Transparency & efficiency: Why are Azerbaijan’s state-owned enterprises commercialized?

State-owned enterprises play an important role in Azerbaijan’s economy: 14 large state-owned enterprises provide a quarter of all tax revenues to the state budget and ensure 25% share in employment in the country. In addition, the State Oil Company of Azerbaijan (SOCAR) is the largest taxpayer in the country.

The country has more than 5,000 active state-owned enterprises operating in at least 29 sectors, including manufacturing, hospitality and banking. Many large state-owned enterprises enjoy a monopoly or near-monopoly status in their field. However, many state-owned enterprises are now suffering losses, making an insignificant contribution to the budget, while receiving significant subsidies from it.

In order to avoid risks for Azerbaijan’s state budget due to the inefficient work of most state-owned enterprises, their high debt burden, losses and the risk of losing solvency, in June 2019, the implementation of their reform program began.

In particular, the rules and standards of corporate governance were adopted, including evaluation of the efficiency of state-owned enterprises, and a system of bonuses based on the result was created.

To improve the management and performance of large enterprises, the Azerbaijan Investment Holding (AIH) was established in August 2020, under whose management 14 largest state-owned enterprises were transferred. This decision confirms the government’s commitment to maximize efficiency and strengthen the management of strategic state-owned enterprises, which will remain state-owned. After all, most of the state-owned enterprises transferred to the holding operated at a loss.

Over the almost two years, according to Minister of Economy Mikayil Jabbarov, the country has “a number of achievements in ensuring the efficiency of work and transparency in the management of a number of state-owned enterprises.”

“Our achievement is measured by an increase in the efficiency of enterprises, in other words, an increase in their profitability. If an enterprise cannot make a profit from a structural point of view, say, due to a tariff policy or some other objective reasons, then it is measured by improving its quality indicators. We observe this in most of the companies included in the portfolio of Azerbaijan Investment Holding,” Jabbarov noted.

In confirmation of the minister’s words, it is worth noting that the state-owned companies that are part of the holding - SOCAR, AzerGold, Azerbaijan Caspian Shipping Company (ASCO), Baku International Sea Trade Port, International Bank of Azerbaijan (ABB), Azer-Turk Bank - completed 2021 with operating profit.

A positive trend in financial performance was also observed in the first quarter of 2022. For example, SOCAR ended the 2021 financial year with an operating profit of 8 billion manats ($4.704 billion), earning a net profit of 2.1 billion manats ($1.234 billion), while EBITDA for the first quarter of 2022 reached 3 billion manats ($1.764 billion).

ASCO ended 2021 with a net profit of 51.792 million manats ($30.457 million), up 15% from 2020, while the operating income of the shipping company increased by 9% to 459.133 million manats ($270.007 million).

ABB completed 2021 with a net profit of 208.8 million manats ($122.790 million), an increase of 61.4% compared to 2020, with revenues of 604.652 million manats ($355.579 million), an increase of 13.7%, and in the first half of the year the bank earned a net profit of 118.4 million manats ($69.627 million) with revenues of 335.496 million manats ($197.295 million), an increase of 6.6%.

The net profit of Azer-Turk Bank last year increased by 29% and amounted to 546,000 manats ($321,085), while revenues reached 35.819 million manats ($21.064 million), an increase of 15.4%. The bank completed the first half of this year with a profit of 812,000 manats ($477,512), an increase of 81.3%, and revenues amounted to 23.219 million manats ($13.654 million), an increase of 60.4%.

Given that Azerbaijan Investment Holding intends to adopt a roadmap for the further development of state-owned enterprises to manage state-owned companies in the coming years, it is safe to expect an improvement in the financial performance of other members of the holding.

According to IMF analysts, a successful reform in reducing state participation in the Azerbaijani economy will support the transition to a growth model based on the private sector and help reduce fiscal risks.

IMF economists propose to separate commercial activities from non-commercial, while the latter should be financed from the budget. It is also proposed to increase SOE transparency and performance monitoring through the Azerbaijan Investment Holding, promote privatization and financial restructuring where necessary, and introduce measures to mitigate the social impact of SOE reforms.

The Asian Development Bank (ADB) also urged the Azerbaijani authorities to continue expanding reforms aimed at introducing corporate management standards in large state-owned companies and pay more attention to the financial recovery of enterprises put up for privatization.

ADB considers it necessary to improve public procurement procedures, create a high-quality dividend policy, change the system for appointing heads of state enterprises, create a new bonus system, etc. In addition, it is necessary to increase the transparency of the publication of quarterly financial reports, strategies of state-owned enterprises, the results of their activities, and the conclusions of external auditors.

According to ADB estimates, another reason for the inefficient work of state-owned enterprises is the fact that they are involved in the implementation of state policy in the field of employment and social security. In addition, almost all state-owned enterprises need support from the state budget due to the unfavorable financial situation in them.

The World Bank (WB), in turn, while supporting the reforms carried out by the Azerbaijani government to strengthen the efficiency of management in state-owned enterprises, believes that the further process will require a consistent set of reforms aimed at justifying the preservation of state ownership. It also requires a separation of the role of the state in the regulatory, policymaking and operational functions of state-owned enterprises in the dominant sectors of the economy.

The recommendations also include a proposal to strengthen company incentives and accountability to improve operational efficiency. To attract private investors to competitive sectors, it is necessary for the state to withdraw from participation in some state-owned enterprises. Finally, the introduction of the necessary social safety nets and other support in the form of training, retraining and assistance in finding work for the labor force, which can be released as a result of the increase in the efficiency of state-owned enterprises.

Ultimately, ongoing reforms will ensure that state-owned companies move from unprofitable to profitable, control over debt obligations and prevent excessive spending. By creating new sources of income, budget subsidies can be minimized.

Given the unique location of Azerbaijan, which creates opportunities for the country to become a regional transit and transport hub, the strengthening of state-owned companies will only increase their competitiveness in the global market.

Report’s Analytical Group