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The low energy prices ravaging the economies of Russia and Kazakhstan will now start to have a tangible effect on the Azerbaijan market. After years of strong growth, averaging 11 percent YOY in the 2000 to 2014 period, we are forecasting Azerbaijan’s economy to contract by over 4 percent YOY in 2016 as energy revenues, which make up 50 percent of the economy, have been slashed. Multinationals must adjust their 2016 targets and manage possible disruptions to their local partners as consumer, business and government demand are projected to fall precipitously.

Azerbaijan has avoided significant hardship thus far. After devaluing the manat by 33.5 percent against the US dollar in February, the government instituted price controls to stem inflation and protect consumer demand. Likewise, the government maintained most of the budgeted 2015 spending plans, in particular the high-profile projects related to the recent European Games in Baku. Price controls and government spending for 2015, which was based upon an oil price of US$ 90/bbl, proved to be particularly costly: foreign currency reserves, at nearly US$ 16 billion in mid-2014, have fallen to US$ 7 billion currently and have declined by over 30 percent since the February 2015 devaluation alone.

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As energy prices are forecasted to remain low all of next year and only rising minimally in 2017 and 2018, significant adjustments are now coming to the economy. Unable to maintain its current peg to the dollar of 1.05 manat, we expect the central bank to move to a free-floating exchange regime (a 30 to 40 percent depreciation), as Kazakhstan did in August, or to devalue the currency (by about 20 percent) between November 2015 and the end of Q1 2016. Meanwhile, the 2016 budget plans for a cut in expenditures by 23 percent YOY in local currency terms as government revenues have fallen by 25 percent YOY. The government is cutting transfers from the State Oil Fund of Azerbaijan (SOFAZ) to the budget by nearly 50 percent in recognition of the need to preserve funds for several years of low energy prices.

As a result, inflation is set to rise significantly (by 12 percent YOY next year), and a tighter credit environment will take hold to combat price increases and the greater dollarization of the economy. Beyond 2016, the poorly diversified economy will continue to rely on oil income; however, oil production has recently begun to decline by 3 to 5 percent per year and gas revenues will only rise in 2018 when the Shah Deniz II field comes online. After contracting in 2016, we forecast the economy to stagnate in 2017 and grow by 3 percent YOY in 2018.

How should businesses respond?

The market slowdown for the next few years does not necessitate a departure from the market. Azerbaijan still retains many attractive qualities with respect to its CIS neighbors: a high urban population with a high per capita GDP, political stability and a comparatively positive environment for doing business in the CIS region.

With purchasing power set to struggle in 2016, multinationals focused on consumers must reassess their targets, focus increasingly on market share, and consider segmenting their customers to find niche opportunities.

B2B and B2G firms need to work with local partners to identify and capitalize on the signature government energy and infrastructure projects that will be maintained in the coming years. Moreover, the falling demand and currency depreciation will undermine the financial health and capability of distributors and local partners. Thus, firms will need to improve their distributor management, including increased monitoring and possible assistance to valued partners in order to strengthen their businesses for the long-term.

Within their CEE portfolio, firms should evaluate Azerbaijan in comparison to the region and consider temporarily redistributing investment resources towards higher-growth markets in Central Europe. Multinationals need to set realistic expectations amid this downturn and prioritize partnership management in order to strengthen their business for the long-term.

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