Press Release No. 95/24

Press Release: IMF Approves STF Drawing for the Republic of Azerbaijan

April 19, 1995

Background

Economic activity declined sharply in 1993 and 1994, with real GDP falling by more than 20 percent in both years as production was affected, inter alia, by the conflict over Nagorno-Karabakh and the disruption of transportation routes through Georgia and Chechnya, and inflation accelerated. While supply disruptions and corrections of administrative prices, particularly on bread and energy played a role, the principal sources of inflation were inappropriate financial policies. In particular, the fiscal deficit remained large and was fully financed by the central bank, and, because of the lack of effective control by the Azerbaijan National Bank, lending by the two large state banks increased rapidly. Moderate stabilization gains in the first half of 1994 were subsequently reversed and inflation accelerated to over 50 percent in November and December and averaged 29 percent a month for the year as a whole. Financial policies were tightened in late 1994 and the monthly inflation rate was reduced to below 3 percent by March 1995.

The 1995 Program

The main objectives of the 1995 economic program, which is supported by the STF drawing, are to stabilize prices quickly, creating an environment of low inflation conducive to a resumption of economic growth, and initiate comprehensive structural reform. The program's main aims are to (i) limit the decline in real GDP to 6 percent, (ii) reduce monthly inflation to about 2 percent by the end of the year, and (iii) limit the external current account deficit to below 10 percent of GDP and restore a sound external reserve position to the central bank.

To these ends, the Government will reduce the overall fiscal deficit to 4.8 percent of GDP in 1995 from 13.2 percent in 1994. A tight monetary and credit policy, consistent with the program objectives, will be implemented; net credit to the Government from the banking system will be limited to 2 percent of GDP, reserve requirements have been raised, and interest rates will be maintained at positive real levels. The authorities envisage substantial cuts in government expenditures, including security- related expenditures, the latter as a result of the progress toward a permanent peace in Nagorno-Karabakh. General commodity subsidies will be replaced with targeted cash transfers, and all extrabudgetary funds will be integrated in the 1996 state budget. To improve cash management techniques and reporting, a Treasury will be established in the Ministry of Finance. On the revenue side, to address the recent decline in tax collection, the authorities are increasing the efficiency of the tax administration and are stepping up efforts to collect tax arrears, including those from state enterprises. The base of major taxes and import tariffs has been widened and exemptions and privileges in profit taxes and the value-added tax eliminated.

Structural Reforms

Azerbaijan took several important measures to improve the functioning of the market as prior actions for the program. The exchange rate regime was unified and liberalized, foreign exchange holdings were concentrated at the central bank, the state order system was eliminated, the trade regime was liberalized, bread price subsidies were abolished, and energy prices were adjusted substantially toward international levels. Under the program, the authorities intend to complete the price liberalization. Plans for a comprehensive privatization program are being reviewed to emphasize the cash sales of shares; public enterprises will be transformed into corporations and tender rules are being prepared for the case-by-case privatization of large enterprises. The authorities are also undertaking a rapid conversion of medium and large companies into joint-stock companies, so that sales of the majority of shares to domestic and foreign investors can begin as soon as possible. In addition, the privatization program should guarantee the quick privatization of several hundred of small-scale enterprises during 1995.

Addressing Social Costs

The Government is preparing with Fund staff assistance a comprehensive package of measures to restructure the social safety net and make it more cost effective. To shield the most vulnerable groups the Government will target cash transfers already provided to help compensate for the elimination of subsidies, on the basis of family income and improve the financing of the unemployment benefit system.

The Challenge Ahead

The authorities have undertaken a comprehensive approach to Azerbaijan's current economic and financial difficulties. They appreciate that it is crucial to frontload the adjustment effort so as to lay quickly the foundation for a sustainable economic recovery and for the proper development and use of Azerbaijan's oil wealth which, over the medium term, can help to bring about a dramatic transformation of the economy. The program is an ambitious one, particularly as it relates to the budget, and there are risks that slippages could make it difficult to sustain the right policy stance. However, these risks have been mitigated to some extent by the policies already implemented and by the monitoring arrangements in place at the ministerial and senior official level. The availability of external financial assistance on appropriate terms will also be important for the program's success. Azerbaijan joined the IMF on September 18, 1992 and its quota² is SDR 117.0 million (about $184 million). Azerbaijan had no outstanding obligations to the IMF.