Azerbaijan, the world's fastest- growing economy last year, must reduce its dependence on energy and improve regulation of its capital markets to combat inflation and counter ``external shocks,'' Moody's Investors Service said.

The former Soviet state must improve the business climate, diversify its economy within three to five years and maintain ``prudent'' fiscal policies to sustain growth, Moody's said in an e-mailed report today.

``Given the windfall nature of Azerbaijan's oil and gas- related revenues, the government faces the difficulties of sheltering the economy from its current overexposure to potential external shocks,'' Moody's said. ``Further reform of the financial sector would be extremely useful'' to ``play a more efficient role in management of large oil-related capital inflows.''

The economy of Azerbaijan, a Caspian Sea nation with 0.6 percent of the world's proven oil reserves, will probably expand 13 percent this year, compared with 23.4 percent in 2007, Moody's said. Inflation will probably slow to 15.5 percent from 16.7 percent last year, according to Moody's.

The government plans to produce 50 million tons of crude oil this year and 60 million tons next year, according to President Ilham Aliyev. Crude oil for August delivery rose 77 cents, or 0.6 percent, to $136.81 a barrel at 10:54 a.m. on the New York Mercantile Exchange. Prices are up 90 percent from a year ago.

``Massive capital inflows and poorly developed local capital markets interact to fuel inflation,'' said Moody's. ``Large increases in both budgetary current expenditures and capital expenditures reinforce such trends.''

Moody's set Azerbaijan's foreign currency credit rating at Baa2 with stable outlook in September 2006.