Wanted: Investment Strategy for Azerbaijan’s Oil Money

As Azerbaijan's economy booms, public debate is growing about how the government should spend the country's oil revenues. Experts, repeating past admonitions, are urging the government to expand a strategy that emphasizes safeguarding the country's economic future. The government, meanwhile, points to a newly created state-run company that will invest in Azerbaijan's non-oil economic sectors as proof that it has its eye on the long term.

Oil revenues, amplified by record-setting oil prices in 2005, have fueled unprecedented economic growth for this Caspian Sea state. In January, Azerbaijan posted the highest growth rate in the Commonwealth of Independent States (40.2 percent), outstripping fellow energy player Russia by a factor of ten, according to a monthly report issued by the Intergovernmental Statistics Committee of the Commonwealth of Independent States (CIS). Azerbaijan's State Statistics Committee cites even more dramatic figures. In January and February 2006, the Gross Domestic Product increased by 48.1 percent, to stand at 2.226 billion AZN (about $2.45 billion). For the same period, per capita income stood at $292, an increase of 46.5 percent.

Amid the oil boom, a struggle is being waged over how to plan for the country's future. Many experts are pressing the government to develop detailed guidelines on what amount the country should save from current revenues, how much should be spent, and where the incoming petrodollars should be invested.

Azerbaijan's oil production is expected to peak in 2009-2012, with a steady decline thereafter. The country's main oil production project, in the Caspian Sea's Azeri-Chirag-Guneshli off-shore fields, will end by 2025-2030. Expected total revenue from this project alone is $160 billion, an overwhelming influx of capital for a country with a population of just 8 million.

Like some economists, ordinary Azerbaijanis say that they are concerned about how Azerbaijan will use this cash to its economic advantage. Some worry that a large chunk of the windfall will be squandered. "All that is left from the first oil boom [from the late 1800s to the early 1900s] is Baku's beautiful architecture. [T]hat money could have made the country one of the leading states in the world," argued Vahid Mammadov, a 56-year-old Baku businessman. "We have already wasted the first option and now Allah has given us a second chance. However, no one has yet explained what they are going to do to make sure that the country will prosper when there will be no oil in the [Caspian] Sea."

The government, however, argues that it already has a strategy in place for when Azerbaijan's oil wealth starts to dry up. Officials point to the State Oil Fund (SOFAZ), set up in 1999 to manage oil revenues and related investments. Specifics on how the revenues should be spent are laid out in the four-page Long-Term Strategy on the Management of Oil and Gas Revenues, a document completed in 2004 and signed by President Ilham Aliyev.

As of April 2006, the Fund had accumulated $1.5 billion, according to SOFAZ CEO Samir Sharifov, Turan news agency reported on April 6. The 2006 state budget forecasts that most of the Oil Fund's revenues will be spent this year on the budget deficit and social welfare projects. About $600 million will be transferred to the state budget, while more than $300 million will be spent on building camps for Internally Displaced Persons, and reconstruction of the water supply and irrigation system. Another $41.7 million will be spent on financing Azerbaijan's share in the Baku-Tbilisi-Ceyhan pipeline, Samir Sharifov told Turan on April 6. [For additional information see the Eurasia Insight archive].

The 2004 Strategy document, however, outlines future plans only in general terms. Target areas for oil revenue expenditures include "[d]eveloping the non-oil sector, regions, SMEs [Small-and-Medium Enterprises]; large-scale development of infrastructure; fulfilment of poverty reduction measures and the solution of other social problems; development of 'human capital' ... consolidating the defence capabilities of the country, etc."

According to the paper, a minimum of one-quarter of the country's oil and gas revenues should be saved when the funds reach "maximum levels." The paper, however, does not provide specific guidelines for defining those levels. "During the initial period," the document states, "larger expenditures" will "create conditions for development of the [economy's] non-oil sector and a gradual reduction in the dependence on oil and gas revenues." In turn, the paper concludes, the need for foreign loans will also decline.

Controversy has long surrounded both SOFAZ and the Strategy document, but one government project slotted for 2006 promises to spur further debate. Officials have announced that the government plans to transfer about $100 million from the Oil Fund to a State Investment Company (SIC), intended to facilitate government-funded development of the economy's non-oil sector. Under a March 30 decree, President Ilham Aliyev specified that the Azerbaijani State Investment Company will be set up as a joint stock company with initial capital taken from the State Oil Fund.

The company's activities will be mainly focused on acquisition of shares of joint stock companies and other commercial organizations operating mostly in the non-oil sector. The company could expand its activities and increase investments by issuing additional shares and bonds, and allotting credits. According to Aliyev's decree, the Ministry of Economic Development will be responsible for managing SIC shares; dividends will be transferred to the State Oil Fund. Day-to-day management will be carried out by an executive director to be appointed by a so-called Observation Council. Economic Development Minister Heydar Babayev has been appointed chairman of the Observation Council, while SOFAZ CEO Samir Sharifov will serve as his deputy.

Finance Minister Avaz Alakbarov sees the SIC as "a tool for attracting of four-five times more foreign investments to the country." Alakbarov told a February 13 press conference that he estimated potential SIC-facilitated investments at "about $400-$500 million . . . within a short period of time."

Experts suggest several different likely scenarios for the SIC project. Inglab Ahmadov, director of the Public Finances Monitoring Center, a Baku-based non-governmental organization supported by the Open Society Institute-Assistance Foundation Azerbaijan, cites reports that international financial organizations such as the World Bank, Asian Development Bank and International Finance Corporation have been asked to take part in the project as shareholders. Ahmadov sees considerable use for the SIC as a development bank. "The mission of such a bank might be investing in strategic and profitable projects such as transport corridors, pipelines and so on." [The Open Society Institute-Assistance Foundation Azerbaijan makes up part of the Soros Foundations Network. EurasiaNet.org operates under the auspices of the Open Society Institute in New York City, also part of the foundations network].

A government source, speaking on condition of anonymity, told EurasiaNet that the government sees the company as one of the key tools for development of Azerbaijan's economy. SOFAZ CEO Sharifov came up with the idea for the company, the source added. According to the source, the Ministry of Economic Development and the Ministry of Industry and Energy had been waging a fierce battle for control over the company.

"Money might be invested in a transport project, renovation of an oil refinery or non-oil production fields. Everything depends on who is the decision-maker," the source said.

Experts have been critical of the government's desire to spend oil money on social welfare and infrastructure projects, however.

Gubad Ibadoglu, head of the Economic Research Center, a Baku-based non-governmental organization, said that the government's strategy was developed as a result of pressure from the International Monetary Fund and was not submitted to adequate public discussion. A need still exists to identify how the revenues will be spent, he said.

To date, the ruling Yeni Azerbaijan Party (YAP) has insisted on centralized management of oil revenues. ""If we will arrange a public discussion on how to use the oil money, we will receive 3 million ideas. The president has been given responsibility to make decisions on this issue and we are satisfied with the results," YAP Deputy Executive Secretary Mubariz Gurbanly told EurasiaNet in October, 2005. [For background see the Eurasia Insight archive].

The Public Finances Monitoring Center's Inglab Ahmadov agrees with Ibadoglu, however. "The budget is too dependent on transfers from SOFAZ, while the oil and gas industry is supplying more than half of the country's GDP. Infrastructure projects are positive in general, but the problem is that these kinds of projects are traditionally misused by corrupt institutions, and there is not a watchdog structure [in place] to ensure proper spending of the allocated funds," Ahmadov said.

The billions of dollars to be spent by the Oil Fund will only fuel inflation, Ahmadov argued. Government measures to control inflation through the currency market do not offer a solution, he added. Although some of SOFAZ's revenues have been invested in high-yield treasury bills, one way of earning a return, the strategy is risky, Ahmadov continued. Investing money "in infrastructure projects, green-field development or development of industrial zones to attract investments" is a second option, he said. "So far, some minor achievements have been seen in this regard."

Gubad Ibadoglu, however, countered that oil revenues should not be invested in infrastructure projects unless large-scale corruption is first eliminated. "Only quick-return investments are justified in this situation, along with long-term prospective development projects in education, information technologies and implementation of new technologies in the non-oil sectors of economy. We need good roads, but it is much more important to create a good business climate to attract investments and encourage local businesses. The government should pay more attention to economically effective projects such as the small-and-medium enterprise (SME) development projects," Ibadoglu said.

Meanwhile, some community organizations are trying to add their own voice to the debate. The Mobile Alumni Network, a Baku-based movement that unites several hundred Western-educated Azerbaijani university graduates, has started a campaign for President Aliyev to sign a decree that would allocate oil revenues to pay for the education of 500 young Azerbaijanis each year at the world's top universities. A similar idea has been successfully implemented in Kazakhstan since 1993. Under the terms of the program, students must return to Kazakhstan to work for five years upon graduation.

Ilgar Mammadov, an independent, Western-educated political analyst, calls such a program the best way to derive the maximum return from oil revenues. "Since uncontrolled and populist spending of oil revenues is dangerous for the economy, emphasis should be placed on building new human capital," Mammadov said.