Identifier
Created
Classification
Origin
08BAKU1026
2008-10-27 14:07:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Baku
Cable title:  

SCENESETTER FOR DEPARTMENT OF COMMERCE DEPURTY

Tags:  ETRD ECON EINV ENRG PREL AJ GG 
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ZNR UUUUU ZZH
P 271407Z OCT 08
FM AMEMBASSY BAKU
TO RUEHC/SECSTATE WASHDC PRIORITY 0250
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUCNMEM/EU MEMBER STATES PRIORITY
RUEHAK/AMEMBASSY ANKARA PRIORITY 3100
RUEKJCS/SECDEF WASHDC PRIORITY
RHMFISS/CDR USEUCOM VAIHINGEN GE PRIORITY
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RUEKJCS/JOINT STAFF WASHDC PRIORITY
RUEKDIA/DIA WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
UNCLAS SECTION 01 OF 03 BAKU 001026 

SENSITIVE
SIPDIS

EMBASSY TBILISI PLEASE PASS DEPUTY SECRETARY OF COMMERCE
SULLIVAN

E.O. 12958: N/A
TAGS: ETRD ECON EINV ENRG PREL AJ GG
SUBJECT: SCENESETTER FOR DEPARTMENT OF COMMERCE DEPURTY
SECRETARY SULLIVAN VISIT TO BAKU, OCTOBER 29, 2008

UNCLAS SECTION 01 OF 03 BAKU 001026

SENSITIVE
SIPDIS

EMBASSY TBILISI PLEASE PASS DEPUTY SECRETARY OF COMMERCE
SULLIVAN

E.O. 12958: N/A
TAGS: ETRD ECON EINV ENRG PREL AJ GG
SUBJECT: SCENESETTER FOR DEPARTMENT OF COMMERCE DEPURTY
SECRETARY SULLIVAN VISIT TO BAKU, OCTOBER 29, 2008


1. (SBU) SUMMARY: Your visit to Baku comes on the heels of
Azerbaijan's October 15 presidential election, which resulted
in a landslide victory for President Ilham Aliyev. This fall
also marked a troublesome time for the region, with Russia's
invasion of Georgia casting a shadow on security and
stability. Energy continues to figure prominently in
Azerbaijan's geostrategic vision, economic development, and
partnership with the United States. President Aliyev,s next
administration must address Azerbaijan's economic development
and the need for additional political and economic reforms in
the face of an international finance crisis, declining oil
prices, and regional insecurity resulting from the
Russia-Georgia conflict. Azerbaijan's leadership will be
interested in hearing your views on the U.S. reaction to the
international credit crunch ahead of the November 17
U.S.-Azerbaijan Economic Partnership Commission, which the
State Department will host. Although Azerbaijan's overall
macroeconomic situation is relatively stable, endemic
rule-of-law and corruption problems, as well as monopolistic
practices, continue to threaten sustainable growth in
non-energy sectors. End summary.

MACROECONOMIC OVERVIEW
--------------


2. (SBU) Azerbaijan's economic performance in 2007 showed
increasing resilience and strength as GDP grew last year by
more than 25 percent, and is tracking to reach nearly 20
percent for 2008. Azerbaijan's continued growth prospects
remain closely linked to oil prices, given that the energy
sector provides 95 percent of total export earnings and more
than 50 percent of GDP and an estimated 60 percent of budget
revenue. In 2007, inflation reached 19 percent and in 2008
it looks likely to exceed 20 percent. Public investment is
expanding rapidly, but more rigorous project selection and
execution procedures must be put in place to ensure that
these expenditures promote sustainable growth in the non-oil
sector. In the coming year, the economy will continue to
grow as Azerbaijan will receive a larger share of profits

(80/20 split) from the ACG production sharing agreement.
However, sharply lower oil prices and an international
banking crisis will constrain that growth over the medium
term. Given that the current budget is based on an assumed
oil price of USD 70, Azerbaijan should be able to avoid
deficits or funding shortfalls if crude oil prices remain at
or above current levels.


3. (SBU) The business climate outside the oil sector is
challenging, but American companies have been able to report
profits that are substantially higher than in developed
markets. Corruption remains a serious roadblock to further
investment. Transparency International's Corruption
Perceptions Index (as well as anecdotal evidence from
American business contacts in Baku) confirms that Azerbaijan
still has a long way to go in stamping out corruption. On
the other hand, Azerbaijan is taking important steps to
simplify its regulatory requirements, and for this reason the
World Bank named it the world's "Number One Reformer" in its
most recent "Doing Business" report.

SECURITY
--------------


4. (SBU) As a result of the recent Russian invasion of
Georgia, stability and security have become an area of
uncertainty in the region. The Azerbaijani government,
besides expressing concerns about threats to the East-West
corridor for energy exports and other trade, has voiced its
concern and desire to find a peaceful resolution in
Norgorno-Karabakh (NK) and has calle for more intensified
international, and especially, U.S., attention to this
"frozen" conflict. Press reporting has indicated that
Russian President Dmitriy Medvedev has proposed a meeting
between himself, President Aliyev and Armenian President
Sargsian before the end of the year. The USG has also
stepped up engagement. Deputy Assistant Secretary Matt

BAKU 00001026 002 OF 003


Bryza, the U.S. representative to the Minsk Group, has been
in the region multiple times since the Georgian invasion,
actively working to assist in brokering a deal.

REFORM
--------------


5. (SBU) Securing and advancing U.S. interests in the longer
term depends on Azerbaijan's continued stability and
development. Although President Aliyev and his closest
advisors continue to affirm their commitment to democratic
reform, Azerbaijan's progress is incomplete. The media
environment is heavily restrictive, with implausible criminal
court cases against journalists and violent attacks against
members of the media that have gone un-prosecuted and
unpunished. Freedom of assembly, in practice, is severely
limited. Opposition parties complain that the GOAJ has
placed undue restrictions on their ability to organize and do
basic grassroots work, and believe that they must have parity
in electoral commissions in order to have a level playing
field. As a result of these complaints, some opposition
parties chose not to participate in Azerbaijan's October 15
presidential election.


6. (SBU) On the economic front, being named the number one
reformer in the World Bank's "Doing Business 2009" report has
boosted the spirits of many reform minded officials and
called to task those ministries and agencies whose
performance did not substantially contribute to that ranking.
The WTO accession process could help bring about the
legislative and regulatory changes needed to reform
Azerbaijan's economy and introduce transparent, market-driven
practices. President Aliyev pledged to support accelerating
Azerbaijan's WTO accession in 2007 and, with the help of
USAID's Trade and Investment Program, Azerbaijan has made
significant progress towards accession. In this regard, the
GOAJ developed and submitted to the WTO Working Group 30
draft legal and regulatory reforms designed to liberalize the
trade and investment regime. Moreover, this past May the WTO
held the first Working Party Meeting on Azerbaijan's WTO
accession bid in almost three years, reflecting the GOAJ's
renewed seriousness of intent in the area of trade reform.
Recently, the GOAJ submitted comprehensive revised market
access offers, and as a result USTR has agreed to conduct a
bilateral negotiating meeting on the margins of the next
Economic Partnership Commission, scheduled for November 17 in
Washington, and the WTO is planning a second Working Party
Meeting tentatively in December.

STATE OIL FUND
--------------


7. (SBU) Since its creation in 1999, the State Oil Fund of
Azerbaijan (SOFAZ) has acted as Azerbaijan's energy revenue
stabilizer and long-term savings vehicle. The bulk of
SOFAZ's inflows come from proceeds generated under production
sharing agreements from sales of Azerbaijan's share of
hydrocarbons; bonuses paid under the terms of production
sharing agreements; acreage fees and other revenues. SOFAZ
is one of the most transparent GOAJ organizations, publishing
internationally-audited quarterly and annual reports. SOFAZ
also plays a leading role in the Extractive Industries
Transparency Initiative (EITI). In 2007, the United Nations
awarded SOFAZ a public service award for its transparency,
accountability and responsiveness in the public sector.


8. (SBU) SOFAZ currently has assets in excess of USD 10
billion (expected to grow to about USD 12 billion this year,
and to generate about USD 200 billion in revenue over the
next 15 years, based on an oil price of USD 70). In 2007,
its rate of return was approximately five percent in real
terms. Using a grant from the U.S. Trade and Development
Agency, SOFAZ is now re-evaluating its portfolio strategy and
developing a more aggressive investment strategy with the
goal of boosting SOFAZ assets' rate of return. The
management of SOFAZ assets appears sound. However, SOFAZ

BAKU 00001026 003 OF 003


only incorporates 75 percent of oil and gas revenues above
USD 50/barrel. The remainder is controlled by SOCAR and
other elements of the government.
DERSE