12 December 2017

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"GOLDEN RULES" FOR THE ROADMAP

Vusal Gasimli, Executive Director, Center for Analysis of Economic Reforms and Communications, shared his vision of Azerbaijan's economy in the coming years in his interview with R+.

Author:

01.01.2017

- With the approval of strategic roadmaps, Azerbaijan has launched a completely new model of economic development. Prior to this, the development of national economy was based on government programs. What are the reasons behind this shift into a new model, and why is the preference given to roadmaps?

- First of all, I would like to note that the All-national Leader, Heydar Aliyev, had ensured socio-political and macroeconomic stability in the country and been the architect of the current development model in Azerbaijan. He had made sure that large-scale oil revenues were used to improve economic and social infrastructure, to deepen market relations, to reduce poverty, and to improve the economic security and strengthening of state administration. Thanks to this model, Azerbaijan witnessed the establishment of middle class: a diamond-shaped structure of the society, namely a large middle class in the middle of this structure with relatively rich and poor people (5%) on top and bottom of it, respectively. The stabilizing middle class was a guarantor of socio-economic and political stability that distinguishes us from the Middle East countries with a pyramidal structure of society.

As to economic security, we have achieved success on four major components: energy security, financial security (our strategic currency reserves exceed GDP), food security and, finally, transport and logistics security. Azerbaijan has diverse capabilities in both directions: East-West and North-South.

However, this economic model was based on natural resources. Sharp price decline in global oil markets has made the adjustment of development path necessary. We had several options to choose from: an economic model based on the intensity of labor; a model based on efficiency, and innovative model. We thought that it was too early to introduce the last mode in Azerbaijan. Therefore, we opted for the first two models.

The strategic roadmap combines both models based on their short-term (until 2020) and medium term (until 2025) performance. But the strategic vision until 2025 provides for the transition to a model based on innovativeness. In comparison, , our model is similar to Malaysian model in short and medium terms although, in principle, it is our private model. In the future, that is in 2025 and onwards, we will most likely use models currently implemented in Israel, South Korea, and Singapore.

Why have not we adopted a program but a strategy? In fact, a program is usually implemented to achieve certain goals within a particular model. If we consider a transition from a resource-based model to a performance-based model, a single program is not enough. Considering all these points, the main directions of Strategic Roadmap were developed according to the order of President Ilham Aliyev, dated Martch 16, 2016.

- What about the existing programs?

- In fact, the Strategic Roadmap was developed as part of the process of economic reforms in Azerbaijan, so all initiatives will be continued. But all government initiatives, policies, programs adopted after that must comply with the Strategic Roadmap. It is like a framework document. For example, in addition to horizontal approach consisting of 11 sectors of the national economy, there are another four vertical functional approaches: fiscal and monetary policies, development of human capital, improvement of state enterprises, and improvement of business climate.

- You have mentioned a combination of fiscal and monetary policies as part of these functional areas. The most interesting innovation in this direction is the use of the "golden rule." What is that?

- In accordance with the previous model, the state could create infrastructure and improve social welfare at the expense of fiscal expansion. The essence of the "golden rule" is that if the infrastructure is already available and the state has less financial capabilities, it cannot continue fiscal expansion and should narrow it. Instead, the state can act as a catalyst and encourage private sector to expand investments. So, the void formed as a result of slow retreat of the state should be filled by private investment. Of course, the main condition in this case is to prevent the negative impact of this transition on population. Therefore, it is planned to define fiscal frameworks, fiscal responsibilities and to increase efficiency, to ensure transition to fiscal policy based on final outcome, and the overall implementation of medium-term expenditure strategy.

- And now about the monetary policy. The plans to complete transition to a floating exchange rate of manat have caused many debates. Several experts pointed to the impossibility of implementation of this mechanism given the weaknesses of financial institutions in Azerbaijan. When do you think this transition will be implemented actually?

- A full transition to floating exchange rate is important and necessary. Currently, there is no balance in the value of money between financial and real sectors of economy. Financial sector aims to sell money as more expensive as possible while the real sector is interested in cheap money. This is due to high popular expectations concerning the cheapening of manat - people believe that if manat is in "free floating regime" and is let to find its stable exchange rate, it will be cheaper. That is why both banks and the real sector prefer keeping money in foreign currency and waiting.

Another challenge for floating exchange rate is the large volume of savings: about $40 billion in strategic currency reserves plus savings of households, banks and the private sector. The total amount is $100 billion. According to classical economic theory, the accumulation must be equal to investment... We have a big gap between these two components. It is associated with expectations for cheap manat. Full-floating exchange rate means we will see the real value of manat, which will eliminate these expectations. The stabilization of manat will restore bridges between the real and financial sectors.

- Does the level of development of our financial institutions allow for this?

- Yes, it is important that the country has developed financial instruments and increased financial depth for a fair determination of exchange rate. But these two questions are so strongly dependent on each other that we cannot develop one of them at the expense of another. Both processes must go hand in hand. Therefore, the Strategic Roadmap assumes that we should support the solution of problems in financial and banking sectors related to liquidity and capitalization. Secondly, we should solve the issues related to risk management in this sector. Thirdly, it is necessary to ensure the privatization of the International Bank of Azerbaijan, which is included in the plans for 2017. Fourthly, it is planned to ensure institutional promotion of the Deposit Insurance Fund and, finally, to solve issues related to problem assets. The entire scope o works should be implemented in the short term, and the logical result will be a floating exchange rate regime.

If we analyse the problem based on the new economic history, the situation in Kazakhstan and Ukraine, which have already switched to a floating exchange rate of their national currencies, was not better than ours. Of course, after this transition, there is a certain volatility of national currency but this process diminishes over time and the situation stabilizes. Even then everyone understands what the real market price of currency is. Expensive or cheap – this is a different question.

- What is the role of state in this issue?

- The role of the state in the transition period is to protect the population, banks and businesses from negative influences, and I think this will be achieved. Anyway, if we defer the transition to a floating exchange rate, we will worsen the situation. Do you know what it looks like? Suppose a person is sick, and he needs a painful treatment. But he does not want to undergo such a treatment. The longer it is delayed, the more is the aggravation of disease, and the healing process starts with an even weaker position. In short, if we move from a resource economy to performance-based economy, we should implement this mechanism. You cannot change fiscal policy, business climate, and leave the old exchange rate policy. This can lead to very bad consequences. Therefore, our media, opinion leaders have come up with a more objective position in this matter without creating hype.

I want to stress one more time. We have modeled inflation and determined that the rise in prices in Azerbaijan is influenced not so much by objective factors rather than psychological ones. That is very important to direct people's expectations in a positive direction.

By the way, the fiscal and monetary policies are the main instruments of the state to stabilize the economy. But its impact will be short-lived. To have a long-term effect, it is required to improve the business climate. This is the only way to make sure that the signals coming from the implementation of fiscal policy are appreciated positively. Along with the establishment of business climate, we also need to develop human capital that is able to meet modern challenges.

- It means we have underdeveloped human capital?

- I think now we need to build not a "knowledge economy" and a "skills economy." For example, the secondary schools in Singapore teach two main subjects, mathematics and a foreign language. The same is true even for the best schools in London. The human capital development is based on skills. We also need human resources with skills. This requires a transition from one model to another.

Until now, 600 thousand people were involved in the construction sector. But currently the volume of public investment has declined, and we will develop the commercial sector. Therefore, the labor force must be ready for this. Of course, this will take years, and the history of economy does not know short-term and painless transitions. The economies of Japan and Korea are striking examples of an innovative model of development but each of them took 30 years to build the automotive industry, which today is an important part of their economy. Norway has a better strategy on spending oil revenues but the country made serious mistakes that led to the unwarranted spending to achieve this result: in the 70s and 90s. The transition to a new economic model in Azerbaijan will be gradual and will require some time.

- You have mentioned the development of the commercial sector. Do we have a market for this?

- We have indicated another interesting point in the Strategic Roadmap: Azerbaijan is surrounded by three large markets with a total volume of GDP reaching $3 trillion, and the population - 300 million people... I mean Russia, Turkey and Iran. If you expand this area a little bit, you will come to an even larger market - China, the European Union and the Gulf countries. The total volume of this market is already $30 trillion. Access to this market is not too difficult for us, as we have only one country between each of these areas. We have Kazakhstan between us and China, Georgia to reach the EU, and Iran to reach the Gulf countries. Our geographical location is extremely favorable.

But all of these markets have their own standards. Many of them, especially the markets of EU and the Eurasian Union follow the standards of the World Trade Organization. We must also improve our standards to that level. Another advantage is that under the previous model, we were able to create well-developed transportation and logistics networks. Azerbaijan is the only country in the world today, which has a small area without access to oceans but also ambitions to become a transport hub to successfully implement the ideas behind it.

- So, we do not have serious problems in getting our products to world markets?

- That is true. But there is another important point. Currently, it is globally popular to connect to a certain value chain. What is this? Today, 80% of world trade is carried out between offices of leading companies. For example, Apple company distributes production of parts of its famous products among different countries. Neither economy is able to produce all sorts of products perfectly. Especially such a small country as Azerbaijan. From this perspective, specialization is a very important factor. We have to find our place in the global value chain and focus on what will be an advantage. We do not have such a big country to be able cover a wide area. On the contrary, it will be much more useful to focus on areas where we can show competitiveness able to mobilize resources in specific areas. For instance, Costa Rica and Malaysia have followed the same path of development: starting with the production of small parts to large companies in the future, they have made important achievements in the sphere of high technologies.

- This value chain system ​​existed in the Soviet Union. What is more effective for Azerbaijan - to return to traditional experience or find its place in the new value chain?

- Based on experience of other countries, both ways are acceptable. No economy in search of new spheres does not refuse traditional sources of income. For example, Malaysia continues to hold the leading position in exports of palm oil along with the production of high-tech products. Chile exports inorganic products and traditional fish products. Joining the global value chain must be based on the principle of competitiveness. After that you need to consider access to markets, transport and logistic capacity of the country, geo-economic position, policymakers and other important issues. We have tried to clarify these points in the Strategic Roadmap. They will be refined step by step. Let me also note that Azerbaijan has repeatedly demonstrated its capacity for industrialization since the 19th century, and I'm sure this will be done again.

- As indicated, the implementation of plans published in the Strategic Roadmap will require 27 billion manats. This raised many questions. Although the document specifies capital investments as a main source of this resource, some experts doubt the existence of such possibilities. What will ensure the inflow of investment?

- About $200 billion have been invested into the national economy since the independence. Thanks to this, we are now able to talk on the implementation of the Strategic Roadmap. The indicated 27 billion manats will be attracted from several sources: public finances and private sector, grants from international financial institutions, investment funds, etc. I also note that after the approval of the first strategic roadmap, I was invited to meet ambassadors from 20 EU member-states. The main question that interested them was the possibility of contributions of European investors in Azerbaijan's economy in the coming years.

As far as the investment flow is concerned, today we have all conditions for that. First of all, the decreasing public investment makes this area attractive to investors. Previously, state capital investments were the only source of investment absorption opportunities. And the economy was no longer able to "digest" private investment. Today, new opportunities are open for investors. On the other hand, following the devaluation of manat, the country has an inflow of cheaper foreign currency, labor, utilities. Of course, another incentive will be the start of the next stage of privatization, and output to the auctions of strategically important enterprises. And, of course, consistent implementation of measures to improve the business climate in the country and increasing their efficiency.

I am confident that Azerbaijan's position will improve significantly in the next report of the World Bank's Doing Business.

- What are the additional reforms proposed for the development of small and medium-sized businesses?

- As you know, one of the directions outlined in the Strategic Roadmap covers exactly this area. First of all, it is necessary to ensure effective coordination of SMEs. With regard to such pressing problems today, as monopolies, most of them will be solved with the adoption of Competition Code. In addition, a full transition to a floating exchange rate will facilitate business access to financial resources.

Currently, banks experience a so-called "risk aversion phenomenon", which is based on the low level of trust to them. But the improvement of laws, the solution of institutional issues will help to remove all these obstacles. Also, as part of the Strategic Roadmap, it is envisaged to introduce credit insurance mechanism.

Another important issue is the simplification of access of small and medium business to foreign markets. Our centre has launched the website www.azexport.az, as instructed by the President Ilham Aliyev. In fact, this is a simple and broad trading platform for entrepreneurs. The database of the portal is integrated with the world's largest database of electronic trading platforms such as eBay, Alibaba, AllBiz. Large companies specializing in the transport such as DHL, FEDEX, the payment system PayPal, 2Chekout, the electronic giant Microsoft and finally, the United Nations Development Program support Azexport.az. 24 hours a day, 7 days a week, the customers are offered services through a variety of communications tools. We also offer some entrepreneurs, especially those living in the regions, translation services. If there are problems in communication between the seller and the buyer, they are assisted through the integrated website translation services via Skype. I mean there are all conditions in order to facilitate the sale of local products and make the markets close to local producers. With a click of a button Azexport.az can turn into the Alibaba of the region.

In general, I think the beginning of post-oil period will bring more benefits to Azerbaijan and will be a stimulus for new opportunities. We have 1-2 difficult years ahead but it is inevitable, otherwise we cannot move the economy from one rail to the other. After the temporary difficulties of the transition period, we will witness both quantitative and qualitative sequential growth.



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