How to Deal with Azerbaijan’s Oil Boom? Policy Strategies in a Resource-Rich Transition Economy

IMF Working Papers, January 1, 1998

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Examines the dual challenge of managing the transition to a market economy and a booming resource sector in petroleum-rich former Soviet republics around the Caspian Sea, with particular reference to Azerbaijan.
Modifies the standard “Dutch disease” model to capture the special conditions of transition economies, with specific attention to the pattern of real exchange rate movement.
Finds that “transition factors” add to the speed of real appreciation.
Concludes that non-oil sectors may suffer, but less through the real appreciation than through transition-specific structural problems.
Describes a medium-term policy strategy for Azerbaijan and relates its prospects to the experience in the 1970s of Ecuador, Indonesia, and Nigeria.
Argues that the adverse effects of the Dutch disease may be avoided if Azerbaijan pursues policies to promote savings and open trade, and strengthens the supply side through structural policies.

“Transition factors” accelerate real appreciation in transition economies.
The modified Dutch disease framework emphasizes the pattern of real exchange rate movement specific to transition settings.
Non-oil sector contraction is driven more by transition-specific structural problems than by real appreciation alone.
Historical comparisons: draws lessons from Ecuador, Indonesia, and Nigeria in the 1970s to inform Azerbaijan’s medium-term strategy.

Promote savings to mitigate macroeconomic pressures associated with resource booms.
Open trade to reduce adverse allocation effects and support competitiveness of non-oil sectors.
Strengthen the supply side through structural policies to address transition-specific constraints on non-oil sectors.
Implement a medium-term policy strategy informed by historical experiences of other resource-rich countries.

Subjects: Commodities, Commodity booms, Dutch disease, Economic theory, Environment, Foreign exchange, Natural resources, Oil, Real exchange rates
Keywords: appreciation pressure, Azerbaijan, Azerbaijan economy, Baltics, Central Asia, central bank, chapter II, Commodity booms, current account, Dutch disease, Dutch Disease model, goods price, goods sector, market economy, money supply, Natural resources, nominal exchange rate, oil, oil boom, oil sector, Real exchange rates, traded goods sector, transition, unbalanced growth, WP