Will Oil Funds Benefit the Masses? (Or Just the Ruling Classes)

by David Stern

Azerbaijan and Kazakhstan are planning to direct some of their oil wealth into oil funds which could be used for social development and economic stabilization. David Stern, Caucasus and Central Asia correspondent for the Financial Times, examines how the funds work, what these two countries have done so far, and the challenge of creating transparent and effective funds.

he recent creation of oil funds in Azerbaijan and Kazakhstan cuts to the heart of whether these two former Soviet states will be able to successfully manage the petrol dollars expected to engulf their societies in the next decade.

Significant questions about the structure of the funds, how the money will be spent, and what roles international and domestic organizations may play remain unanswered.

Observers see both governments' interest in establishing the funds and their public statements about exercising tight fiscal control as a positive sign. But at the same time others have expressed nagging doubts that, given Azerbaijan and Kazakhstan's reputations for corrupt and authoritarian regimes, the money might be wasted, or even worse, simply disappear.

After ten years of post-Soviet decline, both countries are in dire need of social development projects and improvements to their infrastructure. The funds present an excellent opportunity to right social ills, some observers say, which may threaten the countries in the long run.

An oil fund, or "future generations fund" as it is sometimes known, is an extra-budgetary institution set up by an oil-producing nation to deal with huge profits from the sale of its oil and gas.

Judging by funds already established in Norway and Kuwait, the money is usually put aside in an outside account, which can be saved for a "rainy day" when oil reserves begin to run out. Or it can be used to finance needed projects, such as developing infrastructure or helping the national pension plan.

At the heart of every oil fund also is the attempt to avoid the high inflation and economic imbalances that often plague oil-producing economies. Oil profits inject enormous sums of hard currency into a domestic market. This in turn drives up the local exchange rate.

Prices for domestic goods and exports as a result skyrocket. Local industry then becomes less competitive and starts to stagnate. In no time, a country finds itself depending almost exclusively on its energy sector with nothing from other industries to balance it out.

The real danger here, say analysts, are the gross imbalances being created in the country as a whole. Not only does the country's economy become lopsided, but so does society, since only those people connected to the oil sector reap any benefits. Divisions between the haves and the have-nots increase, and the country faces possible political instability.

Oil funds avoid this scenario simply by getting the profits out of the economy. The cash collects interest or it can be invested in some reliable financial instrument, and only gradually, in an orderly fashion, will the money be injected back into the economy.

 

“The greatest single question is who will exercise ultimate control over the fund. Both countries are run by authoritarian regimes where the presidents were elected by less than democratic means. It is unclear to whom the presidents are accountable.”

This is at least the theory.

At the moment, Azerbaijan and Kazakhstan, with advice from international financial institu-tions like the World Bank and the IMF, have just begun the process of creating their funds.

Kazakhstan announced that it had deposited $660 million from the sale of its five-percent stake in the Tengiz onshore field. Azerbaijani President Heydar Aliyev signed a decree in the last days of 2000 for the establishment of a national oil fund with a starting capital of around $300 million.

The two funds appear to be similar, although the guidelines published provide only the roughest of outlines. Both funds will be supplied by oil royalties, signing bonuses, and taxes from the oil companies. Both will be held in a special government account and supervised by a special government body.

The Azeri oil fund is directed by Samir Sharifov, and is supervised by an intergovernmental committee. Sharifov has pleased members of the international financial community by stating that the fund's management will be fully transparent, including yearly audits, and fiscally conservative. In fact, Sharifov said that no monies will be spent at all in the first years, and when spending begins, it will draw on dividends, but not the principal. At first, the money will be held in the Azerbaijani National Bank, but eventually it will be moved to accounts abroad.

"The idea is to bring the amount of money to some substantial figure first, which will give us the chance to study the experiences of other countries. Only then will disbursement begin," said Sharifov.

In the U. S., Alaska's state oil fund gives an annual dividend to tax-paying residents. Alberta, Canada, and Norway have used their funds to supplement government revenues. Colombia and Venezuela also established similar funds, but their success has been hindered by mismanagement, corruption, and an overestimation of revenues.

For Azerbaijan and Kazakhstan, the devil, as always, is in the details. What sort of audits will be conducted? ask observers. How will the supervisory committee fulfill its duties? How will the money eventually be spent? Sharifov said that all these questions will be worked out in the coming years.

Some analysts say that there is a risk that the fund could inject too much cash into the economy if extra measures are not taken. "The question is whether the fund is going to be well-integrated and coordinated with the government's budget," said Michael Mered, the IMF's representative in Baku. "The spending of an oil fund needs to be calibrated within the macroeconomic framework."

At the same time, however, both countries are in desperate need of infrastructure improvements and poverty relief. Azerbaijan is considered the poorest country in Europe, with an average per capita income of $40 per month. Kazakhstan is not much better off.

Sabit Zhusupov of Kazakhstan's Institute of Social and Economic Information is a strong advocate of using the monies to alleviate social ills. According to him, schools, hospitals, and small businesses in the country's provinces are in desperate need of support. The lack of infrastructure is creating an exodus from the smaller towns to larger urban centers.

But he sees little chance of the oil money going to benefit society at large. "The social aspect will not be important for the fund—what will be important will be national defense and developing more oil fields." The result could be disastrous for the country in the long run, he said.

Azerbaijan and Kazakhstan's "breathtakingly corrupt" societies, in the words of one observer, also give pause for thought. Although corruption may not directly affect the management of the fund itself, it could nevertheless play a role in how the money is dealt with once it is disbursed.

"There is no proper system for managing investments and expenditure. They just dream things up, "said a Western expert. Sharifov, when asked how the disbursements will be monitored, simply said, "Good question."

But probably the greatest single question is who will exercise ultimate control over the fund. The difficulty here is that both countries are run by authoritarian regimes where the presidents were elected by less than democratic means.

In the words of Azerbaijan's regulations, "the fund shall be accountable and responsible to the President of the Azerbaijan Republic," who also has the power to appoint or dismiss the fund's director and approve the supervisory board.

Kazakhstan also provides for a fund under the control of its president, Nursultan Nazarbayev, with little input by the country's parliament or other outside bodies. It is unclear to whom the presidents are accountable.

Arvind Ganesan, director of the Business and Human Rights Program at Human Rights Watch, says the best way to insure that the funds function properly is to make them transparent to as many organizations and government bodies as possible. "That is where issues of governance, corruption, and human rights converge. If the government does not allow public scrutiny of its accounts and is not accountable for their use, these funds become huge pots of money ripe for corruption and mismanagement, while broader goals of development and democratic participation are undermined."

Although Kazakhstan's oil reserves already dwarf those of Azerbaijan, the problems the two countries face are the same. The trick is making sure that their new-found wealth works to the benefit of their respective societies.

"All these ideas are up in the air. That is why we at the moment are not entirely confident in their program," said one representative of an international financial institution in Baku. "They still have a ways to go."

 

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