2009 Investment Climate Statement - Azerbaijan
Azerbaijan's ongoing transition to a market economy presents both significant prospects and challenges. Over the past decade, Azerbaijan has successfully executed a strategy to develop its oil and gas resources and is now benefiting from the receipt of energy revenue inflows. Much work remains to be done, however, to spread the wealth and produce attendant prosperity or the country's population of eight and a half million. This includes improving governance and curbing corruption, diversifying the economy through domestic and foreign investment, strengthening public expenditure planning, and creating jobs. The long running and unresolved conflict with Armenia over Nagorno-Karabakh has left Azerbaijan with approximately 700,000 refugees and internally displaced persons (IDPs) for more than a decade and constitutes an enormous burden on economic and democratic development.
Azerbaijan's macroeconomic situation continued to improve in 2008. According to the National Bank, GDP exceeded USD 40 billion by year-end 2008, largely driven by growth in the energy sector. The economy was expected to grow in real terms in 2008 by about 13 percent, despite relatively high inflation, a second-half decline in oil production and export prices, and the dampening effects of a weakened global economy. Growing inflation has become a public and private sector concern; official statistics will likely show an inflation rate in the range of 15-20% for 2008. Independent sources quote increased public spending and import monopolies as main drivers of inflation.
The national currency, the Manat, appreciated less than one percent in real terms against the U.S. dollar in 2008. The nominal exchange rate was approximately 1 USD = 0.80 AZN as of January 1, 2009. In response to the global financial crisis and a decline in confidence in financial sector stability, the National Bank abandoned its market basket policy, adopted earlier in the year, and began re-pegging to the dollar. The market basket system was designed to achieve gradual nominal appreciation against a basket of relevant currencies, but was temporarily suspended due to the major volatility in the exchange rate between the two currencies in the basket, the dollar and the Euro. The National Bank's currency reserves grew 75.6 percent and reached USD 3.5 billion as of December 2008. The State Oil Fund continues to support macroeconomic stability, transferred over 5.5 billion USD to the state budget in 2008 and is slated to provide over 7 billion USD in support of the 2009 budget. The Fund's reserves are estimated to exceed 14 billion USD.
Since the completion of the Baku-Tbilisi pipeline in 2006, oil export revenues have expanded dramatically and the energy sector has shifted from infrastructure construction to service provision and exploration. Despite offshore technical problems and the disruption of oil transportation through Georgia in August, the BTC pipeline delivered approximately 700,000 barrels of oil per day from Azerbaijan's offshore Azeri-Chirag-Gunashli (ACG) field at year's end, down from a peak of approximately 950,000 earlier in the year. In addition, the South Caucasus pipeline (SCP) conveyed 9.5 billion cubic meters of natural gas from the Shah Deniz field to Georgia and Turkey. Azerbaijan has taken significant steps to implement the Extractive Industries Transparency Initiative (EITI), which promotes oil revenue transparency, and is taking steps to become the first country to be rated "fully compliant" with EITI norms.
Azerbaijan continues to cooperate with international financial institutions in its reform efforts, and was named the "Number One" reformer in the World Bank's Doing Business 2009 Report. It is also receiving economic reform and financial development sector support as a participant in the EU's "Good Neighbor" Program. Azerbaijan is not yet a member of the WTO, but is working closely with USAID to develop WTO-consistent legal and regulatory reforms, and has made notable progress toward its accession goal. The United States designated Azerbaijan as a beneficiary developing country for the purposes of the Generalized System of Preferences program in late 2008.
In 2005 World Bank estimates showed that 24 percent of the population lived in poverty, with slightly more than nine percent in extreme poverty. Government of Azerbaijan statistics state that poverty was reduced to 20.8 percent in 2006 and 16 percent in 2007 despite significant price hikes for basic items - including fuel, water, electricity and public transportation, which unavoidably led to across-the-board price increases on consumer goods and services and would deteriorate the poverty numbers. In 2008 the World Bank conducted its own household survey-based poverty assessment, the results of which are expected to be made available in early 2009. Despite continued strong economic growth (real GDP growth was over 30 percent from 2006 to 2007, and is estimated to be about 13 percent for 2008), poverty remains particularly acute in Azerbaijan's regions, and developing an investment climate which encourages private investment and increases employment opportunities in the regions remains crucial for Azerbaijani policymakers.
Corruption is a significant deterrent to investment in Azerbaijan, especially in the non-energy sector. Laws and regulations that exist to combat corruption are not effectively enforced, with corruption in the regulatory, tax, and dispute settlement systems most pervasive. Problems in the quality, reliability, and transparency of governance, as well as abuse of the regulatory system and poor contract enforcement, significantly impede the ability of many companies to do business in Azerbaijan. These problems have driven many companies, including some major Western firms, from the market. Although Azerbaijan adopted a new and much-anticipated anti-corruption law in 2005 and a National Strategy on Increasing Transparency in Combating Corruption, as well as an ethics code for civil servants in 2007, little progress in implementing these measures has been made.
Openness to Foreign Investment
The Government of Azerbaijan officially welcomes foreign direct investment, realizing that it plays a vital role in development of the country's economy. Since 1994, Azerbaijan has attracted significant amounts of foreign investment to develop further its energy sector. Government bureaucracy, weak legal institutions and predatory behavior by politically connected monopoly interests continue to hinder investment outside of the energy sector. Azerbaijan made an unprecedented improvement in the World Bank 2009 "Doing Business" Report, jumping 64 places from 97 to 33, garnering it the designation of "Number One" Reformer for the year. This improvement is primarily due to the creation of a one-stop-shop for business registration which halved the time, cost and number of procedures to start up a business. Azerbaijan made noteworthy advances in seven of the ten criteria covered by the report, but still has room for improvement in the areas of Trading Across Borders, Construction Permits, and Closing a Business.
The Law on Protection of Foreign Investments permits foreign direct investment (FDI) in any activity open to a national investor unless prohibited by law. Prohibited areas include those relating to national security and defense. The government carefully controls other key sectors, such as energy and communications. In the past, the process of investment in the oil and gas sector has been to conclude a Production Sharing Agreement (PSA) with the State Oil Company of Azerbaijan (SOCAR), which is subsequently ratified by parliament. The establishment of a Ministry of Fuel and Energy, renamed the Ministry of Energy and Industry (MEI) in 2004, has not meaningfully changed this procedure, although the MEI has been given nominal responsibility for conclusion of PSAs. A limitation on FDI in the banking sector was reduced when the National Bank of Azerbaijan (NBA) increased the limit on participation of banks with foreign ownership from 30 to 50 percent of the commercial banking market. A new regulatory guideline on insurance also eliminated foreign ownership restrictions on insurance companies, and a new law on investments is being considered.
Azerbaijan is not yet a member of the World Trade Organization, but the Government, with much international technical assistance, has been working to amend existing legislation. The progress made to achieve the World Bank Doing Business report ranking, and development of WTO-consistent legal reforms have been a visible result of the Government's desire to accede to the WTO. The Ministry of Economic Development has been tasked to lead the WTO accession process, and Azerbaijan held two WTO Working Party Meetings in Geneva in 2008, in addition to bilateral discussions with USTR and the EU. Creating a stable and predictable business environment is especially crucial for attracting investment to the non-energy sector. At present, however, Azerbaijan remains a challenging market in which to do business.
Under Azerbaijani law, foreign investors may participate in the Azerbaijani market through joint ventures with local companies, establishment of subsidiaries wholly owned by foreign investors, and representative offices and branches of foreign legal entities. The Law on Protection of Foreign Investments provides that the Azerbaijani government will treat foreign investors in a manner "not less favored" than the treatment accorded to local investors. This law provides for repatriation of profits, revenues, and other investment-related funds so long as applicable Azerbaijani taxes have been paid. The law also provides a 10-year grandfather clause in the event new legislation less favorable to the foreign investor is adopted. However, this provision does not apply to changes in tax legislation.
While the Azerbaijani government employs no formal screening mechanisms for general foreign investment, the process of registering an enterprise with the Ministry of Justice serves as a de facto screening process. Although by law required only to determine that documents of enterprises seeking registration are in order, the Ministry operates in a non-transparent and arbitrary manner. Credible reports indicate that ministry officials make extra-legal determinations of whether individual foreign investments are of an appropriate nature before making decisions about registration. Some investors have alleged that they have received demands for bribes when attempting to register their enterprises.
Conversion and Transfer Policies
Azerbaijan has a liberal exchange system, and, in general, there are no restrictions on converting or transferring funds associated with an investment into freely usable currency and at a legal, market-clearing rate. Conversion is carried out through the Baku Interbank Currency Exchange Market and the Organized Interbank Currency Market. The Baku Electronic Currency Exchange System (BEST) was launched in July 2002. Cash exchange is carried out at numerous currency exchange points and no difficulties exist in obtaining foreign exchange.
Since 2001, the NBA has required that cash transactions be conducted in Azerbaijani Manats. In 2006, the NBA completed the denomination of the national currency, and starting from January 2007 new Azerbaijani Manats (1 AZN equals 5000 old Azerbaijani Manats) are the only legal cash tender. The average delay for remitting investment returns is two to three business days. Additional requirements relating to the disclosure of the source of currency transfers have been imposed in an attempt to reduce illicit transactions. Parliament amended legislation in 2007 to eliminate custom duties for cash currency exports, a move that is in-line with a WTO requirement and is believed to help ease inflationary pressures. The Tax Ministry has occasionally frozen bank accounts of companies that it believes have failed to meet their tax obligations.
Expropriation and Compensation
The Law on Protection of Foreign Investments protects foreign investors against nationalization and requisition except under certain specified circumstances. Nationalization of property to prevent harm to the population or damage to state interests of Azerbaijan is possible by parliamentary resolution. Requisition by a decision of the Cabinet of Ministers is possible in the event of natural disaster, epidemic, or other extraordinary situation. In the event of nationalization or requisition, foreign investors are entitled by law to prompt, effective, and adequate compensation. There have been no cases of nationalization or requisition against foreign firms in Azerbaijan.
Dispute settlement mechanisms exist in Azerbaijan, but effective means of protecting and enforcing property and contractual rights are by no means assured. While the Azerbaijani government does not officially interfere in the court system, in practice courts are weak, judges often inexperienced, and progressive new tax and other economic legislation poorly understood. The Economic Court, which has jurisdiction over commercial disputes, is weak, widely regarded as corruptible, and its decisions are often inconsistent. The Civil Procedure Code of September 2000 sets forth basic civil legislation.
Since 2000, the Law on International Arbitration provides for the possibility of local arbitration in international commercial matters. However, in practice arbitration is seldom used to resolve disputes. A Bilateral Investment Treaty between the U.S. and Azerbaijan, which came into effect in 2001, provides U.S. investors with recourse to the International Center for the Settlement of Investment Disputes. Azerbaijan is a party to the World Bank Convention on the Settlement of Investment Disputes between States and Nationals of Other States and is also a member of the Multilateral Investment Guarantee Agency (MIGA). Azerbaijan is also a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, which provides for binding international arbitration of investment disputes between foreign investors and the state. The Civil Procedure Code provides that foreign arbitral awards may be enforced in Azerbaijan so long as they do not contravene legislation or public policy, and if reciprocity exists.
Investment disputes have arisen in Azerbaijan when a foreign investor's success threatened well connected or favored local interests. Reportedly, resolution of such disputes has occasionally involved the foreign investor acquiring a local partner with strong ties to influential persons. Azerbaijan's bankruptcy law does not function effectively and is rarely used. However, USAID will be working directly with the Ministries of Economic Development and Justice to promote a legal/regulatory reform of the bankruptcy/business closure system in 2009.
Performance Requirements and Incentives
Azerbaijan has not yet developed effective incentives to attract foreign investment, other than the incentives provided by Production Sharing Agreements in the oil and gas sector; however a special economic zone law has been crafted and presented to Parliament and is expected to be enacted in 2009. Performance requirements are not imposed on new investment, but investors who participate in the privatization process of enterprises often assume specific obligations regarding future investment and employment. Foreign investors are not required to purchase from local sources or export a certain percentage of output. Except for those state monopolies identified above, there is no requirement that nationals own shares in enterprises. Investors in PSAs assume obligations and requirements as provided within the PSA.
There are no legal requirements for employment of host country nationals. Employers wishing to hire foreign workers in Azerbaijan must obtain a license from the Ministry of Labor. Foreigners who wish to work in Azerbaijan must register with local authorities at their place of residence and obtain work permits from the Ministry of Labor. Heads of representative offices and branches of foreign legal entities and their deputies do not require work permits. In 2008, the Government introduced a work permit regime for all immigrant employees. Unfortunately, due to a lack of transparency and printed fee schedule, there are
Right to Private Ownership and Establishment
Under Azerbaijani law, foreign investors may engage in investment activities not prohibited by law. Private entities may freely establish, acquire, and dispose of interests in business enterprises. In practice, access to markets, credit and other business operations is often impeded by licensing and other regulatory requirements and by politically connected business interests that can mobilize the powers of the state to their advantage. In sectors of interest to certain senior government and political figures, competition is actively impeded through administrative barriers.
Legislation regulating real property rights include the Law on Mortgage (2005), Land Code of the Republic of Azerbaijan (1999), the Law on Land Reform (1996), the Law on Land Leasing (1999), and the Law on Land Market (1999). New laws on collateral and cadastral law have been drafted which would significantly strengthen creditor rights, and improve the transparency and fluidity with which markets for real and moveable property function. Azerbaijani citizens and Azerbaijani legal entities, including enterprises with foreign investment, can legally own, buy, sell, and trade property. Foreign citizens and enterprises may lease, but cannot own, land.
Protection of Property Rights
Secured interests in property, both movable and real, are technically recognized. While the Government, together with World Bank, has been working to improve the property registration system, the system is filled with bureaucratic requirements and is generally seen as corrupt and inefficient. In 2006, the Government centralized processing of residential real estate transactions through a network of notary offices under the Ministry of Justice.
In the mid-1990s, Azerbaijan began implementing a national system for registering and protecting intellectual property rights with the assistance of the World Intellectual Property Organization (WIPO), of which it is a member. Azerbaijan enacted improved copyright legislation (Law on Copyright and Related Rights) in 1996, patent legislation (Law on Patents) in 1997, and trademark protection legislation (Law on Trademarks and Geographic Names) in 1998. Azerbaijan is a party to the Convention Establishing the World Intellectual Property Organization, the Paris Convention for Protection of Industrial Property, and the Berne Convention for the Protection of Literary and Artistic Works. Azerbaijan is also a party to the Geneva Phonograms Convention, and acceded to the two WIPO Internet treaties in 2005.
The State Copyright Agency has formed an anti-piracy commission, with representatives from various ministries. While the Agency has made some progress by conducting raids and initiating civil court proceedings for violation of copyrights, in practice, there is limited enforcement of intellectual property rights. Pirated software and movies, as well as knock-off clothing and luxury items, are widely available in Azerbaijan. Shortcomings in its intellectual property rights laws and enforcement thereof resulted in Azerbaijan remaining on the U.S. Special 301 Watch List from 2000 to 2005. Improvements in IPR enforcement allowed Azerbaijan's removal from the list in 2006. As part of its WTO accession program, Azerbaijan has recently developed a range of WTO-consistent IPR legal and regulatory reforms, which could significantly strengthen IPR rights and enforcement protections.
Transparency of the Regulatory System
Although the Azerbaijani government has improved its regulatory system in the past several years, lack of transparency and allegations of corruption remain key problems in this area. The lack of transparent policies and effective laws to establish clear rules and foster competition are particularly serious impediments to investment. Informal bureaucratic control mechanisms often impede with application of laws and regulations and hinder competition.
While laws and decrees are usually published in one of the country's official newspapers, implementation is often delayed while regulations are developed. Those regulations in many cases are not published or distributed. In 2008, the government began a concerted effort to improve the transparency and predictability of the business regulatory environment with the assistance of USAID and the WB/IFC. This is reflected in the well publish progress made in the World Bank's 2009 Doing Business rankings. The major areas of improvement included establishing a one-stop shop for business registration, streamlining property registration and transfer procedures, automation of key tax administration processes, broadened coverage of the credit registry system, and improved corporate governance guidelines. Significant areas for improvement remain, including customs operations, business closure, and business permitting systems; however Azerbaijan announced in fall 2008 its plan to establish a one-stop shop for customs entry/clearance in 2009.
Azerbaijan has announced plans to adopt 29 national accounting standards to be in-line with International Financial Reporting Standards (IFRS) by 2009. Audited financial statements have only been adopted in banking and finance, where foreign ownership is most advanced.
Efficient Capital Markets and Portfolio Investment
As of December 2007, there were 43 banks in Azerbaijan. The banking sector is dominated by the International Bank of Azerbaijan (IBA), which controls more than 50 percent of the banking sector. Foreign ownership in the banking sector is limited to 50 percent on an aggregate basis. There are 18 banks with foreign capital. As of November 2007, Moody's Weighted Average Bank Financial Strength Rating for Azerbaijan was "E+".
According to the National Bank of Azerbaijan (NBA), as of December 2007, total assets of the Azerbaijan banking system were about 7 billion USD. Total capital of banks grew by 77 percent and reached AZN 1 billion as of December 1, 2007. Deposits grew by 39 percent and reached AZN 3100 million. Azerbaijan in 2007 established the National Depository Insurance Fund, which, as of December 2007, has 37 banking members.
The NBA has taken steps to improve bank supervision, and reduced capital requirements in December 2008 in response to the global financial crisis. A presidential decree required installation of point of sale (POS) terminals in all shops within two years beginning in January 2006. Despite some progress in installation of POS terminals, the vast majority of stores and restaurants do not carry POS terminals or, if they do, avoid running card transactions to minimize taxation. The Baku Interbank Currency Exchange (BICEX) carries out inter-bank auctions of foreign exchange. Treasury bill auctions are conducted by the Baku Stock Exchange, which was established in 2000. Overall the securities market remains as a very nascent stage of development.
In November 2008, Fitch Ratings affirmed Azerbaijan's long-term issuer default rating as BB+ with a stable outlook. In July 2008 Moody's Investor Service raised its outlook on Azerbaijan's Ba1 issuer rating from stable to positive.
There have been no acts of political violence against U.S. businesses or assets, nor against any foreign-owned entity. The risk of political violence affecting foreign investors remains minimal. In 2006 and 2007, the Azerbaijani authorities arrested two separate groups that were accused of plotting terrorist acts against Western interests. Police periodically use force to disperse unauthorized demonstrations or spontaneous acts of public discontent; police also used force to break up a peaceful protest during the January 2009 conflict in Gaza.
Corruption is a significant deterrent to investment in Azerbaijan, especially in the non-energy sector. Laws and regulations that exist to combat corruption have not been effectively enforced. A new anti-corruption law came into force in January 2005. Under the terms of the law, a new commission has the authority to require full financial disclosure from government officials. However, Azerbaijan made little progress on implementation of this law. The Azerbaijani government recognizes that corruption is a problem, although it frequently disagrees with the results of international rankings produced by groups such as Transparency International. According to Transparency International, the situation in Azerbaijan worsened in 2008 and the country ranked 157th out of 163 countries, compared to 130th in 2006. Popular opinions identify the State Customs Committee as the institution of greatest concern of businesses in Azerbaijan, followed by the Ministry of Taxation. Corruption appears most pervasive in the regulatory, tax and dispute settlement systems. Throughout the country, problems in the quality, reliability and transparency of governance, as well as abuse of the regulatory system and poor contract enforcement, significantly impede the ability of many companies to do business in Azerbaijan and have driven many companies, including some major Western firms, from the market.
In the past several years, politically connected businesses appear to have benefited from government regulatory and other decisions to achieve effective control over several lucrative sectors of the economy, and U.S. investors have been among those victimized. Currently, powerful state-owned enterprises, such as the Azerbaijan State Caspian Shipping Company (CASPAR) and the State Airlines (AZAL), have protected their commercial interests by blocking entrance of new entrants into the market through the exercise of their regulatory authority -- a clear conflict of interest. A focus of current international community work in Azerbaijan is combating corruption and improving governance. In 2004, Azerbaijan joined the Council of Europe's Group of States against Corruption (GRECO), but Azerbaijan is not a signatory to the OECD Convention on Combating Bribery.
In 2004, Azerbaijan adopted an implementation plan for the Extractive Industries Transparency Initiative (EITI) to promote more transparent management of oil revenues.
Bilateral Investment Agreements
On October 18, 2000, the U.S. Senate ratified the Treaty between the Government of the United States of America and the Government of the Republic of Azerbaijan Concerning the Encouragement and Reciprocal Protection of Investment (commonly known as a "Bilateral Investment Treaty" (BIT). Azerbaijan and the U.S. exchanged instruments of ratification on July 3, 2001, and the treaty entered into force on August 2, 2001.
In addition to the above agreement, Azerbaijan has bilateral investment protection agreements with the following countries: Austria, Belgium, Bulgaria, China, Egypt, Finland, France, Georgia, Germany, Greece, Iran, Italy, Kazakhstan, Kyrgyzstan, Latvia, Libya, Moldova, Pakistan, Poland, Saudi Arabia, Switzerland, Turkey, UAE, Ukraine, and the United Kingdom.
OPIC and Other Investment Insurance Programs
OPIC provided USD 100 million in political risk insurance to U.S.-based financial institutions and U.S. equity partners in the Baku-Tbilisi-Ceyhan oil pipeline. In 2002, OPIC invested USD 50 million in Soros Investment Capital for projects targeted to all three Caucasus countries. OPIC also disbursed a USD 4.6 million loan to Caucasus Airlines, a regional air carrier based in Tbilisi. Caucasus Airlines ceased operations in late 2004 after a dispute arose with Azerbaijan's state air carrier AZAL over terms on the Baku-Tbilisi route. In 2005, OPIC provided financing to Baku Oil Tools for a joint venture with the State Oil Company, SOCAR. In 2006, OPIC provided USD 7.5 million to ShoreBank International Ltd for SME and mortgage loan portfolio expansion in Azerbaijan.
In March 2004, the Export-Import Bank of the United States (Ex-Im Bank) provided a USD 19.3 million loan guarantee to Saba, Inc., a mid-sized U.S. company, for engineering, design, and construction services to build a business and residential center in Baku.
Azerbaijan has an abundant supply of qualified, trained technicians and skilled and unskilled laborers at attractive rates to employers. At the same time, companies cite increasing problems with hiring skilled professional staff, which could be result of a decline in quality education and labor emigration. The collapse of the old Soviet industrial sector in this country during the 1990s resulted in large numbers of Azerbaijanis becoming unemployed or underemployed. Government sources estimate the rate of unemployment at seven percent, but other sources quote up to twenty percent or more, with underemployment much higher. The Government has announced plans to increase the minimum monthly wage increased from AZN 60 to AZN 84 in 2009. A Labor Code that took effect in 1999 regulates labor relations. The workweek is generally forty hours, the right to strike exists, and industrial strikes occur occasionally. Azerbaijan is a member of the International Labor Organization and has ratified more than 50 ILO Conventions. Azerbaijan is currently engaged with the World Bank in a program to reform the state pension system.
Foreign Trade Zones/Free Ports
Although the government announced in 2003 its intention to create special economic zones, there are currently no foreign trade zones or free ports operating. The Ministry of Economic Development has announced plans to create a special economic zone near a new Caspian port to be completed in 2012. The Ministry of Communication and Information Technologies has conducted a feasibility study to create Regional Innovation Zones with an aim to boost development of the sector and to turn Azerbaijan into a regional information and communication technology hub.
Foreign Direct Investment Statistics
Below numbers are the latest available from the State Statistical Committee of Azerbaijan:
|Investments (million USD)||2004||2005||2006||2007|
|FDI (million USD)||2004||2005||2006||2007|
|Foreign Companies & Joint Ventures||104.2||230.5||368.4||276.9|
Significant foreign investors in the energy sector include BP, Unocal, ExxonMobil, Devon Energy (Pennzoil), TPAO, Statoil, Lukoil, Itochu, Agip, ChevronTexaco, ENI, Halliburton, Schlumberger, Kvaerner, and Aker Maritime (Technip-Coflexip). Significant non-energy investments include Garadagh Cement, Castel (brewery), Coca Cola, Pepsi Cola, Azercell (mobile telephony), Bakcell (mobile telephony), Azerfon (mobile telephony), and Hyatt Hotels Baku.