Natavan Mammadova and Narmina Mamishova
20 September this year celebrates the quarter-century anniversary of the historic “Contract of the Century.” Signed in Baku between the Azerbaijani government and the consortium of 11 leading international oil com-panies from six nations under the umbrella of the Azerbaijan International Operating Company (AIOC), the Contract of the Century pledged to develop the rich Azeri-Chirag-Gunashli (ACG) deep-water oil fields. The sonorous name ascribed to the agreement reflected its tremendous importance, and not only because of the fields’ huge potential reserves. The contract represented the first major investment by Western multinational companies in any country of the former Soviet Union and brought a strategic European and Euro-Atlantic interest to the small Caucasian country for the years to come.1 It marked a clear success for then-President Heydar Aliyev, leading a newly-born state with more than 20 percent of its territories occupied by neighboring Armenia and over one million refugees and internally displaced persons. The contract also promised Azer-baijan substantial foreign investment flows.2 Lo and behold, having world market giants – British Petroleum, Amoco, Penzoil, Unocal, Statoil, McDermott, Ramco, and others – investing here was Azerbaijan’s first signif-icant post-independence achievement.
Azerbaijan developed its first offshore Production Sharing Agreement (PSA) for an initial $7.4 billion investment over 30 years in the three major oil fields in its sector of the Caspian Sea3. But how did this journey towards prosperity begin? It started in November 1997, when the first, “early” crude oil was produced under the historic deal to be exported later via the low-capacity Baku-Supsa pipeline to the Georgian Black Sea Port of Supsa; the Baku-Tbilisi-Ceyhan (BTC) pipeline, which stretched across Georgia all the way to the Turkish Mediterranean coast, and earned the nickname of the “oil window to the West;”4 and the Baku-Novorossiysk pipeline across the Caucasus to Russia’s Black Sea port. Azerbaijan enjoyed a “golden age” in the late 1990s and early 2000s, benefiting from its new oil wealth and the inflow of foreign investment into the sector. The numbers speak for themselves—so far, more than 3.5 billion barrels of oil have been extracted from Azeri oil fields, and more than $36 billion has been invested in the country.5 With oil money now flowing into the state coffers, President Heydar Aliyev initiated the establishment of the State Oil Fund of the Azerbaijan Republic (SOFAZ,) the purpose of which was to accumulate and efficiently manage oil revenues for future generations. The assets of SOFAZ reached $37.6 billion two decades after the contract had been signed.6 This was the “peace before the carnage,” when the world-market oil price collapsed for the second time in 2014.
In many ways, 2014 marked the end of the epoch during which Azerbaijan played its “energy card” alone. The unprecedented increase in oil prices between 2000 and 2008, which was mainly caused by a boom in demand and stagnation of production, led to a sharp increase in revenues. It was in 2008 when the world witnessed the oil downcycle against the backdrop of the Global Financial Crisis, aka The “Second” Great Re-cession, with oil prices dropping from historic highs of $144.29 in July 2008, to $33.87 five months later.7 After reaching deep lows they peaked in the first quarter of 2011 and fluctuated within a narrow band around $105/barrel until June 2014, when they began to plummet again.8 This was how the miracle met its demise. While fluctuations in the oil prices over the last few years remained “modest,” no major deviation from the trend was expected.9 Despite the accumulation of significant revenues from crude oil exports and remarkable economic growth over almost two decades, Azerbaijan’s economy was hit hard by another dip in global oil prices, leading to a period of painful economic adjustments10, including national currency devaluation, drop in GDP, and increase in public external debt-to-GDP ratio. While the availability of the State Oil Fund reserves would mitigate the risk of financial and macroeconomic collapse in the short run, Azerbaijan’s government moved to change course and marshal its efforts to fight off the budding “Dutch disease.” In short, Azerbaijan began to adapt to the new circumstances of the world economy.
Apparently, the overall agility of regional and global geo-economics, and the volatility of oil prices—perhaps more thought-provoking in the case of the oil-based economy—have in recent years created a brand-new geo-economic reality for Azerbaijan. The solution to Azerbaijan’s predicament was hiding in plain sight: develop the non-oil economy. Azerbaijan began to shift away from its traditional approach, based largely on the distribution of oil revenue, in favor of developing other sectors of the economy. President of Azerbaijan Ilham Aliyev approved the Strategic Road Map on National Economy and Key Sectors of the Economy of Azerbaijan On December 6, 2016, in order to provide a framework to ensure the economy’s competitiveness and inclusion.11 The document covered national economic perspectives and strategic road maps on eleven priority economic sectors, including agriculture, tourism, information and communication technologies, heavy machinery and manufacturing, logistics, and trade. This was an action plan to rebalance the economy’s structure through investing in the private sector, rather than the public sector, and encouraging technology-intensive sectors, inter alia. The Strategic Road Map placed a special emphasis on attracting more non-oil foreign direct investment (FDI) – with the “milestone” of at least four percent share in GDP by 2025, compared to 2.6 percent in 2015. This marked a positive and practical step to ensure Azerbaijan’s economic future would be diversified and robust.
Baku has learned from past lessons since then. Its far-reaching economic measures accompanied by institutional and administrative reforms are being recognized. An example that illustrates the country’s positive momentum is the 2019 World Bank’s “Doing Business” annual report, analyzing the world economies’ regulations that encourage business activities and those that constrain them. It ranked Azerbaijan among the top 10, “showing the most notable improvement” with the proud number four.12 The overall World Bank “ease of doing business rating” places Azerbaijan at 25, making a jump of 32 spots. Azerbaijan implemented as many as eight reforms to make it easier to conduct commercial business in the country—a record number among the 10 top improvers and globally. Among them were opening a single window at the Baku City Executive Office for dealing with construction permits to streamline their processing; establishing an ASAN (reads like “easy”) Communal facility to facilitate more reliable power supply and transparency of tariff information alongside with improved and less costly process efficiency; creating a new credit bureau to improve the sharing of credit information; and starting a new unified collateral registry to develop access to credit, making resolving insolvency easier by providing for the avoidance of preferential transactions.
The Azerbaijani government is focused on improving the ease of doing business in the country, including foreign investors. A clear success of the State Agency for Public Service and Social Innovations and its one-stop-shop “ASAN-services” is the ease in getting visas. The citizens of the CIS countries are visa-exempt, while the majority of global travellers may obtain an e-visa within three working days. Citizens of a number of countries (particularly countries of the Middle East since February 2016) are entitled to obtain a single entry visa at all international airports upon arrival. As a result, one may see the Gulf States, particularly Saudi Arabi and Iraq, becoming larger investors in Azerbaijan.13 The multi-faceted reforms that might benefit a foreign investor already in Baku include the strengthening of minority investor protections and requirements of greater corporate transparency; the introduction of electronic invoicing (e-invoicing) along with simplified tax-compliance processes and a decreased number of tax filings; the streamlining of electronic customs procedures and implementation of the “green corridor” gating system in order speed trade across borders; and the new rules on redundancy to cut down on red tape.
Since January 2016, Azerbaijan has introduced far-reaching incentives for entrepreneurs to receive investment-promotion certificates. These measures include numerous tax and customs preferences valid for seven years from the date of the certificate,14 including 50 percent exemption on corporate income tax and personal income tax for legal entities and individuals accordingly, and exemption from fixed assets and land tax, as well as from customs duties for construction, and research and development purposes. Another achievement of the “self-help” economic policy of the Azerbaijani government is a recently launched Free Trade Zone in the Alat township of Baku’s Garadagh district, which has given life to a special customs regime eliminating tariffs on goods, plants or machinery imported into the zone. In parallel, “latent” institutional reforms in the country, which include expanding coverage of one-stop-shop “ASAN-services,” and establishing the Financial Mar-kets Supervision Authority, the Agency for Development of Small and Medium-Sized Enterprises, the Food Safety Agency, and the Energy Regulation Agency, as well as others, has strengthened Azerbaijan’s appeal to foreign investors. Together with progressive judiciary reforms, growing public-private dialogue, and political stability, these changes give hope for Azerbaijan to turn, step by step, into a trustworthy non-oil FDI destination.
Oil will remain the Azerbaijani economy’s top economic engine, accounting for 84.3 percent of FDIs15 as of early 2019, especially with the celebrated “Contract of the Century” recently extended until 2050. The new deal would secure large investment in Azerbaijan’s oil sector for decades, because there are still “billions of barrels to recover and billions of dollars to invest,” with a specific focus on a brand-new production platform (Azeri Central East) which will be commissioned in the 2020s.16 This is good news, but the story is far from over. Hopefully, Azerbaijan will be able to “have its cake and eat it too” by pushing for growth in the non-oil sector. Non-oil FDIs in Azerbaijan are increasing, albeit moderately. This means there is a lot to be done to encourage the country’s economic diversification – starting with developing greater human capital through needed investments in health and education, improving competition and protection of property rights, and mitigating continued exchange rate risks. At the same time, concerted efforts of all stakeholders – be it technical assistance on the main macroeconomic policy areas from the international financial institutions or political support from partnering countries – are badly needed to back up Azerbaijan in its endeavours to increase attractiveness in the eyes of foreign businesses.