Iran’s opening, a bigger opportunity than threat to Baku’s growth goals




The impending lifting of sanctions on Iran will open enough opportunities for Azerbaijan to partially offset the competition from Iran’s oil and gas exports, according to a September 28 report released by rating agency Moody’s.

The lifting of sanctions is expected to add between 600,000 and one million barrels of oil to global supply by March 2016, turning Iran into a downward pressure for oil prices and a credit negative for all oil exporting countries in the region, including Azerbaijan. However, Moody’s believes that increased trade, infrastructure projects and investment in non-oil sectors will boost Baku’s economic diversification agenda and contribute to its growth.

A sizeable opportunity

Having a large and competitive economy like Iran’s open up to global trade is bound to enhance trade with Azerbaijan; case in point, Iran’s Minister of Communications and Information Technology Mahmoud Vaezi expects bilateral trade to reach $1.5bn in 2016, up from $500mn in 2014.

Iran is the world’s 18th largest economy measured by its nominal GDP at purchasing power parity, and is the third largest economy in the Middle East and the Commonwealth of Independent States, after Russia and Saudi Arabia. While its competitiveness has been stifled by the US and EU sanctions imposed in 1996, Iran’s large population of 78mn remains highly skilled, and the country is among the top 50 most innovative in the world according to Bloomberg, scoring particularly well in patents (22nd in the world) and tertiary efficiency (18th).

Azerbaijan was among the countries that immediately started to seek new foreign trade and investment opportunities with Iran, Moody’s notes. Since August, the two neighbours have been working on a number of joint projects in hydropower, railway connections, oil and gas swaps, and engineering.

“Iran was an important export market destination for Azerbaijan during the pre-sanctions period. Before the first round of sanctions was imposed in 1996, Azerbaijan’s exports of goods to Iran accounted for a very large share of Azerbaijan’s total exports of goods. In 1994, the share of Azerbaijani goods exports to Iran in Azerbaijan’s total goods exports reached a high of more than 35%. In the aftermath of the sanctions on Iran, however, Azerbaijan’s goods exports to Iran plummeted and they currently account for a meagre 0.1% of Azerbaijan’s nominal GDP only,” the report reads.

A new avenue to boost non-oil growth

The increase in trade with Iran would serve well one of Baku’s top development strategies, which is that of diversification away from oil and gas. A thriving industrial hub, where industry accounts for over 40% of GDP, Iran could be a source of know-how and commerce in areas such as IT services, pharmaceuticals, agro-industrial processing, construction materials, chemicals and petrochemicals, and mining.

Assuming Azerbaijan’ exports of goods go back to pre-sanction levels and partly takes place in non-oil sectors, Azerbaijan could somewhat reduce its over reliance on hydrocarbons, thus helping Baku reach its target of a 7% annual growth rate of the non-oil economy.

In the times of oil bonanza, when the barrel of oil traded at over $140, Azerbaijan was able to tap into its generous state reserves to foster growth in the non-oil economy. As recently as this year, Baku registered a 7.3% growth in the non-oil economy between January and August, on the back of increased public spending on infrastructure projects like Baku White City and stadiums, swimming centres, residential compounds, and public transportation schemes in preparation for the European Games in June. The economy remains over reliant on hydrocarbons, which account for 37% of GDP, 70% of budget revenues and over 90% of exports. 

Meanwhile, the 50% drop in oil prices since last summer is beginning to take its toll on the Azerbaijani economy. With an expected $3.5bn budget deficit this year and $1.6bn in 2016, Baku’s will be increasingly strapped for cash, and need to find other ways to sustain its economic diversification efforts. Iran’s opening is therefore timely, and Baku is rushing to set up transport infrastructure to send its exports to its southern neighbour when sanctions are lifted.

In August, the two countries discussed the construction of a 7km railway link between the towns of Astara in Azerbaijan and Astara in Iran, a $400mn project that would effectively integrate their railway networks and which could be ready as early as 2016. In early October, bilateral discussions focused on a different route for freight transport that would connect Iran’s Persian Gulf ports to Baku. The second route would entail ferrying trains from the Iranian Caspian Sea port of Amirabad to Baku, from where they would be sent further north to Azerbaijan, Georgia or Russia by rail.

Azerbaijan would also benefit from a road through Iran, the Moody’s report posits, as it “would significantly shorten shipping distance and the number of transiting countries of the 25% of Azerbaijan’s oil exports that go to Asia. Currently, Azerbaijan’s main oil export route goes through the Black Sea, the Mediterranean Sea and the Red Sea,” the report concludes.