IMF presents recommendations to Azerbaijan - UPDATE

Increased non-oil revenues are a key factor in reducing the Azerbaijani economy's on dependence the oil sector, the IMF said after talks with Azerbaijan on Article IV. The consultations were held from Oct. 20 to Nov. 2 during the visit of an IMF mission to the country headed by Middle East and Central Department Deputy Director Asia Nadeem Ilahi.

"Reviewing the execution and structure of non-oil revenues in Azerbaijan shows that there are opportunities for successful reforms in parallel with bringing the tax system in accordance with the standards in other developing economies," the statement said. "Reforms may include the expansion of the tax base, reduction of the costs of observing the requirements and increase in effectiveness of the tax system."

A range of factors point to the need to increase tax revenues from the non-oil sector in Azerbaijan. Increased non-oil tax revenues could help protect the economy amid oil price volatility. This may lead to the reduction in oil revenues. It will also help to develop long-term stable source of funding for the state with limited oil reserves and a sharp decline in oil production expected after 2018.

The presence of large hydrocarbon revenues creates the opportunity to bring the tax system's structure in line with successful practice.

Global experience shows that tax incentives are more successful when they are well planned and fulfilled, and they are not caused by severe short-term fiscal crisis. Thus, when the state uses a convenient financial situation, it can modernize the tax system in line with early IMF recommendations by expanding the tax base and reducing the costs for observing the requirements.

The IMF thinks that these reforms can bring as much income as one can get with the non-oil GDP growth by 5-6 per cent. "Expanding the tax base will require the reforms in VAT and income tax," a statement said.

According to the IMF experts, expanding the tax base will lead to the creation of optimal variants of special tax regimes within the PSA contracts and joint ventures.

The modernization of tax and customs control systems can be supplemented with appropriate technology for self-assessment and risk management.

/Trend/

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10:35

The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Azerbaijan on a lapse of time basis on Jan.9. Under the IMF’s lapse of time procedures, the Executive Board completes Article IV consultations without convening formal discussions.1

The IMF report reads that non-oil economic growth continues to be strong; it could reach 9 percent in 2011, up from 7½ percent in 2010, largely supported by oil-financed government spending. Though output shortfall from new wells and maintenance issues will result in a sharply reduced oil output for 2011, the external position is projected to remain strong. Inflation fell to 6.8 percent in October after surging early this year, because of global food price developments, but could rise with planned public spending and non-hydrocarbon output beginning to exceed potential. The manat exchange rate has appreciated by less than 2 percent against the U.S. dollar since November 2010.

Strong fiscal stimulus continued in 2011 triggered by unanticipated increases in global oil prices. With the substantial increase in capital spending, staff projects the non-hydrocarbon fiscal deficit could increase to 44 percent of non-hydrocarbon GDP in 2011, from 38 percent in 2010, and could exceed 50 percent if the 2012 draft budget is fully implemented.

In 2011 there was some unwinding of supportive monetary and financial sector policies adopted in response to the 2009 global crisis. Policy rates and reserve requirement were raised modestly, as recovery took hold and signs of spillovers from rising global food prices emerged on domestic inflation. Market interest rates, however, have been unresponsive and credit growth has remained sluggish. Support provided by the Central Bank to state enterprises has continued, albeit at a slower pace, and there has been little progress with the privatization of the systemic public bank.

Near and medium–term economic prospects are favorable and non-hydrocarbon growth could reach 6 percent in 2012 and remain in the 5–5½ percent range thereafter, if underpinned by medium–term fiscal consolidation and supported by non-oil Foreign Direct Investment. This outlook assumes a substantive adjustment in the non-hydrocarbon fiscal position beginning in 2012 and progress with structural reforms, including on business environment and governance to foster private non-hydrocarbon investment. Risks emanate mainly from a fall in oil prices given Azerbaijan’s low reliance on non-oil exports and remittances. But large foreign assets could provide sufficient buffer to mitigate the impact of future shocks, including a sharp and sustained decline in oil prices.

In concluding the 2011 Article IV consultation with Azerbaijan, Executive Directors endorsed staff’s appraisal, as follows:

Until recently, Azerbaijan’s strong economic performance has benefited from prudent economic policies. Since the early 2000s, government policies have contributed to keeping non-hydrocarbon growth high and the macroeconomic environment relatively stable. The policy of transparently saving a sizable portion of oil revenues has enabled the economy to avoid the adverse consequences of harvesting natural resources. In addition, non-hydrocarbon growth and well-targeted social assistance have contributed to significant reduction in poverty and inequality.

Nevertheless, significant actions would be needed for Azerbaijan to maintain the record of high growth and significant poverty reduction. Given the limited horizon of hydrocarbon resources, the economy needs to be reoriented from its symbiotic dependence on natural resource revenues. An important prerequisite for a successful transition to economic diversification and private sector–led growth is to improve governance and the business environment. The authorities’ recent steps in this regard are welcome, but the anticorruption campaign needs to be extended widely and pursued resolutely. To improve the business climate, trade barriers should be eased and regulations made less restrictive with a view to enhancing competition.

Fiscal policy should be delinked from the global oil price cycle. Supplemental public spending, driven by changes in hydrocarbon prices, has exposed the economy to volatility and posed risks to macroeconomic stability. With the non-hydrocarbon economy recovering strongly and government spending likely to result in demand pressures in 2012, the non-hydrocarbon deficit should be lowered. The intra-year execution of government spending should be made less uncertain and more even.

Finite hydrocarbon resources underscore the need to achieve medium–term fiscal sustainability. The authorities understand the need to undertake medium–term fiscal consolidation, but near-term demands on public resources, especially for infrastructure and other large-project spending, have, to date, trumped longer– term considerations. The non-hydrocarbon fiscal stance in 2011 has worsened fiscal sustainability, and the 2012 draft budget could exacerbate it further. Fiscal consolidation should commence now, and there is considerable scope for trimming capital expenditures and boosting non-hydrocarbon revenues over the medium term. To build public support for the consolidation effort, the authorities could employ indicative annual targets on the non-hydrocarbon fiscal deficit. They should also strengthen the process underlying the selection and appraisal of public investment projects.

A tightening of monetary policy, through allowing greater exchange rate flexibility, may also be needed if demand pressures emerge. The de facto stabilized exchange rate has limited the effectiveness of monetary policy. Allowing greater exchange rate flexibility by employing a sufficiently wide exchange rate band would help contain inflation, and should be supplemented with other monetary policy tools, such as interest rates. However, staff does support the authorities’ view that the exchange rate should not be used to absorb the shocks from an uneven and uncertain pattern of public spending. The monetary policy framework needs to be strengthened to better counter inflation over the medium term, and in addition to helping develop the associated infrastructure (e.g. debt markets), the central bank should improve the communication of monetary and exchange rate policies with the public.

Addressing financial sector weaknesses is key for supporting sustainable and inclusive growth. Effectively dealing with IBA would help maintain financial stability, contribute to transforming the financial sector by unlocking its resources and improving efficiency. To level the playing field and enhance competition, IBA should be downsized, and smaller banks encouraged to consolidate into competitive entities. Steps should also be taken to enhance SME access to finance. To minimize conflict of interest, the central bank should unwind the support it has been providing to state enterprises (through commercial banks), and limit its role to lender of last resort for financial institutions.

It is expected that the next Article IV consultation with Azerbaijan will be held on the standard 12–month cycle.


/imf.org/