Identifier
Created
Classification
Origin
06BAKU1076
2006-07-21 07:50:00
CONFIDENTIAL
Embassy Baku
Cable title:  

AMBASSADOR DISCUSSES ECONOMIC ENVIRONMENT WITH

Tags:  ECON EFIN EAID PREL AJ 
pdf how-to read a cable
VZCZCXRO7198
RR RUEHDBU
DE RUEHKB #1076/01 2020750
ZNY CCCCC ZZH
R 210750Z JUL 06
FM AMEMBASSY BAKU
TO RUEHC/SECSTATE WASHDC 0836
INFO RUCNCIS/CIS COLLECTIVE
RUEHAK/AMEMBASSY ANKARA 1664
RHMFISS/CDR USEUCOM VAIHINGEN GE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEAIIA/CIA WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHDC
C O N F I D E N T I A L SECTION 01 OF 03 BAKU 001076 

SIPDIS

SIPDIS

E.O. 12958: DECL: 07/17/2016
TAGS: ECON EFIN EAID PREL AJ
SUBJECT: AMBASSADOR DISCUSSES ECONOMIC ENVIRONMENT WITH
INTERNATIONAL FINANCIAL INSTITUTIONS


Classified By: AMBASSADOR ANNE E. DERSE, PER REASONS 1.5 (B, D).

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 001076

SIPDIS

SIPDIS

E.O. 12958: DECL: 07/17/2016
TAGS: ECON EFIN EAID PREL AJ
SUBJECT: AMBASSADOR DISCUSSES ECONOMIC ENVIRONMENT WITH
INTERNATIONAL FINANCIAL INSTITUTIONS


Classified By: AMBASSADOR ANNE E. DERSE, PER REASONS 1.5 (B, D).


1. (C) SUMMARY: The Ambassador July 11 hosted a breakfast
with representatives from the IMF, EBRD, ADB and World Bank
to review recent developments on international assistance to
Azerbaijan and the status of the economy. The Ambassador
explained U.S. economic priorities, highlighting the
importance of WTO membership, transparency and
anticorruption, development of the non-oil sectors of the
economy, and oil revenue management. The IFIs described to
the Ambassador their current and future operations and
projects. The IMF noted that inflation in 2006 would most
certainly be in the double-digits and worried that continued
appreciation of the manat (2.6 percent so far in 2006) and a
14 percent increase in GOAJ expenditures would overheat the
economy. The bulk of the conversation revolved around the
difficult operating climate in Azerbaijan. The EBRD and IMF
representatives highlighted endemic corruption, lack of
government coordination and the increasingly independent
attitude of the GOAJ economic leadership in light of
Azerbaijan's new oil wealth. The overall pessimistic
attitude of the IFIs operating in Azerbaijan reinforces the
need for renewed and intensified Western engagement with the
GOAJ on economic issues. As the energy revenue flow
increases, the GOAJ will require the international
community's technical assistance to ensure that the country
remains on the development path. END SUMMARY.


2. (C) At a breakfast meeting with Ambassador Derse,
representatives from the International Monetary Fund, World
Bank, Asian Development Bank and European Bank for
Reconstruction and Development briefed on their respective
operations, current projects and challenges of working in
Azerbaijan. The Ambassador explained U.S. economic
priorities, highlighting the importance of WTO membership,
increasing transparency and fighting corruption, oil revenue
management and development of the non-oil sector. The World
Bank and ADB have been focusing their efforts on developing

the public sector infrastructure. The World Bank
representative told the Ambassador that it would fund five to
six projects per year worth approximately USD 300 million.
The EBRD representative said it has financed both private and
public sectors but noted that the bank's financing operations
in 2006 will decrease dramatically as it finds it more
difficult to find eligible clients. The IMF representative
briefed on the macroeconomic environment and noted that an
IMF Article IV team planned to visit Baku in early September.

MACROECONOMIC ENVIRONMENT
--------------


3. (C) The IMF stated that macroeconomic growth during the
first half of 2006 remained relatively tame as the GOAJ moved
slowly to begin government disbursement of budgetary and
capital expenditures. (According to official GOAJ figures,
released after this meeting, GDP growth was a record 36
percent for the first half of 2006. Full details septel.)
According to the IMF, the GOAJ accelerated its expenditures
in late March and early April 2006. The IMF representative
noted that inflation has begun to increase and will most
likely accelerate in 2006 reaching double-digits. He told
the Ambassador that year-over-year inflation in June had
risen to eight percent, although this figure may under-report
true price increases. The IMF representative told the
Ambassador that the government's official CPI statistics have
been consistently lower since late 2005 when the GOAJ
adjusted the manner in which it calculated the CPI. The IMF
representative added that the National Bank is experiencing
difficulty controlling the money supply.


4. (C) Compounding this situation, according to the IMF, is
the expansionary fiscal policy that the GOAJ is pushing. The
IMF representative added that while the National Bank had an
excellent team, it does not wield the political influence
necessary to affect fiscal policy, nor does it possess the
tools, including open market operations, to control money
supply. In addition, with more U.S. dollars than Azerbaijani
manat flowing in the economy, the National Bank has been
forced to convert its dollar reserves to manat, further
appreciating the currency and hurting the export sector. The
government's large capital expenditure projects were also
contributing to the overheating of the economy. So far in
2006, the manat has continued its upward trend and has
appreciated approximately 2.7 percent.


5. (SBU) The IMF representative told the Ambassador that

BAKU 00001076 002 OF 003


long-term oil revenue management was a key issue that the IMF
discusses regularly with the GOAJ. He noted that some
officials in the GOAJ used to maintain an anti-inflationary
stance, notably current Finance Minister Sharifov, but that
this attitude had shifted in late 2005. This shift was
evident in the 2006 State Budget and the revised budget. The
2006 State Consolidated Budget forecast government
expenditures of USD 3.78 billion. In May 2006 the GOAJ
submitted a revised budget increasing government revenues to
USD 4.2 billion and government expenditures to USD 4.4
billion, an increase of approximately 14 percent. The GOAJ
justified the increase in government expenditures based on
the high price of crude oil and increased government receipts.


6. (C) The IMF noted that the "economic lag" in Azerbaijan is
longer than other developing countries, equaling between
eight and nine months. For this reason, the true
macroeconomic effects of increasing government expenditures
on prices and currency appreciation may not be fully felt
until late fourth quarter 2006 and early 2007. By the time
the macroeconomic environment begins to show signs of
destabilizing consequences, the GOAJ may not be well
positioned to reverse course and rein in government spending
leading to macroeconomic harm.

NEW SOVEREIGN DEBT RATING
--------------


7. (C) The IMF and EBRD representatives both told the
Ambassador that Moody's has sent a sovereign debt rating team
to Azerbaijan in order to obtain a second sovereign rating.
In January, Fitch reiterated its "BB" rating for Azerbaijan.
The GOAJ is interested in a second rating in order to float a
Eurobond offering in order to establish a benchmark. The
EBRD representative noted that the lack of transparency in
Azerbaijan would limit Moody's ability to rate the country
higher than Fitch's rating. Economic Development Minister
Babayev and Finance Minister Sharifov have both highlighted
to Embassy interlocutors the government's interest in a
second sovereign rating. Citibank has assisted Moody's with
its review in Azerbaijan, hoping to take the lead on any debt
offering by the GOAJ. (Comment: The Citigroup advisor
working with the GOAJ on the Moody's rating was less
pessimistic, citing Azerbaijan's low and falling sovereign
debt, shift from deficit to surplus in the current account,
growing reserves and ability to service its debt. See
septel.)

WTO MEMBERSHIP
--------------


8. (C) The Ambassador raised with the group the importance of
WTO membership, transparency and anticorruption efforts,
noting that these elements would be key to the Embassy's
economic strategy. While all agreed on the benefits of WTO
membership, the IMF representative told the Ambassador that
the GOAJ really just wants to "belong to the club" without
actually abiding by the rules and reforming the economy. The
EBRD representative added that Azerbaijan viewed
international organizations as a means to win support for its
side in the Nagorno-Karabagh issue with Armenia. In
addition, several participants noted that the GOAJ appears
also to use it relations with the IFIs to gain "legitimacy."

DIFFICULT OPERATING ENVIRONMENT
--------------


9. (C) All the breakfast participants agreed that Azerbaijan
is becoming a more difficult environment in which to operate.
They highlighted the lack of inter-ministerial coordination,
rampant corruption, lack of procurement procedures and the
government's increasing disinterest in conditionality in loan
and financing terms. The new World Bank head, a lone
holdout, told the Ambassador that he believed the Ministers
of Health, Economic Development and Justice were efficient
and supportive of the Bank's programs. He noted that the
Bank is moving away from IDA funding for Azerbaijan and
moving towards the loans on IBRD terms. (NOTE: The GOAJ
generally has been supportive of the World Bank compared to
other international financial institutions. This support may
be due to the Bank's enormous lending plans in the country
and the projects' focus on large infrastructure (roads,
highways, water sanitation) and social reform projects
(judiciary and primary health care).


10. (C) The EBRD representative noted that the Minister of

BAKU 00001076 003 OF 003


Finance has recently refused several EBRD loans based on
"negative pledge clause." He particularly noted a power
generating station deal that the GOAJ now wanted to cancel
based on this conditionality. While the EBRD representative
personally understood the reasoning behind the refusals, he
noted that all the IFIs included such language and that only
as a group should remove it from lending conditionality.
Both the EBRD and IMF representative opined that the GOAJ
really only wanted to support the "perception of engagement
with the IFIs" while really disengaging from their programs.
The EBRD representative told the Ambassador that the IFIs
bring value added with project implementation and management
and that the GOAJ is not interested in this aspect of
financial assistance.


11. (C) In addition, the EBRD representative said that while
the new Minister of Finance Samir Sharifov is an effective
manager, he is "not a power-player" and is for "show" for the
international community. (NOTE: Embassy does not fully agree
with this assessment of Sharifov and believes that he has
access to key individuals in the government, including the
President.) He added that "other people" are actually
controlling the GOAJ and making decisions. In addition,
several of the IFI representatives noted that the attitudes
of key officials in the GOAJ appear to be more nervous and
less secure. Some officials are afraid to discuss
potentially negative issues, and instead only focus on the
positive. This perception, however, may come from the new
economic team's growing confidence and experience.

CORRUPTION
--------------


12. (C) Corruption remains one of the largest impediments to
doing business in Azerbaijan. According to some of the IFI
representatives the system in Azerbaijan is built upon
corruption and without it, it would collapse. They added
that there are no cultural norms against corruption and no
recourse to combat it. All Azerbaijanis depend upon the
system since there is no credible alternative. The EBRD
representative highlighted the "punishment" of Turkish
electricity distributor Barmek for not participating in
corrupt activities.


13. (C) The EBRD rep also related to the Ambassador the
difficulty of finding good private sector companies with
clean balance sheets to finance and invest. He noted that
GOAJ authorities, especially the Customs service, pressure
many companies to under-report imports and kickback money to
officials. He added that good companies were not being
allowed to operate in Azerbaijan. Due to the poor business
and investment climate, EBRD will only invest USD 30 million
after having invested USD 280 million in 2005 and USD 250
million in 2004.

COMMENT
--------------


14. (C) While the problems cited by the IFIs are real, some
of the IFIs' comments appear to reflect their growing
unhappiness that their influence with the GOAJ is waning as
oil revenues come on line. The waning influence of the IFIs
reinforces, in our views, the importance of intensified USG
dialogue with the GOAJ on critical issues of economic policy,
reform and liberalization.
DERSE