BP QUIETLY LAUNCHES MACROECONOMIC MODELING UNIT IN

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 001274

SIPDIS

SIPDIS

DEPT PLEASE PASS TO USTR

E.O. 12958: DECL: 08/29/2016
TAGS: ECON EFIN ENRG PREL PGOV PINR AJ
SUBJECT: BP QUIETLY LAUNCHES MACROECONOMIC MODELING UNIT IN
EFFORT TO STRENGTHEN GOAJ ENERGY REVENUE MANAGEMENT

Classified By: Ambassador Anne E. Derse per 1.4 (b,d).


1. (C) SUMMARY: BP has quietly launched an intensive effort
to help the Government of Azerbaijan better manage its
anticipated billions of dollars in energy revenue. After
years of discussions, the GOAJ agreed to place a BP-funded
macroeconomic modeling unit at the State Oil Fund (SOFAZ).
BP hopes the new macreconomic modeling unit will improve GOAJ
awareness of the dangers of mismanaging its oil revenues and
promote a cohesive, long-term approach to economic
decision-making within the GOAJ. BP Senior Economist Mark
Henstridge told the Ambassador that high degrees of
resource-dependency in economies like Azerbaijan's present
enormous commercial risks to BP; BP Policy Advisor Jacob Nell
(who had worked for several years as an advisor to
Azerbaijan's Finance Ministry) more bluntly said that GOAJ
mismanagement of its energy revenue presents the greatest
risk to BP. BP believes that Azerbaijan has "two or three
budget cycles" (e.g. until 2008 or 2009) to set up proper
procedures for revenue management in order to stave off
hyperinflation. Nell separately told the Ambassador that BP
is also thinking of creating a trust fund to finance
macroeconomic framework studies that would analyze the
economic situation in Azerbaijan, another step to increase
the public's awareness of the importance of proper economic
management. Henstridge and Nell commented positively on the
new GOAJ economic team led by Finance Minister Sharifov and
Minister of Economic Development Babayev, and believe the new
economic modeling unit will be a key tool for the team to get
a better grip on the GOAJ budget planning and budget process.
END SUMMARY.

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BP WORRIED ABOUT MACROECONOMIC RISKS IN AZERBAIJAN
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2. (C) BP Senior Economist Mark Henstridge told the
Ambassador in late July that high degrees of
resource-dependency in economies like Azerbaijan's present
enormous commercial risks to BP. In a separate August 24
meeting, BP Policy Advisor Jacob Nell more bluntly told the
Ambassador that BP's biggest risk in Azerbaijan is the
government's potential mismanagement of its oil revenues.
With energy revenue in the State Oil Fund (SOFAZ) already at
1.5 billion and projected to double over the next few years,
BP believes that Azerbaijan must set up proper procedures to
manage its energy revenue as soon as possible. Henstridge
said that, thanks to Azerbaijan's full participation in the
Extractive Industries Transparency Initiative (EITI),the
GOAJ has the proper procedures in place to transparently
transfer funds to the State Oil Fund. The real question is
whether Azerbaijan has the proper planning structures to
adequately control expenditure of its energy revenue. Based
on his previous discussions with Azerbaijan's economic
policy-makers, Henstridge is not confident that the GOAJ has
the proper structures in place. He said that senior
policy-makers routinely ask him, "How do we know how much to
spend?" According to Henstridge, they also want to know
which industries will create jobs.


3. (C) Henstridge believes that the GOAJ has "two or three
budget cycles" (e.g., until 2008 or 2009) to set up the
proper procedures for revenue management in order to stave
off hyperinflation. If the current inflation rate --
reported by the GOAJ at 11 percent -- increases, Henstridge
said that window will narrow, but he also believes increased
inflation as well could force the GOAJ to make the right
economic decisions. Henstridge noted that, with presidential
elections looming in 2008, the GOAJ faces enormous political
pressure to spend oil money now and demonstrate some concrete
benefits to ordinary citizens. He commented that Azerbaijan
already has seen a "sizable" increase in public spending,
with a doubling in the state budget that could drive
inflation. (Henstridge also commented that the GOAJ CPI is
not a good measure of inflation, a view shared by IFIs and
the embassy.) Henstridge noted that Azerbaijan's political
pressures are compounded by Azerbaijan's annual budget cycle.
According to Henstridge, the solution would be to create a
medium-term spending plan that is linked to the GOAJ budget
process. Through the new economic modeling unit at SOFAZ, BP
is hoping to steer the GOAJ in the right direction.
Henstridge also mentioned that BP is keeping its support for
the modeling unit quiet in order not to be seen as infringing
on GOAJ sovereign authority.

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NEW ECONOMIC MODELING UNIT AT SOFAZ
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4. (C) Since late 2004, BP has been working quietly with
Oxford Economic Forecasting and SOFAZ to create an economic
modeling unit that can help the GOAJ decide how to spend its
energy revenue. BP and SOFAZ finally signed a Memorandum of
Understanding on the modeling unit in early August, and on
August 24, Jacob Nell of BP's Policy Department briefed the
Ambassador on the initiative. Nell told Ambassador that the
MOU negotiations between BP and the Oil Fund regarding the
unit had been difficult due to the lack of cooperation
between different government ministries. The Oxford Economic
Forecasting group is currently delivering the model and
training Oil Fund staff. BP and State Oil Fund Executive
Director Shahmar Movsumov plan to unveil the macro unit in a
closed-door presentation to GOAJ ministers at the end of
September.


5. (C) At the presentation, the ministers will see that if
the government spends too much, it will lead to higher
inflation and possible macroeconomic instability. Nell said
that BP hopes this meeting will spark additional dialogue
about the government's responsibility to control
expenditures. Nell also told the Ambassador about possible
plans by BP to create a USD 1 million trust fund managed by
the IMF or World Bank that will finance macroeconomic
framework studies to further publicize the need for fiscal
discipline as oil revenues increase. Henstridge believes
that a "network of mature voices," internationally recognized
economists, will be necessary to convince both senior
Azerbaijani government officials and the broader Azerbaijani
public of the need to rein in GOAJ spending. According to
Nell, BP also is drafting a white paper on the State Oil
Company, BP, and the next phase of economic cooperation in
Azerbaijan, due to be delivered to President Aliyev in
October.

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GOAJ ECONOMIC LEADERSHIP GETTING STRONGER
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6. (C) Nell said that Azerbaijan was fortunate to have
political stability and leadership that had a long-term
economic vision that included liberalizing the economy. He
specifically mentioned the reform efforts of Finance Minister
Sharifov, Economic Development Minister Babayev, State Oil
Fund Executive Director Movsumov and National Bank Chairman
Rustamov. Henstridge echoed these remarks, specifically
singling out Finance Minister Sharifov for his good work in
establishing SOFAZ. While the economic team is strong, BP
believes it needs a "bigger picture" understanding of the
budget process and the need to manage public expectations and
spending pressures. Henstridge and Nell believe the new
modeling unit will provide a useful tool. Nell noted that
the GOAJ's ability to "manage" the domestic political
situation will be helpful, commenting that he believes
Azerbaijan would follow path of "incremental progress" as it
develops.


7. (C) Nell noted that the political "old guard" remains a
barrier to true political and economic reforms and that this
group does not fear an increase in government spending or
higher inflation. Nell felt that the GOAJ needed to get
"burned" with higher inflation and macroeconomic instability
in order to understand the need for fiscal discipline. He
and the Ambassador agreed that it is important to strengthen
the hand of the economic policymakers that understand the
potential problems while trying to send the message to the
political establishment of the inherent dangers in
overspending in an economy unable to absorb additional
inflows.

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GOAJ PERSONALITIES/BIOGRAPHIC NOES
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8. (C)Regarding the new Deputy Minister of Economic
Development, Sevinj Huseynova, Nell said that she was
intelligent, skilled in bureaucratic management, and from the
politically powerful Nakhchivan area of Azerbaijan. Nell,
who worked with Huseynova at the Ministry of Finance during

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the early 2000s, indicated that she is focusing on developing
three key areas: a medium-term macroeconomic framework, a
national development plan and a public investment plan.
Huseynova, until her appointment at the MED, had been working
with USAID-implementer DAI on the Public Investment Planning
Project.


9. (C) Commenting on National Bank Chairman Rustamov, Nell
said that he is one of the few in Azerbaijan "who really
understands monetary policy," has extensive monetary policy
experience and knowledge and has recently been building
capacity at the National Bank, including in the banking
supervision department. Nell said that since Rustamov's
failed bid to become Prime Minister, his political influence
has diminished, but he has proceeded to work hard at this
current post. His ability to effect reform and build
Azerbaijan's banking sector is limited by political factors,
including the dominance of two state-owned banks.
HYLAND