Press Release No. 99/5

Press Release: IMF Approves Third Annual ESAF Loan for Azerbaijan and Financing Under the CCFF and EFF

January 26, 1999

The International Monetary Fund (IMF) has approved loans and credits equivalent to SDR 79.7 million (about US$112 million) to support Azerbaijan’s 1999 economic and financial program and to compensate for an export shortfall. Of this total, SDR 23.4 million (about US$33 million) is available under the Enhanced Structural Adjustment Facility (ESAF)¹ and SDR 56.3 million (about US$79 million) is available under the Compensatory and Financing Facility (CCFF)². At the same time, the IMF completed the fourth review under Azerbaijan’s Existing Fund Facility (EFF)³ program releasing an additional tranche of SDR 1.8 million.

Background

Azerbaijan’s economy continued to grow strongly in the first three quarters of 1998, with real GDP 8 ½ percent higher than a year earlier. Inflation remained very low, reflecting the maintenance of a stable exchange rate coupled with prudent monetary management. Progress in structural reforms, however, has been mixed, especially in the areas of bank restructuring and the development of an appropriate framework for law enforcement.

Program implementation during 1998 was affected adversely by two external shocks --the sharp fall in oil prices and the financial crisis in Russia -- that have worsened the fiscal and balance of payments positions. Persistently weak oil prices, combined with less favorable than expected results from some recent exploration activities, appear to be leading to cuts in planned investment in the oil sector. Growth of the non-oil economy has been especially strong in the construction and service sectors, but there are signs that such growth is slowing. This is especially true for manufacturing and agriculture, which are being hurt by weaker external demand and increasingly competitive imports, especially from Russia following the depreciation of the ruble in August.

Following the Russian financial crisis in August, Azerbaijan received pledges in late 1998 from international donors in support of its reform efforts. The oil price reduction and resulting export revenue loss in 1998, which were beyond the control of the authorities and are expected to be temporary, have made Azerbaijan eligible for financing under the CCFF.

Medium-Term Strategy and the 1999 Program

During 1999-2001, the program envisages average annual GDP growth of about 7 percent and average annual inflation of about 4 percent. While overall growth is expected to be supported by increased oil production, non-oil-sector growth is projected to slow in 1999, reflecting the impact of weaker external demand, especially from Russia, and real exchange rate appreciation during 1998. Growth, however, is expected to recover as the reform efforts deepen. The external current account deficit is projected to be 32.5 percent of GDP during 1999, rising to about 38 percent in 2000 and 2001, which will reflect both the lower price of oil exports and a rise in imports. The projected external deficits are expected to be financed mainly by foreign direct investments, with some additional support coming from multilateral and bilateral creditors.

The third year of the ESAF program proposes macroeconomic policy adjustment, including a revised financial program for 1999, and strengthened efforts toward structural adjustment. The projected budget deficit of 3.1 percent of GDP in 1999, while significantly lower than achieved in 1998, is larger than previously planned. However, this should be manageable given the very low level of government debt and the availability of adequate external financing. Fiscal consolidation will be needed -- in particular measures to strengthen tax collection, to offset the effects of lower oil prices and to allow some expansion of expenditures to finance structural reforms and arrears reduction. Important measures under the program aim to increase transparency in the use of public resources.

The authorities will continue to pursue a cautious monetary policy during 1999, with a flexible approach to the exchange rate, consistent with financial stability and a competitive non-oil sector.

Structural Reforms

In the structural area, the authorities attach highest priority to reforming the public sector, tackling corruption, and improving the efficiency of the government. Important measures will be taken to limit unwarranted interference of law enforcement agencies in economic matters, strengthen the treasury, begin the reorganization of the civil service and government structures, and reduce public sector employment while improving incentives.

The authorities also plan to focus on measures to restructure the banking sector and strengthen the financial system, broaden and strengthen the privatization process, reform public enterprises, and develop a market-based agricultural sector.

Addressing Social Needs

The authorities continue to be committed to reform in the health and education sectors, and to better targeting of the social safety net. The resettlement and rehabilitation of internally displaced persons remain priorities. The process of reorienting the public sector will temporarily raise the need for social safety net provisions.

The Challenge Ahead

Azerbaijan faces the considerable challenge of focusing on essential structural reforms, despite more immediate macroeconomic pressures. With signs that non-oil related growth is slowing, rapid progress in structural reforms is vital to ensure that growth will be broadly based.

Azerbaijan joined the IMF on September 18, 1992, and its quota⁴ is SDR 160.9 million (about US$225 million). Its outstanding use of IMF financing currently totals SDR 228 million (about US$320 million).