This article is part of ECFR's Wider Europe Forum

Collapsing oil prices are hastening the moment of reckoning for the tottering Azerbaijani political and economic system

Azerbaijan's economic and political systems have been destined to collapse for quite some time. The recent drop in oil prices has merely accelerated the process and made it seem even more obvious. The lack of free elections and freedom of speech, along with the persecution of civil society, politically-motivated arrests, and weak local government have all made a systemic crisis inevitable.

In order to understand the Azerbaijani economy you need to look at the balance of trade and the budget. Sixty-five percent of the 2015 budget came from the State Oil Fund of Azerbaijan. If you include indirect revenues, this means that 80 percent of the total budget comes from energy. The most striking example of energy dependency is the trade balance. Official data shows that total exports for 2015 came to $11.4 billion – nearly 50 percent less than in 2014. Of this, $9.9 billion is for energy, meaning that non-energy exports represented a measly $1.4 billion of the total.Moreover, the public sector accounts for $10.1 billion of all exports (with EU countries as the main destination of $6.8 billion).

Azerbaijan has a huge dependency on oil, and the global fall in oil prices has led to the country’s current economic problems and the 2015 currency devaluations (in February the currency was devalued by 34 percent, and in December by 48 percent). The price of oil may fall yet further on the back of the Iran deal and the return of the United States to the oil market. Azerbaijan’s oil fund reserves are falling because its investments were risky, because they were placed in real estate, gold, and the currencies of developing countries. Moreover, National Bank reserves were $16 billion in October 2014, whereas now they are just $5 billion, and falling. The economic crisis in Russia has also had a knock-on effect in Azerbaijan, with remittances from the country being only one tenth of what they were before the crisis ($4 billion).

Making the situation even more precarious is the fact that Azerbaijan depends hugely on imports. Seventy percent of food is imported, and for clothes, medicine, and cars, import dependency is at almost 100 percent. Faced with economic crisis, the price of ordinary goods in Azerbaijan immediately skyrocketed. There were public protests around the country, although they were not of a political nature. People demanded jobs and a decent standard of living. As prices have risen, incomes have plummeted. Over the course of the last two years, many people have returned home from Russia and Baku itself where they have lost their jobs. Over the past six months, after the European Games in June 2015, and after the devaluations, there was a significant uptick in unemployment, especially in Baku,with a massive reduction in construction contracts. It is estimated that about 120,000-130,000 jobs will be lost in the construction industry in 2016. The Turkish and (post-sanctions) Iranian construction markets could come to replace those of Russia and Azerbaijan.

Social tension in towns and rural areas is high and will only get worse. Moreover, there is no real local government; the regions are controlled by a chief executive directly appointed by the president, who follows orders from Baku rather than listening to local demands. Azerbaijan is the only member of the Council of Europe that has not yet created an institution of elected mayors, despite this being one of its commitments.

Oil prices will likely fall to the levels of the late 1990s and early 2000s and the declining prices have already had a knock-on effect on real estate, the car market and luxury goods. What’s more, all of this is about to get a lot worse, with a major banking crisis on the horizon. If the banking crisis strikes, Azerbaijan will be sent back to the 1990s, sustaining itself through a thriving black market, barter, and rampant crime.

Voices on social media generally blame the government, which has failed over the years to build a normal diversified economy and reduce dependence on oil. The feeling is that the fall in oil prices wouldn’t be so disastrous if the economy had been managed properly. People are especially shocked by wastefully expensive public events like the European Games in 2015 (which is estimated to have cost $4 billion and failed to bring the increase in tourist numbers that the government promised)and theFormula 1 race which will take place in Baku in July 2016 (with expected costs of $350 million). The public are not fooled by the government, which explains the fall in oil prices by pointing towards a supposed global conspiracy against Russia and its economy, causing Azerbaijan to suffer in parallel.

The government blithely ignored the price rises for consumer goods and announced that the official inflation rate for 2015 was 4 percent, whilst US financial services company Standard & Poor’s estimate that it might reach 15 percent this year. The government quite simply has no idea how to pull the country out of its crisis. The people in power have no clear ideology; they only have loyalty, because of corruption and personal interests, which dominate the conversation at all levels of the power structure. This system of patronage has worked so far because of the sheer amount of oil money in circulation, and a repressive police apparatus and biased courts help to protect the interests of those in power. Even supposing that anyone actually wanted to reform the system, they would run into a significant amount of resistance. There are various clans whose personal financial interests would be affected, especially the president’s family clan (known asthe "Nakhchivan clan") and the "Pashaevsky clan" (relatives and friends of the first lady) who have been fighting over Azerbaijan’s rapidly dwindling resources. Any radical steps, like dismantling monopolies or fighting corruption, would necessitate the "lower classes" breaking their loyalty to those higher up, which is unthinkable.

The authorities have to realise that the root of the many problems facing the country is not the price of oil. Rather, it is that Azerbaijan does not have a democratic electoral system or due respect for the rule of law. If the government had held free parliamentary elections in 2015, it would be much easier to have a proper debate and come up with a solution to the crisis. Instead, ithas spent the last few years destroying civil society, independent media and independent academic institutions. The result is that now, when they’re needed most, there is no one on hand to advise the government about how to get out of this crisis.

What is happening now is a classic example of a crisis of the system and the powers that oversee it. We are already at the stage where economic reform alone will not be enough to remedy the situation. Azerbaijan can still avoid complete economic failure, but debt is growing as fast as its international rating is falling. If the government continues to take no action, then in a year or two, there may well be a default.

What Azerbaijan needs is fundamental systemic reform: new democratic parliamentary elections, independent courts, local government reform, and improved relations with the West. Before 2013, it might have been possible to put in place major economic reforms without political reform. There were huge financial resources and the regime’s political myths - about stability, security and a strong manat currency - were still believed. But this is no longer the case.

Although the cornerstone of Azerbaijani foreign policy has always been isolationism and independence from outside powers, such a policy is a luxury that it cannot afford now that “peak oil production” has reportedly been reached. Baku badly needs loans from somewhere and fast.

The West is the most obvious option. To improve relations with the West, we would need to see some radical steps. The first is, of course, the release of political prisoners, followed by the creation of a safe space for civil society and the political opposition to flourish. Azerbaijan also needs independent courts and a comprehensive structural reform of the system.However, this is unlikely to happen because there is a very strong "pro-Russian" faction within the government, which is against any sort of rapprochement with the West.

In spite of Moscow’s overtures, the Eurasian Economic Union (EEU) does not look very enticing either. Trade with the EU and the US represents approximately 60 percent of Azerbaijan’s total trade, whilst trade with Russia other CIS countries is only 11 percent. Moreover, joining an economic and customs union with Armenia is problematic for Baku.

Notwithstanding the downturn in Turkish-Russian relations, the focus on bilateral relations looks set to continue, with Baku playing a dangerous balancing act between Moscow and Ankara. Just as Russia is trying to starve Turkey of business, investment, and energy supplies following the downing of the SU24 fighter jet, Azerbaijan has promised to step into the breach. Yet, Baku is still mindful of Moscow, recently agreeing to expedite the TANAP project, their shared major gas export pipeline. Azerbaijani businessmen have quietly been warned against exporting Turkish products to Russia under Azerbaijani labels (as Belarus does with European goods).

The EU High Representative Federica Mogherini is planning to visit Azerbaijan in February and President Aliev has been invited to the Nuclear Security Summit in Washington in March. Baku needs to use this moment to begin a dialogue, before tensions in society, and God forbid, Nagorno Karabakh, erupt.

Natig Jafarli is an economist and Executive Secretary of the Board of the Republican Alternative Movement

Read more on: Wider Europe Forum