Macroeconomic Situation

Before 1991, Azerbaijan’s economy was part of Soviet Union. As a result, very large enterprises active in the oil exploration and extraction industry, agribusiness (especially cotton, cereal, livestock, fruit, tobacco and tea) and the industrial sector (including metallurgical, chemical, petrochemical and oil services/machinery) dominated the economy. A large part of Azerbaijan’s industrial and agricultural production was exported to other Republics in the form of raw materials, semi-finished goods, and component parts, resulting in a significant underutilization of Azerbaijan’s economic potential and a situation of high dependency. As a result of its structure, the country’s economy suffered from the sudden separation from Soviet markets and the drop of demand.

The economy went to trough a severe decline until 1995. Since 1995 3 government programs aimed at providing macroeconomic stabilization, structural adjustment and resumption of economic growth have been implemented. Government reforms consisted of several major components: macroeconomic stabilization through responsible fiscal and monetary management; economic liberalization through the removal of production control and the liberalization of domestic and foreign trade regimes; and small-scale privatization.

As a result of stabilization policies implemented since 1995, recovery began from the second half of 1996 and accelerated until late 1998, with 5.8 percent growth of real GDP in 1997 and 10 percent in 1998. Growth slowed to 7.4 percent in 1999 in the context of the decline in global economic activity, as well as the Asian and Russian crises. Excess oil capacity in world markets also had a serious effect on the Azeri economy in 1999. Higher oil prices led to a new acceleration of growth to 11.1 percent in 2000, 9.9 percent in 2001, and 10.6 percent in 2002.

Price stability and currency convertibility were restored and maintained in a manner unparalleled in the countries of the CIS. As a result of the Central Bank’s tight monetary policy, the dramatic hyperinflation characteristic of 1991 – 1995 period, which reached approximately 1,660 percent in 1994, was eliminated. Inflation decreased to 3.6 percent in 1997 and remained negative throughout 1998 and 1999. Inflation stayed low in 2000 at 1.8 percent, 1.5 percent in 2001, and 2.8 percent in 2002.

Most importantly, the economic turmoil since independence caused dramatic shifts in the origins of GDP. The industrial sector accounted for 23.6 percent of GDP in 1991 but comprised 34.9 percent of GDP in 2002, due mainly to the oil sector. The size of the transport and communications, trade and construction sectors, all affected by the boom of the oil industry, has also increased. By contrast, agriculture was 30.4 percent of GDP in 1991, but fell to 14.2 percent in 2002, even if it remains the largest employer and its share of employment still rising.

Overall, GDP recovery was due mainly to the oil sector, the driving force of the economy. In order to reverse the output decline in oil production that took place after 1987, the government adopted a liberal policy to attract foreign investment in the oil and gas sector. In September 1994, the state oil company, SOCAR, signed the first 30-year Production Sharing Agreement (PSA), called the “contract of the century”, with an international consortium of oil companies, the Azerbaijan International Oil Consortium (AIOC) to develop offshore oil fields in the Caspian Sea subsequently another 20 similar agreements were signed.

Initially, the impact of the booming oil sector on overall economic growth was due mainly to foreign direct investment inflows in oil equipment and related activities, such as construction. Consequently, the construction sector played the dominant role in the early recovery period. Growth in the construction sector was impressive: the share of this sector reached 13 percent of total GDP in 1998 (compared to 3.7 percent in 1995). The volume of foreign investments into construction sector for 2002 was about 50 mln US $. From early 1999 oil extraction increased rapidly, boosted by the activities of the AIOC’s new offshore wells. The second recovery period was characterized by faster industrial growth due to expansion in oil extraction, refining and transportation.

Performance across non-oil sectors varied significantly. With only modest growth in recent years, production in the non-oil industrial and agricultural sectors has not recovered to preindependence level however changes in trends and structure of the production provide strong basis for speedy growth.