Azerbaijan’s 2020 budget remains vulnerable to external jolts

The 2020 draft budget of Azerbaijan shows that while it is possible to increase earnings through the non-oil sector, the government continues to pump oil revenues into the state budget even when it goes against the existing fiscal policies. 

About the Author: Gubad Ibadoghlu, Senior Policy Analyst for social and economic studies at Azerbaijan’s Economic Research Center, a Baku-based NGO that promotes economic development and good governance.

2020 draft budget 

The recently disclosed 2020 draft budget of Azerbaijan reveals that the projected budget expenditure level at $15,069.2 million – $251.5 million more than in 2019.

The budget forecasts projected the state budget revenues at $14,402.4 million by 2020 – $774.1 million or 5.7% more than the current revenue level. Of those budget revenues, approximately 57% will be from the oil sector. 

At the same time, the Ministry of Economy released a different forecast for the coming three years (2020-2023), projecting that only 34.2% of the GDP would be coming from the oil sector and 65.8% would be coming from the non-energy sector. 

Such an increase of the oil sector share in the budget revenues resulted from the $6.92 billion transfer from the State Oil Fund of the Republic of Azerbaijan (SOFAZ) to the state budget by 2020. In comparison, in 2019 the budget transfer from SOFAZ amounted to $6.68 billion –  $237 million or 3.55% less than the 2020 projection. 

Fiscal regulations

There is a direct correlation between world oil prices and the increase in budget expenditures in Azerbaijan. 

This surge is illustrated by the dramatic increase in budget expenditures between 2005 and 2014, when the expenses increased from $2 billion to $24,331 billion. 

On the other side of the medal, the rapid depreciation of crude oil on the global market led to the double devaluation of the national currency in 2015 and dramatically reduced the dollar equivalent of budget revenues. 

As demonstrated by studies, in order to ensure macroeconomic stability and protect the budget from the surges of the global market, the state needs to have restrictive fiscal rules and policies to break the balance between budget expenditures and oil revenues. 

While most oil-rich countries usually introduce fiscal rules prior to gaining oil revenues, such rules were adopted in Azerbaijan only 17 years after getting oil revenues for the first time. 

The need for such rules was officially acknowledged in 2016 in the “Strategic roadmap for the development of national economy of Azerbaijan Republic”. The Roadmap defined the need to develop fiscal frameworks to address the potential challenges caused by global macroeconomic trends and to study their impact and unpredictable external shocks in order to create financial reserves for future generations. 

Amendments to the Law on Budget System dated June 29, 2018, incorporated fiscal rules into the existing legislation. 

According to the fiscal rules, annual oil expenditure should amount to the difference between 30% of net financial assets accumulated in the beginning of the forecasted budget year and the oil revenues,  and adding 20% of this difference to the lowest number of the indicators.

According to the fiscal rules, annual oil expenditure should amount to the difference between 30% of net financial assets accumulated in the beginning of the forecasted budget year and the oil revenues,  and adding 20% of this difference to the lowest number of the indicators.[1]

Moreover, one of the main strategic goals of the “Medium and long-term public debt management strategy of the Republic of Azerbaijan,” endorsed by the presidential decree of August 24, 2018, is to set the upper limit of the national debt  with a ratio not exceeding 30 percent of the GDP from 2018-2025 and dropping that limit to 20% by 2025. The Strategy determines that the share of service expenditures will constitute less than a 15% ratio of the total public debt by 2025.

An initial presentation of the 2020 draft budget demonstrates that while it was possible to achieve an increase in expenditures through the non-oil sector, the government of Azerbaijan continued its policy of pumping oil revenues into the state budget even under the existing fiscal policies that should limit transfers from SOFAZ to the Azerbaijani state budget. 

For example, the volume of transfers to the state budget in neighboring Kazakhstan constitutes $8 billion at the current rate. According to the rules, the transfer amount can be increased or reduced by 15% depending on the state of the economy. The parliament has a right to increase the transfer amount by 15 % in the case of economic recession, or reduce it by 15% if there is economic growth in the country. 

Unlike Kazakhstan, in 2020 Azerbaijan plans to increase the volume of transfers from SOFAZ to the state budget by 3.55%, despite the forecasted 2.4% growth of GDP in the country. 

Accordingly, the effective functioning of the fiscal regulation is possible not only through the proper selection of mechanisms and norms, but also requires a responsible approach to budgetary policy, in particular, through ensuring conservative budget planning and sustainable economic stability, and by establishing a common institutional environment for the rules.

To conclude, I would stress that sustaining the current high level of the state budget’s dependence on resources in 2020 will increase the national economy’s vulnerability to periodic jolts of the world markets. This tendency will subsequently lead to lower savings for future generations.

[1] 20 percent of the difference between oil revenues and 30%of the net financial assets is added to the net financial assets