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How can transitional countries like Azerbaijan, rich in natural resources, manage them to the maximum advantage, whilst limiting the risks it poses? becomes a little sunnier
The publicly approved development of Azerbaijan's oil fields started in 1994, with the signing of the "Contract of the Century" with leading international oil companies. Despite being faced by Armenian aggression, the country is today experiencing an investment boom in the petroleum and other oil-related sectors like construction and services.
Being the oldest oil producing country located in the South Caucasus region, it has the potential of recoverable crude and condensate of 1,356 million tons - 931 million tons onshore, and 425 million tons offshore. This approximately equals 4% of the world production. 68 oil and gas fields have been discovered in Azerbaijan, with 42 onshore and 26 offshore. 61 fields are targeted for commercial development, 21 with participation of US-based companies. The Azeri government publicly reported that such a rapid rise in oil revenues in the country have not been registered anywhere else. According to them, the country's oil income in 2010 might reach $22bn if oil prices comprise $16 a barrel.
Due to the efforts of the government of Azerbaijan and supplementary programmes, designed by international monetary institutions, the country has overwhelmed the structural difficulties and macroeconomic problems. The large volume of direct foreign investment directed into the regional energy sector resulted in improvements of oil and oil-related businesses but caused some regional political uncertainty.
Although the vast financial inflows currently appear quite beneficial to Azerbaijan's economy, it has been turning into the problem commonly known as the "Dutch disease". It is well known that the classic Dutch disease argument focuses on unbalanced growth among the petroleum sector, the non-petroleum traded goods sector, and the expanding non-traded goods sector. If the additional wealth created by oil production is spent on non-traded goods, their prices relative to those of tradable goods prices must rise, and the real exchange rate will appreciate. As a result, the international competitiveness of the traditional traded goods sector will diminish. Indeed, there are already indications in Azerbaijan that the share of the non-traded goods sector (which consists primarily of retail trade, restaurants and hotels, and construction) in GDP is expanding faster than in transitional countries that are not oil producers.
Today it is predictable that the macroeconomic stability of Azerbaijan could be affected through three channels.
Firstly, there is a risk to monetary stability, particularly if the central bank does not react appropriately to the balance of payment inflows associated with the petroleum boom. Often such inflows are related to an increase in money demand and sterilization of the monetary impact of these flows by the Central Bank to contain inflation may be neither necessary nor desirable. If the credibility of the stabilization programme is weak and inflows are particularly strong however, partial sterilization may be called for in order to avoid an excessive increase in the money supply and inflation and consequently, a further push toward real exchange rate appreciation. On the other hand, if monetary policy overreacts and is too tight, this may lead to a strong nominal appreciation and to an overshooting of the real exchange rate, particularly if domestic goods prices are sticky but asset prices are flexible. The problem is to strike a balance between price stability and nominal appreciation. In contrast to Nigeria that suffered from the lack of the previously mentioned component of Dutch Diseases, the Government of Azerbaijan is partly handling this issue. In order to solve this problem the country's administration introduced Azerbaijan's medium-term monetary policy designed with extensive support of IMF that primarily aims at maintaining low inflation to consolidate its still-fragile macroeconomic stabilization. Its annual inflation target of 5-6 % during the period following the discovery of oil is ambitious. Besides the establishing of the State Oil Fund has been helping to preserve oil revenue.
Since its formation in 1999, the Fund has accumulated more than $750 million in oil profit, bonuses and other income derived from the country's growing oil production. These revenues currently represent over half of Azerbaijan's currency reserves. However such kind of steps designed by the IMF cannot prevent the lack of counter-balance in the national GDP formation. According to the President's Economic Advisor Mr. Vahid Akhundov the GDP volume in Azerbaijan has surged by 55% since 1996, with $7 billion invested in the country in 1995-2001, including $3 billion in the oil sector. The economic benchmarks for 2002 have risen by 4% in the oil sector, 7.6% in food industry and 25% in energy related mechanical engineering. But in reality, it hard to say that such optimism exists in the non-oil sector, particularly in agribusiness. Recent difficult weather conditions that basically have not affected the averaged price index, prove that Azerbaijan is highly dependent on importation of consumer goods.
Second, uncertainties about the magnitude and timing of petroleum revenues pose risks to the balance of payments sustainability. The increased tendency of Azerbaijan's current account deficit (mainly owing to oil sector imports), and pressures to contract large amounts of non-concessional foreign debt are mounting. According to statistics promulgated by the Ministry of Finance, Azerbaijan's foreign debt is $1.94 billion. Per capita debt for $174 million that have been spent out of those credits makes more than $120. These figures also depict the Government of Azerbaijan's self-confidence in the debt management, primarily due to the active international organizations' activities. Recent controversy between the country's administration and the IMF was successfully resolved, demonstrated the constructive positions of both sides in reforms' implementation.
Last but not least is that the incoming petroleum revenues have been promoting rent-seeking behavior: resource-rich Azerbaijan has pursued protectionist policies that foster extensive bureaucracy and corruption and have significant negative impacts on growth. Primarily this policy consists of artificial impetuses introduced by the national customs system, the lack of implementation mechanism in the country's legal framework, especially that carry the non-oil sector, mishandlings in taxations. In general it has resulted in the well known bureaucracy and corruption within Azerbaijan. It was also proven by the recent statement from Transparency International, in which the country was ranged at 95th place before Indonesia and Kenya.
Despite the above mentioned, it is easy to predict that the supply-side reforms will enable the non-oil traded goods sector to operate in a market environment. Measures include: government restructuring; simplifying the tax code and undertaking mass privatization with business reforms. The banking sector restructuring will definitely be used to help channel oil sector savings into investment in the non-oil sector. With these policies Azerbaijan may be able not only be able to eliminate the "appreciation premium" of a transitional economy but also to achieve a "democratized business environment".
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