Falling oil prices challenged Azerbaijan’s growth model in 2015, which had been heavily oil revenue-financed, particularly through construction and trade in non-oil sectors. A strong local currency, again supported by oil-related inflows, had been another characteristic of the economy, contributing to banking sector stability, low dollarization, and improved welfare. These “givens” were shattered in 2015, forcing Azerbaijan to enter the uncharted territories of low oil prices, low public expenditure, currency fluctuations, and monetary tightening. As a result, growth slowed to 1.1% in 2015 and contracted 3.3% y/y in January 2016. With these challenges, Azerbaijan’s growth prospects have worsened, necessitating a new growth model. We believe that the massive capital expenditure seen in previous years has created spare capacity, but it is probably underutilized. Utilizing this capacity, particularly through foreign participation, may be one of the sources of growth.
