# Management of Oil Revenues: Has That of Azerbaijan Been Prudent?

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## Abstract

**:**

## 1. Introduction

## 2. Further Background on Azeri Oil, Its Management, Accomplishments and Problems

## 3. Literature Review

“Investment is critical, but it cannot be done all at once. Economies have a limited ability to absorb new investments, which are typically constrained by diminishing returns. For instance, if a government tries to build too much infrastructure too quickly, it will lead to poor planning, lax oversight, and shoddy construction at inflated prices”

## 4. Data and Methods Used

#### 4.1. Data and Its Sources

#### 4.2. Methodology

#### 4.2.1. Models to be Estimated

#### 4.2.2. The Unit Root Test

#### 4.2.3. The Johansen Cointegration Method

_{t}is a (n × 1) vector of the n variables of interest, µ is a (n × 1) vector of constants, Г represents a (n × (k − 1)) matrix of short-run coefficients, ε

_{t}denotes a (n × 1) vector of white noise residuals, and П is a (n × n) coefficient matrix. If the matrix П has reduced rank (0 < r < n), it can be split into a (n × r) matrix of loading coefficients α, and a (n × r) matrix of cointegrating vectors β. The former, matrix Г, shows the importance of the co-integration relationships in the individual equations of the system and the speed of adjustment to disequilibrium. On the other hand, the latter (matrix П) represents the long-term equilibrium relationship, so that $\Pi =\alpha {\beta}^{\prime}$. Testing for cointegration, using Johansen’s reduced rank regression approach, centers on estimating the matrix П in unrestricted form, and then testing whether the restriction implied by the reduced rank of П can be rejected. Max Eigen Value and Trace test statistics are used to test for non-zero characteristic roots. If a given variable is statistically significant, it implies that the null hypothesis of corresponding β = zero can be rejected, while stationarity or trend stationarity of a variable assumes that a ${\left(100\right)}^{\prime}$ restriction on long-run coefficients cannot be rejected.

#### 4.2.4. Fully Modified Ordinary Least Squares Method (FMOLS)

#### 4.2.5. Dynamic Ordinary Least Squares Method (DOLS)

#### 4.3. Empirical Results

#### 4.3.1. Unit Root Test Results

#### 4.3.2. Results of the Cointegration Analysis

#### Oil Prices and Government Capital Expenditures

#### Government Capital Expenditures and Non-Oil Exports

#### Government Capital Expenditures and Real Non-oil GDP

## 5. Conclusions

## Acknowledgments

## Author Contributions

## Conflicts of Interest

## References

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1 | Ciaretta and Nasirov (2012) attribute the Azerbaijani comparative success in this relative to that of their neighboring oil producers (Russia, Kazakhstan and Turkmenistan and Uzbekistan) to (1) its willingness to offer exemptions from various kinds of fees and taxes and restrictions on foreign bank accounts (which in turn have been facilitated by the absence of parliamentary involvement in the negotiations, making it easier to reach the agreements, and (2) its efforts to improve its business environment. |

2 | Joining the EITI (retrieved 13 April 2017). |

3 | The Decree entitled “The Long term Strategy on Management of Oil and Gas Revenues” was announced publicly in 2004 and covers the 2005–2025 period. According to this rule, “when oil revenues reach their maximum level, no more than 75% of these oil revenues can be spent by the government, the remaining 25% being saved in SOFAZ (Ciaretta and Nasirov 2012, p. 284). |

4 | This plan, currently under implementation, arose from a decree of the President of the Azerbaijan Republic ordering relevant ministries and institutions to prepare “Azerbaijan 2015–2020 State Program on the Industrial Development”. |

5 | http://stat.unido.org/ (United Nations Industrial Development Organization, UNIDO statistics) |

6 | http://stat.gov.az/xeber/index.php?id=3465 (The State Statistical Committee of the Republic of Azerbaijan). |

7 | Norway puts almost all of its oil revenues into its oil fund and then transfers to the budget a specified percent of its returns on those assets (not the assets themselves). In 2014 these transfers accounted for 10% of total government expenditures (NMF 2013, p. 7). |

8 | http://www.oilfund.az/en_US/hesabat-arxivi/rublukh/2016_1/2016_1_4/ (SOFAZ official website) |

9 | |

10 | If productivity in the tradable non-oil sector were low in Azerbaijan as Cherif and Hasanov (2013) suggest, this would underscore the importance of putting more of its oil revenues in its oil fund rather than investing in its domestic sectors. |

11 | In redirecting the emphasis in the relation between oil prices and non-oil production from real exchange rates to government investment, we do not wish to deny that the link through exchange rates or savings rates is no longer of relevance. Indeed, we believe that it is a complicated one which could be explained in a number of different ways. First, it can be explained indirectly by the effect of oil prices on input prices. When the input costs rise in the non-oil industrial sectors, it takes a toll on production of tradable goods like manufacturing which have to compete with imports. Second, it can be attributed to a direct effect of oil prices on manufacturing since many manufacturing industries use oil as an input, in many cases quite intensively. Third, when the oil price increases, not only does the real exchange rate rise, but so too does the terms of trade. Fourth, the depletion effect on adjusted national savings rates will tend to be greater when oil rents are higher. Note also, that Azerbaijan’s manat continued to appreciate nominally until 21 February 2015 when its currency was devaluated by 34,6% relative to the US dollar for purposes of stimulating economic diversification and export competitiveness. On December 21, 2015, Central Bank of Azerbaijan devalued the manat again, in this case by over 48% (Report News Agency 2017). The World Bank’s data series on Adjusted National Savings has also shown something of a decline in the last few years and is lower than in a number of other large natural resource exporting countries. |

Years | Agriculture | Mining | Manufacturing | Utilities | Construction | Trade, Transportation. Accomodation., Food | Finance, Technical Services | Public Administration, Defence | Other Services |
---|---|---|---|---|---|---|---|---|---|

2005 | 9.9 | 45.7 | 7.1 | 0.9 | 9.8 | 12.9 | 5.8 | 6.8 | 1.0 |

2006 | 7.5 | 53.3 | 6.0 | 0.8 | 8.2 | 11.2 | 5.8 | 6.6 | 0.6 |

2007 | 7.0 | 57.1 | 5.1 | 1.1 | 6.9 | 11.7 | 5.6 | 5.1 | 0.5 |

2008 | 6.0 | 56.0 | 5.0 | 1.3 | 7.4 | 12.0 | 5.8 | 5.9 | 0.7 |

2009 | 6.6 | 46.4 | 6.0 | 1.4 | 7.9 | 15.6 | 6.1 | 8.3 | 1.6 |

2010 | 5.9 | 49.2 | 5.0 | 1.1 | 8.7 | 14.0 | 6.6 | 7.5 | 1.8 |

2011 | 5.4 | 50.9 | 4.2 | 1.9 | 8.4 | 13.7 | 6.6 | 7.1 | 1.6 |

2012 | 5.5 | 45.9 | 4.5 | 2.2 | 10.7 | 14.1 | 7.7 | 7.5 | 1.8 |

2013 | 5.7 | 42.8 | 4.5 | 2.2 | 12.4 | 14.3 | 8.5 | 8.1 | 2.0 |

2014 | 5.7 | 37.0 | 5.1 | 2.1 | 13.6 | 15.7 | 9.7 | 8.6 | 2.3 |

2015 | 6.8 | 28.8 | 5.8 | 2.4 | 13.2 | 19.8 | 10.9 | 9.7 | 2.5 |

**Source:**Computed from National Accounts and Macroeconomic Indicators, Statistics Department to the State Statistical Committee of the Azerbaijan Republic, Table 2.4 labeled in Value Added by Industries at Current Prices (ISIC Rev 4) (http://www.stat.gov.az/source/system_nat_accounts/indexen.php).

Years | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 | 2016 |
---|---|---|---|---|---|---|---|---|---|---|---|---|

State Budget Revenues (million manat) | 2055 | 3881 | 6007 | 10,762 | 10,326 | 11,403 | 15,701 | 17,282 | 19,495 | 18,401 | 17,153 | 16,822 |

Transfers from SOFAZ to the State Budget (million manat) | 150 | 585 | 585 | 3800 | 4915 | 5915 | 9000 | 9905 | 11350 | 9337 | 8130 | 7615 |

Share of SOFAZ transfers in State Budget Revenues, percent | 7 | 15 | 10 | 35 | 48 | 52 | 57 | 57 | 58 | 51 | 47 | 42 |

SOFAZ Revenues | 660 | 986 | 1886 | 11,864 | 8274 | 13,089 | 15,628 | 13,674 | 13,601 | 12,731 | 7721 | 8341 |

Share of its transfers to the State Budget in SOFAZ revenues, percent | 23 | 59 | 31 | 32 | 59 | 45 | 58 | 72 | 83 | 73 | 105 | 91 |

SOFAZ oil revenues from the oil PSAs (million manat) | 569 | 929 | 1800 | 11,633 | 7870 | 12,656 | 15,258 | 13,117 | 13,108 | 12,320 | 7370 | 8320 |

Share of state budget transfers in the “Profit Oil”, percent | 26 | 63 | 33 | 33 | 62 | 47 | 59 | 76 | 87 | 76 | 110 | 92 |

**Table 3.**Azerbaijan: Consolidated Central Government Operations (2008–2015), in percent of non-oil GDP.

Item | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | 2015 Preliminary | 2016 Projection | 2017 Proj. | 2018 Proj. |
---|---|---|---|---|---|---|---|---|---|---|---|

Non-oil primary balance ^{1} | −39.2 | −35.5 | −36.3 | −40.3 | −45.4 | −45.6 | −35.8 | −34.4 | −37.7 | −32.6 | −31.8 |

Share of public sector in fixed capital investments (percent of total) ^{2} | 54.4 | 42.8 | 38.6 | 42.7 | 43.8 | 48.7 | 42.3 | 41.9 | na | na | na |

^{1}This is defined as non-oil revenue minus expenditure (excluding interest payments) and statistical discrepancies. Sources: IMF (2013) Country Report No. 13/164, p. 27; IMF (2014) Country Report No. 14/159, p. 29; IMF (2016) Country Report No. 16/296, p. 4.

^{2}Sources: Central Bank of Azerbaijan (2008) Annual Report 2008, p. 17; Central Bank of Azerbaijan (2009) Annual Report 2009, p. 21; Central Bank of Azerbaijan (2011) Annual Report 2011, p. 13; Central Bank of Azerbaijan (2015) Annual Report 2015, pp. 15–16; National Bank of Azerbaijan (2007) Annual Report 2007, p. 19.

Variable | Mean | Max | Min | Standard Deviation | Coefficient of Variation, % |
---|---|---|---|---|---|

Op | 0.608 | 1.109 | 0.216 | 0.268 | 44 |

govcap | 364.596 | 1576.700 | 29.300 | 343.963 | 94 |

noex | 216.391 | 496.438 | 87.821 | 83.948 | 39 |

gdpno | 1951.575 | 4081.400 | 750.900 | 840.958 | 43 |

Variable | Intercept | Intercept and Trend | ||||||
---|---|---|---|---|---|---|---|---|

Level | k | First Difference | k | Level | k | First Difference | k | |

op | −0.950 | 2 | −6.411 *** | 1 | −3.495 * | 1 | −6.346 *** | 1 |

govcap | −1.270 | 3 | −4.774 *** | 4 | −5.514 *** | 0 | −4.721 *** | 4 |

noex | −1.840 | 3 | −7.442 *** | 2 | −2.374 | 3 | −7.365 *** | 2 |

gdpno | −1.228 | 4 | −3.930 *** | 3 | −1.897 | 4 | −4.075 ** | 3 |

Endogenous Variables: govcap and op | ||||||
---|---|---|---|---|---|---|

Lag | LogL | LR | FPE | AIC | SC | HQ |

0 | −188.066 | NA | 7.547 | 7.695 | 8.145 | 7.867 |

1 | 13.267 | 340.717 | 0.0038 | 0.105 | 0.705 | 0.335 |

2 | 28.490 | 24.591 | 0.0025 | −0.327 | 0.424 | −0.039 |

3 | 41.236 | 19.609 | 0.0018 * | −0.663 * | 0.238 * | −0.317 * |

4 | 42.170 | 1.365 | 0.0020 | −0.545 | 0.506 | −0.142 |

Panel A: Johansen’s Cointegration Test Results ^{a} | ||||

Number of CE | Trace Statistics | Max-Eigenvalue Statistics | ||

None | 23.843 *** | 23.812 *** | ||

At most 1 | 0.0295 | 0.0295 | ||

Panel B: Results of the Phillips-Ouliaris Cointegration Tests ^{b} | ||||

Dependent Variable | z-Statistic | p-Values | tau-Statistic | p-Values |

govcap | −32.153 | 0.000 *** | −5.004 | 0.000 *** |

Panel C: Results of Cointegration Equations ^{c} | ||||

Variable | VECM | FMOLS | DOLS | |

op | 2.13 ^{***} (0.000) | 1.99 *** (0.000) | 1.91 *** (0.000) |

**The test type is Intercept and no trend in the cointegrating equation and the VAR; Critical values are taken from MacKinnon et al. (1999); CE means cointegrating equation(s); Estimation period: 2001Q1–2013Q4;**

^{a}**The null hypothesis for both tests is: variables are not cointegrated and is rejected; p-values are MacKinnon (1996) p-values for the tau-statistic;**

^{b}**The dependent variable is govcap. Estimation period is 2001Q1–2013Q4. p-values are in parentheses. The Speed of Adjustment Coefficient in the VECM equation is found to be (−0.45) and statistically significant at the 1% significance level. For all panels ***, ** and * indicate significance of the coefficients at the 1%, 5% and 10% significance levels, respectively.**

^{c}Panel A: Johansen’s Cointegration Test Results ^{a} | ||||

Number of CE | Trace Statistics | Max-Eigenvalue Statistics | ||

None | 23.042 *** | 19.395 *** | ||

At most 1 | 3.646 | 3.646 | ||

Panel B: Results of the Engle-Granger Cointegration tests ^{b} | ||||

Dependent Variable | z-Statistic | p-Values | tau-Statistic | p-Values |

noex | −24.731 | 0.000 *** | −3.448 | 0.000 * |

Panel C: Results of Cointegration Equations ^{c} | ||||

Variable | VECM | FMOLS | DOLS | |

govcap | −0.233 *** (0.000) | −0.112 *** (0.000) | −0.121 *** (0.000) |

**The null hypothesis for both tests is: variables are not cointegrated; ***, ** and * denote rejection of the null hypothesis at the 1, 5 and 10% significance levels, respectively; p-values are MacKinnon (1996) p-values for the tau-statistic;**

^{a}**The dependent variable is non-oil export. The estimation period is 2001Q1–2013Q4. p-values are in parentheses. ***, ** and * indicate significance of the coefficients at the 1%, 5% and 10% significance levels, respectively. Speed of Adjustment Coefficient in VECM equation is found to be (−0.43) and statistically significant at 1% significance level.**

^{b}Panel A: Johansen’s Cointegration Test Results ^{a} | ||||

Number of CE | Trace Statistics | Max-Eigenvalue Statistics | ||

None | 16.418 ** | 13.0986 * | ||

At most 1 | 3.319 | 0.998 ** | ||

Panel B: Results of the Phillips-Ouliaris Cointegration tests ^{b} | ||||

Dependent Variable | z-Statistic | p-Values | tau-Statistic | p-Values |

gdpno | −31.406 | 0.000 *** | −4.753 | 0.000 *** |

Panel C: Results of Co-integration Equations ^{c} | ||||

Variable | VECM | FMOLS | DOLS | |

govcap | 0.452 *** (0.000) | 0.381 *** (0.000) | 0.388 ** (0.000) |

**The test type is Intercept and no trend in co-integrating equation and the VAR; Critical values are taken from MacKinnon et al. (1999); CE means co-integrating equation(s); Estimation period: 2001Q1–2013Q4;**

^{a}**The null hypothesis for both tests is: variables are not cointegrated; p-values are MacKinnon (1996) p-values for the tau-statistic;**

^{b}**Dependent variable is non-oil GDP. Estimation period is 2001Q1–2013Q4. p-values are in parentheses. Speed of Adjustment Coefficient in VECM equation is found to be (−0.02) and statistically insignificant. For all panels ***, ** and * indicate significance of the coefficients at the 1%, 5% and 10% significance levels, respectively.**

^{c}© 2017 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (http://creativecommons.org/licenses/by/4.0/).

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**MDPI and ACS Style**

Gurbanov, S.; Nugent, J.B.; Mikayilov, J.
Management of Oil Revenues: Has That of Azerbaijan Been Prudent? *Economies* **2017**, *5*, 19.
https://doi.org/10.3390/economies5020019

**AMA Style**

Gurbanov S, Nugent JB, Mikayilov J.
Management of Oil Revenues: Has That of Azerbaijan Been Prudent? *Economies*. 2017; 5(2):19.
https://doi.org/10.3390/economies5020019

**Chicago/Turabian Style**

Gurbanov, Sarvar, Jeffrey B. Nugent, and Jeyhun Mikayilov.
2017. "Management of Oil Revenues: Has That of Azerbaijan Been Prudent?" *Economies* 5, no. 2: 19.
https://doi.org/10.3390/economies5020019