28 February 2017

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A PATH TO POST-OIL FUTURE

The Strategic Roadmap declared a transition of Azerbaijan to a new model of economic development

Author:

15.12.2016

The transition to a new model of economic development is started in Azerbaijan. A document, or rather, a set of documents of completely new form and substance has been prepared and approved by in the shortest possible time: strategic road maps for the national economy and the main sectors of economy. The necessity to accelerate the development of non-oil sector of the economy amidst the sharp drop in oil revenues, as well as the decision to substantially reduce public spending not only posed new challenges to the government but also made it impossible to implement a number of previously scheduled plans under existing government programs. We needed a new mechanism for actions given the realities of the post-oil period, with specific objectives and a detailed vision of implementation.

The choice of the format of new road maps is not accidental - they are quite popular today in many countries, and especially in neighboring Russia, which is experiencing similar problems due to the fall in oil prices.

The development of road maps was commissioned to a new structure full of young professionals and experts - Center for Analysis of Economic Reforms and Communications. The projects were open for discussion, many opinions and suggestions of stakeholders, including civil society and citizens, were taken into account in the preparation of the final document. The new road map does not supersede existing programs, most likely they will be amended in the course of implementation, as required.

The strategic roadmap includes 12 documents: Strategic roadmap on perspective development of the national economy and smaller roadmaps covering 11 specifically significant areas of the economy. The whole package includes an action plan for years 2016-2020, a long-term outlook for the period until 2025 and a target view for the period after 2025.

 

Pros and cons of the past

The document estimates Azerbaijan's chances of achieving stable development dynamics as high enough due to a sharp increase in the growth during 2004-2014. In addition, favorable geo-strategic location of the country, socio-political stability, efficiency and transparency in the provision of public services to the population (ASAN centers), the creation of favorable investment climate and other factors are also taken as a positive basis for further development. All these achievements enabled Azerbaijan to become one of the countries with a high level of competitiveness, achieve leading positions in the region and international recognition.

However, the authors of the road map laid out an objective analysis of past errors. That gives us hope that they will be eliminated gradually in the future. In particular, the weaknesses include procyclical macroeconomic policies, poor economic diversification and exports, dependence on oil revenues, lack of corporate governance in public and private sectors. A significant omission was also the translation of foreign direct investment in oil and gas sectors of the economy, and the fact that, in general, the state's share of investments was definitely greater than the contributions of the private sector. As a result, the country is still dependent on imports, while the national exports mainly consists of raw materials.

All these drawbacks are recognized and have been criticized at the highest level. New challenges and dangers leading to negative growth rates necessitate the resolution of these drawbacks. The intensity of geopolitical tensions in the region, the events shaking the neighboring and partner countries, of course, continue to have a negative effect on the country. In addition, according to the authors of the road maps, serious cause for concern is the increase of tax burden, problems associated with attraction of investments in infrastructure projects, the depletion of natural resources and the probability of revenue recession.

 

The four objectives of the new model

Full-scale reforms may eliminate the above-mentioned risks. In particular, it is necessary to speed up judicial and legal reforms, and fully ensure the protection of investors' rights in institutional terms, as stated in the basic strategic map on prospects of Azerbaijan's economy. In addition, more efforts are needed to improve the business climate (including tax and customs reforms, the enhancement of dialogue between businesses and the state, etc.), efficient allocation of financial resources and, finally, the establishment of a model for forecasting economic policy, which depends on the increase of transparency and accountability of state agencies and the private sector.

As a result of these reforms, it is forecasted to achieve annual GDP growth by an average of 3% by 2025 and the creation of more than 450 thousand new jobs.

It is also planned to increase the share of investments in non-oil GDP from the current 2.6% to 4% in 2025; increase non-oil exports per capita from $170 in 2015 to $450 in 2025; reduce budget dependency on transfers of the State Oil Fund (SOFAZ). The last point needs a detailed review, as most experts believe it is the main reason of problems in the national economy. “It is very important to ensure stable growth rates and less dependence on SOFAZ transfers to increase the share of private investment in the economy”, reads the road map. According to the data indicated in the strategy, if the SOFAZ transfers to the state budget in 2010 amounted to ₼5.9 billion only, this volume reached its maximum level, ₼11.4 billion in 2013. In 2016, SOFAZ transfers to the state budget totaled ₼7.615 billion. The draft budget for 2017 provides for ₼6.1 billion of transfers. Today every second manat spent in public sector is provided by SOFAZ. According to the document, this figure should be reduced to 15% in 2025.

 

The main objectives

It is proposed to introduce “golden rules” for a more efficient use of oil revenues. Currently, the amount of funds that SOFAZ directs to state treasury depends on oil prices. The use of “golden rules” will help stabilize the volume of transfers and transfer to the budget only a certain amount that will not depend on oil prices. This will help improve the protection of public spending on oil prices. According to this principle, the state budget can only spend a certain, clearly specified level of oil revenues. The rest of income from oil sales will be deposited in SOFAZ. To make sure that SOFAZ could not affect private investment in the country, the fund will invest only abroad.

This method is used in many other countries. For example, The Oil Fund of Norway - Government Pension Fund - may send only 4% of income to the state budget annually. It is noteworthy that the government is considering four options for transfer restrictions in the treasury, and the Norwegian method is one of them.

In addition, the “golden rules” will simplify the forecasts regarding manat’s value, which, in turn, will make it possible to build longer-term plans to improve the efficiency of public spending, etc. SOFAZ is able to make a high-yield and long-term investments, and transfer restrictions will help increase the accumulation of funds intended for future generations. The first stage of implementation of “golden rules” may begin as early as next year.

In general, the first strategic goal provides for ensuring fiscal sustainability and, in addition to the savings of income received from the sale of natural resources, strengthening of control over the proper use of those resources. It is planned to define medium-term expenditure framework that will help form the annual budget. All of these measures will not only distribute funds of the state budget properly between sectors but will also to increase the responsibility of specific entities that use state funds, as it is implied to establish a mechanism of control over the use of budgetary funds.

In addition, the first objective requires that monetary policy of the country is based on floating exchange rate of manat starting in 2017. In this context, the support of import substitution policy may be chosen as the main strategic goal of the exchange rate policy. According to the road map, the reduction of the volume of imported goods in consumer basket will ensure an effective transition to the floating regime.

“One of the conditions of transition to a floating exchange rate regime is the introduction of tools to develop domestic financial market, insure hedge and exchange rate risks in the market, etc. Also, a strategy providing for Central Bank's participation in the foreign exchange market strategy will be prepared”, reads the document.

One of the important signals for liquidity growth is the development of liquidity in the interbank market due to loan growth. Meanwhile, the deepening of capital markets will create opportunities for local investors. Therefore, it is important to increase the number of local creditors in capital markets. The government estimates that these measures will reduce the volatility of capital markets and diversify them increasing the attractiveness of the national currency (manat). Consequently, the level of dollarization in public savings will decrease.

 

Sources of financing

The second goal assumes privatization and reforms related to state-owned enterprises. A new law “On privatization of state property” is prepared according to the road map. The purpose of this law is to reduce government spending by changing the government's role as the governing body. Under the same law, the government will support companies that have privatized state-owned enterprises in accordance with the I and II State Programs on Privatization.

The third objective of the government is the development of human capital, which requires the improvement of the quality of education at all stages.

Finally, the fourth objective laid down in the road map is the establishment of favorable business environment and strengthening the role of the government in this direction. The first item listed is improving the competitiveness of businesses, which proposes the creation of a separate independent competition authority. It is expected that the Azerbaijan Competition Code is adopted. It is stated that it is important to improve fiscal policy, as well as the efficiency of state services, etc.

The overview of the road map quite clearly states that the scope of the work is huge. An investment of ₼27 billion is required for the implementation of all these works outlined in the strategic roadmap. This funding will be provided both by public and private sources, in particular the state budget, extra-budgetary funds, foreign direct investment, bank loans and grants, technical and financial assistance of international organizations and foreign countries.

Thus, the objectives are defined, and the achievement of these goals will boost Azerbaijan’s economy once again.



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