That President Ilham Aliyev's party, the New Azerbaijan Party (YAP), won the November 1 parliamentary elections by a landslide took no-one by surprise: YAP has not lost a single election since 1993, and the main opposition parties boycotted this year's vote. But though Aliyev enjoys limitless power in Azerbaijan, his party’s new mandate will not be free of challenges, for the country's weakening economy promises to give him headaches for the next three years.

On the eve of the elections, Aliyev signed a decree on October 26 limiting tax and other state inspections of private companies to those firms with activities that can directly affect the population's health or national security, thus giving a carte blanche to operators in other sectors until November 2017. The move might have made him more popular among business owners, but it will likely prove insufficient to boost a depressed private sector, which has been hit by a number of external pressures this year, including a 50% drop in oil prices, the economic slowdown, cuts in public spending, and a 33% depreciation of the national currency.

YAP has not yet revealed how it is going to tackle the pressures on the country's economy, although Aliyev has been speaking about a general set of reforms he is targeting – including fiscal responsibility, economic diversification and rural development – for the better part of the past year.

More clarity is needed from the governing party about its agenda for economic reform because consumers and businesses in Azerbaijan are being left in the dark, and anecdotal evidence indicates that consumer confidence is low (there are no official measurements of consumer confidence in the country).

That is not to say that Azerbaijan is on the brink of economic collapse. The country continues to be cushioned by considerable oil and gas revenues, tucked away in its sovereign wealth fund Sofaz, and its low debt to GDP ratio of 15% means that it can afford to increase its debt, should the need arise.

Nor is the Aliyev likely to suffer much public scrutiny over a bad economy, at least not at home, as Chatham House's Laurence Broers shows in a recent paper. He says that if anything, Aliyev has consolidated his grip on power this year, by cracking down on civil society, eliminating dissent, imprisoning journalists, ousting foreign non-governmental organisations (NGOs) and, more recently, by attacking the powerful ministers that he himself appointed at the helm of the country.

But structural reforms and economic diversification are badly needed in order to sustain economic growth between 2016 and 2019. If Aliyev's policies weather the economic storm in the medium term, 2019 will bring welcome respite. That is because the Shah Deniz 2 offshore gas field is set to start exporting gas to Turkey then, and later Europe, through a network of interconnected pipelines in what has been called the Southern Gas Corridor.

If past experience is anything to go by, this will give an incredible boost to the Azerbaijani economy, and a break to its dictatorship. The last time Azerbaijan inaugurated an oil pipeline, the Baku-Tbilisi-Ceyhan pipeline, its GDP growth shot up to 41.7% in the first quarter of 2007.

Downward manat

In an October report, rating agency Moody's notes that the central bank "devalued the local currency in a surprise move on 21 February 2015 by around 25%. The devaluation has eased the strains from lower oil prices on public finances and the balance of payments, which is credit positive. However, a weaker manat leads to higher inflation, which in turn impairs private households’ purchasing power, and thus adversely affects GDP growth, which is credit negative."

After the February devaluation, the banking sector moved to restructure more than $600mn worth of foreign currency denominated loans, and all but stalled mortgage lending. The value of restructured loans might seem manageable, but  "loan restructuring by the banks will take some time to be reflected in their numbers", according to James Watson, Director of Financial Institutions at rating agency Fitch. 

Meanwhile, the real estate sector is reporting a 30% drop in turnover this year because of the decline in mortgages. And consumers and markets are fretfully waiting for a second devaluation of the national currency, while refraining from purchases that are not essential.

Like Moody's, the International Monetary Fund (IMF) has a rather dim outlook for the Azerbaijani economy this year, noting that inflation might reach 8.5% by the end of the year, despite government intervention on the markets to control prices.

"The near-term macroeconomic outlook has deteriorated considerably. Non-oil GDP growth is expected to decelerate to 3.5% this year as the sizeable fall in export revenue and the slowdown in public investment will spill over in the private sector demand, already weakened by some loss of confidence after the devaluation," an IMF delegation concluded after a June visit to Baku.

But the manat might experience worse days still, for the markets are fretting over a second devaluation, which would echo similar devaluations in Kazakhstan and Turkey in recent months. "There is a bigger demand for dollars these days, because people are afraid of a second devaluation," a bank treasurer who asked to remain unnamed told bne IntelliNews. "If the central bank lets the manat float freely, I expect it to devalue by a further 50% against the dollar," he added.

Fears have been fuelled by official statements that the central bank and the Ministry of Finance are indeed mulling a second devaluation. "The manat's rate is being determined by the global price of oil, as well as budgetary and currency policies of partner nations," Elman Rustamov, governor of the central bank, told a parliamentary committee on October 13. The regulator has spent half of its foreign currency reserves to bolster the currency in the last 12 months, so it is not likely to continue to use its own funds to do so.

Azerbaijan is new to currency volatility; the February devaluation ended a four-year peg to the dollar. Since then, the currency has been reportedly artificially maintained against an undisclosed basket of foreign currencies, which experts have estimated to include the dollar (approximately 78%), the euro (20%) and other currencies. 

On a tighter budget

Used to budget surpluses financed from an oil and gas bonanza, Baku is finding itself increasingly cash-strapped as of late, after revenues from oil exports halved between January and September. This means that Aliyev will no longer be able to afford the generous public spending he has been employing to keep his people content in the last decade.  

This year's generous spending, coupled with the 50% drop in oil prices since last summer, will likely dig a $3.8bn hole in the budget that will conveniently be covered by the sovereign wealth fund Sofaz, which sits on $35bn worth of assets.

For next year, Baku has provisioned a much more cautious spend of $15.5bn, 22.9% less than in 2015 in manat terms and 40% less in dollar terms. In practice, that will mean that, while certain areas, like education and defence – which is paramount to Azerbaijan because of the frozen conflict with Armenia – will be left untouched, others will have sharp declines in public spending.

Foremost among them, construction, Baku's favourite pastime, will have its budget slashed by 48.5% compared to 2015; the underperforming healthcare sector, which the Aliyev administration has been promising to reform for a long time, will receive 4.2% less from the budget; research and development will have its budget slashed by 12.5%, social services by 7.1%, and the judiciary by 7.2%.

Even so, Baku is still expecting to incur a $1.6bn budget deficit next year, which it intends to cover from sources other than Sofaz, most notably privatisations, foreign and domestic borrowing, and the treasury. This in turn will push up Azerbaijan's foreign debt, which is still commendably low at 15% of GDP.

Construction projects have been a source of pride for the Aliyev administration, which has been using oil revenues to give capital city Baku a major makeover, building suspension bridges, skyscrapers, parks, promenades, sports venues, malls, office buildings and roads. A few years ago, Aliyev even contracted the services of renowned architect Zaha Hadid's firm to design a one-of-a-kind entertainment centre commemorating his late father, for a sizeable fee of $250mn.  

Provincial poverty

But Azerbaijan's oil-fuelled construction expenditure is less visible outside of its capital city, for the rest of the country still relies on old, Soviet-era buildings and infrastructure. The state of Azerbaijan's roads is so poor that this reporter once spent six hours travelling 225km from Baku to the northern town of Gabala.

Narrow roads, with one lane in each direction, littered with potholes, poor signalling, and a traffic that is complicated by trucks carrying merchandise to and from Russia, means that driving outside of Baku is an adventure in its own right. Too much of an adventure for some, such as Hollywood star Milla Jovovich, who reportedly had a meltdown traveling from Baku to Gabala to film a commercial for the Milla dairy brand in 2013. Azerbaijan duly set up a flight connection between Baku and Gabala after this incident, to prevent stars visiting its northern town from experiencing the roads that connect it to Baku.

Azerbaijan's exclave Nakhchivan is  an exception to the rule, but that likely has to do with its special status as the birthplace of the Aliyevs and other elite families in Azerbaijan.

That is not to say that Baku does not invest at all in regional development. A recent example of such an investment was the completion of two rural roads linking the northern towns of Sheki, Gakh, and Zagatala on November 4, the inauguration of which was attended by the incumbent himself. But it is to say that more such investments are needed, faster. And that Aliyev and his YAP will have a hard time financing such investments in the next three years.

Not only are the country's regions poorly connected to the capital city but they are also underdeveloped. Some mining activities, metallurgy, and some industry, particularly agribusiness and chemicals, are the only sources of jobs in the Azerbaijani provinces, other than subsistence agriculture.

This has pushed rural dwellers to move to Baku in large numbers. Officially, the capital city's population in 2012 was 2.1mn, but many estimate its population nowadays to be closer to 3mn, or almost a third of the country's total population. Meanwhile, the second largest city, Ganja, has a population of 320,000, while the rest of the towns do not surpass 200,000 people.

Regional and rural development have long been part of the ruling party's propaganda, but in reality little has been done to enfranchise the country's rural population. YAP touts the severe poverty reduction rates, from 50% in 2001 to 5% in 2015, but fails to mention the fact that a large number of Azerbaijanis continue to subsist at a level that does not qualify them for World Bank poverty status, but is far from affording them a dignified life.

For example, only 1.5mn of the 4.8mn "economically active" Azerbaijanis were employed as of September. The remaining 3.3mn were presumably either engaged in subsistence agriculture, studying, or simply did not have an (officially declared) occupation. Of the 1.5mn employees, a staggering 880,000 worked for the state, the inflated bureaucracy of which costs the administration $2.5bn a year to maintain.

The average salary among the 1.5mn employees was $440 a month in September, but, again, this figure leaves out the income - or lack thereof - of 3.3mn adults.

The government might have posted a commendable GDP growth rate of 5.7% in January-June, surpassing all forecasts by international analysts, but that growth is not immediately obvious on the streets. On the contrary, people are beginning to feel the brunt of the economic slowdown.

Ceyran, a 60-year-old selling groceries in one of Baku's bazaars, told bne IntelliNews on October 30 that "sometimes the market was empty for a few days, but these periods were always short. But now it has been like this for several months. Before, I used to be able to eat as much meat as I wanted, but now I need to ration it".

Another farmer selling his groceries seconds her. "I have worked in this market for 15 years and I have never seen a crisis like this one, there are no jobs, people don't have money, the prices are going up. And I can only see the situation getting worse in the future," he said.