IFIS COMMENT ON INVESTMENT CLIMATE IN AZERBAIJAN

C O N F I D E N T I A L BAKU 000025 SIPDIS EEB/IFD/OIA EEB/EPPD EUR/ERA FOR BENJAMIN ROCKWELL TREASURY FOR JEFF BAKER E.O. 12958: DECL: 01/12/2019 TAGS: ECON EFIN ETRD EXIM EINV AJ SUBJECT: IFIS COMMENT ON INVESTMENT CLIMATE IN AZERBAIJAN REF: A. BAKU 23 ¶B. 08 BAKU 863 Classified By: Political-Economic Counselor Rob Garverick, Reasons 1.4 (b and d). ¶1. (C) Summary: In early December, EconOffs met individually with representatives of the EBRD, IFC, IMF, and World Bank in Azerbaijan to discuss financial developments, business conditions and the investment climate. The financial experts noted the effects of the global financial crisis on the Azerbaijan economy (Ref A) and highlighted Azerbaijan,s improvement in the World Bank,s most recent Doing Business Report (Ref B) as developments that could prompt the GOAJ to pursue further economic reforms that would support growth in the non-oil sector. They cautioned, however, that despite Azerbaijan,s progress in some Doing Business indicators, Azerbaijan,s investment climate "particularly for foreign businesses" continued to be clouded by its poor performance on measures such as trade across borders and taxes. Corruption at all levels also contiues to be a significant problem. End Summary. EBRD -------------- ¶2. (C) EconOffs met with EBRD Senor Banker and Head of Office Francis Delaey on Dcember 4 to discuss banking and business conditios in Azerbaijan. He acceded that the GOAJ had iproved on the "easier" aspects of the World Bank's Doing Business indicators but still considered the reforms to be encouraging and an important development. He pointed out that the GOAJ is planning to set up a one-stop-shop for taxes and is looking to do the same for permitting and licensing. Delaey suggested that the positive results achieved through the Doing Business report might encourage GOAJ to keep up reforms. By following through on WTO membership provisions and pursuing customs reform, Azerbaijan might be able to stay in the survey's top 10 next year. However, he said that there was still a question about whether these reform efforts focused solely on report criteria would actually address the underlying problems in the business environment and suggested that GOAJ really needs to try to improve their performance in Transparency International's corruption survey. He also noted that the customs department is one area where there is much room for improvement and suggested that reforms to achieve WTO accession could be a lever to institute some of these needed improvements. ¶3. (C) Delaey noted that corruption in Azerbaijan is endemic, and specified that corruption involving tax officials and artificial monopolies are key factors impeding FDI. As an example, he explained that when a business becomes successful enough to draw attention to itself, either by just being very successful or by becoming (or being poised to become) real competition to one of the local oligarchs, there is strong government pressure (coercion) to partner with a local company controlled by one of those oligarchs. He observed that almost all the key ministers in Azerbaijan have their own holding companies which are involved in a broad range of sectors. The coercion comes in the form of harassment from tax adminstrators, and endless inspections by various entities such as emergency services or building code officials. In order to survive, Delaey said these companies end up giving up to 50 percent of their business to their government connected "partner," while receiving nothing real in return. He enjoined that, if the GOAJ is serious about attracting investment and developing the non-oil sector, it needs to address this corruption and level the playing field. If not, there will be no mechanism to successfully increase the knowledge base in the country or effectively reduce prices. In his experience, Azerbaijan is "much more corrupt than Moldova" which the EBRD considers to be one of the most difficult environments where it does business. International Finance Corporation (IFC) -------------- ¶4. (C) On December 4, EconOffs met with IFC Country Officer for Azerbaijan Aliya Azimova to discuss IFC initiatives for the upcoming year. Azimova stated that the IFC has been working directly with Ministry of Economic Development (MoED) to improve the business environment, both in the context of the Doing Business report and on its own. She noted that the IFC recently signed an MOU with the GOAJ which was ratified by President Aliyev in August and calls for a 5-year project "funded by the Swiss" to regularly monitor the Azerbaijani business climate. This project will conduct regular surveys of small and medium-sized enterprises (SMEs) to try to capture local perceptions of the business environment. ¶5. (C) In 2008 the IFC completed the first SME survey, which covered all of Azerbaijan, as opposed to the Doing Business Report which Azimova said covered only Baku. The IFC is currently analyzing the results and thus far the information from the survey paints a relatively encouraging picture of the business climate for Azerbaijan's SMEs. In order to verify these results, the IFC also conducted follow-up focus group studies which seemed to corroborate the overall results of the study. The final conclusions of the survey will not be flushed out until the full report from the IFC is released, likely January 2009. Azimova noted that the release of the report is not contingent on GOAJ approval so it will be made public, even if its conclusions are not what local officials would prefer to see. She stated that, based on findings from this survey, the IFC intends to develop an action plan for future efforts to improve the business climate. ¶6. (C) Azimova informed EconOffs that another key IFC project for the year is a full, country-wide review of the permitting process. She acknowledged that this is a very ambitious project but explained that although the number of licenses required to run a business has dropped dramatically in recent years -- from more than 270 to 15 currently -- much of this administrative burden has simply been shifted to an opaque and inconsistent system of permit requirements. She said the number of required permits is on the rise, yet there is no standardized list of mandatory permits, and regional inconsistencies as to what permits are required further complicate the process. The IFC hopes the review of the permit system will result in a country-wide standardization and reduction of required permits. ¶7. (C) Azimova noted that the project would not include the construction sector, commenting that she believes GOAJ officials would prefer to focus on zoning and other regulations without tackling the more difficult (and highly corrupt) construction sector. She admitted that the Doing Business report did not fully capture the burden of many of these permit requirements because the test case used in the report simply inventoried the steps required to "build a warehouse". Following the permit review project the IFC plans to begin a review of the inspection process. The IFC is also working with USAID on reforms to the bankruptcy law to improve Azerbaijan,s score on the "closing a business" indicator in the Doing Business report. ¶8. (C) The IFC is focusing on the perceptions and experiences of local SMEs because, according to Azimova, GOAJ officials do not appear to be very interested in attracting FDI outside of the oil sector. She noted that at one point IFC planned to bring private sector participation into infrastructure projects but got the clear message from the GOAJ that this was not something it was interested in pursuing. She commented that the World Bank involvement in infrastructure projects would hopefully bring some discipline into project planning and procurement, etc. but suggested that the dearth of foreign private investors allows inefficiencies to persist. ¶9. (C) Regarding new Minister of Economic Development Shahin Mustafayev, Azimova noted that the heads of three groups - the anti-monopoly group, the consumer market group, and the entrepreneurship group - had been removed. She mentioned that some of these teams had been assigned new heads or deputy heads, but emphasized that not all posts have been filled. Azimova has heard that Mustafayev is very demanding and has even fired some staff for arriving late to work on Sundays. (NOTE: While it is normal for government offices to operate on Saturday, Sunday is not a normal work day for Azerbaijan. End Note.) Mustafayev is reportedly in the office routinely from 9 a.m. to 11 p.m., and expects the same of his staff. Azimova speculated that he is detail oriented and very good with numbers but less policy-focused than his predecessor, former Minister Babayev. It appears he is in still in the learning process, having come from the Taxation Department, as he has raised such questions as: "If grain prices are falling, why aren't bread prices declining also?" ¶10. (C) Additionally, Azimova noted that the new head of the Securities Commission, Rufat Aslanani, was formerly a deputy at the NBA and seems very ambitious and motivated. He has reached out to the IFC stating that one of his first priorities will be to build the capacity of his staff. Azimova reported that the IFC is working with him on investment regulations to protect minority shareholders. The IFC already conducted a pilot program with one firm where they helped institute a dividend program and established decision-making rights for minority shareholders. The IFC is hoping some of these measures will boost interest in the stock market as potential investors perceive that there are gains to be had from being a minority shareholder. World Bank -------------- ¶11. (C) EconOffs met with World Bank Country Manager Gregory Jedrzejczak and Senior Operations Officer Saida Bagirli on December 15 to discuss recent macroeconomic developments and economic reforms. They said the World Bank plans to continue working with the GOAJ on business environment projects as well as a solid waste program. They revealed that World Bank co-financing arrangements typically call for 10% share to be covered by Azerbaijan but that this is due to increase. However, they mentioned that they have recently encountered some difficulty getting the GOAJ to agree to finance a higher share of joint projects. (NOTE: Co-financing agreements have proved difficult for US agencies as well. As of this writing, Minister of Finance Sharifov has still not signed the co-financing MOU with USAID which should have been finalized in late November. End Note.) ¶12. (C) Jedrzejczak echoed others opinions regarding MoED's Mustafayev as very detail-oriented and something of a micro manager. He implied that Mustafayev may be closely linked to the Minister of Emergency Situations. According to Jedrzejczak, during Mustafayev's first and so far only meeting with World Bank staff (November 2008) he stuck to GOAJ talking points but noted this was "understandable given that he was so new on the job." World Bank has heard reports that Mustafayev has been working his staff until 10 PM, 7 days a week and instructing them to go through all the details of the ministry. They noted that former Minister Babbayev had been a very hands-off manager. World Bank believes it is too early to tell if this management change at MoED is a positive or negative development for the course of economic reform in Azerbaijan. In addition, they posited that perhaps the new MoED was appointed specifically to sift through all the work of the former head, possibly in search of some incriminating information. Comment -------------- ¶13. (C) Despite the noteworthy improvement in business regulations captured by the World Bank Doing Business report, it is quite evident from speaking with international experts that there is still much work to be done for Azerbaijan to qualify as a "normal" business environment. Corruption remains one of the highest hurdles for the GOAJ, and the one it appears least inclined to tackle. It remains to be seen what effect the new Minister of Economic Development will have on the playing field. LU