How does Azerbaijan exploit its Natural Resource Revenues?

Abstract

Resource management has been an important area of development economics for the last few decades as, a growing number of countries to large extent have relied on natural resource rent. These resources, namely, oil and later gas have been the major growth factor of the Azerbaijani economy since the sign of the country s first biggest oil contract in 1994. Significant revenue flow led to remarkable growth rate in mid 2000s but also causing contractions in the non-oil sector. Although the share of oil sector was expanding gradually before the establishment of the state oil fund, SOFAZ has become the crucial part of the economy with an upsurge of lump sum transfers which is still following an unconstrained expenditure pattern. The government aimed to increase the socio-economic performance by injecting the oil proceeds to the economy via annual state budget expenditures. This type of policy is arguably consistent with economic literature which advocates the use of resource rent domestically, generally, in the form of public investment with proper administrative and institutional arrangements to assure long run sustainability of growth in capital scarce developing countries. This thesis aims to discuss the Azerbaijani case, thereby answering questions how, through what channels, those arrangements have been successful and to what extent the spending of the large oil revenues contributed to non-oil economic growth. As the resource rent constitutes the largest share of the revenue source of the public expenditure, the thesis presents the investment strategy of SOFAZ along with the governance issues and then compares it with two other wealth funds to make relevant appraisals over international practices in administrative and value creation contexts. The comparison shows that SOFAZ s investment strategy is inefficient in terms of its risk choices and there are no prospects that oil proceeds can be replaced with capital income upon depletion of the natural resources. The thesis further investigates how far the petroleum sector has been involved in economic progress, whether announced and implemented policies match and what future perspectives look like in the light of current economic situation. Inspection of the fiscal budget formulations reveals some important information. It turns out that the initially declared spending rule has not been followed and also the amount of transfers has become the major fiscal instrument for the government. Moreover, the disaggregation of total tax revenues shows that the share of the oil sector in state budget formulation as well as in GDP is much higher than those that are shown in government s annual reports. A gradual decrease in production accompanied by increase in transfers to the state budget in order to meet the non-oil primary deficit will exhaust reserves of SOFAZ much faster thereby leaving no scope for upholding consumption profile. The spending of the resource rent is intended to affect the growth of non-oil sector positively. As there is no previous empirical work discussing the government expenditure and its impacts on growth rate of Azerbaijani non-oil aggregate output, the thesis presents empirical method to capture this relationship by use of time-series data over 1994 - 2014. Although Johansen cointegration tests shows no long run relations among the variables of interest thereby rejecting the use of vector error correction model (VECM) using a vector autoregressive (VAR) model exhibits the short run causality among government expenditure, exports and non-oil economic growth. The results of the Granger Causality tests with single lag choice indicate no causality running from government expenditure towards the non-oil economic growth at 10% significance level. Furthermore, non-oil GDP growth is found to affect the government expenditure at the 5% significance intervals thereby demonstrating the signs of Wagner s law for the Azerbaijani economy. It should also be noted that the VAR analyses, in general, are able to capture approximate relations of the variables of interest.

Resource management has been an important area of development economics for the last few decades as, a growing number of countries to large extent have relied on natural resource rent. These resources, namely, oil and later gas have been the major growth factor of the Azerbaijani economy since the sign of the country’s first biggest oil contract in 1994. Significant revenue flow led to remarkable growth rate in mid 2000s but also causing contractions in the non-oil sector. Although the share of oil sector was expanding gradually before the establishment of the state oil fund, SOFAZ has become the crucial part of the economy with an upsurge of lump sum transfers which is still following an unconstrained expenditure pattern. The government aimed to increase the socio-economic performance by injecting the oil proceeds to the economy via annual state budget expenditures. This type of policy is arguably consistent with economic literature which advocates the use of resource rent domestically, generally, in the form of public investment with proper administrative and institutional arrangements to assure long run sustainability of growth in capital scarce developing countries. This thesis aims to discuss the Azerbaijani case, thereby answering questions how, through what channels, thosearrangements have been successful and to what extent the spending of the large oil revenues contributed to non-oil economic growth. As the resource rent constitutes the largest share of the revenue source of the public expenditure, the thesis presents the investment strategy of SOFAZ along with the governance issues and then compares it with two other wealth funds to make relevant appraisals over international practices in administrative and value creation contexts. The comparison shows that SOFAZ’s investment strategy is inefficient in terms of its risk choices and there are no prospects that oil proceeds can be replaced with capital income upon depletion of the natural resources. The thesis further investigates how far the petroleum sector has been involved in economic progress, whether announced and implemented policies match and what future perspectives look like in the light of current economic situation. Inspection of the fiscal budget formulations reveals some important information. It turns out that the initially declared spending rule has not been followed and also the amount of transfers has become the major fiscal instrument for the government. Moreover, the disaggregation of total tax revenues shows that the share of the oil sector in state budget formulation as well as in GDP is much higher than those that are shown in government’s annual reports. A gradual decrease in production accompanied by increase in transfers to the state budget in order to meet the non-oil primary deficit will exhaust reserves of SOFAZ much faster thereby leaving no scope for upholding consumption profile. The spending of the resource rent is intended to affect the growth of non-oil sector positively. As there is no previous empirical work discussing the government expenditure and its impacts on growth rate of Azerbaijani non-oil aggregate output, the thesis presents empirical method to capture this relationship by use of time-series data over 1994 - 2014. Although Johansen cointegration tests shows no long run relations among the variables of interest thereby rejecting the use of vector error correction model (VECM) using a vector autoregressive (VAR) model exhibits the short run causality among government expenditure, exports and non-oil economic growth. The results of the Granger Causality tests with single lag choice indicate no causality running from government expenditure towards the non-oil economic growth at 10% significance level. Furthermore, non-oil GDP growth is found to affect the government expenditure at the 5% significance intervals thereby demonstrating the signs of Wagner’s law for the Azerbaijani economy. It should also be noted that the VAR analyses, in general, are able to capture approximate relations of the variables of interest.