How effective Natural Resource Funds in Russia, Kazakhstan and Azerbaijan - Term Paper Example

How effective Natural Resource Funds in Russia, Kazakhstan and Azerbaijan? Introduction Stabilization Fund of Russia National Fund of the Republic ofKazakhstan State Oil Fund of Azerbaijan Republic Conclusion How effective Natural Resource Funds in Russia, Kazakhstan and Azerbaijan? Introduction The oil situation CIS countries is somehow similar to the 1970s, when the Soviet Union was suddenly bestowed with soaring incomes from oil exports. However, unlike today, a large portion of funds returned to the industry during that period. It was in the 1970s that the intense development of oil fields was started in Western Siberia and Azerbaijan. Huge funds were invested in construction of modern refineries in the Soviet republics and the development of the transportation infrastructure received a lot of attention. Today, the situation is fundamentally different. Post-Soviet Russian history explains this. While it seems obvious that the investor role in the market economy should shift from government to private business, it hasn’t happened. The 1990s saw the reorganisation of the property structure. Companies changed hands and their owners simply had no time for strategic business development. Only four companies showed relatively stable development in the oil sector: Surgutneftegaz, LUKOIL, Tatneft and Bashneft. In addition, there were no efficient barriers in the country to prevent capital export and no adequate motivation for capital reinvestment. Direct foreign investments were measured in dozens, while capital exports in hundreds of millions of dollars. Increasing tax burden on the oil sector is aimed at stimulating capital inflow into the CIS economy. Yet, the efficiency of these measures raises doubts, as the funds accumulated by the government are not reinvested either. The establishment of the Investment Fund will hardly improve the situation – its size is not sufficient to complete infrastructure projects. There is a more complex and a more efficient alternative to improve the investment climate while encouraging major investors and limiting opportunities for market participants who tend to divest from the economy. The business sector, in its turn, has to prove to the governments that it is ready to invest surplus funds in production growth. The objectives of this work are: to point out the role of the Natural Resource Funds in Russia, Kazakhstan and Azerbaijan; to determine the effectiveness of the Natural Resource Funds in Russia, Kazakhstan and Azerbaijan; to define the main peculiarities of the Natural Resource Funds activity in the CIS countries. It is worth mentioning the work is of great value nowadays because of the difficult world oil situation. This work analyses the Natural Resource Funds situation in the CIS countries comparative to other oil-export countries of the world. Speaking about the methodology of the research it should be mentioned that there were used such methods as comparative (comparing the situations in Russia, Kazakhstan and Azerbaijan); collective (collecting the information concerning the problem). The tasks of the work are: to research the literature concerning the problem of Natural Resource Funds; to make proper analysis of the problem using the methods mentioned above. Stabilization Fund of Russia Undoubtedly, Russia has emerged as one of the world’s primary energy suppliers today. Its increasing reliance on natural resources, however, raises questions essential for Russia’s future evolution, as well as its international role. On the one hand, it can capitalize on its resources and boost its economic development, eventually joining the industrialized world as a competitive partner. On the other extreme, natural resources may turn out to be a bad feature, rather than good, hindering Russia’s economic diversification, expanding the level of corruption, and raising the risks for repeated economic (and political) crises. The establishment of Russia’s Stabilization Fund in 2004 is a reflection of several trends. First, a major shift in Russian government’s focus regarding oil revenues has occurred in the past few years. The major challenge for the Russian state during Yeltsin’s presidency centered on its ability to collect revenues from the oil sector. Most revenues were ending up in the hands of a few oligarchs, which effectively employed various schemes to alleviate their tax burden. Putin’s rise to power was followed by several successive measures that allowed the state to capture increasing shares of the oil rents in the Russian economy. The tax burden on the oil sector was not only increased, but tax collection was also improved, owing to higher priority on the development of tax enforcement agencies, intimidation of private oil companies, as well as the greater willingness of these companies to emerge as good corporate players in order to attract foreign partners. Consequently, the state’s new found ability to collect taxes from the oil sector allowed the government to focus on another aspect of Russian oil revenues, namely their management. 1 This shift in the government’s focus occurred amidst an expanded role for the state in the oil sector overall. This was achieved through an improved and regularized intervention of regulatory bodies determining export quotas and access tariffs to the nation’s pipeline network. The rising trend in oil prices since 1999 also contributed to the establishment of Russia’s stabilization fund. It helped to intensify debates on how to spend the sizable oil rents captured by the state. It also raised apprehensions among a number of economists about the potential harm inherent in suddenly acquiring such rents. Within this background, the establishment of Russia’s stabilization fund reflects the government’s desire to achieve greater control over the revenues collected from the oil sector, as well as its expanded ability to do so as opposed to the preceding Yeltsin period. Scholars are far from consensus on the benefits of setting up a stabilization fund in a resource abundant country. Some have criticized the idea of establishing such a fund on the grounds that it could hardly be effective if overall budget discipline is absent, while countries with a strict fiscal system don’t really need additional mechanisms for managing rents acquired from natural resources. Still, many scholars believe that a stabilization fund helps to establish some regularity and predictability in the management of resource revenues. Especially in developing countries lacking a disciplined budgetary process, setting up a fund could enhance accountability in regards to resource rents. 2 Two additional benefits are attributed to stabilization funds. First, they help reduce budgetary dependence on resource rents, as revenues accumulate in the fund when prices of the commodity in question are high, and are withdrawn into the budget in periods when prices are lower than the baseline. This was a particularly strong argument in Russia. Second, establishment of a fund provides a safeguard against the so-called “Dutch Disease”, which entails inflationary pressures and appreciation of the national currency as a result of the inflow of sizable revenues from the export of natural resources. This was another concern among Russian economists focusing their efforts on convincing the policy-makers on the establishment of a stabilization fund. For the purpose they addressed a widespread concern among the Russian public that Russia is losing its competitiveness in manufacturing and transforming into merely a raw material provider for the rest of the world. The Russian stabilization fund was approved in December 2003. Accordingly, the fund’s revenues accrue from several sources: a portion of the export duty on oil and petroleum products, part of the revenues from the severance tax on mineral resources, and a portion of the surplus of the federal budget at the beginning of the fiscal year. The law set the base price at 20 USD per barrel of Urals oil, above which revenues start accumulating in the stabilization fund, while the government has the right to withdraw money if oil prices fall below the base level. It also determined a base threshold for the overall amount accruing in the stabilization fund. Russia’s decision to establish a stabilization fund is a major success by itself. It could potentially alleviate the country’s excessive dependence on oil prices, as well as address concerns about the “Dutch Disease”3. Nevertheless, Russia faces two major challenges, which are partly an outcome of the current design of the stabilization fund. First, the 500 billion rubles threshold appears considerably low. The law adopted in 2003 set the fund’s threshold level to be equivalent to nearly 3.8 percent of Russia’s GDP. By contrast, the Finance Ministry had proposed the threshold level to be at least 9 percent of the GDP. While establishing no limits about the size of the fund is also deemed to be inefficient for the economy overall, its size needs to be large enough to insure the budget against several years of low oil prices. This does not appear to be the case in Russia, where fiscal difficulties could reappear if oil prices remain below 20 dollars again. Second, setting the fund threshold low immediately invited sharp political battles for using the oil windfalls. In fact, the designers of the fund believed that the threshold would provide them a breathing space for at least 3-4 years until fund money could be used. However, within just one year, the 500 billion ruble threshold was surpassed, with revenues accumulated in the fund reaching 740 billion rubles (26.7 bn USD) by February 2005. Calls for the “easy money” from the stabilization fund have intensified and will further grow in strength as the revenues in the fund reach new records. 4 Russia’s stabilization fund has increasingly appeared at the center of debates about sustaining high levels of economic growth. Since Putin announced the target of doubling Russia’s GDP within a decade, factors affecting the country’s potential growth have become a dominant theme in Russian politics. It is possible to define the most important targets of the Russian state strategy concerning the effectiveness of natural resources funds: - effective providing for state functions of the country as the owner of natural resources consenting their use, reproduction, protection with the help of amendment of the legislative, economical and scientific approaches; - resource-intensiveness reducing of economy; - using the possibilities of the natural-resource potential with the aim of gaining the maximum income; - improving the system of state regulating in the natural resources sphere (control, licensing and resort audit); - creating the effective economic mechanisms of resources consumption considering the special features of Russia and increasing payments for natural resources use to the budgets of all levels; - solving the problem of natural resources ownership; - considering the regional peculiarities and priorities concerning the areas with the special economy conditions.5 National Fund of the Republic of Kazakhstan Kazakhstan has made significant progress to transform its economy after the break-up of the Soviet Union in 1991. The country’s economic performance after the 1998 regional financial crisis has been impressive and its reform record is among the best in the Commonwealth of Independent States. With significant Gross Domestic Product growth absolute poverty has been decreasing albeit not as fast in other middle income countries in the CIS. Kazakhstan has successfully implemented a number of structural reforms, including those of the pension system, public sector resource management, electricity sector, and banking. The early phase of an oil windfall has been managed prudently as part of the revenues has been saved in the National Fund whose balance is above $5 billion. This has contributed to a very commendable macroeconomic stability. Kazakhstan is working on improving its legal and regulatory frameworks and standards with a view of joining the WTO in the near future. Oil is and will continue to be the driving force of the economy, both directly and indirectly. With oil production expected to double by the end of this decade, prospects for the future are bright, but they will depend on how well the Government continues to manage increasingly large oil revenues to avoid excessive volatility in key macro-parameters as well as the so called "Dutch disease," i.e., a relative shrinkage of the non-oil tradable sectors such as agriculture and manufacturing. The Government understands all the risks of heavy dependence on oil and has developed a vision to achieve greater competitiveness and diversification of the economy with emphasis on competition, investment climate, institutions, human capital and basic infrastructure. Globalization with its many interpretations and manifestations, presents Kazakhstan both opportunities and challenges. It is evident that the performance of successful economies has been a function of the speed with which they have adapted to the changing global environment: by capturing a growing share of world trade and investment flows, by raising the quality of their human resources and technological infrastructure, and by creating a competitive domestic environment that promotes innovation and productivity growth. Over the last five years Kazakhstan has been showing an impressive record of macroeconomic performance. Annual real GDP growth rate in 2000-2003 averaged 10.6 percent. In 2004 the economy grew by 9.3 percent, and Kazakhstan has been recognized as one of the fastest growing countries in the world. The oil dependence of the economy is likely to continue to grow as the country is expected to produce 2 million barrels of oil per day by 2010 and 3 million barrels of oil per day by 2015. 6 The National Oil Fund similar to that in Norway, was founded to provide stability for social and economic development of the country, to accumulate financial resources for future generations, to mitigate external economic shocks for Kazakhstan. The assets of the National Oil Fund are accumulated on the accounts of the Government with the National Bank of Kazakhstan. This fund stands at around $5Billion or approx 15% of the GDP. Finances forming the base for carrying out the National Fund’s savings function are accumulated from the following: - official transfers from the republican and local budgets, calculated at 10% of planned revenues from the aforementioned taxes and other mandatory payments; - investment income from administration of the fund; - other inputs and income not prohibited by Kazakhstan law. The primary goals of the Kazakhstan National Fund are defined as follows: - the creation of an investment base capable of yielding future income, so that by the time oil revenues fall a source of financing will be preserved for meeting the socioeconomic needs of Kazakhstan residents; - legislative allocation of a significant portion of the income received from oil under the government’s oversight, with the goal of not permitting wasteful state expenditures; - turning a non-renewable source of wealth into a renewable one. - saving for the future; - reducing the province’s need for outside loans; - improving the quality of life for the province’s population; - diversifying the territory’s economy. The national Fund’s main task is to maximize its value through a range of long-term investments, and to protect its primary capital, in order to earn revenues in the interests if all generations of Kazakhstan residents. The Kazakhstan National Fund was created as a means of helping the government of that country achieve maximum transparency in the process of organizing and using its oil revenues. Therefore, according to the approved procedure, the fund receives all income from the sale of raw hydrocarbons. The Fund is part of the state’s general budget; according to established procedure, net profits are not placed in the fund unless the tax budget shows an excess. Inputs into the National Fund of the Republic of Kazakhstan are organized depending on their localization within the fund. Finances forming the base for carrying out the National Fund’s stabilizing function are accumulated through the allocated of excess taxes and other mandatory payments to the state budget from organizations engaged in the extraction and refining of raw hydrocarbons and non-ferrous metal ores (copper, zinc, lead, and others) in the following forms: - income taxes on legal entities; - the value-added tax (VAT); - the tax on excess profits; - bonuses; - royalties; - the share of the Republic of Kazakhstan from production-sharing agreements, according to contract.7 A report on the activities of the National Fund of the Republic of Kazakhstan must be presented annually by the government of Kazakhstan, jointly with the National Bank, by February 1 of the following year. The government submits an annual report on the formation and use of the fund, together with the results of an external audit, by April 1 for the President’s approval. Information regarding the annual report and audit results is published in the mass media. An external audit is performed annually, with the aim of guaranteeing the transparency of activities concerning the National Fund’s administration. The choice of an independent auditor is made on a competitive basis, according to the procedure established by the government of Kazakhstan. (Askarov, 2002). According to the decree of the President of Kazakhstan on the creation of the National Fund of the RK, management of the fund is undertaken by the President himself, under whom a Council on Administration of the National Fund is formed, consisting of representatives of the government, Parliament, the President’s administration, and the National Bank of the Republic of Kazakhstan Petroleum is an exhaustible and highly volatile commodity and cannot be a reliable source for long-term sustainable economic growth. It is a source of significant government and foreign exchange revenues, which could be an invaluable source of financing for economic development. At the same time, these revenues tend to fluctuate greatly in line with volatile world market prices and risk pushing up real exchange rates and undermining the competitiveness of local manufacturing. In order to cope with these challenges and to sustain the transition from a resource-based to a diversified and manufacturing economy, it is necessary to put in place coherent and consistent policies in the areas of enterprise development, education, entrepreneurship, research and innovation. These policies should be all guided by the need to support the development of higher skill, knowledge-intensive activities in which Kazakhstan could be a significant player and could build truly distinctive competencies. State Oil Fund of Azerbaijan Republic Notwithstanding the countrys natural resources, Azerbaijan remains one of the seven lowest income countries in Europe and Central Asia and poverty continues to present a major challenge. In 2001, some 50 percent of the population lived in poverty and 17 percent in extreme poverty. There are significant regional variations in poverty rates with the incidence of income poverty being highest among households in provincial towns. Access to services is more limited in the rural areas, giving rise to significant rural-urban migration. Appropriate management of oil resources will be crucial in securing more equitable growth for current and future generations. The government of Azerbaijan has established a new State Oil Fund to provide for economic stability and fund future economic development, particularly in the non-oil sectors of the economy. This fund is the only one of its kind within the CIS managed by an autonomous government agency. The government promises conservative, rational and transparent spending of oil profits extracted from the Caspian Sea deposits. Azerbaijan’s State Oil Fund was established by presidential decree in December, 2000, and funding began in January 2001. The fund now has four main revenue sources: All "profit oil" revenues accruing to the Republic of Azerbaijan; that is, profits from the sale of the government’s share of oil produced under off- shore Production Sharing Agreements signed with investing oil companies; All "surplus and performance" bonuses paid to the government of Azerbaijan by the oil companies; The rental or sale of assets belonging to the PSAs; Income from investing and managing the assets of the Oil Fund. Azerbaijani politicians have discussed how to use the wealth that is expected to flow into the Oil Fund and further accrue from its investments. Some leaders favor short term needs – spending large amounts on much- needed infrastructure development, or financing large investments in the non-oil sector, or meeting urgent social needs of the refugees and the population in general. 8 The key to the government’s strategy is to set up careful guidelines for saving, spending and investing fund revenues. Moreover, the government established the fund as a separate agency, making its management both transparent and subject to international audit. The Oil Fund must first collect revenues for five years, before major expenditures can be made. Fund assets will be invested conservatively, primarily in high-rated government bonds, both domestic and foreign; in some preferred equities funds; in U.S. agency bonds, and government-secured debts. The Oil Fund will also be a lender to the World Bank or other international development banks. The fund will not, however, be invested in real estate, precious metals, commodities or speculative funds. The fund will be used mostly for non-oil sector investment funding, since development of this sector is an important precondition for economic development. In order to attract that investment, the government needs to think about basic infrastructure development, but it would be a big mistake to involve Oil Fund money directly in development, although co-financing of some projects with international financial institutions is not excluded. The Oil Fund budget expresses public policy and is to be coordinated with the general government budget. 9 The fund’s objective is to find the right balance between saving and spending. And proper spending is important. Consumption is a very important part of Azerbaijan economy – but not excessive consumption. There are so many examples of how other countries have spent their oil money inefficiently. Main responsibility of the Fund is to ensure collection and effective management of foreign currency and other assets that are generated from the implementation of agreements signed in the field of oil/gas exploration and development, as well as from the Funds own activities, in the interest of citizens of the Republic of Azerbaijan and their future generations.10 The Fund is formed on the account of the following sources: - Revenues generated from implementing agreements on exploration, development and production sharing for oil and gas fields in the territory of the Republic of Azerbaijan including the Azerbaijani sector of the Caspian Sea (Lake), as well as other agreements on oil and gas exploration, development and transportation entered into between the State Oil Company of the Republic of Azerbaijan or other authorized state body and investors; - Net revenues from the sale of hydrocarbons falling on the share of the Republic of Azerbaijan (to deduct expenditures incurred for hydrocarbons transportation, customs clearance and bank costs, marketing, insurance and independent surveyor fees and not to include revenues falling on a participating interest or investment of the State Oil Company of the Republic of Azerbaijan in a project if it is an investor, participant or a contracting party of this project); - Oil and gas agreements signature and/or performance bonuses paid by investors to the State Oil Company of the Republic of Azerbaijan or an authorized state body; - Acreage payments due to the State Oil Company and/or an authorized state body of the Republic of Azerbaijan from investors for the use of contract area in connection with oil and gas exploration and development; - Dividends and profit participation revenues falling on the share of the Republic of Azerbaijan in connection with oil and gas agreements implementation ( not to include revenues falling on a participating interest or investment of the State Oil Company of the Republic of Azerbaijan in a project if it is an investor, participant or a contracting party of this project); - Revenues generated from oil and gas pass over the territory of the Republic of Azerbaijan with the use of Baku-Supsa, Baku-Tbilisi-Ceyhan and Baku-Tbilisi-Erzerum export pipelines; - Revenues generated from transfer of assets from investors to the State Oil Company and an authorized state body within the framework of oil and gas agreements; - Revenues generated from placement and management of the Funds assets, including interest, dividend, asset revaluation and other revenues; - Grant and other free aid; - Other revenues and receipts in accordance with the legislation. 11 Conclusion Main responsibility of the CIS Funds is to ensure collection and effective management of foreign currency and other assets that are generated from the implementation of agreements signed in the field of oil/gas exploration and development, as well as from the Funds own activities, in the interest of citizens of the CIS countries and their future generations. The funds’ main objective is to find the right balance between saving and spending. And proper spending is important. Consumption is a very important part of the economy of any country – but not excessive consumption. There are so many examples of how other countries have spent their oil money inefficiently. Petroleum is an exhaustible and highly volatile commodity and cannot be a reliable source for long-term sustainable economic growth. It is a source of significant government and foreign exchange revenues, which could be an invaluable source of financing for economic development. At the same time, these revenues tend to fluctuate greatly in line with volatile world market prices and risk pushing up real exchange rates and undermining the competitiveness of local manufacturing. Read More