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Economy in focus: Azerbaijan

Baku faces several challenges in its diversification efforts

November 6, 2024

7 min read

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November 6, 2024

By

7 min read

The 29th edition of the annual United Nations climate change conference, COP, which begins next week, has placed a great deal of spotlight on host country Azerbaijan—not all of it welcomed by the government in Baku. 

Last month, Human Rights Watch claimed that in the run up to the event, the Azeri authorities have used politically motivated, bogus criminal charges to prosecute and imprison civic activists, journalists, and human rights defenders. 

“The Azerbaijani government’s contempt for civic freedoms is putting independent groups and critical media on the path of extinction,” said Giorgi Gogia, associate Europe and Central Asia director at Human Rights Watch.  

“This is not the image the government should be projecting of itself on the eve of COP29. It is not too late for the government to improve its reputation by freeing imprisoned critics and immediately ending the use of spurious charges against civil society, but it needs to act now.” 

Another report meanwhile revealed that Azerbaijan will see a large expansion of fossil gas production in the next decade. Azerbaijan’s state-owned oil and gas company, Socar, and its partners are set to raise the country’s annual gas production from 37bn cubic metres (bcm) today to 49bcm by 2033. Socar also recently agreed to increase gas exports to the European Union by 17 per cent by 2026. 

Nevertheless, there is also evidence that Azerbaijan is making at least some attempt to diversify its economy away from fossil fuels, a process that has long been seen as essential to fostering sustainable growth in the country.

Economic growth and sectoral contributions 

While it is the industrial sector that remains the cornerstone of Azerbaijan’s economy, contributing approximately 39.7 per cent to the GDP, recent data indicates a shift towards non-hydrocarbon industries, reflecting a significant pivot in economic strategy that prioritises long-term stability over short-term gains tied to energy markets. In the first seven months of 2024, the non-oil and gas sector experienced 7.7 per cent growth, while the oil and gas sector saw a modest increase of just 1.2 per cent. 

This development is not solely a matter of numbers. Each sector’s growth represents a substantial shift in Azerbaijan’s economic priorities and capacities. The construction sector, for example, exhibited remarkable year-on-year growth of 69 per cent, bolstered by substantial public investments in infrastructure projects.  

These projects span a range of needs, from developing new roads and public transit systems to constructing educational facilities, hospitals, and renewable energy plants. The Information and Communication Technology (ICT) sector achieved an 18 per cent increase, reflecting Azerbaijan’s commitment to digital transformation, which is vital for future-proofing the economy in a fast-evolving technological landscape.  

The hospitality industry also grew by eight per cent, indicating a recovering tourism sector and increased domestic consumption, as well as the country’s ambition to emerge as a major regional travel hub. 

The government’s targeted approach to fostering these diverse sectors signals an understanding that long-term growth is only feasible with a broad economic base. 

Investments in ICT, tourism, and construction do not merely add value; they represent a future where Azerbaijan’s economy is less vulnerable to the cyclical downturns that can plague resource-dependent nations. 

Diversification imperatives and COP29 

Azerbaijan’s economic diversification is not merely a strategic choice; it has become a necessity, especially in light of global shifts towards sustainable energy.  

The nation’s hosting of COP29 underscores its stated commitment to environmental sustainability and economic transformation. This key international event places Azerbaijan under the global spotlight, reinforcing both its obligation and determination to transition from a carbon-intensive economy to one rooted in renewables and green innovation. 

The Azerbaijani government has made substantial investments to drive this transformation. Initiatives focused on wind and solar energy are at the forefront of this effort. Azerbaijan has a technical potential for wind energy estimated at approximately 3,000 MW, with economically viable capacities of 800 MW.  

Beyond these national resources, Azerbaijan is playing a proactive role in the regional energy market. In collaboration with Georgia, Romania, and Hungary, Azerbaijan is developing a 1,100-kilometer subsea interconnector across the Black Sea.  

This ambitious project aims to transmit 1,000 MW of renewable power, mainly from Azeri wind farms, to Europe. By diversifying energy exports and reducing reliance on oil and gas, the project could signal a new era in Azerbaijan’s energy landscape and its potential as a clean energy exporter. 

Investment climate and opportunities 

Azerbaijan’s strategic location, abundant natural resources, and ongoing economic reforms present substantial opportunities for foreign direct investment (FDI).  

The Azerbaijani government actively seeks FDI across various sectors, especially in agriculture, transportation, tourism, and ICT.  

The establishment of the Azerbaijan Export and Investment Promotion Agency (AzPromo) reflects the government’s dedication to encouraging foreign investment into the non-oil sector and boosting non-oil exports. It could do better, however. In the latest edition of Emerging Europe’s Investment Promotion Report, Azerbaijan ranked last of the 23 countries included in the report. 

Investments in agriculture and food production have been essential in recent years as Azerbaijan strives for food security and increased self-sufficiency. Transportation infrastructure, bolstered by investments in rail and road networks, is another priority, given Azerbaijan’s location along the Southern Gas Corridor and its potential role in the Middle Corridor, a key transit route linking Asia with Europe that avoids Russia. 

One of the recent developments that highlight Azerbaijan’s openness to foreign investment is the signing of a Memorandum of Understanding between the State Oil Fund of the Republic of Azerbaijan (SOFAZ) and Saudi Arabia’s Hassana Investment Company.  

This agreement aims to explore collaborative investment opportunities, particularly in the non-oil sectors, underscoring a shift towards more diverse economic engagement. Furthermore, the Azerbaijani government has announced plans to borrow five billion US dollars from international credit institutions over the next few years to finance major infrastructure projects, particularly in regions that have seen territorial recovery in recent years. These projects are set to improve connectivity and enhance economic potential in areas previously constrained by limited infrastructure. 

Future outlook 

According to the Asian Development Bank, Azeri GDP will increase 2.7 per cent in 2024 and 2.6 per cent in 2025. Despite these relatively positive economic indicators, Azerbaijan faces several challenges in its diversification efforts. The country’s heavy reliance on the oil and gas sector has made it vulnerable to global commodity price fluctuations.  

Such dependency, while profitable during periods of high oil prices, can expose Azerbaijan to economic instability during downturns in the energy market.  

Additionally, while the government has made strides in improving the business environment, there remain significant bureaucratic hurdles and regulatory challenges that can hamper the ease of doing business, particularly for foreign investors. 

To sustain and enhance economic growth, Azerbaijan must continue to improve its business environment by reducing bureaucratic obstacles and increasing transparency, making the country more attractive to foreign investors.  

Streamlined procedures, clear regulatory frameworks, and measures to combat corruption will not only attract international capital but also foster a more competitive domestic market. Investing in human capital is equally critical.  

Sectors like ICT and renewable energy require specialised skills and knowledge, which means Azerbaijan must invest in education and training to build a workforce that can meet these sectors’ demands. 

Hosting COP29 serves as both a symbol and catalyst for Azerbaijan’s transition towards a more diversified and sustainable economy. The country has invested a great deal in attempting to convince the world that it is changing – but it is on its actions, not words, that it will be judged.

Marek Grzegorczyk

Marek Grzegorczyk

Marek Grzegorczyk is an analyst at Reinvantage.

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