ING has initiated regular coverage of Azerbaijan. The bank’s chief economist, CIS, Dmitry Dolgin and EM sovereign strategist James Wilson, take a broad look at what the recent geopolitical shift in the CIS region as well as domestic developments mean for the country’s economic activity, fiscal and monetary policy, interest and exchange rates. They also provide a snapshot of what the bank sector lending looks like.

Country view: Azerbaijan, the most financially solid on a comparison to fellow regional CIS sovereigns Kazakhstan, Uzbekistan and Armenia, is enjoying some recovery despite an otherwise lagging economic growth rate, aided by new gas contracts with the EU and upcoming state investments into reintegrated Karabakh.


Economic overview: Following the reintegration of the breakaway Nagorno-Karabakh state, Azerbaijan is at an inflection point.

Economic activity seems to be picking up cautiously amid a recovery in the oil and gas output, fiscal policy is on the verge of easing, and inflation is about to show a material (though temporary) slowdown.

The potential increase in state investments should be the key watch factor in the coming months.

The risk of further tensions with Armenia, which seem low now, may remain on the agenda, preventing a decline in defence spending. A low-risk financial powerhouse, Azerbaijan would be an attractive borrower, if it were to need the money.

Economic activity for Azerbaijan is on a cautious recovery track. Having slowed from 4.6% in 2022 to just 0.5% YoY in 1H23, GDP growth was 1.6-1.8% YoY and, in August, industrial production turned positive at 4.9% YoY thanks to a 7.3% YoY spike in commodity extraction.

The oil GDP (40% of total) has been the main drag lately, due to disruptions in oil production, exports and transportation, but this seems to be improving.

Non-oil GDP appears to be resilient, especially on construction and trade, although positive spillovers from the Russia-Ukraine conflict reflected in elevated transportation may be receding.

Overall, we see 2023 GDP posting a modest 1.2% increase this year. However, the 2024 result should be 2.5%, closer to normal, thanks to the removal of some transportation bottlenecks, higher gas output (thanks to the substitution of Russian gas by the EU) and potential public investments into the recently reintegrated Nagorno-Karabakh.

Budget policy remains Azerbaijan’s key strength. Azerbaijan’s consolidated surplus reached an impressive 11.1% of GDP (12M rolling basis) as of June 2023.

Fuel revenues, accounting for 60% of the total and comprised of the state budget’s corporate profit tax and the SOFAZ (state sovereign oil fund) proceeds from fuel trade and asset management, have strengthened. Annual revenues collected per US$1/bbl of Brent increased from the traditional US$150-160m to US$210-220m in 2022-23 despite lower physical volumes of extraction and exports.

Meanwhile, starting in 2H23, we observe an inflection point, related to some moderation in fuel and non-fuel revenues amid some pickup in spending. Expenditures have been growing in 2023 in real terms due to higher social support and public investments, and there is further appetite to maintain economic momentum and to develop Nagorno-Karabakh.

Also, defence spending is likely to remain elevated given the continued tensions with Armenia. Azerbaijan’s desire to create a land connection with its Nackhchivan exclave over Armenian territory will be a watch factor.

We see Azerbaijan’s consolidated surplus narrowing to 3.8-4.8% of GDP in 2023-24. With a fiscal configuration like that, Azerbaijan does not appear to require any new borrowing.

Inflation and monetary policy: Azerbaijan’s inflation is on a cautious deceleration path thanks to global price disinflation. As of August, local CPI growth decelerated to 8.0% YoY vs the 15.6% YoY peak recorded in September last year.

The favourable base effect combined with actual easing in the inflationary pressure may lead to a temporary decline in the CPI rate to around 3% YoY in 1H24. At the same time, sustainability of this slowdown will be challenged by the recovery in economic activity and potential easing in the fiscal policy.

As a result, the central bank is likely to remain cautious and any downside to the key rate, currently at 9.0%, may start materialising only by this year-end. We see the year-end 2024 key rate at 8.0%.

This means that the monetary policy is unlikely to provide material support to the economic growth in the medium term.

Balance of payments: Azerbaijan’s external position remains strong. In 2022, annual fuel exports per US$1/bbl of oil price shot up from a normal US$250-280m to US$380m, and as of mid-2023 (4Q rolling basis) reached US$390m, presumably thanks to higher gas supplies.

At the same time, imports are catching up, limiting the expansion of the trade balance and the current account. As a result, we see the current account surplus narrowing from 30% of GDP in 2022 to 19% of GDP in 2023.

This means a relatively stable breakeven at a comfortable level of around US$40/bbl. At this point, the risk of devaluation of AZN, currently pegged to USD at 1.70, seems quite low.