USACC Investment Guide to Azerbaijan

USACC

Investment Guide 2007 to Azerbaijan

Business Opportunities for the 21st Century

A Publication of the U.S.– Azerbaijan Chamber of Commerce (USACC)

Join USACC Contacts and Networking Business Opportunities Exposure Information and Knowledge www.usacc.org

Publication Information USACC Investment Guide to Azerbaijan, 6th Edition

Publisher:

The United States –Azerbaijan Chamber of Commerce (USACC)

Publication Director:

Mahir Iskender

Production Manager:

Taleh Ziyadov

Production Assistant:

Aynura Huseynova

Advertising Manager:

Javid Mammadov

Editor:

John Boit

Art Director/Designer:

Abolfazl Bahadori

Photos:

Agdes Baghirzade Alakbar Aghasiyev Jeyhun Abdulla AzerTac News Agency

USACC expresses its gratitude to all authors who have generously contributed to this publication.

USACC would like to thank all the advertisers and sponsors who made this publication possible:

AtaHolding

Azercell Telecom JV

Azersun Holding

Bertling Logistics

CASPEL

Hess Corporation

International Bank of Azerbaijan

Karasu Operating Co.

Middle East Petrol Farm

Occidental Corporation

PRANT Real Estate Agency

Salans

Copies of this publication may be ordered from: United States – Azerbaijan Chamber of Commerce (USACC) 1212 Potomac Street, NW, Washington, DC 20007 Tel: 202-333-8702; Fax: 202-333-8703 E-mail: chamber@usacc.org; Website: www.usacc.org Copyright 2007 USACC ISBN 978-0-9664104-6-4 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of the publisher.

The opinions expressed in this publication are those of the authors and do not necessarily reflect those of the USACC. This publication is produced by the USACC to provide foreign investors with general information pertaining to Azerbaijan. The USACC is not responsible for the use made of information contained in this publication.

Table of Contents Welcome from Azerbaijan’s President Ilham Aliyev...................................4 Welcome from USACC Co-Chairmen......................................................5 IN TRODUCT ION Azerbaijan Emerges from Its Cocoon........................................................6 Azerbaijan Overview.................................................................................9 Population and Demographics................................................................12 GOV ER NM EN T Foreign Affairs........................................................................................18 Partnerships and Possibilities .................................................................20 Azerbaijan’s Reforms Signal Long-Term Success.....................................24 Political Environment: Risk Analysis......................................................28 The Armenia-Azerbaijan Conflict...........................................................32 ECONOM Y Economic Reforms: Goals and Outcomes...............................................36 Credit Rationale ....................................................................................40 Economic Outlook.................................................................................44 Taxation in Azerbaijan . .........................................................................49 Opportunities and Challenges in Azerbaijan’s Agricultural Sector..........58 ENERGY SECTOR A ND R EGIONA L PROJECTS Oil and Gas Development.......................................................................62 The Baku-Tbilisi-Akhalkalaki-Kars Railway Project...............................66 PROJECT FINA NCE , INSU R A NCE A ND DE V ELOPM EN T Financing the diversification of Azerbaijan’s economy.............................68 Asian Development Bank........................................................................72 Export-Import Bank of the United States................................................76

Welcome from President Ilham Aliyev

President of the Republic of Azerbaijan

Dear Members of the US-Azerbaijan Chamber of Commerce, It is with great pleasure that I invite you to learn about the many recent strides in Azerbaijan’s development through the 2007 Investment Guide of the US-Azerbaijan Chamber of Commerce (USACC).

With its geopolitically strategic location, Azerbaijan has for centuries served as a vital gateway for commerce and culture between Europe and Asia. From the trade caravans of yesterday that linked empires in the east, west, north and south, to the energy routes today that contribute to a global economy and energy security, Azerbaijan remains at an important crossroad for the world.

Projects such as the Baku-Tbilisi-Ceyhan oil pipeline and the Baku-Tbilisi-Erzurum gas pipeline contribute to the world’s energy security. Transportation projects, such as the construction of the Baku-Tbilisi-Akhalkalaki-Kars Railroad will integrate Western Europe and the Far East, into a single transport system.

Such projects have helped lead to Azerbaijan’s impressive growth over the last few years, and the country now ranks as the most rapidly developing economy in the world. Newly built schools, highways, bridges, hospitals, airports and sport facilities have been built and are integral parts of our vision for the prosperous future of this nation.

Azerbaijan continues to follow the path of democratization as set forth by President Heydar Aliyev. Our government has held free and fair elections and participates in such important political institutions as the United Nations, the Organization for Security and Cooperation in Europe, and the Council of Europe.

We continue to seek a resolution to the painful issue of the occupation of 20 percent of Azerbaijan’s territory, a result of Armenian aggression that forced about one million Azerbaijanis from their native lands. While not yet solved, we are confident that sustained efforts by the international community in helping mediate this conflict will lead to a long-sought resolution.

We also recognize that other nations have sufferred from instability, and we are committed to working in cooperation with the international community to bring peace to their lands. For this reason, our soldiers stand shoulder-to-shoulder with US and international peacekeeping forces in Kosovo, Afghanistan and Iraq.

Azerbaijan’s future depends on continuing to strengthen its economic potential. We believe firmly in free trade and commercial relations with partners around the world. The USACC is a major player in helping establish such connections and cooperation.

On behalf of my country and fellow citizens, I wish success to the USACC team and its members. I welcome you to Azerbaijan, and I thank you for your support and friendship.

Sincerely,

Ilham Aliyev

Investment Guide

Welcome from USACC Co-Chairmen Dear USACC members and friends, Since its establishment in 1995, the United States – Azerbaijan Chamber of Commerce has become a vital resource for companies seeking to do business with Azerbaijan, and in so doing increase the two countries’ trade ties. The USACC is the only organization with a presence in the U.S. dedicated to such commercial relations between America and Azerbaijan.

Azerbaijan is an emerging democracy with enormous potential. This has been well demonstrated in the oil sector, which has developed rapidly following the signing of the Contract of the Century in 1994 by President Heydar Aliyev. Other sectors, such as infrastructure, transportation, construction, information technology and agriculture are also ripe for American -Azerbaijani cooperation. The USACC is uniquely positioned to guide American investors through the legal, economic and cultural landscape in order to establish and maintain successful business operations in Azerbaijan.

The Chamber has already made great progress in growing business links between Azerbaijan and the United States, organizing and hosting recent trade missions in both the realm of information technology as well as food and agriculture. These trade missions sparked great interest and involvement among some of America’s largest and well-known industry leaders in each of these sectors.

While new business opportunities and economic growth form the backbone of Azerbaijan’s transition to a stable free-market economy, cultural development also plays an equally important role in sustaining a country in transition. The USACC is active in a wide array of cultural, educational, and humanitarian endeavors such as the USACC Humanitarian Mission – Pilot School Construction Project for Refugee Children in Azerbaijan, the endowment of the Caspian Studies Program and Azerbaijan Initiative at Harvard University, and the Azerbaijan Trade and Cultural Center.

We were also extremely proud to have organized and hosted a dinner in honor of First Lady Mehriban Aliyeva during her official visit to Washington, D.C. in December 2006. A USACC dinner at which she was the guest of honor featured an impressive array of young Azerbaijani musicians, singers and dancers who accompanied the First Lady on her visit. Evenings such as these, as well as other events organized by the Chamber, such as art exhibits and concerts, are vital in helping promote a richer understanding of Azerbaijan’s history and culture to the rest of the world.

As co-chairmen of the Chamber, we are pleased to present the 2007 edition of the USACC Investment Guide to Azerbaijan. We hope this guide will contribute to a broader understanding of, and a strong interest in investing in, the country of Azerbaijan.

Finally, we would like to express our gratuity to the contributors and sponsors whose efforts have made possible the 2007 Investment Guide.

Sincerely, James A. Baker, IV

Reza Vaziri

A Publication of the U.S.-Azerbaijan Chamber of Commerce

INTRODUCTION

Azerbaijan Emerges From Its Cocoon

By Thomas Goltz, Adjunct professor, Central and Southwest Asia Studies Program, University of Montana

Since re-establishing independence in 1991 as the Soviet Union was falling apart, the Republic of Azerbaijan moved from being a near-case study of a “failed state” to becoming an economic development motor in the Caspian and Caucasus region. Its young and increasingly confident population appears determined to create a lasting mark on the world.

One need only look at a “then and now” list of Azerbaijan’s experience over the last 15 years.

The late Soviet and early independence period of 1991 can be dismissed as the “Mutalibov Era,” when Soviet Azerbaijan’s last communist party boss, Ayaz Mutalibov, attempted to keep Azerbaijan inside Moscow’s direct sphere of influence. Relations with the rest of the world were virtually non-existent, with the exception of Soviet-era ties to Turkey and Iran. Neither of these two immediate neighbors wanted to recognize Azerbaijani independence without a nod from Moscow. Neither did the United States or Europe, for that matter, lest recognition of “marginal” elements of the collapsing Soviet Union further erode the position of Mikhail Gorbachev.

Creating even more complexity was the slowslide into war with Armenia over the western Azerbaijani region known as Mountainous (‘Nagorno,’ in Russian) Karabakh, where local separatists were attempting to ethnically cleanse the territory of its native Azerbaijani population, and then stitch Karabakh to Armenia. The international community, never having heard of Azerbaijan aside from vague (and erroneous) allusions to inhabitation of Shia Muslims somehow associated with the Islamic Republic of Iran, bought the Armenian argument of “self-determination” almost completely.

Introduction Investment Guide

The new Republic of Azerbaijan is looking boldly into the future, a butterfly emerging from its cocoon.

In addition to the devastation of life and property in and around Karabakh, between 1992 and 1993, the growing violence resulted in a chaotic political situation in Baku, starting with the forced resignation of Mutalibov, his return and second departure during a failed coup, followed by the rise and rapid demise of the government of Abulfez Elchibey and the Popular Front. Azerbaijan seemed ready to pitch itself into civil war as diverse factions attempted to find various outside sponsors in Moscow, Ankara and Tehran, and then sought exile in those capitals when coup efforts failed. The Armenians, of course, took advantage of the situation to first conquer and cleanse Karabakh proper, and then extend their occupation of much of western Azerbaijan, forcing almost a million people to flee their homes.

The Armenians remain in occupation of some 20 percent of the country to this day.

On June 15, 1993, veteran politician Heydar Aliyev returned from self-exile in the Azerbaijani exclave of Nakhchivan to attempt to impose some measure of security and stability in a country that sorely needed it. That date is now celebrated by most Azerbaijanis as a national holiday marking “The Return of the Leader.”

Despite criticism among opposition groups (including members of the several failed governments that preceded Aliyev’s return), few close observers of the situation he inherited would quibble about the urgent need for the late president to impose necessary discipline on a truly chaotic situation that threatened to undermine Azerbaijan’s very existence as an independent state.

But the roller-coaster ride was not over.

In 1994 and then again in 1996, the specter of renewed inter-communal violence hung over the country, threatening to extinguish the first tentative steps made the Aliyev team to jump-start the moribund economy and establish an international profile, based largely on the signing of new contracts in Azerbaijan’s neglected oil sector.

Although synonymous with the concept of “Black Gold’” in the late 19th and early 20th centuries, when such men as the Nobels, Rothschilds and Taghiyevs made their fortunes in and around the Apsheron peninsula, the Bolshevik take-over of the first Azerbaijani Republic in 1920 (and the 70 years under Soviet occupation that followed) led many to believe that there were virtually no resources left in 1991.

The legacy of the past – creaking fields of rusted drill rigs, vast lakes of stinking oilspills and the bizarre remains of the crumbling city-on-stilts-at-sea known as “Oily Rocks” –seemed almost too much to surmount.

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Thomas Goltz is the author of several books, including, “Azerbaijan Diary”, which cronicals Azerbaijan’s early years of independence following the break up of the Soviet Union.

But in 1994 came the so-called “Deal of the Century.” Major foreign oil companies and the industry that supports them took renewed interest in Azerbaijan, culminating in the opening of the 1,071 mile-long Baku-Tbilisi-Ceyhan pipeline that linked the Caspian to the eastern Mediterranean.

Once snidely referred to as a “pipeline to nowhere,” the $4 billion line officially opened on July 13, 2006 to international applause and the first physical symbol of a new “East-West Energy Corridor.”

For Azerbaijan, the opening of the pipeline was a vindication of Heydar Aliyev’s vision of securing Baku as the new “hub” of the Caspian energy sector, with multiple “spokes” running to all points of the compass. It has planted Azerbaijan squarely on the world map, both as an economic entity and a political player.

Indeed, on a foreign policy level, the period between 1993 and 2006 saw an extraordinary expansion of Azerbaijani diplomacy, which has grown from a few run-down rooms with few computers on a side street in central Baku to the hustle and bustle of the current Ministry of Foreign Affairs, which coordinates information flow from at least four dozen foreign embassies, many of which double as interest sections in which organizations like the UN or OSCE maintain their headquarters.

The most recent success of this policy of persistent, diplomatic outreach was the unanimous passing of a United Nations’ General Assemble resolution “urgently” calling for an investigation in the causes of fires that have ravaged the occupied territories in and around Karabakh last summer. When compared to 1992, when the notorious Article 907 “rider” to the Freedom Support Act restricting U.S. aid to Azerbaijan was attached in the U.S. Congress with scarcely an objection, one can cite real progress.

Progress is also seen with Azerbaijan’s decision to offer peace-keeping troops to international missions in Kosovo, Afghanistan, Iraq, as well as the pending decision to send soldiers to Lebanon. The young state on the shores of the Caspian is starting to make waves, successfully playing a balancing act between regional and global powers, while cultivating a wide variety of ties with other countries and international institutions, ranging from UNESCO to the Organization of the Islamic Conference, to maintaining friendly relations with both Iran and Israel.

Unlike the bleak situation of 1991, the new Republic of Azerbaijan is looking boldly into the future, a butterfly emerging from its cocoon.

Introduction Investment Guide

Azerbaijan Overview

By Gregory Twyman, Adjunct professor, Department of History, Monmouth University

Location and History The Republic of Azerbaijan is an independent country located in the Caucasus region of Southeast Europe, encompassing a total area of 33,400 square miles. The country shares borders with the Russian Federation’s province of Dagestan to the north, Georgia to the northwest, Armenia and Turkey to the west and southwest, Iran to the south, and the Caspian Sea to the east.

Many ethnic Azerbaijanis also live in neighboring northwest Iran, mainly in provinces known as Eastern Azerbaijan, Western Azerbaijan, Ardabil and Zanjan.

People on both sides of this border speak the same Turkic language, share the religion of Islam and once shared a common history. That changed when Russia annexed the Azerbaijan north of the Araz River as a result of the Treaty of Turkmanchai on February 10, 1828.

Capital:

Baku

Population:

8.5 million

Area:

33,440 square mile (86,600 sq. km)

Highest point:

14,715 feet (4,485 meters) Mount Bazardyuzyu

Lowest point:

85 feet (26 meters) below sea level

Principal language:

Azerbaijani

Principal religion:

Islam (70% Shia, 30% Sunni)

Political divisions:

76 Administrative Divisions, 1 autonomous republic, 1 autonomous district

Currency unit:

Manat

National holiday:

May 28, Republic Day

National anthem:

“Azarbayjan Vatanimizsan” (“Azerbaijan, Our Homeland”)

Azerbaijan was part of the Russian Empire from the early 19th century until 1918, was then briefly an independent republic until 1920, and then a part of the Soviet Union from 1922 to 1991. On August 30, 1991, Azerbaijan declared its independence from the Soviet Union, and it was fully restored nearly two months later, on October 18, 1991.

The capital and largest city of Azerbaijan is Baku. The republic includes two administrative divisions with special status. One is the autonomous Republic of Nakhchivan, which is separated from Azerbaijan proper by southern Armenia, and Nagorno-Karabakh (Qarabag), which is populated mainly by Armenians and has been occupied by Armenian military forces since 1992.

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Topography Mountains cover half of Azerbaijan and three of the dominant relief features converge within the country.

These features are the Greater Caucasus Mountains in the northeast, the Lesser Caucasus in the southwest and the Kura River depression in between. In the southeastern most part of the country, the Araz River Valley extends between the Zangazur and Dilagarez ranges. Mount Bazardyuzyu, located in the Great Caucasus range and along the Russian border, is Azerbaijan’s highest peak, reaching 14,715 feet.

In the higher elevations, there are countless glaciers and rapids, while the mid-elevation ranges are dissected by deep chasms. The Greater Caucasus descends abruptly in the east and shrinks to low, arid hills. To the north of the Greater Caucasus, in eastern Azerbaijan, extends the sloping Gusar Plateau. The lowest region in the country, the Kura depression in the southeast, is divided into two parts. Its western area and northern rim are marked by hills, ridges and valleys.

Along the foothills of the subtropical southeastern coast, viewers can observe tea plantations, citrus groves, numerous mud volcanoes, and minerals springs, while gulches and ravines are prevalent near Gobustan Mountain, located to the west of Baku. The central and eastern areas of the depression consist of alluvial plains and the low delta of the Kura River along the coast. The 500-mile-long Caspian coast line of Azerbaijan is largely consistent. The largest land projections are the Absheron peninsula, the Sara Peninsula and the Kura sand bar.

Rivers and Lakes There are more than 1,000 rivers in Azerbaijan, and only 21 are longer than 60 miles. The Kura, the largest river in South Caucasus, flows through Azerbaijan from the northwest to the southeast, and empties into the Caspian Sea. The Caspian is the source of the world's largest population of caviar-producing sturgeon. The main tributary of the Kura River is the Araz River, also known as the Araxes. Most of Azerbaijan's rivers are in the Kura basin. In the plains, the rivers are used for crop irrigation. The large Mingachevir Hydroelectric Power Plant and the Mingachevir Reservoir – 234 square miles in total – are located on the Kura.

Most of the 250 lakes in Azerbaijan are small. Lake Hajigabul is the largest, with an area of six square miles, while Lake Boyukshor, with an area of four square miles, is next largest.

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Introduction Investment Guide

Climate Azerbaijan has a unique diversity of climates, which includes nine climate zones.

These range from arid sub-tropical and humid sub-tropical to a mountainous tundra climate featuring cold and dry weather. The mean annual temperature ranges from 59 degrees Fahrenheit in low-lying areas to 32 degree Fahrenheit in the mountains. The mean temperatures in July are 70 degrees in low-lying areas and 41 degrees in the highlands. Summers are dry in the lowlands. The distribution of annual rainfall is highly uneven, with 8 to 12 inches in coastal areas and in the southeastern lowlands, 12 to 35 inches in the foothills of the medium-elevation mountains, 39 to 51 inches in the southern slopes of the Great Caucasus range and 47 to 55 inches in the southern Lankaran lowland. In the lowlands, precipitation decreases in the winter, and in the mountains and hills it decreases primarily from April to September.

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Population and Demographics

This article has been prepared by SIAR Research and Consulting, and is based solely on official data of the State Statistical Committee of Azerbaijan.

All population numbers in the tables below are represented in thousands.

Population Size In 2006, Azerbaijan’s population reached a level of almost 8.5 million, an increase of 2.9 percent since 2003. The increase stems from the high cumulative growth of Azerbaijan’s urban population, which accounted for 4.9 percent within the same period, in contrast to 0.7 percent cumulative growth among the rural population.

Total number of population and distribution by urban/rural areas

12

# of urban population # of rural population

Years

Total # of population

#

%

#

%

2003

8202.5

4154.3

50.7

4048.2

49.3

2004

8265.7

4254.3

51.5

4011.4

48.5

2005

8347.3

4298.3

51.5

4049.0

48.5

2006

8436.4

4356.6

51.6

4079.8

48.4

Introduction Investment Guide

Gender and Age The period from 2003 to 2005 shows a slight decrease in the number of women in the country.

Distribution of population by gender Male

Female

Years

#

%

#

%

2003

4023.0

49.1

4179.5

50.9

2004

4058.5

49.1

4207.2

50.9

2005

4103.7

49.2

4243.6

50.8

The working age in the country is set between 15 and 61 years old for men and 15 to 56 for women. Analysis of these figures shows that the share of children under 15 years old has decreased between 2004 and 2006, comprising 24.5 percent of the population at the beginning of last year. The reason for this decline lies in the high increase in infant mortality observed between 1991 and 1996. This negative tendency is expected to reverse in the near future.

Distribution of population by age groups # of population under working age

# of population at working age

# of population over working age

Years

#

%

#

%

#

2004

2178.8

26.4

5305.5

64.2

781.4

9.4

2005

2121.0

25.4

5439.5

65.2

786.8

9.4

2006

2066.8

24.5

5579.4

66.1

790.2

9.4

%

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Ethnicity and Language While the number of ethnic groups existing in Azerbaijan is quite high, the overwhelming majority of the country’s population is Azerbaijani, with an even higher share of those belonging to other groups but for whom main language was Azerbaijani. It should be noted, however, that this breakdown is only studied every 10 years when the government undertakes a nationwide census. The last census was conducted in 1999.

Distribution of population by ethnic group Azeri

90.6%

Lezgin

2.2%

Russian

1.8%

Armenian

1.5%

other

3.9% Source: CIA World Fact Book

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Introduction Investment Guide

Education Level More than half of the population has reached the secondary level education by age 15. Secondary and higher education levels have shown modest increases since 2004.

Distribution of education Higher

Incomplete higher

Specialized secondary Secondary

Incomplete secondary

#

%

#

#

Years

#

2004

668.6 11.1

54.2

0.9

722.8 12.0

3138.3 52.1

903.6 15.0

2005

688.2 11.2

55.3

0.9

743.5 12.1

3195.2 52.0

915.6

2006

709.7 11.3

56.5

0.9

747.4

3278.4 52.2

935.8 14.9

%

%

11.9

#

%

% 14.9

Employment According to the official data of the State Statistical Department of Azerbaijan the number of employed persons among the working age population in 2004 comprised 3.81 million, with the majority of those employed working in the private sector.

Distribution of employed population by state/private sectors State Sector

Private Sector

Years

#

%

#

%

2003

1180.0

31.5

2567.0

68.5

2004

1209.3

31.7

2599.8

68.3

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Employment distribution by types of economic activity followed the pattern shown below:

Distribution of employment by sector # of employed Type of economic activity

#

%

Agriculture, hunting and forestry

1502.7

39.5

Fishing

3.3

0.1

Mining and quarrying

41.9

1.1

Manufacturing

181.2

4.8

Electricity, gas and water supply

39.8

1.0

Construction

190.6

5.0

Wholesale and retail trade; vehicle repair; personal and household goods

630.7

16.6

Hotels and restaurants

12.4

0.3

Transport, storage and communication

190.5

5.0

Financial intermediation

13.1

0.3

Real estate, renting and business activities

100.0

2.6

Public administration and defense; compulsory social security

269.7

7.1

Education

330.8

8.7

Health and social services

174.6

4.6

Other community, social and personal service activities

127.3

3.3

Extra-territorial organizations and bodies

0.5

0.0

Total

3809.1

100.0

Agriculture remains the most active sector in terms of employment percentage, with 39.5 percent of the population engaged in the industry. The second and third largest employers by sector are the wholesale and retail trade/repair/personal and household goods at 16.6 percent, and education at 8.7 percent. These three sectors combined cover more than 60 percent of all employed persons in Azerbaijan.

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Introduction Investment Guide

GOVERNMENT

Foreign Affairs

By Elmar Mammadyarov, Minister of Foreign Affairs

In recent years, Azerbaijan has become increasingly known to foreign investors and the Western public in general. From an exotic unknown, the country has turned into a place of common knowledge and of considerable interest for Americans. The steady progress of Azerbaijan - U.S. cooperation has been marked by comprehensive concerted mutual efforts, on both bilateral and multilateral levels.

This resulted from Azerbaijan’s policy of engaging the international community, which the country has pursued since the restoration of its independence in 1991.

This policy was supported by the world’s fastest-growing economy at 26.4% in 2005 with prospects of almost the same, or even higher, figures for 2006. All other major economic indicators point to a similar growth, with average salaries growing at 21.9% (2005 figure). Relations with the United States have been a crucial component of this policy.

Participation by the international energy industry in the development of the Azerbaijani sector of the Caspian, which started in 1994 after the signing of the Contract of the Century, serves as the backbone of the country’s economic development. As a result of the energy-based transformation of the economy, Azerbaijan remains in a leading position among post-Soviet states in terms of per capita foreign direct investments.

Foreign direct investment now exceeds $20 billion, with $15 billion of that from the oil sector alone. For 2005, Azerbaijan was first in the world in terms of the Foreign Direct Investment Inflow Performance Index and is among the top 20 in the world in equity capital attraction.

The intensity of foreign investments in Azerbaijan’s economy remains steady, with over $5 billion in 2006. Considerable efforts are being made by the Government to tackle inflation, which decreased 9.6% in 2005 and was less than 8% for the first three-quarters of 2006. Since the adoption of the National Strategy for Information and Communication Technologies in 2003 and its core documents, such as the ones on e-signature, e-commerce, postal communication and others, the ICT sector started growing rapidly and the communications’ share in GDP reached 2.3% in 2005. The Government is doing its utmost to broaden employment opportunities, with President Ilham Aliyev’s economic programs well underway.

Special attention is being paid to the issue of sustainable development, with a Presidential decree having established a National Committee to pursue the implementation of programs on sustainable development in forestry, poverty reduction, regional development, farmland and ecology.

Azerbaijan’s energy transportation system and its transportation network in general are improving steadily, most markedly with the milestone in 2006 of the arrival of first oil to the Turkish port of Ceyhan. Progress of the Baku–Tbilisi–Erzurum

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Government Investment Guide

American companies doing business in Azerbaijan have the opportunity to witness our genesis first-hand, and help contribute to the continuing consolidation of this beautiful friendship.

gas pipeline, set to begin operations in the near future will also contribute to the diversification of the world’s hydrocarbon supply. And the Baku-TbilisiAkhalkalaki-Kars route will be vital in terms of further integrating regional emerging democracies into Europe.

Azerbaijan, with its strategic location at the crossroads between East and West, North and South, continues to be instrumental in promoting security and stability in the vitally important region of the South Caucasus and the Caspian.

Azerbaijan’s unconditional participation in the Global War On Terrorism, contributing troops to KFOR, ISAF, and Iraq stabilization forces, represent a policy aimed at promoting stability in various parts of the world. Having itself suffered from terrorist attacks in the mid- and late-90s, Azerbaijan is well aware of the dangers and challenges to statehood that international terror poses.

The unresolved Armenia – Azerbaijan Nagorno-Karabakh conflict continues to undermine the security and stability climate and integration processes underway in the region. The Government still believes, however, that a settlement to this conflict is attainable. Despite the occupation of 20 percent of its territory and the continued plight of 1 million Azerbaijani refugees and internally displaced people, the Azerbaijan Government’s continuing efforts to pursue a settlement through peace talks is the best indicator of the country’s constructive approach.

The Government considers that, with the international community’s determined approach and each side’s dedication to the peace process, it is possible to achieve a lasting settlement that will further address the issue of regional re-integration and rebuilding.

Broad democratic reforms underway in Azerbaijan are a logical product of the country leadership’s policy aimed at strengthening civil society, including the strengthening of human rights protection, rule-of-law, full transparency of the state agencies, and more. Special attention is paid by the Government in fighting corruption. This is yet another key factor in further improving the investmentfriendly climate in Azerbaijan.

Azerbaijan’s position as a strategic ally of the United States further deepens and develops our economic links, which form the basis for our booming partnership.

American companies doing business in Azerbaijan have the opportunity to witness our genesis first-hand, and help contribute to the continuing consolidation of this beautiful friendship.

On behalf of the Government of Azerbaijan, I thank you for your interest in doing business with our country, and I look forward to further strengthening our mutual economic ties in 2007.

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Partnerships and Possibilities

By Yashar Aliyev, Ambassador of Azerbaijan to the United States

After regaining its independence in 1991, the Republic of Azerbaijan announced its commitment to the transformation and construction of a democratic society based on the rule of law. The establishment of an open market society through economic reforms and development projects is an integral part of this commitment. It is my honor, as Ambassador of Azerbaijan to the United States to take the opportunity to elaborate on many of the steps we have taken as a nation to achieve this commitment and to highlight prospects for the future.

Azerbaijan has joined almost all major international treaties on human rights and has covered considerable ground in bringing itself closer to international democratic standards. The government has passed laws and enacted state programs that enhance the social well-being of the Azerbaijani people, foster economic growth and seek to eliminate poverty and corruption. The creation of the Office of the Ombudsperson in 2001, the adoption of a national plan of action to combat human trafficking in 2004 and the approval of a national plan of action to protect human rights in 2006 show the government’s loyalty to democratization and the rule of law.

Azerbaijan is also committed to integration into European and Euro-Atlantic structures. As such, Azerbaijan has been a member of NATO’s Partnership for Peace Program since 1994, and has been a vigorous participant and host of many events within the NATO framework. Currently, Azerbaijan is in the process of completing its Individual Partnership Action Plan with NATO and is an active participant in the Partnership Action Plan against Terrorism.

Azerbaijan has become an indispensable link in ensuring the energy security of European consumers and of the development of trade within the region.

A strong partnership with the U.S. has been of critical importance for Azerbaijan’s foreign policy. Our bilateral relations have endured the significant challenge of the adoption of Section 907 of the Freedom Support Act in 1992 by the U.S. Congress, which prohibits direct assistance to the Government of Azerbaijan. We are pleased to note, however, that our relations entered a new stage following the annual waiver of this legislation by presidential order since 2002. Still, the total abolishment of this legislation is critical to opening up new horizons for the expansion of our bilateral cooperation.

After the tragic events of September 11, 2001, Azerbaijan was among the first countries to join the International Anti-Terror Coalition. Today our country remains a staunch ally of the U.S. in the Global War on Terrorism, with Azerbaijani and American soldiers serving shoulder-to-shoulder in Afghanistan, Iraq and Kosovo.

Azerbaijan’s law-enforcement and other relevant authorities have arrested and

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Azerbaijan President Ilham Aliyev (second from right) addresses the GUAM Organization for Democracy and Economic Development. Standing with him are (from left) Moldovan Prime Minister Vasile Tarlev, Ukrainian President Viktor Yushchenko, and Georgian President Mikhael Saakashvili.

extradited dozens of terrorists and have discovered and frozen the accounts of organizations supporting terrorist activities. Azerbaijan also regularly shares terrorist-related information with the international intelligence community.

In April of 2006, the first official visit to the U.S. of Azerbaijan President Ilham Aliyev gave an additional boost to many areas of cooperation, including political, economic, military and security concerns. Inter-parliamentary relations between the two countries are also expanding. The Azerbaijan Caucus in the U.S. Congress is playing a visible role in increasing the understanding of the importance of strong U.S.-Azerbaijan relations. The 2006 visit of an Azerbaijan Parliamentary delegation headed by the First Lady of Azerbaijan, Mrs. Mehriban Aliyeva, in her capacity as Chairperson of the Azerbaijan-U.S. Inter-Parliamentary Working Group also helped significantly in strengthening our ties.

Today, Azerbaijan is in the midst of unprecedented development, with one of the highest economic growth rates in the world. Our GDP growth in 2006 totaled 35%, and has more than tripled in the last four years. Government measures to advance rural economies and fight poverty have yielded impressive results: more than 500,000 new jobs have been created and poverty has been reduced from 49% to 26% in the last three years alone.

Located at the crossroads of Europe and Asia, Azerbaijan holds a strategic position within East-West and North-South energy and transport corridors. Azerbaijan has become an indispensable link in ensuring the energy security of European consumers and of the development of trade within the region. After signing in November of 2006 the European Neighborhood Policy and the Memorandum of Understanding on Energy Partnership, our country has assumed obligations, as a strategic partner of the European Union, to be its reliable energy supplier and contribute to EU energy security.

Azerbaijan’s importance in the region has grown not only as a large hydrocarbon producer, but also as an important hub for the development of regional energy transit routes. Completion of the construction of the Baku-Tbilisi-Erzurum gas

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pipeline, as well as the signing of an agreement on the transportation of Kazakh oil to international markets via the Baku-Tbilisi-Ceyhan pipeline, and an agreement between Azerbaijan, Georgia and Turkey on the new railway connection Baku -Tbilisi-Kars, which is also called the Silk Route Railway, are vivid examples of this.

With the growing production of oil and gas, and the ensuing inflow of petro-dollars into the economy, Azerbaijan, which has in the past been merely a recipient of foreign investments, is now emerging as a regional investor. The acquisition and modernization of the Kulevi oil-terminal in Georgia, the provision of $200 million to Georgia for the construction and rehabilitation of that country’s segment of the Kars-Tbilisi-Baku railway, and investment in the construction of a refinery plant in the Turkish port of Ceyhan are examples of this exciting new role for Azerbaijan.

Keenly aware of the need for energy diversification, the government is committed to the development of alternative energies. In this regard it has adopted and is implementing the National Alternative Energy Program for 2004-2013.

In order to preserve macroeconomic stability, effectively manage oil revenues and provide economic security for future generations, the government has established the State Oil Fund and has adopted a long-term strategy for oil revenue management. This fund also serves as a mechanism for avoiding the inflationary pressure associated with the introduction of petro-dollars into Azerbaijan’s economy.

To ensure the transparency of revenue derived from its mining industry, Azerbaijan has joined the Extractive Industries Transparency Initiative (EITI). Through this initiative, Azerbaijan has become a pioneer country in introducing new reporting standards for revenues received from hydrocarbon resources and other mining activities.

Azerbaijan is keen to provide an environment that is welcoming and transparent to potential investors. With that in mind, the government maintains an “opendoor” policy for foreign investors, and works to constantly improve investment and banking legislation. This has resulted in Azerbaijan attaining one of the highest rates of per capita Foreign Direct Investments (FDI) among the countries of Eastern Europe and the Commonwealth of Independent States, and was ranked in first place in the FDI performance index according to the “World Investment Report 2006” of the United Nations Conference on Trade and Development.

All of these achievements have led to the improvement of Azerbaijan’s risk category—moving from level 6 to level 5—at the OECD Country Risk Experts meeting in June of 2006. In addition, Azerbaijan’s standing as ranked by Fitch Ratings has recently been upgraded from “BB” to “BB+”.

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These indicators set the stage for continued economic ties with the U.S., the second largest investor in Azerbaijan. Between 1993 and 2006, American companies invested approximately $5 billion in Azerbaijan.

Bilateral trade turnover was $947 million in 2006—an impressive five times more than the turnover in the previous year. Still, 86 percent of trade volumes were in oil-related equipment and oil products. Obviously, trade diversification measures need to be taken.

Some important steps have already been made in advancing the close collaborative relations between Azerbaijan and the U.S. One example of this is the establishment of the Economic Partnership Commission between our two countries. Partnership relations between our countries open up bright new possibilities for close economic cooperation and joint participation in strategic projects in the Caspian and Black seas region.

In addition to the energy sector, there are abundant opportunities for investment in the non-oil sector in Azerbaijan. The country is rich in mineral resources and ferrous and non-ferrous metals, including gold and silver. Despite its relatively small territory, nine of the world’s 11 climatic zones are found in Azerbaijan, creating extremely favorable conditions for the development of agriculture, and the country is famous for its fruits, vegetables, juices and wines. Azerbaijan is known throughout the world for its tradition of carpet weaving thanks to the country’s long history of wool, silk and cotton production. In addition, many possibilities for investment exist in the sector of information and communication technologies, as well as in the fast-moving sectors of construction, chemical and machine-building industries.

With its stunning natural beauty and tradition of warm hospitality, Azerbaijan provides an excellent opportunity for tourism. Snow-capped mountains, alpine meadows, desert plains and sandy beaches are all within a few hours drive of one another. Combined with its rich history, cultural monuments and delicious cuisine, Azerbaijan has the potential to become one of the world’s most sought-after destinations for travelers.

These are just a few of the highlights of Azerbaijan’s development and economic prospects. For those of you already familiar with Azerbaijan, I thank you for your interest in my country and for your friendship. And for those who have not yet been to Azerbaijan, I invite you to come and see my country firsthand in 2007. As it has through the centuries, Azerbaijan stands at the crossroads of commerce and culture, ready to welcome you.

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Azerbaijan’s Reforms Signal Long-Term Success

By Anne Derse, U.S. Ambassador to Azerbaijan

As I begin my posting as ambassador for the United States to Azerbaijan, it gives me great pleasure to share my vision of our future economic and commercial relationships.

Azerbaijan is a good friend and an important partner for the United States. We have excellent, ongoing cooperation in security and the Global War on Terrorism, global energy security, and political and economic reform. President Ilham Aliyev’s very successful visit to Washington last year highlighted the breadth of our bilateral relationship, and laid the foundation for even more robust strategic dialogue and cooperation. President Aliyev’s visit also renewed interest in increasing trade with the U.S. and expanding the amount of commercial opportunities for American companies.

We expect great things for Azerbaijan’s future. With enormous energy reserves and an astounding 36 percent growth rate in the first half of 2006, Azerbaijan is poised on the brink of greatness. With energy wealth and rapid economic growth come many challenges, of course, and I believe the United States can play a critical role in helping Azerbaijan successfully navigate those challenges. To that end, the U.S. wants to raise the level of economic dialogue with the Government of Azerbaijan to ensure that we have the appropriate forum to address vitally important issues such as revenue management, anti-corruption measures and WTO accession.

Sustained dialogue and cooperation on these issues are critical to Azerbaijan’s future prosperity and stability and hence to the United States’ own interests in this vitally important region.

Much of Azerbaijan’s growth has been driven by the spectacularly successful energy industry, and the jump in production due to the completion of the Baku-TbilisiCeyhan (BTC) pipeline. In order to transform Azerbaijan’s energy wealth into the foundation for a stable, prosperous and market-oriented economy, Azerbaijan will need to create through its entire economy the same kind of open and transparent system that has regulated the development of the energy sector. Reform and transparency are key to the diversification of Azerbaijan’s economy, and are essential to ensuring sound management of Azerbaijan’s revenue.

Accession to the WTO will improve the business and investment climate while bringing about the regulatory and legal changes necessary to bring greater transparency and openness—and hence greater diversity and sustained growth—to Azerbaijan’s economy. The U.S. has supported Azerbaijan’s WTO accession efforts through both technical assistance and political dialogue. I hope that we will continue such support in the coming year, to ensure that Azerbaijan builds on the progress of recent years and meets its stated goal of acceding to the WTO by 2009.

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Azerbaijan is poised on the brink of greatness. With energy wealth and rapid economic growth come many challenges, and the United States can play a critical role in helping Azerbaijan successfully navigate those challenges.

With a projected energy revenue topping $42 billion by 2010, Azerbaijan presents enormous commercial opportunities in a wide range of sectors, from oil and gas to agriculture and telecommunications. Azerbaijan’s unique and strategically important geographic location has played an important role in the country’s development as an energy provider. With access to markets in Europe, Russia and Central Asia, that same geographical advantage puts Azerbaijan in a perfect position to develop as a regional hub in other non-oil related areas, particularly construction and maritime transport.

In order to take advantage of these opportunities, however, Azerbaijan must invest some of its oil revenue in public infrastructure and encourage entrepreneurs and foreign investment in the non-oil sector. Improvements to the government’s economic decision making and planning are critical short-term priorities, as is renewed dedication to anti-inflationary measures. Reforms in revenue management that create efficiency and accountability are key to the sound development of Azerbaijan’s economy.

One key step Azerbaijan can take to absorb the oil revenue influx is to renew its efforts in banking and financial sector reform. Azerbaijan must attract international financial institutions if its financial sector is to become globally competitive. The government of Azerbaijan could take steps to increase the National Bank’s role in regulating the banking system. The U.S. is already working with the National Bank to improve and expand banking sector supervision. As oil wealth increases, a robust financial sector – banks, insurance, and stock and bond markets – will be a crucial tool to manage private sector investment in the economy.

As Azerbaijan focuses on poverty reduction, it would do well to move boldly to improve the non-oil sector of the economy. Of particular note is agriculture, which makes up Azerbaijan’s second largest economic sector after oil and gas and the largest source of employment in the country. Agriculture, therefore, represents the best means to have Azerbaijan’s rural areas outside of the capital enjoy an equitable share of the country’s prosperity. Burdened with an unwieldy bureaucracy and a legacy of land privatization that ensured few farmers received enough land to become commercially viable, Azerbaijan also needs agricultural policies aimed at smart development of value-added agriculture. This means more modern and efficient farming techniques, as well as investment in infrastructure in areas such as irrigation. It also means support for small scale growers so that they can begin to meet the needs of a growing number of agro-processors for quality inputs, which will bring higher-quality goods to Azerbaijani consumers and lucrative export markets.

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President Aliyev has made rural development a top priority, and continued growth and demand for agricultural inputs is expected. Whether it is tractors, fertilizers, or other implements, all present opportunities for U.S. firms. U.S. companies have had some success penetrating this sector, but there is ample opportunity for significant expansion.

Construction is another possible area for increased U.S. exports. Looking out over Baku, you can now see dozens of new, multi-story apartment complexes being built, with renovation work on nearly every street corner. Virtually all types of highquality building materials are being imported, with notable opportunities for U.S. firms. Azerbaijan has acquired world-class expertise in large-scale energy construction, and U.S. firms tell me that Azerbaijan has the potential to become a hub for construction and shipping infrastructure throughout the Caspian region.

Growth in this exciting sector, however, would require changes in Azerbaijan’s business climate. I encourage the government of Azerbaijan to consider incentives, such as special duty-free zones, that could make this happen.

Telecommunications and information technology present two additional areas with potential for U.S. businesses. The government of Azerbaijan understands the need to deregulate the IT and telecommunications sector and establish an independent and separate regulatory body. The government has realized it must forego the 51 percent stake it holds in most telecommunication companies. These bold steps could encourage market participation in a sector ready for growth, and simultaneously provide the infrastructure necessary for Azerbaijan’s future development.

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However, perhaps the single biggest challenge for Azerbaijan in the coming years is the effect of corruption on the economic and social life of the country. For its part, the U.S. Embassy, through the Department of Justice, USAID, and partner organizations like ABA/CEELI, is providing technical support to the government to begin the process of eliminating corruption. The Azerbaijan government has taken some steps to fight against corruption, but more remains to be done. The government’s anti-corruption commission, audit institution and procurement agency can and must assume a much more active role in ferreting out corruption, particularly within government and public services.

For those American companies seeking to do business in Azerbaijan, the process of navigating through corruption and foreign bureaucracy is often challenging. Please keep in mind that the U.S. Embassy and my staff are here to help address your needs.

Finally, a word on energy. With the completion of the BTC pipeline this summer and the SCP gas pipeline nearing completion this fall, Azerbaijan’s role as a key supplier of energy is just beginning. The governments of Azerbaijan and Kazakhstan have signed an agreement to bring Kazakh crude into the BTC pipeline. Azerbaijan also could play a key role in bringing Caspian gas to world markets. Full-field development of the Shah Deniz gas field could greatly advance energy security both for Europe and the broader Caucasus region.

Looking forward, Azerbaijan’s future is very bright. Over the last decade the Azerbaijan government has created the proper conditions that have allowed the Deal of the Century to come to realization. Now is the time to apply the same degree of creativity, transparency and bilateral cooperation across all sectors of economy to ensure that the blessings of Azerbaijan’s enormous energy resources translate into sustainable development for generations to come.

I look forward to working with all of you to help Azerbaijan realize its goal of economic reform and broad-based development. In exploring opportunities or facing a challenge to your business in Azerbaijan, please consider enlisting the embassy as your ally. You will find embassy staff that are ready to assist you in your efforts as you enter this market. I look forward to working with you as you capitalize on the opportunities that await you in Azerbaijan.

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Political Environment: Risk Analysis

By Zeyno Baran, Senior Fellow and Director of the Center for Eurasian Policy at the Hudson Institute in Washington, DC.

The death in 2003 of President Heydar Aliyev, the longestserving leader of Azerbaijan, was for years called “Event X,” since no one could confidently predict whether the country would fall into chaos. Yet despite all fears, the country remained stable after Aliyev passed away, in large part because his son Ilham had assumed the presidency following elections in October 2003. More recently, parliamentary elections took place in November 2005, and today, Azerbaijan is on its way to becoming a key energy and security ally of the West in the Caspian and Black Sea regions.

Currently, the Middle East has captured the attention of the West on a number of issues ranging from terrorism and radicalism to political reform. Although many observers often fail to consider the case of Azerbaijan, it is extremely relevant to these debates. Azerbaijan has both a Shiite and a Sunni population, and enjoys little to no tension between the groups. Azerbaijan is also one of only two Muslim countries (the other is Kazakhstan) contributing peacekeepers to Kosovo, Afghanistan and Iraq. It has supported the broader U.S. campaign against extremist movements by offering “crucial law enforcement and intelligence cooperation, blanket overflight rights, and the possible use of bases.” At a time when the U.S. enjoys little support from many non-Muslim countries, let alone Muslim ones, this makes Azerbaijan even more relevant as an ally.

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The November 2005 parliamentary elections were an important measuring stick for Azerbaijan’s democratic progress, as well as an indicator of the country’s willingness to continue reforms. Given increased emphasis on democracy promotion, the United States, along with various international organizations such as the Council of Europe (COE) and the Organization for Security and Cooperation in Europe (OSCE), made clear that the conduct of the parliamentary elections would be a turning point for Azerbaijan’s relations with the international community.

Azerbaijanis often say how proud they are that their country established the first

Government Investment Guide

secular democracy in the Muslim world, doing so in 1918. Many wanted to reclaim that pride by holding the country’s first free and fair elections since independence.

Both Azerbaijanis and international observers also recognized that a transparent election would encourage support for a peaceful resolution to the Karabakh conflict, and further commit Azerbaijan to reforms that would draw the country closer to European and Euro-Atlantic institutions.

It was in this context that the Azerbaijani parliament approved changes in the electoral law in June 2005. Of course, the true challenge was always one of implementation; accordingly, President Aliyev twice (in May and in October) issued decrees urging local officials to obey the electoral code.

For the first time, exit polls were conducted, and voters’ fingers inked to avoid the problem of doublevoting. President Aliyev also registered both domestic and international observer missions, and ended the two-year-old ban on public rallies—demonstrating his willingness to meet Western standards for the conduct of elections.

The development of Azerbaijan’s vast gas reserves has been vital in reducing the region’s dependence on Moscow.

The Azerbaijani opposition hoped to continue the recent trend of successful postelectoral revolutions in Georgia (November 2003), Ukraine (November 2004), and Kyrgyzstan (March 2005). However, due to the opposition’s inability to offer a realistic and attractive alternative to the Aliyev government, its efforts did not succeed. As Jamestown Foundation senior fellow Vladimir Socor pointed out, the paradox in Azerbaijan is that there is a young and forward-looking president—but an older generation of opposition leaders whose focus is on the past. The opposition leaders are also tremendously unpopular due to their association with the turmoil of 1992-1993. As then-Azerbaijani Ambassador to the U.S. Hafiz Pashayev noted during a meeting I hosted at the Nixon Center, the Azerbaijani people “reject[ed] revolution, preferring evolution.” Echoing Pashayev’s observation, then-American Ambassador to Azerbaijan Reno Harnish stated that the goal of the United States was “to promote a new evolutionary model of political change.”

That said, the November elections were a disappointment due to many instances of fraud, especially during the vote count. However, following a strong international reaction to these allegations, the government decided to annul ten disputed districts, holding new elections there in May 2006. Further indicating a desire to work with the West, the Government fired corrupt officials and conducted recounts on questionable results.

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Since the election, President Ilham Aliyev has dismissed several major officials such as as Farhad Aliyev (no relation), the former Minister of Economic Development; Rafik Aliyev (also no relation), the former head of Azpetrol, Azerbaijan’s largest oil company; and Ali Insanov, the former minister of health. All three were dismissed due to their alleged involvement in a coup plot against President Aliyev. A second round of purges included the parliamentary leadership as well as the ministers of energy, culture, youth and sports and the leaders of regional governments. While President Aliyev may continue with additional purges, there is no risk of major political instability.

As in previous years, corruption, rule of law and legal reform remain key areas of concern for Azerbaijan and its leaders. Transparency International’s 2006 Corruption Perceptions Index placed Azerbaijan 130 out of 163 countries.

Although an improvement of seven over the previous year, the situation must still be improved since Azerbaijan will soon be awash in oil money. Azerbaijan’s GDP grew an estimated 32.5 percent in 2006, further improving on its blistering 2005 growth rate of 26.4 percent. Seeking to avoid the “resource curse,” President Aliyev’s administration has created a State Oil Fund to responsibly manage oil wealth and has made non-oil sector development a top priority—setting a target of 600,000 new jobs. If the investment climate improves, there are serious growth possibilities in the retail, agricultural, (the second-largest contributor to GDP and the largest employer in the country for many years to come), telecommunications and construction sectors, just to name a few.

Azerbaijan is geo-strategically relevant thanks to its rich oil and gas resources. In 2006, after years of effort by the international oil consortium and its Azerbaijani, Georgian, and Turkish partners, the official opening of the Baku-Tbilisi-Ceyhan oil pipeline was celebrated on July 13. The parallel South Caucasus Gas Pipeline (SCP), which transports Azerbaijani (and eventually Central Asian) gas via Georgia to Turkey, was also inaugurated at the end of 2006.

The development of Azerbaijan’s vast gas reserves has been vital in reducing the region’s dependence on Moscow. In late 2006, Gazprom more than doubled its asking price for Russian natural gas deliveries to Azerbaijan and Georgia. Faced with this exorbitant price Baku decided to forgo all Russian gas supplies. At the same time, Georgia was able to arrange for the replacement of around two-thirds of its Russian imports with Azerbaijani gas. Some of this gas will be supplied as part of its original SCP contract quota and some will be purchased from Azerbaijan, which decided to sell its neighbor gas at the deeply discounted price of $120 per 1,000 cubic meters. Georgian President Mikheil Saakashvili called President Aliyev’s effort to help Georgia resist Russian extortion an act of “political heroism.”

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Azerbaijan will also be critically important for European energy security and diversification, especially in natural gas. Gas from its rich Shah Deniz field will reach European markets via Turkey and then Greece and Bulgaria. The Turkey-Greece line is expected to deliver first gas from Azerbaijan in late 2007 or early 2008. An extension of this TurkeyGreece pipeline is scheduled to be built into Italy. A second gas pipeline, Nabucco, will deliver Azerbaijani (and later Central Asian and Middle Eastern) gas from Turkey to Austria, via Bulgaria, Romania, and Hungary. From these projects, it is clear that Azerbaijan will play a prominent role in European energy policy for years to come.

Looking Ahead Overall, the future of Azerbaijan—a secular, democratic Muslim country that is eager to join NATO and the EU—looks promising. There are, of course, issues and concerns that need to be watched closely. These include the rise of political Islam in the region and its possible effects in Azerbaijan; the potential for a U.S. military campaign against Iran, with which Azerbaijan shares a border; and the possibility of clashes with Armenia over Karabakh, a conflict where Baku and Yerevan have yet to reach a final agreement after almost 20 years.

Despite these three issues mentioned, Azerbaijan’s future is promising both economically and politically. As President Aliyev implements key reforms, Azerbaijan has a strong chance of becoming an exemplary oil-rich, secular, democratic country that will provide inspiration to other countries in both the postSoviet sphere and in the Islamic world.

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The Armenia-Azerbaijan Conflict

By Dr. Svante E. Cornell, Research Director of the Central Asia-Caucasus Institute at Johns Hopkins University

The conflict between Armenia and Azerbaijan over Mountainous Karabakh, now in its nineteenth year, remains unresolved, and as such constitutes the greatest impediment to Azerbaijan’s security, prosperity and development. Recurring hopes for a resolution and continuous negotiations have failed to reach a solution.

Background The conflict over this mainly Armenian-populated area in western Azerbaijan, known also by its Russian name Nagorno-Karabakh date back a century.

Historically, no clear settlement pattern divided the southwestern parts of the Caucasus into Armenian and Azerbaijani lands. Whereas the greatest concentration of Armenians in the nineteenth century lived in Baku and Tbilisi, the province of Yerevan was known at one point to have had a Muslim majority. The collapse of Czarist Russia in 1917 and the creation of three nation-states in the Caucasus amid a regional conflagration created major upheavals. Karabakh was claimed by both republics, leading to a short war in 1918-20.

The British occupying forces had granted Karabakh to Azerbaijan, and the Soviet Union followed suit, making the territory an autonomous province within Soviet Azerbaijan. Unlike many other minorities, Karabakh Armenians enjoyed the benefit of holding an autonomous status, but were barred from becoming a part of Armenia. What made Karabakh different and contested, however, was the historical and emotional value that both Armenians and Azerbaijanis gave it. Many Armenians never accepted the Soviet decision, petitioning repeatedly for Karabakh to be transferred to Armenia.

The Karabakh issue re-emerged soon after Gorbachev’s liberalizing reforms in 198687. By 1988, the conflict escalated, with Azerbaijanis rapidly leaving Armenia and vice versa. Guerrilla warfare enveloped Karabakh in 1991, and the collapse of Soviet rule that year propelled the conflict to a full-scale war as the two republics gained independence. Armenia was considerably better prepared, enabling it to gain the upper hand militarily, with substantial help from the Russian military. Azerbaijan, on the other hand, suffered from power struggles in Baku in both 1992 and 1993 that led morale in the army to plummet. Most Armenian victories were gained at times of intra-Azerbaijani power struggles. By early 1994, when a cease-fire was concluded, Azerbaijan had lost Karabakh as well as seven adjoining regions, which had been ethnically cleansed by Armenian forces of their homogenously Azerbaijani population. Over 17 percent of the country’s territory was under Armenian occupation, and Azerbaijan had to harbor almost a million refugees and internally displaced persons from the occupied territories and Armenia proper. This gave Azerbaijan as a country the highest ratio in the world of displaced people per capita.

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Occupied Territories and Refugee/IDP Camps in Azerbaijan

Source: Ministry of Foriegn Affairs of Azerbaijan

Impact on Azerbaijan The conflict over Mountainous Karabakh was a bitter formative experience for the young independent nation. Taking place while the Balkan wars were raging, Karabakh never elicited the level of international attention that the conflict merited, forcing Azerbaijan to deal with the consequences of the conflict largely on its own.

The conflict’s most obvious implication for Azerbaijan has been humanitarian.

Hundreds of thousands of refugees to this day live in refugee camps, incurring a heavy social and economic burden on a state already ravaged by war and the heavy economic recession following the Soviet collapse. Aside from this, the conflict reinforced investor wariness of the Caucasus, slowing Azerbaijan’s economic recovery. Politically, the chaos and deprivation of war strengthened authoritarian forces in Azerbaijan’s polity, who offered the restoration of order and stability.

Diplomatically, the conflict slowed Azerbaijan’s integration into the international community, and consumed energy and resources that could have been used for state-building and economic development. The conflict has also impeded regional cooperation in the South Caucasus, keeping the region divided and hence less secure. But on a less tangible level, the war also affected the Azerbaijani psyche.

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The defeat against a smaller neighbor – though aided from abroad – led to a predominant feeling of frustration and humiliation in society. As efforts to resolve the conflict peacefully faltered, this was gradually compounded by growing revanchism. All in all, the conflict made a lasting mark on the emerging polity and society of independent Azerbaijan.

Negotiations and International Ramifications International negotiations to resolve the conflict have been underway since 1992, under the auspices of the Organization for Security and Cooperation in Europe (OSCE). Co-chaired since 1997 by the U.S., Russia and France, these negotiations have suffered from the often conflicting geopolitical interests of the three mediators.

At times, the negotiations have been practically absent, to be replaced by bouts of renewed interest and energy in conflict resolution.

Last year was long hailed as an opportunity to finally resolve the conflict, the 2006 negotiations aspired to a more realistic objective. They sought a half-page document outlining the main principles of a settlement, with details to be negotiated subsequently. And though the two parties did reach agreement on more issues than ever before, the expected breakthrough did not materialize.

Prospects Though a solution remained elusive, most experts agree on the character of a final settlement: Mountainous Karabakh would be given a form of de facto self-rule that approximates independence, but leaves it within the borders of Azerbaijan – hence satisfying both Armenian demands for self-determination and Azerbaijan’s insistence on its territorial integrity.

Why, then, has the conflict not been resolved? Domestic considerations in both countries are one factor, as painful compromises will have to be made by all parties.

With the nationalistic mood dominating in both Armenia and Azerbaijan, these compromises will inevitably elicit protests and dissent. But equally importantly, the geopolitical ramifications of the conflict continue to be a major impediment. The conflict is the main factor sustaining Russia’s political dominance over Armenia, the pivot of Russian influence in the South Caucasus. Given the increasing assertiveness of Russian foreign policy in the Caucasus and Central Asia, there is little to suggest that Moscow is interested in a solution. While this complicates a solution, it is not insurmountable – but it places additional responsibility on the parties, as well as on Western powers to push for a breakthrough.

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ECONOMY

Economic Reforms: Goals and Outcomes

By Heydar Babayev, Minister of Economic Development Azerbaijan is one of the fastest growing countries in the world in terms of political and economic reforms. Since the restoration of its independence in 1991, Azerbaijan has encountered a number of military, political, socio-economic problems. The well-defined policy of the late President Heydar Aliyev mitigated the severe political and economic crisis in the country in the 1990s and laid a foundation for a marketoriented national economy. Today, Azerbaijan enjoys the positive results of these reforms, which are successfully followed by the socio-economic policy of the current President, Ilham Aliyev.

Stability and Strength Thanks to well-targeted macroeconomic reforms, the national economy has stabilized and GDP growth has increased steadily since 1996. Azerbaijan is now among the fastest-growing countries in the world with expected 2007 GDP growth index above 30 percent.

Projects implemented in the oil and gas sector, especially the completion of the BakuTbilisi-Ceyhan oil pipeline and the Baku-Tbilisi-Erzurum gas pipeline, provide a firm ground for a long-term sustainable growth. This, in turn, has made the diversification of energy routes a priority for the economic security of the country.

The reforms and new oil revenues have increased Azerbaijan’s currency reserves, leading to the creation of the State Oil Fund of the Republic of Azerbaijan (SOFAZ) in 2000. In addition, the State Investment Company, with $100 million in charter capital, was established by a Presidential Decree. Funded by SOFAZ, the State Investment Company is a key agency that invests oil and gas proceeds into development of the non-oil sector of the country.

Many large-scale infrastructural projects in Azerbaijan that are currently financed from the state budget testify to the growing financial strength of the country.

Moreover, Azerbaijan has the best record among the CIS countries with the lowest amount of external credits and loans. The external debt of the country stood at $2.5 billion in 2006 – a number that is likely to decrease as the country grows stronger economically. Many large-scale infrastructural projects in Azerbaijan that are currently financed from the state budget testify to the growing financial strength of the country.

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Business Environment and Improving Living Standards As a result of privatization, land reforms and other steps taken to boost private ownership, the share of the private sector in the GDP has reached 81 percent. Such success attained in such a short period is a result of continuous, systematic measures taken to develop entrepreneurship, which constitutes the backbone of reforms in the country.

A progressive legislative base, as well as institutional and economic mechanisms have ensured the successful regulation of entrepreneurial activities in the country.

There are well-defined, sustainable and comprehensive arrangements in place to monitor and support the growth of entrepreneurship. There are also a number of term-specific state programs that aim to improve business environment in the country and support small- and medium-size businesses.

Entrepreneurial regulations have been liberalized to a great extend and the Government has developed the means to offer financial assistance to entrepreneurs.

In addition, export duties have been waived, the maximum rate for import duties has been set at 15 percent, practical mechanisms for securing entrepreneurs’ rights have been established, and the state registration process for entrepreneurial businesses has been simplified.

Poverty reduction remains a main goal of the Government. There are a number of current state programs that deal with poverty reduction and regional development.

These programs improve living standards and generate the balanced growth of the economy. These programs also strengthen the private sector by stimulating growth.

These actions have led to remarkable results: since 2003, more than 520,000 jobs have been created and the poverty rate has declined from 49 percent to 20 percent.

Foreign Investment In recent years, several significant measures have been taken to protect the interest of investors, including ensuring property immunity, creating equal opportunities for local and foreign investors. All potential bottlenecks facing businesses, such as currency conversion, international transfer or re-investment of profit, have been removed and a single exchange rate corresponding to the market economy has been established.

Presidential decrees on the creation of new facilities as well as on the privatization of existing facilities, have boosted foreign investment flow into the country. This has created or reinvigorated factories in such sectors as metallurgy, chemistry, utilities, machinery, transportation and communication.

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To increase the volume of foreign investment, the Azerbaijani government has expanded cooperation with international financial institutions. The Government has signed agreements on the promotion and mutual protection of investments with several countries, including the United States, Turkey, China, Finland, Switzerland, Germany, France, Italy, the United Kingdom, Austria, Belgium, Greece, Poland, Latvia, Bulgaria, Rumania, Iran, Lebanon, Egypt, Pakistan, Saudi Arabia, Georgia, Moldova, Ukraine, Kazakhstan and Kyrgyzstan.

Countries like Turkey, the United States, France, the United Kingdom, China, Iran, Switzerland, and the Netherlands represent the major share of investors in Azerbaijan’s privatized sector. More than $37 billion has been invested in the economy since 1992, of which $25 billion are foreign investments. Azerbaijan is among the leading countries in per capita volume of foreign direct investment in both the Commonwealth of Independent States and Eastern Europe.

International Ratings and Global Integration The improvement of business conditions and the country’s investment climate is reflected in international reports. According to the “Global Competitiveness Report 2006” by the World Economic Forum, Azerbaijan is rated 64th among 125 countries. Reports by The Heritage Foundation and The Wall Street Journal covering 161 countries state that the Index of Economic Freedom in Azerbaijan has been gradually improving, as indicated by a decline in the index from 4.78 in 1996 to 3.51 in 2006. Moreover, the Inward FDI Performance Index by UNCTAD lists Azerbaijan first among 141 economies.

Integration into the global economy is a major priority of the Azerbaijani government, a goal that is reflected in the steady growth in cooperation with international financial institutions and international organizations. Azerbaijan enjoys strong relations with such international organizations as the United Nations, the World Trade Organization, the European Union, the Commonwealth of Independent States, the GUAM Organization for Democracy and Economic Development, the Economic Cooperation Organization, and the Black Sea Economic Cooperation Organization. In addition, Azerbaijan is cooperating closely with the World Bank, the International Monetary Fund, the European Bank for

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Economy Investment Guide

Reconstruction and Development, the Asian Development Bank, the Islamic Development Bank, Kreditanstalt für Wiederaufbau, and the International Finance Corporation (IFC).

Azerbaijan has trade relations with more than 135 countries and the Government is negotiating the country’s membership in the World Trade Organization. Azerbaijan is also an active participant of the EU-sponsored Transport Corridor EuropeCaucasus-Asia, also known as the TRACECA project. The Azerbaijani government views the restoration of the historic Silk Road as an important component of regional economic cooperation and vital trade linking Europe and Asia.

Future Goals With a firm base in economic achievements, Azerbaijan has tremendous potential for continued growth. Sustainable development would be impossible without a competitive and well-developed non-oil sector, the achievement of which is the main goal of ongoing state programs. Hence, one of the priorities of the strategy for economic growth determined by the President is to ensure the high-quality production of competitive goods and products. This is done by improving the business climate throughout the country, providing additional incentives for foreign investment and incorporating modern technology, equipment and management practices in the development of the economy.

Our over-arching goal is to increase the competitiveness of the national economy and to ensure the sustainability of socio-economic growth, which will help integrate Azerbaijan further into today’s global economy. The Government has given special consideration to the growth of the non-oil sector and the new law “On Investment Activities” is expected to be adopted by the National Parliament soon. This law, developed in cooperation with World Bank experts, provides strong state guarantees for foreign investment and envisages additional incentives for foreign investors.

Another important development will be the establishment of Special Economic Zones. There is already an ongoing project to create an industrial center in the country. In addition, in upcoming years, the main priorities will include further improving the securities market, better protecting intellectual property, strengthening corporate responsibility and governance, ensuring the country’s access to international financial and securities markets, and stimulating an innovative economy.

As is evident, Azerbaijan has taken bold moves to improve and integrate its economy to develop its own industries and improve the lives of its people, as well as to welcome and work closely with foreign interests who have invested in the country. Such goals are and will continue to be the bedrock of economic improvement and stability in Azerbaijan.

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Credit Rationale

Excerpted from Fitch Ratings, February 2007

Azerbaijan’s credit rating is underpinned by strong and sustained economic growth driven by rising hydrocarbons production, low government and external debt ratios, and a growing current account surplus. Furthermore, the country’s projected oil and gas production profile over the medium term supports Fitch’s central scenario, which assumes that these rating strengths will be maintained.

The completion of key energy export pipelines in 2005-2006 was a significant milestone in Azerbaijan’s economic development. With the Baku-Tbilisi-Ceyhan (BTC) pipeline beginning deliveries in mid-2006, the necessary infrastructure is in place for Azerbaijan to become a major oil exporter. Fitch estimates that production from the flagship Azeri-Chirag-Guneshli (ACG) field rose to almost 450,000 barrels per day (bpd) in 2006 and it expects the field’s output to continue increasing rapidly until 2009-2010. Net oil exports were around 470,000bpd in 2006 and are still projected to rise to over 1 million bpd by 2010. In late 2006, the requisite infrastructure for gas exports was also put in place with the completion of the South Caucasus Pipeline. Azerbaijan has now started exporting gas from its Shah Deniz field, which has estimated reserves of around 420 billion cubic metres (bcm), making it one of the world’s largest gas discoveries in the last two decades.

With the completion of these projects, annual average GDP growth, in double digits since 2003, accelerated to almost 35% in 2006. Furthermore, the current account ended 2006 with a 14% of GDP surplus as the finalisation of pipeline construction reduced imports of goods and services, and oil production rose in an environment of high oil prices. Official reserves are rising steadily and although income debits are climbing as foreign firms repatriate profits, Fitch expects the National Bank of Azerbaijan (NBA) to have accumulated reserves of USD2.4bn at end-2006, compared with USD1.2bn in 2005.

The government’s share of profits from current oil and gas projects as well as transit and acreage fees accrue to the State Oil Fund of Azerbaijan (SOFAZ), which had accumulated assets of USD1.45bn in January 2007 (equivalent to around 6% of GDP). Fitch forecasts SOFAZ could accumulate assets of around USD2.6bn by 2008, and the authorities estimate that total assets could rise to USD150bn in 20 years. Azerbaijan’s external liquidity ratios are strong: in 2007, Fitch expects the ratio of official reserves plus banks’ foreign assets over debt service and current external liabilities to be 297% – well above the ‘BB’ range median of 175%. If SOFAZ’s assets are included in the ratio, it rises to 427%.

Azerbaijan’s low government debt levels are a rating strength. Government debt was just 11% of GDP in 2006, compared with a ‘BB’ range median of 42%, and was the lowest government debt/GDP ratio among all the ‘BB’ range sovereigns. Debt/ revenue ratios were also favourable, at 40%, compared with a ‘BB’ range median of 162% in 2006. The structure of Azerbaijan’s government debt is positive as well: although the bulk of debt is to external creditors, it was granted by multilateral

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Economy Investment Guide

institutions on concessional terms and has long maturities. Azerbaijan plans to issue a debut eurobond of around USD300m in 2007 to raise the country’s profile and provide a benchmark for other entities. The government was a net external creditor to the tune of 9% of GDP in 2006 – the second largest in the ‘BB’ range.

Azerbaijan’s external debt stock is the second smallest in the ‘BB’ range at just 20% of GDP at end-2006. Fitch estimates that Azerbaijan became a small net external creditor (to the tune of 0.5% of GDP) in 2006. Bank external borrowing is very low but almost entirely short term. The country’s state budget deficits averaged under 0.5% of GDP from 2000-2005 and Fitch expects the general government consolidated budget to remain in surplus in the medium term.

Macroeconomic Indicators of Sovereign Creditworthiness 2006 (% GDP)

Azerbaijan BB median Peru (BB+) Russia (BBB+)

Consolidated budget balance

Kazakhstan BBB (BBB) median

0.8

-2.8

0.6

7.9

6.4

-1.9

C u r r e n t a c c o u n t b a la n c e

1 4 .0

-1 .8

1 .1

9 .9

1 .1

-1 .8

Government debt

11.1

41.8

33.3

10.2

6.2

33.7

N e t p u b lic e x te r n a l d e b t

-8 .6

3 .6

8 .5

-2 4 .7

-3 6 .3

-8 .8

NXD (% of CXR)

-0.7

39.4

39.4

-11.5

42.2

24.2

F o r e ig n r e s e r v e s

1 2 .1

1 6 .7

1 6 .7

3 1 .5

1 9 .6

1 9 .6

6.3

n.a.

n.a.

8.9

18.5

n.a.

2,373.0

2,616.0

3,072.0

6,750.0

4,843.0

5,007.0

297.0

175.0

227.0

355.0

83.0

140.0

17.5

5.2

5.5

6.5

9.5

5.1

Oil fund GDP pc at market exchange rates (USD) Liquidity ratio (2007) Real GDP growth (5 year average, %)

Source: Fitch Ratings

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The Oil Fund SOFAZ was established in 1999 to ensure that current oil wealth would be shared with future generations.

The fund receives the government’s share of profits from current oil and gas PSAs together with flows from transit and acreage fees paid by AIOC. In contrast, income tax payments by the oil industry accrue directly to the state budget. From January 2006, SOFAZ has also been receiving 50% of the taxes paid by SOCAR on its excess profits if oil prices exceed USD40 pb and 75% if they exceed USD50 pb.

SOFAZ is managed by a supervisory board headed by the prime minister. Following the board’s review, SOFAZ’s annual budget is submitted to the president before being approved by parliament along with the state budget. Budget amendments must be agreed by the president and approved by parliament. SOFAZ’s annual budget has been amended once since its creation, to finance cost overruns on the construction of the BTC pipeline in 2005. Asset management at SOFAZ is very conservative, with four-fifths of assets invested in fixed-income securities (only investment grade). In 2006 guidelines were relaxed to allow a small part of the fund’s assets to be invested in equities.

SOFAZ’s total assets have risen steadily since its creation, except in 2006 when it recorded a deficit.

At end-2006, the fund held USD1.26bn, equivalent to around 6% of GDP. Flows to the fund will increase substantially as oil production peaks, while SOFAZ officials expect that transfers to the state budget will continue to decline in GDP terms as the corporate tax revenues accruing to the government reduce the need for extra funds. Fitch forecasts total assets of around USD2.6bn in 2008 and the authorities estimate that total assets could rise to USD150bn in 20 years (assuming an average oil price of USD50 pb).

Ratings

Peer Group

Foreign Currency Long-Term IDR* .................................BB+ Short-Term IDR*.......................................B Outlook.............................................Stable

Local Currency

Croatia

India

Namibia

BB+

Azerbaijan

Egypt

El Salvador

Long-Term IDR* .................................BB+

Guatemala

Outlook.............................................Stable

Macedonia

Panama

Peru

BB

Brazil

Colombia

Costa Rica

Philippines

Country Ceiling...................................BB+

* IDR – Issuer Default Rating

Rating History

42

BBB-

Date

LTFC

LTLC

5 Feb 2007

BB+

BB+

22 Nov 2004

BB

BB

20 Jul 2001

BB-

BB-

3 Jul 2000

B+

BB-

Source: Fitch Ratings

Economy Investment Guide

Net External Debt

Current Account Balance

% of CXR

% of GDP

80.0

30.0

70.0

20.0

60.0 50.0

10.0

40.0

0.0

30.0

-10.0

20.0

International Liquidity Ratio, 2006

GDP per capita Income, 2005

%

At market exchange rates, USA=100 Egypt (BB+)

Panama (BB+)

Macedonia (BB+)

Macedonia (BB+)

Azerbaijan (BB)

Peru (BB+)

Peru (BB+)

Median

Philippines (BB)

Azerbaijan (BB)

Median

Egypt (BB+)

Panama (BB+)

Philippines (BB)

0.0

Azerbaijan

100.0

200.0

300.0

400.0

0.0

5.0

10.0

2007 2007

2006 2006

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

0.0

2005

10.0

2004

20.0

2003

30.0

2002

40.0

2001

50.0

2000

4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 1999

60.0

1998

% of GDP

1997

General Government Balance

% of GDP

1996

General Government Debt

2005

2004

2003

2002

2001

2000

1999

1998

1996

2007

2006

2005

2004

2003

2002

2001

2000

1999

-40.0

1998

-10.0

1997

-30.0

1996

0.0

1997

-20.0

10.0

15.0

Source: Fitch Ratings

BB Median

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Economic Outlook

Excerpted from the Economist Intelligence Unit (EIU)

Policy Trends The government’s principal policy challenge will be to maintain macroeconomic stability during a period of rapid economic growth. However, it will struggle to contain the inflationary pressures exerted by a combination of growing budget expenditures on welfare and infrastructure projects, and a large increase in foreigncurrency inflows from oil exports. The issuance of domestic debt will increase as a way of mopping up excess liquidity linked to foreign-currency inflows, and once the government has secured an investment-grade credit rating, it intends to tap the international capital markets by issuing its first Eurobond, probably in the second half of 2007. Greater reliance on hydrocarbon resources will adversely affect the structure of Azerbaijan’s economy. Together with increasing concerns about the business environment and the poor legal framework, the growing dependence on hydrocarbons will continue to marginalize non-oil sectors.

Fiscal Policy The government is targeting a deficit on the state budget—which is the largest component of the consolidated budget reported in our tables—equivalent to 1.7% of GDP in 2007, compared with an outturn of a small surplus of 0.6% of GDP in 2006. High oil prices and increasing oil export volumes will permit strong growth in both revenue—which is expected to rise by around 40% year on year, to $6.2 billion –and expenditure, which is likely to increase by close to 50% to $6.7 billion.

Although the government is devoting more expenditure to capital projects—for example, the rehabilitation of infrastructure—it will continue to allocate a large share of spending to current outlays, including a cumulative 50% increase in the monthly minimum wage to $70 by July 1, 2007. As in 2006, the increase in government spending is premised both on an anticipated rise in budget revenue (mainly from oil receipts) and on the use of resources from the State Oil Fund of the Republic of Azerbaijan (SOFAZ), an overseas windfall fund, into which all oil revenue over a price threshold stipulated in the budget is channeled.

The 2007 budget is premised on an oil price of $50 per barrel. This is a less conservative assumption than for 2006, when the price threshold was $40 a barrel, compared with the average price of dated Brent Blend crude oil of $65 a barrel.

However, as oil prices are still expected to average around $63 a barrel in 2007, the government is likely to meet comfortably its state budget target for the year.

Should it prove necessary, the government intends to finance any deficit through a combination of privatization revenue and bonds.

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Economy Investment Guide

Electoral considerations will influence the state budget for 2008, when the government is expected to implement another large rise in the minimum wage, increases in public-sector salaries and further spending on infrastructure projects.

Higher than budgeted oil prices should again enable the government to meet its budget targets.

The data in the tables refers to the consolidated budget, excluding SOFAZ. Based on the government’s expenditure projections, this budget is likely to revert to deficit as of 2007, having recorded a surplus estimated at 1.3% of GDP in 2006. Most of the deficit will be covered by funding from SOFAZ, demonstrating the authorities’ growing dependence on the oil sector for revenue—and, in turn, the vulnerability of the fiscal position to external shocks.

Monetary Policy The authorities will face conflicting pressures in their conduct of monetary policy, given the limited tools at their disposal. Large inflows of oil export revenue are causing consumer price inflation to accelerate rapidly. In theory, this should necessitate a tighter monetary policy. However, any such monetary tightening would choke off liquidity in the non-oil economy and result in further real appreciation of the local currency, the manat. In an attempt to dampen inflation, the National Bank of Azerbaijan (NBA, the national bank) raised the refinancing rate from 9.5% to 12% in April 2007. This is still negative in real terms (the yearon-year rate of inflation was 16.4% in March) but the authorities will be reluctant to raise the cost of money too much further for fear of attracting speculative foreign-currency inflows and thereby accelerating the pace of real currency appreciation. The NBA will sterilize as much of the foreign-currency inflows as it can through the sale of Treasury bills and NBA bills, and some foreign currency will be kept in SOFAZ as a sterilization measure.

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International assumptions summary (% unless otherwise indicated) Real GDP growth

2005 2006 2007 2008

World

4.7

5.3

4.7

4.6

EU27

1.7

3.0

2.5

2.3

Euro area

1.4

2.8

2.3

2.2

Turkey

7.4

6.1

5.0

5.5

110.1

116.2

115.9

104.5

Exchange rates ¥:US$ US$:€

1.246

1.256

1.360

1.383

SDR:US$

0.677

0.680

0.651

0.640

€ 3-month interbank rate

2.18

3.08

4.10

4.30

US$ 3-month commercial paper rate

3.38

5.03

5.07

4.95

Oil (Brent; US$/b)

54.7

65.3

63.3

60.3

Gold (US$/troy oz)

445.0

604.5

652.5

642.5

Financial indicators

Commodity prices

Food, feedstuffs & beverages (% change in US$ terms)

-0.5

16.1

10.2

0.2

Industrial raw materials (% change in US$ terms)

10.2

49.9

6.3

-14.2

Source: Economist Intelligence Unit 2007

Azerbaijan’s growth prospects are closely linked to oil prices: in 2006 the oil sector provided an estimated 93% of total export earnings (on a balance-of-payments basis), more than 50% of GDP and around 55% of budget revenue. Strong oil demand from rapidly growing countries in Asia, a slowdown in the growth of supplies from Russia and other non-OPEC producers, and a geopolitical risk premium pushed the cost of Brent crude upwards in 2006 to an average price of $65 a barrel. Prices have dropped quite sharply since then, owing to the mild northern-hemisphere winter and an increase in oil stocks. However, a combination of geopolitical factors—including rising tension in the Middle East—and delays in completing new production facilities elsewhere will push oil prices upwards again in the second half of 2007, when the expected average price will reach around $61 a barrel. In 2008, an increase in crude oil output in Africa and some non-OPEC countries is likely to result in a slight fall in oil prices, with Brent expected to average about $63 a barrel.

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Economy Investment Guide

Economic Growth Surging oil output and export volumes are supporting Azerbaijan’s economic growth. Crude oil is being exported from the Azeri-Chirag-Guneshli (ACG) offshore oilfields to Western markets through the BTC pipeline, which links Azerbaijan with the Mediterranean Sea. Output will increase steadily over the forecast period, reaching one million barrels a day in 2008. Exports from the Shah Deniz gasfield will provide a further boost to growth from the second quarter of 2007—later than anticipated, owing to delays in bringing the field on stream, in addition to technical problems. Development of the hydrocarbons industry will continue to spill over into sectors such as telecommunications, transport and construction, and the rehabilitation of infrastructure —much of it financed by oil receipts — will also drive growth. These factors will ensure that the economy continues to expand rapidly, although base-period effects will result in a steady deceleration in real GDP growth from almost 35% in 2006 to around 20% in 2007, and to 15% in 2008.

Inflation Rapid growth in budget expenditure, continued strong foreign-exchange inflows associated with the oil and gas sector, and higher fuel prices will be the main factors fueling consumer price inflation over the forecast period. Robust private consumption, reflecting sharply rising wages in the oil and oil-related sectors, will also exert inflationary pressure. In response, the authorities will tighten monetary policy slightly and allow the manat to appreciate. However, this will be insufficient to counter the inflationary effects of the rapidly expanding money supply. Annual average inflation is expected to accelerate to around 16% in 2007—the highest rate since 1996— before easing to around 10% in 2008 as growth in the money supply slows.

Exchange Rates Foreign-currency inflows from oil exports will strengthen the manat in both nominal and real effective terms in 2007 and 2008. The NBA will attempt to sterilize foreign-currency inflows through the sale of T-bills and the use of Azerbaijan’s overseas oil fund, SOFAZ. However, the amount of short-term paper involved will be small. Azerbaijan’s rate of inflation will remain high compared with those of its trading partners. This will help to produce a real effective appreciation of around 20% between now and the end of 2008.

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Annual indicators

2002a

2003a

2004a

GDP at market prices (Manat bn) 6.1 7.1 8.5 GDP (US$ bn) 6.2 7.3 8.7 Real GDP growth (%) 10.6 11.2 10.2 Consumer price inflation (av; %) 2.8 2.1 6.7 Population (m) 8.2 8.3 8.3 Exports of goods fob (US$ m) 2,304.9 2,624.6 3,743.0 Imports of goods fob (US$ m) 1,823.3 2,723.1 3,581.7 Current-account balance (US$ m) -768.4 -2,020.9 -2,589.2 Foreign-exchange reserves excl gold (US$ m) 720.5 802.8 1,075.1 Total external debt (US$ bn) 1.5 1.7 2.0 Debt-service ratio, paid (%) 6.3 7.0 5.9 Exchange rate (av) Manat:US$ 0.97 0.98 0.98 a Actual. b Economist Intelligence Unit estimates.

2005a

2006a

12.5 17.7 13.2 19.9 26.4 34.5 9.6 8.3 8.4 8.5 7,649.0 13,014.6 4,349.9 5,269.3 167.4 3,704.9 1,177.7 2,500.4 1.9 2.0b 3.1 2.2b 0.95 0.89

Source: Economist Intelligence Unit 2007

External Sector A near-fourfold rise in oil export volumes between 2005 and 2008, in conjunction with high global oil prices, will ensure that the current account runs a large surplus throughout the forecast period. Moreover, growth in spending on imports of capital goods will slow, as the initial phase of hydrocarbons investment nears completion.

However, an appreciating currency and rising wages will boost expenditure on imported consumer goods. Services debits for the oil and gas sector, on activities such as consultancy and geological services, will remain high, and the increased payment of dividends by foreign investors in the hydrocarbons sector will swell the income deficit.

Nevertheless, the large trade surplus will still dwarf the invisibles deficit.

Forecast summary (% unless otherwise indicated) Real GDP growth Industrial production growth Gross fixed investment growth Unemployment rate (av) Consumer price inflation (av) Consumer price inflation (year-end) Short-term interbank rate Consolidated government balance (% of GDP)d Exports of goods fob (US$ bn) Imports of goods fob (US$ bn) Current-account balance (US$ bn) Current-account balance (% of GDP) External debt (year-end; US$ bn) Exchange rate Manat:US$ (av) Exchange rate Manat:Rb (av) Exchange rate Manat:YTL (av)

2005a

2006a

2007b

2008b

26.4 40.0 11.1c 1.1 9.6 5.3 17.0 0.6c 7.6 4.3 0.2 1.3 1.9 0.95 0.03 0.7

34.5 36.6 12.3c 1.0c 8.3 11.4 17.9 1.3c 13.0 5.3 3.7 18.7 2.0c 0.89 0.03 0.63

20.0 30.0 12.0 1.0 16.0 15.2 19.0 -1.2 18.2 6.4 6.5 22.6 2.2 0.86 0.03 0.60

15.0 11.0 10.0 1.0 10.1 9.3 17.5 -1.5 22.6 7.3 9.1 23.9 2.6 0.82 0.03 0.54

a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit. d Includes statistical discrepancy.

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Source: Economist Intelligence Unit 2007

Economy Investment Guide

Taxation in Azerbaijan

By Arzu Hajiyeva, Tax Services Manager, Ernst & Young

Whatever brings you to work in Azerbaijan, it is vitally important to understand and adhere to any applicable tax laws. As in any country, understanding the various laws can be difficult.

What follows are brief explanations of various aspects of the tax laws since the Parliamentary approval of new amendments to the code that came into effect on Jan. 1, 2007.

This article contains information in three sections: the Statutory Tax Regime, the Oil and Gas Tax Regime, and the Host Government Agreements Tax Regime.

Statutory Tax Regime Statutory taxation applies to all persons who do not operate under one of Azerbaijan’s Production Sharing Agreements (“PSAs”) or conduct activities under the Host Government Agreements (“HGA”) governing the main export pipeline. It applies regardless of an entity’s form of legal organization. Foreign legal entities operating in Azerbaijan must register to do business in Azerbaijan and can establish either a branch office or a representative office.

The following sections provide specific guidance on various aspects of Azerbaijan’s newly introduced tax code.

Profit Tax Legal entities operating as registered taxpayers in Azerbaijan are subject to profit tax at a rate of 22% on their profits. As resident taxpayers, Azeri legal entities (“ALEs”) are subject to tax on their worldwide income, while foreign legal entities are subject to tax only on their income from sources in Azerbaijan. Capital gains are included in taxable income and taxed at the standard profit tax rates. Most expenses connected with the generation of income in a commercial activity are deductible.

Income Tax at Source Income from a source in Azerbaijan to a non-resident person who is not a registered taxpayer in Azerbaijan is subject to income tax that the payer should withhold at the source of payment.

Some of the types of income from a source in Azerbaijan are included below: 

Income from employment in Azerbaijan;



Income from rendering services in Azerbaijan;



Income from commercial activity attributable to a permanent establishment in Azerbaijan;



Income from management, financial or insurance services if paid by a resident company or a permanent establishment of Azerbaijan.

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The rates of tax on various types of Azeri-source income are the following: 

Dividends - 10%



Interest - 10%



Lease payments - 14%



Royalties - 14%



Insurance premiums - 4%



Income from international transport and telecom - 6%



Other income - 10%

Personal Income Tax Individuals are subject to tax at graduated rates that reach a maximum rate of 35%. Tax-resident individuals are subject to tax on their worldwide income, while non-residents are subject to tax only on their income from sources in Azerbaijan.

An individual is treated as a tax resident of Azerbaijan if present in Azerbaijan more than 182 days or more in a calendar year. Most items of compensation received in exchange for employment services constitute taxable employment income. However, food and housing benefits provided by an employer to its employee are not taxable to the employee (and only specific limits for meal expenses are deductible by the employer).

Social Contributions Both citizens of Azerbaijan and expatriate individuals working in Azerbaijan are subject to social contributions. Employers must make contributions to the Social Protection Fund at a rate of 22% of gross payroll to citizen. Employers must also withhold 3% of an employee’s gross salary and remit this as an additional contribution to the Social Protection Fund.

Value Added Tax Generally, VAT at a rate of 18% applies to all payments made for supply and import of goods, works or services that are provided in the territory of Azerbaijan, except for certain exempt supplies and activities. The application of VAT will depend on whether or not the place of performance of works and services is considered to be in Azerbaijan and whether a taxpayer is required to register for VAT purposes. VAT is charged by persons registered for VAT purposes. Registration is required for the persons conducting commercial activity and whose volume of taxable activities during the previous three months exceeds approximately $26,000. Any other person may also voluntarily register as a VAT payer.

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Economy Investment Guide

If a non-resident who is not a registered VAT payer is deemed to render services in Azerbaijan, any taxpayer making payment to the non-resident must self-charge and remit VAT in connection with the payment at the standard rate.

Excise Tax Various types of goods produced in or imported into Azerbaijan are subject to excise tax, which is then included in the sales price of the goods. Excise goods are tobacco products, petroleum products, and alcohol and spirits. Effective Jan. 1, 2007, imported vehicles are also subject to excise taxes that are applied depending on engine capacity. Other excise tax rates vary from 0.08% to 12.5%.

Customs Duties Customs duties apply to most goods imported into Azerbaijan and depend on the type of item imported. Some rates are measured as a percentage of the declared customs value of the goods (from 0% to 15%), while others are assessed as a fixed amount per specified volume or quantity of the goods.

In addition to customs duties, the State customs authorities also levy a customs processing fee on both imports and exports. This fee is based on the type of good or the purpose for which a good is imported and applies from 0.15% to 0.3%.

Property Tax Companies owning fixed assets in Azerbaijan are subject to property tax on those assets. The property tax rate is 1%. The property tax base is an arithmetic average of the annual residual value of fixed assets at the start and end of the accounting period.

Land Tax Persons owning or using land in Azerbaijan are subject to a tax on land use. The tax applies irrespective of the financial results of the economic activity of the owners or users of the land. Land tax rates take into account the size, geographical location and use of the land.

Road Tax Persons owning motor vehicles in Azerbaijan and non-residents who bring vehicles into Azerbaijan for passenger and cargo transport within the country are subject to a road tax. The tax rates depend on the type of vehicles and cargo capacity of the vehicle, total weight of the vehicle and cargo, degree of danger involved in cargo, number of seats, and distance to be traveled within Azerbaijan.

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Mining Tax Persons extracting commercial minerals in Azerbaijan are subject to a mining tax.

The following are the mining tax rates for select mineral resources: 

Crude oil - 26%



Natural gas - 20%



Metals - 3%

Simplified Tax System Entities and individuals with revenues below a certain threshold (aggregate revenues not exceeding an amount equal to approximately US$26,000 during any period of three consecutive months) are not required to register as VAT payers and are permitted to report their taxes under a simplified tax system. The following persons cannot be payers of this tax: 

Persons engaged in production of excise goods;



Credit and insurance organizations, investment funds and professional participants in security markets;



Private pension funds;



Persons receiving rent and royalty income;



Those persons who own property with a value of more than approximately $1,150,000.

Enterprises that qualify for taxation under this system are subject to only a single unified tax that takes the place of profit tax, property tax, land tax and VAT. The tax is assessed as 4% of gross revenues and 2% in other regions of the country.

As of Jan. 1, 2007, a special mechanism for simplified tax has been introduced for businesses engaged in the construction of apartment buildings. Unlike general simplified taxpayers, these businesses are also required to pay VAT.

Branch Profit Tax A tax on net profits of permanent establishments of foreign legal entities is implemented at the rate of 10%. The tax applies only to actual remittances of profit.

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Oil and Gas Tax Regime As mentioned above, companies operating under a PSA are subject to a special tax regime in Azerbaijan. Each PSA contains a tax section that outlines the general regime for that particular agreement, but all PSA tax regimes are relatively similar.

PSAs and the associated tax protocols that supplement them typically provide a specific treatment for five types of tax: profit tax on the contractor parties to the PSA, taxation of foreign subcontractors, VAT, import tariffs, and personal taxation of expatriates working under the PSA. The following sections provide a discussion of each tax.

Profit Taxation of Contractor Parties The profit tax rate applicable to contractor parties is fixed in the PSA and is based on the prevailing statutory rate in effect on the date of signature of the contract.

Typically, PSAs provide protection against future increases in the effective profit tax rate.

Taxable income is calculated in accordance with internationally accepted accounting practices in the petroleum industry rather than in accordance with Azeri statutory accounting procedures. Losses incurred by contractor parties during the period of preliminary exploration are deductible once production starts.

Activities that are not connected with hydrocarbon activities in relevant contract areas in Azerbaijan are deemed to be outside the scope of a PSA and the corresponding tax regime. If a company engages in both PSA-related activities and unrelated activities, separate books of account in accordance with statutory rules must be maintained to reflect income and expenses generated in connection with the activities that are not related to a PSA.

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Operating companies that administrate a PSA are not taxable and allocate all income and expenses to the contractor parties in proportion to their participating interests in the PSA.

Taxation of Subcontractors A foreign subcontractor (defined as a subcontractor incorporated, legally created or organized outside of Azerbaijan) that operates under a PSA in Azerbaijan is generally subject to a tax regime that is much simpler than the statutory tax regime.

Under this simplified tax regime, foreign subcontractors are in most cases subject to income tax withheld at the source of payment, and this tax at source satisfies in full their profit tax obligations in Azerbaijan. Accounting requirements are simplified, because the need to track revenues and expenses is greatly curtailed. The rate of tax to be withheld ranges from 5% to 8%, depending on the applicable PSA. Likewise, a foreign subcontractor must withhold tax on any payments it makes to its own lower-tier foreign subcontractors.

A few PSAs stipulate that foreign subcontractors working under a contract, the duration of which is more than six months during the production and development stage of the PSA, are subject to domestic taxation.

ALE subcontractors operating under a PSA cannot benefit from this simplified tax regime. ALEs are subject only to domestic tax law. No taxes are withheld at the source of payment to an ALE. Rather, corporate profit tax at the standard rate of 22% applies to an ALE’s net profits. In addition, tax must be withheld on any profit remittances from the ALE to a foreign investor.

Value Added Tax Hydrocarbon activities conducted under PSAs are exempt from VAT. The mechanism for achieving this is a VAT exemption certificate to be obtained from the tax authorities. Contractor parties and foreign subcontractors issue these certificates to their suppliers to absolve them of the liability for charging VAT on their supply.

Import Tariffs Imports of goods and services for use in PSA hydrocarbon activities are also exempt from import VAT and customs duties. Similar to the VAT exemption, this exemption from import tariffs is achieved through the use of exemption certificates to be obtained from the customs authorities. This certificate is then presented to the customs authorities at the time of each import.

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Employee Taxes A PSA typically stipulates that foreign employees who are tax residents are subject to Azerbaijan personal income tax on their income earned as a direct result of their employment in Azerbaijan. Under a PSA, the term “tax resident” is defined as: 1. an individual who is present in Azerbaijan for any period exceeding 30 consecutive days. Such an individual is subject to Azerbaijan personal income tax only on income earned as a direct result of employment in Azerbaijan and only on income earned after the 30th day in Azerbaijan; 2. an individual whose presence in Azerbaijan does not exceed 30 consecutive days in any calendar year but whose presence in Azerbaijan does cumulatively exceed 90 days in such calendar year. Such an individual is subject to Azerbaijan personal income tax only on income earned as a direct result of his employment in Azerbaijan and only after the 90th day in Azerbaijan; 3. in the case of rotating employees, an individual whose presence in Azerbaijan exceeds 90 cumulative days in a calendar year. Such an individual is subject to income tax on income earned as a direct result of employment in Azerbaijan, including income earned during the first 90 days of employment in Azerbaijan before tax residency is established.

Foreign employees working under a PSA are not subject to social taxes.

Other Taxes PSAs specify that no taxes other than those outlined in the PSA apply to hydrocarbon activities conducted under the PSA. Thus, contractor parties and foreign subcontractors working under a PSA should face no other tax burden or tax compliance costs. In contrast, ALEs are potentially subject to all taxes that exist under domestic legislation and must comply with the reporting obligations for a number of taxes.

Host Government Agreements Tax Regime Azerbaijan currently has two HGAs: Baku - Tbilisi - Ceyhan (“BTC”) for the main export pipeline for the transportation of oil and South Caucasus Pipeline (“SCP”) for the transportation of gas. Azerbaijan’s HGAs stipulate that BTC and SCP participants (i.e. contractor parties) are subject only to the taxes outlined in the HGAs, which are profit tax, VAT and employee taxes. No other taxes should apply.

The following sections provide a discussion of the taxes applicable under the HGA.

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Profit Tax The tax rate is 27%. Taxable losses can be carried forward indefinitely for offset against future profits. Income and deductions are recognized according to the cash method of accounting.

Profit is defined as income less deductions, where income includes both tariff income and other income. Tariff Income is cash received from tariffs for transport though the pipeline. Other income consists of other cash received by HGA participants.

Deductions include all costs incurred during the year in connection with the project, within or outside of Azerbaijan.

No tax applies to any subcontractor, to any payment to any entity established outside of Azerbaijan or to any individual who is not an employee of the payer. In addition, no tax applies to any payment made by an HGA participant, operating company or affiliate in reimbursement of costs incurred on behalf of the payer.

Further, no income tax at the source of payment is required on payments of interest, dividends, royalties, service fees or other profit remittances.

Value Added Tax All goods and services sold to or imported by an HGA participant, contractor, operating company or shipper are exempt from VAT. The procedure for avoiding VAT is similar to that for PSAs: tax authorities will issue VAT exemption certificates to companies working on the HGA, and these certificates would absolve suppliers of the obligation to charge VAT on their supplies.

Employee Taxes Foreign employees are subject to tax only on income earned from employment in Azerbaijan and only if they spend more than 182 days in Azerbaijan during the year. Personal taxes apply only after the time in the year when an employee becomes subject to tax. Personal tax applies at the standard domestic tax rates. Foreign employees are not subject to social taxes.

Local national employees are subject to all payroll taxes in Azerbaijan. As discussed above with respect to the statutory tax regime, these include personal income tax at graduated rates that reach a maximum of 35%. Employers are also required to pay for social insurance for employees who are citizens of Azerbaijan, and this results in a total burden of 22% of local gross payroll. The further 3% employee-paid social tax must be withheld from each employee’s salary.

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Opportunities and Challenges in Azerbaijan’s Agricultural Sector

Compiled in part from information by the USAID/Rural Enterprise Competitiveness Program and the Ministry of Agriculture of Azerbaijan

Home to nine of the world’s eleven climate zones, Azerbaijan provides the perfect environment for the cultivation of a wide variety of agricultural products.

Azerbaijan’s agricultural sector is dominated by two areas: crop production and livestock. In the late 1980s, Azerbaijan was one of the leading republics in the Soviet Union that exported raw cotton, tobacco, cognac, vegetables and canned fruits. At that time, there were 120 factories that processed grapes. In addition, there were 10 wine-making plants, 54 canning factories, 19 cotton processing operations, 16 tea production facilities and one cigarette factory.

Some of these enterprises have been successfully renovated and privatized. But the majority of them have halted their operations and require investment to restart their operations.

Today there are more than 2,600 farms in Azerbaijan and agriculture’s overall role in the economy has been increasing. The total share of agricultural products in the economy has grown from 5.6 percent in 2003 to 7.5 percent in 2005. By 2005 figures, Azerbaijan had $284 million worth of agricultural exports.

Since almost 50 percent of Azerbaijan’s population resides in rural areas, the food and agriculture sector constitutes an important part of the job market. In 2006, 40 percent of workers were engaged in the agriculture and forestry business. Rural development is a top priority for the Azerbaijani government as well as many aid and development organizations, and demand for agricultural input is growing rapidly.

The Ministry of Agriculture has invited foreign companies and investors to take part in the revitalization and modernization of Azerbaijan’s food and agriculture sector. The Government of Azerbaijan has already begun allocating revenues from the State Oil Fund of Azerbaijan to the development of the agriculture sector, one of the critical non-oil sectors of the economy.

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There is great expectation that Azerbaijan will be able to strengthen its agricultural business ties with foreign countries and thereby broaden its markets.

Fruits, vegetables, juices and nuts produced or raised in Azerbaijan are already competitive in international markets. Some of these products include pomegranates, feijoa, grape juice, olives, tomatoes, forestry, cotton, tobacco, berries, and hazelnuts.

In addition, wine production has a long history in Azerbaijan that dates back to the Middle Ages.

Many of these crops and products are beginning to see a resurgence with the help of new market interests. In the past year, for example, the recent explosion of interest in pomegranate juice in the United States encouraged American buyers to explore markets that previously held little interest for them. Inevitably, word leaked out that Azerbaijan was a producing nation and that it might have juice and concentrate for sale.

Azerbaijan’s Priorities in Agricultural Development  Upgrade and modernization of canning factories  Upgrade and modernization of grape and wine processing enterprises  Upgrade of existing poultry factories and construction of modern food processing plants  Development of the refrigerated and frozen food industry  Construction of modern greenhouses  Construction of glass-packing factories  Sugar beet and dried fruit processing  Production of artificial fertilizer  Vegetable oil production  Construction of temperature-regulated storage facilities  Organization of agro-services providing technical and chemical services in Azerbaijan’s rural areas

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Buyers who first came to Azerbaijan were struck by two things: the quality of the product and the scale of production. Azerbaijani pomegranate juice, they found, was of excellent quality, possessing a natural sweetness greater than many other juice providers.

However, they also discovered that most processors were very small scale and only capable of providing one or two containers of product.

For their part, Azerbaijani processors were quick to realize the potential in exporting to a market beyond their traditional export boundaries, and the entrepreneurs among them began acquiring more product and restructuring their Soviet-era plants to meet this demand. Through projects supported by USAID and on their own, these companies raced to meet the new standards that exporting to the U.S. demanded. Used to Soviet and post-Soviet era industry standards, company executives now had to upgrade to ISO and HACCP standards demanded by the West. Some companies have done this and have even gone further—two, for example, discovered the advantages of kosher certification, the obtaining of which gained them access to Israeli markets as well.

While visiting and negotiating with pomegranate processors, American buyers discovered other products that piqued their interest. Hazelnuts, exotic juices such as Hawthorn, Cornelian cherry, and feijoa, and unique products such as pickled walnuts and nasharab, a fish and meat sauce with a pomegranate base, were seen as having potential in American markets, and trial containers of these products have been acquired.

The foundation for sustainable trade in value added agriculture has thus been established, and there is room for substantial growth. Azerbaijan’s small size (roughly the size of Maine) belies a number of agriclimatic zones that enable it to produce citrus in the south and stone and pome fruits in the north. Kiwis, walnuts, tangerines, lemons, apples, apricots and peaches are merely some of the many products that thrive in the country, as do most horticultural products.

The Azerbaijani government and business organizations such as the U.S.-Azerbaijan Chamber of Commerce are moving to promote opportunities for buyers and investors in agribusiness. In May 2007 the USACC, in conjunction with the USDA Foreign Agricultural Service, hosted its second annual trade mission to Azerbaijan for U.S. firms in the food and agriculture sector. The trade mission featured a host of field visits to food and agricultural facilities in Azerbaijan, as well as meetings with senior level and local government officials and industry representatives. The trade mission coincided with the USACC-sponsored U.S.-Azerbaijan Agribusiness Forum, and participants had the opportunity to visit the 13th Azerbaijan International Food, Drinks and Packaging Exhibition, held in Baku.

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Available Investment Projects in Azerbaijan’s Agricultural Sector  Processing Industry (canning factories for fruit and juice production)  Organization of Storage, Packaging and Marketing  Meat Processing and Construction of Mini-Meat Processing Facilities (with its own supermarket chains)  Poultry, Egg-Production, and Farming  Viticulture and Modernization of Wine-Making Industry  Fertilizer and Pesticides Production  Setting up Small-Scale Milk Processing Factories and Enterprises  Glass-Packing Industry  Sugar Beet Processing Industry  Tobacco Processing  Certified Seeds and Seedling Production and Modernization of the State Seed Inspection System  Olive Production, Planting and Processing Industry  Tea Production  Setting up Agrochemical Laboratories  Silkworm Egg Production  Acquiring Advanced Irrigation Technologies  Gypsum Production (for improving Saline and Salinized Soil)  Pasture Restoration Projects  Establishing a National Animal Semen Bank and Enhancing Artificial Insemination Services  Developing Apiculture in the Mountainous Regions of Azerbaijan  Developing Drought-Resistant Cereal Varieties  Establishing National Fruit and Vegetable Procurement and Distribution Network  Setting up Modern Agriculture Scientific Research Centers

The trade mission represented an ideal opportunity for U.S. firms to explore the fast-growing food and agriculture market in Azerbaijan, study available investment projects and secure short- and long-term contracts with Azerbaijani importer, suppliers and producers of diverse food and agricultural equipments and products.

The mission was designed specifically to help U.S. firms establish long-term partnerships with Azerbaijani firms, identify potential investment projects, and find reliable buyers and/or suppliers of valuable agricultural products from the region.

There are, of course, challenges that remain for Azerbaijan’s agriculture sector.

Landholdings tend to be very small, and foreign acquisition can be difficult.

Farmers remain largely oriented to local markets, and forward contracting with processors remains a challenge. Transportation continues to be underdeveloped, cold chain services are only in their infancy, and corruption continue to be nagging problems. Further, the finances of exporting remain problematic. Banks are only now moving into the rural sectors and considering investment there. Letters of credit need to be more readily accepted by processors used to cash transactions.

In short, opportunities exist for the intrepid entrepreneur prepared to develop a long-term strategy of selective investment and hands on interaction with Azerbaijani counterparts. The risks are there but so are potential rewards.

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ENERGY SECTOR AND REGIONAL PROJECTS

Oil and Gas Development

By Julia Nanay, Senior Director, PFC Energy

Upstream Investments Foreign investors have poured over $17 billion into projects in Azerbaijan’s oil and gas sector since 1994, when the Contract of the Century was signed with the Azerbaijan International Operating Company (AIOC). Today, 18 upstream projects are being undertaken, both offshore and onshore, with close to 30 companies represented from 13 countries.

Azerbaijan’s oil production, which reached 600,000 barrels per day (bpd) in 2006 (up from 450,000 bpd in 2005) is expected to more than double by 2010. Its gas production reached 6.1 billion cubic meters in 2006 and will also more than double by 2010. In fact, by the end of 2007, Azerbaijan’s oil and condensates production (condensates will be extracted from the Shah Deniz gas field) is likely to exceed 1 million bpd. Oil and gas production growth for the rest of this decade, and well beyond, will be driven by the success of two offshore projects in the Caspian: AIOC’s Azeri, Chirag, and deepwater Guneshli (ACG) oil fields and the Shah Deniz gas and condensate field. Both projects are led by BP with Statoil as the commercial operator of Shah Deniz (responsible for gas sales).

Over $6 billion has been spent so far on the ACG fields’ development. Oil production at the ACG fields is expected to grow to 700,000 bpd in 2007, up from about 450,000 bpd in 2006. As of November 2006, ACG’s proven oil reserves are estimated at 6.5 billion barrels, up from earlier estimates of 5.4 billion barrels.

Since 1994, 15 production sharing agreements (PSAs) have been signed for Azerbaijan’s offshore fields. Nine PSAs were suspended because of a lack of commercial reserves. Azerbaijan’s State Oil Company, SOCAR, may revisit the possible development of some of the fields in these suspended PSAs by itself or with new partners.

Two PSAs are on hold. Further activity on the Araz-Alov-Sharg contract area awaits resolution of an Iranian challenge to its location in what Iran claims are shared waters. Implementation of the PSA for the Inam structure has been delayed because of high pressure encountered in drilling. The Korean National Oil Corporation (KNOC) seeks to join BP and Shell in Inam by buying out part of SOCAR’s 50 percent stake. This could reinvigorate activity on this PSA. SOCAR is discussing various new projects in both the shallow and deepwater offshore with interested foreign partners so additional PSAs could be forthcoming.

While offshore fields have provided Azerbaijan with the financial cushion it needs to ensure its future, Azerbaijan’s onshore has also been receiving attention and investment from a diverse group of smaller players as well as two Chinese national oil companies. CNPC and Sinopec are participants in five of the eleven onshore

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PSAs. There are also two joint venture contract areas. While the onshore has attracted a few companies to exploration projects, much of the onshore activity involves very old fields which yield small production volumes. Chinese companies are particularly focused on Azerbaijan’s onshore because of the technology they can bring to capture the oil which remains in these old fields. Extracting this oil is cheaper than venturing into the offshore, where the risks can be much higher.

Over the last years, there has been a high turnover of players in the onshore consortia, with the make-up of these groupings frequently changing. Uncertainty over access to export routes discouraged some companies as did the requirement at times to supply oil to the domestic market.

Exports Rise with New Pipelines Access to export markets is an important criteria for companies as they look at the greater Caspian region. With the mid-July 2006 start-up of the Baku-TbilisiCeyhan (BTC) oil pipeline, export access has eased. By the end of 2006, a gas export pipeline was also up and running from the Shah Deniz gas and condensate field offshore Azerbaijan, although production problems in Shah Deniz in December 2006 have slowed the pace of gas exports. The proliferation of export routes for oil from Azerbaijan and this new gas pipeline will focus new interest by foreign investors on the country’s oil and gas potential.

The July 13, 2006 inauguration in Ceyhan, Turkey of the 1,768 kilometer, 1 million barrel per day, Baku-Tbilisi-Ceyhan (BTC) oil pipeline marked a milestone in the Caspian region. BTC, which cost $4 billion to build, is the first private company-government partnered pipeline that will bring oil to western markets without crossing Russian territory. The pipeline’s capacity is eventually expected to be expanded to 1.8 million bpd.

Initially dedicated to carrying oil from the AIOC’s offshore Azeri-Chirag and Deepwater Guneshli (ACG) fields, BTC will eventually also transport oil from Kazakhstan’s giant offshore Kashagan field. ENI, Total and ConocoPhillips are partners in the Kashagan development but not in AIOC. By joining the BTC consortium, they have committed to linking at least 150,000 bpd of future Kazakh volumes to this route.

Azerbaijan’s oil exports can reach markets through the 155,000 bpd Baku-Supsa pipeline from Azerbaijan to the Georgian port of Supsa and through the 1 million bpd BTC pipeline, as well as the 100,000 bpd Baku-Novorossiysk pipeline which reaches Russia’s Black Sea port. Thus, exports can go north through Russia, west through Georgia or west through Turkey.

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Gas is Rising in Importance Azerbaijan’s average gas production of 6.1 bcm (January-November 2006) is expected to rise to 11 bcm per year in 2007 with the development of the Shah Deniz gas and condensate field. Estimated reserves for Shah Deniz are 1 trillion cubic meters (tcm) of gas and 101 million tonnes (over 700 million barrels) of condensate. Shah Deniz was brought onstream in late 2006 at a cost of about $4.1 billion for the first phase of development, with its production expected to reach 8.6 bcm by sometime in 2008.

The 693 km, $1.3 billion Baku-Tbilisi-Erzurum (BTE) gas pipeline (also referred to as the South Caucasus Gas Pipeline (SCP) was completed in October 2006, with an initial capacity of 8.6 bcm. It will transport Shah Deniz gas to export markets in Georgia (0.8 bcm), Turkey (6.6 bcm) and Europe. By 2012, this pipeline could be expanded to carry 16-20 bcm, with Greece and Italy among future target customers. The anchor market for the initial stage of BTE is expected to be Turkey. As Georgia tries to diversify its gas imports away from Russia, it is seeking additional volumes on top of what it has contracted already. The importance of both the Shah Deniz gas field and the SCP will grow over time as increasing production volumes provide Georgia, Turkey and European customers with a new supply source through a gas pipeline that diversifies export routes from this region, bypassing both Russia and Iran.

The partner members of the Azerbaijan International Operating Company include:  BP (34.137%)  Chevron (10.2814%)  Inpex (10%)  Statoil (8.563%)  ExxonMobil (8%)  TPAO (6.75%)  Devon (5.62%)  Itochu (3.92%)  Delta-Hess (2.7213%)  SOCAR (10%)

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Delta-Hess 2.7213% Itochu 3.92%

SOCAR 10%

Devon

BP 34.137%

5.62%

TPAO

6.75% ExxonMobil 8% Statoil 8.563%

Inpex 10%

Chevron 10.2814%

Energy Sector and Regional Projects Investment Guide

The Shah Deniz field is being developed by the following partners:  BP (25.5%)

SOCAR 10%

 Statoil (25.5%)

BP 25.5%

TPAO 9%)

 Total (10%)  Lukoil (10%)  Iran’s NICO (10%)  TPAO (9%)

Iran’s NICO 10%

 SOCAR (10%).

Statoil 25.5%

Lukoil 10% Total 10%

The Baku-Tbilisi-Ceyhan pipeline stretches across Azerbaijan (443 km), Georgia (248 km) and Turkey (1,076). The longest pipeline in the world, it brings together 11 companies.

The partner members of Baku-Tbilisi-Ceyhan pipline project:  BP (30.1%)  SOCAR (25%)

Inpex ConocoPhillips 2.5% 2.5% Itochu 3.4%

 Chevron (8.9%)  Statoil (8.71%)  TPAO (6.53%)  ENI (5%)  Total (5%)  Itochu (3.4%)  ConocoPhillips (2.5%)  Inpex (2.5%)  Hess (2.36%)

ENI 5%

Total 5%

Hess 2.36%

BP 30.1%

TPAO 6.53% Statoil 8.71% Chevron 8.9%

SOCAR 25%

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The Baku-Tbilisi-Akhalkalaki-Kars Railway Project

By Taleh Ziyadov, USACC The Baku-Tbilisi-Ceyhan (BTC) oil pipeline and the Baku-Tbilisi-Erzurum (BTE) natural gas pipeline have transformed the economic and geopolitical stances of the South Caucasus. As a result, the energy networks of Azerbaijan, Georgia and Turkey have become more integrated, raising the importance of the East-West Transport Corridor even more.

Today, these states are ready to take on a new challenge by building an interstate railroad connections that will link the rail networks of Azerbaijan, Georgia and Turkey. This new rail line, the Baku-Tbilisi-Akhalkalaki-Kars railroad, will lay a key section of the transportation corridor stretching from the countries of the Europe Union to China.

Part of the Trans-European Railway networks, its construction will not only boost continental container trade between Asia and Europe via the South Caucasus, but also further integrate the South Caucasus region within Europe.

The idea of connecting Azerbaijani, Georgian and Turkish railways was first discussed during a meeting of the Joint Transport Commission in 1993. The initiative was later integrated into the master plan on Trans-European Railway networks sponsored by the United Nations Economic Commission for Europe.

In July 2002, the Ministers of Transport of Azerbaijan, Georgia and Turkey signed a protocol confirming the route and agreed to conduct a feasibility study at a February 2005 meeting. UNECE lists this route as a Priority I project, indicating that it could be funded and implemented by 2010. Stakeholders hope to begin construction late in 2007. Most forecasts suggest that during the first two years of operation, transport will reach 2 million tons, and will then grow to 8 to 10 million tons over the following three years.

The realization of this project depends on the construction of a 98 kilometer rail segment from Kars in Turkey to Tbilisi in Georgia (68 kilometers in Turkey and 30 kilometers in Georgia). The project is estimated to cost around $400 million.

The length of the Baku-Tbilisi-Akhalkalaki-Kars segment and the Kars-Istanbul rail sections are 826 kilometers and 1,933 kilometers, respectively. Once completed, cargo from the EU can be shipped directly by rail to China through Turkey, Georgia, Azerbaijan and Central Asia, increasing the volume of container traffic through Azerbaijan and providing a shorter, more secure trade route to China.

The construction of the Kars-Akhalkalaki railway will also open markets in the Mediterranean region. Goods and products would be shipped directly to Mersin, a coastal Turkish port at the Mediterranean Sea. From there they could be transported by sea to myriad destinations, from Egypt to the United States.

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Since the railroad bypasses Armenia, Yerevan is still opposing the project. Instead, Armenia proposes to use the century-old Kars-Gyumri (Armenia)-Tbilisi railway.

Baku argues that the Kars-Gyumri link has not been used since the collapse of the Soviet Union and that its renovation would cost more than the construction of a new line. Moreover, due to Armenia’s refusal to withdraw its troops from occupied Azerbaijani lands in return for re-establishment of communications between Baku and Yerevan, Azerbaijan is not likely to use the Kars-Gyumri railroad. Azerbaijani officials have repeatedly stated that they cannot delay strategic and economic projects until the Karabakh conflict is resolved. Thus, the construction of this project is likely to advance even if the Karabakh peace process does not.

The construction of the Baku-Tbilisi-Akhalkalaki-Kars railroad will address a missing link in the transportation networks connecting Europe and Asia. It will increase the volume of continental trade via Azerbaijan and Georgia and boost these states’ role as transit countries. It will also move Azerbaijan and Georgia closer to the Euro-Atlantic community and create new opportunities for American and European engagement in the region. The project will accommodate the EUsponsored TRACECA initiative as well as the U.S.-backed East-West Transport Corridor and make the region a crossroads for Trans-European and Trans-Asian continental trade. This project is indeed a landmark development for all of the involved countries who hear the call, “All aboard!”

Some segments of this article were previously published in CACI Analyst (April 19, 2006).

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PROJECT FINANCE, INSURANCE AND DEVELOPMENT

Financing the diversification of Azerbaijan’s economy

By Aygen Yayikoglu, Head of the EBRD office in Baku The European Bank for Reconstruction and Development was set up in 1991 to foster the transition from the centrally-planned economies to market economies in Central and Eastern Europe and the Commonwealth of Independent States.

The EBRD, owned by 61 countries and two intergovernmental institutions, is the largest single investor in the region. It has invested more than $40 billion in the 29 countries in which it operates. The EBRD invests mainly in private enterprises, and provides project financing for banks, industries and businesses, both in new ventures and in existing companies. The EBRD also works directly with the various member governments and publicly-owned companies to finance infrastructure projects, support privatization, restructure state-owned firms and improve municipal services.

The EBRD and Azerbaijan The EBRD began its operations in Azerbaijan in 1992 when the country declared its independence following the dissolution of the Soviet Union. The EBRD’s office in Baku has nine staff members, and more than 60 local projects in which it has invested, totalling nearly $1 billion in financing. The project costs of the investments in the country has exceeded $5 billion. The majority of the EBRD’s investments are in the private sector.

Azerbaijan is also part of the EBRD’s Early Transition Countries Initiative, launched in 2004 to increase its impact in selected countries through a streamlined approach to financing the private sector. The initiative is aimed at mobilizing more investment, especially for small- and medium-sized enterprises. It also encourages economic reform, with donor funds playing an important role as catalyst for investment.

In its current strategy for Azerbaijan, approved in May 2005, the EBRD has set out the following priorities: 

the development of the non-oil sector and regional economic diversification;



the enhancement of the competitiveness of the banking sector, while at the same time using the sector as an intermediary to provide support to micro-, small- and medium-sized enterprises;



the upgrading of public infrastructure, including roads, rail, power, and telecommunications;



the continuing development of the natural resources sector, with due regard to the environment, transparent management and effective utilization of revenues.

Azerbaijan is currently enjoying exceptionally strong growth rates thanks to a large increase in oil production and exports. High revenues have provided the country with the financial means to support the diversification of the economy, lessen the

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country’s dependence on natural resources and lay the foundation for sustainable growth. Despite increasing revenues, achieving these goals while preserving a stable macroeconomic environment remains a huge challenge, and the EBRD is strongly committed to supporting the diversification of Azerbaijan’s economy. It is currently preparing a new country strategy for the 2007-2009 period.

The EBRD’s Role in Azerbaijan Today Financial Sector First and foremost, the EBRD helps people to help themselves. In order to achieve this, and to help diversify the economy, the EBRD focuses particularly on the development of the financial sector in Azerbaijan. Its aim is to help develop an efficient financial sector which would play a central role in channelling the vast oil and gas revenues into other areas of the economy, and help private entrepreneurs start and grow their businesses across the country. To this end, the EBRD uses multi-bank framework facilities to channel funds to thousands of entrepreneurs via local banks. These loans range from just a few thousand manats to several million, and are tailor-made for the needs of local businesses of micro-, small- and mediumsized businesses.

The EBRD is involved in the Azeri banking sector through investments in nine banks, two non-bank organisations and one insurance company. The EBRD is proactively supporting the development of the financial sector through equity stakes in private banks and the introduction of new products such as trade finance, co-financing, insurance and leasing finance. With its investments, EBRD is not only bringing funding, but the equally important expertise, training, institution building, international practices and regional experience.

Corporate Sector In addition to channelling funds through the local banking sector, the EBRD also provides direct financial and strategic support to local and foreign investors.

It has recently provided debt and equity to a number of local entrepreneurs for the expansion of their production capacity in the agribusiness sector, and will continue to support new clients engaged in agribusiness, manufacturing, construction, trade and services.

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The EBRD is also ready to provide support and co-invest with foreign strategic investors, especially in the non-oil and gas sectors, with a view to help improve the business environment, attract private capital to diversify the economy, and ensure the transfer of technology and know-how. One recent example is the EBRD’s 10 percent equity subscription in Garadagh Cement, which is the largest cement factory in the country in which a foreign strategic investor is the majority owner.

In addition to financial support, the EBRD also provides management advice to various local businesses through its business advisory and turn-around management programmes under which it mobilizes highly experienced executives who work directly with company owners to transform and improve their businesses.

Infrastructure Another emphasis of the EBRD’s work is the development of rural areas, in which 70 percent of Azerbaijanis live under difficult conditions. Providing rural entrepreneurs with access to finance is one way. Investing in the country’s infrastructure, especially its energy supply and transport systems, is another important path the EBRD is following. The needs are enormous as a result of inadequate funding and years of neglect. EBRD works jointly with the Azerbaijani Government and international financial institutions to prioritize needs and channel funds accordingly. The EBRD also provides to the Government and state-owned enterprises institutional support in terms of sector restructuring, improved management and financial reporting.

One example is the EBRD’s recent loan for the rehabilitation of the country’s largest power plant. The plant, with capacity of 2400 MW, supplies half the country’s electricity. In addition to improved security of supply, the EBRD’s investment will also help reduce carbon dioxide emissions at the plant and help the company to qualify for carbon credits and earn an additional source of income.

The EBRD intends to provide further financing for investments, which would improve municipal services and help clean up the contaminated environment. In transport, in addition to its past investments in roads, railways, and air navigation, the EBRD is currently financing more than 85 kilometers of road linking the western part of the country to the historic Silk Road, the ancient trading route between Asia and Europe.

This loan, and the EBRD’s activities in general, serve one particular goal: bringing people together, and assisting countries and regions in fostering sustainable development.

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Asian Development Bank

Submitted by the Asian Development Bank office in Baku

The Asian Development Bank (ADB) is a multilateral development financial institution owned by 66 members, 47 from the region and 19 from other parts of the globe. ADB’s vision is a region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their citizens.

ADB’s main instruments for providing help to its developing member countries are: 

policy dialogue



loans



technical assistance



grants



guarantees



equity investments.

ADB’s annual lending volume is typically about $6 billion, with technical assistance totaling $180 million a year. ADB’s headquarters is in Manila, Philippines. We have 26 other offices around the world, including 19 resident missions in Asia, three subregional offices in the Pacific, and representative offices in Frankfurt for Europe, Tokyo for Japan, and Washington, DC for North America.

Relationship with ADB Azerbaijan is the 18th largest shareholder among regional members and the 26th largest overall.

Established in 2004, the Azerbaijan Resident Mission serves as ADB’s primary development interface in the country and has contributed to making ADB more responsive to the country’s development needs. This helped ADB become one of the first donor agencies to provide an emergency grant to address the avian flu threat.

To ensure the sustainability of the Government’s efforts in fighting poverty, ADB has provided a number of loans and technical assistance (TA), including loans to rehabilitate water supply and sanitation facilities in regional towns, and a TA to support the Government’s efforts to prepare a long-term sustainable economic and social development strategy and program. As a committed development partner, ADB shares the objectives and aspirations of the Government to reduce poverty and promote sustainable and inclusive economic growth.

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The Asian Development Bank was one of the first donor agencies to provide an emergency grant to successfully address the avian flu threat and help private entrepreneurs start and grow their businesses across the country.

As of December 2006, ADB has approved: 

Five loans totaling US$104 million to finance the following three projects: Flood Mitigation; Urban Water Supply and Sanitation; and East-West Highway Improvement;



Three private sector loans and/or equity investments totaling US$15 million to strengthen private banking and leasing sectors;



Nineteen technical assistance grants totaling US$9.832 million;



Azerbaijan has to date received $104 million in loan assistance since joining the Asian Development Bank (ADB) in 1999. It is the 27th largest borrower;



The Azerbaijan government agency handling ADB affairs is the Ministry of Economy and Development;



The Country Strategy and Program Update for 2006 can be found at www.adb. org/Documents/CSPs/AZE/.

Impact of Assistance Given the relatively short time since ADB operations in Azerbaijan began in 2000, much has been achieved in terms of strengthening the relationship with the Government, increasing the size of the lending and non-lending portfolios, and disseminating information about ADB’s activities. A number of projects administered or directly funded by ADB have made significant impacts in reducing poverty.

ADB administered a $2.5 million grant from the Japan Fund for Poverty Reduction (JFPR) for integrating Internally Displaced Persons (IDPs) into society in Mingechavir. The pilot project has made a substantial difference to living conditions by improving housing for more than 412 families and creating job opportunities. This has benefited more than 12,000 people, about 73% of whom were classified as poor.

In 2003, a $22 million loan from the Asian Development Fund was approved for works to protect 12 districts in four flood-prone areas, where poverty is significantly higher than the national average. Recurrent floods have pushed insurance premiums for personal coverage, crop damage, and loss of livestock beyond the reach of most people in the area. The project will protect five towns and 43 villages, and support the livelihoods of more than 200,000 people living on 76,790 hectares of floodplains. It will prevent an estimated $4.83 million in annual losses due to flooding.

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ADB also approved in 2004 two loans totaling $30 million to provide residents, industries and small businesses in three towns with improved water supply and sanitation services, which have deteriorated significantly in the years since Azerbaijan’s independence. The project will upgrade aging infrastructure, bringing in private sector partners to help build distribution networks, reservoirs, chlorination facilities, waste stabilization ponds, sewers and sewerage pumping stations. The project will benefit an estimated 110,000 people. ADB has also provided advisory assistance for capacity building in the sector and administers a JFPR grant to rehabilitate residential water supplies and sanitation in the three towns.

In 2005, ADB approved two loans totaling $52 million for the East–West Highway Improvement Project. The project will rehabilitate 127 kilometers of the Yevlakh– Ganja and Qazakh–Georgian border sections of the highway, as well as 65 kilometers of connecting local roads. It will also support policy reform by strengthening institutional capacity in the sector. A preparatory TA was approved in 2005 to study the feasibility for another road improvement project.

ADB is supporting the energy sector with the approval of a TA project to prepare the Renewable Energy Development Project, which examines the potential of wind, solar and mini-hydroelectric power to improve electricity supplies to regional towns.

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Operational Challenges Key development challenges facing Azerbaijan are reflected in the Government’s strategies to promote sustainable economic development in the non-oil sector by developing income-generating sectors and improving infrastructure, and to make social development more inclusive by reducing economic disparities in regional areas, promoting good governance and improving the climate to encourage privatesector growth.

ADB’s main challenge is to streamline project processing activities and harmonize them with the Government’s project timetable. The selection of ADB interventions is guided by CSP directions, the performance of the portfolio, the activities of other development partners, and the institutional framework. A new project will be included only if it is fully supported by the oversight of executing agencies, and is socially acceptable to the community.

Azerbaijan’s ADB Membership: Joined

1999

Shares held

15,736 (0.448%)

Votes

29,445 (0.67%)

Partnership In May 2005, ADB signed a joint declaration with the Government of Azerbaijan, the European Bank for Reconstruction and Development, the International Monetary Fund, the United Nations Development Programme and the World Bank to align country strategies and programs with the Government’s new long-term development strategy. Sector working groups, first formed under the State Program on Poverty Reduction and Economic Development, will bring stakeholders together to provide substantive and coordinated guidance to the strategy.

ADB cooperates with civil society organizations in Azerbaijan to strengthen the effectiveness, quality and sustainability of the services it provides.

A summary of procurement contracts awarded to companies and consultants from Azerbaijan for goods and related services, civil works and consulting services can be found at www.adb.org/Documents/Fact_Sheets/Azerbaijan/procurement.asp.

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Export-Import Bank of the United States

By Brian Sant Angelo and Natasha Zamecnik of Ex-Im Bank

Export-Import Bank of the United States The Export-Import Bank of the United States (Ex-Im Bank) – the official export credit agency of the United States – supports the purchases of U.S. goods and services by creditworthy international buyers that cannot obtain credit through traditional trade and structured finance sources. The Ex-Im Bank does not compete with private sector lenders, but provides financing products that fill in the gaps in areas of trade and structured financing. The Bank assumes country and credit risks that the private sector is unable or unwilling to accept, and helps to level the playing field for U.S. exporters by matching the financing that other governments provide to their exporters. In more than 72 years of operation, Ex-Im Bank has supported more than $450 billion of U.S. exports worldwide, particularly to developing markets.

Ex-Im Bank in Azerbaijan The Ex-Im Bank sees numerous opportunities for U.S. exporters in the Caucasus, particularly in Azerbaijan, which offers a huge potential market for U.S. good and services. Azerbaijan’s healthy macroeconomic environment, coupled with doubledigit growth rates, provides the potential for the Ex-Im Bank involvement in a number of different sectors. The Ex-Im Bank recently opened for long-term business in the private sector, allowing the Bank to support all types of transactions (short-, medium- and long-term) in the public and private sectors. Furthermore, public-sector and privatesector projects that demonstrate a strong ability to generate revenues can be considered on a limitedrecourse project finance basis.

Azerbaijan’s healthy macroeconomic environment, coupled with double-digit growth rates, provides the potential for Ex-Im Bank involvement in a number of different sectors across the country.

Currently, the Ex-Im Bank has an outstanding portfolio in Azerbaijan of over $64 million in such sectors as aircraft, construction, financial services and engineering services. The Ex-Im Bank has supported a number of transactions in Azerbaijan that have contributed to economic growth in the country. The best example remains the Bank’s backing of the Baku-Tbilisi-Ceyhan (BTC) pipeline. The Ex-Im Bank supported over $150 million in engineering services and compressors for the BTC pipeline. The pipeline’s completion highlights the collaborative efforts of numerous international public and private entities to complete a large scale project that has significantly increased

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the capacity of Azerbaijan’s hydrocarbon sector, as well as enhanced the growth prospects of the country.

In addition to the hydrocarbon sector, the country’s infrastructure needs, agricultural sector and banking system all present tremendous opportunities for collaboration with commercial firms that may be eager to utilize the Ex-Im Bank roducts.

Ex-Im Bank Products The Ex-Im Bank has several financing products to assist U.S. exporters and international buyers in their efforts to sell or purchase U.S. goods and services. The products can be broadly placed into three categories: loan guarantees, export credit insurance and direct loans.

Loan guarantees cover the risks assumed by commercial banks when funding loans to international buyers. The product allows buyers in Azerbaijan to obtain loans from private commercial banks, often at lower interest rates and longer maturities than they would typically receive through local bank financing.

Repayment terms up to five years are generally available for exports of capital equipment and services.

Terms up to 10 years may be available for transportation equipment and exports to large-scale projects. The buyer of U.S. goods or services is required to make a minimum 15 percent down payment directly to the U.S. exporter. The Ex-Im Bank can then guarantee repayment of the loan made by the private commercial bank to the Azerbaijani buyer. The total level of the Ex-Im Bank support will be the lesser of 85 percent of the value of all eligible goods and services in the U.S. supply contract or 100 percent of the U.S. content in all eligible goods and services in the U.S. supply contract. The loan guarantee can cover purchases of capital equipment and services, refurbished equipment, software, certain banking and legal fees, and in certain cases, some local costs and expenses.

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Export credit insurance is a financing tool that can support transactions on short-term repayment (typically up to 180 days, exceptionally up to 360 days) and medium-term repayment (from one to five years) by providing coverage to U.S. exporters and commercial banks for commercial and political risks associated with foreign transactions. There is a 51 percent U.S. content requirement for short-term transactions. Short-term insurance policies can be set up for single or multiple transactions.

Medium-term insurance transactions offer support for up to 85 percent of the U.S. net contract value. Coverage can be provided for up to five years for all contract amounts up to $10 million.

The Ex-Im Bank also offers insurance products that cover additional transactions types and allows buyers in emerging markets like Azerbaijan to receive open-credit terms or short-term loans from banks as well as coverage for confirming banks on letter of credit transactions.

Direct loans are offered on a limited basis by the Ex-Im Bank. These loans are offered to creditworthy international buyers of U.S. goods and services and are intended to support transactions that otherwise would not receive support through a standard loan guarantee transaction. Given the unique nature of these transactions, direct loans play a limited role in the Ex-Im Bank’s portfolio; however they do allow the Ex-Im Bank to act as a comprehensive source for financing of U.S. sales contracts.

For each of the financing products mentioned above, there are credit requirements and criteria that buyers must meet, as well as a 15 percent down payment for transactions involving medium- and long-term financing. To ensure use of the best product for a specific transaction, consult the official website at www.exim.gov and speak with a member of the Ex-Im Bank’s International Business Development staff.

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JOIN USACC TODAY! USACC MEMBERSHIP BENEFITS USACC offers a range of membership levels to meet the varying needs of its members. Whatever the size and focus of your company or organization, there’s a membership level to help you.

USACC Members Common Benefits:  Receive updates on business, economic, and political developments in Azerbaijan.  Receive invitation to events dedicated to issues important to members.  Receive invitation to USACC Annual Conference.  Enjoy complimentary or discounted subscriptions to USACC Investment Guide to Azerbaijan, USACC Business Directory and USACC Business Weekly Electronic Newsletter.  Access to exclusive directory of important government and business contacts.  Post profile of your company and its website link at www.usacc.org  Access to “Member Only” section of the USACC Website.  Get complimentary listing in USACC Business Directory  Discounts for Azerbaijani Language classes.  Assistance with Business and Travel Visas.

These benefits are available to all member levels, unless specified otherwise.

In addition to the benefits listed above, members receive benefits based on their membership level. Please see below for more details.

BENEFACTOR MEMBER - $8,750 ANNUALLY As a Benefactor Member, your company or organization receives all exclusive benefits of the USACC membership.

This membership level has been designed for companies with long-term business interests in Azerbaijan and those interested in gaining visibility in the market. It is the most prestigious level of USACC Membership with a number of inclusive complementary services.

Benefits include:  Access to events featuring Azerbaijani dignitaries visiting the United States.  Arranging meetings with senior government officials and private sector representatives.  Assistance in business related problem solving.  Personal briefings on political and economic developments in Azerbaijan.

 Access to “Benefactor Member Only” events.  Priority consideration for all limited attendance events.  Expedited visa services and assistance with logistical issues  Eligibility for membership on the Board of Directors and Board of Trustees.  Complimentary Azerbaijani language courses.

SUSTAINING MEMBER - $5,000 ANNUALLY This level of membership has been designed for those companies that just entered the market in Azerbaijan or the United States and are planning to expand their operations.

SUSTAINING Membership is a great benefit to companies seeking to expand their business network and government connections. USACC will assist these companies in gaining recognition and visibility in the market.

In addition to the common membership benefits, Sustaining Members benefits include:  Access to events featuring Azerbaijani dignitaries visiting U.S.  Receive assistance with arranging meetings with senior officials and major businesses in Azerbaijan and U.S.  Assistance in business related problem solving.  Eligibility for membership on the Board of Trustees.  Discounts on the executive appointment services.

REGULAR MEMBER - $2,500 ANNUALLY Regular Membership level has been designed for companies that have business interest in Azerbaijan or the United States and/or interested in business opportunities and in promoting their products/services in these countries. This is an ideal membership level for the companies that wish to network with government and business representatives.

Regular Members can attend most of the networking events organized by the Chamber and are briefed about business and political developments in Azerbaijan or the United States. This membership level includes all common membership benefits.

ASSOCIATE - $450 ANNUALLY (Individuals Only) Associate Members are individuals who are interested in keeping up-to-date on issues concerning Azerbaijan and the Caspian Region. These members receive weekly newsletters and a complementary copy of USACC publications and attend events and exhibitions sponsored by the Chamber.

United States – Azerbaijan Chamber of Commerce (USACC) 1212 Potomac Street, NW Washington D.C. 20007 Tel: (202) 333-87-02 Fax: (202) 333-87-03 chamber@usacc.org www.usacc.org

USACC MEMBERS DIRECTORY The US-Azerbaijan Chamber of Commerce wishes to thank its members for their continuing support:

BENEFACTOR         

Ahmedov Investments Amerada Hess AtaHolding Azercell Telecom JV Azertrans Azpetrol BP Chevron CISCO Systems Inc.

        

ConocoPhillips Devon Energy Corporation ExxonMobil Fintur Holdings International Bank of Azerbaijan (IBA) Karasu Operating Company Middle East Petrol Farm Occidental Petroleum Corporation (OXY) Science Applications International Corporation (SAIC)

   

J. Ray McDermott The Livingston Group Solar Turbines ZEVS-Z

                 

Creative Associates International Development Alternatives Inc. (DAI) Eurasian Cargo USA Eni Eurasia Foundation Grand Hotel Europe Hazar Investments Ltd. Hyatt Hotels Baku Impressa Club AZAL, Ltd. Iteca Jefferson Waterman International (JWI) LITWIN Melwood Global Overture Financial PFC Energy Prant Real Estate Agency R.I.S.K. Company Salans

SUSTAINING    

American International Group Bob Lawrence and Associates, Inc. Coca-Cola Halliburton Company

REGULAR                  

AA Services Alliance Law Group (ALG) American-Turkish Council Anglo Asian Mining PLC ATAA Azerbaijan International Azerfon LLC AzEuroTel Baker Botts, LLP Baker & McKenzie Bank of New York Company Bertling Logistics Boeing Company California Caspian Consulting Caspian American Telecom (CATEL) CASPEL Cinderella Travel Corp.

Consolidated Contractors International Company (CCIC)

ASSOCIATE    

George Debakey Gulzar Babaeva Tapdyg Amiraslanov Timur Edib

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