Youri Smakouz
Azerbaijan is a major energy exporter. It is also one of the most
oil-dependent economies in Eurasia and has been hit hard by lower oil
prices. If the current fiscal trends persist, regional stability is
likely to come under growing threat.
The country’s 2015 budget, which envisaged a high level of spending
on infrastructure projects, was drawn up under the assumption that the
average oil price would be $90 per barrel. Now the oil price is hovering
around $60 per barrel and previously envisioned levels of state
spending do not seem sustainable, at least in the near term. As a
result, the government must confront austerity.
Initially, the government insisted that the planned level of
expenditure could be maintained despite the reduced oil revenue.
However, oil and gas exports are simply too important for Azerbaijan:
they account for 95 percent of the country’s exports and more than 70
percent of revenue. Budget cuts, then, seem unavoidable in the near
future.
Already, the Azerbaijani government has had to react to lower energy
prices. The first move came on February 21, when the Central Bank of
Azerbaijan (CBA) devalued the local currency, the manat, by 33.5 percent
against the US dollar and 30 percent against the euro. The regulator
claimed this was necessary “in order to support diversification of
Azerbaijan’s economy, strengthen its international competitiveness and
export potential, as well as to provide balance of payments
sustainability.”
The devaluation came as a shock to many Azeris. Retailers increased
their prices shortly after the Bank’s move, and further price hikes are
anticipated. Economists expect an increase in the cost of most food
products, public transport and utilities, a development that would
likely intensify discontent among the population. Several small protests
have occurred in Baku and Lankaran, a city on the Caspian coast near
the Iranian border.
The devaluation is forcing officials to revise state budget
parameters. While the government is expected to maintain defense and
social spending at existing levels, infrastructure expenditures may well
take a hit. Private sector investments in infrastructure projects are
also likely to decrease. Investors will now think twice before backing
projects with unclear financial returns.
One of the first casualties is likely to be the Khazar Islands
project, a $100 billion initiative to build 41 artificial islands in the
Caspian Sea. Although the project is primarily being financed
privately, it is far from completion and it will now be much harder for
the developer to attract new financing.
Another project likely to suffer is Baku White City, an office and
residential complex. Experts believe that government funding for this
and similar projects will like dry up after the inaugural European
Games, an Olympics-style extraveganza to be held in Baku in June.
In the absence of a sharp and sustained increase in the oil prices in
the coming months, it is clear that the Azeri government will no longer
be able to sustain a high level of economic growth. Living standards
accordingly will decline.
Large-scale social protests are unlikely in the near future, but the
recent shifts in global oil markets have highlighted a serious long-term
problem for the Azeri economy – its lack of diversification and heavy
dependence on energy revenue. Most experts agree that the best way
Azerbaijan could address diversification challenges would be to improve
its investment climate and attract foreign direct investments in sectors
other than oil and gas: agriculture and food processing, alternative
and renewable energy, tourism and construction offer the greatest
potential.
The ability to achieve these targets will pose a major test for the
country’s ruling elite. Pervasive corruption needs to be tamed, and the
rule of law bolstered. The window of opportunity will not be open
forever: the country’s oil reserves will be depleted in 15-20 years.
According to some estimates, Azerbaijan’s $37 billion rainy-day oil
fund, SOFAZ, can help the government survive low oil prices for a year
or two without serious risks to social stability. However, if the oil
market does not recover within two to three years, quality-of-life
standards in Azerbaijan are likely to fall sharply. In that case, the
government could well have a social crisis on its hands.
Vladimir Putin has demonstrated that an authoritarian leader’s
popularity can grow if a country goes to war against a weaker neighbor.
The Crimea, given its history, means a lot to Russians, but
Nagorno-Karabakh means even more to Azeris. Its loss to Armenia during
the Karabakh war, fought amidst the collapse of the Soviet empire,
remains a touchstone of bitterness for Azerbaijan.
Since a ceasefire went into effect in 1994, talks between Armenia and
Azerbaijan on a permanent settlement for Karabakh have remained
stalemated. Meanwhile, some of the deadliest clashes along the so-called
Contact Line involving Azerbaijani and Armenian troops have occurred in
recent months. The frontline remains highly militarized and there are
no peacekeeping troops separating the sides. In other words, there is an
increasing probability that a new “hot” phase could erupt in the near
term.
Azerbaijan is, of course, smaller than Russia and it does not have
nuclear weapons, but an attempt to take back Nagorno-Karabakh by force
could be a way for Aliyev to remain in power if a deteriorating economic
situation starts to threaten social and political stability.
Eurasianet.org, May 14, 2015
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