Moody s Ba2 / S&P BB+ / Fitch BB+ 1 Economy: Agriculture 6%, Industry 52%, Services 42%

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1 Azerbaijan Summary Moody s Ba2 / S&P BB+ / Fitch BB+ 1 Economy: Agriculture 6%, Industry 52%, Services 42% Azerbaijan has abundant energy resources, low debt levels, political and social stability, and marketfriendly policies. The country has managed its natural resources well, as reflected in fiscal and current account surpluses and an accumulation of savings. However, the collapse of global oil prices has adversely affected Azerbaijan, with growth contracting in 2016 and 2017, fiscal surpluses turning into sizable deficits, and double-digit current account surpluses largely evaporating. Azerbaijan s sovereign wealth fund has reduced vulnerability to global commodity fluctuations and helped offset economic imbalances. Other vulnerabilities include a volatile relationship with Armenia, lack of diversification, and exceptionally weak institutions. Azerbaijan s oil production is likely to stagnate in the short term, making the performance of the non-oil sector vitally important, and further progress is needed to improve business conditions. It is uncertain how successful Azerbaijan will be at diversifying the economy, which is a challenge faced by other commodity-producing countries. Corruption remains another major constraint on growth. Economic Indicators F 2018F Population (Millions) GDP per Capita (USD) 7,932 7,946 5,514 3,863 3,601 3,623 Nominal GDP (USD Billions) Real GDP (%) Year-End CPI (%) Fiscal Balance (% of GDP) Interest (% of Revenues) FC Debt/Public Debt (%) Government Debt (% of GDP) Government Debt (% of Revenue) Current Account (% of GDP) FDI (% of GDP) External Debt (% of GDP) Foreign Reserves/External Debt (%) Foreign Reserves (Mo. of imports) Foreign Reserves (% of GDP) As of November Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change. Source: Lazard, Haver Analytics, IMF, NB of A, SSC of Azerbaijan 111

2 Lazard Emerging Markets Debt Rating History Below is a history of the country s foreign and local currency ratings by the major agencies dating back to We have also included a chart of the country s hard currency external debt spread and the JP Morgan EMBI Global Diversified Index spread for comparison. Rating History Hard Currency BBB BB+ BB B+ Local Currency BB- BBB- BBB BBB- BB+ BB BB- B B Moody s S&P Fitch Moody s S&P Fitch As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: Bloomberg, Fitch, Moody s, Standard and Poor s Bond Spreads Azerbaijan 2010 EMBIGD 2017 As of December 2017 Performance represents past performance. Past performance is not a reliable indicator of future results. Source: JP Morgan 112

3 Azerbaijan Strengths Abundant Energy Resources Azerbaijan s key strength is its abundant energy resources, especially oil and gas. The country is among the 20 largest oil producers in the world and one of the largest when measuring per capita oil production. Azerbaijan produces 845,000 barrels per day (bpd), 2 and has 7 billion barrels of oil reserves that should last more than a decade. 3 About 20% of production comes from the State Oil Company of Azerbaijan Republic (SOCAR) and the remainder from a consortium of 10 companies known as the Azerbaijan International Operating Company, or AIOC, led by BP. Domestic oil consumption is around 100,000 bpd, which means most of the oil is exported, mainly through the country s Baku Tbilisi Ceyhan (BTC) pipeline. In addition, Azerbaijan has 1.1 trillion cubic meters (tcm) of natural gas reserves and produces 17.5 billion cubic meters (bcm) of gas, some of which it has recently begun to export. Gas output is expected to more than double when the Shah Deniz Stage 2 project is completed in A new pipeline, at a projected cost of more than US$11 billion, is under construction and expected to be finished by late 2018, which will allow Azerbaijan to export gas to Georgia, Turkey, and eventually Europe. 4 Strong Balance Sheet Azerbaijan has one of the strongest government balance sheets in the world. The government has managed its oil resources well, posting fiscal surpluses averaging 7.2% of GDP between 2000 and 2014, before the fiscal balance turned negative following the sharp decline in global oil prices in With the recovery of oil prices, Azerbaijan is projected to return to slight fiscal surpluses over the forecast horizon. Past fiscal surpluses allowed for the accumulation of savings in the State Oil Fund of Azerbaijan (SOFAZ) amounting to more than US$33 billion, equal to nearly 90% of current GDP. The management of SOFAZ assets has been unpredictable and subject to presidential discretion, although the government is working with the IMF on a fiscal rule that will provide greater predictability and preserve assets while allowing for countercyclical responses to oil price shocks. Meanwhile, the stock of public debt has more than tripled since 2014 following the sharp devaluation of the manat in December A debt restructuring by the International Bank of Azerbaijan in 2017 resulted in a further increase in public debt levels, since the government assumed a portion of the bank s debt. Nevertheless, Azerbaijan s total stock of public debt remains manageable, at less than 50% of GDP and it is expected to gradually decline over the forecast horizon as growth picks up again. Solid Balance of Payments Azerbaijan s balance of payments position is solid, notwithstanding a deterioration of the current account balance in recent years. The country posted large current account surpluses averaging 19.1% between 2005 and The sharp deterioration in 2015 was largely due to the collapse of global oil and gas prices, since these products account for the bulk of Azerbaijan s exports. Current account surpluses have helped offset sizable financial account deficits, allowing accumulation of a large amount of external assets totaling nearly $40.0 billion, equal to more than 100% of GDP. This is more than 2.5 times the level of external debt, which is estimated at 37% of GDP. 7 Political Stability Azerbaijan is a politically stable country because one family and one party have been in power for nearly 25 years. The current president, Ilham Aliyev, began his tenure in 2003 when he replaced his father, Heydar Aliyev, who took power in October Aliyev also won the 113

4 Lazard Emerging Markets Debt 2013 presidential election with 85% of the vote, although the international community indicated elections were unfair and rife with fraud. Aliyev s New Azerbaijan Party won the November 2015 parliamentary elections by a landslide and now holds a majority in the unicameral National Assembly, with 69 of 125 seats, owing to the opposition s boycott of the election. The next presidential election is scheduled for Social Stability Azerbaijan is a highly stable country. Social protests are rare because of strong government repression, which is not uncommon among the Commonwealth of Independent States (CIS). Azerbaijan also remains stable because the government has improved social conditions for the majority of the population. This has probably added to the president s popularity since significant progress has been made in reducing poverty, which has declined from 50% in 2001 to 6% in 2014, while extreme poverty decreased from 20% to less than 3%. 8 Nevertheless, the deterioration of economic conditions in recent years has led to occasional protests, which have been quickly suppressed. Although the government has largely maintained social stability, there is still occasional unrest in the Nagorno Karabakh region, which is occupied by an ethnic Armenian majority. Attempts at resolving tensions within the region have failed. The regional conflict led to a war between Azerbaijan and Armenia that ended with the signing of a ceasefire agreement in However, sporadic fighting and confrontation have erupted since then and could easily escalate. Armenia claims the disputed territory as its own, and Armenian leaders who have attempted to resolve the conflict have been forced to resign following domestic popular resistance. 9 Key Allies Azerbaijan has maintained a good relationship with Russia, Europe, and the United States. The US considers Azerbaijan a strategic military ally that has helped with the conflicts in Iraq and Afghanistan. The importance of ties with the European Union is measured by trade. The EU is seeking to reduce its reliance on Russian gas and looking to Azerbaijan to fill the gap. The new Trans-ANATOlian natural gas pipeline should allow Azerbaijan to increase gas exports to Europe. Weaknesses Commodity Dependence Despite the decline in oil prices in recent years, oil and gas remain the main drivers of the Azerbaijani economy, accounting for 87.4% of total exports, 27.9% of GDP, and 54% of revenues. 10 Like other commodity-dependent countries, changes in oil and gas production, and prices largely determine the direction of economic growth. However, the government has done a good job of reducing economic volatility related to the oil sector through the creation of the sovereign wealth fund. The government spends these funds when oil prices are low and accumulates savings when prices are high. 114

5 Azerbaijan Slower Economic Growth After a decade of strong economic growth, the economy has taken a sharp downturn, falling 3.1% in 2016 and a projected 0.6% in If the magnitude of this downturn is confirmed, the economy will have contracted at an average annual rate of 1.0% over the past three years, compared to average annual growth of 11.2% between 2005 and The poor performance in recent years is due to a combination of lower oil production in the Azeri, Chirag, and Guneshli oil fields, as well as the shock from lower oil prices. Gas production is expected to increase by 2018 as the Shah Deniz Stage 2 project becomes operational. Despite the sluggish oil sector, the non-energy sector is performing well, growing at a projected 2.4% in 2016 after a 3.6% contraction in Risk of War with Armenia Azerbaijan lives with the constant possibility of an intensification of its conflict with Armenia over the Armenian-occupied territory of Nagorno Karabakh, which is currently controlled by the ethnic Armenian majority with the support of the Armenian government. Tension between the two countries remains high, despite the signing of a ceasefire agreement in Since that time, there has been sporadic fighting and an increase in border tension. Azerbaijan often threatens to retake the region by force, although international organizations continue to appeal for a non-violent resolution. Weak Institutions Institutions in Azerbaijan are fragile, which adversely affects growth. The country languishes in the bottom third of many international governance and corruption indicators, such as Transparency International s Corruption Perception Index, where it ranks 123rd of 176 countries. 12 Transparency International highlights that corruption is a major problem, hindering economic development and political stability, although this is characteristic of other countries in the region, including Armenia, Kazakhstan, Moldova, and Ukraine. 115

6 Lazard Emerging Markets Debt Country Background Size Capital Population 86,600 KM 2 (113th) Baku 9.9 Million Religion Muslim 96.9%, Christian 3.0%, Other 0.1% Median Age 31.3 Years Literacy Rate 99.8% Independence 30 August 1991 Political System Government Leadership Next Election 2020 Legislative Branch Presidential Republic President Ilham Aliyev; Prime Minister Artur Rasizade Unicameral National Assembly Economy Agriculture 6.0%, Industry 51.7%, Services 42.3% Labor Force Agriculture 37.0%, Industry 14.3%, Services 48.9% Merchandise Exports Oil and Gas, Machinery, Foodstuffs, Cotton Export Partners Italy 19.9%, Germany 10.5%, France 8.0%, Czech Republic 5.2% Currency As of November 2017 Source: CIA Azerbaijanian Manat (AZN) 116

7 Azerbaijan Country Timeline 1988 Nagorno Karabakh region seeks to become part of Armenia. Ethnic Azeris begin to leave Karabakh and Armenia and ethnic Armenians leave Azerbaijan. At least 26 ethnic Armenians and six Azeris are killed in violence in Azerbaijani town of Sumqayit Ethnic strife between Armenians and Azeris escalates. Azeri nationalist Popular Front rallies support amid growing disorder After failed coup attempt in Moscow, Azerbaijani parliament votes to restore independence. In elections boycotted by opposition, Mr Mutallibov becomes president. Heydar Aliyev becomes leader of the Azerbaijani exclave of Nakhichevan. Leadership of Nagorno Karabakh declares the region an independent republic. Inter-ethnic hostilities escalate Hostilities develop into full-scale war over Karabakh. More than 600 Azeris are killed as they flee an Armenian attack on Karabakh town of Khodzhaly. Ethnic Armenian forces break through Azerbaijani territory to create a corridor linking Armenia to Karabakh. President Ayaz Mutallibov resigns. Abulfaz Elchibey, leader of nationalist People's Front, becomes president in Azerbaijan's first contested elections Armenia, Azerbaijan and Nagorno Karabakh sign a ceasefire accord. Ethnic Armenians remain in control of Karabakh and a swathe of Azerbaijani territory around it. Mr Aliyev cracks down hard on People's Front. Azerbaijani forces mount Karabakh counteroffensive. Armenia, Azerbaijan and Nagorno Karabakh sign a ceasefire. Ethnic Armenians remain in control of Karabakh and a swathe of Azerbaijani territory around it. Prime Minister Huseynov is dismissed and flees to Russia after accusations of involvement in an attempted coup. Azerbaijan signs what it calls the contract of the century with a consortium of international oil companies for the exploration and exploitation of three offshore oil fields Robert Kocharian leaves Karabakh to become prime minister in Armenia. Foreign Minister Arkadiy Gukasian is elected Karabakh president. Former PM Surat Huseynov is extradited from Russia. Following a lengthy trial for high treason he is eventually sentenced to life imprisonment. The Armenian leader is criticized at home for making too many concessions and subsequently resigns. The first oil is produced by the Azerbaijani International Operating Company under the contract of the century Azerbaijan becomes full member of Council of Europe, though council officials criticise it over human rights record. US lifts aid ban, imposed during Nagorno Karabakh conflict, after Azerbaijan provides airspace and intelligence after 11 September al-qaeda attacks in US. Azerbaijan, Georgia and Turkey reach agreement on oil and gas pipelines linking Caspian fields with Turkey. Azerbaijan officially shifts to the Latin alphabet for the Azeri language, in the fourth alphabet change in a century Construction work starts on multi-billion-dollar pipeline to carry Caspian oil from Azerbaijan to Turkey via Georgia Aliyev appoints his son, Ilham, as prime minister. Ilham Aliyev wins landslide victory in presidential poll said by observers not to reach international standards. Opposition protests met with police violence; hundreds arrested Baku-Tbilisi-Ceyhan pipeline formally opened at ceremony in Turkey after Caspian oil starts flowing along it Ilham Aliyev wins a second term as president. Western observers say conduct of the election, boycotted by the main opposition parties, was an improvement on previous votes but still fell short of democratic standards. Armenia and Azerbaijan sign a joint agreement aimed at intensifying efforts to resolve their dispute over territory of Nagorno Karabakh Azerbaijani-Armenian talks on Nagorno Karabakh end without achieving major breakthrough Presidential elections. President Aliyev wins another third five-year term Deadly clashes between troops from Azerbaijan and Armenia over the disputed enclave of Nagorno Karabakh. British Petroleum announces start of construction of Southern Gas Corridor to deliver gas to Europe directly, bypassing Russia. Pipelines scheduled for completion in

8 Lazard Emerging Markets Debt 2017 President Aliyev appoints his wife, Mehriban, as first vice-president. Fighting flares up in Nagorno Karabakh between the Azerbaijani army and ethnic Armenian troops along the line separating them. Source: BBC Notes 1 As of October As of Source: Azerbaijan, U.S. Energy Information Administration, 3 As of Source: BP Statistical Review World Energy 2017, BP, en/corporate/pdf/energy-economics/statistical-review-2017/bp-statistical-review-of-world-energy-2017-fullreport.pdf. 4 Azerbaijan, U.S. Energy Information Administration, rankings/#?prodact=53-1&cy=2016, and Shah Deniz Stage 2, BP, operationsprojects/shahdeniz/sdstage2.html. 5 Azerbaijan, International Monetary Fund, World Economic Outlook Database October 2016, accessed 14 October 2016, 6 International Monetary Fund, World Economic Outlook Database October 2017, 7 As of December 2016, Source: Lazard estimates. 8 Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, and World Bank Group Azerbaijan Partnership Program Snapshot, World Bank Group, April 2015, worldbank.org/content/dam/worldbank/document/azerbaijan-snapshot.pdf. 9 Armenia, Azerbaijan Move Closer To Settling Frozen Conflict, Stratfor Global Intelligence, 17 November 2015, accessed on 23 November 2015, 10 Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, Republic of Azerbaijan 2016 Article IV Consultation, IMF Country Report 16/296, September 2016, Transparency International, Corruption Perceptions Index: 2016, 118

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