Economic Diversification in Azerbaijan and Its Geopolitical Implications

On August 19, Azerbaijani President Ilham Aliyev issued a decree on applying the “Agrarian Insurance Law” and establishing the “Agrarian Insurance Fund”—key steps designed to help diversify the South Caucasus country’s economy (Azertag, August 19). In recent years, diversification of the economy has become a driving goal of Azerbaijan’s government due to sharply decreased oil revenues caused by low global prices (see EDM, March 3, 2015; March 4, 2016). As a crucial non-energy sector of the economy, agriculture needed this legislation to maintain financial stability and support future development.

In the early 1990s, development of the oil and natural gas sectors enabled Azerbaijan to recover from the post-Soviet economic crisis. Following the “Contract of the Century,” signed between the government of Azerbaijan and the British Petroleum (now BP)–led consortium of energy companies in 1994, oil exports brought huge financial resources that resulted in remarkable economic development in a short period of time. By 2007, Azerbaijan became one of the fastest-growing economies in the world (Azernews, January 14, 2008).

Azerbaijan’s dependence on oil and gas also increased its sensitivity to hydrocarbon commodity price fluctuations. However, the transition to a market economy and the war with Armenia had damaged much of the country’s economic infrastructure and foreign trade relations, adding additional pressure to rely on developing its petroleum and gas reserves.

Following the 2007–2008 global financial crisis, Baku refocused on addressing this consequent fragility of Azerbaijan’s economic system by attempting to lay the groundwork for sectoral diversification. The first noticeable attempt was the “Azerbaijan—2020: The Vision of the Future” concept, elaborated in 2012 (Azertag, December 3, 2012), which aimed at establishing a competitive economy beyond hydrocarbons. These early attempts were wholly insufficient to withstand the considerable effects of unexpected oil shocks in 2014 and 2015, however (see EDM, March 3, 2015; March 4, 2016). As a result of decreased oil revenues, the Central Bank of Azerbaijan devalued the national currency by about 80 percent against the dollar in 2015. A worsened economic situation led to 3.8 percent economic contraction in 2016, further spurring Azerbaijan to accelerate its diversification process (Cesd.az, January 2017). In particular, the government adopted so-called “Strategic Roadmaps” to formulate a new development strategy focused on diversification.

Along with the roadmaps, Baku implement several other structural reforms. The Center for Analysis of Economic Reforms and Communications was established to analyze the effectiveness of the ongoing reforms (Azernews, April 22, 2016). And in the financial sector, the government created the Chamber for Control Over the Financial Markets to enforce stricter and more transparent control over the financial sector (Azertag, February 3, 2016).

As part of its diversification strategy, Azerbaijan is also concentrating on the development of the country’s cross-regional transit potential. Inter alia, the government has taken an active part in promoting itself as a strategic link within the China-led Belt and Road Initiative (BRI) and the North-South Transport Corridor. To increase the flow of goods and people across its territory and improve the operation of its border crossing points, Azerbaijan seeks to simplify the transportation process by implementing the eTIR system (which ensures the secure, digitalized exchange of data between national customs systems) with neighboring countries such as Iran (Azernews, August 19).

Another important measure taken was the creation of a Free Trade Zone (FTZ) on the territory of the newly launched Baku International Sea Trade Port (BISTP), where all businesses are exempt from taxes and state duties (Azernews, March 6, 2018). The FTZ will facilitate the fuller exploitation of the country’s transit potential and strengthen Azerbaijan’s international position as a trans-regional logistics and transport hub. Recently, the BISTP signed an agreement with the Venlo Transport Hub, in the Netherlands, intended to attract well-known European companies operating as part of global logistics chains between Asia and Europe (Freshplaza.com, May 1, 2019).

The measures Azerbaijan has taken to develop its non-oil sectors are bearing fruit. In 2018, non-petroleum economic activity accounted for 58.7 percent of the country’s GDP (Trend, June 23, 2019). In the first seven months of 2019, the non-oil sectors increased by 3 percent, non-oil exports by 17 percent and non-oil industries by 15.8 percent (Trend, September 4). However, the oil sector still holds the highest share of exports by dollar value (around 90 percent in 2018— Stat.gov.az, September 3, 2019) and, thus, remains the state’s main source of financial revenue.

Economic diversification requires more varied export destinations, which might become possible through cooperation with new partners. The recent expansion of Sino-Azerbaijani economic relations is a result of this necessity. But this development also increases the political influence of China in the South Caucasus vis-à-vis traditional regional powers. Azerbaijan is also aware of the debt problems in countries involved in the BRI. Taking into account these factors, Azerbaijan is cautious in its economic relations with China, which slows Baku’s diversification drive.

Another important factor affecting diversification is the overwhelming dependence of Azerbaijan’s non-oil exports on trade with two neighboring countries—Russia and Turkey. Exports of agricultural products, which have the highest share of all non-oil exports, are mostly directed to those two destinations (Azvision, June 28). However, the search for new markets takes time, as does the subsequent redirection of domestic exporters and adjustment of the quality and characteristics of their products to the demands of new foreign customers.

Accession to the World Trade Organization (WTO) could also be an effective way to boost economic diversification. But Baku has been unwilling to meet the WTO’s demands of substantially decreasing Azerbaijani agricultural subsidies (Wto.az, March 9). The production of foodstuffs employs 36 percent of the country’s labor force, and Azerbaijan’s local products cannot currently compete with imports in terms of price and quality. Therefore, the government fears that accession to the WTO at this time would destabilize the political and economic situation by increasing unchecked foreign economic influence (Stat.gov.az, August 19).

Diversification of the economy is a complex process, and Azerbaijan has a long way to go. Hence, dependence on the oil and gas sector persists. Yet, threats of a looming global economic recession could have a negative effect on oil prices, thus increasing the importance of carrying through with developing non-petroleum and non-gas industries or sectors. Azerbaijan has a hard task ahead of itself, made even more difficult by the existence of the aforementioned barriers. Still, it has already embarked on several strategically important projects, which have the potential for future growth.