Rapid development of the Azeri economy in the former USSR was based on the expansion of both its industrial sector, led by oil-related industries, and its agricultural sector, led by grape, tobacco, and cotton production. With grape and wine production weakened by the effects of Gorbachev's anti-alcoholism campaign in the 1980s, and much of the country's industrial sector afflicted by technological obsolescence, overall economic growth in the republic had already begun to decline by 1989, when NMP dropped 6%. Real gross domestic product (GDP) contracted by almost 60% from 1990 to 1995. However, in late 1990s, foreign investment in the country's oil and natural gas sectors opened a period of steady growth. Key strategies of the Azeri government to bring about economic revitalization have included both an economic restructuring program as well as efforts to expand its economic ties to countries beyond the former Soviet Union. To the latter end, Azerbaijan joined the Economic Cooperation Organization set up by Iran, Pakistan, and Turkey to promote trade among Muslim countries. It was also the first of the former Soviet republics to become a member of the Islamic Development Bank, which provides potential access to financing for programs related to agriculture, construction, training, and food aid. In 2002, economy's prospects brightened considerably with progress made on its two major pipeline projects designed to connect the Caspian Sea to the Turkish Mediterranean to provide oil and gas for the European and North American markets, the Baku-Tbilisi-Ceyhan Export Oil Pipeline (BTC) and the Baku-Tbilisi-Erzrum Gas Pipeline. The BTC particularly received an important impetus when the Azeri government came out as a strong ally of the United States in its War on Terror.
The restructuring program in Azerbaijan has been similar to those of other countries in the former USSR. Its main points include stabilization measures (price liberalization, introduction of national currency, and establishment of an exchange rate stabilization fund); introduction of new legislation regarding privatization, foreign investment, and employment; fiscal and monetary reform (including introduction of a VAT and controls on government expenditures); civil service reform; and development of the banking sector. Four committees on antitrust, support for enterprises, state property, and land reform have been established to oversee the implementation of reform legislation. Privatization of the state enterprise sector is moving at a slow pace. Particular attention is being directed at modernizing those strategic sectors of the economy with the greatest potential for export growth, particularly the oil industry and, to a lesser extent, textile production; the role of foreign investment is seen as pivotal in these areas.
With construction on the BTC pipeline scheduled to begin in March 2003, and the real prospect of an increase in the country's oil production by a factor of almost 350% by 2005, clear progress can be seen on the strategy to develop into oil and gas resources in partnership with foreign investment.
Since 1994, the Azerbaijan parliament has ratified 22 other PSCs, 19 of which were still operative in 2003. Virtually every major oil company in the world is a player in Azerbaijan, including over 90 American companies resident in Baku in 2002. The US State Department estimates that for the period 2002– 2005 opportunities for sales of upwards of $10 billion will be available in association with the expansion of AIOC's offshore oil and gas production. Macroeconomic stability has also been a clear achievement with the government's tight fiscal and monetary policies producing low consumer price inflation rates in 2000 and 2001 of 1.8% and 1.5%, respectively, according to IMF staff reports, after two years of actual declines in the price level in 1998 and 1999, of -0.8% and -8.5%, respectively.
Economic reforms in Azerbaijan have come increasingly under the supervision of increasingly under the conservative supervision of the IMF and the World Bank, which have also taken aim at the problem of pervasive corruption in the administration of taxes and custom duties. In 2002, Azerbaijan was under a three-year Poverty Reduction and Growth Facility (PRGF) program with the IMF, the objectives of which include establishing financial discipline in the energy sector, and increasing efficiency and transparency in the operations of the Ministry of Taxation and the State Customs Committee, and developing a comprehensive anticorruption program.
In March 2002, Azerbaijan reached agreement with the World Bank for a second Structural Adjustment Credit (SAC-II) program, funded at $60 million. If implemented, the IMF and World Bank programs would greatly improve the investment climate in Azerbaijan. Azerbaijan's two privatization programs since its transition to a free market economy have faltered on the lack security and market transparency. The first, from 1996 to 1998, focused on small and medium-sized enterprises was hindered by lack of resources to properly prepare assets for privatization and insufficient information about these enterprises. A presidential decree of August 2000 opened up case-by-case sales of some of the country's largest enterprises, and in March 2001 additional decrees were issued identifying about 450 enterprises to be privatized during the second privatization program. Progress continues to be slow, however. Attempts to privatize large state enterprises, such as the Azerboru pipe facility, failed for lack of qualified bidders, although by January 2002 the government had succeeded in placing the Baku electrical distribution network under the long-term private management of a Turkish firm, Barmek Holdings. There has been no substantial progress in privatizing the important telecommunications sector. The private sector's contribution to the economy does continue to grow due to both the first privatization program and to land reform. Official statistics placed the private sector's contribution to GDP at over 70% for 2002, although independent economic observers estimate this share at closer to 50 to 60%, according to the US State Department.
The pursuit of development plans remains hampered by ongoing political conflicts in the country. The border between Azerbaijan and Armenia, still closed in 2003, limits vital trade with Turkey, not to mention the overall economic benefits of a lasting peace between the two countries. Azerbaijan's potential for economic development based on both its natural and human resources remains high, but the challenges posed by both external and external politics which have eaten at the supporting infrastructure, tangible and intangible, remain quite formidable.