VZCZCXRO5636
PP RUEHAG RUEHDF RUEHIK RUEHLN RUEHLZ RUEHROV RUEHVK RUEHYG
DE RUEHKB #1026/01 3011407
ZNR UUUUU ZZH
P 271407Z OCT 08
FM AMEMBASSY BAKU
TO RUEHC/SECSTATE WASHDC PRIORITY 0250
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUCNMEM/EU MEMBER STATES  PRIORITY
RUEHAK/AMEMBASSY ANKARA PRIORITY 3100
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RHMFISS/CDR USEUCOM VAIHINGEN GE PRIORITY
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RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 03 BAKU 001026 
 
SENSITIVE 
SIPDIS 
 
EMBASSY TBILISI PLEASE PASS DEPUTY SECRETARY OF COMMERCE 
SULLIVAN 
 
E.O. 12958: N/A 
TAGS: ETRD ECON EINV ENRG PREL AJ GG
SUBJECT: SCENESETTER FOR DEPARTMENT OF COMMERCE DEPURTY 
SECRETARY SULLIVAN VISIT TO BAKU, OCTOBER 29, 2008 
 
¶1.  (SBU) SUMMARY:  Your visit to Baku comes on the heels of 
Azerbaijan's October 15 presidential election, which resulted 
in a landslide victory for President Ilham Aliyev.  This fall 
also marked a troublesome time for the region, with Russia's 
invasion of Georgia casting a shadow on security and 
stability.  Energy continues to figure prominently in 
Azerbaijan's geostrategic vision, economic development, and 
partnership with the United States.  President Aliyev,s next 
administration must address Azerbaijan's economic development 
and the need for additional political and economic reforms in 
the face of an international finance crisis, declining oil 
prices, and regional insecurity resulting from the 
Russia-Georgia conflict.  Azerbaijan's leadership will be 
interested in hearing your views on the U.S. reaction to the 
international credit crunch ahead of the November 17 
U.S.-Azerbaijan Economic Partnership Commission, which the 
State Department will host.  Although Azerbaijan's overall 
macroeconomic situation is relatively stable, endemic 
rule-of-law and corruption problems, as well as monopolistic 
practices, continue to threaten sustainable growth in 
non-energy sectors.  End summary. 
 
MACROECONOMIC OVERVIEW 
--------------------------- 
 
¶2.  (SBU) Azerbaijan's economic performance in 2007 showed 
increasing resilience and strength as GDP grew last year by 
more than 25 percent, and is tracking to reach nearly 20 
percent for 2008.  Azerbaijan's continued growth prospects 
remain closely linked to oil prices, given that the energy 
sector provides 95 percent of total export earnings and more 
than 50 percent of GDP and an estimated 60 percent of budget 
revenue.  In 2007, inflation reached 19 percent and in 2008 
it looks likely to exceed 20 percent.  Public investment is 
expanding rapidly, but more rigorous project selection and 
execution procedures must be put in place to ensure that 
these expenditures promote sustainable growth in the non-oil 
sector.  In the coming year, the economy will continue to 
grow as Azerbaijan will receive a larger share of profits 
(80/20 split) from the ACG production sharing agreement. 
However, sharply lower oil prices and an international 
banking crisis will constrain that growth over the medium 
term. Given that the current budget is based on an assumed 
oil price of USD 70, Azerbaijan should be able to avoid 
deficits or funding shortfalls if crude oil prices remain at 
or above current levels. 
 
¶3. (SBU) The business climate outside the oil sector is 
challenging, but American companies have been able to report 
profits that are substantially higher than in developed 
markets.  Corruption remains a serious roadblock to further 
investment.  Transparency International's Corruption 
Perceptions Index (as well as anecdotal evidence from 
American business contacts in Baku) confirms that Azerbaijan 
still has a long way to go in stamping out corruption.  On 
the other hand, Azerbaijan is taking important steps to 
simplify its regulatory requirements, and for this reason the 
World Bank named it the world's "Number One Reformer" in its 
most recent "Doing Business" report. 
 
SECURITY 
-------------- 
 
¶4.  (SBU) As a result of the recent Russian invasion of 
Georgia, stability and security have become an area of 
uncertainty in the region.  The Azerbaijani government, 
besides expressing concerns about threats to the East-West 
corridor for energy exports and other trade, has voiced its 
concern and desire to find a peaceful resolution in 
Norgorno-Karabakh (NK) and has calle for more intensified 
international, and especially, U.S., attention to this 
"frozen" conflict.  Press reporting has indicated that 
Russian President Dmitriy Medvedev has proposed a meeting 
between himself, President Aliyev and Armenian President 
Sargsian before the end of the year.  The USG has also 
stepped up engagement.  Deputy Assistant Secretary Matt 
 
BAKU 00001026  002 OF 003 
 
 
Bryza, the U.S. representative to the Minsk Group, has been 
in the region multiple times since the Georgian invasion, 
actively working to assist in brokering a deal. 
 
REFORM 
------ 
 
¶5.  (SBU) Securing and advancing U.S. interests in the longer 
term depends on Azerbaijan's continued stability and 
development.  Although President Aliyev and his closest 
advisors continue to affirm their commitment to democratic 
reform, Azerbaijan's progress is incomplete.  The media 
environment is heavily restrictive, with implausible criminal 
court cases against journalists and violent attacks against 
members of the media that have gone un-prosecuted and 
unpunished.  Freedom of assembly, in practice, is severely 
limited.  Opposition parties complain that the GOAJ has 
placed undue restrictions on their ability to organize and do 
basic grassroots work, and believe that they must have parity 
in electoral commissions in order to have a level playing 
field. As a result of these complaints, some opposition 
parties chose not to participate in Azerbaijan's October 15 
presidential election. 
 
¶6.  (SBU) On the economic front, being named the number one 
reformer in the World Bank's "Doing Business 2009" report has 
boosted the spirits of many reform minded officials and 
called to task those ministries and agencies whose 
performance did not substantially contribute to that ranking. 
The WTO accession process could help bring about the 
legislative and regulatory changes needed to reform 
Azerbaijan's economy and introduce transparent, market-driven 
practices.  President Aliyev pledged to support accelerating 
Azerbaijan's WTO accession in 2007 and, with the help of 
USAID's Trade and Investment Program, Azerbaijan has made 
significant progress towards accession.  In this regard, the 
GOAJ developed and submitted to the WTO Working Group 30 
draft legal and regulatory reforms designed to liberalize the 
trade and investment regime.  Moreover, this past May the WTO 
held the first Working Party Meeting on Azerbaijan's WTO 
accession bid in almost three years, reflecting the GOAJ's 
renewed seriousness of intent in the area of trade reform. 
Recently, the GOAJ submitted comprehensive revised market 
access offers, and as a result USTR has agreed to conduct a 
bilateral negotiating meeting on the margins of the next 
Economic Partnership Commission, scheduled for November 17 in 
Washington, and the WTO is planning a second Working Party 
Meeting tentatively in December. 
 
STATE OIL FUND 
----------------------- 
 
¶7.  (SBU) Since its creation in 1999, the State Oil Fund of 
Azerbaijan (SOFAZ) has acted as Azerbaijan's energy revenue 
stabilizer and long-term savings vehicle.  The bulk of 
SOFAZ's inflows come from proceeds generated under production 
sharing agreements from sales of Azerbaijan's share of 
hydrocarbons; bonuses paid under the terms of production 
sharing agreements; acreage fees and other revenues.  SOFAZ 
is one of the most transparent GOAJ organizations, publishing 
internationally-audited quarterly and annual reports.  SOFAZ 
also plays a leading role in the Extractive Industries 
Transparency Initiative (EITI).  In 2007, the United Nations 
awarded SOFAZ a public service award for its transparency, 
accountability and responsiveness in the public sector. 
 
¶8.  (SBU) SOFAZ currently has assets in excess of USD 10 
billion (expected to grow to about USD 12 billion this year, 
and to generate about USD 200 billion in revenue over the 
next 15 years, based on an oil price of USD 70).  In 2007, 
its rate of return was approximately five percent in real 
terms.  Using a grant from the U.S. Trade and Development 
Agency, SOFAZ is now re-evaluating its portfolio strategy and 
developing a more aggressive investment strategy with the 
goal of boosting SOFAZ assets' rate of return.  The 
management of SOFAZ assets appears sound.  However, SOFAZ 
 
BAKU 00001026  003 OF 003 
 
 
only incorporates 75 percent of oil and gas revenues above 
USD 50/barrel.  The remainder is controlled by SOCAR and 
other elements of the government. 
DERSE