Information about Middle East Oriente Medio
Chapter

Chapter 6. Conclusion

Author(s):
Niko Hobdari, Eric Le Borgne, Chonira Aturupane, Koba Gvenetadze, John Wakeman-Linn, and Stephan Danninger
Published Date:
April 2004
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In the near future, Azerbaijan is expected to benefit from a substantial, but short-lived, oil- and gas-related revenue windfall. Even under conservative assumptions, revenues accruing to the country are expected to average around US$800 million during the period 2003–07 and over US$2 billion per year during the period 2008–24, compared to 2002 GDP of just over US$6 billion. Because few countries have been successful in managing natural resource wealth of this relative magnitude, the government faces a key and immediate challenge: managing this short-lived natural resource wealth in such a manner as to avoid the pitfalls of Dutch disease and ensure the simultaneous development of the non-oil sector.

This paper aims to provide a broad policy agenda for the government for managing this natural resource wealth. The key policies and recommendations in the paper are as follows.

A. Institutional Arrangements and Capacity

  • Consolidate oil revenue management and treat all oil revenue as one source of financing.
  • Develop and maintain a model for long-term projections of oil and gas revenues.
  • Develop institutional capacities for project selection, monitoring, and evaluation, including the establishment and development of a project appraisal department as well as capacity building in fiscal policy analysis.

B. Level of Expenditures

  • Set expenditures of oil and gas revenues consistent with a long-term savings objective of conserving assets for the future, particularly given the short-lived nature of the windfall. The goal should be to ensure constant real expenditures out of oil wealth.
  • Use the concept of a sustainable non-oil deficit to provide an expenditure ceiling for the use of oil assets that is consistent with this long-term savings objective. Under the baseline scenario for oil and gas reserves and conservative assumptions for the price of oil, substantial non-oil deficits are affordable until 2010, with subsequent steadily declining non-oil deficits.
  • Avoid large fluctuations in the non-oil deficit.
  • Revise the estimate of the sustainable non-oil deficit in light of new information. The appropriateness of the sustainable non-oil deficit should be reviewed at regular and sufficiently spaced intervals, based on updated information on oil and gas reserves, production patterns, and price developments.
  • As the sustainable non-oil deficit provides only an expenditure envelope for the medium term, do not increase expenditures to this ceiling in the near future. This would not be advisable given the macroeconomic implications of excessive growth in spending. In particular, a rapid increase in expenditures consistent with this ceiling could exert substantial upward pressure on the exchange rate with all its negative consequences for the non-oil sector. It could also strain the government’s institutional capacity for planning, executing, and monitoring expenditures, resulting in substantial waste.
  • Do not borrow against future oil revenue to finance current spending.
  • Take macroeconomic stability considerations into account when deciding how much oil revenue to spend in the medium term. Strengthened coordination between the Ministry of Finance and the Azerbaijan National Bank will be imperative.

C. Composition of Expenditures

  • Revenues should be utilized primarily for investment rather than consumption. Expenditures on physical and human capital will provide a solid foundation for the future growth of the country, while excessive current consumption could have a potentially destabilizing impact in the short term. Capital expenditures have the added advantage of a substantial import content, providing an automatic means of sterilizing part of the substantial foreign exchange inflows associated with the oil windfall.
  • Capital investment should target the building and maintenance of a well-designed physical infrastructure necessary for improving the competitiveness of the non-oil sector, including the reliable provision of energy and water, an efficient transport and communications network, and improved education and health services, particularly in the regions outside the capital city.
  • A notional investment maintenance fund should be established for meeting recurrent costs associated with physical infrastructure projects. This would increase transparency of already committed resources and ensure proactive savings for long-term maintenance costs.
  • Reductions in tax rates could be an alternative to increased expenditures, with the direct positive impact on competitiveness offsetting, at least in part, the negative effects of real appreciation.

Political pressures for excessive and speedy expenditures of oil wealth are inevitable. Successful long-run development of the economy will require that the government withstand such pressures. But this will not be easy. The government will need to demonstrate to the population not only that oil wealth is being saved for future generations but that it is also being used to effectively benefit the current population of Azerbaijan. The policies recommended above—focusing on infrastructure development and protecting non-oil competitiveness—should help generate new employment opportunities and meaningful economic growth. If the government can succeed in doing this, and also succeed in explaining to the population the dangers—not just to future generations but to the current population of Azerbaijan as well—of excessively rapid expenditures of oil wealth, Azerbaijan may succeed where so many other oil-producing countries have failed: it may manage to use its oil wealth to help develop the non-oil sectors of its economy.

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