Azerbaijan Republic: Staff Report for the 2003 Article IV Consultation, Second Review Under the Poverty Reduction and Growth Facility, and Requests for Waivers of Performance Criteria, Extension of Arrangement and Rephasing of Purchases
Author: International Monetary Fund
Publication Date:
06 Jun 2003
eISBN:
9781451802641
Language:
English
Keywords:
ISCR; CR; SOCAR; government; PRGF arrangement; policy commitment; tax obligation; exchange rate; banking system; treasury bill; balance of payments; poverty reduction goal
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This paper evaluates Azerbaijan’s 2003 Article IV Consultation, Second Review Under the Poverty Reduction and Growth Facility (PRGF), and Requests for Waivers of Performance Criteria, Extension of Arrangement and Rephasing of Purchases. Performance relative to the quantitative targets under the program was strong, as all quantitative performance criteria and most indicative targets were met. Implementation of the structural reforms under the program was slower than planned, delaying completion of the second review. The authorities are requesting several waivers related to delays in structural reforms.

Abstract

This paper evaluates Azerbaijan’s 2003 Article IV Consultation, Second Review Under the Poverty Reduction and Growth Facility (PRGF), and Requests for Waivers of Performance Criteria, Extension of Arrangement and Rephasing of Purchases. Performance relative to the quantitative targets under the program was strong, as all quantitative performance criteria and most indicative targets were met. Implementation of the structural reforms under the program was slower than planned, delaying completion of the second review. The authorities are requesting several waivers related to delays in structural reforms.

I. Introduction

1. The staff discussions for the 2003 Article IV consultation and the second review under the Poverty Reduction and Growth Facility (PRGF) were held in Baku during February 23-March 6, 2003.1

2. The Executive Board completed Azerbaijan’s 2001 Article IV consultation, and approved completion of the first review and disbursal of the second tranche (SDR 8.05 million) under Azerbaijan’s PRGF arrangement, on February 20, 2002. Directors commended the authorities for continued strong economic performance, felt prospects for broad-based economic growth were encouraging, and stressed that economic diversification was crucial for sustained reduction in poverty. Directors welcomed the comprehensive plan to strengthen energy sector financial discipline, noting that failure to reduce quasi-fiscal subsidies would threaten economic stability and prospects for diversification. Finally, Directors were encouraged by the regulations designed to ensure the planning, execution and monitoring of the oil fund and state budgets in the context of a consolidated budget, stressing that, if used wisely, the oil fund could make a crucial contribution to combating poverty in Azerbaijan.

3. In the attached letter of intent (LOI) to the Managing Director, dated April 23, 2003 (Attachment I), the authorities set out their economic performance under the PRGF arrangement to date and their planned economic policies for 2003, and propose performance criteria for end-June and end-December 2003, indicative targets and benchmarks for end-June, end-September and end-December 2003. The authorities also request several waivers, a rephasing of the third review and an extension of the PRGF arrangement through March 31, 2005, as noted below.

4. Azerbaijan continues to avail itself of the transitional arrangements under Article XIV, but no longer maintains restrictions under such transitional arrangements. Staff has identified measures in connection with the granting of tax clearance certificates that give rise to exchange restrictions under Article VIII, Section 2(a), which Azerbaijan should eliminate before accepting the obligations of Article VIII, Sections 2, 3 and 4.2 Discussions with the authorities on the elimination of these restrictions are ongoing. Azerbaijan has not sought, and staff does not recommend, approval of these exchange restrictions.

II. Recent Developments

A. Macroeconomic Developments

5. Economic developments in Azerbaijan in recent years have been characterized by strong economic growth—averaging over 10 percent per year for the last few years—combined with low single-digit inflation. While exports have been dominated by oil and oil products, and investments in the energy sector have been an important engine of growth for the economy, other sectors—including transportation, communications and services—have also grown rapidly. Particularly noteworthy is the agricultural sector where, following comprehensive land reform in the mid-1990s, value added has increased by more than 5 percent per year for six consecutive years, with growth in some years exceeding 10 percent. Nonetheless, the economy remains heavily dependent on oil and oil product exports—which account for around 90 percent of total exports—and thus vulnerable to international oil market developments.

6. Economic developments continued to be favorable in 2002, and were slightly better than expected. High oil prices and significant growth in investment (largely FDI) in the oil and gas sectors, combined with strong performance in other sectors, contributed to 10.6 percent real GDP growth (Table 1, Figure 1), notwithstanding a generally weak international economic environment. Prices remain fairly stable, with end-period consumer price inflation of 3.3 percent.

Table 1.

Azerbaijan: Selected Economic and Financial Indicators, 2000-2005

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Sources: Azeri authorities and staff estimates and projections.

Excludes the increased revenues and expenditures from including SOCAR’s quasi-fiscal activities in the budget.

In percent of beginning of the year broad money (MB) stock, unless otherwise specified.

In terms of nonoil GOP.

For2001 and 2003 includes Investments of US$5O mln. and US$121.5 mln., respectively, for the government’s share in BTC, equivalent to 0.8 percaitmo 1.8 percent of GDP. respectively.

Calculated by deducting Oii Fund and SOCAR revenue from the consolidated government budget balance.

Government and government guaranteed external debt

In percent of exports of goods and services.

Figure 1.
Figure 1.

Azerbaijan: Recent Economic Developments, 1997—2002

Citation: IMF Staff Country Reports 2003, 154; 10.5089/9781451802641.002.A001

Source: Azerbaijan authorities and Fund staff estimates.1/ 12-month growth rates.2/ Includes the balances of the General Government and of the Oil Fund.3/ Sustainable non-oil fiscal balance is defined below.4/ Includes only public and publicly guaranteed external debt.5/ Excludes capital repatriation from foreign investors.6/ Decrease means depreciation.

7. The most significant development in the real sector in 2002 was the sanctioning3 by investors of the Baku-Tbilisi-Ceyhan (BTC) oil export pipeline, as well as the associated mil field development of the Azeri-Chirag-Guneshli (ACG) oil field. Combined with the Shah Deniz gas field and associated gas export pipeline (which was sanctioned in early 2003), these and other energy sector projects will result in over US$8 billion in investments over the period 2002-2004, and will contribute to a rapid growth in energy sector output and exports (Box 1).

Azerbaijan Oil Production and Oil Exports: A Regional Comparison

Azerbaijan has a rich natural resource endowment with substantial oil reserves in the Caspian region. Overall, oil reserves in the country are estimated to be the third largest in the Caspian region, following Kazakhstan and Turkmenistan.

On the basis of current oil reserves estimates the oil production profile for Azerbaijan indicates a short but steep increase in oil production relative to other countries in the region. Total oil production for Azerbaijan is expected to rise sharply from 2004 through the turn of the decade and subsequently fall almost as rapidly, in the absence of a significant new oil discovery (Figure 1). On the other hand, oil production in Kazakhstan is expected to have a lengthy sustained peak. Revenues from oil wealth accruing to Azerbaijan will be substantial, but short-lived.

Figure 1.
Figure 1.

Oil Production, 1994-20242

Citation: IMF Staff Country Reports 2003, 154; 10.5089/9781451802641.002.A001

Azerbaijan is much mare dependent on oil exports than other countries in the region. Oil exports (crude oil and oil products exports) comprised almost 90 percent of Azerbaijan exports in 2002 and are expected to retain a similar share through the end of the decade (Figure 2). In contrast, oil exports in Kazakhstan and Russia comprised 50 and 37 percent of total exports respectively in 2002.

Figure 2.
Figure 2.

Oil Exports,1 1995-20082

Citation: IMF Staff Country Reports 2003, 154; 10.5089/9781451802641.002.A001

1 Oil exports comprise crude oil and oil products exports for Azerbaijan and Russia and only crude oil exports for Kazakhstan. Oil products exports for Kazakhstan are negligible.2 Source: IMF staff estimates.

8. Balance of payments developments were somewhat better than projected in 2002. In addition to higher than expected oil prices, non-oil exports grew faster than anticipated, led by agricultural and chemical product exports. There was an expected current account deficit in 2002, largely due to oil-sector related imports, which was more than financed by FDI. Azerbaijan’s exchange rate policy continues to rely on the exchange rate as a nominal anchor, with interventions focused on stabilizing fluctuations around a trend judged to be consistent with the authorities’ inflation target. As noted earlier, Azerbaijan’s inflation has remained in low single digits since 1996. The modest depreciation of the real effective exchange rate, which has been ongoing since mid-1999, continued in 2002.

9. The most crucial reforms in Azerbaijan in recent years have focused on enhancing energy sector financial discipline. As discussed in detail below, nonpayments and other implicit and explicit subsidies in the energy sector have been the major economic problem facing the country. With the reforms of the last two years, the government has made significant strides toward the eradication of this problem.

10. Despite the strong economic performance in recent years, poverty remains a serious problem in Azerbaijan, with the State Statistics Committee estimating that 49 percent of the population living in poverty, and 17 percent in extreme poverty. Thus, combating poverty remains the key economic challenge facing the country.

11. Overall, economic developments and prospects reaffirm the importance of the primary objective of Azerbaijan’s PRGF-supported economic program: the development of the non-oil sectors of the economy (and thereby the creation of income opportunities) through continued implementation of monetary and fiscal policies consistent with macroeconomic stability, improving the environment for private sector development including through improved governance, accelerating structural reforms, and strengthening energy sector financial discipline.

12. Experience also reaffirms the appropriateness of the program design. Macroeconomic stability continues to be an important feature of the Azerbaijan economy, and exchange rate policy is contributing to growth in non-oil exports. Combined with improved governance and progress in structural reforms, macroeconomic stability has helped the country begin to experience new private investments outside the oil and gas sector (including, for example, in the aluminum and electricity industries). Finally, improvements in financial performance in the energy sector will increasingly free up resources for important infrastructure reforms and poverty alleviation efforts.

13. The one area in which economic performance has been somewhat at odds with program assumptions has been the pace of structural reforms. Going forward, it will be important for the government to ensure that timetables for structural reforms are realistic, and to seek to enhance their ability to more quickly implement needed reforms.

B. Program Performance

14. Financial policies were broadly in line with program projections, as all quantitative performance criteria and most indicative targets for end-March, June and September 2002 were met (Table 2-8).4 While most indicative targets for end-December were missed, except those related to external debt and net international reserves, this was due to actions taken, in consultation with the Fund and Bank staffs, to finance SOCAR’s share of the BTC.5 Given the importance of BTC to Azerbaijan’s economic prospects, the staff supports the decisions made regarding this financing, and would have proposed a modification of the end-December targets to make room for this financing if there had been a Board discussion of Azerbaijan’s PRGF arrangement in late 2002.

Table 2.

Azerbaijan: Monetary Survey, 2000-2003 1/2/

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Sources: Azerbaijan National flank; and Fund staff earimsics.

The accounts are based on the new classification of monetary accounts recommended by STA and adopted by the authorities, and do not include the Oil Fund.

As of June 2001, accouols are valued at program nschaugc rates of 4,606 manat per US dollar and 1.26 US dollar per SDR.

Velocity is defined as nominal non-oil GDP divided by average broad money.

Table 3.

Azerbaijan: Summary Accounis ofthc Azerbaijan National Bank, 2000-2003 1/2/

(In billions of millions)

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Sources: Azeri authorities and staff estimates projections.

These accounts are bused on the new classification of monetary accounts by STA and adopted, and do nor include the Oil Fund

As of June 2001, accounts are valued at program exchange of 4,606 manat per US dollar and 1.26 US dollar per SDR.

Table 4.

Azerbaijan : Consolidated Government Operations, 2001-2003

(In billions of manats)

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Sources. Azzeri authorities and staff estimates and projection.

Includes profit oil, sereage fees, and income earned on Oil Fund assets. Oil bonuses also enter in the Oil Fund, but these are trusted us a financing item

Includes SOCAR’s quasi-Facst energy sector revenues and expenditure

Table 5.

Azerbaijan; Selected Fiscal Indicators, 2000-2003

(In percent of GDP, unless otherwise specified)

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Sourcest Azeri authorities and staff estimates and projections.

For 2002 and 2003 includes quasi-fiscal energy sector revenues and expenditures. Program estimate for oil revenue in 2002 has been adjusted accordingly.

Investment expenditure increases by 0.8 percent of GDP in 2002 and by l.8 percent of GDP in 2003 due to an equity investment by the government in BTC Azerbaijan.