Overcoming the curse of hydrocarbon: goats and governance in the oil funds of Kazakhstan and Azerbaijan.

Kalyuzhnova, Yelena

INTRODUCTION

The management of oil revenues--which are volatile, unpredictable, and ultimately exhaustible--offers important opportunities but can also greatly complicate economic policy-making. To tackle this management challenge, many oil-producing countries are setting up oil funds. In light of experience, there is a need to ask a fundamental question: under what circumstances can such funds become part of a policy solution--rather than ending up as a part of the problem?

The literature on resource-rich economies supports the view that oil and gas revenues can pose problems for economic management. In a range of cases, economic performance appears to suffer rather than benefit from the impact of natural resources endowment (Gylfason and Zoega, 2003; Paldam, 1997). The international community, including international financial organisations, have become growingly concerned about the effectiveness with which natural resource revenues are used, and notably how they can help foster long run economic and social development. The latter fits into the wider topic of the political economy of resource-driven growth. At the present time there is a growing literature on the concept that natural resource endowment is an economic curse rather than a blessing (Auty and Mikesell, 1998; Auty and de Soysa, 2006; Gylfason, 2001; Kalyuzhnova and Kaser, 2006; Sachs and Warner, 2001, etc). In this paper we are making an initial assumption that for Kazakhstan and Azerbaijan their resource endowment is a potential blessing to overcome transition disruptions. However, the lesson of experience in other countries is that realizing this promise--and avoiding the risk that natural resources become a 'curse'--is crucially dependent on policies, and in particular on transparency. Oil funds, we will argue, can contribute by smoothing some of the instability that may arise from energy price fluctuations; and transparent rules of operation can also avoid many of the adverse incentives that have plagued some resource-rich countries. Of course, the optimal design and practical implementation of these instruments of hydrocarbon revenue management in Kazakhstan and Azerbaijan remain to be seen in the years ahead.

This paper analyses one of the possible instruments of hydrocarbon revenue management--oil funds. Such funds have become fashionable in the wake of recent high and volatile oil prices, and with new discoveries of hydrocarbon deposits. In recent years, many countries either established oil funds or are considering doing so. These funds have different titles, goals and rules, but they share the underlying objective of helping governments deal with the problems created by large revenues from the energy sector. The core question to be addressed is whether oil funds, generically, are panacea for the so called 'paradox of plenty'--or whether they are effective only in circumstances that are in any case particularly benign. The oil funds may serve as a form of 'commitment mechanism', thus substituting for the IMF commitment mechanism. The paper suggests that the key requirements for success with such funds lie in governance issues.

The paper is divided into three main sections. The first reviews the conceptual framework relevant to natural resource funds--taking into account the broad context of macroeconomic and energy policies, in a setting oil price uncertainty. The second section turns to institutional issues-including management costs and problems of organisational design. This section highlights the critical role of governance in three respects: defining transparently the goals of each fund; communicating these goals to build a constituency of public support; and ensuring the efficient and transparent management of the fund on an ongoing basis.

The third section of the paper analyses the evolution of two oil funds, the State Oil Fund of the Azerbaijani Republic (SOFAZ) and the National Fund for the Republic of Kazakhstan (NFRK). It highlights the main principles that govern the operation of these funds, and reviews managerial steps that have been taken so far as a consequence of the policy process in these countries. It explores core governance issues, and so doing probes the question whether, in the Azeri case, the typical goals of an oil fund are appropriate at this stage of developments. A final section of the paper offers brief conclusions--drawing these threads together, and identifying future priorities for research.

A FRAMEWORK OF ANALYSIS

Statement of the problem

The governments of resource-rich countries face the challenge of devising policies that can channel effectively 'income transfers to governments and the inflow of foreign exchange from foreign investments' (Kalyuzhnova, 2002, p. 79). In this context, the literature identifies oil funds as a tool that may help in addressing two specific problems associated with oil revenues: the unpredictability and volatility of world market prices, and the concern to save part of the revenues for future generations 'The Permanent Income Hypothesis' (PIH). (ECON, 2002; Davis et al., 2001, 2003a, b; Fasano, 2000; Gelb, 1986; Karl, 1997). A further problem could in principle also be mitigated by oil funds: the incidence of 'Dutch Disease.'

The volatility of the prices and the public finances

The international price of crude oil is a carefully watched indicator and could be considered as a parameter of a stochastic process. Although the participants of the oil market are trying to reach an agreement, the reality demonstrates that there are too many problems with keeping the promises and the participants could deviate from their original strategies. That creates a volatility of oil prices and uncertainty of the oil revenue.

In the academic literature on energy abundance, the question of volatility and short-run policy responses is viewed as one of the most sensitive (Auty and Mikesell, 1998; Esanov et al., 2001; Van Wijnbergen, 1984). Experience in many countries confirms the importance of achieving some smoothing of the impact on revenues. This implies a need for governments to find instruments and approaches--such as oil funds--that help formulate and conduct fiscal policy in an optimal way.

The potential costs of failing to smooth revenues can be high. The volatility and unpredictability of the world oil price is transmitted through export earnings and taxation to government revenues--which, even over the short run, may vary widely from the amount included in the budget. When the authorities have overestimated the oil price in the budget, the revenue shortfall requires a corresponding expenditure reduction; an increase of other fiscal revenue sources; or borrowing more than projected.

The first of these responses, expenditure reduction, may be needed--but it can pose major challenges to efficiency, since in practice the cuts may fall on investment and other high-priority programs, while less productive transfers may be hard to prune back quickly--especially in a poor economic setting. The second is also potentially problematic, since it is difficult (though not impossible) to swiftly broaden the tax base, and short-term expedients may also be distortive--for example, heavier taxes on labour income. Borrowing may be effective as a short-run expedient, but ultimately issues of debt dynamics and stability may arise.

A key dilemma for governments, however, is that oil prices as a time series do not have a mean-reverting quality. The literature suggests that they perform more like a random walk, punctuated by regime shifts. Under these circumstances, one must he thinking of a pragmatic smoothing approach, not an optimal one.

Saving for future generations

The issue of saving for the future is even more complex, and the policy goals of the saving funds are inherently more complicated to determine. The financial provision of these types of funds, which are supposed to generate income for the future generation, mainly depends on a share of hydrocarbon revenue (which in most cases would be a fixed one).

A first approach to devising rules envisages an optimal path for expenditure and saving, based on assumptions about key variables such as the future level of natural resource prices and the real interest rate. (2) However, there are huge complexities in trying to arrive at an optimal saving policy. With rising productivity levels, future generations are likely to enjoy higher living standards than today's population. Moreover, funds spent today--for example in public investments--may also benefit future generations. The re-distribution of the economic savings sometimes could be quite irrational (from the economic point of view), although still politically justifiable (see the discussion below of the Azeri fund). Indeed, optimizing models describe an ideal world. In reality the governments of resource-rich countries are facing a problem of dynamic inconsistency, which reaps the gains from the optimal management strategy of the resource wealth. (See Newbery, 1981 and Benabou and Marek, 2002.)

Hence some governments have adopted alternative approaches. The most cautious example is the Norwegian policy of spending only the investment income on natural resource wealth--the so-called 'bird in the hand' approach. This, however, has little to recommend it in a developing economy setting, where the returns to domestic investment--for example, in areas such as education or infrastructure--are potentially high compared with available external investments. Moreover, such domestic investments clearly benefit future generations directly and substantially by raising potential growth rates of the economy over the medium and long run.

Between these extremes of an optimizing model and bird-in-the-hand caution lie more pragmatic approaches. These recognize fundamental uncertainties about the key variables in optimizing models, and take into account (explicitly or implicitly) the availability of high social returns to some public expenditures. The advocates of such approaches, however, have found themselves in search of a theoretical framework in which to assess different policy approaches. The discussion in later sections of this paper suggests that one natural reference point for such a framework is to be found in the field of governance rather than in principles of optimal resource allocation.

Dutch Disease and sectoral imbalances

A further concern that supports the case for cushioning the impact of energy prices on the economy is the issue of 'Dutch Disease.' This is the potentially negative impact on the traded goods sector of strong real appreciation due to buoyant export earnings in the natural resource sector. (3)

Arguably, the damage attributed to Dutch Disease does not arise from the longer-run balance of the economy with a large natural resource sector: over time the level of the real exchange rate is an equilibrating factor, not one to be fought against. However, one element that can be problematic is short-to medium-run variability in the real exchange rate. This--coupled with hysteretic effects and inefficiencies in the financial sector--can damage output and employment, as resources are not shifted swiftly between the sectors.

This suggests a two-pronged policy approach--aiming to develop the financial sector over time, and meanwhile seeking to buffer the impact on the economy of sharp price fluctuations. Developing the financial sector will facilitate the switching of resources between tradeable and non-tradeable goods, and thus mitigate risks of 'Dutch Disease' (Hausmann and Rigobon, 2002). It should also help mobilise domestic savings for investment outside the mineral sector; and efficient financial markets help attract external capital, which can be invested in non-resource branches and hence support industrial diversification. More fundamentally, of course, there is the challenge of investing sufficiently in physical and human resources, so as to foster rapid productivity growth and hence a viable traded goods sector in a setting of medium- and long-run real appreciation.

The role of oil funds

These considerations point, first, to the case for some form of stabilization of the impact of natural resource prices on the economy, and an oil fund can be thought of as institutionalizing such a rule. It is also, second, a natural vehicle to address the issue of saving for future generations.

An oil fund can perform both roles if it ensures that a proportion of revenues, over time, is invested in foreign assets, but with some component of this varying in the short- to medium-term in order to smooth the impact on the budget of sharp changes in oil prices. Put in these terms, the role of an oil fund can be thought of as formalizing--or giving institutional focus to--a set of fiscal rules. The effectiveness of the fund can be thought of as deriving from this role: does it reinforce good policy rules, and thus leverage market expectations to help buffer the economy from shocks? Or are its operations neutral--or even problematic--in this respect? (4)

To achieve these goals, institutional context matters hugely. As Barnett and Ossowski concluded, in general, governmental fiscal policy of the oil-producing state should take into account the relative importance of oil to the given economy, 'the size of the oil reserves, maturity of the oil industry, etc' (Barnett and Ossowski, 2003).

Moreover, as discussed above, with oil prices following a random walk, one must be thinking of a pragmatic smoothing approach, not an optimal one. The nature of the world oil market does not allow governments to set up a confident set of rules relating to the management of stabilisation funds. Indeed, history provides many illustrations, where stabilisation policies relating to commodities collapsed with the rapid exhaustion of finance.

It could be argued that the stabilization role performed by oil funds could also be achieved by the use of oil futures markets, with the country's future oil production, or a part of it, sold now at a known price for up to 10 years into the future. Countries such as Chile have experimented with the use of futures markets in this connection. Hedging strategies, however, typically involve the costly roll-over of relatively short-term positions.

In sum, policy-makers may need to think of the stabilization role of oil funds as potentially valuable in reinforcing prudent fiscal rules, but not a panacea--and not offering the prospect of some economically optimal smoothing. If this framework of analysis is accepted, then a core criterion against which to judge such funds is governance: whether the way in which they operate achieves this limited but promising task in a manner that is clear, persuasive and efficient.

INSTITUTIONS AND ORGANISATIONAL DESIGN

The considerations above bring us to focus particularly strongly not on optimal rules but on political economy factors: institutions and organisational design. These issues are critically important whether funds have stabilisation or saving functions, or both. They also appear particularly relevant in the setting of economies that are in transition and endowed richly with natural resources: both features can be associated with a number of institutional weaknesses.

Institutions and transparency

A first area where institutional issues are key is in the microeconomic domain: concerns about rent-seeking and corruption. These problems can be worsened by a lack of transparency. The principles where clarity is most needed are the rules that ultimately govern who will benefit from re-distribution of (all forms of) the nation's resource wealth; and how far governmental policies act as disguised transfers in this regard (Tullock, 1997). For resource funds, the role of the commitment mechanisms is extremely important in order to limit the possibility of dynamic inconsistency (Dixit, 1996).

Overcoming perverse incentives in government intervention could be perceived as a challenge in achieving an optimal path of the public welfare from resources. Constraints on organisational options are defined by lack of democracy, economic instability, etc. The implications of corrupt government lacking democratic power for resource-rich countries are discussed in Damania and Erwin (2004). A special place here should be given to rent-seeking behaviour of corrupt governments, namely to the aggregate resources absorbed by rent-seeking. In case of resource-rich countries these resources are quite large, because as a rule they represent the main sector of the economic activities in these countries. Therefore, the effect of rent-seeking on the organisational design of the governmental programmes is significant overall. Stigler (1975) and Posner (1975) demonstrated that the latter can be particularly observed in the area of regulation.

A second area where institutional maturity and transparency are crucial concerns macroeconomics: the design and implementation of fiscal policy. Links to fiscal policy are particularly important in a saving context. In successful cases these funds should ensure significant public savings. Creation of the oil fund, and agreement on its rules, can be seen as a commitment device. It could also help to build a public constituency for saving part of revenues. In cases where the government finances deficits by borrowing from saving funds, then 'saving fund assets are merely offset by government debt' (Davis et al., 2001). This highlights, again, the critical link between the operation of an oil fund--here in a saving role--and the design of fiscal policy. The key issue is the strict discipline and ability of the government to keep a financial balance in the accumulation and spending of the saving fund income. Of course, the large accumulation of the oil fund assets could create political unrest (the public could ask the government to increase public spending and decrease taxes, etc).

These considerations help answer the legitimate question whether a sound strategy of public saving for future generations could not be implemented without creating a formal oil fund. In financial terms, yes, but oil funds can potentially play a key role by helping to promote public understanding of the need to save for future generations. To achieve this goal, however, the analysis needs to be clearly set out, and the rules transparent: only thus will these prove persuasive to political circles and the wider public. On this reading, governance is the core challenge.

How should the funds be used: externally or internally? Saving funds could look at risk-adjusted rates of return on domestic and external assets, including externalities that result from the domestic intervention if markets could not have supplied this. There seems little logic, however, in having the domestic component actually identified as part of the saving fund. It does not mitigate risks of 'Dutch Disease,' and it could more transparently be included as public investment in the budget.

Assessing performance of some resource funds

It may be helpful to consider, first, the two key objectives assigned to resource funds--stabilization and saving--and ask in what framework their effectiveness can be analysed? What are the main criteria of success of the funds? The crucial point is clear goals of the fund. For example Norway or Alaska's funds pursue stabilisation and perform saving functions. Many other funds have the same functions but have not been successful.

The second not less important set of criteria that should be put forward are fund management rules that guarantee accountability. It is crucial that every fund could clearly answer to the following questions: who is managing the fund? The Norwegian fund is managed by the Norwegian Central Bank according to the Ministry of Finance guidelines. The Alaska Permanent Reserve Fund is managed by the Alaska Permanent Fund Corporation and external managers handle equity, fixed income and real estate portfolios.

The last but not least set of criteria of success should be connected with a high level of transparency of fund's operations. Every fund requires professional management. Financial authorities of the country should be responsible for financing non-oil deficits or income for all kind of expenditures. If the fund has independent spending authority, that could undermine the budgetary process. Regular reporting and audit are quite important. In addition the management of the fund need to maintain public awareness about the existence of the fund. There are different steps in this respect: press releases, advertisement, etc. For example in Alaska an annual dividend paid to each Alaska resident (amounting to about 50% of the income, the rest is saved).

As Table 1 illustrates resource funds come in various forms and their nature is quite diverse: stabilisation funds (eg Kuwait, Oman, etc); contingent funds (eg Azerbaijan, Kazakhstan, etc). Some oil funds represent separate institutions (eg Azerbaijan, Algeria, and Iran); others just have specific accounts at a Central Bank (eg Kazakhstan and Norway). The common characteristic of all these funds, however, is that they represent a public institution (separated from the budget) that accumulates income from the non-renewable sources of the country.

The data in Table 1 illustrate the relative performance of the funds that would comply with the country-specific conditions, institutional and organisational design. The ranking could vary between 'good', 'average' and 'poor' performance. The qualitative aspect of this assessment is remaining an assessor judgment and in the existing literature there are different assessments of the performance of the same funds (eg Birdsall and Subramania (2004) evaluated Venezuela's oil fund performance as poor, while Zolotareva et al. (2002) classified it as successful). The active resource funds (ie excluding those that have just been established or that have completed the saving process) are faced with the problem of beating the market, which is a consistently difficult task due to the competitive pressures, the expectations of investors as well as market factors.

The analysis of the experience of some funds presented in Table 1 produced several patterns 'for' and 'against' the creation of such funds. The summary of the finding is presented in Table 2.

The role of the oil funds is controversial and the empirical evidence is inconclusive. The academic literature with regard to the oil funds remains patchy and mainly consists of the work by the IMF and World Bank, where the role of the oil funds is also being debated. In general, it is possible to identify two points of view. One point of view is that the oil funds are not necessary because if the conditions that are required for the successful functioning of these funds exist, then the revenue windfall can be managed without them within the budgetary process (eg Davis et al., 2001).

The other point of view is that even if it is impossible to create 'ideal' conditions, the existence of oil funds could prevent excessive spending and help to overcome the resource curse. The experience of the successful funds (eg Alaska, Kiribati, Norway, etc) (Birdsall and Subramania, 2004; Fasano, 2000; etc) is usually cited in support of this argument. To date, indeed, there are not many examples of success. The Alaskan and Norwegian oil funds are striking exceptions here--but did these countries need the oil funds in the first instance--given the transparency for the national policy frameworks and the broad support for deferring some wealth gains for future generations? At the moment of inception of the oil funds in these countries, capital intensity was already high, absorption problems were small, investment risks were low, and hence there was no conflict between domestic capital needs and macro-stabilisation. It is tempting to think that had savings decisions been left to private actors they would simply have saved the money abroad too, given low domestic returns. Oil funds worked because private and public preferences were aligned--hence the funds were also unnecessary.

History provides us with many examples of unsuccessful funds, the number of which exceeds the successful cases (eg Nigeria, Venezuela, etc) (Davis et al., 2003a, b; Delvin and Lewin, 2002, etc). 'Unfortunately, apart from Norway (with its strong government institutions and healthy democracy), the experience of national oil funds has not been encouraging' (Birdsall and Subramania, 2004, p. 85). The examples of other countries (particularly in the Middle East) demonstrate limited success in the functioning of the oil funds. The reason for the inefficiency of the oil funds is in its lack of clear rules and operations, which 'should be transparent, with stringent mechanisms to ensure accountability and prevent the misuse of resources' (Davis et al., 2003b, p. 311). The operational side of this management could cause further obstacles (Barnett and Ossowski, 2003).

In conclusion, the experience of different oil funds (the Venezuelan Investment Fund, Nigerian Petroleum Trust Fund) has highlighted an even more complicated problem: the question of transparency, rigorous governance and accountability. A recent report by Caspian Revenue Watch provided a public debate on these issues (Tsalik, 2003). One of their findings is that 'weak governance makes these countries less likely to convert social expenditures into improved income' (Tsalik, 2003, p. 11). In the political economy assuming that funds are important in order to protect people's money, the essential element is transparency of management. The experience of many countries demonstrated that the combination of a non-transparent fund and the ability to spend in an extra budgetary manner is bad and harms the national economy.

TWO CASPIAN CASES: AZERBAIJAN AND KAZAKHSTAN

To explore more concretely the frame of reference discussed above, it is helpful to consider experience with the oil funds of Azerbaijan and Kazakhstan. These two economies represent examples of natural resource dependency, which have emerged recently, and both have set up oil funds during the past decade.

Key similarities between the two economies

A number of academic papers have analysed economic development in the Caspian Sea Region since its independence (Pomfret, 1995; Kaser, 1997; Kalyuzhnova, 1998, 2002). All of these highlight that the last decade has brought significant changes to the Caspian Sea Region. The hydrocarbon sector in particular gave these economies a new shape. Kazakhstan and Azerbaijan became strategically important to world energy markets and thus attracted the largest share of FDI in the region (Figure 1).

[FIGURE 1 OMITTED]

In recent years the hydrocarbon sector in both these economies has played a crucial role in recovery from the post-transition trough, and attainment of a high rate of economic growth. From 2000 a steady increase in GDP, with a rate of 9-10%, annually was recorded in the Azerbaijani and Kazakhstani economies.

In general, both economies continue to grow strongly as a result of rising oil exports funded by foreign direct investment. Both, indeed, have a high export concentration in mineral resources (see Figure 2 and Table 5). Table 5 in particular depicts the high (and somewhat increasing) rate of dependency on oil and oil-related products in both countries. This, however, makes their economies particularly vulnerable to fluctuations in world commodity prices. In addition, it leads to a concentration in specific markets which again highlights significant dependence--the 1998 Russian financial crisis being one of the major examples.

[FIGURE 2 OMITTED]

The task of both the Azeri and the Kazakhstani governments on the macroeconomic and structural front is relatively similar at first glance: strengthening domestic institutions to encourage investment, building human and physical capital, and providing adequate and sustainable social protection mechanisms.

Key developmental differences

There is a striking difference in income level between the two countries. According to the World Bank classification, Kazakhstan belongs to the Lower Middle Income country group. To a certain extent this explains the behaviour of the decision-makers. From the author's personal observation, during the last 2 years the Kazakhstani government appears more willing to pass on the benefits of the oil boom to the population than in the earlier years of transition. This can be explained in part by a pre-emptive effort to defuse potential popular discontent. However, the gradual changes in governmental thinking and operations, and the country's substantial fiscal resources could also explain this change in behaviour.

By contrast in the case of Azerbaijan, classified by the World Bank as a Low Income country, the government is faced with the problems of a low level of GDP per capita, limited fiscal resources and administrative capacity, a substantial informal sector and a Kazakhstani economies is clear--to ensure the stability of current economic progress. High incidence of poverty (Dobronogov, 2003): according to a recent survey 49% of the population is living below the absolute poverty line (approximately USD 25.8 per capita/ month) and 17% of the population lives in extreme poverty (approximately USD 15.5 per capita/month) (State Statistics Committee, Household Budget Survey, 2001). However,' as a result of rapid economic growth [due to the high oil prices] and increased social spending, poverty declined to 40.2% in 2004 from 49% in 2001' (IMF Country Report No. 05/260, July 2005, 5). Still, there is a long way to poverty alleviation in the country which is reflected in the current 3-year State Programme of Poverty Reduction and Economic Development (SPPRED).

The pattern of public expenditure in part reflects these different levels of development. Moreover, there are significant differences in the labour market reflecting historical circumstances. Azerbaijan has to look after people who were displaced from their own towns within the territory of Azerbaijan since the dispute between Azerbaijan and Armenia in 1989--and among whom poverty is endemic. Moreover, true unemployment is significantly higher than the officially recorded level (which puts the unemployment rate at around 1.3%-1.5% of the labour force in 2003). In Kazakhstan, by contrast, there is no comparable problem of displaced persons. The unemployment rate is falling. And incomes are cushioned by extensive under-employment in the economy, especially in industrial enterprises, which still need to be restructured. Moreover, real wages are rising strongly--resulting in an improvement in average living standards.

In sum, the economies of these two oil-rich economies differ--with Kazakhstan being somewhat richer and more advanced in transition but with a mixed performance in social indicators (see Table 4). Both Kazakhstan and Azerbaijan are expected to triple their income per capita by 2007 based on their oil and gas exports. It is important to avoid the vulnerability to oil price declines that has caused adversity in the past for countries such as Venezuela in the period after the oil booms in the 1970s and early 1980s. The governments should without doubt look at the possibilities to diversify the industrial production and to foster competitiveness of the economies, but based on the specifics and needs of Azeri and Kazakhstani economies (eg recently risen inflation in Azerbaijan). Partly as a result the demand on the oil funds will differ as well, reflecting the different priorities and initiatives by their governments. The management of oil revenue may require pursuing reform agendas that are markedly different. And in each case the economics of the challenge are undeniably complex--and ultimately require finely balanced political judgements. Nonetheless, an examination of the way their respective oil funds operate suggests interesting parallels in terms of the steps needed to ensure that these institutions are fully effective in these two very different economic contexts.

The roles and objectives of the national oil funds

To facilitate the management of oil revenue, both countries have already established national oil funds--in Azerbaijan 1999 and Kazakhstan 2000. In each case, the fund operates as both a stabilisation and savings funds (see Table 1).

On 29 December, 1999 Azeri President Aliyev signed the decree N240 'On setting up the State Oil Fund of the Azerbaijani Republic' (SOFAZ) to govern the collection of oil revenue and bonuses. According to the presidential decree, SOCAR received authorization to ensure the transfer of funds to a special oil fund account in the National Bank of Azerbaijan. Initially, according to SOCAR's President N. Aliyev, USD 270,964,652 of Azeri oil revenues and bonuses provided by the foreign companies were transferred to the oil fund account. The largest part of this amount was made up of revenues from the sale of 967,805 tonnes of oil produced from the Chirag field. The Oil Fund is directly accountable to the Azeri President, who appoints the executive director and confirms members of the Supervisory Council. Mr Samir Sharifov was appointed by the President as the first general manger of the fund.

The SOFAZ receives all revenues associated with the 'new oil fields.' These fields are the ones included in the 1994 'Contract of the Century' (Aliyev, 1997, p. 9). It receives and records proceeds from the state's share of oil sales, royalties, pipeline fees, rental fees, bonus payments, and interest income. Most of the revenues presently come from the first and only operational consortium at the Azeri, Chiraq, and Guneshli (ACG) oil fields, the source for the Baku-Tbilisi-Ceyhan oil pipeline. (See SOFAZ Press release-April 16, 2003.)

The Kazakh oil fund (the National Fund for the Republic of Kazakhstan (NFRK)) was established in August 2000 and the legal aspects were defined by Presidential Decree N402, 23 August 2000. The NFRK is run by a special Management Council, formed by President Nazarbayev. The governing body includes the president of the country, the prime minister, the heads of the two chambers of parliament, the National Bank chairman and the finance minister. The fund is managed by the National Bank and overseen by a governing board chaired by the President of Kazakhstan. Information on the fund's revenues, expenditure, and the audit results is published in the local press and the fund is subject to an annual independent audit.

The NFRK invests in liquid foreign equities, and will be capitalized by corporate income taxes, VAT, royalties, bonuses, and Kazakhstan's revenues from production sharing agreements. The Fund has a long-term investment function (75%) and a smaller stabilisation function (25%).

The rules governing the accumulation and use of resources in the National Funds of Kazakhstan and Azerbaijan are markedly different, and a comparison is given in Table 5.

In Kazakhstan, the national fund is designed to save resources for future generations, and avoid undue pressure on the domestic economy--and layered on this is a stabilization function. President Nazarbayev made clear at the outset that resources would not be spent on covering current expenses, but would accumulate in the NFRK for future generations, as well as for the contingency of economic recession. Stabilization by the NFRK is achieved by means of 'reference prices' for gas, oil, and four metals (chrome, zinc, lead and copper). The nine largest oil companies and three from the metals sector are subject to transfers based on the reference price. When the targets are exceeded, surplus tax payments are transferred to the NFRK. On the other hand, if market prices are below the reference prices, the Fund provides revenue to the government. The stabilization portfolio must constitute at least 20% of NFRK assets.

With the Kazakhstan budget in a strong position, and oil prices rising in the recent past, this strategy has proved entirely workable. During the first 5 years of its existence the NFRK has accumulated extra payments made to the republic's budget from major companies operating in the raw materials (oil and gas) sector. In 2003, the fund began accumulating proceeds from the sale of state property. The fund's reserves currently exceed USD 8 billion (see Figure 3).

[FIGURE 3 OMITTED]

The underlying situation in Azerbaijan is different. At the present time, the economy requires substantial investment for economic development. The state budget does not have the means to meet this demand. Therefore, the Azeri government is in the situation of borrowing resources from the international economic organizations, sometimes with conditions viewed as unfavourable for the country. There is a difficult question how far it makes sense to borrow money from international economic organizations for the country's economic needs and to pay the debt back later with interest (which would come from the oil fund) or, alternatively, to spend oil money now directly on the development of the national economy? Part of the answer depends on the cost of official borrowing--which is in part on concessional terms. However, there is also a question whether the rate of return on the international investments of the fund is higher than would be achieved--subject to capacity constraints--by investing infrastructure and other reform needs in the domestic economy.

These differing roles and objectives are reflected in the investment strategy of the funds.

From its conception, the investment strategy of the NFRK was based on the rules governing the foreign exchange reserves of the National Bank of Kazakhstan: eligible assets were low-risk interest-bearing securities (AA-grade or better). According to the FitchRatings agency 'the NFRK offers a good degree of fiscal and balance of payments support, but as its assets are still not especially large, this support is finite. Assets should rise more rapidly during the coming years, in part related to the timing of additional oil production, although the authorities might wish to revisit the question of the trigger price to ensure regular and reliable inflows into the Fund' (FitchRatings, 2003, p. 12). Of course, a prudent strategy of investing resources in high-quality external assets could be compatible with a more diversified portfolio approach in the future. (5)

In Azerbaijan, by contrast, the oil fund has a strong commitment to the financing of investment in the finance the state oil company's (SOCAR) share of the equity investment in Baku-Ceyhan. This, clearly, is not a liquid, market-based and diversified investment--rather the opposite. However, in this particular situation when Azerbaijan needs an alternative route for its oil to export and where the future economic prosperity is highly dependent on the implementation of this project, the investment may be strategically prudent. Moreover, this is not consistent with the Bird-in-hand rule (BH), (6) which was adopted by SOFAZ. In contrast, to date Kazakhstan is very cautious in this front and has been praised by IMF (see IMF, 2004a, b, p. 73).

Examining the current operations of the funds, some pragmatic difference in philosophy is already to be found in practice:

* In both cases (SOFAZ and NFRK) it was planned that the funds would not be touched for the first 5 years of their existence, but an exception has been made in the Azeri case, given the need to support citizens forced from their historic places of settlement, to build housing for refugees from the Fuzilin and Agdam regions and to administer the fund.

* There are, again, marked differences between the two countries in terms of investment targets. NFRK invests only abroad. In Azerbaijan, by contrast, the government is using the oil fund to finance the state oil company's (SOCAR) share of the equity investment in Baku-Ceyhan, which amounts to approximately USD 170 million. In the Azeri case the argument is often advanced that without BTC SOFAZ would simply not exist (Mann, 2003).

One reaction to this would be in terms of institutions--to question whether it was optimal to create SOFAZ. Without doubt the question of the creation of the oil fund is quite a complex one. The answer will require too many factors to be taken into account. The economy needs investment in order to diversify the economy, the investments could only come from the hydrocarbon development and therefore savings into the oil fund could be problematic. Azeri President Ilham Aliyev has already adopted a long-term oil revenues management strategy for 2005-2025. This strategy focuses on hydrocarbon resource depletion and maintenance of macroeconomic stability with the expected growth of oil revenues.

Current efforts to diversify the Azeri economy have remained weak and structural reforms have stalled. The privatization programme is still procrastinated and experience resistance. The economy overall is highly exposed to oil price fluctuations despite the fact that the country's external balance sheet has been substantially improved as well as public finances strengthen on the back of rising oil revenues.

An alternative approach to the issue in Azerbaijan would be to think in terms of transparency and governance. What better example than how best to use the Azeri fund, given domestic development needs? The arguments may be finely balanced. The governance challenge, in assessing the policy issues, is to set out clearly the present goals of the fund, and a transparent critique of the rates of return on different strategies. This would facilitate a public debate on the appropriate use of the fund, in this situation--which differs markedly from that in many oil-rich economies.

Again, if the conclusion in Azerbaijan were to channel more resources to domestic development, then this needs to be done in a transparent way. It could be by diverting more resources to the budget for public investment. Or it might be by creating a development bank capitalised by the Oil Fund to issue loans and credits outside the oil sector. This might assist in stimulating development of the non-oil sector of the Azerbaijani economy at a time when financial resources are short, as well as securing an economic return for the fund when the loans are repaid. However, dedicating resources to domestic investors would not smooth the economic impact of oil revenues or mitigate the impact of Dutch Disease.

Transparency and governance

The challenge ahead for both Azeri and Kazakhstani economies is clear--to ensure that current economic progress is stable and sustained. This can be achieved only by strengthening structural reforms and enforcing transparency at every level of the economy. As Glennester and Yongseokh (2003) showed, transparency is correlated to improvements in investment and growth performance. Azerbaijan and Kazakhstan are already known as countries with a low level of transparency and opportunities for fraud and corruption (see Transparency International's Corruption Perception Index). Without doubt both countries need to improve their disclosure of negative practices.

What is true for the economy at large is all the more true for the resources concentrated in the oil funds. Transparency in the management of oil revenues is essential to present few interest groups from appropriating oil resources by allowing a democratic debate and avoiding corruption and waste of public resources. Part of this initiative is to increase transparency with respect to revenues by those host country governments. Resource revenue transparency has been advocated by international financial institutions, including the IMF (2004a, b). The concept of transparency is expected to focus initially on the transparency of the general government, but because of the special needs of transition economies it should be extended also to relevant stakeholders (including companies investing in the sector and financial and strategic investors supporting lending).

Four dimensions of transparency deserve particular attention in this connection: a clear definition of goals, and rules-based operations; the public availability of information; and the adequacy of internal accounting and auditing of the funds; and arrangements for the appointment of officials and managers. Experience in Azerbaijan and Kazakhstan is considered briefly below in light of these priorities, illustrating that transparency is a significant issue for both funds.

The main objective for the management of both NFRK and SOFAZ is defined to be the investment of capital in such a way that the international purchasing power of the Funds is maximised, taking into account an acceptable level of risk. Following also IMF guidelines, the investment portfolio of the 'oil funds' is best placed abroad. In sum, both domestic electorate and the international community should have confidence that the funds are well-managed, transparent, and used for the purposes set out by law' (Kalyuzhnova and Kaser, 2006, 16).

As to whether the funds are rules-based, in a mechanical sense this is broadly satisfied. However, in the case of Azerbaijan, the rules have proved susceptible to an interpretation that dilutes some of the value of the fund, through deployment of resources for priority domestic needs. In Kazakhstan, much of the legislation and administrative infrastructure was borrowed from Norway's oil fund. However, the closer implementation of the Norway's model based on a non-oil deficit target rule could be a way to enhance the transparency of the NFRK. Broader recommendation for Kazakhstan to increase its degree of transparency include consolidation of the treasury reports and better integration of all fiscal costs and risks associated with extra budgeting operations (including NFRK itself).

Recently, in order to establish a long-term strategy for the use and accumulation of oil revenues the rules governing the NFRK have been redesigned. Under the current system, fiscal payments from identified companies in the natural resources sector are subject to transfer to the NFRK. In 2004, the number of companies was reduced and the transfer of their fiscal payments is calculated on the basis of a reference oil price. However, the main criticism of the original reference price (19 USD billion) which was established long time before the oil boom, is that this does not reflect the true situation. The original rules for placing resources in the NFRK allowed the government to deplete the balance if prices were to fall significantly below the reference price. The practical difficulty here was that the rules were not applied vigorously, due to the fact that the definitions of oil income and oil enterprises could be interpreted differently and easily changed, depending on the intention to save less or more than the rule currently commits the government to. Overall, even if at first sight the rules look quite straightforward, the practice demonstrated that the reality was a complex one with all the computations, etc. The Kazakhstani authorities intend to fully integrate the NFRK with the budget, and devise a rule to guide the use of oil revenue, possibly by linking the non-oil fiscal deficit to the amount of development spending. From 2007 all central government oil revenue will accrue to the NFRK and will flow into the fund via the budget. Then, some funds will be released back into the budget to finance development spending. There is an intention to set up clear limits on how much can be spent in any 1 year. In addition, for the 3-year periods the ceilings will be set up. These changes aim to strike the balance between meeting current development needs and providing a savings cushion for future generations.

Two more general considerations are also relevant:

* It is arguable that the principles of operation should be formally enshrined in legislation, to guarantee reliable functioning of the oil fund over the long term. Legitimacy and permanence would be improved by having the formation of the oil funds come from the parliaments of the republics, rather than presidential decrees.

* Issues of implementation matter. The relevant question in each case is not just the principles agreed at the outset but the question how transparent the implementation is likely to be. (7)

Public availability of information

A first important dimension is the public availability of information, including the disclosure of payments related to resources, according to the principles of The Extractive Industries Transparency Initiative which was announced by UK Prime Minister Tony Blair at the World Summit on Sustainable Development in Johannesburg, September 2002 (8) Greater transparency enhances the monitoring capacity of civil society.

In terms of public availability of information, until now the population of both countries is largely unaware of the existence of oil funds. (9) However, they should have a primary voice in their country's development since the citizens of Kazakhstan and Azerbaijan will face the economic, environmental, human rights, and social impacts of hydrocarbon development. By involving them in the process, the problem of corporate and governmental accountability could be partially solved. The Azeri and Kazakhstani citizens have to know how much income was taken from the fund, on what grounds, and how that money was spent. In this regards both countries have expressed their interest in The Extractive Industries Transparency Initiative (EITI). However, while Azerbaijan has volunteered to become a pilot case of the Initiative, (10) Kazakhstan was initially hesitant. One of the transparency challenges for Kazakhstan is to follow-up of this Initiative proactively, moving towards practical implementation. The new NFRK rules will no doubt enhance the transparency of hydrocarbon revenues and their use. In 2005, the decision on Kazakhstan's participation in the EITI was welcomed by international institutions, following consultation with oil companies operating in Kazakhstan on their willingness to participate. There is a direct benefit to Kazakhstan from joining this initiative. First of all, there is a unilateral commitment to disclose the oil revenues received by the treasury from all 51 legal entities operating in the oil and gas industry; secondly, it motivates every legal entity operating in the sector to make available to any interested party information on the amounts of tax they pay, as well as detailed reports on their social and local content initiatives they pursue in the fulfillment of their PSAs with the Kazakhstani state; and thirdly, it makes sure that the information base is available to the general public on the National Fund of the Republic of Kazakhstan.

Accounting and auditing

In terms of adaptation of best practice in accounting and auditing, both funds report quarterly in the press on the total amounts of assets, inflows received, expenditures, and interest earned by the funds. The funds have their websites. These visible attributes of transparency in both cases are the main arguments used by the executive directors of the funds in the debates about transparency.

Since their existence external audits of both funds have been conducted (by Ernst & Young), the last one is underway. Although the NFRK has a website, it only gives information on the total National Fund assets, broken down by portfolio. Commentators have criticized this point and claim that it demonstrates a greater lack of transparency compared to Azerbaijan.

An annual audit of the funds is prima facie evidence of transparency, but it is only the tip of the iceberg as regards high standards of governance. It is encouraging that in both Kazakhstan and Azerbaijan increasing emphasis is being laid at present on the transparency and efficiency of investment processes in the funds. This should pay close attention to compliance with the rules under which the funds were set up and in the diversification of investment projects within the areas of funds' operations.

Appointment of officials and managers

An analysis of the Azeri and Kazakhstani oil funds highlights some structural weaknesses. In both cases, the funds have been characterised as representative and participatory. The rule is that the President approves all the members of the board and all of them are government officials. This strong control by the executive branch has enabled uses of the fund that are contrary to its purposes. The official explanation for this is that the maturity of the society is quite rudimentary and by allowing other people (for example, the parliament) to decide the strategy for using oil funds, control over the oil wealth will be lost. If transparency of the oil funds of the two countries is to be established in a credible manner, the structure of the fund management needs to become more representative and less dominated by government. Only through such a structure can the high level of political influence be overcome. In Azerbaijan, at the present time, the SOFAZ is in the process of selecting foreign managers for the placement of its assets in foreign banks.

By 2003, Kazakhstan saved 63% of its oil-windfall in the NFRK, which by all standards demonstrates a remarkably prudent fiscal stance and gives rise to hope for cautious optimism for the future.

CONCLUSIONS AND POLICY IMPLICATIONS

The experience to date of resource-rich countries in operating oil funds demonstrates empirically that these are no panacea for the 'paradox of plenty.' Moreover, the path of oil prices over time does not encourage a view that funds can be designed to achieve an optimal smoothing of income or assurance of inter-temporal equity. To the extent that oil funds serve a useful purpose, this is at once a more modest and more ambitious one. Modest, because a realistic goal is to achieve some degree of pragmatically based smoothing and inter-temporal redistribution, with no pretence of optimality. Ambitious, because their value can lie in reinforcing the transparency, implementation, and credibility of key fiscal rules--thus addressing at source a number of the institutional weaknesses that may lie behind the poor performance of many resource-rich economies.

In Azerbaijan and Kazakhstan, as Wakeman-Linn et al. (2003) stated, the oil funds are new and therefore 'any judgments about their success in meeting their stated objectives must, of necessity, be preliminary'. The establishment of the oil funds is itself a major change in fiscal practice, but as both of the funds were required to accumulate funds for 5 years without spending from them (save for emergency spending on refugees and financing BTC pipeline in Azerbaijan), the degree to which the stabilization function (as distinct from the accumulation) has yet to be demonstrated. Indeed, the present market context of high oil prices is providing some test whether the existence of the funds will result in greater fiscal restraint.

A long period of time is needed to determine the real impact of the funds. But the case made in this paper, in the meantime, is the core importance in these countries of continuing to enhance governance and transparency of the oil funds in order to maximize the chances of success. Inevitably this limits government discretion in disposing off the mineral wealth of the nation. It is, however, essential to build public support for the funds, and to leverage their economic impact through a strong influence on market expectations.

By establishing periodic auditing and analysis of the management performance, it is possible to ensure the sustainability and efficiency of the management revenue. The fund's assets should be placed abroad (to provide protection from the populist ideas to help the local economy by investments from the fund) and greater diversification of the assets portfolio is required (as it was demonstrated in case of the NFRK). To date it is difficult to confirm whether SOFAZ and NFRK have gained public support. The public is hardly aware that such funds exist.

The governments of both the states discussed above need to have a long-term vision and determination in pursuing their policies of management of the oil revenues, which should contribute to the sustainable development. Among these goals, greater confidence in the transparent management of oil funds, and greater public understanding of their objectives and operations, are essential in order to safeguard the sustainability and efficiency of the oil funds. In these respects, there is a long way to go for both SOFAZ and NFRK.

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(1) My sincere appreciation goes to Mark Casson, Jeff Miller and Maria Vagliasindi who made valuable criticism and ideas for improvement. I am grateful for the comments of the anonymous referees. Max Watson's creative suggestions fundamentally improved the quality of the paper.

(2) The problem of optimal resource allocation was discussed by, among others, Barnett et al. (2002) who considered government spending over time, denoted by t. The key assumption is that oil revenue [Z.sub.t] is certain, constant, and lasts for exactly N periods. The social planner (government) must choose the optimal path of government expenditures [G.sub.t] that maximise the social welfare function discounted over time, subject to a budget constraint and a balance budget condition for government debt.

(3) For the definition and discussion of Dutch Disease see Davis et al. (2001), Hausmann and Rigobon (2002), Kalyuzhnova (2002).

(4) Barnett and Ossowski (2003) suggest that the existence of an oil fund does not alter the relationship between oil export earnings and government expenditure. They analysed 10 countries with oil funds and 16 without, using the latest oil price upswing 1999-2001. Real expenditure (deflated by CPI) rose on average by 20%-21% in both groups. They did not find a difference between the two groups within these countries. To date the empirical results cannot provide a certain answer to the question.

(5) It is important to note that already at the present stage the management of the fund could envisage a longer-term investment horizon and a broader diversification. Although investments in equity instruments involve a higher risk of exposure to short-term fluctuations in market value compared to bonds, historically it has been shown that they have provided a better average return. The idea that returns on equities are higher has taken quite a knock with the experience of the last few years but it still seems to have been true over long enough (20+ years) periods. Whether risk-adjusted returns are higher depends on how big an adjustment you make for risk and that depends on the investor's risk-aversion. Generally only the richest countries (eg Kuwait) invest any more than a very small proportion of their assets in equities.

(6) For the definition of BH see IMF, 2004a, b, pp. 50-51.

(7) In April 2003, Kazakh National Bank Chairman Marchenko endorsed President Nazarbaev's decision to divert over USD 1 billion from a secret account into the NFRK, telling journalists that 'this was the right decision from the economic point of view,' although it may have been flawed from a political or legal perspective (Reuters and Interfax-Kazakhstan, 2003). The Kazakhstani officials claim that almost USD 880 million of the USD 1 billion deposited 5 years ago in Swiss bank accounts was used to pay off pension arrears and support the national budget. Mr Marchenko refused to reveal how much money the government still has in foreign bank accounts on the grounds that it is a state secret.

(8) See http://www.dfid.gov.uk.

(9) Author's interviews with a number of citizen of Kazakhstan and Azerbaijan in 2002-2003.

(10) In January 2006, the third EITI report has been released in Azerbaijan.

YELENA KALYUZHNOVA (1)

The Centre for Euro-Asian Studies, The University of Reading, Whiteknights, PO Box 218, Reading, RG6 6AA, UK. E-mail: y.katuyzhnova@reading.ac.uk

Table 1: Overview of some resource funds

Country Fund

Algeria Algeria State Fund
Azerbaijan State Oil Fund
Canada Alberta Heritage Saving Fund
Government of Nunavut Trust
Nunavut (Canada)
Chad Revenue Management Plan
Chile Copper Stabilisation Fund
Colombia Oil Stabilization Fund
Iran Foreign Exchange Reserve Account
Kazakhstan National Fund
Kiribati Revenue Equalization Reserve Fund
Kuwait General Reserve Fund
Nigeria Petroleum Trust Fund
Norway Government Petroleum Fund
Oman State General Reserve Fund
Papua New Guinea Mineral Resources Stabilisation Fund
USA Alaska Permanent Reserve Fund
Venezuela Investment Fund for Macroeconomic
 Stabilisation

 Commencement
Country date Type

Algeria 2000 Stabilisation
Azerbaijan 1999 Stabilisation and saving
Canada 1976 Stabilisation and saving
Government of 1990 Saving
Nunavut (Canada)
Chad 1999 Saving and stabilisation
Chile 1985 Stabilisation
Colombia 1993 Stabilisation
Iran 1999 Stabilisation
Kazakhstan 2000 Stabilisation and saving
Kiribati 1956 Stabilisation
Kuwait 1960 Stabilisation and saving
Nigeria 1995 Stabilisation and saving
Norway 1990 Stabilisation and saving
Oman 1980 Stabilisation
Papua New Guinea 1974 Stabilisation
USA 1976 Stabilisation and saving
Venezuela 1998 Stabilisation

Country Size Performance

Algeria N/A
Azerbaijan USD 1.4 billion N/A
Canada Canadian dollar 12 billion Average
Government of Canadian dollar 475 million Average
Nunavut (Canada)
Chad Not yet funded N/A
Chile USD 2 billion Average
Colombia Average
Iran USD 1.2 billion Average
Kazakhstan USD 8.1 billion N/A
Kiribati $A 677 million at end-2000 Good
Kuwait Provision of public Average
 information on the
 fund's assets is
 prohibited by Law
Nigeria Poor
Norway USD 82 billion Good
Oman USD 2 billion Good
Papua New Guinea Government recently closed Average
 the fund
USA USD 22.7 billion Good
Venezuela USD 3.7 billion Poor

We based our assessment only on the funds that already existed by 1998.

Table 2: Pros and cons of the resource funds

For Examples of funds Against

The funds can help Alberta Heritage Funds are no
avoid rent-seeking Saving Fund Alaska guarantee of an
and corruption Permanent Reserve appropriate fiscal
creating the Fund stance and indeed
conditions for are no substitute
proper management for sound fiscal
of the resource and macro-economic
revenue management

Funds could improve Copper Stabilization The rules of the
fiscal policy impact Fund (Chile) management of the
during the time when funds are constantly
prices are high changing under
 political pressures

If the funds are Government Petroleum The existence of
sufficiently Fund (Norway) fund could create an
protected from the Revenue Equalization artificial sense of
external influence Reserve Fund security causing the
(including the (Kiribati) need for real fiscal
political discipline to be
pressures), they are abandoned
able to ensure that
resource revenues of
the country are
saved for future
generations

Investing the fund's General Reserve The existence of
assets abroad could Fund (Kuwait) funds encouraged
prevent exchange corruption and fraud
rate appreciation

For Examples of funds

The funds can help Mineral Resources Stabilization
avoid rent-seeking Fund (Papua New Guinea)
and corruption
creating the
conditions for
proper management
of the resource
revenue

Funds could improve Investment Fund for
fiscal policy impact Macroeconomic Stabilization
during the time when (Venezuela)
prices are high

If the funds are Foreign Exchange Reserve
sufficiently Account (Iran)
protected from the
external influence
(including the
political
pressures), they are
able to ensure that
resource revenues of
the country are
saved for future
generations

Investing the fund's Petroleum Trust Fund (Nigeria)
assets abroad could
prevent exchange
rate appreciation

Table 3: Kazakhstan and Azerbaijan: Oil and Oil
Products in Total Export, in percentage, 2002-2005

Country 2002 2003 2004 2005 (a)

Azerbaijan 89 86 83 90
Kazakhstan 50 53 55 61

Source: IMF Country Report No. 05/260
and IMF Country Report No. 05/244.

(a) IMF staff projections.

Table 4: Key socio-economic indicators
for Azerbaijan and Kazakhstan, 2005 *

Indicator Azerbaijan Kazakhstan

1. Minerals as % of exports 90.0 (87.9) 85
2. Human Development Index Rank (2002) 91 78
3. Gini Index, % 36.5 31.3
4. GNI per capita (dollar PPP), 2003 3,380 6,170
5. EBRD Transition indicator, 2005 3- 3
6. GDP index (1989=100) 76.3 101.4
7. Government consumption as % of GDP 6.0 11.4
8. Private sector as % of GDP 60 65

Source: Author's estimations for 2005, figures in brackets for full
year 2004 Rows 1, 5 and 7 Asian Development Bank, Key Indicators of
Developing Asian and Pacific Countries (2005); rows 2, 3 Human
Development Report (2004); rows 5 and 8 EBRD (2004a) Transition
Report 2005 (London, EBRD), arithmetical average of nine indicators
graded 1 to 4+); row 6 UNECE, Economic Survey of Europe 2005, No. 1
(Geneva, United Nations, 2005).

Table 5: Comparison of rules for accumulation and use
of the National Funds of Azerbaijan and Kazakhstan

Azerbaijan

Use of the Fund Profit gained from the Fund's deposits placed in
 credit organizations with a high rating is mainly
 used for investment purposes.

 The Fund's resources are used according to
 directions (programmes) confirmed each year by
 decrees of the President of the Azerbaijani
 Republic.

 For the country's socio-economic progress, the
 Fund's resources can be used for solving national
 problems, and constructing and reconstructing
 infrastructure facilities of strategic importance.

Management of The executive director carries out operational
the Fund management of the Fund's activities. He/she is
 appointed by the President of the Azerbaijani
 Republic.

 The executive director of the Fund:
 * organizes the current work of the Fund
 and manages it;
 * prepares proposals on the main directions
 (programme) of spending the Fund's resources
 and submits them for approval to the President
 of the Azerbaijani Republic, along with the
 opinion of the Supervisory Council;
 * prepares an annual report about the Fund's
 activities and submits it to the president
 of the Azerbaijani Republic, along with the
 opinion of the Supervisory Council;
 * prepares a draft estimate of expenses on the
 management of the Fund (including expenses on
 personnel) and submits it for approval to the
 president of the Azerbaijani Republic;
 * ensures the preparation of materials on the
 basis of instructions from the president of
 the Azerbaijani Republic,
 * appoints employees of the Fund's administration
 to positions established by the law and
 dismisses them, and applies measures of
 encouragement and reprimand with regard to them;
 * ensures the necessary conditions for the auditor
 appointed by the president of the Azerbaijani
 Republic to conduct audits; publishes in the
 press the auditor's opinion reflecting the
 Fund's annual activities;
 * prepares analytical certificates on the Fund's
 activities and submits them to the President of
 the Azerbaijani Republic and the Supervisory
 Council; implements other authorities in
 accordance with the legislation of the
 Azerbaijani Republic and this statute.

 With the aim of ensuring general supervision over
 the Fund's activities, the Supervisory Council is
 formed from representatives of relevant state bodies
 and public organizations, as well as other people.
 The President of the Azerbaijani Republic confirms
 members of the Supervisory Council.

 The Supervisory Council examines and expresses its
 opinion regarding the main directions (programme)
 of using the Fund's resources, its annual report
 (together with the auditor's opinion attached to
 it) and balance, as well as the draft estimate of
 the Fund's annual expenses on the basis of the
 executive directors representation.

 The Supervisory Council holds its sessions when
 necessary, but no less than once a quarter. The
 Supervisory Council can hold extraordinary sessions
 at the initiative of the executive director or half
 the members of the Supervisory Council.

 The members of the Supervisory Council carry out
 their activities on a public basis (without
 payment).

Report and The Oil Fund is subordinated directly to the
Accountability President and is accountable to him.

Azerbaijan
 The Fund carries out accounting procedures and
 statistic reports as established by the law. The
 annual financial activities of the Fund have to be
 inspected and confirmed by an independent auditor
 appointed by the President of the Azerbaijani
 Republic.

Kazakhstan

Use of the Fund The Fund could be used:
 * for the purpose of execution of its
 stabilisation function--in the form of receipts
 from the Fund to the republican and local
 budgets to compensate for losses to be
 determined as the difference between approved
 and actual amounts of tax and other mandatory
 payments receipts;
 * in the form of targeted transfers of the Fund
 to the republican and local budgets for the
 purposes defined by the Kazakhstani President;
 * to cover expenses connected with management of
 the Fund and annual external audit conducted.

Management of The President of the Republic of Kazakhstan is:
the Fund
 (1) Establishing a Management Council of the
 National Fund;
 (2) Issuing directives that are binding on the
 Council, the Government and the National Bank
 with regard to issues relating to the Fund;
 (3) Exercising other authorities stipulated in
 the rules of the Fund.
 With regards to management of the Fund, the
 Kazakhstani Government exercises the following
 powers:
 (1) develop and approve rules for the compilation
 of reporting documents and the order for
 accumulation and use of the Fund;
 (2) develop together with the National Bank and
 approve a schedule for the submission of
 informational materials and financial
 reporting on activities associated with
 the management of the Fund;
 (3) provide for the submission of a report on
 the accumulation and use of the Fund to the
 President and information on activities
 related to the formulation and use of the
 Fund for the Parliament;
 (4) ensure that an annual audit of the Fund
 is carried out;
 (5) ensure that accounting is carried out for
 formulating and use of the Fund; and
 (6) exercise other powers stipulated by the Rules.

 The National Bank is exercising fiduciary management
 of the Fund on the basis of a fiduciary management
 agreement concluded between the National Bank and
 the government.

 A consultative and deliberative body (the Council)
 is created under the Kazakhstani President for the
 purpose of implementing the powers of the President
 with regard to the management of the Fund. The main
 task of the Council is to provide assistance and
 develop recommendations for the President with
 regard to issues of the use of the Fund.

Report and Each year by February 1 of the year following the
Accountability reporting year the Government together with the
 National Bank has to compile an annual report on
 accumulation and use of the fund.

 By April 1 of the year following the reporting year
 the Government should submit for the approval of the
 President, the annual report on accumulation and use
 of the Fund together with the results from external
 audit.