## _cr04323

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---

### Overview and main findings
- SPPRED approved on February 20, 2003; presented to IMF and IDA Boards on May 14 and May 27, 2003 respectively.
- Progress Report reviews implementation and addresses six key areas: (i) SPPRED and Millennium Development Goals (MDGs); (ii) economic growth and employment; (iii) social policy and human capital; (iv) regional policy; (v) institutional reform and capacity building; and (vi) the participatory process.
- Noted accomplishments:
  - New Household Budget Survey (HBS) to update and improve poverty analysis.
  - Strengthened SPPRED Secretariat capacities via establishment of a Monitoring Unit.
  - New Budget Systems Law integrating extra-budgetary funds into the state budget.
  - Improved costing and prioritization through the Medium Term Expenditure Framework (MTEF).
  - Enhanced links between the SPPRED and the MDGs.
  - Medium term strategy for enhancing targeting of social assistance.
  - Established audit institutions and adopted a governance and management framework for the Oil Fund.
- Key weaknesses identified:
  - Weak analysis of policies in key sectors and limited identification of implementation problems.
  - Insufficient prioritization of projects and project costing; limited detailed analysis of budgetary allocations across key sectors.
  - Lack of elaboration on efforts to design the Long Term Oil Revenue Management Strategy.
  - Limited discussion of governance issues in social sectors.
  - Insufficient suggestions to improve engagement of key line ministries with SPPRED goals.

### The participatory process
- Consultation involved Government, civil society, private sector, and donors; participation broadened and became integral to SPPRED implementation.
- 15 Sector Working Groups composed of government and civil society representatives remain functional.
- Public outreach: regional Town Hall meetings, seminars, workshops, mass media, radio and TV broadcasting, newspapers, website forums, and NGO trainings in participatory methods.
- Donor coordination improved; USAID, the EU and other donors directly support the SPPRED secretariat.
- Staff recommendations:
  - Institutionalize the participation process as integral to policy formulation.
  - Generate well-focused and realistic action plans directly from participatory inputs to foster greater ownership.
  - Enhance the role of Parliament (already engaged through the PRSP Support Group).
  - Continue donor coordination efforts.

### Updated poverty diagnostic (HBS 2002 and related data)
- Poverty estimates (HBS 2002):
  - Poverty incidence: 46.7 percent of the total population.
  - Extreme poverty incidence: 8.8 percent.
- Methodological changes in 2002 (EUROSTAT consistency) and poverty line calculation changes preclude direct comparison between 2001 and 2002 without adjustments.
  - Main methodological differences:
    - Changes in definition of consumption expenditure in the HBS questionnaire.
    - Differences in poverty lines: 2002 figures define a minimum consumption basket for food and non-food products; 2001 figures incorporate only food items.
    - Changes to weights and prices of items in aggregating the consumption basket.
- Poverty profile observations:
  - Urban poverty incidence: 47.8 percent.
  - Rural poverty incidence: 45.4 percent.
  - Baku poverty rate: 40 percent (largest absolute number of urban poor).
  - Poverty incidence highest in provincial towns.
  - Children under 15 and households with 3 or more children face highest poverty risk.
- Refugees and IDPs:
  - Nagorno Karabakh conflict produced nearly 209,000 refugees and 576,000 IDPs according to official registration; in total almost 10 percent of the population.
  - Monitoring of living standards for refugees and IDPs has serious shortcomings; no unified annual survey introduced as envisaged by SPPRED.
- Education and health:
  - Households with heads educated to higher levels are less likely to live in poverty.
  - Current personal expenditures on education are low; potential decline in human capital could have serious implications for poverty.
  - Official health data underestimate the real health situation; progress noted in aims to improve registration of infant and child deaths and health information systems.
- Staff recommendations for poverty diagnostics:
  - Ensure future survey methodology revisions do not compromise data consistency and comparability.
  - Integrate poverty analysis with Labor Force Survey (LFS) to analyze the working poor.
  - Conduct social incidence analysis of public expenditure allocation and integrate qualitative data in poverty diagnosis.
  - Continue focus on improving quality and accessibility of education and health services and on developing reliable databases to assess progress.
  - Commendation for inclusion of an MDG matrix (Appendix 1) showing targets and status of actions.

### Labor market data and recommendations
- LFS initial estimates:
  - Overall unemployment rate: 10.7 percent.
  - Labor force participation rate: 62.9 percent.
  - Employment to population rate: 56.2 percent.
  - Inactivity rate for women higher than for men in the 25-59 age group.
- Staff recommendations:
  - Conduct the LFS regularly (administrative data do not cover the informal sector).
  - Integrate poverty analysis with LFS to better assess the working poor.
  - Include a broader analysis of labor market issues in future Progress Reports.

### Implementation and updating of the strategy
- General critique:
  - Report reviews progress but is relatively weak in critically assessing achievements and providing specific measures to improve public policy effectiveness.
  - Focus on achievements without much data on specific indicators.
  - Substantial work needed to better prioritize SPPRED strategic focus and better estimate public action costs in each area.
  - Report stresses importance of reporting on all standard MDGs annually.

### Macroeconomic policies and public expenditure management
- Macroeconomic framework and growth projections:
  - Framework targets real GDP growth of around 11 percent per annum over the period 2003-05.
  - Oil-sector growth forecast in 2005: around 40 percent.
  - Real growth in the non-oil sector projected to average 9.7 percent between 2003-2005.
  - Staffs note risk of rapid oil-sector expansion impeding non-oil growth and recommend continued fiscal prudence and expanded sterilization tools for the Azerbaijan National Bank.
  - Suggest presenting alternative scenarios and policy considerations for exogenous risks (e.g., world oil price volatility).
  - Report period of reference should have been 2004-2006 rather than 2003-2005 to better guide medium-term expenditure prioritization beyond 2005.
- Fiscal stance and public expenditure priorities:
  - Staff view: continuation of prudent fiscal policies essential for stability and balanced growth.
  - CPIA rating improvement since 2000; ranking among IDA countries improved from fourth quintile in 2000 to second quintile in 2003.
  - Government aligning budgetary expenditures with SPPRED priorities, but expenditures on education and health remain low as a ratio of GDP relative to other countries.
  - 2004 budget changes:
    - In 2004, GDP is expected to increase by 16 percent in nominal terms, and total government spending (excluding BTC investments) by 25 percent.
    - The Budget Law allocated increases in expenditures of 27 percent for education and 32 percent for health in 2004 (in nominal terms, with an expected CPI inflation rate of 5 percent).
  - Staff caution to monitor efficiency of social expenditures given institutional capacity and governance issues.
- Oil revenue management:
  - State Oil Fund established; a Long Term Oil Revenue Management Strategy has been drafted.
  - Strategy aims to set fiscal rules targeting a constant real non-oil deficit with limits on year-to-year fluctuation in the non-oil deficit as a percentage of non-oil GDP.
  - Formal adoption of the Strategy and explicit discussion of its budgetary implications are important next steps.
- Public expenditure composition concerns:
  - MTEF target: increase ratio of government consolidated expenditure to non-oil GDP from 27.4 percent in 2001 to 33.4 percent in 2005.
  - Staff reservations on composition: expenditures should be more targeted toward poverty reduction and basic services.
  - Recent significant and widespread wage and pension increases introduced in 2003 and 2004, with more planned for 2005.
  - Governance problems at all levels adversely affect impact of budgetary spending in priority sectors (health and, to some extent, education) and impede donor assistance.
  - Staffs recommend efforts to broaden the non-oil tax base, lower tax rates, and continue structural changes to increase non-oil revenue performance; highlight high social security contribution rates on labor taxes.
- Decentralization and local finance:
  - Importance of decentralization for SPPRED implementation recognized.
  - Steps taken to improve local budget revenues and build capacity for local budget preparation.
  - Need for a transparent budgetary transfer mechanism and transfer of state properties to municipalities.
  - Report unclear why only one-fifth of budgeted transfers were made available to municipalities in 2003.
  - Priority: further define decentralization strategy and create a governmental body responsible for municipal affairs to promote regional development and capacity building.

### Fiduciary framework and public financial management
- New Law on Budget System adopted in July 2002 and amended in May 2003; 2004 budget preparation first attempt under this Law.
- New Accounting Law will:
  - mandate the use of pure International Financial Reporting Standards (IFRS) by public interest companies, including large government enterprises;
  - mandate the use of National Accounting Standards (NAS) by all other entities;
  - provide the basis for adoption of International Public Sector Accounts Standards (IPSAS) for government accounting.
- Accounting and auditing framework for 2004-2006 envisages:
  - revisions of laws and related regulations to harmonize with the Civil Code and the Joint-Stock Company Law;
  - establishment of a new Audit Law according to International Standards of Auditing (ISA).
- Progress Report details tax and customs administration reforms to improve transparency and governance, but is silent on:
  - public procurement issues;
  - the Chamber of Accounts and the need to markedly improve its effectiveness as an independent control agency.

### Sector policies — education and health
- Education:
  - Progress Report emphasizes accessibility but is silent on class size and specific policy steps to improve quality and delivery.
- Health:
  - Advances include development of a basic health package, establishment of community drug funds, and community health councils on a pilot basis.
  - Capacity building and awareness efforts target birth safety, AIDS, Malaria, and TB; monitoring strengthened to reduce incidence.
  - Report does not adequately address reasons for health care expenditures persistently being less than 1 percent of GDP.
  - It understates serious governance issues across the health sector, including chronic informal payments and pseudo privatization of health services.
  - Staffs warn that without governance improvements, envisioned increases in health care expenditures are unlikely to be used efficiently.

### Social protection and pensions
- Government program (supported by the IDA Pension and Social Assistance Project) will focus on increasing efficiency, effectiveness and sustainability.
- Social insurance measures:
  - link benefits more closely to contributions;
  - modernize and strengthen financial management of the State Social Protection Fund (SPF);
  - move all social insurance benefits administration from enterprises to the SPF;
  - draft new legislation on pensions to introduce parametric changes and closer links between contributions and benefits.
- Social assistance measures:
  - target benefits based on eligibility assessment taking into account economic and social situation of applicants;
  - consolidate various benefits into a single targeted family poverty benefit in cash as of 2006 and significantly increase resources allocated to its financing;
  - modernize Ministry of Labor and Social Protection (MoLSP) capacity to administer social assistance benefits using computerized MIS.
- A draft framework law on Targeted Social Assistance submitted to the Cabinet of Ministers.
- Staffs support linking these programs with ongoing utility sector reforms to mitigate adverse impacts on the poor.

### Energy sector and SOCAR
- Progress Report recognizes efforts to reduce energy subsidies, intensify reforms, and provide reliable energy outside the capital.
- 2003 budget incorporated energy-related subsidies provided by SOCAR to Azerenergy, Azerigas, and Azerchemia; Government approved the 2004 revenue and expenditure plans of these companies to control subsidies.
- Staffs note the Report should highlight:
  - difficulty in controlling and reducing energy-related subsidies;
  - large quasi-fiscal subsidies implicit in oil product prices which are approximately 62 percent of world market rates.
- Supply of commercial energy outside Baku remains unsatisfactory (power supplied a limited number of hours per day).
- Increase in electricity and natural gas consumption in 2003 was matched by increased supply costs, causing the subsidy to the energy sector from the state budget to expand significantly.
- Government intends to develop a medium-term tariff policy (in parallel with improved social protection) and establish an independent utility regulatory agency.
- A Presidential Decree (January 2003) identified SOCAR restructuring initiatives including separation of non-core activities in advance of privatization, but implementation has been limited.
- Recommendations for financial restructuring of SOCAR prepared; additional technical assistance under preparation to review SOCAR’s commercial structure and implement a commercialization plan.

### Agriculture, infrastructure, and rural development
- Agriculture:
  - Government prepared a rural development strategy, enhanced farmers' access to finance, developed the land market, and improved access to water.
  - Staffs recommend SPPRED further encourage an enabling environment for small- and medium-sized rural businesses by reducing transaction costs and developing marketing infrastructure, improving infrastructure reliability, reducing corruption, and facilitating rural business associations.
  - Priority: enforce consistent and transparent standards for private sector activities.
- Infrastructure:
  - Progress in construction/rehabilitation of highways, rural roads, railroads, and the Nakhchivan airport.
  - Additional gains require providing municipal governments with adequate resources and capacity to manage infrastructure assets.
  - Staffs support community development and recommend preparation of a strategy and timely registration of community-based organizations.

### Financial sector and banking
- Measures to strengthen banking system and broaden outreach:
  - expansion of the banking network in the regions;
  - creation of a functional micro-finance market;
  - expansion of credit unions; improved access to finance in rural areas.
- Registration and regulatory framework for non-bank credit institutions streamlined, increasing institution numbers and credit volume; total credit to rural and disadvantaged populations remains small.
- Needed actions:
  - facilitate appraisal and management of credit risk for non-bank financial institutions;
  - create a better business and market environment for private sector in regions.
- Report fails to highlight substantial delays in privatization of IBA and BUS Bank and their de-monopolization; over 2003 and 2004 IBA attempted to consolidate monopoly power, sometimes with Government assistance (e.g., Social Protection Fund tender).
- Staffs recommend addressing these issues to foster competition and efficiency in banking.
- Legislation and supervision:
  - Recently enacted Banking Law consistent with Basel Core principles, but an associated implementing decree raises problems by effectively transferring control of supervision to the Presidential Office.
  - Decree calls for a Banking Sector Codex, details unclear and have stalled progress on the draft National Bank Law.
- Banking infrastructure progress:
  - creation of a credit register to improve credit risk management and access to credit;
  - advances in bank governance and introduction of international accounting and reporting standards in the banking sector;
  - improvements in the national payment system and NBA’s development of a comprehensive system to introduce electronic payment means.
- Staffs caution that supervision problems could overwhelm benefits and that expanding payments system access and financial services to rural areas would help integrate those areas into the national economy.

### Business environment, investment, and trade
- Report highlights measures to create favorable conditions for income-generating opportunities:
  - adoption of laws facilitating registration of legal entities and combating corruption;
  - simplification of licensing system;
  - implementation of Small and Medium Enterprises development program;
  - creation of an investment promotion foundation; development of a public investment program;
  - reductions in tax burden and simplification of tax system;
  - WTO accession facilitated by technical assistance.
- Staffs recommend Government focus more on eliminating impediments to private sector development and FDI, including unreliable utilities/infrastructure outside Baku and administrative barriers to business start-up and site acquisition/development.

### Environment and gender
- Environment:
  - Progress Report emphasizes need for greater monitoring and control of pollution as the economy expands.
  - SPPRED addresses household drinking water shortages and inadequate water quality (especially rural) via infrastructure rehabilitation with donor help.
  - National forest rehabilitation plan adopted in 2002 has been implemented.
  - Staffs concur institutional capacity for monitoring environmental problems and developing regulatory framework should be core SPPRED activities.
- Gender:
  - Progress Report recognizes gender issues have not received sufficient attention.
  - Staffs recommend next progress report address gender systematically, with mechanisms to utilize various data sources for assessment and propose a country gender assessment of activities supported by Government and donors.

### Monitoring and evaluation
- Establishment of the Poverty Monitoring Unit at the SPPRED Secretariat and capacity building for poverty analysis welcomed.
- SPPRED Secretariat monitors poverty changes and, where possible, analyzes policy effects on poverty results.
- Capacities need strengthening in key line ministries for policy monitoring and evaluation.
- Next progress report should be more explicit on monitoring outputs and outcomes; Government intends to gradually expand core set of indicators, especially for measuring targeting of social services.
- Reporting annually on all standard MDGs is critical.
- Staffs encourage establishing annual surveys such as the Labor Force Survey and the survey of IDPs to assist in building a credible monitoring database; data should remain available to independent researchers.
- Education and especially health sector data need dramatic improvement.
- Government engaged in Poverty and Social Impact Analysis (PSIA) on energy tariff reform and worker displacement due to enterprise restructuring and privatization.

### Risks to the strategy
- Institutional and political risks not evaluated in the Progress Report:
  - Leading risk: implementation risk from weaknesses in coordination among line ministries and multiple agencies charged with implementing SPPRED policies and programs.
  - Capacity constraints and governance problems in line ministries that could impede full implementation.
  - Risk of power struggles from recent political transition leading to major policy shifts.
- Staffs recommend future Progress Reports include assessment of exogenous risks and detailed mitigation plans, including contingency plans, alternative scenarios, and policy considerations.

### Conclusions and staff recommendations
- Government has made significant progress in implementing SPPRED within a short period, notwithstanding 2003 political challenges; Progress Report is a credible and inclusive effort and provides a basis for more harmonized and effective donor support.
- Shortcomings to address during implementation and in subsequent progress reports:
  - Strengthen poverty analysis by expanding information base (labor market surveys, social impact assessment); improve health statistics urgently.
  - Better prioritize policies to identify pro-poor spending programs.
  - Strengthen link between policies and budgetary allocations through the MTEF process, including detailed analysis of budgetary allocations across key sectors and poverty implications and a more critical review of government policies to identify future support needs.
  - Further analyze and clearly identify capacity constraints, including possible donor support needs.
  - Provide more accurate costing of programs.
  - Give more attention to gender analysis.
- Staffs of IDA and IMF consider Azerbaijan’s poverty reduction strategy continues to provide a credible framework for Bank and Fund concessional assistance and recommend respective Executive Directors reach the same conclusion.

*Source: IMF staff summary of the Government of Azerbaijan’s first Annual Progress Report of the SPPRED.*

### 1.      The Government of Azerbaijan has prepared the first Annual Progress Report of its

### _cr04323 - 1.      The Government of Azerbaijan has prepared the first Annual Progress Report of its

### Overview and main findings
- The State Program for Poverty Reduction and Economic Development (SPPRED) was approved on February 20, 2003 and presented to the Boards of the IMF and IDA on May 14 and May 27, 2003 respectively.
- The Progress Report reviews implementation and addresses six key areas: (i) SPPRED and Millennium Development Goals (MDGs); (ii) economic growth and employment; (iii) social policy and human capital; (iv) regional policy; (v) institutional reform and capacity building; and (vi) the participatory process.
- Noted accomplishments:
  - A new Household Budget Survey (HBS) to update and improve poverty analysis.
  - Strengthened SPPRED Secretariat capacities via establishment of a Monitoring Unit.
  - A new Budget Systems Law that integrates extra-budgetary funds into the state budget.
  - Improved costing and prioritization through the Medium Term Expenditure Framework (MTEF).
  - Enhanced links between the SPPRED and the MDGs.
  - A medium term strategy for enhancing targeting of social assistance.
  - Established audit institutions and adopted a governance and management framework for the Oil Fund.
- Key weaknesses identified in the Report:
  - Weak analysis of policies in key sectors and limited identification of implementation problems.
  - Insufficient prioritization of projects and project costing; limited detailed analysis of budgetary allocations across key sectors.
  - Lack of elaboration on efforts to design the Long Term Oil Revenue Management Strategy.
  - Limited discussion of governance issues in social sectors.
  - Insufficient suggestions to improve engagement of key line ministries with SPPRED goals.

### The participatory process
- Consultation process involved Government, civil society, private sector, and donors; participation broadened and became integral to SPPRED implementation.
- 15 Sector Working Groups composed of government and civil society representatives remain functional.
- Public outreach conducted through regional Town Hall meetings, seminars, workshops, mass media, radio and TV broadcasting, newspapers, website forums, and trainings in participatory methods by NGOs.
- Donor coordination improved; USAID, the EU and other donors directly support the SPPRED secretariat.
- Staff recommendations:
  - Institutionalize the participation process as integral to policy formulation.
  - Generate well-focused and realistic action plans directly from participatory inputs to foster greater ownership.
  - Enhance the role of Parliament (already engaged through the PRSP Support Group).
  - Continue donor coordination efforts.

### Updated poverty diagnostic (HBS 2002 and related data)
- Poverty estimates based on the Household Budget Survey (HBS) for 2002:
  - Poverty incidence: 46.7 percent of the total population.
  - Extreme poverty incidence: 8.8 percent.
- Methodological changes to the HBS in 2002 (consistency with EUROSTAT) and changes in poverty line calculation preclude direct comparison between 2001 and 2002 without adjustments.
  - Main methodological differences include:
    - Changes in definition of consumption expenditure in the HBS questionnaire.
    - Differences in poverty lines: 2002 figures define a minimum consumption basket for food and non-food products; 2001 figures incorporate only food items.
    - Changes to weights and prices of items in aggregating the consumption basket.
- Poverty profile observations:
  - Urban poverty incidence: 47.8 percent.
  - Rural poverty incidence: 45.4 percent.
  - Baku poverty rate: 40 percent (largest absolute number of urban poor).
  - Poverty incidence highest in provincial towns.
  - Children under 15 and households with 3 or more children face highest poverty risk.
- Refugees and IDPs:
  - IDPs of the Nagorno Karabakh conflict particularly vulnerable; conflict resulted in nearly 209,000 refuges and 576,000 IDPs according to official registration, in total almost 10 percent of the population.
  - Monitoring of living standards for refugees and IDPs has serious shortcomings; no unified annual survey introduced as envisaged by SPPRED.
- Education and health findings:
  - Households with heads educated to higher levels are less likely to live in poverty.
  - Current personal expenditures on education are low; potential decline in human capital could have serious implications for poverty.
  - Official health data underestimate the real health situation; progress noted in aims to improve registration of infant and child deaths and health information systems.
- Staff recommendations for poverty diagnostics:
  - Ensure future survey methodology revisions do not compromise data consistency and comparability.
  - Integrate poverty analysis with Labor Force Survey (LFS) to analyze the working poor.
  - Conduct social incidence analysis of public expenditure allocation and integrate qualitative data in poverty diagnosis.
  - Continue focus on improving quality and accessibility of education and health services and on developing reliable databases to assess progress.
  - Commendation for inclusion of an MDG matrix (Appendix 1) showing targets and status of actions.

### Labor market data and recommendations
- Labor Force Survey (LFS) initial estimates:
  - Overall unemployment rate: 10.7 percent.
  - Labor force participation rate: 62.9 percent.
  - Employment to population rate: 56.2 percent.
  - Inactivity rate for women higher than for men in the 25-59 age group.
- Staff recommendations:
  - Conduct the LFS regularly (administrative data do not cover the informal sector).
  - Integrate poverty analysis with LFS to better assess the working poor.
  - Include a broader analysis of labor market issues in future Progress Reports.

### Implementation and updating of the strategy
- General critique:
  - Report reviews progress but is relatively weak in critically assessing achievements and providing specific measures to improve public policy effectiveness.
  - Report focuses on achievements without providing much data on specific indicators.
  - Substantial work needed to better prioritize SPPRED strategic focus and better estimate public action costs in each area.
  - Report stresses importance of reporting on all standard MDGs annually.

### Macroeconomic policies and public expenditure management
- Macroeconomic framework and growth projections:
  - Framework targets real GDP growth of around 11 percent per annum over the period 2003-05.
  - Oil-sector growth forecast in 2005: around 40 percent.
  - Real growth in the non-oil sector projected to average 9.7 percent between 2003-2005.
  - Staffs note risk of rapid oil-sector expansion impeding non-oil growth and recommend continued fiscal prudence and expanded sterilization tools for the Azerbaijan National Bank.
  - Suggestion that alternative scenarios and policy considerations for exogenous risks (e.g., world oil price volatility) should be presented.
  - Report period of reference should have been 2004-2006 rather than 2003-2005 to better guide medium-term expenditure prioritization beyond 2005.
- Fiscal stance and public expenditure priorities:
  - Staff view: continuation of prudent fiscal policies essential for stability and balanced growth.
  - CPIA rating improvement since 2000; ranking among IDA countries improved from fourth quintile in 2000 to second quintile in 2003.
  - Government aligning budgetary expenditures with SPPRED priorities, but expenditures on education and health remain low as a ratio of GDP relative to other countries.
  - 2004 budget allowed significant increases in allocations to education and health:
    - In 2004, GDP is expected to increase by 16 percent in nominal terms, and total government spending (excluding BTC investments) by 25 percent.
    - The Budget Law allocated increases in expenditures of 27 percent for education and 32 percent for health in 2004 (in nominal terms, with an expected CPI inflation rate of 5 percent).
  - Staff caution to monitor efficiency of social expenditures given institutional capacity and governance issues.
- Oil revenue management:
  - State Oil Fund established; a Long Term Oil Revenue Management Strategy has been drafted.
  - Strategy aims to set fiscal rules targeting a constant real non-oil deficit with limits on year-to-year fluctuation in the non-oil deficit as a percentage of non-oil GDP.
  - Formal adoption of the Strategy and explicit discussion of its budgetary implications are important next steps.
- Public expenditure composition concerns:
  - MTEF target: increase ratio of government consolidated expenditure to non-oil GDP from 27.4 percent in 2001 to 33.4 percent in 2005.
  - Staff reservations on composition: expenditures should be more targeted toward poverty reduction and basic services.
  - Recent significant and widespread wage and pension increases introduced in 2003 and 2004, with more planned for 2005.
  - Governance problems at all levels adversely affect impact of budgetary spending in priority sectors (health and, to some extent, education) and impede donor assistance.
  - Staffs recommend efforts to broaden the non-oil tax base, lower tax rates, and continue structural changes to increase non-oil revenue performance; highlight high social security contribution rates on labor taxes.
- Decentralization and local finance:
  - Report recognizes importance of decentralization for SPPRED implementation.
  - Steps taken to improve local budget revenues and build capacity for local budget preparation.
  - Need for a transparent budgetary transfer mechanism and transfer of state properties to municipalities.
  - Report unclear why only one-fifth of budgeted transfers were made available to municipalities in 2003.
  - Priority: further define decentralization strategy and create a governmental body responsible for municipal affairs to promote regional development and capacity building.

*Source: IMF staff summary of the Government of Azerbaijan’s first Annual Progress Report of the SPPRED.*

### 18.      The Progress Report lists the many actions taken by the Government, and

### 18.      The Progress Report lists the many actions taken by the Government, and

### Fiduciary framework and public financial management
- A new Law on Budget System was adopted in July 2002 and amended in May 2003; the 2004 budget preparation was the first attempt with this Law.
- Government is adopting a new Accounting Law that:
  - mandates the use of pure International Financial Reporting Standards (IFRS) by public interest companies, including large government enterprises;
  - mandates the use of National Accounting Standards (NAS) by all other entities;
  - provides the basis for adoption of International Public Sector Accounts Standards (IPSAS) for government accounting.
- The accounting and auditing framework for 2004-2006 envisages:
  - revisions of laws and related regulations to harmonize with the Civil Code and the Joint-Stock Company Law;
  - establishment of a new Audit Law according to International Standards of Auditing (ISA).
- Progress Report details tax and customs administration reforms to improve transparency and governance, but is silent on:
  - public procurement issues;
  - the Chamber of Accounts and the need to markedly improve its effectiveness as an independent control agency.

### Sector policies — education and health
- Education:
  - Progress Report emphasizes accessibility but is silent on class size and specific policy steps to improve quality and delivery.
- Health:
  - Advances include development of a basic health package, establishment of community drug funds, and community health councils on a pilot basis.
  - Capacity building and awareness efforts target birth safety, AIDS, Malaria, and TB; monitoring has been strengthened to reduce incidence.
  - The Report does not adequately address reasons for health care expenditures persistently being less than 1 percent of GDP.
  - It understates serious governance issues across the health sector, including chronic informal payments and pseudo privatization of health services.
  - Staffs warn that without governance improvements, envisioned increases in health care expenditures are unlikely to be used efficiently.

### Social protection and pensions
- Government program (supported by the IDA Pension and Social Assistance Project) will focus on actions to increase efficiency, effectiveness and sustainability:
  - Social insurance:
    - link benefits more closely to contributions;
    - modernize and strengthen financial management of the State Social Protection Fund (SPF);
    - move all social insurance benefits administration from enterprises to the SPF;
    - draft new legislation on pensions to introduce parametric changes and closer links between contributions and benefits.
  - Social assistance:
    - (i) target benefits based on eligibility assessment taking into account economic and social situation of applicants;
    - (ii) consolidate various benefits into a single targeted family poverty benefit in cash as of 2006 and significantly increase resources allocated to its financing;
    - (iii) modernize Ministry of Labor and Social Protection (MoLSP) capacity to administer social assistance benefits using computerized MIS.
  - A draft framework law on Targeted Social Assistance has been submitted to the Cabinet of Ministers.
  - Staffs support linking these programs with ongoing utility sector reforms to mitigate adverse impacts on the poor.

### Energy sector and SOCAR
- Progress Report recognizes efforts to reduce energy subsidies, intensify reforms, and provide reliable energy outside the capital city.
- 2003 budget incorporated energy-related subsidies provided by the State Oil Company of the Azerbaijan Republic (SOCAR) to Azerenergy, Azerigas, and Azerchemia; Government approved the 2004 revenue and expenditure plans of these companies to control subsidies.
- Staffs note the Report should highlight:
  - difficulty in controlling and reducing energy-related subsidies;
  - large quasi-fiscal subsidies implicit in oil product prices which are approximately 62 percent of world market rates.
- Supply of commercial energy outside Baku remains unsatisfactory (power supplied a limited number of hours per day).
- Increase in electricity and natural gas consumption in 2003 was matched by increased supply costs, causing the subsidy to the energy sector from the state budget to expand significantly.
- Government intends to:
  - develop a medium-term tariff policy (in parallel with improved social protection);
  - establish an independent utility regulatory agency.
- A Presidential Decree (January 2003) identified SOCAR restructuring initiatives including separation of non-core activities in advance of privatization, but implementation has been limited.
- Recommendations for financial restructuring of SOCAR have been prepared; additional technical assistance is under preparation to review SOCAR’s commercial structure and implement a commercialization plan.

### Agriculture, infrastructure, and rural development
- Agriculture:
  - Government prepared a rural development strategy, enhanced farmers' access to finance, developed the land market, and improved access to water.
  - Staffs recommend SPPRED further encourage an enabling environment for small- and medium-sized rural businesses by reducing transaction costs and developing marketing infrastructure, improving infrastructure reliability, reducing corruption, and facilitating rural business associations.
  - Priority areas include enforcing consistent and transparent standards for private sector activities.
- Infrastructure:
  - Progress made in construction/rehabilitation of highways, rural roads, railroads, and the Nakhchivan airport.
  - Additional gains require providing municipal governments with adequate resources and capacity to manage infrastructure assets.
  - Staffs support community development and recommend preparation of a strategy and timely registration of community-based organizations.

### Financial sector and banking
- Measures taken to strengthen the banking system and broaden outreach include:
  - expansion of the banking network in the regions;
  - creation of a functional micro-finance market;
  - expansion of credit unions; improved access to finance in rural areas.
- Registration and regulatory framework for non-bank credit institutions have been streamlined, increasing institution numbers and credit volume; however total credit to rural and disadvantaged populations remains small.
- Needed actions:
  - facilitate appraisal and management of credit risk for non-bank financial institutions;
  - create a better business and market environment for private sector in regions.
- Report fails to highlight substantial delays in privatization of IBA and BUS Bank and their de-monopolization; over 2003 and 2004 IBA attempted to consolidate monopoly power, sometimes with Government assistance (e.g., Social Protection Fund tender).
- Staffs recommend addressing these issues to foster competition and efficiency in banking.
- Legislation and supervision:
  - Recently enacted Banking Law is consistent with Basel Core principles, but an associated implementing decree raises problems by effectively transferring control of supervision to the Presidential Office.
  - Decree calls for a Banking Sector Codex, details unclear and have stalled progress on the draft National Bank Law, which aimed to improve supervision, regulation, and disclosure.
- Banking infrastructure progress:
  - creation of a credit register to improve credit risk management and access to credit;
  - advances in bank governance and introduction of international accounting and reporting standards in the banking sector;
  - improvements in the national payment system and NBA’s development of a comprehensive system to introduce electronic payment means.
- Staffs caution that supervision problems could overwhelm benefits and that expanding payments system access and financial services to rural areas would help integrate those areas into the national economy.

### Business environment, investment, and trade
- Report highlights measures to create favorable conditions for income-generating opportunities:
  - adoption of laws facilitating registration of legal entities and combating corruption;
  - simplification of licensing system;
  - implementation of Small and Medium Enterprises development program;
  - creation of an investment promotion foundation; development of a public investment program;
  - reductions in tax burden and simplification of tax system;
  - WTO accession facilitated by technical assistance.
- Staffs recommend Government focus more on eliminating impediments to private sector development and FDI, including unreliable utilities/infrastructure outside Baku and administrative barriers to business start-up and site acquisition/development.

### Environment and gender
- Environment:
  - Progress Report emphasizes need for greater monitoring and control of pollution as the economy expands.
  - SPPRED addresses household drinking water shortages and inadequate water quality (especially rural) via infrastructure rehabilitation with donor help.
  - A national forest rehabilitation plan adopted in 2002 has been implemented.
  - Staffs concur institutional capacity for monitoring environmental problems and developing regulatory framework should be core SPPRED activities.
- Gender:
  - Progress Report recognizes gender issues have not received sufficient attention.
  - Staffs recommend next progress report address gender systematically, with mechanisms to utilize various data sources for assessment and propose a country gender assessment of activities supported by Government and donors.

### Monitoring and evaluation
- Staffs welcome establishment of the Poverty Monitoring Unit at the SPPRED Secretariat and capacity building for poverty analysis.
- SPPRED Secretariat monitors poverty changes and, where possible, analyzes policy effects on poverty results.
- Capacities need strengthening in key line ministries for policy monitoring and evaluation.
- Next progress report should be more explicit on monitoring outputs and outcomes; Government intends to gradually expand core set of indicators, especially for measuring targeting of social services.
- Reporting annually on all standard MDGs is critical.
- Staffs encourage establishing annual surveys such as the Labor Force Survey and the survey of IDPs to assist in building a credible monitoring database; data should remain available to independent researchers.
- Education and especially health sector data need dramatic improvement.
- Government engaged in Poverty and Social Impact Analysis (PSIA) on energy tariff reform and worker displacement due to enterprise restructuring and privatization.

### Risks to the strategy
- Staffs identify institutional and political risks not evaluated in the Progress Report:
  - leading risk: implementation risk from weaknesses in coordination among line ministries and multiple agencies charged with implementing SPPRED policies and programs;
  - capacity constraints and governance problems in line ministries that could impede full implementation;
  - risk of power struggles from recent political transition leading to major policy shifts.
- Staffs recommend future Progress Reports include assessment of exogenous risks and detailed mitigation plans, including contingency plans, alternative scenarios, and policy considerations.

### Conclusions and staff recommendations
- Government has made significant progress in implementing SPPRED within a short period, notwithstanding 2003 political challenges; Progress Report is a credible and inclusive effort and provides a basis for more harmonized and effective donor support.
- Shortcomings to address during implementation and in subsequent progress reports:
  - strengthen poverty analysis by expanding information base (labor market surveys, social impact assessment); improve health statistics urgently;
  - better prioritize policies to identify pro-poor spending programs;
  - strengthen link between policies and budgetary allocations through the MTEF process, including detailed analysis of budgetary allocations across key sectors and poverty implications and a more critical review of government policies to identify future support needs;
  - further analyze and clearly identify capacity constraints, including possible donor support needs;
  - provide more accurate costing of programs;
  - give more attention to gender analysis.
- Staffs of IDA and IMF consider Azerbaijan’s poverty reduction strategy continues to provide a credible framework for Bank and Fund concessional assistance and recommend respective Executive Directors reach the same conclusion.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04323.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2004/_cr04323.pdf_