Previous Quarterly Editions
Expropriation Risk: 51 51 47 48 ▲ Political Violence Risk: 57 57 57 59 ▲ Terrorism Risk: 42 42 40 40 ► Exchange Transfer and Trade Sanction Risk: 64 64 64 64 ► Sovereign Default Risk: 47 47 47 47 ►
TREND ►
Exchanges of gunfire and deadly incidents have occurred regularly since the end of the 44-day war which ended in a military and political victory for Baku. The deadliest incident took place in late July, resulting in casualties and fatalities on both sides, which led Baku and Yerevan to accept a Russian ceasefire proposal to try and calm tensions. As part of the agreement signed in November 2020 to end the war, Moscow has deployed 2,000 peacekeepers for at least five years on the Nagorno-Karabakh frontline and along the Lachin corridor which connects the enclave with Armenia.
Baku remains heavily concerned about the impartiality of Russian peacekeepers, as reflected in the formal statement issued in mid-August by the Azerbaijani defence ministry, condemning the Russian peacekeepers’ inaction to the deployment of Armenian armed forces to Nagorno-Karabakh through the Lachin corridor. On the same day, the Azerbaijani foreign affairs ministry issued a note of protest to Tehran over Iranian vehicles entering and exiting the parts of Nagorno-Karabakh which are under the control of Russian peacekeepers.
President Ilham Aliyev has voiced similar concerns, underlining the need for strong and continuous support from Ankara. The Shusha Declaration on allied relations signed on June 15 during the visit of Turkish President Recep Tayyip Erdogan to Nagorno-Karabakh is seen in Baku as a key document securing Turkish backing in any renewed military conflict. The pact focuses on defence cooperation and affirms that the two states will jointly ward off foreign threats. The November deal did not resolve Nagorno-Karabakh’s final status and Armenians have retained control of parts of the enclave, most notably regional capital Stepanakert (Hankendi). Baku is keen to get Yerevan to renounce any claims to Nagorno-Karabakh and has been exerting pressure on Yerevan to sign a final resolution of the conflict on Baku’s terms.
Despite close political relations, Turkish state-owned company Botas did not renew a long-term contract with BP-Azerbaijan for the annual supply of 6.6 billion cubic metres of gas (bcm), which expired in April. The gas previously travelled via the Baku-Tbilisi-Erzurum pipeline for offtake in Turkey but, after the contract expired, was sent further on to Europe via the newly completed Southern Gas Corridor (SGC). Azerbaijan became a gas exporter to Europe when gas from Shah Deniz-2 reached Greece and Bulgaria in December 2020. This year, gas supplies via the SGC were planned at 5 bcm and expected to double to 10 bcm by the end of 2022. However, while negotiations with Turkey are ongoing, Azerbaijan has been sending surplus via the SGC, predominantly to Italy, where gas prices at the hub rose sharply in recent months.
Strong European demand and no agreement with Botas could result in exports of up to 9 bcm of Shah Deniz gas via the SGC by the end of 2021. Baku is actively exploring options for expanding the SGC from the current annual capacity of 16 bcm so it can increase revenue from gas exports, particularly important given the natural output declines at the Azeri-Chirag-Gunashli oil fields.
TREND ▲
The government has been outspoken about its intention to reward ‘friendly’ countries with reconstruction contracts. Following Turkey’s active support in the 44-day war against Armenia, Turkish construction, mining and energy companies have signed dozens of significant contracts to assist in the reconstruction of Nagorno-Karabakh and adjacent regions. Among the key contracts, awarded without tenders, have been the construction of a new international airport in Fuzuli (flights due to start in late 2021), a new ‘Victory Road’ to the strategically and symbolically important city of Shusha and a highway to Kalbajar. Turkish companies have also benefitted from lucrative contracts in Baku, such as the construction of new central bank headquarters and the management of Azerbaijan’s national lottery (awarded by presidential decree).
Expropriation risk for companies already operating in Azerbaijan remains low; however, new contracts will go predominantly to Turkish firms, seen to represent the ‘brotherly nation’. Israeli and Pakistani companies may also benefit as their governments supported Azerbaijan throughout the military conflict.
President Aliyev continues to use the special quarantine regime, extended by a decision of the Cabinet of Ministers until at least November 1, to suppress his few remaining political opponents. Scores of Popular Front 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.
To manage brewing public discontent resulting from COVID-19 restrictions, the government eased the rules ahead of the summer season. Masks have not been required in outdoor spaces since May 31; public transportation, including the Baku Metro, has reopened during weekdays, while beaches, health centres, places of worship, malls and shopping centres have been open since June 10. Weddings, birthday parties and other festivities have also been allowed, although at gatherings of over 150 people all attendees must present a valid proof of vaccination.
Effective September 1, all individuals over 18 years of age have been required to hold COVID-19 proof of vaccination to enter public indoor places, including restaurants and malls. All students over 18 must prove that they are fully vaccinated and over 80% of government employees have been told to get both doses of the vaccine by October. Such measures, the strictest in the region, are expected to raise the percentage of the adult population who have been fully vaccinated from the current 27%. However, they also lead to public anger, which has already manifested itself in violent scenes at local polyclinics.
Air-based entry has been eased over the summer, with more direct flights opening to and from Baku. However, land borders have remained sealed since mid-March 2020 due to COVID-19. This has partially alleviated terrorism concerns.
Fears of the officially dubbed ’Armenian terrorism’ against the civilian population, rife during the war and in its immediate aftermath, have receded in intensity. Security checks, previously prevalent throughout the major cities, and regular inspections for improvised explosive devices of vehicles entering supermarkets in Baku, have now been largely removed. Yet the authorities will continue to control the situation by precluding mass gatherings.
The central bank has abandoned its intended move to a floating exchange rate, and the manat remains firmly pegged at 1.7 to the US dollar. Hard currency reserves from state oil fund SOFAZ were used to support the manat during the period of low oil prices and the economic downturn during the COVID-19 pandemic. These pressures have now eased with the price of oil hovering at over USD70 per barrel since the beginning of the summer. As of July, total assets held by SOFAZ amounted to USD52.2bn (up from USD43.6bn in January), with an additional USD6.5bn held by the central bank. 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. Growth of crude prices since the beginning of 2021 means that Baku is well placed to balance its budget as it needs an oil price of around USD53 per barrel. The additional 7,000 barrels per day, which Azerbaijan has been allowed to produce under the OPEC+ agreement from October (raising its total daily quota to 640,000 barrels), coupled with the gas revenue which Azerbaijan has started to receive from SCG exports, will contribute to economic stability.
Gross domestic product is forecast to grow at 2.0-2.5% in 2021. Rising food prices have driven up inflation, but Aliyev claimed in July that inflation was now at an acceptable rate of 4.3%. Independent economists estimate that inflation is three to four times higher than the official figures suggest. 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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