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Azerbaijan Country Economic Memorandum Report No. 44365-AZ Report No. 44365-AZ Azerbaijan Country Economic Memorandum Public Disclosure Authorized A New Silk Road: Export-led Diversification December 23, 2009 Poverty Reduction and Economic Management Unit Europe and Central Asia Region Azerbaijan Economic Memorandum Country Public Disclosure Authorized Public Disclosure Authorized Document of the World Bank Public Disclosure Authorized FX Foreign exchange GAO General Accounting Office (US) GDP Gross domestic product GED General Employment Department ha Hectare HK Human capital IBA International Bank of Azerbaijan IBFD International Bureau of Fiscal Documentation ICR Implementation Completion Report IDP Internally displaced person IEG Independent Evaluation Group IFC International Finance Corporation IFRS International Financing Reporting Standards ILO International Labor Organization IMF International Monetary Fund IPO Initial public offering IPP Independent power producer ISCO International Standard Classification of Occupations LAC Latin America and Caribbean LTU Large Taxpayer’s Unit JSAN Joint Staff Advisory Note KEI Knowledge Economy Index LFS Labor Force Survey LPI Logistics Performance Indicator LTORMS Long-Term Oil Revenue Management Strategy MED Ministry of Economic Development MoA Ministry of Agriculture MoED Ministry of Economic Development MoF Ministry of Finance MoLSPP Ministry of Labor and Social Protection of the Population MoT Ministry of Taxes MoTr Ministry of Transport MSME Micro, small and medium enterprise MTEF Medium-Term Expenditure Framework n.a. Not applicable NBA National Bank of Azerbaijan NEER Nominal effective exchange rate NEF National Entrepreneurship Fund NGO None Governmental Organization NPL Non Performing Loans NPV Net present value OECD Organization for Economic Co-operation and Development OF (See SOFAZ) OPEC Organization Petroleum Exporting Countries OTC Over the counter PEFA Performance Evaluation and Fiduciary Assessment PI Permanent income PIP Public Investment Program PISA Program for International Student Assessment (OECD) PIT Personal income tax PPA Power purchasing agreement PPP Purchasing Power Parity and also Public Private Partnership PROMINVEST A state bank PRSC Poverty Reduction Support Credit PSA Production Sharing Agreements PWC PricewaterhouseCoopers R&D Research and development RCA Revealed comparative advantage REER Real effective exchange rate RR Reduced rate RTSD Road Transport Service Department SAC Structural Adjustment Credit SCMSP State Committee for the Management of State Property SCADA Supervision Control and Data Acquisition SECO State Secretariat for Economic Affairs (of Switzerland) SME Small and medium enterprises SOCAR State Oil Company of Azerbaijan Republic SOE State-owned enterprise SOFAZ State Oil Fund of Azerbaijan (Oil Fund) SP Social protection SPF Social Protection Fund SPPRED State Program for Poverty Reduction and Economic Development SPS Sanitary and phyto-sanitary standards SPSEDR State Program for Socio-Economic Development of the Regions SSC State Statistical Committee SST Social Security Tax STR Simplified tax regime UNDP United Nations Development Program US United States of America TA Technical assistance TIMS Treasury Information Management System VAT Value-added tax VET Vocational education and training WDI World Development Indicators WTO World Trade Organization YEN UN Secretary General’s Youth Employment Network Vice President: Philippe H. Le Houerou, ECAVP Country Director: Asad Alam, ECCU3 Sector Director: Luca Barbone, ECSPE Sector Manager: Kazi Mahbub-Al Matin, ECSPE Task Team Leader: Christos Kostopoulos, ECSPE CONTENTS FORWARD FROM THE FORUM ON ECONOMIC AND SOCIAL DEVELOPMENT OF AZERBAIJAN .................................................................................................................................... i PREFACE .............................................................................................................................................. iii ACKNOWLEDGEMENTS ............................................................................................................................. v EXECUTIVE SUMMARY ............................................................................................................................ vii CHAPTER 1. INTRODUCTION ................................................................................................................ 1 A. INTRODUCTION ...................................................................................................................................... 2 B. ECONOMIC BACKGROUND ..................................................................................................................... 3 C. EMPLOYMENT AND POVERTY REDUCTION ........................................................................................... 10 D. MEDIUM-TERM CHALLENGES .............................................................................................................. 12 E. AZERBAIJAN’S DEVELOPMENT STRATEGY AND RESPONSE OF THE ECONOMY ..................................... 16 F. SUCCESSFUL DEVELOPMENT IN RESOURCE-RICH AND SMALL ECONOMIES ......................................... 21 G. OVERCOMING THE HURDLES CAUSED BY THE GLOBAL CRISIS ............................................................ 27 H. CONCLUSION........................................................................................................................................ 28 CHAPTER 2. THE ECONOMY AND ITS PROSPECTS ..................................................................... 30 A. AZERBAIJAN’S FUTURE: BROAD STROKES FOR THE MEDIUM TERM .................................................... 30 B. SECTORAL DEVELOPMENTS AND IMPEDIMENTS ................................................................................... 33 C. REGIONAL INTEGRATION AND TRADE .................................................................................................. 42 D. GOING FORWARD ................................................................................................................................. 48 E. CONCLUSION........................................................................................................................................ 49 CHAPTER 3. FISCAL SUSTAINABILITY AND PUBLIC FINANCE GOVERNANCE .................. 51 A. INTRODUCTION .................................................................................................................................... 51 B. SMOOTHING OIL SPENDING: PERMANENT INCOME APPROACH ............................................................ 55 C. STRATEGY FOR AZERBAIJAN’S PUBLIC FINANCES ............................................................................... 58 D. BUDGET INCREASES AND CONSTRAINTS ON FUTURE SPENDING (2005-2008) ..................................... 62 E. INSTITUTIONAL STRUCTURES, BUDGET MANAGEMENT AND MAXIMIZING SPENDING IMPACT ........... 66 CHAPTER 4. TAILORING INVESTMENT IN UTILITIES TO PRIVATE SECTOR NEEDS ....... 73 A. INTRODUCTION .................................................................................................................................... 73 B. INFRASTRUCTURE READINESS AND QUALITY OF PUBLIC SERVICES ..................................................... 75 C. DIRECTION OF PUBLIC INVESTMENT PROGRAM (PIP) .......................................................................... 78 D. ELECTRICITY ........................................................................................................................................ 80 E. TELECOMMUNICATIONS ....................................................................................................................... 85 F. ROADS ................................................................................................................................................. 87 G. RAILWAYS ........................................................................................................................................... 90 H. WATER SUPPLY AND WASTEWATER .................................................................................................... 91 I. CRITICAL CROSS-SECTORAL ISSUES .................................................................................................... 94 CHAPTER 5. ENCOURAGING A BROADER, MORE COMPETITIVE PRIVATE SECTOR ...... 96 A. INTRODUCTION .................................................................................................................................... 96 B. INTERNATIONAL STANDINGS ............................................................................................................... 97 C. THE STATE AS A MAJOR PRODUCER AND INVESTOR .......................................................................... 100 D. INCENTIVES FOR ENTRY AND EXPANSION .......................................................................................... 102 E. FOREIGN TRADE REGIME AND COMPETITION .................................................................................... 109 F. PRO-GROWTH/DIVERSIFICATION REFORM PACKAGE ........................................................................ 111 CHAPTER 6. AZERBAIJAN’S FINANCIAL AND BANKING SECTORS...................................... 115 A. INTRODUCTION .................................................................................................................................. 115 B. FINANCIAL INTERMEDIATION ............................................................................................................. 116 C. ACCESS
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