Mission Concluding Statement 

Azerbaijan: Staff Concluding Statement of the 2025 Article IV Mission

April 8, 2025

Washington, DC, April 8, 2025: An International Monetary Fund (IMF) staff team visited Baku and held discussions on the 2025 Article IV consultation January 22 to February 5, 2025. The IMF team would like to thank the authorities and other interlocutors      in Baku for their frank and open discussions. The views presented here are our preliminary findings based on these discussions.

Context: Signs of broad-based growth

1. Following the slowdown in 2023, growth picked up in 2024. Real GDP increased by 4.1 percent in 2024, up from 1.4 percent in 2023, driven by a 6.2 percent increase in non-hydrocarbon GDP, particularly in the construction, communications, transportation, and hospitality sectors. Hydrocarbon GDP shrank by 2.0 percent in 2023 but eked out a small increase of 0.3 percent in 2024, with stable crude oil production and moderate expansion in gas output. The estimated output gap turned positive in 2024.

2. Inflation picked up in the second half of 2024 but remains within the central bank’s target band. After peaking in 2022, inflation eased over 2023, reaching 2.1 percent in December 2023. Inflation continued to ease to around zero in April 2024, before picking up in the second half of 2024, reaching 4.9 percent in December 2024, still within the CBA target of 4±2 percent. The recent increase in inflation is driven in part by a one-off adjustment in energy and other administered prices (transportation and utilities). Still, core inflation also increased from 2.3 percent in December 2023 to 4.4 percent (y-o-y) in December.

3. The moderation in oil and gas prices reduced the external surplus. The current account balance recorded a surplus of 11.5 percent of GDP in 2023 (from 29.8 percent in 2022). While the current account remained positive in the first three quarters of 2024, it is about 50 percent lower compared to the same period in 2023. The combined CBA and SOFAZ reserves nonetheless reached 41 months of next year’s imports and about US$71 billion by end-2024. Sustained foreign currency (FX) earnings continue to support the de facto peg, although demand for FX in official auctions increased in 2024.

4. Following a pause in 2023, fiscal consolidation resumed in 2024. In 2023, the nonoil primary deficit (NOPD) remained broadly unchanged compared to 2022 at around 22½ percent of nonoil GDP. The NOPD was nonetheless about 2 percent of nonoil GDP lower than projected, reflecting stronger nonoil sector tax revenues and the slight under-execution of budget spending. For 2024, preliminary data point to an NOPD reduction of about 2 percent of nonoil GDP compared to 2023, supported by robust nonoil revenue growth, while lower oil revenues led to a decline in the overall budget surplus.

5. Credit growth accelerated in 2023 and 2024. Growth in total credit accelerated further to 22 percent (y/y) in 2024, from 19 percent (y/y) in 2023, precipitated by a sharp increase in nonbank lending. In particular, credit growth has been driven by loans to households and to legal entities, mainly industry and manufacturing whose share in total loans increased from 5 to 8 percent during 2024. In response to macroprudential measures, growth of household borrowing moderated in 2023 and 2024 but remains brisk.

6. The banking sector continues to be resilient, but some vulnerabilities remain. Financial soundness indicators have strengthened and are in line with regional peers. The capital adequacy ratio stood at 17.6 percent as of end-2024, while the systemwide total and foreign currency liquidity coverage ratios have exceeded the minimum requirements. Asset quality has been improving, and the nonperforming loan (NPL) ratio has fallen to 2.4 percent as of December 2024, from 3.8 percent at end-2022, as loans expanded despite some tightening of prudential regulations on consumer loans while the NPL amount has remained broadly constant. Profitability remains strong, underpinned by wide interest margins. The main vulnerabilities in the banking sector include high reliance on potentially volatile wholesale corporate deposits, high—albeit declining—deposit dollarization, and credit concentration.

Outlook: Risks and opportunities in an uncertain external environment

7. Growth is projected to moderate in 2025, and inflation will remain within the CBA target band. Growth is projected to decelerate to 3.5 percent in 2025, as the impact of investment diminishes and hydrocarbon production remains subdued, and the output gap closes by 2026. The economy is projected to expand by 2½ percent in the medium term. The external position is expected to weaken in the medium term, with shrinking trade surpluses from lower hydrocarbon production and prices and subdued non-hydrocarbon exports, but FX reserves will remain strong. Inflation is projected to remain in the CBA target band of 4±2 in the medium term, assuming broadly stable international food and energy prices and continued fiscal prudence.
8. Risks to the outlook remain broadly balanced, but external uncertainty is high. Supply and demand fluctuations of oil and gas, including from the energy transition or from a global slowdown, could reduce hydrocarbon prices, significantly affecting growth, the external position, and fiscal revenues. Other risks have a more uncertain impact. The intensification of conflicts could improve Azerbaijan’s terms of trade, if hydrocarbon prices increase, and worsen it, if food prices increase. Deeper fragmentation could undermine efforts to develop and diversify the nonhydrocarbon sector, but if trade and investment are diverted to the region, could also provide opportunities. Domestic risks continue to arise from pro-cyclical fiscal policies and extreme climate events that could affect agricultural production, food security, and inflation.

Fiscal policy: Striving for a more consistent and credible fiscal adjustment

9. Staff’s baseline projections show an increase of the NOPD in 2025, reflecting the approved budget, before declining in the medium term. Compared to the preliminary 2024 outcomes, the 2025 budget envisages a weakening of the overall fiscal balance by about 4 percent of non-oil GDP, from a surplus to a small deficit, while the NOPD is projected to increase by about 1 percent of non-oil GDP. Beyond 2025, staff’s projections reflect the authorities’ medium-term spending plan, which is subject to significant risks. It assumes continued moderate growth in current spending and a decline in capital spending as the current reconstruction spending winds down. On the revenue side, it assumes the expiration of the private nonoil sector PIT exemption by end-2025 and no further tax revenue losses due to new tax holidays and exemptions. New spending demands would necessitate additional revenues to keep the fiscal consolidation on track. In the baseline scenario, the overall risk of sovereign stress is assessed to be low.

10. Continued fiscal consolidation is needed for cyclical reasons in 2025 and to ensure that future generations benefit from hydrocarbon wealth. From the cyclical perspective, given robust economic growth and the projected positive output gap, fiscal easing is not appropriate in 2025. Instead, starting in 2025, an annual fiscal adjustment of about 1 ½ to 2 percentage point of non-oil GDP should be maintained for about 10 years until the NOPD approaches the estimated level that ensures real annuity across generations—currently estimated at 6 to 6 ½ percent of non-oil GDP. Adhering to this consolidation plan, which is broadly consistent with earlier Presidential Decrees on the fiscal rule, would represent an important step towards intergenerational equity, ensuring that future generations benefit from Azerbaijan’s hydrocarbon wealth. Further revisions and backloading of fiscal adjustment would weaken the fiscal rule credibility and complicate efforts to preserve assets for future generations.

11. Achieving substantial fiscal consolidation would require a comprehensive strategy. The authorities need to implement a range of measures, including broadening the tax base (the authorities estimate annual revenue loss from tax expenditures in excess of AZN 2 billion, or about 1.5 percent of GDP), continuing to strengthen tax administration and tax compliance, and reviewing the current tax system to identify new sources of revenues. Undertaking the TADAT could help identify potential weaknesses in tax administration and assist in the effort to improve revenue collection. On the expenditure side, the authorities should pursue the moderation of wage bill growth and rationalization of subsidies. In this context, staff welcomes the recent increase in some administered prices. Gradual unwinding of public investment spending while focusing on improving investment efficiency should also contribute to fiscal consolidation. In this context, the authorities could consider undertaking a PIMA.

12. Sustained fiscal adjustment should be supported by a strengthened fiscal rule. While the authorities have so far been meeting the fiscal rule targets, largely due to significant overperformance in 2022, the medium-term target has shifted. Avoiding similar slippages in the future and sticking to the targeted deficit reduction path are essential to boost the credibility of the fiscal rule. In addition, in the context of planned changes to the budget legislation system, the authorities could consider specifying a clearer and more limited escape clause to minimize changes to the fiscal rule targets and putting in place an automatic correction mechanism. Efforts to more closely link the annual budget to the fiscal rule and to take stock of fiscal risks should also continue.

Monetary policy: Remaining vigilant and committed to enhancing the policy framework

13. As inflation fell rapidly in 2023 and the first half of 2024, the CBA responded by gradually cutting policy rates. Even as inflation began to decline from its peak of 15.6 percent in October 2022, the CBA initially continued to increase its refinancing rate in the first half of 2023, from 8 percent to 9 percent. However, continued sharp decline in inflation to around 2 percent by end-2023 and to zero by April 2024 prompted the CBA to reduce the policy rate to 7.25 percent by May 2024. The sharp disinflation was driven by lower imported inflation (slowing food inflation), together with continued nominal effective exchange rate appreciation. Since mid-2024, inflation began to increase again, reaching 4.9 percent by end-2024, and the CBA kept monetary policy on hold, assessing its policy stance as broadly neutral and expecting inflation to remain within its 4 ±2 percent target range in 2025 and 2026.

14. With inflation projected to stabilize within the CBA’s target range, staff recommends keeping monetary policy on hold while remaining vigilant, forward-looking, and responsive to incoming data. To some extent, the recent increase in inflation reflects the adjustment in administered prices. Considering current and projected inflation, the CBA’s refinancing rate remains broadly neutral in real terms. However, both domestic (demand pressures from budget expenditure growth and strong credit growth) and external risks (geopolitical tensions, disruptions of global supply chains) of inflation remain, and the CBA needs to remain vigilant, monitor these risks closely, and be prepared to respond should these risks materialize.

15. The CBA should continue to further strengthen monetary policy transmission. The new liquidity management instruments introduced in 2022 have helped to improve the transmission of the policy rate to the interbank rate. Activity in the unsecured interbank market has increased, and the average interest rate on one-day unsecured transactions (1D AZIR) has been within the CBA interest rate corridor since November 2023. The CBA also strengthened monetary policy communication, including by publishing their forecasts. The authorities should build on these achievements and continue to further enhance monetary transmission, including the simplification of interbank transaction processes in secured markets, as well as steps to elevate monetary policy communication. These steps should further improve the efficacy of monetary policy, increase confidence in the domestic currency, and lay the ground for a possible transition to a hybrid inflation targeting regime in the medium term. Closer coordination between the government’s debt management operation and the CBA’s liquidity management operations is also required.

Financial sector policy: Addressing remaining vulnerabilities 

16. The banking sector financial soundness indicators continue to be strong, but some vulnerabilities remain. As the recently completed FSAP concluded, the banking sector remains resilient, and bank solvency stress tests point to adequate capitalization under baseline and adverse scenarios although some banks with thin capital buffers could breach the regulatory minimum in the adverse scenario. Also, reflecting the large role of the hydrocarbon sector in Azerbaijan’s economy, potentially volatile wholesale corporate deposits may pose a liquidity Financial dollarization—while declining—remains elevated and could also be a source of vulnerability. Moreover, strong growth of unsecured consumer lending could be a source of cyclical risk.

17. Staff welcomes the authorities’ continued efforts to strengthen prudential oversight and the financial safety net. The CBA has made important progress in establishing new financial sector regulations and macroprudential policies to enhance prudential oversight, corporate governance, and risk management standards to underpin a more resilient banking sector that is better positioned to support economic growth. In response to recent strong credit growth and rising positive credit-to-GDP gap, the CBA has implemented a requirement for an additional counter-cyclical capital buffer of 0.5 percent of banks’ total regulatory capital starting March 1, 2025. Additionally, measures have been taken to mitigate liquidity risks, including higher reserves requirements for banks with high deposit concentration. Staff would like to emphasize the importance of further progress in the following macro-critical areas: (1) reinforcing the resilience of domestic systemically-important banks (D-SIBs) by introducing differentiated higher loss absorbency buffer requirements; (2) expediting legal and prudential steps to ensure full adoption of a consolidated supervision framework; (3) bolstering financial safety nets by finalizing resolution plans for D-SIBs and other banks whose failure would have systemic consequences; and (4) strengthening the emergency liquidity assistance (ELA) framework.

Structural policy: Enabling private sector-led growth

18. Diversification remains Azerbaijan’s most urgent challenge, given limited hydrocarbon reserves and the ongoing energy transition. The economy has diversified in terms of output in recent years, but exports remain highly concentrated, even more so than other resource-rich economies. The authorities have been positioning Azerbaijan as a logistics, transport, and green energy hub that would connect Central Asia with Europe. Azerbaijan 2030 recognized the role of the private sector to drive investment, growth and employment, and the government simplified business procedures and licensing and has started taking steps to develop financial markets. Further growth is however constrained by major state presence in the non-oil sectors, governance issues, and limited access to skilled labor and capital. Staff urges the government to continue to create the conditions to attract private investment, minimize risks to public finances, and pursue several key reforms:

• Reducing the footprint of the state and improving SOEs performance. The government established the Azerbaijan Investment Holding (AIH) in 2020 and the Azerbaijan Transport and Communications Holding (AZCON) in 2024 to improve the performance of several strategic state-owned enterprises (SOEs). Since 2020, the AIH has introduced several reforms on their portfolio companies, including establishing supervisory boards and committees, enhancing financial reporting and independent audit, and setting up KPIs and developing a monitoring dashboard. Following the OECD review of the AIH and SOEs, the authorities developed an action plan to implement the recommendations. Staff looks forward to progress on several key areas, such as developing an ownership policy, leveling the market playing field where SOEs compete, introducing independent board members, and improving transparency and disclosure practices. Applying good governance standards to all large SOEs and implementing the privatization roadmap should also be prioritized.
• Sustaining gains in transparency and fighting corruption. Azerbaijan has made progress in enhancing fiscal transparency, ranking 23^rd out of 125 countries in the 2023 Open Budget Survey, and implementing its anti-corruption policy and action plan. The authorities should continue efforts to close the gaps identified by the OECD, including by finalizing the draft law on conflict of interest, applying more transparent and competitive public procurement practices, and operationalizing the asset disclosure system for public officials. The authorities should also prioritize addressing MONEYVAL recommendations, building on recent initiatives to increase resources and build capacity on countering ML/FT, set up a centralized beneficial ownership registry, and enhance the sanctioning regime.
• Promoting private sector access to finance. Despite recent improvements, Azerbaijan’s financial and capital markets remain underdeveloped, and access to finance remains an obstacle to faster private sector-led growth. The authorities have made progress towards achieving a stable banking sector, a necessary but insufficient condition for further financial deepening. Improving corporate governance, strengthening accounting and auditing standards in the private sector, and modernizing legal frameworks are some reforms to support capital market development. Given their large number, improved access of SMEs to financing is also particularly important for future growth and diversification. The authorities’ Financial Sector Development Strategy 2024-26 appropriately seeks to address these constraints.

19. Climate policies will prepare Azerbaijan for the global energy transition and contribute to reducing emissions and enhancing adaptation. As host of COP29, Azerbaijan played a significant role to advancing the global climate agenda. In addition, the government finalized its National Adaptation Plan and is expected to submit more ambitious mitigation targets this year, while efforts to meet its current NDC target of 35 percent reduction by 2030 compared to 1990 levels continue. The authorities have laid out electrification plans and initiatives to upgrade the transmission grid and enhance energy efficiency in buildings and transportation. Although the Carbon Border Adjustment Mechanism is not expected to have a significant impact on current trade with the EU in the near term, diversification to the metals and chemicals sectors could be affected, and the oil and gas sectors could be covered in the medium term. Staff welcomes efforts by the authorities to expand the share of renewables in installed capacity to 30 percent by 2030 and the state oil and company’s net zero and methane reduction targets. Staff reiterates the need to withdraw direct and indirect fossil fuel subsidies to induce more efficient use and to free up resources for green technology investments as well as the more vulnerable.