Kavkaz Files ISSN 2975-0474 Volume 25 Issue 3
Author: Giuliano Bifolchi

Executive Summary

Its strategic location, natural resources, and complex history shapes Azerbaijan’s geopolitical landscape. This SWOT analysis provides a comprehensive understanding of Azerbaijan’s current socioeconomic and political environment and guides investors in understanding the country’s potentialities and challenges.

Azerbaijan: Scenario Context

Azerbaijan, situated at the crossroads of Eastern Europe and Western Asia, plays a significant role in the South Caucasus region. It shares borders with Russia to the north, Georgia to the northwest, Armenia to the west, Iran to the south, and the Caspian Sea to the east. Because of its strategic geographical position, Azerbaijan enjoys crucial access to trade routes that link Europe and Asia, thus increasing its economic and geopolitical significance.

Politically, Azerbaijan is a secular republic with a predominantly Turkic and Shia Muslim population. Following its brief independence in 1918-1920 and subsequent incorporation into the Soviet Union, Azerbaijan regained independence in 1991. Since then, the country has faced ongoing conflicts, notably with Armenia over the Nagorno-Karabakh region. Despite recent events, such as Baku’s military conquering of entire Nagorno-Karabakh, tensions remain high, influencing both domestic and international political dynamics.

Socially, Azerbaijan has seen substantial improvements since independence, particularly in poverty reduction and infrastructure development, fuelled by oil and gas revenues. The nation is struggling with governance problems, as allegations of authoritarianism and corruption have a significant impact on its political environment. The Aliyev family has maintained a powerful grip on power, with Ilham Aliyev winning the early presidential elections in February 2024 and serving as the nation’s leader for his fifth term.

Economically, Azerbaijan relies heavily on its hydrocarbon resources, which account for a significant portion of its GDP, exports, and government revenue. While this wealth has enabled considerable economic development, it also poses risks related to market fluctuations and the need for economic diversification.

Strengths

1. Hydrocarbon Wealth. Azerbaijan’s substantial oil and gas reserves are the backbone of its economy. The country has leveraged its hydrocarbon wealth to establish the State Oil Fund of the Republic of Azerbaijan (SOFAZ), which supports economic stability and growth. Oil and gas have played a crucial role in Azerbaijan’s positioning as a prominent energy supplier to Europe, particularly through the Southern Gas Corridor.
2. Strategic Geographical Position. At the juncture of Europe and Asia, Azerbaijan enjoys strategic access to major trade routes. This positioning facilitates its role as a transit hub for energy and goods, enhancing its economic and geopolitical clout. The development of the Middle Corridor further underscores Azerbaijan’s importance for regional trade dynamics.
3. Economic Development and Infrastructure. The government has invested heavily in infrastructure development, using hydrocarbon revenues to modernise transport, communication, and urban infrastructure. This investment has contributed to the enhancement of the country’s connectivity and the stimulation of economic growth, particularly in the capital city of Baku.
4. Sovereign Wealth Fund. SOFAZ has a crucial role in maintaining economic stability. The fund’s significant assets mitigate the impact of economic shocks and provide support for a range of developmental endeavours. Its strategic investments contribute to long-term economic sustainability.
5. International Partnerships. Azerbaijan’s active participation in international organisations and partnership enhances its global standing. These partnerships facilitate economic cooperation, security collaboration, and integration into global markets, bolstering the country’s international influence.

Weaknesses

1. Economic Dependence on Hydrocarbons. Azerbaijan’s economy is susceptible to changes in global energy prices because of its heavy dependence on oil and gas revenues. This dependence limits economic diversification and exposes the country to significant financial risks, particularly as oil production shows signs of decline.
2. Governance and Corruption. Corruption and weak governance structures hinder Azerbaijan’s economic and social development. The politicisation of the judiciary and repression of media freedom exacerbate these issues, undermining public trust and deterring foreign investment. Transparency and accountability remain significant challenges.
3. Political Instability and Authoritarianism. The concentration of political power within the Aliyev family and the ruling New Azerbaijan Party has led to accusations of authoritarianism. The consolidation of power hampers political diversity and civil liberties, which may cause domestic instability and international censure.
4. Low Economic Diversification. Despite efforts to develop other sectors, the country’s economy remains poorly diversified. The overwhelming influence of the hydrocarbon sector impedes the progress of industries such as agriculture, manufacturing, and services, constraining job creation and economic resilience.
5. Demographic Challenges. Baku faces demographic issues, including low population growth and an aging population. The presence of these challenges makes it difficult to maintain long-term development and address labour market needs, putting a burden on social services and economic productivity.

Opportunities

1. Expansion of Gas Exports. The growing European demand for natural gas presents a significant opportunity for Azerbaijan. By increasing its gas exports, particularly after the beginning of the Ukraine conflict and through new projects in the Caspian Sea, Baku can enhance its revenue base and strengthen energy ties with Europe, reducing regional dependency on Russian gas.
2. Economic Diversification Initiatives. Thanks to its oil and gas revenues, Azerbaijan has the potential to diversify its economy by investing in different sectors. Government initiatives and foreign investments aimed at developing these sectors can reduce dependency on hydrocarbons and create sustainable economic growth.
3. Regional Trade and Infrastructure Projects. Participation in regional trade initiatives and infrastructure projects, such as the Middle Corridor and the Baku-Tbilisi-Kars railway, can boost the country’s role as a transit hub. These projects enhance connectivity, facilitate trade, and attract foreign investment, contributing to economic development.
4. Renewable Energy Development. Azerbaijan can take advantage of its favourable geographical conditions to develop and exploit renewable energy sources like wind and solar power. Investing in renewable energy infrastructure can diversify the energy mix, reduce environmental impact, and position the country as a leader in sustainable energy within the region.
5. Technological Advancement and Innovation. Fostering a culture of innovation and technological advancement can drive economic diversification and modernisation. By investing in education, research and development, and digital infrastructure, Azerbaijan can boost productivity, generate high-quality jobs, and establish itself as a strong contender in the global technology sector.

Threats

1. Regional Instability. Ongoing tensions with Armenia over border demarcation poses a persistent threat to the regional stability. Sporadic clashes and unresolved border issues can escalate into broader conflicts, undermining economic growth and investor confidence. Regional instability remains a significant geopolitical risk.
2. Global Energy Market Volatility. Fluctuations in global energy prices directly affect Azerbaijan’s economy because of its heavy reliance on hydrocarbon exports. If alternative sectors are not adequately developed, price volatility can cause revenue instability, budget deficits, and economic uncertainty.
3. International Criticism and Sanctions. Azerbaijan’s human rights record and governance practices have drawn international criticism. Potential sanctions or reduced cooperation with Western countries, particularly from the EU, could hinder economic and political relations, affecting trade and investment opportunities.
4. Environmental Challenges. Environmental degradation and climate change pose long-term threats to Azerbaijan’s economic and social well-being. Addressing problems like pollution, water scarcity, and the effects of climate change on agriculture and infrastructure requires comprehensive strategies.
5. Economic Disparities and Social Unrest. Persistent economic disparities and social inequality can lead to domestic unrest and instability. When corruption, unemployment, and insufficient social services are prevalent, public discontent can lead to protests and pose a challenge to the government’s capacity to ensure order and stability.

Outcome for Investors

Azerbaijan presents a complex landscape for investors, characterised by significant opportunities and notable risks. With its vast hydrocarbon reserves and advantageous geographic position, the country has the potential for economic growth and regional dominance. However, investors should carefully considerate country’s opportunities because of challenges regarding governance, economic diversification, and regional instability.

Investors should focus on sectors with growth potential, such as natural gas, renewable energy, and infrastructure projects. While the hydrocarbon sector remains lucrative, diversification efforts in agriculture, technology, and tourism can provide sustainable returns. It is essential to understand and navigate the political landscape, analysing geopolitical risks, especially in relation to Armenia and the broader regional dynamics.

Azerbaijan presents lucrative investment prospects in the short to medium term, but careful risk management and a thorough understanding of the changing geopolitical situation are necessary.

To obtain additional reports, risk assessments, and consulting services regarding Azerbaijan and the Caucasus, please contact us at info@specialeurasia.com.