AZERBAIJAN INCREASES 2008 BUDGET WITH LARGE

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E.O. 12958: DECL: 07/10/2018
TAGS: ECON EINV ETRD ENRG EFIN AJ
SUBJECT: AZERBAIJAN INCREASES 2008 BUDGET WITH LARGE
TRANSFERS FROM STATE OIL FUND

REF: (A) BAKU 291 (B) BAKU 429 (C) BAKU 322

Classified By: AMBASSADOR ANNE E. DERSE PER REASONS 1.4 (B, D)


1. (C) SUMMARY: With the May 2 approval of the 2008
supplemental budget by Parliament, the Government of
Azerbaijan (GOAJ) increased expenditures by USD 3.7 billion,
raising total expenditures to USD 12.2 billion. In order to
fund the dramatic increase in expenditures, the GOAJ will
increase the total amount transferred from the State Oil Fund
to the budget by USD 3.2 billion to USD 4.4 billion.
Transfers in 2008 from the Oil Fund to the budget could total
more than 50 percent of the Oil Fund's total revenue inflows
this year. In this presidential election year, the
supplemental budget boosts defense, health and education
spending. Defense will receive USD 1.6 billion and the GOAJ
plans to spend USD 5.1 billion on public capital investments,
including USD 1.29 billion on highway, energy, transport, and
gas infrastructure upgrade projects. The international
financial institution (IFI) community has expressed concern
regarding the GOAJ's expansionary fiscal policy, especially
noting how the GOAJ is using the Oil Fund. The IMF has
raised its 2008 inflation estimates for Azerbaijan to more
than 26 percent. END SUMMARY.

BUDGET EXPENDITURES UP 30 PERCENT
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2. (C) Azerbaijan's Parliament on May 2 approved an annual
supplemental budget expenditure increase of USD 3.7 billion,
an increase of 42 percent, pushing the total 2008 budget
expenditures in excess of USD 12.2 billion, an increase of 35
percent from 2007. In 2007, Azerbaijan increased its budget
expenditures in the supplemental budget by more than USD 750
million. The large supplemental budget package was not
unexpected and includes large increases in defense, health
and education expenditures. Worrisome to many financial
observers in Baku, however, is the large transfer from the
State Oil Fund to support the large increases in budget
expenditures. Finance Minister Sharifov told a visiting USG
official that the GOAJ will begin preparations for the 2009
state budget in early September but he did not comment on the
potential increase in the budget.


3. (SBU) In the supplemental budget, the GOAJ will increase
defense spending to USD 1.6 billion, an increase of
approximately 32 percent from the original budget proposal.
In addition, the GOAJ will increase healthcare spending by
almost 17 percent with funding totaling USD 454 million. The
government will spend more than USD 200 million on hospital
upgrades and more than USD 60 million on outpatient services.
The Government plans to spend an additional USD 150 million
for "other healthcare services." The Government also
increased education spending by 14.5 percent bringing the
total to USD 1.31 billion.


4. (SBU) Also included in the supplemental budget is an
increase in capital investments. In 2008, the Government
plans to spend USD 5.1 billion on public capital investments,
including USD 1.29 billion on highway, energy, transport, and
gas infrastructure upgrade projects. The GOAJ is currently
implementing a multi-year capital investment program in order
to modernize the infrastructure of the country and the
increase in the supplemental budget is part of this broader,
ongoing effort. (COMMENT: It is unclear if the GOAJ has
effectively planned for the large increase in expenditures or
performed cost-benefit analysis, especially with respect to
the half of the spending which will go for public
investments. END COMMENT).

OIL FUND TRANSFERS TO THE BUDGET
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5. (C) In 2008, the GOAJ will transfer a total of more than
USD 4.4 billion from the State Oil Fund to the state budget
for support, including the USD 3.2 billion planned in the
supplemental budget. In 2008, the Oil Fund expects to
receive more than USD 8 billion in oil revenues and its
assets will increase to nearly USD 10 billion. Transfers in
2008 from the Oil Fund to the budget could total more than 50
percent of the Oil Fund's total revenues this year.
According to press reports, Minister Sharifov has stated that

Azerbaijan's foreign exchange reserves grew 25 percent from
January to March 2008 to USD 9 billion.


6. (C) COMMENT: The State Oil Fund, Azerbaijan's most
transparent government agency, acts as Azerbaijan's energy
revenue sterilizer and long-term savings vehicle. It is also
used to support key national development objectives and
programs. The GOAJ's reliance on the Oil Fund for budget
support while addressing important national development
priorities, impacts its effectiveness in insulating the
Azerbaijani economy from the negative effects of its
burgeoning inflow of energy revenues, especially inflation.
It also raises concerns about the Oil Fund's ability to
fulfill its role of safeguarding energy revenues for
Azerbaijan's long-term sustainable development. END COMMENT.

STEADY ECONOMIC GROWTH
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7. (C) While still growing, Azerbaijan's economy is poised to
slow in 2008 after fours years of extremely rapid growth and
the maturing of Azerbaijan's energy sector. According to the
Azerbaijani State Statistics Committee, Azerbaijan's Gross
Domestic Product grew 13.8 percent year-on-year to USD 9.6
billion from January to March 2008. Azerbaijan is
forecasting that GDP will reach USD 37 billion in 2008. In
July, the GOAJ announced a series of salary increases for
government employees, including Azerbaijani military officers
and Ministry of Internal Affairs employees. According to the
State Statistics Committee, the average nominal monthly wage
increased 26.5 percent year-on-year to USD 271 from January
to March. The GOAJ had planned to increase salaries
throughout 2008 in the run-up to the October presidential
election.

IFI REACTION
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8. (C) In discussions with representatives from the
International Monetary Fund, European Bank of Reconstruction
and Development, World Bank, and International Financial
Corporation, all expressed concern regarding the Government
of Azerbaijan's expansionary fiscal policy, and the large
increase in spending included in the 2008 supplemental
budget. The IFIs are also concerned by the GOAJ's reliance
on the Oil Fund for budgetary support, as it risks
diminishing the fund's sterilizing function. The IMF
representative said that inflationary pressures would
continue to mount in 2008 and continue into 2009. The IMF
has raised its 2008 inflation estimates for Azerbaijan to
more than 26 percent. Other local economic observers expect
inflation in 2008 to surpass 30 percent.

COMMENT
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9. (C) With the presidential election scheduled for October,
many IFI observers believe that some of the additional
spending is politically motivated. The macroeconomic effects
of the large increase in spending included in the
supplemental budget will probably not be felt until early
2009 as it will take the GOAJ several months to disburse
funds. The government's increasingly expansionary fiscal
policy continues to be worrisome as inflationary pressures
increase. In the current expansionary environment, inflation
is unlikely to decrease and the government's efforts to raise
salaries and wages could lead to the wage-price spiral that
damages long-term economic stability.
DERSE