decline in gas production and improving the energy balance.

Table 25.Azerbaijan: Energy Balance

(In millions of tons)
Oil and oil products
Net trade4.
Of which: crude oil- -1.1- -- -- -
Imports-4.1-1.9-0.2- -- -
Apparent use 1/
(In billions of cubic meters)
Natural gas
Production (net of venting) 2/
Net trade-8.2-3.9-2.5-2.5-1.0
Exports- -- -- -- -- -
Apparent use 1/16.811.
Memorandum item
Energy trade balance 3/-3.1- --0.9-0.41.0
Sources: Goskomstat; Ministry of Economy; World Bank; and IMF staff estimates.

Apparent use is defined as production plus net imports.

Production excluding vented gas.

Expressed in tons of oil equivalent, with one tone of oil equal to 1,120 cubic meters gas.

Sources: Goskomstat; Ministry of Economy; World Bank; and IMF staff estimates.

Apparent use is defined as production plus net imports.

Production excluding vented gas.

Expressed in tons of oil equivalent, with one tone of oil equal to 1,120 cubic meters gas.

2. Developments in 1994-95

a. Current account

Since independence in 1991, Azerbaijan’s trade has been burdened by payments and transportation difficulties related to the dissolution of the U.S.S.R., the conflict over the Nagorno-Karabakh region, and more recently, events in Chechnya. As a result, the balance of recorded trade (including imports of transportation services but excluding foreign-financed project imports) turned from a US$88 million surplus in 1993 to a deficit of US$141 million in 1994 (Table 26). At the same time, Azerbaijan experienced a sharp decline in the level of trade. The volume of trade declined sharply between 1993 and 1994, with the volume of recorded imports (nonproject related) declining by an estimated 40 percent and the volume of exports by 30 percent. Most of this decline is accounted for by a deterioration in trade with other CIS countries. The volume of trade is expected to decline further in 1995 as payments and transportation difficulties with CIS countries continue.

Table 26.Azerbaijan: Balance of Payments

(In millions of U.S. dollars)



A.Current account-160-121-59-63-52-131-305
Trade balance-122-109-50-68-17-91-225
Exports f.o.b.69768293115154123484
Of which:CIS3622813431
oil products19820744404949181
oil consortium- -- -- -- -- -- -- -
unrecorded- -45435517
Imports f.o.b.-819-791-142-183-170-213-709
Of which:CIS-441-498-62-36
natural gas-66-193-39-7- --32-78
oil consortium- -- -- --18-30-42-90
unrecorded 1/-240-115-27-83-65-77-252
Of which: factor services- -- --3-1- --1-6
Of which:oil consortium- -- -- --6-10-14-30
Current transfers307529572020126
Of which:humanitarian aid307125481515103
B.Capital account142541262258165370
Oil bonus 2/60- -303083- -143
Disbursements135410- -- -1020
World Bank/EBRD project loans- -- -- -- -- -1010
Other135410- -- -- -10
Amortization- -- --16-8-1-28-53
Turkmenistan- -- -- -- -- -- -- -
Russia- -- -- -- -- --10-10
Other- -- --16-8-1-3-44
Direct investment- -226506585206
Of which: oil consortium- -- -- -305070150
Banking system (net)-64-2296-50-899855
Short term/other 3/133- -- -- -- -- -- -
C.Errors and omissions18-21-29-1- -- --29
D.Overall balance- --8938-416- -12
E.Financing- -89-3840-6-94-98
Net foreign assets (- increase)- --2-101726-132-201
Central bank gross reserves- --2-101-4026-132-247
IMF- -- -- -46- -- -46
Arrears to Turkmenistan- -81278-52-5-22
Increase in current liabilities- -813313-47- --1
Reduction of arrears- -- --66-5-5-5-81
Rescheduling of arrears- -- -60- -- -- -60
Other debt rescheduling- -- -1991332
World Bank- -- -- -- -- -2121
European Union- -101717192072
Other financing- -- -- -- -- -- -61
Memorandum items
Gross reserves of the ANB end of period- -2102142115249249
In weeks of imports of goods and nonfactor services 4/- -- -6861414
Sources: Goskomstat; Azerbaijan National Bank; Ministry of Finance; Ministry of Economy; and IMF staff estimates.

Includes humanitarian assistance, shuttle trade, and oil consortium imports.

Represents the contract signing bonus paid to the Government by the members of the oil consortium.

In 1993, includes interstate enterprise arrears and a loan from Pennzoil to SOCAR.

Excluding imports by oil consortium.

Sources: Goskomstat; Azerbaijan National Bank; Ministry of Finance; Ministry of Economy; and IMF staff estimates.

Includes humanitarian assistance, shuttle trade, and oil consortium imports.

Represents the contract signing bonus paid to the Government by the members of the oil consortium.

In 1993, includes interstate enterprise arrears and a loan from Pennzoil to SOCAR.

Excluding imports by oil consortium.

Much of the recent deterioration in Azerbaijan’s current account (excluding unrecorded trade) stems from a sharp decline in the terms of trade (Table 27). With the decline in centralized trade throughout the CIS, countries began raising their export prices toward world market levels. Since a large part of Azerbaijan’s exports was already sold to non-CIS countries, the move to world market prices in trade within the CIS had only a limited impact on Azerbaijan’s overall export proceeds. Meanwhile, prices of Azerbaijan’s imports from CIS countries rose sharply. In the fourth quarter of 1993, Turkmenistan quadrupled the price it charged for natural gas exports to Azerbaijan to US$80 per 1,000 cubic meters. As a result, the value of gas imports increased sharply (to US$189 million in 1994), although gas imports in volume terms remained constant. This increase accounted for most of the deterioration in Azerbaijan’s (nonproject related) current account in 1994. Higher prices also led to payments difficulties, and gas imports in the first half of 1995 were significantly lower than during the same period in 1994.

Table 27.Azerbaijan: Terms of Trade, Import and Export Prices of Selected Goods
Value in

199319941995 1/
(In millions of U.S. dollars)
Import price index (c.i.f.)100130186
Export price index (f.o.b.)100118126
Terms of trade1009168
(In U.S. dollars per ton)
CIS imports (c.i.f.)
Natural gas (per ’000 cm.)193218080
Non-CIS imports (c.i.f.)
Wheat 2/108282138
Flour 2/4168168219
Exports (f.o.b.)
Air conditioners (per unit)2198182133
Sources: Goskomstat; and IMF staff estimates.

Based on prices through July 1995.

Excludes humanitarian assistance.

Sources: Goskomstat; and IMF staff estimates.

Based on prices through July 1995.

Excludes humanitarian assistance.

In addition to rising prices of imports from the CIS countries, the deterioration of Azerbaijan’s terms of trade was amplified by an intensification of transportation difficulties via Georgia in early 1994 and via Chechnya in late 1994. The result was a sharp increase in transportation costs to both CIS and non-CIS markets, reflected in a further increase in import prices paid at the border of Azerbaijan and a sharp decline in export prices received at the border of Azerbaijan. Price increases were particularly large for imports from CIS republics, although prices of food imports from non-CIS countries also rose considerably. Despite the favorable terms of trade effects of an increase in the world market price of cotton, Azerbaijan’s terms of trade deteriorated between 1994 and the first half of 1995 by an estimated 25 percent.

Although little is known about Azerbaijan’s trade in services in 1993, transport costs are believed to have risen sharply in 1994, resulting in a significant deterioration in the service balance in 1994 and 1995. Humanitarian grant assistance is estimated to have increased somewhat in 1994, largely reflecting a grant of 320,000 tons of grain (US$40 million at world prices) imported from the European Union.

b. Capital account and balance of payments financing

In 1994, the deficit in the current account was financed mainly through accumulation of payments arrears of US$81 million to Turkmenistan for natural gas imports. In addition, Azerbaijan borrowed US$54 million from the Turkish Eximbank for imports of wheat and food products. Central bank reserves increased by a modest US$2 million and reserves in the banking system by US$22 million.

In the first three quarters of 1995, gross reserves at the ANB increased to US$115 million, or 1 1/2 months of nonconsortium imports despite continued current account problems. The increase in official reserves reflected mainly the elimination of the Unified Foreign Exchange Fund (UFEF) and consolidation of the country’s foreign reserves, formerly held at commercial banks, at the ANB. Reserves were strengthened further with the first IMF disbursement in April 1995 and disbursements of the oil signature bonus in March and July. Disbursements of official loans consisted of a further US$10 million drawing from the Turkish Eximbank, and by an ECU 67 million loan from the European Union for import of food and medicine. In June 1995, Turkey agreed to reschedule the accumulated debt service on Eximbank’s line of credit, some US$28 million of which is to be repaid in 1996. Azerbaijan accumulated a further US$35 million in payment obligations to Turkmenistan for new shipments accrued in the first half of 1995 before settling them by additional shipments of goods and equipment in July-August 1995.

c. The oil consortium

In September 1994, the Government signed a production sharing contract with a consortium of 11 international oil companies for the development of several deep water oil fields in the Caspian Sea. The contract specifies US$7.5 billion in total investments over 15 years. Investments in the first phase began in 1995 and are projected to yield early exports of oil by 1997 (Appendix III). The production sharing contract stipulates that the oil production (net of operating costs, finance charges, and capital recovery) is to be split between the consortium members and the Government. Gross crude oil output from the project is expected to peak at 33 million tons per year around the year 2005. As a signature bonus of the oil contract, Azerbaijan was granted US$300 million of which US$120 million was disbursed in 1993-95 while further disbursements were tied to progress in implementation of the agreement. With the sale of half of SOCAR’s stake in the oil consortium to Exxon and the Turkish National Oil Company, a new oil bonus of US$173 million will be disbursed to Azerbaijan in tranches during 1995-98.

d. Debt

At end-1994, Azerbaijan’s outstanding stock of public and publicly guaranteed debt was about US$230 million, or about one third of exports. Azerbaijan has signed the zero-option agreement, giving up claims on former U.S.S.R., assets in exchange for being discharged the responsibility for servicing the external debt of the former U.S.S.R. Existing debts include US$81 million owed to Turkmenistan on gas arrears in 1994, US$82 million to Russia mainly for correspondent account balances originating from 1992 and 1993, and US$54 million use of the Turkish Eximbank line of credit for imports of wheat and food products. In April 1995, Turkmenistan agreed to reschedule the repayment of the 1994 gas arrears over four years with no interest. As in the original barter agreement, payment would take the form of oil products, oil equipment, and light manufactures. The debt to Russia is to be repaid during 1995-99 in quarterly installments. In June 1995, Turkey agreed to postpone for two years the scheduled payments on the line of credit falling due in 1994 and 1995. Since the beginning of 1995, Azerbaijan has utilized a large part of the ECU 67 million humanitarian assistance loan from the European Union. This loan carries a market interest rate with a maturity of two years and repayments beginning in 1997.

In addition to public debt, the State Oil Company SOCAR carries large commercial arrears to the American oil company Pennzoil for investments in the gas utilization project. Construction on the compressor station began in 1992 and was completed by Pennzoil on behalf of SOCAR in September 1994. As of July 31, 1995, the total debt to Pennzoil was US$166 million, consisting of US$140.6 million in capital costs, US$19.5 million in interest (LIBOR plus 4 percent), and US$6.3 million in accumulated operating expenses (US$750,000 per month).

VI. Trade, Payments, and Exchange System

1. Exchange and payments system

Until March 1995, exporters were required to surrender a large portion of their foreign exchange earnings to the Government at highly appreciated exchange rates. Surrender requirements had been tightened in late 1993, ranging from 70 to 85 percent for strategic goods (including oil and cotton) and from zero to 65 percent for nonstrategic goods. The manat counterpart in exchange for surrendered foreign exchange earnings was supplied at the domestic price of the good, implying multiple exchange rates. Surrender rates were effectively reduced by 15-20 percentage points in April 1994, when the Unified Foreign Exchange Fund (UFEF) was established under the direct supervision of the President.

On May 24, 1994, the ANB began quoting the official exchange rate for the manat on the basis of a weighted average of exchange rates quoted by commercial banks. The exchange rate was effectively unified in March 1995 when the Government abolished the UFEF and discontinued the practice of surrender requirements at below market exchange rates. This practice was replaced by a temporary provision requiring all exporters to sell 30 percent of their foreign exchange proceeds in the BICEX at prevailing market rates. The BICEX rates are determined three times a week, and the official exchange rate is determined every Wednesday at the rate established at the Wednesday auction session. The official rate is only used for valuation purposes. Rates determined at the auctions apply to all noncash transactions and official transactions. This in essence also eliminated the earlier multiple currency practice subject to Article VIII.

Currently, resident and nonresident persons or enterprises may freely open foreign exchange accounts at banks in Azerbaijan. No declaration of origin of the foreign exchange is required. There are no restrictions on repatriation of foreign exchange by local nonresidents. However, limitations remain on the availability of foreign exchange for individuals for the payments of certain invisible transactions, including tourism allowances, 1/ as well as the remittances for family living expenses abroad. These limitations give rise to exchange restrictions maintained under Article XIV.

With regard to the correspondent accounts with other FSU countries, a distinction must be made between old (pre-1992) correspondent accounts and new accounts. The old correspondent accounts are now all inoperative and, while Azerbaijan has net debit balances under such accounts vis-à-vis Russia, Ukraine, the Kyrgyz Republic, and Tajikistan, such balances are currently under dispute. New correspondent accounts have been opened with central banks of other CIS countries, and in some cases, are not yet used. With regard to those accounts which are actually in operation, they are used for official payments and are not credited with the proceeds of current international transactions. Proceeds of current international transactions between residents of Azerbaijan and other CIS countries are directly channelled through correspondent accounts opened between commercial banks. Accordingly, the operation of the old and new correspondent accounts do not give rise to exchange restrictions.

2. Trade system

Although licensing requirements have been removed for non-strategic exports, exports of strategic goods were required to be licensed by the Ministry of Foreign Economic Relations until recently. At the time of the establishment of the UFEF, a Cabinet resolution on organization of foreign trade decreed that the Ministry of Economy would set minimum quarterly export quotas on strategic goods on the basis of production and domestic consumption estimates, in order to ensure a supply of foreign exchange to the UFEF. Realization of the export quotas was to be carried out through state orders.

Throughout 1994, most international trade was coordinated under the state planning system. With the elimination of the state order system as of January 1, 1995, the Ministry of Economy no longer issued export quotas. Until licensing requirements were removed in November 1995, export contracts had to be submitted to and approved by the Ministry of Foreign Economic Relations (MFER) as a control on export underinvoicing. Contracts were also analyzed by a special state committee, headed by the First Deputy Prime Minister, who reported monthly to the President. Although the MFER was required to approve or reject export licenses within a month, exporters reportedly encountered frequent delays. There are no license requirements for imports apart from a few commodities which are controlled for health, environmental, or security reasons.

As mentioned in Section III, export taxes were imposed in March 1995 on strategic goods whose domestic prices remained significantly below world levels, notably oil products and cotton. In addition, low import duties are assessed which vary by product but not by country of origin. Unless special permission is issued by the Cabinet of Ministers, exporters must present evidence of prepayment or coverage by an authorized letter of credit before the Customs will clear goods for export. As a result of the design of the export tax law--70 percent of the price differential between the domestic and export price is taxed away--this tax will automatically disappear as domestic prices reach world market levels.

Bilateral trade agreements with most CIS countries existed in 1994, and were carried out by the Ministries of Economy, Material Resources, and Foreign Economic Relations through the state order system. Since the beginning of 1995, the Government has significantly reduced its reliance on bilateral trade arrangements and many such agreements have become nonoperational. Although agreements exist with Turkmenistan, Iran, and Ukraine, these agreements are fulfilled by procurement through market mechanisms. According to the agreement with Turkmenistan, natural gas was supplied to Azerigas, the state gas company of Azerbaijan, at a price of US$80 per thousand cubic meters in exchange for light manufactures, oil equipment, and oil products valued at world prices. Since the quality of many of the manufactured goods supplied under this agreement is believed to be significantly below world standards, the effective price Azerbaijan paid for its natural gas was considerably lower than the contracted price. However, domestic arrears to Azerigas reduced its ability to procure goods in exchange for gas imports, resulting in an accumulation of large payments arrears to Turkmenistan during 1994. As mentioned before, these arrears were later rescheduled, and as regards shipments during 1995, Azerbaijan is now current in its payments. The bilateral payments agreement between Azerbaijan and the Islamic Republic of Iran gives rise to an exchange restriction as a result of settlement periods in excess of three months, but is currently covered under the temporary exemption decided by the Executive Board on July 20, 1994.

VII. Structural Reform

1. Price liberalization

Controls on most prices in Azerbaijan were lifted in January 1992. However, price restrictions on key commodities and services applied throughout 1994. Most importantly, prices for bread remained controlled by the Government. Freedom of price setting for agricultural products was also constrained by state procurement of major production items. In January 1995, the Government took an important step toward full price liberalization by announcing the abolishment of the state order system and the end of the bread price subsidy.

At present, prices of public utilities and petroleum products remain controlled. Prices of housing, rents, transportation fares, electricity, and other public utilities are administratively set and remain far below cost-recovery levels. On petroleum products, maintaining price regulations partly reflects the lack of a functioning regional market for oil products while production is highly monopolized domestically. Price setting in this area has aimed at reducing distortions by using world market prices as a standard. During most of 1994, however, prices of oil and oil products remained at 15-20 percent of the world market level. In February 1995, crude oil prices were tripled and in April 1995 subsequently doubled to US$45 per ton, corresponding to about 66 percent of the world market level. At the same time, prices of most oil products were raised to world market levels. In November 1995, the domestic price of crude oil was raised to US$65 per ton, equivalent to the world market level when adjusted for transportation costs. In connection with the April 1995 price increases, relative user prices of oil products were realigned toward the price structure prevailing at the world market in order to reduce the cross-subsidization of industrial oils by consumers who paid relatively high prices for gasoline products. The price of domestically produced natural gas has also been brought closer to production costs; in November 1995 it was raised to US$12 from US$3.5 per 1,000 cubic meters.

2. Privatization

A framework law on privatization was adopted in January 1993, but progress in this area has been slow. So far the privatization of the state property has been limited to the taxi cab fleet, unfinished construction and some housing (only 6 percent of the government owned housing stock, was privatized by October 1995). However, there has been progress in rendering the management of small state-owned enterprises into private hands through long-term lease arrangements. In particular, many shops, restaurants, small firms in manufacturing, and trade and service enterprises have been leased out. These firms are run as private enterprises and their ownership is intended to be transferred to the lessees under the new privatization law.

A number of steps to accelerate the privatization were taken in 1995. The Government has raised the status of the State Property Committee (SPC) by appointing a new chairman with the rank of Deputy Prime Minister. The SPC has redrafted the State Privatization Program for 1995-98, in close cooperation with the staffs of the World Bank and TACIS. The new program introduced substantive changes to the privatization strategy and eliminated a number of deficiencies and restrictions in the earlier draft. However, the initial program included provisions which were in contradiction with the provisions of several other laws, particularly the Privatization Law of 1991. In order to resolve these contradictions, an amended privatization law was passed by Parliament in September 1995. The new law requires the adoption of annual action plans for the implementation of the privatization program. A draft action plan for 1995-96 has been worked out by the SPC and it will be put into effect after the approval by the President.

The Privatization Law defines the method and scope of privatization. It classifies enterprises to be privatized according to their size, method of privatization, and the decision authority. It also sets out detailed procedures for the conversion of state-owned enterprises into joint-stock companies prior to their privatization, and the conduct of different methods of cash and voucher auctions. The law envisages the establishment of specialized investment funds for managing those stocks which the state would continue to hold in privatized enterprises. It also allows for the establishment of private voucher investment funds.

The Privatization Program covers almost all state property, including four large state banks. It does not apply to the privatization of the housing stock which is governed by the Law on Privatization of Housing of 1993, and land which would be covered by a Law on Land under preparation. Foreign investors are also allowed to participate in the privatization process albeit subject to some additional conditions and restrictions.

Enterprises and organizations to be privatized are classified into the following categories: (i) those whose privatization is prohibited; (ii) those whose privatization requires a decision by the President; (iii) those which would be privatized by the decision of the State Property Committee; and (v) those whose privatization is compulsory. Table 28 provides a selective list of enterprises in each of these categories. The law also classifies enterprises by their size into small-, medium-, and large-scale enterprises (Table 29).

Table 28.Selective List of Enterprises by type of Decision Required for Privatization
ProhibitedBy the decision of the PresidentBy the SPC with the consent of Cabinet of MinistersBy the SPC with the consent of local authoritiesThose privatization of which is compulsory
mineral and water resources, forests, resources on the continental shelf elements of historical and cultural heritage budget agencies; public health, veterinary, forest and plant protection institutions; patent, standards, and meteorology institutions public highways state breeding farms, crop/seed development and testing stations and farms social protection institutions; orphanages; dormitories/hospitals for elderly and disabled citizensstate property abroad defence industry; facilities of civil defence and mobilization; grain elevators, refrigerated storages, warehouses allocated for state reserves enterprises in the fuel, energy, and metallurgical complexes; chemical, petrochemical, biochemical, machine-building and metal works, tobacco and alcoholic beverages industries; telecommunications, TV and radio stations; rail, maritime, air, and high schools; institutions and enterprises of the Academy of Sciences, the Ministry of Health, and Ministry of Educationenterprises and organizations which are monopolies or have dominant market power; very large enterprises (>1,500 employees); building- material, construction, enterprises in the gas industry with national importance; highway maintenance/repair agencies; shares in commercial banks and financial institutions in which the state owns more than 25 percent of shares; enterprises and institutions of medical industry, health care, education, and culture; warehouses for medical equipment and Pharmaceuticals; scientific research, project planning, and survey institutions.public transportation enterprises; public baths laundries; waste and sewage processing facilitieswholesale and retail trade, catering and consumer services, enterprises and organizations; foreign trade associations and wholesale trade organizations of the Ministry of Material Resources; pharmacies; building-materials and construction enterprises and organizations; food and agroprocessing agricultural service and supply, agro- machinery enterprises; light industry, including cotton ginning, textiles, and silk processing enterprises; wood, pulp and paper enterprises; grain and bread combines, bakeries, mixed feed factories; highway transportation enterprises; shares in commercial banks and financial institutions in which the state owns less than 25 percent of shares unfinished construction; assets of liquidated enterprises.
Source: State Property Committee
Source: State Property Committee
Table 29.Azerbaijan: Classification of Enterprises by Size
Number of Employees
Source: State Property Committee
Source: State Property Committee

The program allows for mass privatization as well as case-by-case privatization. In the latter case, the state property can be sold for cash and privatization checks. As for mass privatization, every citizen of the Azerbaijan Republic will be given a “pai” (which means share in the Azeri language) which comprises four “privatization checks.” A total of 32 million privatization checks will be issued; they will be tradable, and can be used as collateral. The privatization checks will not carry a nominal value but will represent the entitlement to one out of 32 million shares of the state property to be privatized.

In addition to the privatization checks, the SPC will issue “privatization options” for foreign investors. Foreign investors will be required to submit “privatization options” in order to participate in cash and check auctions. The privatization options will also be tradable. However, unlike the privatization checks, they will have a nominal price which will be determined and published by the SPC on a monthly basis.

The privatization proceeds from cash auctions and the sale of privatization options to foreign investors will be transferred to the budget. However, these funds would be utilized in accordance to special expenditure programs to be approved by the President. These programs would include post-privatization support schemes and social safety net programs.

The two main methods of selling enterprise shares for cash and privatization checks are auctions and investment tenders. The most important difference between these two methods is whether the bids would be evaluated solely on the basis of the bid price or the bidders would be required to submit “investment projects” including business plans. In the latter case, the winner would be assessed on the basis of the “quality” of the proposed investment project. The winner would be required to deliver the commitments set out in the proposed project which would be enforced by the SPC.

The choice of the sales method would essentially determine whether the transfer of ownership would be through mass privatization or through a case-by-case method. The law gives the SPC a wide discretion in this respect; it has the authority to adopt the case-by-case method for most of the large-scale enterprises.

In the privatization of small-scale enterprises, the labor collective of the enterprise would have a leading role. The labor collectives would be responsible for preparing the inventory and revaluation of assets as well as preparing the privatization plan for the enterprise. The shares of small enterprises would be distributed as follows: (i) 15 percent to the labor collective at the start price to be paid in privatization checks and (ii) 85 percent for sale for cash through auctions and investment tenders. The labor collective would receive further concessions as they participate in auctions and tenders. Foreigners would be able to participate in the privatization of small enterprises only with the consent of the labor collective.

The privatization of medium- and large-scale enterprises will be led by Privatization Committees to be established separately for each enterprise. The composition and the responsibilities of these committees will be set out in regulations to be adopted by the SPC. These committees will include representatives of the management of the enterprise, the labor collective, and related ministries. They would be responsible for preparing the privatization plan and revaluation of the assets of the enterprise. After being approved by the SPC the privatization of the enterprise would proceed according to the plan which would include a proposed allocation of shares for different methods and buyers. This is required to be in line with the following distribution: (i) 15 percent to the labor collective at concessional terms; (ii) at least 50 percent to be sold for privatization checks through auctions and investment tender; (iii) 10 to 20 percent to be sold for cash through auctions and investment tenders; and (iv) up to 25 percent to be allocated to Guaranteed Reserve Investment Funds and Closed Investment Funds which would be established as state-owned specialized investment funds. 1/

As regards the divestiture of bank shares, the state-owned shares are to be auctioned for cash by the SPC according to a timetable to be agreed with the Azerbaijan National Bank. Regulations for the divestiture of these shares will be prepared by the Cabinet of Ministers and the ANB and approved by the President.

The implementation of the privatization program requires the adoption of a series of regulations. The SPC is currently preparing some 30 regulations. The adoption of a number of key regulations requires the President’s approval. In addition to the regulations, the SPC would need to finalize the inventory of state property to be privatized, decide on the organizational structure of concerns, associations, and state holding companies, and distribute privatization shares in order to be able to start the implementation of the program, particularly the privatization of medium-size and large enterprises.

3. Enterprise reform

The restructuring of the state owned enterprise sector is still at an initial stage. Most of the medium- and large-scale enterprises continue to be organized under dominant structures such as concerns, associations, and state holding companies. There are about 50 such organizations covering all the enterprises in the respective sector (e.g., machine-building, chemicals, foodprocessing, and light industry). In addition, some line ministries continue to have production and service enterprises under their tutelage. The existence of these structures has effectively prevented enterprises from becoming more market-oriented commercial units in their individual operations.

The new privatization law requires the State Property Committee (SPC) in cooperation with the Anti-Monopoly Committee, to review all the existing concerns, associations, and holding companies, and decide on their new organizational structure. This would also include a decision on whether to privatize shares of these umbrella organizations or to split them up to be privatized as separate entities. Moreover, the law charges the SPC with the restructuring of problem enterprises.

The tight money and credit policy that has been implemented since early 1995 has significantly hardened the budget constraints of enterprises, particularly of those in severe financial problems. However, these enterprises have survived, albeit at very low level of activity, by accumulating interenterprise and tax arrears. A large portion of increased interenterprise arrears has taken place since March 1995 and has been accumulated on account of nonpayment of energy bills by the final users--industrial enterprises, sovchozes and kolchozes, and households.

The main reason for the continuing increase in interenterprise arrears to above normal trade credit proportions has been the weak payment discipline with the lack of instructions to prohibit shipment of goods, particularly petroleum products, natural gas, and electricity, before securing either prepayment or guaranteed letter of credits. The old practice of suppliers requesting payments from the bank of the buyer continues to be in effect, and allows the accumulation of arrears in the accounts of enterprises. Although a bankruptcy law was adopted in late 1994, it has not been enforced.

4. Fiscal reform

Since a major overhaul of the tax system in 1992 and customs tariff reform in 1993, the most important fiscal reform has been the elimination of the foreign exchange budget in March 1995. At that time, with the elimination of foreign exchange surrender requirements, the Unified Foreign Exchange Fund (UFEF) was dissolved. The UFEF had been created in 1994 through the merger of four foreign currency funds administered by the International Bank. Its main source of revenue was the difference between the official exchange rate and the rate paid to exporters of strategic goods.

With the elimination of the foreign exchange revenue, new tax measures were needed to compensate for the revenue loss. For this purpose, a temporary export tax was set on those strategic goods whose domestic prices remained below the world market levels, mainly on oil products and cotton. Also, the VAT has been extended to non-CIS imports at a rate of 20 percent although many exemptions have undermined the performance of this tax. On the other hand, most exemptions on customs duties have been eliminated.

On the expenditure side, a marked reduction of subsidies has been the major structural reform in recent years. Food subsidies from the central government budget for butter, sugar, and meat were discontinued as part of the price liberalization process in 1993. More recently, bread price subsidies were eliminated in February 1995, and the associated implicit subsidy through importation of wheat by the Government was discontinued.

5. Financial sector reform

Successful macro-stabilization has exposed the weakness of the banking system. In the earlier environment of high inflation, the rapid erosion of the real value of loans allowed most borrowers to service their bank loans, while depositors suffered an erosion of their holdings. Now, with lower inflation and high real interest rates, notably the four large state-owned banks are facing an increasing burden of nonperforming assets in their loan portfolio. Already, due to a serious mismatch between its funding costs and the return on its lending activities, aggravated by an increasing amount of nonperforming assets, Amanatbank (the savings bank) faced sudden liquidity problems as it was unable to pay interest to its depositors. A package of measures was developed to address the problems of this bank. Its management was suspended, pending further investigation, and the bank was placed under direct supervision of the ANB and the Ministry of Finance. To alleviate the immediate cash flow problem, the Ministry of Finance extended a 10 year loan to the bank at market terms. Moreover, the bank’s deposit rate structure was adjusted downward to more realistic levels, taking into account the rate of inflation and the bank’s earnings, while depositors were asked to roll over their one month deposits into three month deposits. A work out unit was established to recover as much as possible of the existing loan portfolio. Recovered funds as well as newly attracted deposits were required to be channeled through the credit auctions, in order to improve the bank’s loan portfolio.

APPENDIX I Azerbaijan--Seigniorage and Inflation Tax

1. Introduction

The monetary authorities (the government and the central bank) can finance themselves by extracting resources from the public by means of creating base money. The total amount of resources collected through base money creation is referred to as seigniorage. The authorities have to be careful, though, in deciding how much seigniorage they want to capture, as excessive base money creation will ultimately result in higher inflation, which will erode the real value of the seigniorage captured. The term inflation tax normally refers to the erosion of base money by inflation. 1/ Holders of base money (ultimately the public) will loose a portion of their stock of real wealth as part of their money holdings is taxed away by inflation. 2/

With relatively low rates of inflation, the authorities will be able to capture a certain level of seigniorage, as the public will remain willing to maintain a level of real money balances, despite the inflation tax. However, with high rates of inflation, the public will become reluctant to hold money denominated in the local currency. They will seek ways to protect themselves from current and expected higher inflation rates by shifting into goods and foreign currencies. Thus, the base of the inflation tax will become smaller. To finance the same level of real expenditures the government will have to rely on an increasingly higher inflation tax to obtain the same real resources from seigniorage. Anyone who stays with the domestic currency will end up bearing a heavy inflation tax. Without a change in financial policies inflation will be bound to accelerate further, ultimately pushing the country into hyperinflation.

2. Determining the size of seigniorage and the inflation tax

Seigniorage is equal to the increase in base money:

where S is the amount of seigniorage and H is nominal stock of base money. The amount of real resources, S/P, which the authorities can extract by creating money can be determined in the following way, starting with Fisher’s identity of exchange:


where M is the nominal money stock, v is the velocity of money, P is the price level, y is real GDP, and m is the money multiplier (which is a function of the public’s preference for cash relative to deposits, and the level of funds banks are required and/or willing to hold at the central bank). Differentiating equation (3) gives:

with p^=(ΔP/P),y^=(Δy/y),v^=(Δv/v), and m^=(Δm/m), and with y/(m·v) being equal to H/P, and P/(m·v) to y/H, rearranging results in:

The first part of the right-hand side of equation (5) is the inflation tax, T, which equals the product of the inflation rate (p^) and real base money (H/P). 1/ The second part represents the demand for real money balances. Equation (5) shows that the authorities can extract more real resources from the public by raising the inflation tax. However, higher inflation will cause the public to move away from the domestic currency, resulting in a decline in the demand for real money balances and a higher velocity. This reduces the amount of real resources that can be captured. When the inflation rate is zero, revenue form the inflation tax is also zero. As inflation increases, the tax base–the demand for real money balances–goes down. Assuming a steady rate of inflation, there is a maximum amount of real resources S/Pmax the authorities can extract, with an inflation rate p^max (Chart 1). Further increases in the rate of inflation bring about a drop in revenue, because the higher revenue from the inflation tax is more than offset by a fall in the demand for real money balances that are being taxed. However, the authorities may temporarily obtain resources higher than S/Pmax, but at the cost of accelerating inflation. If the authorities persistently try to finance a deficit by creating money higher than S/Pmax, this will lead to hyperinflation.

Chart 1AZERBAIJAN Seigniorage and Inflation Tax

Sources: Azerbaijan National Bank; and IMF staff estimates.

The inflation tax is often expressed as a percentage of real GDP:

Assuming that the GDP deflator and the consumer price deflator are equal, the result is the same if nominal base money and GDP are used.

3. Seigniorage and inflation tax in Azerbaijan

In Azerbaijan, during the period from 1992 until the end of 1994 the authorities were continuously extracting real resources from the public by creating money, in order to finance the public sector deficit. Given the relative inexperience of the public with high inflation, such an inflationary strategy was possible for some time. In the first half of 1993, with an average inflation tax of 25 percent of GDP, the amount of seigniorage captured was on average nearly 35 percent of GDP (Table 1). However, as people developed their understanding of the inflationary process, they started to move away from the domestic currency in order to protect themselves from future inflation. Reflecting the declining confidence in the domestic currency, the velocity of manat broad money tripled from mid-1993 to end-1994. Real money balances fell dramatically in late 1993 and in 1994 and shifted almost entirely to currency. The level of seigniorage that was captured by the authorities fell with it. As can be seen from the last quarter of 1993, the inflation tax had to be much higher than in the preceding quarters to still bring in an equal amount of resources. In 1994, with an average inflation tax nearly as high as in 1993, the amount of seigniorage that was captured nearly halved. At the end of 1994, real manat balances had fallen by more than 80 percent since end-1992, while household and enterprise real deposit balances had fallen by more than 90 percent. Assuming that households hold most of the currency in circulation, households lost roughly 30 to 40 percent of their disposable income due to the inflation tax in 1993 and 1994.

Table 1.Azerbaijan: Seigniorage and inflation tax

(in millions of manats, unless indicated otherwise)


Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3 1/
Manat base money3,5199,40118,03420,91043,50770,784118,568203,566323,132455,552570,042695,700
Seigniorage in manats (quarterly)5,8828,6332,87622,59727,27747,78484,998119,566132,420114,490125,658
Seigniorage in % of quarterly GDP39.
Inflation tax in manats(quarterly)3,4727,3467,96536,21148,67174,59644,676437,950153,06642,23030,178
Inflation tax in % of quarterly GDP23.127.113.956.532.824.79.737.
Real base money (index Dec 1992 = 100)100.0134.5144.8116.588.768.155.669.334.933.438.244.3
Manat broad money9,35814,81729,34840,39773,541111,622161,095264,162431,036580,179750,155863,480
Currency outside banks2,7226,61114,39118,83543,18759,716103,296172,080276,127366,109460,933545,849
Manat deposits6,6448,20614,95721,56230,35451,90757,79892,082154,910214,070289,222317,631
Enterprise deposits4,8126,24313,50017,95624,08342,94746,65668,380115,587141,442203,003
Household deposits1,8241,9631,4573,6066,2708,96011,14223,70239,32372,62886,219
Real manat broad money (index Dec 1992 = 100)100.079.788.684.656.440.428.433.817.516.018.920.7
Real manat deposits (index Dec 1992 = 100)
Real enterprise deposits (index Dec 1992 = 100)100.065.379.373.135.930.
Real household deposits (index Dec 1992 = 100)
Memorandum items
Nominal GDP(quarterly)13,65715,05627,15757,46664,138148,294302,546458,2621,169,1211,995,0002,009,2961,907,011
Inflation(percent, quarterly)133.498.778.144.2173.2111.9105.437.7215.
Inflation (index Dec 1992 = 100)100.0198.7353.9510.21393.82953.16065.18350.426315.538781.042376.044619.4
Velocity of manat broad money (ratio)4.984.926.594.506.418.888.6213.4515.7812.089.45
Manat money multiplier (ratio)2.661.581.631.931.691.581.361.301.331.271.321.24
Sources: Azerbaijan National Bank, Azerbaijan State Committee of Statistics; and IMF staff estimates.

Manat broad money and GDP figures are estimates

Sources: Azerbaijan National Bank, Azerbaijan State Committee of Statistics; and IMF staff estimates.

Manat broad money and GDP figures are estimates

In early 1995, the authorities dramatically changed their financial policies and reduced their reliance on inflationary financing. Inflation came down rapidly, and with it the inflation tax. This lead to a gradual recovery of the public’s confidence in the domestic currency. Reflecting the public’s growing willingness to hold manat balances, the velocity of manat broad money started to decline and real manat balances began to increase. As a result of the increasing willingness to hold manats, the level of seigniorage that could be captured in the first three quarters of 1995–on average 6.3 percent of GDP–was actually higher than the inflation tax, which declined to an average of 3.8 percent of GDP. With a significant fall in inflation, it is estimated that only 3-5 percent of households’ disposable income will be taxed away by the inflation tax in 1995.

4. Experience in other countries

Other countries in the region also used to rely heavily on inflationary financing of the budget, causing accelerating inflation and a loss of confidence in the domestic currency. As a result, the amounts of seigniorage captured did not keep up with the inflation tax (Table 2). An extreme example is Georgia, where the data for the past few years suggest a relatively modest inflation tax, compared to other countries. However, hyperinflation fueled by excessive monetary expansion sharply reduced the real demand for the Georgian coupon. Consequently, the authorities’ ability to extract seigniorage dwindled. With less reliance on inflationary financing, inflation rates have come down recently in these countries, resulting in a decline of the inflation tax, while–as confidence is gradually restored–the decline in the amounts of seigniorage that the authorities were able to capture was much lower.

Table 2.Inflation tax and seigniorage in selected countries

(In percent of nominal GDP)

1992199319941995 1/




Source: IMF staff calculations.

First half of 1995.

Source: IMF staff calculations.

First half of 1995.

Appendix II Oil and Gas Taxation in Azerbaijan

This appendix examines Azerbaijan’s taxes on the oil and gas sectors in 1994. It appears that, the tax burden on the petroleum sector is lower than in other major petroleum producing countries.

The tax burden on the oil and gas sectors in Azerbaijan could be expected to be well above the burden on the overall economy, first because the government is both the sovereign tax power and the resource owner, and, second because, in countries with relatively poor tax administration, the energy sector often provides a relatively easy tax handle with which to extract revenue.

In 1994, oil revenues to the budget were derived through value added taxation, excise taxes, the enterprise profits tax, the road tax, and the system of surrender requirements (replaced by a temporary export tax in March 1995). The road tax, the collection of which is earmarked to the Road Fund, applies to sales of gasoline, diesel fuel, compressed gas and lubricants, and is levied on the price exclusive of the VAT. Excise taxes on petroleum products, which apply only to domestic sales, were levied at rates ranging between 17 percent and 72 percent in 1994. A royalty on petroleum applied in 1994 at a specific fixed amount rate of 13.7 manat per metric ton for offshore oil and 7.6 manat per metric ton for onshore oil.

Table 1 shows country specific data on oil revenues and the importance of the oil sector in a sample of seven oil producing countries (Indonesia, Kuwait, Nigeria, Russia, Saudi Arabia, United Arab Emirates, and Venezuela). The relative tax burden on the oil and gas sectors, is defined as the ratio of oil and gas revenues to total revenues, divided by the share of the oil and gas sectors in GDP.

Table 1.Azerbaijan: Selected Energy Producing Countries: Government Revenue from Oil and Gas Producers, 1994
Oil and Gas RevenuesOil and Gas


Share of GDP


Percent of

Total Revenue
Percent of

Saudi Arabia74.021.735.12.1
United Arab Emirates77.522.333.62.3

The table indicates that the relative tax burden in Azerbaijan is 1.0, well below those in other countries in the sample, with the exception of Russia. In all other countries, the relative tax burden varies between 1.7 and 3.1.

The main reason for the low tax burden in Azerbaijan lies in the divergence between notional and actual tax liabilities. Table 2 contrasts notional tax liabilities for the petroleum sector--based on the tax provisions–with the actual revenues from the oil sector, and indicates the ratio of these two measures. The ratio averages 43 percent for the sector as a whole, with particularly low ratios for the royalty and road tax, which are close to zero.

Table 2.Azerbaijan: Notional Versus Actual Tax Burden on the Oil and Gas Sectors, 1994
(In billion manats)(In percent)
Total oil sector revenues224.997.343
Value added tax54.613.124
Excise taxes43.513.531
Enterprise profit tax39.214.938
Surrender requirements74.355.775
Road tax13.00.11
Royalty0.3- -- -
Appendix III The Oil Contract and the Balance of Payments


Under the central planning system Azerbaijan was an important supplier of refined products to other republics of the Soviet Union. By importing natural gas from Turkmenistan to fuel its power stations, Azerbaijan was able to export significant quantities of its own processed crude oil as well as processed crude oil imported from Russia and Kazakhstan. After the breakup of the U.S.S.R. in late 1991, CIS countries sought to preserve the trade relationships in energy products through a network of bilateral trade agreements at prices well below world market levels. Beginning in 1992, however, suppliers of crude oil and natural gas began to curtail their shipments to Azerbaijan while raising prices sharply toward world levels. Crude oil imported from the CIS fell from 4.3 million tons in 1991 to about 240,000 tons in 1993 before increasing again to 900,000 tons in 1994. Net imports of natural gas fell in the same period from 8.2 bcm to 2.5 bcm.

As a result, the quantity of refined oil products that Azerbaijan was able to export to CIS and non-CIS markets declined sharply, from 8.1 million tons in 1991 to 1.8 million tons in 1994. This decline in exports resulted in a substantial reduction in the value-added by the refining industry.

While energy consumption in Azerbaijan has fallen with declining industrial production, there has also been a steady reduction in crude oil production associated with the poor maintenance and advanced state of depletion of Azerbaijan’s mature fields. Also, the sharp decline in imports of natural gas from Turkmenistan has sharply reduced the availability of gas for power generation, forcing most power stations to switch to fuel oil. The use of oil in power generation rose from about 48 percent in 1991 to 86 percent in 1994, with a corresponding fall in the availability of oil products for exports. While Azerbaijan remains a net exporter of oil products, its trade in energy has been in broad balance recently as oil exports are balanced by natural gas imports.

Balance of payments effects

While the low sulfur content of the Azerbaijani crude oil allows substantial quantities of diesel fuel to be exported to world markets, Azerbaijan’s energy trade balance has remained precarious as the exports of oil products have been constrained by declining crude oil production and the need to import natural gas has increased rapidly. Recent efforts to increase domestic gas production by capturing some of the natural gas previously being vented into the atmosphere will help to improve slightly the energy balance in 1995, but will not by themselves reverse the trend of declining domestic production of energy products. With the long term decline in production of Azerbaijan’s mature oil fields, the prospects in the oil sector are dominated by the development of its new deep-water oil fields in the Caspian Sea. Azerbaijan’s oil extraction industry has lacked the technology to access these fields on its own. In September 1994, the government signed a contract with a Consortium of 11 international oil companies for the development of its Azeri, Chirag, and deep-water Guneshli fields. 1/ The contract specifies US$7.5 billion in total investments over 15 years to take place in two phases, with the first phase involving investments in the existing Chirag field and the second phase involving the development of the new fields.

Investments in the first phase began in 1995 and are projected to result in “early” crude oil exports as of 1997, mostly through small investments to existing infrastructure. The second phase investment begins upon pre-commitment on a main pipeline route permitting oil produced from the new fields to be exported to western markets. This precommitment could be obtained in late-1997, with oil exports through the main pipeline beginning in 1999. In March 1995, SOCAR sold one half of its initial 20 percent share in the consortium to Exxon and the state oil company of Turkey. As a result, the entire US$7.5 billion investment will be fully financed by the foreign members of the oil consortium.

The production sharing contract stipulates that the oil production net of operating costs, finance charges, and capital recovery is to be split between the consortium members and the Azerbaijan government. The government’s share of this total will range from 20 percent to 80 percent, with the government’s share increasing the larger the rate of return for the project (depending mainly on the world oil price) and the lower the costs of transporting the oil. The structure of the arrangement results in a quick recovery of capital costs so as to reduce the exposure of the consortium members.

Table 1 shows the balance of payments flows resulting from the project’s investment and production in the case that there are no delays in implementation (Chart 12/). Gross crude oil output will increase rapidly reaching 33 million tons (roughly US$3.5 billion) by 2006. Given the assumptions on the rate of return and transport costs, the share of gross crude oil production captured by the government is likely to remain at about 30 percent until the project’s investment capital is paid back, possibly by 2005. Thereafter, the government’s share increases sharply to about 60 percent. Total net foreign exchange inflows--including net investment inflows, domestic operating costs, profits retained by the government and SOCAR, profit taxes on the other consortium members, and signing bonuses paid to the government--are projected to average at about US$100 million per year through 1998 and to increase sharply to over US$2 billion per year beginning in 2006.

Table 1.Azerbaijan: Balance of Payments Effect of the Oil Consortium Production Sharing Contract
Investment (in millions
of U.S. dollars)
Oil investment852856408001,200980994698650579243- -- -- -- -- -- -- -- -- -- -
Of which: foreign852856408001,200980994698650579243- -- -- -- -- -- -- -- -- -- -
Imported goods and services-68-228-512-640-960-784-795-558-520-463-194- -- -- -- -- -- -- -- -- -- -
Bonuses1432711228- -- -91- -- -- -- -- -- -- -- -- -- -- -- -- -- -
Production (in million tons)
Gross production13610141923293233333333333232313130
Operating costs and
capital recovery- -- -1235791215163333333333
Of which: domestic costs- -- -- -
Profit- -- -
Government share
(before tax)- -- -
Consortium share- -- -
Profit tax- -- -
Net profit- -- -
Of which: SOCAR- -- -- -
Net inflow to economy- -- -- -124578101121212121212121202019
Of which: government- -- -- -12346791019191919181818181717
Total net foreign exchange inflow
(In millions of U.S. dollars)160842802974725577768149551,1571,1972,1482,1482,1482,1482,1272,1062,0852,0432,0021,962
From investment1608424018824019629014013011649- -- -- -- -- -- -- -- -- -- -
From production- -- -401092323614866758251,0411,1482,1482,1482,1482,1482,1272,1062,0852,0432,0021,962
Sources: World Bank; and IMF Fund staff estimates.
Sources: World Bank; and IMF Fund staff estimates.

Chart 1AZERBAIJAN Oil Contract

Sources: Data provided by Azerbaijan authorities.

Delays in implementation could, however, alter these flows. Proposals for the main pipeline route for exports of later oil include routing through Russia (Chechnya) to the Black Sea, through Iran, through Georgia and through Turkey. 1/ In addition to the oil fields now opened up to the consortium, several new fields are likely to be tendered before the end of the decade. At least one major field (Shach Deniz) holding the potential for several hundred million tons of oil is ready to be drilled, and negotiations are underway with foreign companies for exploration rights. Production of this field could possibly come on stream within ten years. In addition, there is judged to be a high probability of further large oil discoveries in the Caspian.


Several caveats are appropriate when interpreting real sector developments in Azerbaijan. Macroeconomic statistics remain very deficient, in spite of technical assistance from the IMF, the OECD, and other international organizations. While the national accounts are now compiled according to the System of National Accounts (SNA) classification, the calculation of both nominal and real GDP are plagued by deficiencies, both in terms of methodological accuracy and coverage. Price statistics are virtually nonexistent, with the notable exception of the Consumer Price Index (CPI). Labor market data remain inadequate because a systematic recording of the labor force is lacking. Data regarding the emerging private sector are scarce and not systematically collected.


Since Azerbaijan does not export or import crude oil, changes in crude oil production are largely reflected in the aggregate refinery output.


Measured as the value added of oil and natural gas exploration, exploitation and primary distribution.


Indeed, the sectoral classification of Azerbaijan’s National Accounts has no explicit entry for services.


Until recently, the State Statistics Committee did not report wages in the oil sector separately but as part of the industrial sector. This explains why industrial wages in Table 13 are relatively high.


The central bank, which is a fiscal agent for the Government, honors payment orders only to the extent that funds are available in government accounts (see Section IV).


Although there were no formal restrictions on the conversion of deposits into currency, shortages of banknotes often posed a de facto restriction during most of 1994. At the end of 1994 the cash shortage was ended due to the arrival of large shipments of banknotes.


As the exchange rate stabilized in early 1995 and the closure of Azerbaijan’s northern trade routes made it more difficult for the charity organizations to operate, they went under and investors lost their deposits.


In March US$70 million of the oil signature bonus was added to the ANB’s international reserves, followed by another US$10 million in July. The manat counterpart of these funds was placed on a government deposit account at the ANB and used gradually to finance the budget.


This is the compounded rate. The rate quoted by the ANB is uncompounded, while interest is charged quarterly.


The availability of reliable balance of payments data is limited, particularly until 1993. In 1994, the authorities began monitoring external trade based on customs data instead of enterprise surveys, which significantly improved the coverage of the external trade. The ANB has also begun estimating trade in services on a quarterly basis. Despite these recent improvements, data deficiencies remain, particularly for items in the capital account, unrecorded shuttle trade and humanitarian aid, and the operations of the oil consortium.


Foreign exchange up to US$1,000 is freely granted, and between US$1,001 and US$5,000 upon presentation of documents.


Guaranteed Reserve Investment Funds (GRIFs) would be established by the SPC as open-end investment funds which would pool together shares in SOEs, joint-stock companies, joint-ventures, and financial institutions (not to be less than 50 million shares). They would issue their own shares per each stock in their portfolio. These shares would be auctioned for cash. Moreover, GRIFs would be able to issue securities to raise financing for priority investment projects. Closed Investment Funds (CIFs) would be established as closed-end investment funds to attract foreign (portfolio) investment. CIFs would be allocated with shares in privatized MLSEs. They would not trade these shares, but would issue their own shares to be sold to foreigner only.


See for example: Stanley Fischer, “Seigniorage and the Case for a National Currency”, Journal of Political Economy, Volume 90, no. 2 (1982), pp. 295-313; Ronald I. McKinnon, The Order of Economic Liberalization: Financial Control in the Transition to a Market Economy, (Baltimore: John Hopkins University Press, 1993); Jeffrey D. Sachs and Felipe Larrain B., Macroeconomics in the Global Economy, (Englewood Cliffs: Prentice Hall, 1993).


The notion of the inflation tax can be extended to cover the loss in the real value due to inflation of all of the public’s money holdings and holdings of government debt, if the interest paid on these assets is negligible in relation to the rate of inflation. In that case, assuming a steady money multiplier, the inflation tax on broad money can be approximated by multiplying the inflation tax on holders of base money by the money multiplier.


No correction for interest payments on banks reserves was necessary in the case of Azerbaijan, because no interest is paid on banks’ required and free reserves held at the central bank.


The consortium consists of the State Oil Company of the Azerbaijan Republic (SOCAR) which now holds a 10 percent share in the project. The other remaining consortium members are BP, Amoco, Pennzoil, Unocal, Statoil, Lukoil, McDermott, Ramco, Exxon, TPAO, and Delta.


The net production flows exclude the added production of natural gas derived from the extraction of oil. This production is expected to be significant, reaching over 6 bcm per year. Rights to this gas production are likely to be distributed among the consortium members.


In October 1995, the consortium decided to transport the early oil to world markets partly through an existing pipeline network of Russia, and partly through a new pipeline via Georgia.

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