Azerbaijan's Strategic Balancing Act: Leveraging Gas Reserves Amid Russia-EU Tensions
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Country strategy: a balanced play
As holder of vast gas reserves Azerbaijan is set to benefit from Russia’s tensions with the EU through higher fuel exports and budget revenues amid conservative fiscal policy.
At the same time, the country’s trade ties with Russia are limited and diplomatic relations are relatively distant, lowering the risk of secondary sanctions and underpinning Azerbaijan’s beneficial position. Meanwhile, outside of strong foreign trade and financial position, Azerbaijan is challenged by a stagnation of the oil sector, slowing growth in non-fuel sectors, sticky elevated inflation, high dependency on food imports from Turkey and Russia, and the need to maintain relatively tight monetary policy.
Tensions with Armenia, despite the recent diplomatic momentum, remain a risk and could also become a trigger for some easing in fiscal policy.
GDP and oil/non-oil contribution (%YoY, ppt)
Activity to slow
Azerbaijan’s GDP growth slowed to 4.6% in 2022, on lower oil production and a tighter fiscal stance (see below). In 2023-24, growth is set to moderate further to 2.0-2.5 pa on stagnation in oil output and an end to the positive spillover from the Russia/Ukraine conflict. In 4M23, GDP growth was 0.1% YoY amid a 2.4% YoY drop in oil-led industrial production. Later, support will still come from the growing gas trade with the EU and some pickup in consumer and lending activity.
While the fiscal policy has some scope for easing, monetary policy is unlikely to provide support because of the elevated CPI, currently at 13%, which prevents the Central Bank of Azerbaijan (CBAZ) from materially lowering the key rate, currently at 9.00%. In 2023, average CPI may slow to 10%, but the outlook is vulnerable to negative developments given the 43% dependence on imports from Russia and Turkey.
Fiscal balance and breakeven oil price
Fiscal stance remains tight
In line with our expectations, the consolidated budget surplus was 6% of GDP in 2022 on higher oil prices, healthy non-oil revenue collection and relatively restrained spending. Breakeven oil increased from US$52/bbl in 2021 to US$64/bbl, which is still comfortable.
The reintroduction of fiscal rules in 2022 should limit further expansion in spending, as the non-oil deficit is targeted to narrow by 5ppt of GDP by 2026. Meanwhile, high inflation, tensions with Armenia, despite the recent diplomatic momentum, and capex on new territories of around 3% of GDP pa create moderate upward risks to spending.
Each US$10/bbl oil price increase assures around 1.5% of GDP of oil revenues, and the recent and upcoming windfall translates into higher state savings (62% of GDP) and early redemption of debt, currently at only 20% of GDP (including guarantees).
Key exports indicators
Exports to be supported by growing gas supplies
In 2022, Azerbaijan’s current account surplus spiked by US$15bn to US$23.5bn, or 30% of GDP thanks to higher oil prices, as well as higher volumes and prices of gas supplies. Fuel accounts for 93% of exports, of which c.65% is attributable to oil. In 2023, the current account should remain at around US$20bn, as a decline in oil and gas prices will be partially offset by growing gas supplies amid stable exports.
Gas exports to the EU went up from 8.1bcm in 2021 to 11.4bcm (51% of total gas exports) in 2022 and are targeted to reach 20bcm by 2027, supporting the current account and economic activity. Azerbaijan’s relatively distant relationship with Russia (outside of Russia’s 21% share in Azerbaijani imports) lowers the exposure to the risk of secondary sanctions.
