Might possession of vast amounts of natural resources represent a stumbling block on the road to reform? Possibly. It may be a misfortune in that it provides a false sense of security and enables governments to delay the hard decisions concerning the implementation of reforms.
Fragmented evidence (economic reality is much more complex than that) suggests that states that lack oil and gas wealth -- such as Armenia, Georgia and Kyrgyzstan -- are more willing to consider reforms than resource rich nations. Officials in Azerbaijan and Turkmenistan, for example, seem to feel that an abundance of oil and gas revenue can buy time, postponing change.
Now that the price of oil has almost tripled since the end of 1998, what are the countries that benefit from this "positive supply-side shock" going to do? Higher prices transfer income from economies that import oil to oil exporters. These receive a windfall which they can either save or spend on imports. What are the two main regional beneficiaries - Azerbaijan and Kazakhstan - going to do to ascertain that oil wealth is not wasted?
Both countries are entering their first oil boom cycle. High oil prices have sent their economies into high-speed growth (projected for this year at 8 percent and 7.5 percent in Kazakhstan and Azerbaijan respectively). For the first time in years, industrial production is growing at double-digit rates. Although little is known about the precise sensitivity of these economies to oil prices, preliminary estimates suggest that budget revenues in Kazakhstan increase by 0.2 percent of GDP at a 10 percent increase in the oil price. There, oil and gas exports amount to roughly 50 percent of total exports, with mining accounting for a further 30 percent. Thanks to non-anticipated higher oil prices, the first six months of this year showed a 1 percent fiscal surplus on IMF estimates. In Azerbaijan, recent estimates indicate that the energy sector makes up 22 percent of value added against a 2 percent share of manufacturing.
To prepare for the eventuality of a commodity price decline, both countries ought to maintain tight fiscal management (fiscal deficits in 2000 are likely to amount to 2 percent of GDP in Kazakhstan and 7 percent of GDP in Azerbaijan), and to accelerate structural reforms to increase robustness in the face of trade shocks.
These are the two big, outstanding issues. Indeed, long-term fiscal challenges remain acute, particularly in Kazakhstan, where the 1999 Budget System Law has decentralized responsibility for social security, health and education to the local government level, without concomitant improvements in the allocation of revenues, and the system of withdrawals and subvention. In Azerbaijan, structural reforms began slowing at the end of 1998. Public sector reforms have stalled and major regulatory reforms have slowed, while the financial sector remains weak.
Sustainable fiscal management of oil wealth is therefore a crucial issue. With oil and gas revenues predicted to rapidly increase, the authorities of both countries admit that a priority should be the strengthening of governance structures to ensure that the windfall is well managed. In Kazakhstan, a National Oil Fund was set up under a decree by President Nazarbayev last September. It stipulates that the head of state (in coordination with the Parliament) will instruct the government on how to spend the fund's resources. Similarly, an Azerbaijani Oil Fund was established in December 1999. It has already accumulated about US$ 230 million, but it is not clear yet whether the fund will be subordinated to the President or the Parliament.
At the moment, we know very little about the way in which these funds will be managed. Their transparency and accountability will be crucial for the future macroeconomic performance of both countries. Should authorities allow mismanagement by vested interests, a seriously flawed development path would become increasingly likely, with the balance between the oil and non-oil sectors becoming more and more distorted.
Structural reforms, including, above all, improvements in government administration and regulatory practice, but also renewed efforts toward a more transparent privatization and the modernization of infrastructure, are paramount for the non-oil sector to grow. It is therefore essential to limit the ability of government officials to tilt the business environment in their favor. In both countries, officials could best demonstrate their intent to foster public accountability by addressing the entire package of public sector reform and improved governance advocated by the international financial institutions (primarily, the World Bank, the International Monetary Fund and the European Bank for Reconstruction and Development). This includes public expenditure management, administrative and civil service, legal and judicial and anti-corruption reforms.
The funds will be well utilized only if the authorities resist demands for profligate investments (such as empty five star hotels in Ashgabat, Turkmenistan), and save accumulated funds for well-targeted projects with high returns, as well as for loans to private sector ventures. Also, governments should avoid the creation of subsidy programs that pass part of the oil and gas profit windfall directly to domestic consumers. At the same time, the funds might be used to finance principal repayments of the countries' foreign debt. Both choices are tough on the population, and could come under considerable pressures in the short term because they are highly unpopular. They are needed though, to ensure that the next generation benefits from the current situation.
The next few months, when we learn more about the modus operandi of these funds in Azerbaijan and Kazakhstan, will tell us whether oil in these countries will prove to be a cure or a curse.
Thierry Malleret is the Director for Europe of the World Economic Forum. The opinions expressed in this article are Mr. Mallerets own, and do not represent the views of the World Economic Forum.