Is Bigger Better for Azerbaijan's Budget?

It's a question that other countries in the South Caucasus would love to ask: How best to use a 42-percent increase in state revenues? Surging oil prices have kicked off a debate in cash-rich Azerbaijan about spending practices and inflation that analysts say highlights dangerous pitfalls in the country's budget planning.

On May 2, parliament revised Azerbaijan's state budget to accommodate rising oil and gas revenues. At roughly $4.6 billion (3.8 billion manats), oil and gas revenues from Azerbaijan's State Oil Fund (SOFAZ) are up six and a half times compared with 2007. The income accounts for 87.3 percent of the fresh budgetary funds.

As a result, state spending is up by 30 percent to 11.6 billion manats or roughly $14 billion, while revenues have surged by 42 percent to 10.5 billion manats, or about $12.7 billion. The state budget deficit, now at about $2.7 billion, has been reduced by half.

The government has indicated two priorities for the new budget: various government infrastructure projects and the armed forces. Infrastructure spending now accounts for close to $2 billion (a 53.3 percent increase from the original 2008 budget), while military spending increased by 31.8 percent to close in on $2 billion. By comparison, expenditures on education, health care and other social welfare categories increased by a mere 10 percent.

With current oil prices at just under $124 per barrel, that spending is expected to only increase. Analysts in Baku, though, question the efficiency of the government's spending strategy and its heavy reliance on the State Oil Fund.

Inglab Akhmadov, director of the Public Finance Monitoring Center, calls the government's decision to revise the budget at mid-year "not a normal practice," and one that could contribute to inflation. The revision is the third such measure for the last three years.

The increased use of money from the State Oil Fund "is even less normal," he charged.

"At the beginning of the year, we criticized SOFAZ transfers to the budget for making up 14 percent of all government revenues. Now the number has reached 36 percent," Akhmadov said.

The Fund, set up in 1999 to oversee government usage of revenue from oil and gas sales, has been closely watched as an indicator of what attempts are being made to diversify Azerbaijan's economy away from its dominant energy industry.

"It is a very serious problem when the government does not put any limit on borrowing from the Oil Fund and everything depends on the government's appetites," commented Akhmadov.

Rasim Huseynov, an economic analyst for the pro-opposition Turan news agency, agrees.

"There is no clear plan on how to spend the revenues and the problem will get worse in the future as revenues increase," Huseynov said. Azerbaijan's lack of a "budgetary culture" – the proposed revised budget passed without amendments or debate – adds to that concern, he noted.

The lack of discussion meant that consideration of what the hike in government spending will mean for inflation was largely absent.

The government has conceded that it will not be able to keep annual inflation within the previously targeted 13 percent – 14 percent range, but has attributed the price increase to a worldwide surge in prices for consumer goods and food. According to the State Statistics Committee, inflation stood at 8 percent for the first three months of 2008.

Independent experts, who dispute the official numbers, however, predict that the expanded budget could contribute to an annual inflation rate of more than 20 percent for 2008.

Inflation, noted the Public Finance Monitoring Center's Akhmadov, "is really a major challenge for the government. And so far, I do not see a clear analysis of the inflationary picture by the government. So far, the government just spurs inflation by increasing spending."

[The Public Finance Monitoring Center has received funding from the Open Society Institute – Assistance Foundation Azerbaijan, a member of the Soros Foundations network. EurasiaNet.org is also part of the Soros Foundations network, though operates as a distinct entity from the Open Society Institute – Assistance Foundation Azerbaijan.]

Aside from military expenditures (largely a closed topic), spending on infrastructure has become a virtual industry in itself in recent years. During the first three months of 2008, the government spent 17.5 times more money on water and sewage improvement than it did for the same period in 2007, according to the State Statistics Committee.

Roads are also a priority: Each month, new bridges and roads throughout the country are completed. On May 9, the government unveiled the first 17 kilometers of a new concrete highway leading to Baku International Airport. The overall cost of these projects has not been released, however.

The scale of the projects, however, has led to questions about their implementation, added Akhmadov. "[T]here are many . . . questions: How efficiently are the funds being spent when there is no transparency in this issue? Who is responsible for choosing the projects? How are the contractors chosen? How is the spending being monitored?"

In a set of recommendations released on May 7, the International Monetary Fund also expressed concerns about the government's growing infrastructure expenditures. Largely echoing Akhmadov's criticisms, the Fund wrote that the economy has "limited" capability to absorb hefty infrastructure spending, while government officials have an "inadequate" ability to "implement large investment programs."

"Although efforts are ongoing to strengthen administrative capacity, the risk of substantial waste of public resources is particularly high when public spending increases rapidly," the IMF wrote. The IMF envoys suggest that officials instead focus on facilitating "medium-term expenditure" to promote "macroeconomic stability."