Azerbaijan - The World Bank's Role in Helping to Ensure That Extractive Industries Benefit Society

1. World Bank is a non-profit organization whose overarching objective is to reduce poverty around the world. Poverty manifests itself in many ways, including lack of income; lack of opportunities for getting a job, good education and health; security including law and order and protection from corruption; and voice through democratic means. In most cases developing countries have preciously few resources for poverty reduction, and the World Bank plays an important role of channeling resources from capital markets as well as donor resources to poor countries in order to alleviate poverty. The CIS is different, with a legacy of highly skilled human resources, and in countries like Azerbaijan and Kazakhstan natural resources in terms of oil and gas. Here, monetary and human resources are available, or capital and labor as economist like to call it, yet poverty, defined as the percentage of people living on less than a dollar a day in Azerbaijan is in the order of 45 percent of the population, according to the 2003 household budget survey.

A. Poverty Trends in Azerbaijan

2. Although Baku has the largest absolute number of urban poor, poverty incidence is highest in provincial towns. Rural areas and small towns suffer from unreliable supplies of energy and gas, inadequate infrastructure, and weak access to basic health and education services. Lack of reliable electricity supply is one of the major factors discouraging investment in the regions outside Baku. Concentration of activities in the oil and gas sector and the development of related services and infrastructure in and around Baku add to the increase in the regional differences in living standards. Also, unemployment and underemployment remain high, particularly among women. Internally Displaced Persons (IDPs) of the Nagorno Karabakh conflict are particularly vulnerable.

B. The Government’s Strategy and Challenges to Reduce Poverty

3. To address poverty, the Government has established to a comprehensive program through a balanced approach to economic reform as outlined in the State Program for Poverty Reduction and Economic Development (SPPRED), which was approved by the President of Azerbaijan in February 2003. The SPPRED was prepared with significant input and participation by a broad range of civil society and key stakeholders to identify priorities for poverty reduction.

II. A Comprehensive Poverty Reduction and Development Strategy

A. Objectives

4. The objective of the World Bank Country Assistance Strategy is to support the Government’s policies and structural reforms as highlighted in the SPPRED. The assistance is structured around four Strategic Goals:

1. Managing the oil boom to maintain macroeconomic stability, avoid “Dutch disease” and facilitate non-oil growth, employment and pro-poor expenditures;

2. Generating jobs and sustainable non-oil growth by improving the business environment and access to financial services, building SME support infrastructure, and stimulating agriculture;

3. Improving access to services and infrastructure by reversing the decline in social services and assistance and in utility services;

4. Realizing the oil and gas potential with efficiency and environmental sustainability;

5. Monitoring outcomes and institutional capacity buildingensuring the reforms make a difference for the poor.

5. These goals are supported by the World Bank through its Poverty Reduction Support Credit (PRSC) and specific sector projects in health, education, social assistance, rural infrastructure, environment, and other areas.

6. Azerbaijan is entering a new phase in its economic development, during a period in which the country’s foreign exchange inflows will greatly exceed its import requirements. Prudent budget management policies and strong institutions for effective and efficient public expenditure execution are key to avoid the disappointing experience of many other oil rich countries who poorly handled the oil boom.

7. While macroeconomic management has been exemplary since 1995 and Dutch disease has been avoided, maintaining macroeconomic stability during the current investment boom and the imminent oil boom will not be an easy task[1]. It requires sound macroeconomic policies and efficient and transparent budgeting and fiduciary arrangements starting with the state consolidated budget and the Oil Fund (SOFAR).

8. Public Expenditure Management takes a central place among the core institutional capacities that needs to be strengthened. To ensure aggregate fiscal discipline, the objective of the State Oil Fund is to manage efficiently the oil and gas related revenues for the benefit of the future generations. Public expenditure decisions, the real exchange rate and growth in the non-oil sector are all intimately linked with this Fund and a conservative asset management and expenditure policy has ensured a steady growth of savings by this fund.

9. To improve allocative efficiency, the Government has embarked on reforming the budget management process. One of the most important reform efforts to improve allocative efficiency has been the approval of the new Budget Systems Law (BSL) in 2002 and its amendments in 2003. The BSL requires that parliament approve the deficit and expenditure ceilings of the consolidated budget including Oil Fund expenditures; and that all expenditures be executed through the single treasury account. The new BSL introduces multi-year budgeting through the preparation of a Medium-Term Expenditure Framework (MTEF) to provide the necessary link with the SPPRED and the public investment program (PIP) consistentcy therewith.

10. To increase operational efficiency implementation of program budgeting as well as performance management and auditing is key across all ministries. Spending units will have to be involved much more closely in developing, costing and prioritizing their sector development programs based on their respective medium term sector resource envelopes, while identifying key performance indicators. Programs are also being implemented for transparent Financial Management and Procurement Systems.

11. The question is how to create more employment opportunities and jobs through the development of the non-oil sector while continuing to maintain macroeconomic stability.

12. The oil sector is not expected to have a direct effect on the poor. In 2002, for example, the oil sector accounted for about 30 percent of GDP, but only one percent of employment.[2] Therefore, the achievement of any significant increases in employment, and the resulting reductions in poverty, will need substantial efforts to stimulate growth and increase competitiveness of Azerbaijan’s non-oil sectors in the marketplace. This requires improving the trade policy regime and the overall investment climate and the infrastructure. In particular, attention to reforming the financial sector and corporate governance is of critical importance to strengthen competitiveness of the non- oil sector.

13. A major concern is the disparities between Baku, where economic growth is very fast due to the oil and gas investments, and the regions outside Baku, that does not have the same growth impetus. The Regional Social Economic Development Program (RSEDP) has already been developed by the Government and recently approved by the President. The program presents a comprehensive matrix of specific policy actions and investment needs broken down by economic sectors within eight regions with clearly monitorable outcome indicators.

14. The program stipulates sector policies for pro-poor growth closely linked to the strategic objectives identified in the SPPRED ranging from structural reform measures to specific investment proposals in the economic and social infrastructure, such as school buildings, health centers, roads, water supply etc. In this respect, the program avoids direct government intervention in commercial activities, and envisages efficient use of public resources.

15. The approach to small and medium enterprise (SME) and private sector development in general is based of the INOTIS agenda, and involves: (i) establishing and financing national laboratories for quality certifications for domestic and foreign products; (ii) expanding value-added forms of production based on local produce; (iii) developing wholesale capacity, warehousing and distribution; and (iv) promoting new technologies and work methods. The World Bank is supporting this agenda through its proposed Rural Infrastructure and Market Service Development Projects, among other things.

16. The programs to improve delivery of utility, infrastructure and social services is reflected in the SPPRED. The PRSC together with our sector projects support the implementation in the following areas: (i) improving utility services for electricity, gas and water by developing tariff policies, a modern regulatory framework, and enforcing payment discipline; (ii) improving telecom and transport services through restructuring and enhanced competition; and, (iii) improving social services. The IDPs are supported by the World Bank’s social fund type project and other donor activities. The Oil Fund is the Government’s main financing source for IDP assistance, with US$47 million allocated in 2004 for housing and settlement projects for IDPs.

17. To increase quality and access to basic education, the SPPRED identifies several major directions for education reform, including curricula reform based on the needs of the market economy, teachers’ training, and improving physical conditions of schools. Also, in order to improve access to education, reforms of the student financial aid system and provision of free textbooks for all students are needed. In line with these objectives the World Bank Education APL focuses on: (i) improving the quality and relevance of education; (ii) improving effectiveness and efficiency in resource allocation; and, (iii) improving management, planning, and monitoring capacity of the Ministry of Education.

18. To improveaccess to Primary Health Care (PHC) services, and effectiveness and coverage of national health programs, the World Bank Health Reform LIL, together with international donor agencies and the NGO community, is piloting a number of programs that focus on improving access to and quality of primary healthcare in selected districts, and increase in surveillance, case detection and cure rates of main communicable diseases (HIV/AIDS and Tuberculosis).

19. To improve equity in health care and efficiency in resource allocation, the program focuses on the longer-term goal of improving user and provider satisfaction in health care. More specifically, the Government would increase budgetary allocations for healthcare needs of the population within the framework of the MTEF and adopt a Ten-Year Health Sector Development Strategy.

20. In the area of social insurance the program supported by the proposed World Bank Pension and Social Assistance Project includes modernization of the social insurance benefits administration through introduction of a comprehensive management information system, and strengthening of the financial management of the State Social Protection Fund (SSPF); and moving all social insurance benefits administration from enterprises to the SSPF.

21. With regards to social assistance, the Government’s program supported by the World Bank includes: (i) national roll-out of the targeting of social assistance benefits based on eligibility assessments, taking into account the economic and social situation of the applicants; (ii) consolidation of benefits into a single targeted family poverty benefit in cash as of 2006 and a significant increase of resources allocated to its financing; and (iii) modernization of the capacity of Ministry of Labor and Social Protection to administer social assistance benefits using computerized MIS.

22. The World Bank Group is providing major financing for BTC and upstream oil development amounting to $310 million. The World Bank also supports the commercialization and restructuring of SOCAR and the separation and privatization of SOCAR’s non-core assets. Annual consolidated financial statements is to be prepared in accordance with International Financial Reporting Standards (IFRS), and subject to audits according to International Standards of Audits (ISA).

23. To address environmental concerns with the aim to improve emergency preparedness and minimize eventual negative environmental impacts from the operations of the oil industry in Azerbaijan, SOCAR and the relevant government authorities would prepare a National Oil Spill Response Plan.

24. The World Bank supports adoption of norms and standards for clean up of brown fields and completing an inventory of industrial contamination based on assessment of health risks. Government would also adopt regulations for corporate compliance with environmental standards

25. The Government would conduct an environment audit of SOCAR and would complete the GIS based inventory of oil-contaminated sites. Clear accountability for cleanup would be established between the Government and SOCAR. In addition, the Government would initiate implementation of the environmental legacies cleanup program.

F. Strategic Goal 5: Implementing SPPRED: Outcomes, Monitoring and Institutional Capacity Building

26. Under the framework of the SPPRED, the World Bank is working closely with the Government, civil society, and other donors to support plans for monitoring and evaluation, based on sample surveys as well as statistical reporting systems. The Household Budget Survey is now performed on a quarterly basis, but quality needs to be strengthened, and the database made available on a timely basis for analysis by other researchers. Full implementation of the Budget System Law will also contribute to improve the timeliness and quality of public expenditure data. Other areas of focus include the health sector, where currently, data unreliability makes it impossible to adequately monitor progress in achieving the MDGs.

27. The SPPRED marked the start of a comprehensive dialogue on the overall development strategy between the Government and all key stakeholders. Participatory appraisals took place at the village level bringing Government officials in direct contact with civil society covering villages and towns across Azerbaijan. The National NGO Forum and the Government has established a working relationship which should develop further during implementation. The World Bank is also encouraging the Forum to reach out to other organizations who are not members, especially those outside Baku, in order to expand participation and representation.

III. Main Conclusions

Azerbaijan has strong potential to grow rapidly in the years ahead because of the oil and gas resources which it is currently developing. These resources are considerable, but finite, peaking in about a decade and then declining steadily. The most difficult challenge Azerbaijan faces, which is well understood by the Government, is to avoid the path followed by many natural resource rich countries, wherein their citizens derive little benefit from the influx of oil revenues. This requires designing and implementing a policy agenda that leads to poverty reduction and improves incomes as well as equity for current and future generations, while maintaining macroeconomic and financial stability. Strong institutions are essential to tackle this challenge, yet Azerbaijan has had little more than a decade in which to build the government institutions and the civil society networks to support them. For this reason, the World Bank Group's assistance is providing cross-country experience, helping to build the institutional capacity and sustain the policy reforms necessary for Azerbaijan to succeed to achieve the ambitious goals of poverty reduction envisaged under the SPPRED.

[1] The potential negative effects of an inadequately managed natural resource boom are often referred to as Dutch disease. They include: (i) macroeconomic adjustment problems stemming from large foreign exchange inflows; (ii) unbalanced growth, leading to crowding out of the non-petroleum traded goods sector; (iii) waste of petroleum wealth through unproductive public expenditures; and (iv) in some cases accumulation of external debt as the resource boom increases the capacity to borrow.

[2] For a more detailed analysis of the issues related to the oil and non-oil sectors and their impact on the economy see Azerbaijan: Building Competitiveness—An Integrated Non-Oil Trade and Investment Strategy (INOTIS), World Bank, Nov. 2003.

Resources For

The World Bank's Role in Helping to Ensure That Extractive Industries Benefit Society