2011 Investment Climate Statement
Bureau of Economic, Energy and Business Affairs
March 2011
Report

Strategic development of Azerbaijan’s oil and gas resources continues to drive the country’s economic growth, and keeps this country of just over 9 million people at the forefront of world energy security discussions. Unfortunately, corruption, lack of transparency, politically connected economic monopolies, and cronyism remain significant obstacles to economic progress, hindering both domestic as well as foreign investment. The nearly two decade-long, and as yet unresolved, conflict with Armenia over Nagorno-Karabakh, which left the country with hundreds of thousands of internally displaced persons (IDPs) to care for, has created a great liability for the government.

Azerbaijan’s GDP growth rate decreased again in 2010, but remained positive at 5 per cent. Moody’s Investor Service upgraded Azerbaijan’s rating and forecast from “negative” to “stable” mid-year. Fitch Ratings raised Azerbaijan’s rating to “investment grade,” citing improved management of the country’s energy resources to bolster public and external finances, while Standard & Poor’s maintained its forecast at “positive.” Foreign investments remained flat, primarily because there have been no significant improvements in the overall investment climate and few new projects related to oil and gas. Due to resource constraints, from decreases in foreign investment and increased global pricing for infrastructure inputs, Azerbaijan has begun to increase its foreign debt. This debt grew to 3.7 billion USD, an increase of 12 per cent in the first 10 months of 2010. Foreign debt now comprises a relatively modest 7.9 per cent of Azerbaijan’s Gross Domestic Product (GDP), and investment project credits make up the majority of the external debt. These credits, also financed by the state budget, helped maintain a certain level of business activity in Azerbaijan’s domestic economy.

Azerbaijan’s revenues fell short of state budget projections by less than 1 per cent in 2010. This strong improvement over 2009 revenues was based primarily on increasing oil revenues and conservative budget projections based on lower aggregate oil prices (45-70 USD/bbl). In 2010 budget revenues increased by 10 per cent, while expenditures increased 12 per cent. The Government of Azerbaijan historically props up budget deficits by direct allotments from the State Oil Fund, up to as much as 50 per cent some years. Also, in spite of the global financial crisis, Azerbaijan’s strategic currency reserves, held by the State Oil Fund and the Central Bank, increased to 29.4 billion USD during the year.

Despite public statements promising focused support for the agriculture, tourism and telecommunications sectors, Azerbaijan’s dependence on the oil and gas sector continues to increase, although at a slower pace. The sector’s share in Azerbaijan’s industrial production was reportedly 75 per cent in 2009 and increased an additional 2.6 per cent in 2010. Azerbaijan’s President acknowledged in 2009 that broader national economic development would continue to depend on the oil and gas sector for the next 10-20 years. The non-oil sector increased overall by 7.6 per cent and non-oil exports increased by 16 per cent in 2010, representing a vast improvement over the stark declines of 2009.

In 2010, 15.5 billion USD were invested in the Azerbaijani economy from all sources of financing, mainly internal. This represents nearly a 100 percent increase over 2009. Investments in the non-oil sector were 9.3 billion USD and exceeded investments in the oil sector. Local investments equaled 7.4 billion USD, an increase of 15.5 per cent, while foreign investment remained flat at 2.9 billion USD. The remaining investments were end-of-year state contributions.

The Government manages to continue to support a constantly “growing” economy by relying on enhancements from the State Oil Fund of Azerbaijan (SOFAZ), with assets totaling 21.7 billion USD in reserves as of October 1, 2010. Annual transfers from SOFAZ to the state budget are significant, but the Government has stipulated that such transfers not exceed 50 per cent of SOFAZ’s accumulated funds, with the rest being preserved as a social “safety net”. Azerbaijan was encouraged in its fiscal policies by the positive results of its efforts to protect the stability of the local currency, the manat (AZN); its high level of foreign reserves; the relatively low level of foreign debt; and increasing export-related incomes against the backdrop of recovering oil and gas prices.

The search for new exports that Azerbaijan could offer to the world is still lackluster. Industrial exports suggested by local officials, such as solar panels, telecommunications services, and atypical agricultural products require much more time and investment to become realistic engines of the economy. A very strong national currency hurts non-oil export efforts. Late in 2009, the Government also stated its intention to encourage industrial projects supporting the oil and gas sector. Related projects in the works include a methanol production plant and the construction of a shipyard in Baku. Both projects are primarily aimed at producing products for export. In the first, a private company has the lead for the project, estimated to cost over 1.1 billion AZN, with financial support from the EBRD and the International Bank of Azerbaijan. Construction on the factory began in 2007 and as of late June 2009 was only 30 per cent complete. The company plans to have the facility up and running by the end of 2011. Former UK Prime Minister Tony Blair attended a signing ceremony for the enterprise in the fall of 2009. As for the shipyard, SOCAR has partnered with offshore and marine giant Keppel, which will have a 10 per cent stake in the venture.

One additional hindrance to foreign direct investment is the difficulty of getting established Azeri businesses to adapt to standard investor-friendly practices, such as those associated with the concept of good corporate governance. Because of this inability or unwillingness to comply with the attendant disclosure and financial transparency required for potential shareholders to confidently invest, many enterprises are unable to successfully market their companies on Azerbaijan’s nascent stock market.

Because of the volumes of money involved, the oil and gas sector is considered by many to be one of the greatest sources of corruption within the country, despite Azerbaijan being named the first participating country to be fully compliant with the Extractive Industries Transparency Initiative’s (EITI) principles and criteria in 2009. However, corruption continues to plague Azerbaijan in every economic sector and is a serious impediment to the country’s economic development. The Public Sector continues to be a common source of rent seeking, damaging both market reform potential and public moral. This leads to real amalgamation of political and economic authorities at even the most basic institutional levels. Under this system, neither commercial nor state powers can develop separately from each other. Thus, losing political power often means losing economic power, and vice versa, which leads to suppression of free economic competition and stagnation of true economic development. The struggle against corruption is extremely difficult under these conditions, and makes Azerbaijan’s economic development even more problematic.

The official currency reserves of the Central Bank of Azerbaijan (CBA) – previously the National Bank of Azerbaijan – increased from 5.09 billion USD in October 2009 to 6.4 billion USD at the end of 2010. Reserves had decreased in 2009 primarily in response to the global financial crisis, which facilitated the dwindling of hard-currency reserves in Azerbaijan’s commercial banks, and prompted the CBA to expend reserves to maintain the manat’s convertibility rate, in direct support of the Azerbaijani economy.

According to the Heritage Foundation’s 2011 Economic Freedom Index, Azerbaijan’s economic freedom score is 59.7, up from 58.8 last year. This makes Azerbaijan’s economy the 92nd freest of the 179 countries ranked, up from 96th. Its overall score is 0.9 points higher than last year, reflecting an improvement in investment freedom offset by modest declines in several other factors. Azerbaijan is ranked 15th out of 41 countries in the Asia-Pacific region, and its overall score is above the regional average.

Openness to Foreign Investment

The Government of Azerbaijan officially welcomes foreign direct investment, stating that it plays a vital role in diversifying the country's economy. Since 1994, Azerbaijan has attracted significant amounts of foreign investment to further develop its energy sector. However, government bureaucracy, weak legal institutions and predatory behavior by politically connected monopolistic interests continue to hinder investment outside of the energy sector. Despite moving up one position in the World Bank’s “Doing Business Report” for 2011, from 55 to 54, Azerbaijan continues to rank among the lowest in “Trading Across Borders” (177), “Dealing with Construction Permits” (160) and “Paying Taxes” (103) of the 183 countries ranked.

The Law on Protection of Foreign Investments permits foreign direct investment (FDI) in any activity open to a national investor unless otherwise prohibited by law. Foreign investors can participate, according to the legislation, in privatization of state and municipal properties, as well as in properties with unfinished construction. In Azerbaijan, foreign investments have complete and unreserved legal protection granted by this law, other laws and international contracts. The Law on Protection of Foreign Investments permits foreign direct investment in most sectors. Prohibited areas include those relating to national security and defense, and the government carefully controls other key sectors, such as energy and communications.

The law provides that Azerbaijan will treat foreign investors in a manner “not less favored” than the treatment accorded to local investors and allows repatriation of profits, revenues, and other investment-related funds as long as applicable taxes have been paid. Azerbaijan regulates most foreign exchange and capital transactions. Foreign citizens and enterprises may lease but may not own land. Expropriation may occur in the event of natural disaster, epidemic, or other extraordinary situation. Foreign investors are legally entitled to adequate compensation. Non-transparent, arbitrary, and corrupt government bureaucracy; weak legal institutions; and predatory behavior by politically connected monopolistic interests have severely hindered investment outside of the energy sector.

Azerbaijan is not yet a member of the World Trade Organization (WTO), but the Government, with much international technical assistance, has been working to amend existing legislation in order to accede. The progress made in 2008 to achieve its rank as the World Bank’s “Doing Business 2009” number one reformer, and the adoption of many WTO-compliant legal reforms have been a visible result of the Azerbaijan's work to accede to the WTO. The Ministry of Economic Development continues to lead the WTO accession process, and Azerbaijan held one WTO Working Party Meeting in Geneva in 2010, in addition to bilateral discussions with the U.S. Trade Representative and the EU. Creating a stable and predictable business environment is especially crucial to attract investment to the non-energy sector. At present, however, efforts to improve the practical business environment have yet to be realized and Azerbaijan remains a challenging market in which to do business.

A “one-stop shop” system was applied at the State Migration Service beginning July 1, 2009. According to a Presidential Decree dated March 4, 2009, foreigners and people without citizenship arriving in Azerbaijan should be granted legal residence and work permits according to the single window principle within seven days of application, although not all applicants experience this level of efficiency. The fee to acquire a one-year license for a migrant worker is equal to 1,000 AZN (approximately 1,250 USD).

Under Azerbaijani law, foreign investors may participate in the Azerbaijan market through joint ventures with local companies, or by establishing subsidiaries wholly owned by foreign investors, as well as through representative offices and branches of foreign legal entities. The Law on Protection of Foreign Investments provides that the Azerbaijani government will treat foreign investors in a manner "not less favored" than the treatment afforded to local investors. This law provides for repatriation of profits, revenues, and other investment-related funds so long as applicable Azerbaijani taxes have been paid. The law also provides a 10-year grandfather clause in the event new legislation less favorable to the foreign investor is adopted. However, this provision does not apply to changes in tax legislation.

While the Azerbaijan employs no formal screening mechanisms for general foreign investment, the process of registering an enterprise with the Ministry of Justice serves as a de facto screening process. Although by law this step is required only to determine that the documents of enterprises seeking registration are in order; the Ministry operates in a non-transparent and arbitrary manner. Credible reports indicate that ministry officials make extra-legal determinations of whether individual foreign investments are of an “appropriate” nature before making decisions about registration. Some investors have alleged that they have received demands for bribes or other illicit payments when attempting to register their enterprises.

If a scroll bar appears below the following table, swipe the table to move left/right of the dashed line.

Measure

Year

Index/Ranking

TI Corruption Index

2010

2.4/134

Heritage Economic Freedom

2011

59.7/92

World Bank Doing Business

2011

54

MCC Gov’t Effectiveness

2010

-0.22/35%

MCC Rule of Law

2010

-0.40/26%

MCC Control of Corruption

2010

-0.46/15%

MCC Fiscal Policy

2010

8.0/88%

MCC Trade Policy

2010

77.1/61%

MCC Regulatory Quality

2010

0.11/62%

MCC Business Start Up

2010

0.991/97%

MCC Land Rights Access

2010

0.917/92%

MCC Natural Resource Mgmt

2010

79.63/48%

Conversion and Transfer Policies

Azerbaijan has a liberal exchange system, and, in general, there are no restrictions on converting or transferring funds associated with an investment into freely usable currency and at a legal, market-clearing rate. Conversion is carried out through the Baku Interbank Currency Exchange Market and the Organized Interbank Currency Market. The Baku Electronic Currency Exchange System (BEST) was launched in July 2002. Cash exchange is carried out at numerous currency exchange points and no difficulties exist in obtaining foreign exchange.

Since 2001, the CBA has required that cash transactions be conducted in Azerbaijani manats, although increasing “dollarization” of the economy is becoming evident. The average delay for remitting investment returns is two to three business days. Additional requirements relating to the disclosure of the source of currency transfers have been imposed in an attempt to reduce illicit transactions. Parliament amended legislation in 2007 to eliminate custom duties for cash currency exports, a move that is in-line with WTO requirements and is believed to help ease inflationary pressures. The Tax Ministry has occasionally frozen bank accounts of companies that it believes have failed to meet their tax obligations.

Legislation on non-bank lending agencies was passed by the Parliament December 25, 2009. It is still unclear whether this legislation will improve the accessibility of financial services for individuals and entrepreneurs, as many of the regulations and mechanisms are not yet being enforced. In October 2010, Parliament also passed the Law on Investment Schemes (Funds); the State Committee for Securities is currently in the process of writing the supporting statutes and regulations to support that law. The Baku Stock Exchange (BSE) currently lists only two stocks, but is active in educating the market and laying the foundations for active exchange once the market matures. Mortgage bonds have also helped to invigorate the market. The value of these bonds amounted to nearly 75 million in 2010, and the prospectus for 2011 is 60 million. The Azerbaijan Mortgage Fund is able to issue bonds totaling at least 100 million AZN.

Expropriation and Compensation

The Law on Protection of Foreign Investments protects foreign investors against nationalization and requisition except under certain specified circumstances. Nationalization of property does occur, when authorized by parliamentary resolution, although there have been no cases of nationalization or requisition against foreign firms in Azerbaijan. Requisition by a decision of the Cabinet of Ministers is possible in the event of natural disaster, epidemic, or other extraordinary situation. In the event of nationalization or requisition, foreign investors are entitled by law to prompt, effective, and adequate compensation.

Dispute Settlement

Disputes or disagreements arising between foreign investors and enterprises with foreign investment; state bodies of the Azerbaijan Republic; or enterprises, public organizations and other legal entities of the Azerbaijan Republic are to be settled in Law Courts of the Azerbaijan Republic or, on agreement between the Parties, in a Court of Arbitration, including those abroad. Dispute settlement mechanisms exist in Azerbaijan, but effective means of protecting and enforcing property and contractual rights are by no means assured. While the Azerbaijani government does not officially interfere in the court system, in practice courts are weak; judges often inexperienced, and seen to be easily intimidated or bought off; and progressive new tax and other economic legislation poorly understood. The Economic Court, which has jurisdiction over commercial disputes, is weak, widely regarded as corruptible, and its decisions are often inconsistent. The Civil Procedure Code of September 2000 sets forth basic civil legislation. Since 2000, the Law on International Arbitration provides for the possibility of local arbitration in international commercial matters. However, in practice arbitration is seldom used to resolve disputes.

A Bilateral Investment Treaty between the U.S. and Azerbaijan, which came into effect in 2001, provides U.S. investors with recourse to the International Center for the Settlement of Investment Disputes. Azerbaijan is a party to the World Bank Convention on the Settlement of Investment Disputes between States and Nationals of Other States and is also a member of the Multilateral Investment Guarantee Agency (MIGA). Azerbaijan is also a party to the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, which provides for binding international arbitration of investment disputes between foreign investors and the state. The Civil Procedure Code provides that foreign arbitral awards may be enforced in Azerbaijan so long as they do not contravene local legislation or public policy, and if reciprocity exists.

Investment disputes have arisen in Azerbaijan when a foreign investor or trader's success threatened well connected or favored local interests. Reportedly, resolution of such disputes has occasionally involved the foreign investor acquiring a local partner with strong ties to influential persons. Azerbaijan's bankruptcy law does not function effectively and is rarely used. However, USAID continues to work to promote a legal/regulatory reform of the bankruptcy/business closure system.

Performance Requirements/Incentives

Azerbaijan has not yet developed effective incentives to attract foreign investment, other than the incentives provided by Production Sharing Agreements in the oil and gas sector; however a special economic zone law was created and passed by Parliament on December 25, 2009. Unfortunately, to date, no such zones have been established. Performance requirements are not imposed on new investments, but investors who participate in the privatization process of enterprises often assume specific obligations regarding future investment and employment. Foreign investors are not required to purchase from local sources or export a certain percentage of output. Except for certain state monopolies, there is no requirement that nationals own shares in enterprises. Investors in production sharing agreements (PSAs) assume obligations and requirements as provided within the PSA.

There are currently no legal requirements for employment of host country nationals, though this policy may be under review by parliament. Employers wishing to hire foreign workers in Azerbaijan must obtain a license from the Ministry of Labor. Foreigners who wish to work in Azerbaijan must register with local authorities at their place of residence and obtain work permits from the Ministry of Labor. Sole proprietors, heads of representative offices and branches of foreign legal entities and their deputies, short-term (3 months or less) secondees, accredited foreign media representatives, education specialists, diplomats and international civil servants do not require work permits. In 2008, the Government introduced a work permit regime for all immigrant employees. Unfortunately, due to a lack of transparency and printed fee schedule, there exist opportunities for confusion and corruption.

As of July 1, 2009, Azerbaijan began applying “one window” principle to the State Migration Service; however, reports of the efficacy of the new system are varied.

Right to Private Ownership and Establishment

Under Azerbaijani law, foreign investors may engage in investment activities not prohibited by law. Private entities may freely establish, acquire, and dispose of interests in business enterprises. In practice, access to markets, credit and other business operations is often impeded by licensing and other regulatory requirements and by politically connected business interests that can mobilize the powers of the state to their advantage. In sectors of interest to certain senior government and political figures, competition is actively impeded through administrative barriers.

Legislation regulating real property rights include the Law on Mortgage (2005), Land Code of the Republic of Azerbaijan (1999), the Law on Land Reform (1996), the Law on Land Leasing (1999), and the Law on Land Market (1999). New laws on collateral and cadastral law have been drafted which could significantly strengthen creditor rights, and improve the transparency and fluidity with which markets for real and moveable property function. Azerbaijani citizens and legal entities, including enterprises with foreign investment, can legally own, buy, sell, and trade property. Foreign citizens and enterprises may lease, but cannot own, land.

Protection of Property Rights

Azerbaijan's judiciary is seen to be corrupt and inefficient and does not function independently of the executive. The poor quality, reliability, and transparency of governance, as well as regulatory abuse and poor contract enforcement, significantly impede the ability of many companies to do business. Politically connected business interests benefit from their control of lucrative sectors. Amendments to the Civil Code adopted in 2007 that permit the authorities to forcibly purchase property have created additional opportunities for the abuse of property rights.

Secured interests in property, both movable and real, are technically recognized. While the Government has been working with the World Bank to improve the property registration system, the system remains awash with bureaucratic requirements and is generally seen as corrupt and inefficient. In 2006, the Government centralized the processing of residential real estate transactions through a network of notary offices under the Ministry of Justice. Azerbaijan's State Real Estate Registry Service at the Committee for Property Issues has plans to improve the real estate registration system and introduce a "single-window" principle by 2013.

In the mid-1990s, Azerbaijan began implementing a national system for registering and protecting intellectual property rights with the assistance of the World Intellectual Property Organization (WIPO), of which it is a member. Azerbaijan enacted improved copyright legislation (Law on Copyright and Related Rights) in 1996, patent legislation (Law on Patents) in 1997, and trademark protection legislation (Law on Trademarks and Geographic Names) in 1998. Azerbaijan is also a party to the Convention Establishing the World Intellectual Property Organization, the Paris Convention for Protection of Industrial Property, and the Berne Convention for the Protection of Literary and Artistic Works. Azerbaijan is also a party to the Geneva Phonograms Convention, and acceded to the two WIPO Internet treaties in 2005.

Pirated software and movies, books, clothing, and other luxury items are widely available in Azerbaijan; legitimate copies of films and other media are difficult to find. The 2009 International Data Corporation study that shows that Azerbaijan is currently number eight on the list of worst offenders worldwide in the use of pirated software, with 88 per cent of all software used in the country being pirated. This is a small improvement over 90 per cent from the previous year; however, Azerbaijan amended its copyright legislation in 2008 and formed an anti-piracy commission in May 2010, with representatives from various ministries to enforce the legislation.

The Copyright Agency reports additional improvements in decreasing piracy in literature from 61 per cent to 40 per cent and in audio and video media from 90 per cent to 70 percent, over the past five years. While the Agency has made some progress by conducting raids and initiating civil court proceedings for violation of copyrights, in practice there is still limited enforcement of intellectual property rights. As part of its WTO accession program, Azerbaijan has developed a range of WTO-consistent IPR legal and regulatory reforms, which could significantly strengthen IPR rights and enforcement protections, if consistently enforced.

Transparency of the Regulatory System

Although the Azerbaijani government has improved its regulatory system in the past several years, lack of transparency and allegations of corruption remain key problems in this area. The lack of transparent policies and effective laws to establish clear rules and foster competition are particularly serious impediments to investment. Informal bureaucratic control mechanisms often interfere with the application of laws and regulations and hinder competition.

While laws and decrees are usually published in one of the country's official newspapers as well as online, implementation is often delayed while regulations are developed. Those regulations in many cases are not published or distributed. In 2008, the government began a concerted effort to improve the transparency and predictability of the business regulatory environment with the assistance of USAID, the World Bank (WB) and the International Finance Corporation (IFC). This is reflected in the well published progress made in the World Bank's 2009 “Doing Business” rankings. The major areas of improvement included establishing a one-stop shop for business registration, streamlining property registration and transfer procedures, automation of key tax administration processes, broadened coverage of the credit registry system, and improved corporate governance guidelines. The improvements made generally benefit local small businesses more than they benefit large foreign investors. Significant areas for improvement remain, including customs operations, business closure, and business permitting systems.

Previously, Azerbaijan announced plans to adopt 29 national accounting standards to be in-line with International Financial Reporting Standards (IFRS) by 2009. So far, audited financial statements have only been adopted in banking and finance, where foreign ownership is most advanced.

Moore Stephens last published a report covering the Extractive Industry Transparency Initiative (EITI) in Azerbaijan in December 2009. According to that report, non-resident companies operating in Azerbaijan extracted 92.8 million barrels of oil and 2,086 million cubic meters of natural gas in H1 of 2009. Those foreign companies paid a total enterprise profit tax of 133.061 million AZN and transit fees of 6.2 million AZN. Local companies paid royalties of 40.6 million AZN, a total enterprise profit tax of 136.1 million AZN and other taxes of 46.3 million AZN. The foreign companies contributed 62 million USD and 356 million AZN to Azerbaijan’s government in the period reported. At the time of this report, no comprehensive information for 2010 was available. In Transparency International’s annual report on corruption perception in the world, Azerbaijan ranked 134th on the list, up from 143rd, while neighboring Armenia and Georgia ranked 123rd and 68th, respectively. In 2008 Azerbaijan ranked 158th. The most corrupt spheres in Azerbaijan are perceived to be law enforcement agencies (especially State Customs), organs of executive power, medicine, and education.

Efficient Capital Markets and Portfolio Investment

As of December 2010, there were 43 commercial banks operating in Azerbaijan. The banking sector is dominated by the International Bank of Azerbaijan (IBA), which controls more than 50 per cent of the banking sector. Foreign ownership in the banking sector is limited to 50 per cent on an aggregate basis. There are 23 banks with foreign capital. According to the CBA, as of December 2010, total assets of the Azerbaijan banking system were 15.9 billion USD. Banks’ assets rose by 14.4 per cent year-on-year. As of November 11, 2010, the volume of individual deposits in the Azerbaijani banks equaled 2,707,000,000 AZN. In 2007 Azerbaijan established the National Depository Insurance Fund, which, as of December 2010, had 43 banking members. The average cost of credit ranges from 18 to 25 per cent, and the maximum interest rate on protected deposits is also quite high at 12 per cent, although lowered from 15 per cent in 2009. The amount of guaranteed secure deposits remains at 30,000 AZN.

In early 2009 the Central Bank of Azerbaijan (CBA) took unprecedented measures (as did many other countries) to support its banking system through the global financial crisis. A variety of methods were used, including decreasing the refinancing rate for a short time to 2 per cent, decreasing the mandatory reserve rates and providing direct credit support for several banks, including two larger banks. After stabilizing the bank system, the CBA began to directly finance the real economic sector under state guarantees at the Government’s request. For the first time the CBA had the right to provide long-term credits in AZN and hard currency. The measures taken to maintain the economy and banks’ liquidity (CBA provided them with over 1.8 billion AZN) helped to stabilize the economy and provide a basis for future economic growth in Azerbaijan. The average annual inflation for 2010 was 5.7 per cent.

Previously, a presidential decree required installation of point of sale (POS) terminals in all shops within two years beginning in January 2006. Despite some progress in installation of POS terminals, the vast majority of stores and restaurants still do not carry POS terminals or, if they do, avoid running card transactions to minimize taxation. The Baku Interbank Currency Exchange (BICEX) carries out inter-bank auctions of foreign exchange and Treasury bill auctions are conducted by the Baku Stock Exchange, established in 2000. Overall the securities market remains at a very nascent stage of development. In June 2010, Fitch Ratings raised Azerbaijan's long-term issuer default ratings from BB+ to BBB- with a stable outlook. In December, Standard and Poor’s reaffirmed its positive outlook on Azerbaijan, while maintaining its long- and short-term sovereign credit ratings at BB+ and B, respectively. In August 2010 Moody's Investor Service upgraded its outlook on Azerbaijan's banking system from negative to stable. Moody's Weighted Average Bank Financial Strength Rating for Azerbaijan remained "E+".

Competition from State-Owned Enterprises (SOEs)

Officially, there are no state-owned enterprises which have been delegated governmental powers. However, the State Oil Company of the Azerbaijan Republic (SOCAR) (oil and gas), Azerenerji (electricity) and Azersu (water) are all closed joint-stock companies with majority state ownership and limited private investment. In each of their spheres they are the monopoly or near-monopoly. Azerbaijan maintains that the state must retain a controlling stake in companies operating in the mining or oil and gas sectors, which strictly limits foreign or domestic private equity in these sectors, exclusive of those which are members of a PSA. Also, there are several private businesses run by politically connected individuals which wield an inordinate amount of influence on the market economy. These monopolistic actors often exercise their political connections and economic power in such a manner that discriminates against, or unfairly burdens foreign investors or foreign-owned investments.

The State Oil Fund (SOFAZ) operates as a sovereign wealth fund for Azerbaijan. It was established in 1999 and reports directly to President Aliyev through the Executive Director. SOFAZ manages all state revenue from oil and natural gas, and is charged with preserving Azerbaijan’s economic stability, helping diversify the economy and preserving the nation’s wealth for future generations. SOFAZ maintains a relatively conservative investment portfolio with 50 per cent of the total amount of the investment portfolio held in assets denominated in USD, 40 per cent denominated in Euro, 5 per cent in denominated in GBP. By policy up to 60 percent of the investment portfolio can be managed by external managers.

SOFAZ funds are routinely used to bolster the state budget and invest in large-scale nation-wide investment projects which support the country’s socio-economic development.

As a member of the Extractive Industries Transparency Initiative, and the first member country to be named fully compliant, Azerbaijan regularly publishes its annual report and independently audited budgets.

Corporate Social Responsibility

Corporate social responsibility is a relatively new concept in Azerbaijan with very little awareness outside of larger entities with strong foreign partnerships. Larger foreign entities do tend to follow generally accepted principles of corporate social responsibility and aim to educate their local partners. There is a local risk management professionals’ association which is working to raise awareness of corporate social responsibility among local firms.

Political Violence

There have been no acts of political violence against U.S. businesses or assets, nor against any foreign-owned entity. The risk of political violence affecting foreign investors remains minimal. In 2006 and 2007, the Azerbaijani authorities arrested two separate groups that were accused of plotting terrorist acts against Western interests. Police periodically use force to disperse unauthorized demonstrations or spontaneous acts of public discontent.

Corruption

Corruption, including bribery, raises the costs and risks of doing business. Corruption has a corrosive impact on both market opportunities overseas for U.S. companies and the broader business climate. It also deters international investment, stifles economic growth and development, distorts prices, and undermines the rule of law.

It is important for U.S. companies, irrespective of their size, to assess the business climate in the relevant market in which they will be operating or investing, and to have an effective compliance program or measures to prevent and detect corruption, including foreign bribery. U.S. individuals and firms operating or investing in foreign markets should take the time to become familiar with the relevant anticorruption laws of both the foreign country and the United States in order to properly comply with them, and, where appropriate, they should seek the advice of legal counsel.

The U.S. Government seeks to level the global playing field for U.S. businesses by encouraging other countries to take steps to criminalize their own companies’ acts of corruption, including bribery of foreign public officials, by requiring them to uphold their obligations under relevant international conventions. A U. S. firm that believes a competitor is seeking to use bribery of a foreign public official to secure a contract should bring this to the attention of appropriate U.S. and international agencies, as noted below.

Corruption is a significant deterrent to investment in Azerbaijan, especially in the non-energy sector. Laws and regulations that exist to combat corruption have not been effectively enforced. A new anti-corruption law came into force in January 2005. Under the terms of the law, a new commission has the authority to require full financial disclosure from government officials. However, Azerbaijan made little progress in implementing this law. The Azerbaijani government recognizes that corruption is a problem, although it frequently disagrees with the results of international rankings produced by groups such as Transparency International. Popular opinions identify the State Customs Committee as the institution of greatest concern to businesses in Azerbaijan, followed by the Ministry of Taxation. Corruption appears most pervasive in the regulatory, tax and dispute settlement systems. Throughout the country, problems in the quality, reliability and transparency of governance, as well as abuse of the regulatory system and poor contract enforcement, significantly impede the ability of many companies to do business in Azerbaijan and have driven many companies, including some major Western firms, from the market.

In the past several years, politically connected businesses appear to have benefited from government regulatory and other decisions to achieve effective control over several lucrative sectors of the economy, and U.S. investors have been among those victimized. Currently, powerful state-owned enterprises, such as the Azerbaijan State Caspian Shipping Company (CASPAR) and Azerbaijan Airlines (AZAL), have protected their commercial interests by blocking new entrants into the market through the exercise of their regulatory authority -- a clear conflict of interest. A focus of current international community work in Azerbaijan is combating corruption and improving governance. In 2004, Azerbaijan joined the Council of Europe's Group of States against Corruption (GRECO), but Azerbaijan is not a signatory to the OECD Convention on Combating Bribery.

In 2009 Azerbaijan became the first participating country to achieve “fully compliant” status in Extractive Industries Transparency Initiative (EITI), which it joined in 2004 to promote more transparent management of oil revenues. As part of its obligation under this program, Azerbaijan issues annual and semi-annual reports and released its 11th EITI report on 14 December 2009 covering the period Jan-Jun 2009.

Over the past few years the Government has spent large amounts on developing Azerbaijan's road-transport system; however, the absence of proper financial controls opens broad opportunities for corruption in implementing these projects. This was the core opinion expressed by the EITI Public Unions Coalition, a union of social watchdog NGO’s, at their December 2009 conference entitled: "Prospering Baku: how much does it cost us?" Local economics experts stated in a report that the financing of major projects from the state budget do not follow standard best practices for cost benefit analyses. They pointed out that contractors for these lucrative projects are not selected through tenders; they are appointed. They also noted that these large social investment projects are not even monitored by the state Accounting services. Such projects include: the reconstruction and expansion of Heydar Aliyev avenue (estimated to value over 40,691,000 AZN), a new road from Azizbekov metro station to the international airport (298,492 AZN), the construction of an intersection near the Excelsior Hotel (95,590,100 AZN) , and the construction of an intersection near Azizbekov metro (128,896,400 AZN). Al Jazeera broadcast an investigative report in 2009, claiming that a government-funded road from Baku to the airport was built at a cost of 23 million USD per kilometer, while a World Bank-funded road south of the capital was built at a cost of 1.5 USD million per kilometer, raising questions about the rationale for such stark differences.

Anti-Corruption Resources

Some useful resources for individuals and companies regarding combating corruption in global markets include the following:

· Information about the U.S. Foreign Corrupt Practices Act (FCPA), including a “Lay-Person’s Guide to the FCPA” is available at the U.S. Department of Justice’s Website at: http://www.justice.gov/criminal/fraud/fcpa.

· Information about the OECD Anti-bribery Convention including links to national implementing legislation and country monitoring reports is available at: http://www.oecd.org/department/0,3355,en_2649_34859_1_1_1_1_1,00.html. See also new Antibribery Recommendation and Good Practice Guidance Annex for companies: http://www.oecd.org/dataoecd/11/40/44176910.pdf

· General information about anticorruption initiatives, such as the OECD Convention and the FCPA, including translations of the statute into several languages, is available at the Department of Commerce Office of the Chief Counsel for International Commerce Website: http://www.ogc.doc.gov/trans_anti_bribery.html.

· Transparency International (TI) publishes an annual Corruption Perceptions Index (CPI). The CPI measures the perceived level of public-sector corruption in 180 countries and territories around the world. The CPI is available at: http://www.transparency.org/policy_research/surveys_indices/cpi/2009. TI also publishes an annual Global Corruption Report which provides a systematic evaluation of the state of corruption around the world. It includes an in-depth analysis of a focal theme, a series of country reports that document major corruption related events and developments from all continents and an overview of the latest research findings on anti-corruption diagnostics and tools. See http://www.transparency.org/publications/gcr.

· The World Bank Institute publishes Worldwide Governance Indicators (WGI). These indicators assess six dimensions of governance in 212 countries, including Voice and Accountability, Political Stability and Absence of Violence, Government Effectiveness, Regulatory Quality, Rule of Law and Control of Corruption. See http://info.worldbank.org/governance/wgi/sc_country.asp. The World Bank Business Environment and Enterprise Performance Surveys may also be of interest and are available at: http://go.worldbank.org/RQQXYJ6210.

· The World Economic Forum publishes the Global Enabling Trade Report, which presents the rankings of the Enabling Trade Index, and includes an assessment of the transparency of border administration (focused on bribe payments and corruption) and a separate segment on corruption and the regulatory environment. See http://www.weforum.org/en/initiatives/gcp/GlobalEnablingTradeReport/index.htm.

· Additional country information related to corruption can be found in the U.S. State Department’s annual Human Rights Report available at http://www.state.gov/j/drl/rls/hrrpt/.

· Global Integrity, a nonprofit organization, publishes its annual Global Integrity Report, which provides indicators for 92 countries with respect to governance and anti-corruption. The report highlights the strengths and weaknesses of national level anti-corruption systems. The report is available at: http://report.globalintegrity.org/.

U.S. Foreign Corrupt Practices Act: In 1977, the United States enacted the Foreign Corrupt Practices Act (FCPA), which makes it unlawful for a U.S. person, and certain foreign issuers of securities, to make a corrupt payment to foreign public officials for the purpose of obtaining or retaining business for or with, or directing business to, any person. The FCPA also applies to foreign firms and persons who take any act in furtherance of such a corrupt payment while in the United States. For more detailed information on the FCPA, see the FCPA Lay-Person’s Guide at: http://www.justice.gov/criminal/fraud/docs/dojdocb.html.

Other Instruments: It is U.S. Government policy to promote good governance, including host country implementation and enforcement of anti-corruption laws and policies pursuant to their obligations under international agreements. Since enactment of the FCPA, the United States has been instrumental to the expansion of the international framework to fight corruption. Several significant components of this framework are the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (OECD Anti-bribery Convention), the United Nations Convention against Corruption (UN Convention), the Inter-American Convention against Corruption (OAS Convention), the Council of Europe Criminal and Civil Law Conventions, and a growing list of U.S. free trade agreements. Azerbaijan is party to the UN Convention, and a signatory to the Council of Europe Criminal and Civil Law Conventions.

OECD Anti-bribery Convention: The OECD Anti-bribery Convention entered into force in February 1999. As of December 2009, there are 38 parties to the Convention including the United States (see http://www.oecd.org/dataoecd/59/13/40272933.pdf). Major exporters China, India, and Russia are not parties, although the U.S. Government strongly endorses their eventual accession to the Convention. The Convention obligates the Parties to criminalize bribery of foreign public officials in the conduct of international business. The United States meets its international obligations under the OECD Anti-bribery Convention through the U.S. FCPA. Azerbaijan is not currently a party to the OECD Convention.

UN Convention: The UN Anticorruption Convention entered into force on December 14, 2005, and there are 143 parties to it as of December 2009 (see http://www.unodc.org/unodc/en/treaties/CAC/signatories.html). The UN Convention is the first global comprehensive international anticorruption agreement. The UN Convention requires countries to establish criminal and other offences to cover a wide range of acts of corruption. The UN Convention goes beyond previous anticorruption instruments, covering a broad range of issues ranging from basic forms of corruption such as bribery and solicitation, embezzlement, trading in influence to the concealment and laundering of the proceeds of corruption. The Convention contains transnational business bribery provisions that are functionally similar to those in the OECD Anti-bribery Convention and contains provisions on private sector auditing and books and records requirements. Other provisions address matters such as prevention, international cooperation, and asset recovery. Azerbaijan signed onto the Convention in February 2004 and ratified it in November 2005.

OAS Convention: In 1996, the Member States of the Organization of American States (OAS) adopted the first international anticorruption legal instrument, the Inter-American Convention against Corruption (OAS Convention), which entered into force in March 1997. The OAS Convention, among other things, establishes a set of preventive measures against corruption provides for the criminalization of certain acts of corruption, including transnational bribery and illicit enrichment, and contains a series of provisions to strengthen the cooperation between its States Parties in areas such as mutual legal assistance and technical cooperation. As of December 2009, the OAS Convention has 33 parties (see http://www.oas.org/juridico/english/Sigs/b-58.html) Azerbaijan is not a party to the OAS Convention.

Council of Europe Criminal Law and Civil Law Conventions: Many European countries are parties to either the Council of Europe (CoE) Criminal Law Convention on Corruption, the Civil Law Convention, or both. The Criminal Law Convention requires criminalization of a wide range of national and transnational conduct, including bribery, money-laundering, and account offenses. It also incorporates provisions on liability of legal persons and witness protection. The Civil Law Convention includes provisions on compensation for damage relating to corrupt acts, whistleblower protection, and validity of contracts, inter alia. The Group of States against Corruption (GRECO) was established in 1999 by the CoE to monitor compliance with these and related anti-corruption standards. Currently, GRECO comprises 46 member States (45 European countries and the United States). As of December 2009, the Criminal Law Convention has 42 parties and the Civil Law Convention has 34 (see www.coe.int/greco.) Azerbaijan is a party to the Council of Europe Criminal and Civil Law Conventions.

Free Trade Agreements: While it is U.S. Government policy to include anticorruption provisions in free trade agreements (FTAs) that it negotiates with its trading partners, the anticorruption provisions have evolved over time. The most recent FTAs negotiated now require trading partners to criminalize “active bribery” of public officials (offering bribes to any public official must be made a criminal offense, both domestically and trans-nationally) as well as domestic “passive bribery” (solicitation of a bribe by a domestic official). All U.S. FTAs may be found at the U.S. Trade Representative Website: http://www.ustr.gov/trade-agreements/free-trade-agreements. Azerbaijan does not currently have a free trade agreement in place with the United States.

Local Laws: U.S. firms should familiarize themselves with local anticorruption laws, and, where appropriate, seek legal counsel. While the U.S. Department of Commerce cannot provide legal advice on local laws, the Department’s U.S. and Foreign Commercial Service can provide assistance with navigating the host country’s legal system and obtaining a list of local legal counsel.

Assistance for U.S. Businesses: The U.S. Department of Commerce offers several services to aid U.S. businesses seeking to address business-related corruption issues. For example, the U.S. and Foreign Commercial Service can provide services that may assist U.S. companies in conducting their due diligence as part of the company’s overarching compliance program when choosing business partners or agents overseas. The U.S. Foreign and Commercial Service (FCS) can be reached directly through its offices in every major U.S. and foreign city, or through its Website at www.trade.gov/cs. The FCS does not maintain an office in Azerbaijan; inquiries may be directed to the Embassy’s Economic Section.

The Departments of Commerce and State provide worldwide support for qualified U.S. companies bidding on foreign government contracts through the Commerce Department’s Advocacy Center and State’s Office of Commercial and Business Affairs. Problems, including alleged corruption by foreign governments or competitors, encountered by U.S. companies in seeking such foreign business opportunities can be brought to the attention of appropriate U.S. government officials, including local embassy personnel and through the Department of Commerce Trade Compliance Center “Report A Trade Barrier” Website at tcc.export.gov/Report_a_Barrier/index.asp.

Guidance on the U.S. FCPA: The Department of Justice’s (DOJ) FCPA Opinion Procedure enables U.S. firms and individuals to request a statement of the Justice Department’s present enforcement intentions under the anti-bribery provisions of the FCPA regarding any proposed business conduct. The details of the opinion procedure are available on DOJ’s Fraud Section Website at www.justice.gov/criminal/fraud/fcpa. Although the Department of Commerce has no enforcement role with respect to the FCPA, it supplies general guidance to U.S. exporters who have questions about the FCPA and about international developments concerning the FCPA. For further information, see the Office of the Chief Counsel for International Counsel, U.S. Department of Commerce, Website, at http://www.ogc.doc.gov/trans_anti_bribery.html. More general information on the FCPA is available at the Websites listed below.

Exporters and investors should be aware that generally all countries prohibit the bribery of their public officials, and prohibit their officials from soliciting bribes under domestic laws. Most countries are required to criminalize such bribery and other acts of corruption by virtue of being parties to various international conventions discussed above.

Public sector corruption, including bribery of public officials, remains a major challenge for U.S. firms operating in Azerbaijan. Although anticorruption legislation is in place and being developed along international norms, corrupt practices permeate all spheres of public life. Officials from the lowest ranks of the civil service to the top echelons of government are believed to be among the key drivers of systemic corruption in the country. According to Azerbaijan’s law on corruption, government officials are required to declare their assets, but the format of this declaration and the rules for submission of financial declarations remains to be approved by the Cabinet of Ministers. Because of this, there is no mechanism to verify the financial declarations of the officials concerned, or to enforce the provisions of the law.

To its credit the Azerbaijani Government has made significant progress in the area of anti-money laundering and countering terrorism finance (AML/CTF) through its newly established Financial Monitoring Service (FMS). The FMS is charged with monitoring and analyzing suspicious transactions across the banking and finance sector. Because of its considerable efforts to improve legislation, statutes, and procedures, the FMS was removed from international Financial Action Task Force and Moneyval watch lists in October 2010.

Bilateral Investment Agreements

Azerbaijan has signed agreements on mutual protection of investments with 39 countries and on the avoidance of double taxation with 40 countries. On October 18, 2000, the U.S. Senate ratified the Treaty between the Government of the United States of America and the Government of the Republic of Azerbaijan Concerning the Encouragement and Reciprocal Protection of Investment (commonly known as a "Bilateral Investment Treaty" (BIT). Azerbaijan and the U.S. exchanged instruments of ratification on July 3, 2001, and the treaty entered into force on August 2, 2001.

In addition to the above agreements, Azerbaijan has bilateral investment protection agreements with the following countries: Austria, Belgium, Bulgaria, China, Egypt, Finland, France, Georgia, Germany, Greece, Iran, Italy, Kazakhstan, Kyrgyzstan, Latvia, Libya, Moldova, Pakistan, Poland, Saudi Arabia, Switzerland, Turkey, UAE, Ukraine, and the United Kingdom.

OPIC and Other Investment Insurance Programs

OPIC provided 100 million USD in political risk insurance to U.S.-based financial institutions and U.S. equity partners in the Baku-Tbilisi-Ceyhan oil pipeline. In 2008, OPIC provided 4.8 million USD to Rabita Bank to expand the bank’s Small and Medium Enterprise (SME) lending portfolio. In 2009, OPIC provided 7.3 million USD to Turan Bank to expand its SME loan portfolio and 1 million and 3 million USD, respectively to FinDev and CredAgro for microfinance lending.

Export-Import Bank of the United States (Ex-Im Bank) states in its 2010 annual report that this year it has authorized insurance and loan guarantees for Azerbaijan in the amount of 7.2 million USD. These authorizations are primarily in support of aviation and telecommunications sales.

In December 2009, the Israel Export Insurance Corp. Ltd. (ASHRA) provided a project loan guarantee to Azerbaijan for the first time. The Ministry of Transport of Azerbaijan announced that country’s finance and transport ministers signed a loan agreement with France’s BNP Paribas to reconstruct several highways in Azerbaijan. The 270 million USD loan was designed to reconstruct a 156 km section of the Baku-Shemakha-Yevlakh (M4) highway, total length 280 km, from Muganli-Yevlakh. The loan was granted for 14 years with a 4-year grace period, and will be repaid in six-month tranches – on 15 June and 15 December every year. Loan rate is rate of 6-month LIBOR in US dollars plus a margin of 3.5 per cent per annum. 70 per cent of the loan will be provided by BNP Paribas (189 million USD) and 15 per cent by Israel’s BANK LEUMI LE ISRAEL B.M. and BANK HAPOALIM B.M (40.5 million USD).

Labor

Azerbaijan has an abundant supply of qualified, trained technicians and skilled and unskilled laborers. At the same time, companies cite increasing problems with hiring skilled professional staff, which could be the result of a decline in quality education and labor emigration. The collapse of the old Soviet industrial sector in this country during the 1990s resulted in large numbers of Azerbaijanis becoming unemployed or underemployed. Government sources estimate the rate of unemployment at 6 or 7 per cent, but other sources quote up to20 per cent or more, with underemployment being much higher. As of September 2010, both the minimum monthly wage and the base compensation for pensions were set at 85 AZN, a 13 per cent increase over the 2008 minimum wage. The average monthly salary also rose to 325 AZN per month (260 USD), representing a 9 per cent increase over 2009.

A Labor Code that took effect in 1999 regulates labor relations. The workweek is generally 40 hours; the right to strike exists, but industrial strikes are rare. Azerbaijan is a member of the International Labor Organization (ILO) and has ratified more than 50 ILO Conventions. Azerbaijan is currently working with the World Bank on a program to reform the state pension system. In 2010, the State Migration Service received over 54,000 registration appeals, a drastic contrast to the approximately 2,000 migrant workers who were registered in Azerbaijan less than five years ago. Most migrant workers are from CIS countries such as Georgia and Russia, but also Turkey, Iran, the U.S., and UK. The State Migration Service also receives frequent appeals from foreigners seeking refugee status in Azerbaijan. Most are from Pakistan and Afghanistan and some are from Iran.

Foreign Trade Zones/Free Ports

Although the government announced in 2003 its intention to create special economic zones, and passed a law to establish such zones in 2009, there are currently no foreign trade zones or free ports operating in the country. The Ministry of Economic Development has also announced plans to create a special economic zone near a new Caspian port to be completed in 2012. The Ministry of Communication and Information Technologies has conducted a feasibility study to create Regional Innovation Zones with an aim to boost development of the telecommunications sector and to turn Azerbaijan into a regional information and communication technology hub.

Azerbaijan’s Cabinet of Ministers has approved simplified rules for customs controls, customs checkpoints, customs clearance of goods, and the crossing of vehicles and individuals at the boundaries of special economic zones (SEZ). According to these rules, customs checkpoints may be established in the SEZ by the State Customs Committee unless otherwise provided for customs registration by the law. For these purposes, electronic control and declarations may be used. Under the new rules, goods imported into and exported from the SEZ are not subject to import duties and VAT, or customs duties and taxes (excluding excise duty).

Foreign Direct Investment Statistics

The following data are the latest available from the State Statistical Committee of Azerbaijan:

Foreign investments (mln. U.S. dollars)

If a scroll bar appears below the following table, swipe the table to move left/right of the dashed line.

2000

2005

2006

2007

2008

2009

Total foreign investments

927.0

4893.2

5052.8

6674.3

6847.4

5468.6

of which:

Financial credits

262.9

698.4

983.5

1576.6

2357.9

1438.3

In oil industry

546.1

3799.9

3422.3

4003.3

3350.7

2412.7

Foreign companies and joint ventures

118

230.5

368.4

439.1

494.1

624.4

of which:

Turkey

31.6

96.2

136.6

109.2

60.8

...

USA

11.2

24.8

70.0

78.0

108.8

...

Iran

2.9

1.2

17.5

4.6

-

...

Germany

1.7

21.5

17.4

22.9

48.2

...

Russia

-

5.1

4.6

10.7

5.8

...

United Kingdom

6.8

39.5

39.1

80.0

146.4

...

UAE

2.8

5.7

18.3

12.3

38.5

...

Switzerland

-

0.5

2.7

3.5

3.7

...

France

39.3

2.6

11.1

4.4

-

...

Cyprus

-

0.2

5.4

13.2

2.2

...

China

-

0.2

1.3

1.2

8.1

...

Italy

-

4.6

2.8

14.0

2.0

...

Pakistan

-

-

3.1

-

-

...

Japan

16.4

-

-

-

0.4

...

Other countries

5.3

28.4

38.5

85.1

69.2

...

Bonus of oil

-

1.0

17.0

68.2

3.5

1.0

Other investments

163.4

261.6

587.1

641.2

992.2

Major Foreign Investors:

Significant foreign investors in the energy sector include BP, ExxonMobil, TPAO, Statoil, Lukoil, Itochu, Chevron, ENI, Halliburton, and Schlumberger. Significant non-energy investments include Garadagh Cement, Baltika (brewery), Coca Cola, Pepsi Cola, Azercell (mobile telephony), Bakcell (mobile telephony), Azerfon (mobile telephony), and Hyatt Hotels Baku.

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