Due to the recent war in Karabakh, the presentation, discussion, and approval of the state budget of Azerbaijan was delayed until the very last days of December. As the proposal has been adopted by the Parliament and signed into law by the President, I have decided to take a brief look and share with you the points that I deem noteworthy.
OVERVIEW OF THE REVENUES
With a 5.4% increase in respect to the amended budget of the 2020, the budget revenues of the upcoming year will stand at 25.4 billion manats. The fundamental drivers supporting the rise are: (a) value added tax (VAT), (b) excise tax, and (c) dividends from state owned enterprises (SOEs). The upturn in VAT and SOEs can be attributed to the expectation by the authorities that the economic activities will (in relative terms) be more stable during 2021. On the contrary, the hike in revenues from excise tax, which equals 13% (much greater than the 2% gain in VAT) gives us enough ground to assert that there are other factors on the move in this case. More specifically, bearing in mind that the excise taxes collected by the customs authorities (which is a subgroup of the whole excise taxes in the budget) are set to decline by 15%, we can argue that the government contemplates to collect 21% more excise tax from the internal market[1]. My speculation is that we can anticipate further excise taxes levied on tobacco or alcohol products, or a general upsurge in prices of goods that are subject to this taxation in the upcoming year (by the time I finalized this post, the government has already announced the increase in price of gasoline (AI-92 and diesel) by 20-30%, and I find it probable that tobacco and alcohol products will follow the suit).
Apart from these, two new sources that did not exist in the previous years’ budgets have been included, which are “Profits of Central Bank” and “Transfers from the Guarantee Fund”. It should also be mentioned that contributions of certain sources have lessened in the new budget, particularly those from corporate and simplified tax, which have been curtailed by 5 and 13 percent, respectively. Their downturn is likely an indication of the intention of the government to maintain the somewhat meager pandemic support schemes during 2021. The reduced corporate tax is also a reflection of the continuation of the production quotas under the OPEC+ deal, which is going to diminish the amount of corporate tax collected from oil companies in Azerbaijan.
OVERVIEW OF THE EXPENDITURES
The expenditure side of the budget has also been on the rise, reaching 27.5 billion manats, meaning 3.8% (or 1.1 billion manats) higher than the previous year. The immediate underlying factors are mostly related to the recent war: “Defense and National Security” expenses are up by 21%, as well as an extra 2.2 billion manats are allocated for reconstruction efforts in Karabakh. These two categories together account for additional expenditures of 3 billion manats, far larger than the 1.1 billion boost in the overall spending, meaning that other categories of the budget have been cut in order to make room for the above-mentioned activities.
The largest slump in expenditures is in “Fixed Capital Investments”, which went from 4.9 billion in 2020 to 2.8 billion in 2021. This essentially means that almost half of the funding for construction have been re-directed towards Karabakh. It is comprehensible why – since cutting such a hefty amount from other categories (education, healthcare, defense, or social security) is practically inconceivable without facing severe social, economic, and political repercussions. Reduced fixed investments will surely have an adverse economic impact over Baku and regions of Azerbaijan outside Karabakh, but it would not lead to an economic recession. In fact, I am rather pleased that the unnecessarily large, corrupt, and unsustainable “Fixed Capital Investments” have been cut and re-directed instead of some other, more vital spending category.
Healthcare expenses are also going to endure a sizeable dip of 18%. This might seem puzzling at first, given that the pandemic is still ravaging the country and the world. Yet, this is a decline only relative to the healthcare spending of 2020. With reference to the same figure of 2019, however, the indicator of 2021 is still 61% higher. I believe the reason is that when the epidemic suddenly swept across the globe in the early 2020, the governments were unprepared and population vulnerable for such an event and hence huge amounts of money were hastily shifted towards healthcare. The situation is a little different in 2021 as the combat against the virus is more coordinated and efficient, therefore it has become possible to spend less. Also, note that the direct funds towards the coronavirus epidemic (261 million manats) is not included within the healthcare category, but rather independently as a subcategory of the “expenditures not belonging above”.
Below, you can see a graphical representation of the 2021 state budget expenditures.
Graph 1: Expenditures of the State Budget
Source: Ministry of Finance of Azerbaijan
SOFAZ, BUDGET DEFICIT AND ITS FINANCE
The transfers from the State Oil Fund to the budget have not been altered and remains at 12.2 billion manats. That is partially welcome news (in a highly relative sense, of course) especially when taking into account that the implementation of the fiscal rule has been suspended for 2021, meaning that the government had the legislative ability to transfer a much larger amount if it wished to. Such a move could have been conveniently justified on the grounds of reconstruction of the newly liberated lands or heightened military expenditures due to the war. Instead, as mentioned above, the extra funds towards reconstruction and defense has been obtained by savings from other sectors and further revenues from VAT and corporate taxes, which was the more fiscally responsible approach among the alternatives.
Similarly, I also consider it a positive development, for the same reasons outlined above, that the deficit of the budget is predicted to be around 3,116 million manats, 7.5% smaller than the respective indicator of the 2020. Nonetheless, it is alarming that the budget deficit is going to constitute 4.1% of the Gross Domestic Product in 2021. For comparison, neighboring Georgia’s budget deficit, despite not having a natural resource fund to boost its revenues, was 2.6% in 2020. In general, many countries around the world, particularly those of European Monetary Union, target 3% as the upper limit of the budget deficit. Anything above than that should naturally cause concern, as it is the case in Azerbaijan. This apprehension is magnified especially when one takes into account that the 4.1% deficit exists in contempt of the record amount (the transfers of 2020 & 2021 are the largest ones since the Fund’s establishment 20 years ago) of transfers from the Oil Fund. From the table below, you can see the change of relevant indicators of the state budget in recent years.
Table 1: State Budget during 2018 – 2021
Source: Ministry of Finance of Azerbaijan
Compared to the preceding years, internal finance is going to play a more substantial role in the budget of 2021. The state envisions to issue 2 billion manats worth of new bonds, 681.5 million of which will go to re-financing of bonds that were originally due in 2021. Rest of the amount, equal to roughly 1.3 billion manats, will cover a portion of the budget deficit. The remaining fraction of the budget deficit is set to be financed by a combination of sources, namely the surplus of treasury from the last year, earnings from privatization, and credits obtained for specific projects.
The rather troublesome news comes when one takes a look at the budget of the State Oil Fund. In the initial version of the budget proposal, the price of a barrel of BRENT crude oil was taken at 35 USD, which was a conservative and, in my opinion, appropriate proposition in our case. Contrarily, something changed during the discussions of the budget because by the time the budget of the Fund was confirmed, the revenues of the Fund was increased from 5.9 billion to 8 billion manats and the expected price of a barrel was taken at 40 USD. It becomes coherent that the Azerbaijani government still has not grasped the idea of learning from its past mistakes.
The final budget of SOFAZ for 2021 incorporates a deficit of 4.2 billion manats, slightly less than the 4.6 billion deficit (per the legislation, not execution) of 2020. But, as I mentioned above, the new budget, with its over reliance on positive estimations of energy markets, still carries considerable risk. Although the prognoses, such as the one made by Energy Information Administration of United States has upped the forecasted average oil price of 2021 to 49 USD, it is not an adequate strategy to rely to such estimates. A single abrupt turn in global economy could lead to a far lower average price than anticipated before, just like it happened with the epidemic. In the beginning of 2020, all of major projections had the average BRENT prices per barrel at 60 USD or higher. The reality was 33% less, around 40 USD. It is improbable that another economic shock in the magnitude of coronavirus will hit us in the near future, however even a relatively small factor, such as slower-than-expected post-coronavirus economic recovery, or lower effectiveness of mass vaccination programs can result in consequential alteration in price of oil. On the other hand, the state budget (and the Oil Fund’s budget) already includes a massive deficit, meaning that if the things take an unfavorably turn, then the population, who even now suffers heavily from the epidemic, will have to carry the burden of the additional deficit because the lawmakers left no margin for error in the design of the state budget. Considering all these, it is an incompetent strategy to use such optimistic estimates when drafting the budget. At the end of the day, it is far better to wrongly commit to a pessimistic forecast than to mistakenly depend on an optimistic one.
FOOTNOTES
[1] Here is how I got the 21%: 100 x (Increase in overall Excise Tax revenues 2021 + decrease in Excise Tax from Customs 2021)/(total Excise revenues 2020 – Excise revenues from Customs 2020)
Economir 