Ifc - Study of Sme in Az

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Study of Small and MediumEnterprises in Azerbaijan


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The contents of this report are protected by copyright.

Neither this report nor its parts may be reproduced, copied or distributed in anyform without reference to the IFC Study of Small and Medium Enterprises inAzerbaijan.

IFC encourages dissemination of this publication and hereby grants permission tothe user of this work to copy portions of it for the users personal, noncommercialuse, without any right to resell, redistribute, or create works derived from thecontents or information contained herein. Any other copying or use of this workrequires the express written permission of IFC.

The materials contained in this report are presented as an overview of results fromthe survey that was conducted in November 2007 January 2008 among 1800SMEs and individual entrepreneurs in Azerbaijan. The information in this report ispresented in good faith for general information purposes, and IFC, the World BankGroup, or the Swiss State Secretariat for Economic Affairs (SECO) shall not be heldliable for any of the information contained herein.

This report does not claim to serve as an exhaustive presentation of the issuesdiscussed herein, and should not be used as a basis for making commercialdecisions. Please approach independent legal counsel for expert advice on all legalissues.

All information and materials used in preparing this report are the property of and

archived by IFC.

2009 International Finance Corporation


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Baku, January 2009

Study of Small and MediumEnterprises in Azerbaijan


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Studyof Smalland medium enterpriSeSin azerbaijan2

Contents

Abbreviations ......................................................................................4

Foreword and Acknowledgements ..................................................5

Executive Summary ............................................................................6

Policy Recommendations .................................................................11

Introduction .......................................................................................22

1. Methodology .................................................................................27

1.1 Background ....................................................................................................... 27

1.2 Purpose o survey .............................................................................................. 27

1.3 Sampling strategy .............................................................................................. 27

1.4 Firm classication in the Azerbaijani economy ................................................. 28

1.5 Data collection................................................................................................... 29

1.6 Qualitative method o data collection............................................................... 29

1.7 Distribution o ocial data and survey sample, by sector o activity ............... 29

2. SMEs in Azerbaijan .......................................................................33

2.1 Individual entrepreneurs .................................................................................... 35

2.2 Small enterprises ............................................................................................... 38

2.3 Main source o investments: own unds .......................................................... 392.4 State subsidies or SME development ............................................................... 40

2.5 Legal environment and SME condence .......................................................... 41

3. Business Registration ...................................................................45

3.1 Registration: the legal ramework ..................................................................... 45

3.2 Registration o legal entities .............................................................................. 46

3.3 Registration o individual entrepreneurs ........................................................... 48

3.4 Economic impact estimate ................................................................................ 49

3.5 Introducing registration one-stop-shop ............................................................. 49

3.6 The new legal ramework ................................................................................. 503.7 Registration procedure or legal entities ........................................................... 50

3.8 Registration procedure or individual entrepreneurs ......................................... 52

3.9 Unocial payments........................................................................................... 54

3.10 Recommendations........................................................................................... 54

4. Business Licensing ........................................................................64

4.1 Licensing: the legal ramework ......................................................................... 65

4.2 Licensing coverage ............................................................................................ 66

4.3 Licensing procedure .......................................................................................... 67

4.4 Economic impact o licensing ........................................................................... 704.5 Recommendations ............................................................................................. 71


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AzerbAijAn business enAbling environment Project 3

5. Business Permits ...........................................................................74

5.1 Permits: the legal ramework ............................................................................ 75

5.2 Permits coverage ............................................................................................... 77

5.3 Permits issuance and revocation procedures are unclear and vague ............... 80

5.4 Permit expenses................................................................................................. 81

5.5 Economic impact o permits ............................................................................. 81

5.6 Main problems aced by entrepreneurs while obtaining permits ..................... 82

5.7 Recommendations ............................................................................................. 83

6. Business Inspections .....................................................................90

6.1 The majority o all active enterprises are subjected to inspections ................... 91

6.2 Inspection outcomes ......................................................................................... 96

6.3 The Inspections Registration Book ................................................................. 102

6.4 MEDs representative presence at the inspections .......................................... 104

6.5 Inspections and regular visits dierent concepts or the entrepreneur........ 105

6.6 Recommendations ........................................................................................... 106

7. Business Taxation ........................................................................110

7.1 Taxation: the legal ramework ........................................................................ 112

7.2 Simplied tax regime....................................................................................... 113

7.3 Standard tax regime ........................................................................................ 116


8. Access to Finance ........................................................................126

8.1 Overview o the Azerbaijani nancial system ................................................. 126

8.2 Financing SME operations ............................................................................... 128

8.3 Poor mutual understanding between banks and SMEs ................................. 135


9. Foreign Trade...............................................................................141

9.1 Foreign trade: the legal ramework ................................................................ 142

9.2 The role o individual entrepreneurs and SMEs in oreign trade .................... 144

9.3 Main diculties aced by IEs and SMEs in importing .................................... 1509.4 Key diculties aced by exporting SMEs ........................................................ 156


Conclusion ........................................................................................164

Reerences ........................................................................................166

List o Laws ......................................................................................167

Statistical Annexes ..........................................................................169


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Abbreviations

AMFA Azerbaijani Micro-Finance AssociaionAPA Azerbaijani Press Agency (APA news agency)

AVIS Auomaed Unied Inormaion Sysem

AZM Azerbaijani mana (replaced as o 2006 wih AZN)

AZN New Azerbaijani mana (AZN 1 = US$ 1.245 as o Dec 29, 2008)

CIS Commonwealh o Independen Saes

CPT Corporae Pro ax

EU European UnionFIAS Foreign Invesmen Advisory Service

IE Individual Enrepreneurs

IFC Inernaional Finance Corporaion

IRB Inspecions Regisraion Book

IT Inormaion echnology

MED Minisry o Economic Developmen

NBA Naional Bank o AzerbaijanNEF Naional Enrepreneurship Fund

OECD Organizaion or Economic Co-operaion and Developmen

OSS One-Sop-Shop

PIT Personal Income ax

SECO Swiss Sae Secrearia or Economic Aairs

SMB Small and Medium Business

SME Small and Medium EnerpriseSSC Sae Saisic Commite

SSPF Sae Social Proecion Fund

SST Social Securiy ax

TIN axpayer Idenicaion Number

VAT Value Added ax

WB World Bank

WTO

World rade Organizaion


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Foreword and Acknowledgements

IFC, wih he suppor o SECO, presens he resuls o he rs survey o he businessenvironmen in Azerbaijan. Te survey has been underaken by IFCs AzerbaijanBusiness Enabling Environmen Projec. Te objecive o his survey was o assesshe exising condiions or doing business in Azerbaijan in 2008 and o developrecommendaions or improving hem.

Tis repor is based on he resuls o a survey o managers o more han 1,800 smalland medium enerprises (SMEs), conduced in lae 2007/early 2008, represeningall is regions and key secors o he economy. Te survey also included he sub-populaions o individual enrepreneurs. Deailed inormaion on he realiies o he

business enabling environmen ha are aced by hese segmens o he populaion ispresened here; i is hoped ha he empirical daa rom his survey will be used by

various sakeholders o simulae he business environmen and make he proceduresmore ecien and ransparen.

During he irs year since is launch, he IFC Azerbaijan Business EnablingEnvironmen (BEE) Projec has beneed rom close ineracion wih many publicand privae insiuions operaing in he counry, as well as a number o inernaionalorganizaions. Te projec would like o hank he governmen o Azerbaijan, wih

whom he projec signed a Memorandum o Undersanding in Augus 2008. Teprojec would also like o exend graiude o he Minisry o Economic Developmen,

wih which i developed a longsanding relaionship, o he Minisry o axes, Minisryo Jusice and oher Sae auhoriies ha have been vial parners during he lasseveral monhs o he projecs work.

Te repor was produced by he projec sa, including: Ilham Abdullayev, BorisDivjak, Vusal Gaarov, Fakhriyar Jabbarov and Ruhiyya Isayeva. Valuable inormaionand suppor was provided by he World Bank and Inernaional Moneary FundOces in Baku, he Doing Business eam in Washingon DC and he SECO Ocein Baku. In he course o he daa collecion and veriicaion, a large number oSME managers in Azerbaijan were conaced and consuled. Imporan echnicaland logisics assisance was also provided by Dina Nicholas and Sabina Majidova.

Numerous individuals and organizaions conribued generously o he preliminaryreview o his repor, including he IFC sa in he Cenral and Easern Europeregion: Craig Bell, Ruslan Mehdiyev, Nadezhda Sinelnik and Vyacheslav Zhuk o heBelorussian BEE Projec; Ekaerine Avaliani and Irina Kokaia o he Georgian BEEProjec; Sanda Liepina, Chrisopher Miller and Sanjuka Mukherjee rom he MoscowIFC Oce; Aliya Azimova, he IFC Counry Ocer in Azerbaijan; and MichaelEdwards rom he Europe and Cenral Asia Privae and Financial Secor Developmenin he World Bank, Washingon. Ediing and srucural inpus were generouslyprovided by: Adham Abdullaev and Aleksey Novikov rom he Uzbekisan BEEProjec, eresa Ha in IFC Moscow and Sarah Cruikshank Ockman in IFC Ukraine.

Baku, 2009


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Execuive Summary

he repor examines closely he key areas o he business lie cycle. Obser-vaions are based on he comprehensive survey o businesses conducedin lae 2007 and early 2008 on a saisically represenaive sample o 1800enrepreneurs, and addiionally in-deph inerviews wih businesses operaing in

Azerbaijan, as well as a review o he legislaive ramework in Azerbaijan. Te reporlooks a he experience o he small and medium sized companies as well as individualenrepreneurs in dealing wih various adminisraive aspecs o doing business inhe counry and he problems hey ace. Tis is hen compared agains he goodinernaional pracices and recommendaions are being made o he Azerbaijaniauhoriies in making improvemens in every specic area o he business lie cycle.Te key ndings and he subsequen recommendaions are summarized below.

1. The business climate in Azerbaijan is steadilyimproving, while urther reorms are being planned

Azerbaijan has been lised as he op global reormer by he IFC/World Banks 2009Doing Business repor, wih improvemens in seven ou o en indicaors o businessenvironmen reorm. Azerbaijan moved ar up he global rankings, rom 97h placeo 33rd, in he overall ease o doing business. Tis increase recognized a number oimporan legislaive and insiuional reorms ha visibly improved he invesmenclimae o he couny.

Ease of DB 2009 rank DB 2008 rank Change in rank

Doing Business 33 97 +64

Starting a Business 13 66 +53

Dealing with Construction Permits 155 160 +5

Employing Workers 15 67 +52

Registering Property 9 63 +54

Getting Credit 12 25 +13

Protecting Investors 18 110 +92

Paying Taxes 102 143 +41

Trading Across Borders 174 176 +2

Enforcing Contracts 26 27 +1

Closing a Business 81 78 3

his SME Repor ocuses on speciic adminisraive and regulaory coss o doingbusiness in Azerbaijan, covering some o he same areas as he Doing Business sudy,

bu using a survey mehodology. In addiion o he snapsho o he curren environmen,i closely examines he eaures ha businesses ideniy as being very imporan andhindering heir urher expansion. Te SME Repor is problem-soluion oriened and


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criically examines all areas o operaions, while IFC remains commited o working wihhe Governmen o Azerbaijan in urher improving he environmen.

Common problems aced by he SME secor include: (a) resriced compeiion anduneven reamen o cerain economic players, such as preerenial reamen o largeor sae-owned enerprises; (b) a ax sysem ha requires addiional enhancemen, ascurrenly business engage in evasions, under-reporing, and oher illici pracices; and(c) use o inormal means o setle issues.

In addiion o hese generic problems, his survey repor examines individual areaso he business lie cycle. Tese are divided in he ollowing caegories: regisraion,licensing and permis, business inspecions, access o nance, axaion, and oreignrade, while ax paymen procedures are seen as comparaively leas roublesome.

2. Several regulatory and administrative areas requireimmediate attention

Accordi ng o he survey res uls , compa ra ively mos di icul procedure orenrepreneurs is relaed o obaining permis and oher ormal requiremens enablingoperaions. A hird o respondens menioned his procedure o be dicul or verydicul. Compulsory cericaion procedures, inspecion by conrolling auhoriies,

business regisraion, as well as obaining licenses were also seen as dicul by aquarer o all enrepreneurs a he ime o he survey (lae 2007/early 2008).

Some o hese issues end o emerge as relaively roublesome in all ransiion econo-mies and rom ha poin o view, Azerbaijan aces similar SME developmen problemsand may bene rom soluions successully implemened elsewhere. Improvemensin he business climae are well eviden, ye businesses do layou he reorm prioriiesas hey perceive hem (see he chars below).

0% 5% 10% 15% 20% 25% 30% 35%

Tax payment procedures

Obtaining licenses

Business registration

Inspections by controlling authorities

Compulsory certification procedures

Obtaining permits and other permissivedocumentation

Chart 2.

The proceduresidentied byentrepreneurs as themost dicult

32%

28%

26%

26%

24%

15%

0% 20% 40% 60% 80% 100%

Total

Legal person

Individual person

Chart 1.

Developmenttendency evaluation

18% 18% 64%

10% 17% 73%

17% 18% 65%

Worsened ImprovedLet the same


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3. Successul registration one-stop shop implementationled to considerable savingsIn 2008, he Azerbaijani governmen, wih IFC suppor, inroduced he one-sopshop sysem or business regisraion, which signiicanly simpliied he processor enrepreneurs o regiser a business. Tis endeavor combined procedures wihseveral governmen insiuions ino a single regisraion sep and hereore madeand exraordinary eor much o he convenience o he enrepreneur. Prior o inro-ducing he one-sop-shop, enrepreneurs needed o complee 13 procedures wih anumber o governmen agencies, legally requiring 33-34 days o sar up a businessas legal eniy in Azerbaijan. According o 2009 Doing Business Repor, Azerbaijansranking on saring a business increased signicanly o he 13h global posiion:only 6 procedures and 7-8 days are now required o sar up a business, o whichhe ormal one-sop shop regisraion akes hree days. In addiion, clien saisacion

was recorded in he in-deph inerviews wih he privae secor ollowing he single-window esablishmen. Business regisraion is now being carried ou by he Minisryo axes hrough a very advanced inormaion sysem ha connecs 14 such ocesacross he counry.

While acknowledging he governmens success in carrying ou he reorms, his sudyalso oulines urher possible improvemens. o bring business regisraion closero bes inernaional pracices, he governmen may consider inroducing severaladvanced ools in a single relaed law: an improved regiser o businesses, on-lineapplicaion orms, auomaic regisraion ec. Te pre-regisraion process may benerom removing he requiremen o obain a conrmaion o he legal address o he

company rom he proposed landlord and noarizaion o he oundaion and relevanregisraion documens.

4. Business licensing and permits should be thoroughlyreviewed and modernized

A simplied licensing and permis sysem has a grea impac on he developmen oa sound business climae. Wih he adopion o he Presidenial Decree No. 782 onLicensing Rules license issuance procedure, validiy period o a license, lis o aciviiessubjec o licensing, licensing ees ec. were closely dened, eecively reducing henumber o licensable aciviies rom 240 o 56. Tis in urn led o a reducion o henumber o enrepreneurs requiring a license, as well as reduced nancial and humanresources engaged in obaining a license.

While licensing remains more coheren and consisen, here is no single legal acha oulines a precise lis o permis and auhorizaions and lays ou a clear issuanceprocedure. As a resul, here is litle conrol over he issuance o permis or auhoriza-ions by various governmen insiuions. Te repor nds ha he scope o coverageo mos permis is no precise and heir applicaion in individual cases is subjec o adhoc decisions o public ocials ha leave room or discreionary power. Addressinghese issues would signicanly improve he business climae.

As a mater o priori y, he governmen should sar reorming he permi sysem

by underaking an invenory o all permis and oher documens currenly issued inAzerbaijan and hen sreamlining he issuance process by adoping an appropriaelegal ac. A he same ime, he governmen should also conduc an individual review


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o each ormaliy. Special atenion should be paid o ensuring general securiy, saey,heah and environmenal proecion. Oher legislaive improvemens include as,

simple and ransparen issuance rules, duraion o permis, ec.

5. Reorm o business inspections needs an additionalboostTe Presidenial Order No. 69 on he Inspecion regisraion book improved plan-ning and co-ordinaion o inspecions, reducing he oal inspecion burden (imespen on-sie, number o inspecors involved, relaed coss), while he PresidenialOrder No. 790 on he Presence o Minisry o Economic Developmen represena-ive during inspecions inroduced cerain qualiy sandards o he on-sie inspecionsand prescribed heir conduc and reporing. Te survey analysis shows ha he mos

requen adminisraive procedures enrepreneurs ace remain business conrols andinspecions (annually, 80 percen o survey respondens underwen some orm oon-sie inspecions a an average o one inspecion a monh). Inspecors are requiredo record each inspecion in he specialized regisraion books, and ha he Minisryo Economic Developmen (MED) ocials are presen during inspecions. Ye, heserequiremens are someimes inormally ignored, which oen suis enrepreneurshemselves, hus avoiding complex inspecion procedures.

Recommendaions include sysems o sreamline and simpliy he inspecions,paricularly ollowing a review o he licensing and permis regime, and o makeheir rules and procedures more ransparen and accounable. In addiion, assigninginspecions based on periodic risk assessmen would make hem more ecien. As a

resul, auhoriies can provide imely noice o an upcoming inspecion, and conduchem in accordance wih legally esablished procedures. Enrepreneurs can have accesso ransparen checkliss and sancions mechanisms o ensure compliance. Finally,inspecions may also consider shiing owards advising businesses and serving hemas an educaion aciliy.

6. Innovative nancing options to SMEs should beexplored

Access o nance is one o he major challenges ha Azerbaijani enrepreneurs ace, inha hree ou o our enrepreneurs experience diculies while seeking operaional

nancing. Neverheless, urher developmen o Naional Enrepreneurship Fund(NEF) demonsraes governmens vision and adherence o a srucured approacho he developmen o enrepreneurship. Te Fund coninues o provide signicanmeans or he businesses, hus improving heir overall access o nance. Accessibil-iy o he banks and heir services as improved, while he cos o borrowing and heime required o process requess has been reduced. Tere are now 142 operaingcredi organizaions in Azerbaijan, 46 o hese commercial banks. However, over 90percen o business sar-ups and working capial are largely nanced privaely by heenrepreneurs hemselves or hrough privae borrowing as a resul o complex lend-ing requiremens. Limied availabiliy o he credi unding and resricive condiions,such as shor or non-exisen grace period and high ineres raes, as well as expensiveprocessing paymens, make loans less atracive or enrepreneurs. An improved com-municaion wih cliens would increase demand or nancing and, consequenly, leado increased supply.


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Furher developmen o Cenral Credi Regisry (esablished in 2005) and he expandedse o inormaion available have all led o he Azerbaijans 12 h posiion in he 2009

Doing Business Repor in he relaed secion. Furher work may lead owards esablish-men o a uncional credi bureau, surpassing he exising regiser o loans and oercommercial services, hus enhancing muual rus beween crediors and borrowers.

7. Taxation calls or simplication, leveled playeldsand greater transparencyDuring he pas decade he Azerbaijani axaion sysem underwen numerous reormsresuling in considerable improvemen o he sysem. Very commendable are hecusomer relaions, wih he Minisry o axes seting up o a Call Cener (a simpleelephone number 195) ha provides axpayers wih inormaion on dieren aspecs

o axaion, hus increasing user riendliness. Moreover, he Online ax Oce enabledon-line submission o ax reurns and inerne-based exchange o oher ax relaedinormaion (htps://www.e-axes.gov.az/) speeding he process and lowering headminisraive coss o boh: companies and he Minisry.

Noiceably improved ransparency o VA collecion a he Minisry and decrease inhe adminisraion (number o paymens and ax reurns, and less ime spen on axcompliance), all lead o a signican rise in 2009 Doing Business ranking: rom 143o 102 posiion globally.

Te simplied ax regime is very ecien in osering he growh o SMEs, bu heshi beween simplied and sandard ax sysems increases he ax burden signicanly

and encourages underreporing by businesses, leading o a shadow economy andcorrupion. ax compliance is mosly pursued hrough repeaed ax inspecions, whichare oen direced a smaller size companies. Among he possible improvemens, herepor prioriizes reviewing he VA hreshold and consolidaing urher he simpliedax, while reducing he number o VA and social securiy repors by inroducing aunied ax reporing.

8. Mostly larger entities engage in oreign tradeTe governmen reorms also ocused a aciliaing and liberalizing oreign rade, anda he ime o wriing a one-sop shop principle in he cusoms procedures was beinginroduced. Te paricipaion o smaller legal eniies and individual enrepreneursin oreign rade sill remains considerably low: only 2 percen o legal eniies haparicipaed in he survey engage in expors and 8 percen in impors, as indicaed byhe IFC survey daa. For as long as he expors o raw maerials, dominanly oil, areprioriized, developmen o he non-oil SME secor will be somewha hindered.

Complicaed and cosly oreign rade procedures represen major consrains or im-por/expor aciviies, resuling in lower compeiiveness o expors and higher pricingor impors. Sandardizaion and cericaion requiremens also represen an obsacleo oreign rade. Impored goods need o mee local qualiy requiremens even i heyconorm o inernaional sandards, and many goods require approval rom varioussae auhoriies. Expor producs, on he oher hand, lack inernaionally recognized

cericaes aciliaing access o he major markes. In addiion, bureaucracy wihinhe execuive agencies, as well as insucien compeiion in a number o oreign radelogisics and adminisraive areas add o he complexiies.


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Problem

s

SourcesoProblem

Recommendatio

ns

ExpectedEect

n

Furthersimpliy

provisionsotheTaxCoderequiring

individualentre

preneurstosubmitaseparatedocum

ent

conrmingthe

placeotheirresidence.

n

Simpliedprocedureand

reducedcostsoreceiving

inormationaboutexisting

legalentities;

n

Numberodocumentsto

be

presentedtothebankred

uced;

n

Volumeoworkorbanksand

registrationocesreduce

d.

Entrepreneurshave

insufcientknowl-

edgeotheirrights

andobligations

(especia

llyinthe

regions

)

1.Lackoatailoredp

ublicawareness

campaignleadstoaninsucient

understandingotheprocess.

n

Increasetheleg

alawarenessoentrepreneursthroug

h:

Simplebroch

uresdistributedtoentrepreneurs;

Clearproced

uralmaps,availableinregistrationo

ces;

Broadcastu

rtherpublicserviceannouncementson

televisionocusedonproceduralchanges.

n

Improvedaccessto

inormationandtransparency

otheentireprocess.

Problem

s

SourcesoProblem

Recommendatio

ns

ExpectedEect

Process

oissuance

orrevokingis

inappro

priately

defned

,withmany

obstaclesand

inorma

lpractices

1.Lackocleargroundsorissuanceo

licensesandtheirre

usal;

2.Lackocleargroundsorreusalo

theapplication;

3.Inormalsettlementsintheissuance

processstimulatedbythepublic

ocialsandbusinesssectoralike;

4.Lowleveloproessionaltrainingo

ocialsissuinglicenses.

n

Streamlinetheprocessby:

Creatingclearchecklistsonthebasisowhichlicenses

arebeinggrantedordeniedinordertosimpliyan

d

shortedinternaldecision-makingprocedures;

Allocatingclearerresponsibilitiestotheregulating

authority,so

thatlessinter-ministerialorlegal

consultationsareneeded.

n

Introducethe

silenceisconsentprincipleoralllice

nsing

bodiesattheendoane.g.15-dayconsiderationperiod

sothatalicenseisautomaticallygrantedunlessanex

plicit

reusalisissued

.

n

Organizetrainingsandseminarsorocials.

n

Reducediscretioninthe

licensingbodiesandincrease

transparencyortheinternalpro-

ceduresorgrantinglicens

es;

n

Fewerornodelaysin-the

applicationreviewingprocess;

n

Financialresourcesor

entrepreneurseconomized;

n

Reducedwaitingtimeto

entrepreneursindealingwith

thelicensingprocedures;

n

GreaterproductivityoSM

Es

byastercommencement

o

operations.

BusinessLicensing


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16/212


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Problem

s

SourcesoProblem

Recommendatio

ns

ExpectedEect

Virtuallyallentities

acealargeburden

oofcialon-site

inspections

1.Noregulatorylimitationonthe

numberoinspections;

2.Noecientmechanismocontrol

overstateauthorities.

n

Agencieswitho

utariskbasedinspection(RBI)system

shoulddevelop

it;

n

Tightencontroloverstateagenciestoreducethenum

bero

inormalinsp

ections.

n

Moreecientdistribution

oregulatoryauthoritys

resources;

n

Reducednumberocomplaints

byentrepreneurs;

n

GreatercomplianceoSM

Es

withstandardsandregulations;

n

Totalnumberoannual

inspectionsoSMEsreduced;

n

Mechanismsencouraging

entitiestovoluntarilycom

ply

developedaswellaseectively

sanctioningviolatingentities;

n

Opportunityorabuseby

eithersideminimized;

n

Increasedeciencyobu

siness

management.

BusinessInspections

Problem

s

SourcesoProblem

Recommendatio

ns

ExpectedEect

Permits

needto

berene

wedtoo

requen

tly

1.Lackouniedand

clearlegislation.

n

Extendthevalidityperiodopermitsbyadoptingthe

lawon

grantingpermitsollowingtheirthoroughreassessment.

n

Reducedexpensesor

entrepreneurs;

n

Reducedworkloador

governmentagenciesand

thus

costsotheiroperations.

Lacko

knowledge

oentre

preneurs

otheir

rightsand

obligations

1.Lackoaccesstoin

ormationby

entrepreneurs.

n

Increasetheleg

alawarenessoentrepreneursthroug

h:

Simplestep-by-stepguidesmadeavailableto

entrepreneurs;

Clearproced

uralmaps,availableinissuanceoce;

Increasedialoguebetweentheprivatesectorandgovern-

mentbyholdingseminars,training,andinormational

round-tables

;

Broadcastpu

blicserviceannouncementsontelevision

ocusedonp

roceduralchanges.

n

Introductionohigherstandards

regulatingtheprocedureo

obtainingpermits;

n

Improvedaccesstoinorm

ation;

n

Loweropportunitiesor

unocialpayments;

n

Increasedlegalprotection

o

entrepreneurs.


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Problem

s

SourcesoProblem

Recommendatio

ns

ExpectedEect

Mostin

spections

endinsanction:

ofcial

fnes

orinor

mal

settlem

ents

1.Non-transparencyindecision-

makingoninspections;

2.Overregulationotechnical

inspections(outdatedSoviet-timeor

overlycomplexnew

requirements);

3.Weakinstitutionsh

andlingappeals

againstillicitactionsoinspectors;

4.Lowlegalawarenesso

entrepreneurs.

n

Introduceinspe

ctioncerticatesthatspeciypenaltiesor

ailuretocomp

lywiththeregulation;

n

Introducesanctionmechanismtobelaunchedonlyb

y

judiciarydecisio

n;

n

Simpliythetec

hnicalrequirementsorbusinessunits

;

n

Increaselegala

warenessoentrepreneurs.

n

Inspectorspreventedrom

illegallyintereringwith

businessoperationandth

us

minimizedopportunityo

r

abuseooce;

n

Businesseslessinclinedto

oer

unocialpaymentsandt

hus

stimulatecorruption;

n

Increasedcompliancewith

establishedstandardsand

regulations;

n

Increasedbusiness

communityslegalawaren

ess;

n

Codiedanduniormed

inspectionprocedures;

n

Eectivemechanismsor

inspectionappealsestablished,

resultingincomplaintsbe

ing

properlyhandled.

Mechan

ismsor

protectionand

appeals

against

unlawulactions

oinspectors

arepractically

inopera

ble

1.Non-transparencyindecision-

makingoninspections;

2.Inspectionsystemisinecient.

n

Introduceinspe

ctioncerticatesspeciyingpenaltiesor

ailuretocomp

lywiththeregulation;

n

Introducesanctionmechanismtobelaunchedonlyb

y

judiciarydecisio

n;

n

Increaselegala

warenessoentrepreneurs.

n

Existenceogenuineappeals

againston-siteinspection

procedures;

n

Increasedcompliancewith

establishedproceduresan

d

rules;

n

Increasedlegalawarenesso

businesscommunitysIncrease

inspectorsliabilityinterm

s

odetermininglegalpressure

methods;

n

Inspectorspreventedrom

illegallyintereringwith

businessoperationand

minimizeopportunityor

abuseooce.


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Problem

s

SourcesoProblem

Recommendations

ExpectedEect

Certain

taxeslead

todoub

letaxation

orinappropriate

incentiv

esand

behavio

r

1.Existenceocorporate

prottax(CPT)and

dividendtaxcauses

doubletaxationo

corporateearnings;

2.Personalincometax

(PIT)rateishigh,

especiallycoupledwith

3percentSSTandPIT

bracketthresholds

arenotindexedor

infation.

n

Eliminatedoubletaxationo

corporateearningsbyallowingora

deductionodividendunder

CPT;

n

IntroducefatrateorPIT(removetaxbrackets),consolidating3

percentSSTtoPIT,loweringcurrenthigh35percentPITrateto10

percentandindexingthePIT

thresholdincomeorinfation.

n

Greaterrateoreinvestmentin

businessdevelopmentoSMEs;

n

Fewerincentivetohiderevenues

andorgeexpensesresultingina

lowerdiscrepancybetweentheblack

booksandtheocialaccountin

g

records;

n

Fewerunocialcontactsand

corruptionreported;

n

Lowerrateounreported

employmentandincreasedorm

al

hiringandemployment;

n

Greaterrateovoluntarycompliance

bybusinessesandlessrequent

impositionosanctionsrelatedto

compliance;

n

Increasedtaxrevenues.

Access

toFinance

Problem

s

SourcesoProblem

Recommendations

ExpectedEect

Loante

rmsnot

avorab

letoSMEs:

highinterestrates,

highcollateral

requirements,and

shortm

aturity

1.Mostbankscannot

attractlong-termand

cheapresourcesor

on-lendingtoSMEs;

2.Insucientlytranspar-

entSMEoperations

resultinbanksadding

probableriskstothe

costotheloans;

3.Bankspreertolend

orconsumergoods,

whichintheiropinion

islessrisky.

n

Ensurebetterpositioningo

thecommercialbankstoobtain

low-interestcreditlinesrom

internationalnancialmarketsand

channelthemtoundSMEs

(e.g.through:diversicationo

nancialproductssuchaseq

uity,needs-basedguaranteesetc.;

soteningcollateralrequirem

entsorSMEcreditlinesetc.);

n

IntensiyoperationsotheN

ationalEntrepreneurshipFund(NEF)

bysystematicallyresearching

andthenimprovingapplicabilityand

transparencyoitsoperation

s;

n

Developandimplementmechanismsoalternativeguaranteesto

SMEs;

n

Improveandmonitorbankin

gsectorperormanceinloan

issuance.

n

Increasednumberoapplication

s,

approvedloansandtheamounts

lenttoSMEs;

n

Increasednumberobanking

customers;

n

Morebankingproductsandloans

oeredinthemarketwithlonger

maturityandcompetitivepricing.


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Problem

s

SourcesoProblem

Recommendations

ExpectedEect

3.Excessivenumbero

documentsisrequired

orexports;

4.Doublecertication

o

goods;

5.Faxeddocumentsare

notacceptedbycus-

tomsauthoritiesand

obtaininghardcopies

delaystheexports.

n

Increasedexportsandimproved

positioningotheAzerbaijaninon-

oilgoodsandservicesinoreign

markets.

Importprocedures

arecom

plicated

anddiscourage

SMEsr

om

engagin

gin

importingactivities

andin-country

trade

1.Importolargenum

ber

ogoodsaresubjec

t

tovariousapprovalsby

thestateauthorities;

2.Excessivenumbero

stateauthoritiesare

involvedinprocessing

oimportdocumen

ts;

3.Excessivenumbero

documentsisrequired

orimports;

4.Goodsbearinginterna-

tionalconormitym

ark-

ingsaresubjectedt

o

mandatoryconorm

ity

assessment;

5.Unclearrulesoras-

sessmentoimport

valueandlacko

mechanismorthe

settlementodisputes

relatedthereto;

6.Absenceobonded

warehouses.

n

Reducethenumberodocumentsrequiredorimportingand

introduceacceptanceoaxe

dimportdocumentsinaccordance

withinternationalpractices;

n

Reducethenumberostate

authoritiesinvolvedinimporting;

n

Eliminaterequirementocon

ormityassessmentonproducts

markedwithinternationalm

arkingsoconormitysuchasCE

markingoriginatinginOrganizationorEconomicCo-operation

andDevelopment(OECD)co

untries;

n

Introducemoreconsistent,p

redictable,simpleanduniormrules

ortheassessmentoimportvalueandestablishamechanismor

quickresolutionodisputesarisinginconnectionwiththis;

n

Encouragetheestablishmentobondedwarehouses;

n

Developcodeoconductorcustomsandrailwayserviceocials

toeliminatethecasesobrib

ery.

n

IncreasednumberoSMEsengaged

inimports;

n

Greaterdiversicationandqualityo

productsavailableatlowerprices;

n

Reductionodiscretionarypowers

ocustomsocials,thusnumbero

arbitrarydecisions;

n

Lessrequentcorruptpracticeso

businessesandcustomsocials

reported.


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Problem

s

SourcesoProblem

Recommendations

ExpectedEect

Technical

regulationis

outdate

dandails

tointeg

ratewith

theinte

rnationally

usedstandards

1.Technicalregulation

systemisnotcoherent;

2.Manystandardsare

outdated;

3.Excessivenumbero

productsaresubjectto

mandatorycertication;

4.Lackotestingacilities

thatcomplywithth

e

internationalstanda

rds.

n

Separatethestandardization

andcerticationunctionsbyestab-

lishingindependentlaborato

riesissuingcerticates;

n

Reviewthelistostandards

andabolishtheonesnotnecessaryon

thegroundsohealthandsaetyinamarketeconomy;

n

Consideradoptinginternationalstandardstoavoidthe

maintenancecostothesystem;

n

Applytherisk-basedapproachbydeterminingwhichgoodsand

servicesneedtobecertied

inordertoexcludenon-riskycatego-

riesrommandatorycerticationandbyabolishingthemandatory

certicationrequirementor

services;

n

Createinternationallyrequiredlaboratoryacilitiestocertiy

Azerbaijanicommoditiesacc

ordingtointernationallyadopted

standardsinordertoacilitatetheirexport.

n

Newcostsavingoptionsor

entrepreneurs;

n

Increasedoccurrenceo

entrepreneursmarketingtheir

productsasbeingincompliancewith

internationalstandards;

n

Reducedrunningexpensesorthe

agenciesresponsibleorelabora

tion

ostandards;

n

Fasterandcheapersaccessto

internationalmarketsorAzerbaijani

exporters;

n

Increasedcompetitivenessothe

Azerbaijanieconomy(goodsand

services),asveriedbyinternational

competitivenessratings(e.g.

CompetitivenessIndex).

Variatio

no

customstaris

orsimilartypes

ogood

s,raw

materia

lsand

process

edgoods

discourages

import/

export

1.Customstaris

signicantlydierw

ith

respecttosimilarty

pe

ogoodsandraw

materialsandully-

processedgoods;

2.VATexemptionsdis

-

couragetradewith

non

VATexemptgoods.

n

Approximatecustomstaris

orsimilartypeogoods,raw

materialsandully-processedgoodsinordertoencourageimport/

export;

n

Introduceuniormtariratesorsimilartypesogoods;

n

EliminateVATexemptionsto

avoiddistortions.

n

Distortionscausedbyunreasonable

tarisloweredoreliminated;

n

Incentivesorcustomsocialst

o

tradebetweenclassesogoods

or

applypreerentialtreatmentin

exchangeorunocialpayments

regulatedandreduced;

n

Moresimpleandlesscostly

calculationocustomspayment

s

increasingcertaintyandcomplia

nce.


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InroducionGeography, history and demographics

Te Republic o Azerbaijan is an independen counry locaed in he Caucasus regiono Souheas Europe, encompassing a oal area o 33,440 square miles. Te counryshares borders wih he Russian Federaions province o Dagesan o he norh,Georgia o he norhwes, Armenia and urkey o he wes and souhwes, Iran o hesouh, and he Caspian Sea o he eas.


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1 Daa rom US-Azerbaijani Chamber o Commerce: Invesmen Guide o Azerbaijan 2007.2 Source: combined ocial Azerbaijani saisics and he World Bank 2008 daa.

Te capial and larges ciy o Azerbaijan is Baku. Azerbaijan Republic includes oneAuonomous Republic o Nakhchivan and 66 adminisraive regions (rayons). Abouone h o he erriory o he Republic o Azerbaijan, including Nagorno-Karabakhregion and 7 rayons adjacen o his area have been occupied by Armenian miliaryorces.

In 2006, Azerbaijans populaion reached a level o almos 8.5 million, an increaseo 2.9 percen since 2003. Te increase sems rom he high cumulaive growh o

Azerbaijans urban populaion, which accouned or 4.9 percen wihin he sameperiod, in conras o 0.7 percen cumulaive growh among he rural populaion.

Te working age in he counry is se beween 15 and 61 years old or men and15 o 56 or women. More han hal o he populaion has reached secondary leveleducaion by age 15. 11.3 percen o ciizens obained higher educaion, specializedsecondary educaion was compleed by 11.9 percen and secondary by 52.2 percen1.Secondary and higher educaion levels have shown modes increases since 2004.

Azerbaijani Economy

Since independence, Azerbaijan has gone hrough a ransiion process ha hasbeen more dramaic han oher ex-Sovie and EU accession counries (able 1),characerized by a deeper recession a he beginning o he 1990s, ollowed by acach-up period: Azerbaijans GDP per capia (in PPP) was 51.5 percen o heEx-Sovie/CIS average in 1992 and 73 percen in 2007. Beore he oil boom, hisrecovery process has been permited by seady non-oil GDP growh, a 4.3 percen onaverage beween 1997 and 2001 and in double digis in 2002-2004 (able 1), driven

by services and consrucion. In 2004, he non-oil economy sill accouned or 68.4percen o oal GDP. I was a sable economy, wih infaion in low single digis andconsolidaed expendiures represening 37.7 percen o non-oil GDP2.

Capital: Baku

Countrys population: 8.5 millionEthnic groups: Azeri 90.6 percen, Legzin 2.2 percen, Russian 1.8 percen andohers

Area: 33,440 square miles (86,600 sq. km)

Principal language: Azerbaijani

Principal religion: Islam

Political divisions: 66 adminisraive divisions and 1 auonomous republic

Currency unit: Mana (exchange rae o US Dollar: US$ 1 = AZN 0.81)


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1992-1996(annual

average)

1997-2001(annual

average)

2002 2003 2004 2005 2006 2007

GDP growth (%) -15.2 7.8 10.6 11.2 10.2 26.4 34.5 25.0

Oil GDP gr. -10.61 9.9 3.6 0.6 2.5 66.3 63.1 36.8

Non-Oil GDP gr. -18.4 4.3 13.8 14.9 13.6 8.3 11.6 11.3

Agriculture -19.1 5.9 6.4 5.6 4.6 7.5 0.9 4.0

Industry (non-oil) -19.6 -0.4 8.9 22.2 9.9 14.8 4.1 7.9

Construction -6.0 25.5 105.0 61.0 41.9 2.0 8.5 16.0

Services -15.3 9.5 6.0 8.0 8.9 9.6 18.2 12.5

GDP per capita (PPP), % o CIScountries average

42.0 44.1 45.0 45.7 46.1 54.0 64.7 73.0

GDP per capita (PPP), % o EU 10countries2

30.3 23.6 25.8 27.0 27.8 33.2 40.3 46.4

Infation (pa) 827.7 -0.5 2.8 2.2 6.7 9.7 8.4 16.6

Oil scal revenues as a % o non-oilGDP

N/A 4.7 15.9 16.2 14.8 17.6 32.0 39.5

Non-oil scal revenues as a % onon-oil GDP

N/A 21.0 22.3 21.6 24.6 27.4 29.9 33.2

Poverty rate, total 68.13 49.04 44.6 39.7 28.5 24 20.8 15.8

Memo

GDP, US$ Mill 2.071 4.761 6.236 7.276 8.682 13.239 20.982 24.229

Non-Oil GDP, US$ Mill 1.662 3730.3 4.300 5.088 5.962 7.402 9.750 12.955

Population, Millions (mid year) 7.53 8.00 8.17 8.23 8.31 8.39 8.45 8.55

Table 1. The Azeri economy ater independence (1992-2007)

1 (1993-1996);

2 Latvia, Lithuania, Estonia, Hungary, Czech Republic, Poland, Slovenia, Slovakia, Romania, Bulgaria;

3 (1995); 4 (2001).

Sources: Azerbaijan authorities and World Bank sta estimates.

Going orward, he governmens principal policy challenge will be o mainain

macroeconomic sabiliy during a period o rapid economic growh. However, i wil lsruggle o conain he infaionary pressures exered by a combinaion o growingbudge expendiures on welare and inrasrucure projecs, and a large increase inoreign currency infows rom oil expors.

Te openness o he economy o oreign invesmen and impor compeiion coupledwih he domesic business climae deermines he compeiiveness o domesicmarkes. Compeiiveness enails no only issues o marke access as embodiedin aris and narrowly conceived non-ari barriers. I also enails marke accessimplicaions or domesic policies and regulaions, as well as reamen aorded ooreign and domesic invesor rms. Higher levels o compeiiveness usually generae

no only higher raes o economic growh bu also help improving compeiivenesso domesic rms, boh local- and oreign-owned and, by he same oken, conribueo beter expor perormance.


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Te sae, ulimaely responsible or assuring compeiiveness o domesic markescombined wih an invesmen-riendly business environmen, aces ransormaion

rom a radiional role o micromanager ino ha o a aciliaor o business aciviies.Tis is no an easy ransormaion: beginning in he 1990s, many saes have success-ully reduced he scope o sae uncions in economic developmen while srenghen-ing heir adminisraive capaciy o reduce he coss o doing business and exposing

businesses o domesic and exernal compeiion. Indeed, insiuions creaing a levelplaying eld or business under sable regulaory condiions are criical o economicdevelopmen. Tis in urn is wha consiues good economic governance.

Business climate in Azerbaijan

In 2008, Azerbaijan was cied as a op 10 reormer by he IFC/World Banks DoingBusiness repor, wih improvemens on seven ou o 10 indicaors o businessenvironmen reorm. Azerbaijan sared operaing a one-sop-shop in January 2008ha halved he ime, cos, and number o procedures o sar a business: regisraionsincreased by 40 percen in he irs six monhs. Azerbaijan also eliminaed heminimum loan cuo o $1,100, more han doubling he number o borrowerscovered a he credi regisry. axpayers can now ile and pay heir axes online.

Azerbaijans exensive reorms moved i ar up he ranks, rom 97h o 33rd, in heoverall ease o doing business.

Te Global Compeiiveness Repor 2008-2009 ranks Azerbaijan 69h o 134 counries

examined wih he score o 4.1 ou o 7. Labor marke eciency and macroeconomicsabiliy have been raed as he key srenghs, while he repor prioriizes corrupion,infaion and ax raes or urher reorm ocus. (Source: Counry prole: Azerbaijan,Te Global Compeiiveness Repor 2008-2009, World Economic Forum, 2008,htp://www.weorum.org/documens/GCR0809/index.hml.

Anoher comparable index ranks Azerbaijan somewha more criical ly: he Indexo Economic Freedom3 score or Azerbaijan is 58, making is economy he 99 h

rees in he 2009 Index. Is overall score is 2.6 poins higher han las year, refecingnoable improvemen in business and labor reedom. Azerbaijan is ranked 17 h ou o41 counries in he AsiaPacic region, and is overall score is slighly less han he

world average.As a ransorming economy, Azerbaijan sill aces subsanial challenges. Financialreedom, invesmen reedom, propery righs, and corrupion remain a signicanchallenge, and an underdeveloped judicial sysem is inadequae o ecienly proecinellecual propery righs, according o he Heriage Foundaion.

3 Te heriage Foundaion: htp://www.heriage.org/index/Counry/Azerbaijan.


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oday, Azerbaijan remains ranked low in ransparency Inernaionals CorrupionPercepion Index, which in 2008 placed i 158 ou o 180 lised counries, wih a

score o 1.9 ou o a possible 10 (no corrupion)4. A he beginning o 2004, hegovernmen adoped a series o ani-corrupion measures aimed a increasingransparency and reducing corrupion. Unorunaely, implemenaion o many ohese laws, including he law requiring nancial disclosures by public ocials, has

been slow or inadequae.

In he summer o 2007, he governmen again ocused is atenion on combaingcorrupion and ook several posiive seps aimed a ackling he problem o corrupion.Firs, he governmen adoped a new Naional Sraegy on Increasing ransparencyand Combaing Corrupion. Second, he governmen adoped an ehics code orcivil servans. Te New Ani-Corrupion Naional Sraegy, se o run rom 2007 o2011, replaces and expands upon Azerbaijans previous Sae Program on CombaingCorrupion (2004-2006).

Since independence, Azerbaijan has aken grea srides in bringing is legislaiveramework ino conormiy wih bes pracice. Te governmen has also ensured hamembers o he public have access o legislaion and knowledge o i. A signican

barrier o he business communiys conribuion o he improvemen o Azerbaijansinvesmen climae, however, is he lack o imely inormaion abou proposedlegislaion beore i is adoped. Dra legislaion is rarely announced in advance andhe business communiy is given litle or no opporuniy o commen on i.

4 ransparency Inernaional CPI or 2008: htp://www.ransparency.org/policy_research/surveys_indices/cpi.


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1. Mehodology1.1 Background

Te survey o he business environmen is a produc o he IFC Azerbaijan BusinessEnabling Environmen Projec. his naional level survey o small and mediumenerprises and individual enrepreneurs in various secors o he Azerbaijani economyis he rs o is kind o be implemened in he counry. Te survey was conducedrom Nov 2007-Jan 2008.

1.2 Purpose o survey

Te main objecive o he survey is o measure regulaory and adminisraive barriersadversely aecing he growh, developmen, and operaions o he privae secorin Azerbaijan. he empirical survey daa and subsequen recommendaions o

Azerbaijani sae auhoriies are expeced o simulae he debae or reorm o he

regulaory and adminisraive environmen or he privae secor in various procedures,such as he ollowings:

n Sae regisraion o business unis;

n Sae conrol and inspecions over exising business unis;

n Licensing o aciviies carried by business unis ha require special permission;

n Obaining permis/approvals or launching and coninuaion o businessaciviies;

n Cericaion o producs and services o exising business unis;

n Impor and expor operaions;

n axaion;n Analysis o he enrepreneurial nancial indicaors;

n Relaions beween privae secor and nancial insiuions.

1.3 Sampling strategy

Te survey used a probabiliy-based sampling mehodology in which he rms wereseleced or inerview according o a known non-zero probabiliy. Te major advanageo his mehod was ha rom a sound sample, saisical inerences can be made aboua larger populaion (a naional, regional or secor levels).

In order o make sure ha he sample disribuion was represenaive o he Azerbaijanieconomy, he sample ramework was based on he incidence and disribuion o


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eniies naionwide rom he ocial saisical daa provided by he Sae SaisicalCommitee o he Azerbaijan Republic as o January 1, 2007. Te sraicaion o

he sample was based on: (i) secors o he economy dened by he Sae SaisicsCommitee; (ii) size and ype o enerprise, dened as number o employees; and(iii) regions. ables 1.1, 1.2 and 1.3 show he disribuion o he ocial daa and hedisribuion o he survey sample.

Sraied random sampling is used o capure all he secors o economic aciviy,including irm classiicaion and geographic disribuion o he business eniiesuniverse. In oher words, in order o make he sample selecion represenaive o asecor, rm ype and region, he seleced sample ully represens he larger economicpicure.

1.4 Firm classication in the Azerbaijani economy

According o decree No. 57 o he Cabine o Minisries o he Republic o Azerbaijanon Ideniicaion o he Small Enrepreneurship Subjecs by ypes o Economic

Aciviy daed April 20, 2004, small businesses are dened as ollows according osecor:

n In he consrucion and indusry number o employees o less han 40 personand annual urnover o less han 200,000 Azerbaijani manas (~$247,000);

n Agriculure number o employees o less han 15 people and annual urnovero less han 100,000 Azerbaijani manas (~$123,500);

n Wholesale rade number o employees o less han 10 people and annualurnover o less han 300,000 Azerbaijani manas (~$370,500);

n Oher branches number o employees o less han 5 people and annual urn-over o less han 100,000 Azerbaijani manas (~$123,500).

Tere is no ocial deniion o midsize legal eniies in Azerbaijan. IEs are classiedas small enerprises while legal eniies are urher classied as eiher small or all heohers ha make up he SME secor. Tereore excep or he large companies, alloher regisered businesses all wihin he caegory o SMEs.

In erms o regional coverage, he survey was conduced in he urban areas o eighregions (Absheron, Ganja-Gazakh, Sheki-Zagaala, Lenkoran, Guba-Khachmaz, Aran,

Yukhari Garabakh, Daglig Shirvan) and he capial ciy Baku. Te survey does nocover he occupied erriories o he Republic o Azerbaijan and Nakhchivan.

In erms o sample size, 873 individual enrepreneurs and 893 legal eniies wereinerviewed during he survey, or a oal o 1,776 respondens in he sample. Terespondens were he owners or op managers o privae secor small and mediumenerprises and individual enrepreneurs, responsible or decision making.

Since reail and wholesale rade individual enrepreneurs orm he larges share o

economic subjecs (58 percen o he enrepreneurs), a decision was aken o reduceheir number, since he scope o heir business operaions is less complex and hus lessinormaive. Teir share was hereore halved. Tis was done wih an aim o increase


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he share o economically acive companies in he sample. Aer ha all weighcoeciens were calculaed and used during he analyical process.

1.5 Data collection

he survey was conduced by an independen survey company commencing inauumn 2007. Te main survey insrumen was a writen quesionnaire wih 134quesions, which was pilo-esed beore commencing he eldwork. Te quesionnairecovered he ollowing procedures: business regisraion, obaining licenses, permisand cericaes, access o nance, inspecions, axaion, and oreign rade regimes.

1.6 Qualitative method o data collection

In addiion o he probabiliy-based quaniaive mehod o daa collecion asdescribed above, he survey also used qualiaive means o gaher inormaion hroughmeeings wih indusry expers, praciioners, and ocus groups discussions.

Qualiaive mehods o gaher inormaion are oen used during idenicaion o aproblem, and when rying o undersand he scope o a problem when inormaiongaps exis in he daa. Since he survey had o do wih quanicaion o dierenregulaory procedures, key inorman inerviews and ocus groups were organized oundersand or example, average expendiures and average ime required or paricularprocedures.

In-deph inerviews wih expers were conduced o undersand he deails o severalspecial procedures. For example, meeings wih expers such as proessional agens/lawyers dealing wih business regisraion were organized o undersand he seps andprocedures relaing o business regisraion.

Focus group discussions wih enrepreneurs were organized in order o ideniy hemos problemaic procedures or enrepreneurs, and also o undersand and inerprehe empirical survey resuls. Te ocus groups, o ve-seven paricipans, were led byan experienced moderaor; a oal number o 10 ocus group discussions were held.opics included business regisraion, permis, and inspecions.

1.7 Distribution o ocial data and survey sample, bysector o activity

Te sampling rame was prepared in accordance wih he ocial saisics daa orAzerbaijan or he las available year he inormaion was ully processed. Te ablesbelow serve he purpose o indicaing he sampling sraegy or he IFCs SME survey.Te oal breakdown includes a spli beween IEs and SMEs in he raio 85:15 percen.Te lower wo ables presen he spli by he economic aciviy.


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Scope o activity Ocial statistics Survey results

Total IE SME IE SME

Agriculture, hunting and orestry / Fishing 7,995 2,439 5,556 31% 69%

Mining/ Manuacturing / Electricity, gas and watersupply

4,967 2,506 2,461 50% 50%

Construction 2,684 412 2,272 15% 85%

Wholesale and retail trade; Repair o motor vehicles,household and personal goods

130,408 119,510 10,898 92% 8%

Hotels and restaurants 10,564 10,066 498 95% 5%

Transport, storage and communication 19,660 18,850 810 96% 4%

Financial intermediation 262 0 262 0% 100%

Real estate, renting and business activities 4,898 2,243 2,655 46% 54%

Public administration and deense; compulsory socialsecurity

1 0 1 0% 100%

Education 186 0 186 0% 100%

Health and social work 585 0 585 0% 100%

Other community, social and personal service activities 20,272 15,733 4,539 78% 22%

Private household with employed persons 0 0 0 0% 0%

Extra-territorial organizations and bodies 0 0 0 0% 0%

Other 0 0 0 0% 0%

Total 202,482 171,759 30,723 85% 15%


Total % romtotal

Number ointerviews

Total

Agriculture, hunting and orestry / Fishing 2,439 1.4% 2,633 1.6%

Mining/ Manuacturing / Electricity, gas and water supply 2,506 1.5% 3,829 2.4%

Construction 412 0.2% 216 0.1%

Wholesale and retail trade; Repair o motor vehicles,

household and personal goods

119,510 69.6% 113,485 70.6%

Hotels and restaurants 10,066 5.9% 9,460 5.9%

Table 1.2 Distribution o ofcial data and survey sample, by sector o activity or individualentrepreneurs

Table 1.1 Distribution o ofcial data and survey sample, or all business units


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Total % romtotal

Number ointerviews

Total

Transport, storage and communication 18,850 11.0% 17,449 10.9%

Financial intermediation 0 0.0% 0 0.0%

Real estate, renting and business activities 2,243 1.3% 2,070 1.3%


0 0.0% 0 0.0%

Education 0 0.0% 9 0.0%

Health and social work 0 0.0% 12 0.0%

Other community, social and personal service activities 15,733 9.2% 11,637 7.2%

Private household with employed persons 0 0.0% 0 0.0%

Extra-territorial organizations and bodies 0 0.0% 0 0.0%

Other 0 0.0% 0 0.0%

Total 171,759 100.0% 160,800 100,0%


Total % romtotal

Number ointerviews

Total

Agriculture, hunting and orestry / Fishing 5,556 18.1% 5,480 18.4%

Mining/ Manuacturing / Electricity, gas and watersupply

2,461 8.0% 2,323 7.8%

Construction 2,272 7.4% 2,190 7.3%

Wholesale and retail trade; Repair o motor vehicles,household and personal goods

10,898 35.5% 10,570 35.4%

Hotels and restaurants 498 1.6% 487 1.6%

Transport, storage and communication 810 2.6% 776 2.6%

Financial intermediation 262 0,9% 262 0.9%

Real estate, renting and business activities 2,655 8.6% 2,602 8.7%


1 0%

Education 186 0.6% 184 0.6%

Table 1.3 Distribution o ofcial data and survey sample, by sector o activity or small and mediumenterprises


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Total % romtotal

Number ointerviews

Total

Health and social work 585 1.9% 599 2.0%

Other community, social and personal service activities 4,539 14.8% 4,366 14.6%

Private household with employed persons 0 0.0% 0 0.0%

Extra-territorial organizations and bodies 0 0.0% 0 0.0%

Other 0 0.0% 0 0.0%

Total 30,723 100.0% 29,839 100.0%

Moderator guide were developed or the ocus group discussions. As an example, the ocus groups guide onpermits is presented below.

1. Dear participants, as ar as we know, or doing business you need to get permits rom state agencies. Could youplease indicate what permits you obtained (and rom which agencies)?

[Moderator takes a note o all indicated permits on the board. Ask again i there are any additions to be made to the list.]

2. Could you please describe why you need these permits or or what purpose this permit is provided?[Moderator asks about the most common permits.]

3. Please describe how you obtain the permits? Please indicate everything in details, even things that you considerednot signicant.

[Moderate listens to one participant and ater each contribution checks it with others to identiy whether this inormation is commonto others.]

4. We drew an approximate outline o obtaining permits and would like to ask whether you agree with this planor you have any comments or suggestions?

[Ater the answers o respondents moderator continues.]

5. Now, let us check these data. I need to learn rom each o you our gures ) how much time on average isrequired or you to pass this stage b) which expenditures you regularly make or are you ready to made at thisstage c) how many people are required or solving this stage; d) how oten you have to renew these permits?

[Figures are put next to icons. I several gures were indicated then average gure is written. I gures are too dierent then reasonsare claried.]

6. Now, lets talk about common characteristics o obtaining the permits. Who in your enterprise is dealing withthis task? Is this person amiliar with obtaining permits? How much are you (or your authorized person) awareo the procedures provided by law or obtaining permits?

7. At the end we would like to request that you talk about any not standard issues, questions, situations or casesthat you or your enterprise aced during the process o obtaining permits?

[I interesting remarks come up the moderator solicits the opinion o other participants, even i they have never aced this situation.It is important to ask them to consider other perspectives.]

Annex 1.1 Focus group discussions


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2. SMEs in Azerbaijan

he aim o his chaper is o presen inormaion on he size and he economicdimension o he micro, small and medium sized secor in Azerbaijan. Tisis required in order o undersand is developmen dynamics, impac on he

economy and he refecion o he curren problems burdening he secor on heiroperaions.

As he counrys economy has grown in recen years, mainly as a resul o is burgeon-ing oil indusry, he number o small and medium enerprises (SMEs) has also grown.However, he growh in SMEs does no refec he conribuion o his enrepreneurialsecor o he GDP. Te growh o he oil secor resuls in he growh o he non-oilsecor almos as ree-riders in he general economic boom. Te recen rends yeindicae a slower growh o he non-oil secor, i.e. is shrinking compared o he oilindusry in proporional erms.

GDP

SOURCE: World Development Indicators database and CIA World Factbook, 2007

Chart 2.1

GDP growth byyears, in billions $

SMEs sharein GDP

0

5

10

15

20

25

200620052004

8.6

1.3 (15%)

13.2

2.1 (16%)

20.1

3.0 (15%)

Micro and small and medium sized enrepreneurship in Azerbaijan is divided ino wogroups: individual enrepreneurs (i.e. sole owners o he enerprise wihou orminga legal eniy); and small and medium enerprises (i.e. legal eniies). All individualenrepreneurs are legally considered small enerprises by deaul, whereas hose regis-ered as legal eniies are classied according o wo indicaors: number o employeesand annual urnover.


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he increase in he SME secor relecs is growing imporance o he counryseconomy. Tis is clearly demonsraed in he expanding number o regisered eniies,

bu even more so he increasing number o employees, eiher hired or ormal lyregisered. Neverheless, approximaely 90 percen o all he labor orce wihin heenrepreneurship communiy is employed by IEs.

According o he Sae Commitee or Saisics daa and some calculaions basedupon hese indicaors, he role o SMEs in he counrys economy is growing,paricularly in is conribuion o he privae secor.

Chart 2.2

From 2004 to2006, the share opeople employed insmall and mediumenterprises romthe total labor orcehas increased rom9 percent to 25percent

0%

5%

10%

15%

20%

25%

30%

200620052004

9%

20%

25%

According to the Cabinet Council Decree o the Azerbaijan Republic on Criteria For Dening Small and Medium Enterprises Based Upon theEconomic Activity #57, dated April 20, 2004, the ollowing legal entities are considered small business units:

n Construction and industry: number o employees o less than 40 people and annual turnover o less than AZN 200,000 (~$247,000)

n Agriculture: number o employees o less than 15 people and annual turnover o less than AZN 100,000 (~$123,500)

n Wholesale trade: number o employees o less than 10 people and annual turnover o less than AZN 300,000 (~$370,500)

n Other sectors: number o employees o less than 5 people and annual turnover o less than AZN 100,000 (~$123,500)

Box 2.1 Defnition o small business units

2004 2005 2006

No osubjects

Total No oemployees

No osubjects

Total No oemployees

No osubjects

Total No oemployees

Small Enterprises

(legal entities)

17,028 68,565 11,982 73,447 12,232 90,134

Individual Entrepreneurs 144,406 292,654* 166,558 687,848* 171,776 922,215*

Total 161,434 361,218 178,540 761,294 184,008 1,012,348

* Ocial sources do not contain inormation on the average number o employees working or individual entrepreneurs (IE). This

calculation was done based upon the empirical evidence, using the ormula:

(Average number o employees per small enterprise 2) x number IE = Total number o employees working or individual entrepreneurs.

Table 2.1 Number o employees o IEs and SMEs


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Meanwhile, he number o small and medium enerprises (SME) per 1,000 residensshows ha here is poenial or he secor o grow even more, providing a signican

conribuion o he GDP and enerprise growh.

2.1 Individual entrepreneurs

Te individual enrepreneur is an individual person (sole owner), who is involved in

enrepreneurial aciviy wihou orming a legal eniy and has unlimied liabiliy.

Individual enrepreneurs represen he majoriy o he SME secor, as ar as henumber o enerprises and he number o employed are concerned. According ohe Sae Commitee or Saisics daa, 93 percen o he local enrepreneurs areregisered as individual enrepreneurs.

Chart 2.4

Individualentrepreneurs orm

the majority o theprivate sector inAzerbaijan

(% o respondents)

7%

Distribution o business entities by legal status

Individual entrepreneurs

Small+Medium and Largecompanies

93%

SME number per 1000 residents SME share in employment, in %Chart 2.3

How AzerbaijansSME sectormeasures upcompared to othercountries (SMBIndicators)

0

20

40

60

80

100

ItalyRussiaEstoniaAzerbaijanUkraine

Source: IFC report on Business Environment in Tajikistan as seen by Small and Medium

Enterprises, 2006.

6

20 22

25 24

5559

49

7873


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As indicaed in he survey, i is simpler or enrepreneurs o operae in he ormaleconomy as individual enrepreneurs or a number o reasons:

1) Te regisraion process is simpler or he individual enrepreneurs han or legaleniies;

2) Te expenses or he regisraion process, license and permis are much loweror individual enrepreneurs;

3) In businessmens opinion, individual enrepreneurs are more oen checked by helocal or regional branches o he inspecion services compared o SMEs, since heheadquarers o minisries and agencies do no have a lis o regisered IEs. Legaleniies mus regiser wih minisries and agencies headquarers; hereore, heyare checked by hese governmen srucures, wih whom i is no always easy o

come o reach an inormal setlemen.In 2007, one in our enrepreneurs on average invesed in xed asses o his enerpriseusing mainly inernal sources o nancing (personal savings/amily capial). Te lowinvesmen level can be parially explained by he limied access o exernal nancingsources (see chaper Access o nance), as well as by insucien condence in he

business environmen.

As he counrys overall economy grows, his corresponds o an increase in incomeor enrepreneurs. I he growing income on he one side increases consumer income,hen on he oher side i creaes he nancial oundaion or he developmen o

individual and small-scale enrepreneurship, which, in urn, should cover he grow-ing consumers needs. Tus, during he 2004-2006 period (according o ocial daarom he Sae Saisics Commitee), he number o individual enrepreneurs grewsignicanly (he aggregae average annual growh was, on average, 6 percen), and ahe beginning o 2006, here were abou 171,000 IEs.

Chart 2.5

The aggregateaverage annualgrowth o individualentrepreneurs was 6

percent

(manats)

Number o Individualentrepreneurs(1000 people)

0

50

100

150

200

20062004

144

171

Individual enrepreneurs represen he larges caegory o SMEs in he counry, as aras he quaniy and share o income are concerned.


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Te economic opporuniies in Baku, employmen shorages in some regions, and lowproabiliy in agriculure creae seasonal employmen and migraion. According oocial daa, he populaion o Baku is slighly more han wo million people, bu hisgure does no include people ormally regisered in oher places in he counry, yeliving in he capial. Some expers believe ha a more realisic gure o Bakus populaionis wice he ocial indicaor, or our million. Hence Baku, ollowed by Sumgayi andGanja, remain he mos populaed ciies in he counry. Te proporions o individualenrepreneurs and SMEs avor he hree mos populaed ciies o he counry; he oalnumber o individual enrepreneurs in Baku, Sumgayi, and Ganja equals 42 percen ohe whole counry. Tese enrepreneurs work mainly in he consumer marke, i.e. hedominaing share is employed eiher in he rade area, or in he services area.

Individual enrepreneurs are predominanly involved in aciviies requiring minimalinvesmens and giving quick income, especially rade. Only a small number o indi-

vidual enrepreneurs are involved in manuacuring, requiring high iniial invesmens,

which bring income aer a relaively long period o ime. Individual enrepreneurs hireon average hree employees on eiher ull or par-ime basis, paying hem an averagemonhly salary o $185.

Indicators on IE

0

10

20

30

40

50

Distribution by regions, in %Chart 2.6

Total numbero individualentrepreneurs inBaku, Sumgayit,and Ganja equals 42percent (Sumgayit isincluded into Aranregion, Ganja isincluded into Ganja-Gazakh region)

Baku

Aran

33

34

20

20

13

20

7

15

6

22

6

28

6

22

5

26

3

17

1

6

Ganja-

Gazakh

Lankaran

Sheki-

Zagatala

Absheron

Guba-

Khachmas

Nakhchivan

Dagliq

Shirvan

Yukhari

Garabakh

IE number per 1000 residents

Average annual turnover AZN 42,000 $51,000

Average prot AZN 10,450 $13,000

Employees number 3 people (ull and part-time)

Average monthly salary AZN 150 $185

Table 2.2 Statistical inormation on IE activity


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Chart 2.7

The individualentrepreneur ismore oten involvedin trade

Individual Entrepreneurs by Sector

Transport, 11%

Public and personal services, 7%

Hotels and restaurants, 6%

Agri processing, 2%

Agriculture, 2%

Other, 3%

Trade, 69%

2.2 Small enterprises

A small enerprise is a privae legal eniy meeing he requiremens o he CabineCouncil Decree on Crieria or dening SMEs.

By he beginning o 2006, here were abou 12,000 small enerprises regisered inhe counry, which corresponds o 6.6 percen o he whole SME secor. Te annualgrowh indicaor rom 2005 o 2006 was 2 percen. Tis indicaor is lower han hecorresponding growh o he secor, refecing he small number o enrepreneurs ha

op o become more srucured by regisering heir business as a legal eniy.

As in he case wih individual enrepreneurs, smaller rms are mainly locaed in largeciies. Tus, he oal number o small enerprises in Baku, Sumgayi, and Ganja equals56 percen o he oal number in he counry. (Sumgai is included in he Aran region,Ganja is included in he Ganja-Gazakh region).

0% 10% 20% 30% 40% 50%

Dagliq-Shirvan

Yukhari Garabakh

Guba-Khamaz

Sheki-Zagatala

Lankaran

Nakhchivan

Absheron

Ganja-Gazakh

Aran

Baku

Chart 2.8

Hal o the smallenterprises are

concentrated in thecountrys capital

48%

15%

9%

7%

7%

4%

5%

3%

1%

1%


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Te ypical small enerprise has he ollowing characerisics:

Unlike individual enrepreneurs, legal eniies are involved in a much greaer varieyo economic secors. Tus, i 69 percen o individual enrepreneurs are involved in

rade, hen, among legal eniies only 28 percen are in rade.

Chart 2.9

Unlike individualentrepreneurs, smallenterprises arediversied acrosssectors

Enterprises by SectorPublic and personal services, 15%

Transport, 3%

Agriculture, 18%

Trade, 28%

Other, 9%

Agri processing, 4%

Construction, 7%

Car and domesticappliances repair, 7%

Real estate services, 9%

2.3 Main source o investments: own unds

One imporan indicaor or measuring he growh o he SME secor is he level and hesource o he invesmens made by enrepreneurs ino heir businesses. Research showsha local enrepreneurs seldom make capial invesmens in expanding heir business.Tus, in 2007, only 28 percen o enrepreneurs invesed in heir enerprises.

A large porion o hese invesmens are nanced rom he enrepreneurs personalmoney. Only a small number o enrepreneurs apply or exernal nancing wih hepurpose o receiving nancial suppor or invesmens. Te chaper on Access onance elaboraes on he reasons or he low level o commercial unding and providesrecommendaions on overcoming he curren limiaions.

In he enrepreneurs opinion, he sable growh in income, he poenial or markedevelopmen, as well as heir business experience allows hem o achieve saisacoryurnover. However, as seen in he course o ocus group discussions, a signican paro heir pro is spen on ren.

Te number o enrepreneurs in Baku ha lease some premises or heir businessaciviy equals more han hal , while in he regions only 26 percen o enrepreneursren heir commercial premises.

Average annual turnover AZN 250,000 $309,000

Average prot AZN 30,000 $37,000

Employees number 15 people (ull and part-time)

Average monthly salary AZN 150 $185

Table 2.3 Statistical inormation on SME activity


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Chart 2.10

More than hal oentrepreneurs in thecapital conduct theirbusiness on leasedpremises Rent

Own premises

0%

20%

40%

60%

80%

100%

CountryRegionsCapital

74%

42%

58%

26%

61%

39%

According o he enrepreneurs own views expressed hrough in-deph inerviews,in he capial, where abou 60 percen o he enerprises are locaed on he leasedpremises, prices or he lease accouns or 30 o 40 percen o he enerprises pros.Closer o he capials cener and on he acive srees o he ciy, locaions wih direcexi o he sree are leased or dieren ypes o aciviy, and change enans some-imes several imes a year. Tis is explained by he ac ha he enerprises pro andheir income are requenly insucien o cover he high renal raes. Accordingly, heenrepreneurs who manage o cover he high expenses o he renal raes, as a rule areorced o shi heir invesmen needs o a lower prioriy.

2.4 State subsidies or SME development

Te Governmen o Azerbaijan provides hree dieren plans or SME suppor. Telarges o hem is he Azerbaijani Invesmen Company (AIC) ha invess in com-panies by aking equiy sakes o a leas $1 million, providing venure capial. TeNaional Enrepreneurship Fund (NEF) provides highly subsidized loans (up o $3.2million in value) o SMEs. Finally, he Morgage Fund also provides highly subsidizedloans or a special purpose. All hree unds rely heavily on he sae oil revenues andissue deb a below marke raes.

According o he Minisry o Economic Developmen daa, in 2007 NEF allocaedmore han $112 million in he orm o such subsidized loans aimed supporing localenrepreneurship. Tese credi lines were allocaed o 882 small businesses in 56 ciiesand regions o he counry. Te ineres o he enrepreneurs in receiving subsidizedloans increases he demand or he unds aciviy, which in urn called or a greaerallocaion o public unds or he purpose. Tus, during he rs hal o he year, heund allocaed an addiional $66.5 million o enrepreneurs or subsidized loans5. Tesysem o resource allocaion and he deails o he beneciaries, including how hesubsidies were spen, remain largely non-ransparen.

5 Bayramov V. Social and Economical developmen Programm o Azerbaijan Regions. Khalq newspaper, 13February 2008. htp://www.elibrary.az/docs/men-08/17x.hm.


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According o he IFC survey, more han hal o he enrepreneurs ace he problem oaccess o nance, i.e. insuciency o nancial resources o grow heir businesses. Te

number o enerprises ha received loans rom he designaed und amouns o only1 percen o hose who aced diculies in access o nance. Moreover, he averageloan size, according o he unds 2007 repor, is $127,000. Te gure suggess ha heloans were no disribued o he smaller enerprises and individual enrepreneurs, buin ac o larger companies, whose urnover and pro margins allow or larger scale

borrowing. Given he IFC survey daa, he average loan size rom NEF more hanriples IEs annual urnover (which sands a $42,000) and is abou he hal o heannual urnover o SMEs ($250,000).

2.5 Legal environment and SME condence

2.5.1 Legal unpredictability higher cost o compliance

Over he las decade, Azerbaijani legislaion has undergone subsanial improvemenand sysemaizaion hrough he enacmen o new laws in line wih bes inernaionalpracices, he inroducion o numerous amendmens o he exising laws, and heabrogaion o dysuncional and obsolee laws. As a resul o hese reorms, Azerbaijan

was named he op reormer or 2007-2008 in Doing Business 2009.

Among many ohers, he ax Code has been amended 19 imes since i came ino e-ec on January 1, 2001 and 30 amendmens have been made o he Civil Code since

i became eecive on Sepember 1, 2000. Considerable amendmens were made ohe law on Sae Regisraion and Sae Regiser o Legal Eniies in connecion wihhe inroducion o a one-sop-shop sysem in he regisraion o commercial legal en-iies. Relevan changes were made o he ax Code as well. Among he more noableimprovemens in he legislaion was he adopion o Presidenial Decree No. 782 onImprovemen o Rules o Issuance o Special Permis (Licenses) or Cerain ypes o

Aciviies daed Sepember 2, 2002. Tese rules unied he licensing issuance rules orall ypes o licenses, approved he lis o aciviies subjec o licensing, deermined heamouns o sae duies or he issuance o licenses, and designaed he license issuingauhoriies and he auhoriy supervising he license issuance process. Also he law onMorgage adoped April 15, 2005, broadened he morgage marke by providing he

necessary legislaion ha was lacking beore.

Such legislaive volailiy, while inended o improve he business environmen inpracice, also has negaive eecs on businesses, especially individual enrepreneursand SMEs, who are less able o say abreas o requen legislaive changes.

he complexiy o he laws and legislaive insabiliy, coupled wih he insuicienmeans or disseminaion o laws, conribues o a poor legal awareness o enrepreneurs.In Azerbaijan, new legislaive acs are published in wo ocial newspapers and hreeocial publicaions depending on he ype o legislaive ac. However, no auhoriy isocially responsible or he eecive disseminaion o inormaion abou new legislaive

acs. Nor are hey published online, or i published, are usually no up-o-dae, and again,no auhoriy is ocially in charge o he publicaion o laws online. o keep rack olegislaive developmens, an enrepreneur needs o subscribe o ocial newspapers and


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publicaions and consanly ollow-up wih he publishers in order no o miss publica-ions, since delays in publishing are no unusual. In ac, a imes even having he exs o

laws available may no be sucien, as undersanding he impac o new legislaion may,more oen han no, require legal experise. Alhough enrepreneurs may le inquiries

wih he sae auhoriies o obain ocial explanaions wih regard o legislaive maters,he procedures or processing such inquiries are oo complicaed and

Documents

Ifc - Study of Sme in Az