On March 31, Fitch Ratings affirmed Azerbaijan's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB+' with a Positive Outlook. 

The report said, "The rating is supported by Azerbaijan's very strong external balance sheet, the lowest public debt in its peer group, and financing flexibility from large sovereign wealth fund assets. Set against these factors are weak governance indicators, lack of predictability of economic policy-making, high banking sector dollarization, heavy dependence on the hydrocarbon sector, and geopolitical risk of conflict with Armenia."

Regarding strengthening external position, it said: "The current account surplus rose an estimated 14.6pp in 2022 to 29.7% of GDP, and we project a narrowing to average 17.6% in 2023-2024, in line with moderating energy prices, but still the highest in the 'BB' category. Oil and gas now comprise close to 93% of Azerbaijan's total exports. Sovereign foreign-currency assets grew by USD5.9 billion in 2022 to USD58.0 billion, 85% of which is held by the sovereign oil fund (SOFAZ), where higher energy revenues more than offset a 5.2% loss on its investment portfolio. Fitch projects Azerbaijan's net sovereign creditor asset position grows 10.9pp in 2023-2024 to 68.7% of GDP, comfortably the highest in the rating peer group."

Speaking of moderate contingent liability risk, the organization stressed, "Government on-lending and guarantees fell 9pp in 2022 to 16.6% of GDP, and 80% relate to the 2017 restructuring of International Bank of Azerbaijan, and the Southern Gas Corridor project where there has been a reduction in contingent liability risk. Lack of transparency and weak corporate governance in the large state-owned enterprise sector hinder public financial management and efforts to diversify the economy, although measures have been taken to centralize their oversight and reporting at Azerbaijan Investment Holdings."

On the inflationary challenge, Fitch said: "Inflation moderated to 14.1% in February from a peak of 15.6% in October 2022, partly reflecting a 4pp easing of food price inflation to 17.1%. There is a somewhat greater domestic component than early last year, with nominal wages growing close to the headline rate. Fitch forecasts inflation falls to an average of 10.3% in 2023 and 7.3% in 2024 on moderating global commodity prices, easing supply chain disruption, and the stronger real effective exchange rate, but still above the CBA target (4% +/-2pp). The main policy interest rate was raised only 100bp over the last year to 8.5%. There is relatively weak monetary policy transmission, although other measures have been taken to absorb banking sector liquidity, including through reserve requirements."

Regarding continuing geopolitical risk, the report added: "Tensions with Armenia have increased over the last year. The closure of the Lachin corridor to Armenia has exacerbated frictions and followed September's more severe fighting that broadened the conflict from areas in and around Karabakh. Azerbaijan's relationship with Russia appears more strained, and the EU has adopted a limited monitoring role in Armenia. Our base case is that Russia will retain its peacekeeping forces at least until the end of the committed period in late 2025 and that a peace agreement will be reached and ultimately lead to a deal on improved trade and connectivity. However, there could well be further sporadic clashes, and downside risk has increased since early last year."

About the banking sector, it emphasized, "The Azerbaijan banking sector has improved in recent years, but is still fairly weak, reflected by Fitch's Banking System Indicator score of 'b.' The non-performing loan ratio fell to 2.9% at the end-2022, from 6.1% in end-2020, helped by strong loan growth. Return on average equity was 17.3% in 2022 and is likely to remain above 15% this year, Tier 1 capital is adequate at 15.2%, and there is a low Russian presence in the sector. The deposit dollarisation ratio fell to 48% at end-2022, from 60% at end-1H20, but is well above the peer group median of 19%, and we view regulatory oversight as improving but still with several weaknesses."

Read also:

Fitch Examines Effects of Russo-Ukrainian War on Azerbaijan's Economy

Fitch Revises Armenia's Outlook to Positive; Mentions Probability of War with Azerbaijan