Previous Quarterly Editions
Expropriation Risk: 48 54 54 56 ▲Political Violence Risk:59 59 60 60 ►Terrorism Risk:40 40 40 45 ►Exchange Transfer and Trade Sanction Risk: 64 64 64 55 ▼Sovereign Default Risk:47 37 37 37 ►
TREND ▼
Geopolitical alignmentEast 1 2 3 4 5 West
Alignment five years agoEast 1 2 3 4 5 West
Degree of contestationSettled 1 2 3 Contested
President Ilham Aliyev has remained a staunch promoter of the policy of manoeuvring between Russia and the West, championed by his father, late President Heydar Aliyev. Azerbaijan abstains from entering economic blocs or military alignments, seeking instead to leverage opportunities that arise from the developing international situation to advance its national interests and avoid antagonising Russia, which remains the preponderant diplomatic and military regional power. Thus, in February, two days before the start of the Russia/Ukraine conflict, Baku signed a declaration on mutual cooperation with Moscow, aimed at counter-balancing its June 2021 Shusha Declaration on allied relations with Turkey.
Azerbaijan has sought to restructure its armed forces, moving away from the Soviet model and adopting a more professional, mobile and high-tech force, emulating NATO member Turkey. Special forces became top priority in the reform: a new branch called “commandos,” based on Turkish units of the same name was established and the number of special forces units has been doubled since the end of the Second Karabakh War in November 2020.
At the same time, Aliyev was quick to dismiss all speculation that Ankara would establish military presence in Azerbaijan, highlighting the military doctrine precluded the establishment of foreign bases in
the country. The lack of Turkish, NATO, or U.S. bases in Azerbaijan has formed a key tenet in Baku’s relations with Moscow, appeasing it but at the same time creating opportunities for a more limited cooperation with Turkey, Israel, the U.S. and others.
In the aftermath of the Second Karabakh War, Baku has addressed its concerns of what it calls “Armenian military revanchism” not by forging military alliances with Turkey, which would have exacerbated relations with Russia, but by increasing its military spending to 5.3% of GDP in 2021, according to a Stockholm International Peace Research Institute report.
The delicate balancing act between Russia and the West has enabled Baku to cooperate with Turkey and modernise its military without antagonising Moscow. On the other hand, the lack of an overt alignment with the U.S. or NATO has enabled Baku to conduct military operations to regain territories and strengthen its positions in the Nagorno-Karabakh region withoutbeing accountable to the West. In fact, Baku has openly dismissed Western criticism during and after the Second Karabakh War.
Hydrocarbons have been at the core of Azerbaijan’s relations with the West, enabling Baku to engage U.S. and European Union interest by offering diversification of supplies and reduced reliance on Russian oil and gas. In the 1990s, Azerbaijani-Western relations centred on the production and evacuation of oil, but since the 2000s, the focus has shifted steadily to gas, and acquired new overtones in the light of Europe’s imminent energy crisis following the Western reaction to the Russian invasion of Ukraine inn February 2022.
First volumes of Azerbaijani gas were exported to Europe in December 2020 when gas from Shah Deniz-2 reached Greece and Bulgaria via the Southern Gas Corridor (SGC). The existence of this pipeline infrastructure led to the signing in July of a Memorandum of Understanding on Strategic Partnership in the Field of Energy between Azerbaijan and the European Union. According to this agreement, Azerbaijan would increase gas supplies to the European Union from 8.1 billion cubic metres (bcm) in 2021 to 12 bcm by the end of this year and 20 bcm by 2027.
The increase by the year-end is likely to be achievable given that earlier export targets had already envisaged a similar growth in volume transported via SGC. However, the doubling of exports within five years seems unrealistic as neither the country’s main gas field, Shah Deniz, nor the smaller fields can increase production to meet the extra demand.
Export capacity via SGC is another key constraining factor for any significant increase within the five-year timeframe. Securing sufficient volumes of gas would require a deal with Turkmenistan and the construction of new pipelines, which, if realised, would increase Azerbaijan’s standing in the region. Yet, if the country fails to strike a deal with its neighbour, then it will
not suffer any legal or financial repercussions as the memorandum is non-binding.
This is a diplomatic victory for the Aliyev government, which has successfully raised Azerbaijan’s international energy profile and considerably repaired the damage to political relations with the European Union inflicted during the Second Karabakh War. Furthermore, the EU acknowledgement of Azerbaijan’s potential in renewable energy presents new opportunities for Baku to tap into the European Union’s growing green energy demand as it seeks ways to carve out a longer-term role for itself in a future where its hydrocarbon exports decline.
If the policy of manoeuvring is to be sustainable over the long term, Baku needs to develop new bargaining chips to use in its relations with the West, which would bind Western attention and interests to Azerbaijan, thus counterbalancing Russia’s continued dominance in the region.
TREND ▲
The government remains 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. 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 which was 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.
TREND ►
A new draft law on political parties has been presented in parliament, which would further constrain the terrain for any meaningful opposition. The draft requires new parties to have at least 200 founding members with each having lived in Azerbaijan uninterruptedly for the past 20 years. By comparison, the constitution requires a presidential contender to have lived in Azerbaijan for only ten years.
Other restrictions would affect the country’s 58 formally registered opposition parties – those parties that do not for any reason, including boycott, participate in two consecutive presential, parliamentary or municipal – would be shut down. The adoption of the law in a parliament dominated by the pro-government New Azerbaijan Party, which is chaired by Aliyev, leaves little doubt.
Since the end of the Second Karabakh War, issues related to living standards, administration of justice, and property have been the most outstanding reasons for citizen resentment. High international price of oil will enable the government to raise salaries, pensions, and social benefits, thus partly alleviating social discontent, while the authorities will continue to overlook occasional issue-specific protests so long as they do not in any way target the president and his immediate family.
The escalation of hostilities with Armenia on September 13 has marked the latest flare-up since the end of the Second Karabakh War. At least 105 Armenian soldiers and 71 Azerbaijani military personnel were killed over two days in incidents which Baku has characterised as “large-scale military provocations” and “acts of terrorism”.
While the overarching aim of such statements has been to justify the attacks on the Armenian territory, the Aliyev government appears to be genuinely concerned about the need to create a ‘buffer zone’ along Armenia’s border with Azerbaijan, to minimise threats to border guards, soldiers, and military infrastructure.
Separately, the Azerbaijani Prosecutor General’s Office has launched a criminal case against “the Armenian extremists” who attacked the building of Azerbaijani embassy in Paris on September 18.
Air-based entry has returned to pre-COVID levels, with more direct flights opening to and from Baku. However, land borders have remained sealed since mid-March 2020, partially alleviating terrorism concerns. In Baku and other major cities, the authorities continue to control the situation by precluding mass gatherings.
The manat remains firmly pegged at 1.7 to the U.S. dollar. The pressure to support the manat has disappeared with the rapidly rising prices of Brent and Azeri Light. As of May, Azerbaijan’s strategic foreign exchange reserves (formed from central bank reserves, the assets of state oil fund SOFAZ and treasury funds of the finance ministry) reached USD54.2 billion (up from USD52.1 billion in January 2022). Risks of a disorderly devaluation remain low.
Azerbaijan’s financial system remains fragile, as demonstrated by strong dollarisation, liquidity problems and high lending rates. Nonetheless, Baku is well placed to balance its budget as it needs an oil price of around USD53 per barrel. The additional revenue Azerbaijan will receive from the record high oil prices, which resulted from the Russia/Ukraine crisis and the efforts by Western states to sanction Russian hydrocarbons, and the gas revenue which Azerbaijan receives from exports, will contribute to economic stability.
While Azerbaijan remains capable of borrowing externally, its international financing is increasingly concentrated in institutions that are not Western led.
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