Conservative fiscal policies restore financial stability
Modernised Azeri banks have now joined international banking system

Azerbaijan had to make the transition from a Soviet republic with a command economy to an independent, democratic country with a market economy in the midst of:

• A war launched by neighboring Armenia which resulted in the loss of 20 percent of Azerbaijan’s territory, resulting in a million refugees and displaced persons.
• Internal political and economic chaos that brought the young country to the brink of civil war.
• Weak institutional development.
• The collapse of the nation’s entire old economic system, including the banking sector, which effectively wiped out much of the population’s life’s savings and destroyed faith in banks, brought hyperinflation, 20% and higher unemployment and massive underemployment.
• Turmoil caused by the fallout from Russian price liberalization decisions in 1992 and its economic and financial crisis of 1998.
• Volatility in oil prices, particularly in 1998 when prices dropped precipitously.

Yet, despite all the social and economic turmoil, Azerbaijan today enjoys the most stable economy of the CIS states. The Azeri government has launched the second phase of its far-reaching privatization program. Many fundamental reforms have already been set in place, and others are being readied for implementation by 2002. The country is poised to foster economic development that aims to rejuvenate the non-oil sectors of the economy.

The way in which officials, such as finance minister Avaz Alakbarov and central bank governor Elman Rustamov, were able to bring the economic chaos under control in six short years is a success story that few countries can rival.

When President Heydar Aliyev assumed power in 1993, the new president immediately set about restoring political and economic stability. Azerbaijan sought help from the International Monetary Fund (IMF), the World Bank, and other international financial institutions.

By the end of 1994, Aliyev’s government had restored a measure of political stability. This enabled Azerbaijan to sign a stabilization agreement with the IMF in 1994, and begin implementing it the next year.

This stabilization arrived none too soon, as inflation had briefly soared to over 1,800 percent. Drastic measures were called for, and the government courageously set about taking them. The new government began to implement effective macroeconomic management.

The government devalued its currency, the manat, by a factor of 12, and took control of the money supply. It began to reduce the government budget deficit from 13 percent of gross domestic product (GDP), to its current level of 1 to 1.5 percent. Completely liberal markets were established.

During the same time, the government brought its oil strategy "in house." In 1994, the government signed the "Contract of the Century" with many of the world’s major oil companies to exploit potentially large new offshore reserves in the Caspian Sea. This led to a great deal of investment flowing into the country, which created a payment capability.

The government then moved to revise existing legislation for the central bank. The legislation provided for classic central bank functions, including currency control, monetary and credit policy, and inflation control.

New budget and tax policies adopted by the government led to the establishment of controls on these two key areas. The government also moved aggressively to collect taxes. By 1996, the current period of economic stability had begun.

Next, the government moved to reorganize the commercial banking sector, which had been operating essentially under the banking system inherited from the former Soviet Union. More than 250 small and poorly capitalized banks, whose lending policies were not well supervised, had characterized the sector. In fact, according to Minister of Finance Alakbarov, Azerbaijan experienced some severe problems in 1995-6 due to recovery of credits that were not adequately considered by the banks and were causing high inflation.

These small banks were not sustainable in the new market economy, the minister says, because they could not compete with larger banks. So, in the last five years, with the support of the IMF and World Bank, the government moved to decrease the number of banks six fold. About 50 commercial banks remain, but observers do not rule out further consolidation.

In addition, four government banks were restructured into two banks, one of which was created as the International Bank of Azerbaijan. That bank now dominates the country’s banking sector.

The government has also welcomed foreign banks that want to operate in Azerbaijan. HSBC, the British bank and several Turkish banks are now present. No American banks have yet ventured into Azerbaijan, despite the presence of several major US oil companies and many other large multinationals involved in supporting oil exploration and production.

Rustamov notes that the banking infrastructure has been strengthened and Azerbaijan banks have joined the international banking system. Azerbaijan has modernized bank payment and settlement systems, set up a banking supervision system and created a banking school.

An international settlement system allows the transfer of monies to any other international capital at any time. "And within two years, we will set up a similar intra-country electronic payment system," Alakbarov says.

According to Alakbarov, Azerbaijan has established cooperative relationships with a number of international financial institutions including the World Bank, the IMF, the European Bank for Reconstruction and Development (EBRD), the Asian Development Bank, the Arab Development Bank, and the Black Sea Development Bank.

The central bank has adopted strategic planning, and will set a strategy for commercial banks by the end of 2001. "Going to European banking standards is an ambitious goal, but we plan to approach those standards within five years," Rustamov says. The government has changed the banking law three times in 10 years, but the new law is set to meet North American and European standards.

Although the banking sector has been reorganized, restructured and modernized, Azerbaijan remains largely a cash economy. Most Azerbaijanis do not use bank services. While some banks can handle credit cards, few businesses accept credit cards.

Central bank governor Rustamov says several factors account for the lack of faith in the banking system. "In the early 1990s, high inflation devalued savings. The number of banks that went bankrupt increased. There was no insurance on deposits.

"Then, the Russian government manipulated its cash policy to cover its currency," he continues, "and began to reduce the cash money supply. This led to a run on the banks. Azeris who were paid in cash couldn’t get their wages and salaries. Savings were devalued by 100 percent. The commercial bank system collapsed in two days, because the cash money belonged only to Russia. The psychological blow that people suffered here has not been overcome yet."

Rustamov reports that with the consolidation of commercial banks, restructuring of the banking sector and other reforms, progress toward restoring faith in the banks has been made.

"During the last six years, the volume of savings has increased eight times. The amount of capital in banks has increased 22 times. We have revamped the insurance system. "

The privatization of agriculture, small-and medium-sized enterprises has been completed, and the privatization of large enterprises is starting. "The government places great importance on privatization in order to create new jobs and solve unemployment. Unemployment and under-employment are very serious issues," Alakbarov says.

The government, he continues, is also giving attention to pension reform. "Thirteen or fourteen percent of Azeris are pensioners," he says. " The President has issued a decree on pension reform. We will switch from the Soviet system to one that meets international standards. The new system will provide for individual record keeping for pensioners. It also provides for the creation of private pension funds and volunteer contributions to pension funds."

The minister readily acknowledges that setting up a farm credit system has lagged far behind demand. "The World Bank is assisting with a pilot program. And we want to educate farmers that these are credits, not grants, so they must provide collateral. But the recovery rate of loans that the World Bank provides is more than 90 percent, a very high indicator of program success.

"Every year, lending to agriculture increases, " he says. " Micro-credit programs are being set up in several regions. There is a big demand for this. In the beginning, the World Bank had only six pilot farms in the program, now there are 130. The Germans are also planning to provide $10 million to us for these purposes. So (meeting the needs) improves from year to year."

Government reforms in the administrative sector are expected to help eliminate a number of problems, the minister continues. Except for the tax ministry, agencies cannot interfere in the private sector. A new civil service law has been adopted, and state support for public servant salaries began in September. "These are key elements of the government’s anti-corruption campaign," he notes. If we can improve salaries, there will be less incentive for corruption."

Looking at what remains to be done to aid the move to a modern market economy, the minister says, "We must change the totalitarian mentality, and teach a market economy. Under the Soviets, our education level was very high. But now education must focus on the needs of a developing market economy, including high technology."