S&P Global Confirms Azerbaijan's Ratings at BB+/B. Stable Outlook

On June 7, the international rating agency S&P Global has reaffirmed Azerbaijan's sovereign credit ratings at BB+/B, maintaining a stable outlook. The agency anticipates that Azerbaijan will achieve both budget and current account surpluses from 2024 to 2027, driven by favorable hydrocarbon prices, which account for 80% of the country’s exports. However, the long-term decline in oil production is expected to continue, and new gas exports are unlikely to fully counterbalance this trend.

Economic and Fiscal Outlook

Azerbaijan has built up substantial liquid fiscal assets within the State Oil Fund of Azerbaijan (SOFAZ), estimated to constitute 70% of GDP by the end of 2023. These reserves provide a buffer against short-term risks. S&P Global's stable outlook is based on expectations that despite the projected decline in oil production, Azerbaijan’s significant fiscal and external buffers will help protect the economy from potential trade shocks.

Potential Risks and Opportunities

The agency warns that a downgrade could occur if Azerbaijan's fiscal balance deteriorates more than expected over the medium term, possibly due to faster-than-anticipated declines in oil production. Additionally, a reduction in hydrocarbon revenues could adversely affect Azerbaijan’s broader economic performance compared to other countries. Conversely, an upgrade could be considered if geopolitical risks in the region diminish and Azerbaijan significantly increases its fiscal reserves beyond current forecasts.

Justification for Ratings

Azerbaijan's robust fiscal and external stock positions underpin its sovereign ratings. The government has amassed significant liquid assets through SOFAZ, projected to be nearly 70% of GDP by 2027. Gross public debt is expected to stabilize at around 20% of GDP. Azerbaijan is anticipated to maintain both budget and current account surpluses over the next three years, with oil prices projected to average $85 per barrel until the end of 2024 and $80 per barrel thereafter.

Economic Concentration and Vulnerability

Azerbaijan's economy remains heavily reliant on the oil and gas sector, which accounts for about 50% of GDP and 80% of exports. This concentration makes the economy vulnerable to fluctuations in hydrocarbon prices. For instance, the decline in oil prices in 2015 significantly impacted the state deficit, current account, and net reserves, triggering a shift to dollar savings and currency devaluation. Despite substantial buffers, these cannot fully shield the concentrated economy from prolonged drops in export prices, especially with the structural decline in oil production.

Institutional and Economic Profile

Oil production in Azerbaijan follows a long-term downward trend as fields age. Gas production is nearing a plateau after recent increases and is expected to rise only slightly compared to 2023 levels over the medium term. S&P Global forecasts Azerbaijan's economic growth to average slightly below 2% from 2024 to 2027, with non-oil sector growth at 3-4% per year.

Azerbaijan’s institutional environment remains weak, with political power concentrated around the presidential administration. Peace talks with Armenia continue amid shifting regional geopolitics. One contentious issue in the peace treaty is border demarcation. The Armenian government had previously agreed to transfer several exclave villages to Azerbaijan, leading to protests in Armenia. Both nations aim to sign an agreement before the COP-29 conference in Baku in November 2024.

Data Gaps and Sector Performance

Gaps in economic data published by Azerbaijani authorities persist, including a lack of detailed national income reports by expenditure and international investment position data.

Azerbaijan's economic growth showed stronger dynamics at the beginning of 2024, with real GDP increasing by 4.3% year-on-year due to growth in the non-oil sector, despite a decline in the oil sector. This follows subdued growth of 1.1% for the full year in 2023. From January to April 2024, the non-oil sector grew by almost 8%, driven by transport, information and communication services, and retail trade, with the construction sector also showing strong growth due to investments in the occupied Karabakh region. Excluding Karabakh-related investments, non-oil sector growth would have been weaker.

S&P Global expects the non-oil sector to grow by 3-4% annually in the medium term. However, limited structural reforms and ongoing efforts to diversify the economy will hinder faster growth. The agency forecasts hydrocarbon sector output, which makes up about 50% of Azerbaijan's nominal GDP, to stagnate from 2024 to 2027.

Hydrocarbon Sector Forecasts

Oil production is expected to average 0.65 million barrels per day (mbpd) through 2027, down from 0.79 mbpd in 2019, due to aging fields. Gas production is stabilizing at about 35-36 billion cubic meters (bcm) per year, with significant increases already achieved from developments like Shah Deniz II (SDII) and the Absheron gas condensate field. Long-term gas production may expand with future projects like the next phase of the Absheron field and the deep gas development of Azeri-Chirag-Guneshli (ACG).

Fiscal and External Positions

S&P Global predicts that Azerbaijan will maintain a double budget and current account surplus, averaging 1.7% and 7% of GDP, respectively, from 2024 to 2027. Azerbaijan will also maintain the average net asset position of the public administration sector at about 50% of GDP through 2027.

Monetary policy effectiveness remains limited by the central bank's constrained operational independence, frequent foreign exchange market interventions, and underdeveloped local currency capital markets. Nonetheless, Azerbaijan’s strong external position, bolstered by SOFAZ's substantial foreign assets, remains a core strength of its rating.

Based on S&P Global's forecasts, Azerbaijan's current account surplus is expected to average 7% of GDP from 2024 to 2027, following a record 30% surplus in 2022. This strong external position is expected to mitigate the adverse effects of economic cycles on domestic development.