Previous Quarterly Editions
Expropriation Risk: 51 51 51 47 Political Violence Risk: 57 57 57 57 Terrorism Risk: 42 42 42 40 Exchange Transfer and Trade Sanction Risk: 64 64 64 64 Sovereign Default Risk: 47 47 47 47
TREND ►
Hostilities over Nagorno-Karabakh escalated sharply in late September, leading to a 44-day war which ended in a military and political victory for Azerbaijan. Frustrated at a peace process that it felt delivered nothing, Baku had been investing in arms, including a fleet of Turkish Bayraktar drones and Israeli kamikaze drones. The relatively low-cost attack drones offered Azerbaijan a huge advantage in the war, enabling it to destroy Armenia’s weapons systems in Nagorno-Karabakh and shifting a long-standing conflict in under six weeks. However, the fighting also caused heavy casualties on both sides: Armenia counted 2,425 dead soldiers, while Azerbaijan stated that 2,783 of its forces had died and another 100 were missing.
The extent of Turkey’s military support remains unclear (Baku and Ankara deny any direct Turkish involvement in the fighting) but diplomatically Ankara openly supported Azerbaijan and conducted joint military exercises. Although Azerbaijan had made irreversible military gains by late October 2020, it did not claim political victory until it strategically recaptured the symbolically important city of Shusha.
News broke overnight on November 10 2020 that President Ilham Aliyev and Armenian Prime Minister Nikol Pashinyan had signed the peace deal brokered by Russian President Vladimir Putin. The terms reflected battlefield realities and stipulated that Azerbaijan would retain control of all the territories it had regained during the war as well as receive control over several adjacent areas occupied by Armenian forces since the early 1990s. The Moscow-brokered deal introduced 2,000 Russian peacekeepers for at least five years; these have already been deployed on the Nagorno-Karabakh frontline and along the Lachin corridor which connects the enclave with Armenia.
However, the deal has not resolved Nagorno-Karabakh’s final status and Armenians have retained control of parts of the enclave, most notably regional capital Stepanakert (Hankendi). Moscow has expanded its military footprint in the region but so has Turkey, by, for example, establishing a joint monitoring centre which decides how to react if the ceasefire is violated.
Despite the war, Azerbaijan successfully launched the first phase of the Southern Gas Corridor (SGC), with the annual capacity of 16 billion cubic metres (bcm), thus becoming a gas exporter to Europe. First gas to Greece and Bulgaria via the newly completed Trans-Adriatic Pipeline arrived on December 31, 2020. Already in January-February 2021, official figures showed that gas exports rose to 3.4 bcm, an increase of 32% year-on-year.
Revenue from gas exports will be particularly important given Azerbaijan’s commitment to reduce its crude oil production from May 2020 as part of the OPEC+ deal, as well as natural output declines at the Azeri-Chirag-Guneshli (ACG) fields. Baku is already actively exploring options for expanding the SGC; in January, it signed an intergovernmental memorandum of understanding with Turkmenistan for the joint development of the previously disputed field, now renamed Dostluk/Dostlug (which means ‘friendship’ in both languages). Azerbaijan's acceptance of a 30% stake in the field shows that it is prepared to compromise on profits from one deposit for the sake of larger gains, such as increased gas transportation through Azerbaijan, which would boost the country’s chances of emerging as a regional gas hub.
TREND ▼
It is unlikely that the current crisis will loosen the tight grip that a small group of government-connected companies has on Azerbaijan’s economy, as they are best-placed to ride out the economic downturn. The arrest of Ilgar Ismayilov, former owner of Azerbaijan’s largest cosmetics chain on corruption charges, demonstrates the risks of confronting more powerful and better-connected individuals. Recently, Ismayilov hinted that he had sold his cosmetics business under pressure and accepted a below-market-value offer. He used the money to invest in top-end dry cleaning boutiques, but these may now also be under threat.
Azerbaijan’s opaque bureaucracy and tame judiciary remain an obstacle to significant investment. Post-war, the government has set up three public funds to help soldiers and their families. While the funds are described as voluntary, some reports on social media and by independent news outlets suggest citizens are being forced to contribute. Employees of state companies have complained that up to 1% of their salary has been transferred into one of the funds without their consent. Although significant amounts have been collected, there is little transparency in how the funds are spent.
Following a large pro-war rally in Baku in mid-July 2021, in which thousands of protesters demanded stronger military action against Armenia, the authorities detained over 70 people. Criminal charges were raised against 17 senior activists of Azerbaijan’s main opposition party, Popular Front (PF). During the rally, which Aliyev subsequently portrayed as “mostly patriotic” albeit infiltrated by a small number of “provocateurs”, a group of people forcibly entered the parliament, causing minor damage. They were removed by the police, but violent clashes continued on the street. In November 2020, 12 of the sentenced PF members were transferred under house arrest.
In August 2020, the Grave Crimes Court in Baku sentenced Polad Aslanov, editor-in-chief of independent news websites Xeberman and Press-az, to 16 years in prison on charges of selling state secrets to Iran. At the closed-doors court hearing, Aslanov denied the charges and said they were in retaliation for his reporting on official corruption.
President Aliyev continues to use the special quarantine regime, expected to remain operative until at least June 1 2021, to suppress his few remaining political opponents. Scores of PF supporters have been detained for up to 30 days on charges of violating COVID-19 quarantine rules. The ban on protests in central Baku looks set to continue post-COVID-19.
Land borders have remained closed since mid-March 2020 due to COVID-19, with only limited air-based entry possible. This has partially alleviated terrorism concerns.
Fears of the officially dubbed “Armenian terrorism” against the civilian population remained rife throughout the war and in its aftermath as the government and members of the public feared retaliation. Additional security checks were introduced throughout the major cities, with vehicles checked for improvised explosive devices at major supermarkets.
All shopping malls have remained closed throughout COVID-19. Strict lockdown rules, according to which Baku residents were required to obtain approval from the police before leaving the house, were reintroduced in December 2020, before being finally relaxed in mid-January the following month. The measures aimed at preventing the spread of COVID-19 has also enhanced the government’s ability to control the situation during and after the war.
The central bank appears to have abandoned its intended move to a floating exchange rate, as the manat remains pegged at 1.7 to the US dollar. Hard currency reserves from state oil fund SOFAZ were used to support the manat, with the drawdown reaching USD2.5bn in March-April 2020 due to the combined shock from the collapse in oil prices and COVID-19.
These pressures eased in the following months, with net demand for foreign currency remaining relatively stable even during the war. As of January 1 2021, total assets held by SOFAZ amounted to USD43.6bn (with an additional USD6.4bn held by the central bank), representing an annual increase of 0.6%. Risks of a disorderly devaluation remain low.
Azerbaijan’s financial system remains fragile, as demonstrated by the collapse of the country’s four top banks in 2020, strong dollarisation, liquidity problems and high lending rates. Liquidity and financial sustainability were among major issues when oil prices collapsed; however, their subsequent recovery and additional gas revenue, which Azerbaijan will now receive from SCG exports, will contribute to economic stability.
Gross domestic product is forecast to grow at 2-2.5% in 2021. Rising food prices have driven up inflation. In 2020, inflation reached an estimated 3%. It is forecast to edge up slightly in 2021 but will remain within the target range of the Central Bank. Unemployment, currently estimated at 6.5%, increased mainly due to the large contraction in travel and tourism. While Azerbaijan remains capable of borrowing externally, its international financing is increasingly concentrated in institutions that are not Western led.
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