Budget process remains to be intra-governmental matter

What amendments are expected to be made in the draft budget?

A head of the Economic Initiatives Promotion Centre, Azer Mehtiyev responds ASTNA questions.

- Azer bey, what can you say about innovations in the 2019 budget?

- As is known, the state budget is a crucial document for all members and strata of society: every citizen of the country, every family, every physical or legal entity are, in a varying degree, exposed to the impact of the budget policy of the government: some as taxpayers, others as employees; some as recipients of grants, others as recipients of loans for construction of schools, kindergartens, etc. It is no mere coincidence that the state budget is a sort of mirror reflecting the economic policy of the government. Following debates and subsequent adoption, the budget is reflective of government"s attitude toward interests of every citizen. For this reason, the society stands in need of budget formation and parliamentary debates openness. However, budget-related discussions in Azerbaijan remain to be an exclusive prerogative of the government where no general public is involoved in the process. As a consequence of such an approach Azerbaijan is ranked among countries with minimum budget openness (78 place with its 34 out of possible 115 points), according to the Open Budget Index of the authoritative International Budget Partnership organization (IBP).

As is evident, the 2019 budget formation process has been launched earlier this year, in the end of January. However, the general public came to know about budget parameters just in the end of October following submission of the draft budget to Milli Majlis. At present, the draft state budget for 2019 is under discussion at Milli Majlis.

It should be remembered that no general public has taken part in the debates. Like previous years, the budget is going to be approved not following the consensus of all parties concerned but the agreement to be reached between intra-governmental groupings. From this point of view, we have noticed nothing new or distinctive on all stages of the state budget-2019 debates.

Of interest is the fact that the so-called "budget regulation" has been put forward as an instrument to form the budget. Note that some amendments and changes having in mind "budget regulation" have been made in the Law of the Azerbaijani Republic "On budget system" in June this year. This rule is applied for softening of negative impact of sharp changes in oil prices on the state budget.

The budget regulation is an instrument of the implementation of the budget policy aimed at ensuring the macroeconomic stability, financial and credit discipline in the medium- and long-term perspective. Under Articles 11-1.2 of the Law, upper limit of summary budget is set at the level of not more than 103% of approved expenditures of the current year"s summary budget. It should be noted that in mid-year the government raised state budget revenues and expenditures in 2018 nearly by 2 bln manats (largely at the expense of transfers from the State Oil Fund) and thus contributed to "profitable beginning" of the budget regulation in forming the state budget in 2019.

As for the budget content, i. e. formation of the structure of revenues and expenditures, it"d be wrong to insist that the next year budget is noted for any innovations that strongly distinguish it from the previous year budget.

It must be said that the dependence of budget revenues upon oil sector tends to grow. According to the governmental statistics, in 2017 a share of oil in the state budget revenues fell to 47.7% as compared with 75.1% in 2011 while this index is expected to rise to 59.8% in 2019. Under government calculations, nearly 60% of state budget revenues in 2019 will be formed at the expense of oil sector.

It should be added that in fact the share of these receipts in the state budget revenues is higher. The reason is that the government takes into account not all oil money, for example, income tax of foreign subcontracted companies acting in accordance with HPBS agreement, as well as payments out of income tax of those employed in the oil sector. Otherwise, the share of direct budget receipts would exceed 60%.

The following changes are expected to take place next year in the sphere of tax policy:

- imposition of income tax allowances for non-government taxpayers engaged in non-oil and gas sector;

-reduction of social security contribution by enterprises of the mentioned type;

-application of single tax rate at 2%;

-gradual expansion of tax-imposed VAT;

-prolongation of tax privileges for 5 years conformably to agricultural producers;

-exemption of small business entity from dividend taxes;

-extension of excised goods, as well as strengthening of control over import, turnover, local production, wholesale and retail of excised goods.

As for the policy of budget expenditures, the government is seeking to avail of the strategy used before 2015: funds allocated from the state budget to the capital investments have sharply increased. Thus, budget financing of capital investments in 2019 is expected to reach 6.8 bln manats (up to 27.6% of all budget expenditures) which is up 1.7 bln manats from 2018 and up 4.1 bln manats (or 2.5 times) from 2017.

- Budget revenues and expenditures provide for 2, 5 bln manats growth. On the basis of what receipts or transfers is it planned to achieve?

- State budget revenues are forecast to reach 22917.5 mln manats in 2019 which is up 768.5 mln manats, or 3.5% from 2018. As compared with 2018 forecast, additional receipts by separate sources of state budget replenishment in 2019 are expected to make up approx. 1191.5 mln manats. Main increase in revenue will include receipts from State Oil Fund transfers (398.3 mln manats); excises (201.0 mln manats); profit tax (income) of legal entities (137.4 mln manats) and paid services of budgetary organizations (127.6 mln manats). Note that total rise by other sources will make up 327.2 mln manats.

At the same time, receipts from some sources of budget revenues are expected to drop by 423.0 from a year earlier. The drop will embrace income taxes of physical entities (316.0 mln manats), simplified tax (58.0 mln manats), land tax (5.0 mln manats) and subsoil tax (3.0 mln manats) of legal entities, as well as levies from difference between contractual (sale) and wholesale prices inside the country for products with regulated prices (41.0 mln manats).

It must be said that next year state budget expenditures are forecast to make up 24780.1 mln manats which is up 1680.1 mln manats (or 7.3%) from 2018 and up 7185.6 mln manats (40.8%) from 2017. As compared with forecast expenditures in 2018, the government is going to allocate additional funds in 2019 as follows: 1.74 bln manats for capital investments; 308.9 mln manats for public health; 243.2 mln manats for common civil service; 230.6 mln manats for education; 210.3 mln manats for social security; 167.8 mln manats for judicial power, law-enforcement and prosecutor"s bodies; 123.4 mln manats for defense; 79.4 mln manats for agriculture and related spheres.

As compared with 2018 forecast, in 2019 the government will have to reduce economic activity-related expenditures by 1.1 bln manats; service expenditures by 273.6 mln manats; housing and communal economy by 98.2 mln manats; fuel and power engineering expenditures by 10.2 mln manats. Public health expenditures will be increased of which 223.9 mln manats (or 72.5%) are expected to be used for the State Agency on Compulsory Medical Insurance.

It must be acknowledged that 489.8 mln manats out of funds to be used for raising the budget expenditures in 2019, are planned to be used for labor remuneration; 417.5 mln manats for construction; 352.6 mln manats for subsidies and current transfers; 183.9 mln manats for pensions and hardship allowances; 142.4 mln manats for payments and percentage; 102.4 mln manats for other expenditures.

As a whole, next year"s state budget expenditures will include 12.55 bln manats (50.7%) as current expenditures; 9.9 bln manats (39.9%) as capital expenditures; remaining 2.3 bln manats (9.4%) as public debt management.

- This time a figure of $60 per barrel has been included in the budget. Is the budget dependent again upon oil revenues? Or this time a share of non-oil sector revenues will be increased in the budget?

- Yes, indeed, a figure of $60 per barrel has been taken as a basis when forming the next year budget. According to the government data, 13.7 bln manats, or 59.8% of state budget revenues will be formed in 2019 at the expense of direct receipts from oil and gas sector, and 9.2 bln manats, or 40.2% - from non-oil sector. In so doing, 11364.3 mln manats of receipts from oil and gas sector fall to the share of State Oil Fund transfers; 1450.0 mln manats - fall to the share of State Oil Fund payments; the rest 886.0 mln manats - fall to the share of income tax of foreign contracting companies working by HPBS. As has noted above, independent studies give grounds to speak about higher share (approx.65%) of direct receipts from oil and gas sector within the framework of the state budget revenues.

Under a government decision, as compared with the 2018 budget, state budget revenues by oil and gas sector in 2019 will grow by 354.3 mln manats (2.7%) while non-oil sector receipts by 414.1 mln manats (4.7%) of which approx. 260.0 mln manats, or 63% fall on the share of returns from foreign economic activity.

Account has to be taken here of a crucial point: a preliminary state budget forecast is known to have been formed on the basis of oil price $45 per barrel; amendments have been made in the mid-year forecasts with due regard for growing oil prices ($55 per barrel), so a forecast on general receipts by oil sector has been increased by 2.2 bln manats. However, a forecast of tax receipts by non-oil sector in the line of the State Customs Committee reduced by 1.0 bln manats while a forecast on the Ministry of Taxes receipts increased by 725.0 mln manats.

When estimating the said alterations, it transpires that in case of the rise in state budget revenues by oil and gas sector by approx. 2.5 bln manats (as compared with preliminary state budget forecasts for 2018), the non-oil sector revenues will suffer a sharp slowdown aside from foreign economic activity receipts.

Worthy of notice here is another aspect - a role of oil money in forming non-oil sector receipts. As noted above, it is exactly oil money (to be exact, State Oil Fund transfers) from the state budget that makes it possible to allocate 6.8 bln manats worth capital investments (as a whole, 9.9 bln manats of capital spending). In other words, increase in investment (capital construction) of state budget expenditures plays a decisive role in the growth of non-oil sector returns.

In 2019, a prognosticated amount of state budget current expenditures, besides State Oil Fund transfers, is 12.55 bln manats, an amount of budget revenues is 11.55 bln manats. From this it follows that 1.0 bln manats of current budget expenditures will be financed at the expense of State Oil Fund transfers. In other words, should next year"s oil prices fall lower than $60 per barrel and the government would have to expend a greater portion of State Oil Fund transfer for current expenditures.

- The Cabinet of Ministers of the Azerbaijani Republic has approved a uniform budget classification to take effect since January 1, 2020. What does a uniform budget classification mean? What are its objectives?

Under a resolution of the Cabinet of Ministers dated October 11, 2018, a uniform budget classification with functional economic and administrative systematization of budget revenues/expenditures was approved. It should be understood that the budget classification is an important instrument to ensure the preparation, formation, performance and control over the state budget, effective organization of budget activity, raising of transparency and accountability of the budget process.

The classification of budget revenues provides for 6-figure coding (section, auxiliary section, paragraph, article and sub-clause) which makes it possible to follow up receipts in detail. Also, the classification provides functional (by main functions of the state - 3-figure coding), departmental (by budget fund owners - 4-figure coding) and economic (by economic assignment of expenditures - 6-figure coding) systematization of budget expenditures.

It is worth emphasizing that such a classification of the budget process forms a basis for electronization of the budget. Note that the currently used budget classification was approved in October 2004 and amended later. However, the current budget classification fell short of international and present-day financial standards.

That"s why it was imperative to adopt a new budget classification, especially making serious changes in the functional and economic classification of budget expenditures. In spite of essential amendments in the new budget classification, it is noted for some essential shortcomings. When adjusted for the fact that since 2020 Azerbaijan has been getting ready for transition to the goal-oriented system of budgeting within the framework of medium-term expenditures, it is dubious that the given classification fully complies with process requirements.

- How do you evaluate the current budget of Azerbaijan? Can it be regarded satisfactory for the country with 27 years of independent existence? Or would it be possible to have more functional and profitable budget based on more sustainable economy and stable development? What, in your view, is barring our advance?

- The budget may be valued differently and, hence, replies are different. For example, the budget may be valued from its revenue/expenditure standpoint. In doing so, it is important to examine an extent of involvement of real economic potential in forming budget revenues and the scope of untaxed revenues or evaded taxes.

Also, it"d be appropriate to assess a tax base possibly formed at the expense of more effective organization of budget expenditures, especially those formed at the expense of oil money. However, lack of these studies makes it no possible to make appropriate assessments.

One might assume that if we succeeded in preventing tax avoidance cases occurring in terms of varying economic and budgetary policy; if we succeeded in putting tax-raised funds into the budget in full; if accountability and effectiveness of state procurements, state investments and budget expenditures would be prompt, today"s budget expenditures and incomes were quite at different level (for greater amount). It is obvious that assumptions shown above are debatable.

It should be added that the budget process and the state budget may be viewed from standpoint of transparency and effectiveness. The situation assessment was mirrored both in the reports of international organizations and researches carried out by independent local civil society and press for a long period of time. Widely spread corruption in the state finances, especially in state budget expenditures, makes the use of the methods stated above particularly ineffective.

It should be understood that the budget may be analyzed from standpoint of budget matter organization. There are countries worldwide to run the budget rationally on the basis of effective institutions and mechanisms in line with standards of international organizations. Suffice it to mention the IMF "Code of successful experience of fiscal transparency", WB "State expenditures and financial statement", "The best experience of fiscal transparency" and "Budget management recommendations", "Organization of economic cooperation and development", etc.

It should be remembered that studies aimed at raising the effectiveness of the budget science and formulating recommendation documents are widely spread today in the countries rich in resources and resource gains. As matter of experience, I can say that the rational organization of the budget matter is dependent upon effective institutions and mechanisms capable of restricting "amateur performance" of appropriate governmental structures in the budget process.

Institutions and mechanisms are cited below:

- fiscal regulations that restrict a level of consuming resource incomes; a level of raising budget expenditures; a level of state debts, etc.;

- medium- and long-term strategic planning;

- medium-term scope of expenditures;

- goal-oriented budgeting based on strategic programs;

- precise and detailed regulation of budget process;

- transparency, accountability and effective parliamentary control, as well as public control;

- general public involvement;

- mechanisms of effectiveness and potentiality assessment.

Except for partial regulation of budget process, one can say it safely that none of the above-quoted institutions and mechanisms have so far been formed in our country, so we are still relying on Soviet-inherited traditional budgeting.

Our research showed that 52.8% of all budget expenditures in line with a preliminary state budget forecast made up "closed" expenditures whose structure remains unrevealed for the general public and even Milli Majlis MPs. Another example: governmental comments on the budget-2019 say that 41.6% of budget expenditures have been performed to comply with specific programs and goal-oriented projects. However, none of them is in keeping with strategic program-based budgeting requirements.

According to research, budget regulations are presently applied in 80 countries worldwide. For instance, our oil-rich neighbors - Kazakhstan and Russia have for more than 10 years applying budget regulations in the use of resource returns. As noted above, our country has begun applying the budget regulation in an attempt to restrict a level of oil and gas revenues spending. Time will show how effective the regulation proves to be.

It must be acknowledged that the use of medium-term expenditures in our Republic is going to start since 2020. With reference to the foreign experience, one can assume that the process is hard to activate. The World Bank studies are illustrative that many countries that meant to use РССР were a failure. As viewed by WB experts, the main reason of the failure is the lack of political will, serious attitude of governmental structures to the matter, reliable system of budget accountability of the government, quaified personnel, mechanisms of future budgetary results forecasting, as well as a high level of corruption. All things considered, we have to take into consideration all the factors above at the stage of РССР introduction and carry out necessary work on this track.

- What do you think has to be done to make the budget formed on the basis of not only oil revenues but on rise of the share of nonoil sector in the budget? What else has to be done to make the budget more updated, functional, profitable and sustainable?

- My previous answers detailed about the importance of the formation of necessary institutions and mechanisms for budget improvements. Along with this, the country needs system refortms in order to ensure the rational use of economic potentialities and economic resources of the country, the expansion of taxable base. In the first turn, the point is about meaures directed to rehabilitation of business environment and investment climate. It has to be kept in mind that some measures have recently been taken to improve the business environment and stimulate investments. However, it is insufficient to change the situation for the better. It is imperative to immediately start implementing institutional reforms as set forth in the Strategic Road Map. Below-cited are perspectives of the national economy of Azerbaijan:

- security and inviolability of property rights;

- supremacy of law and legality (equality before the law);

- independent and fair judicial system, prevention of rent-seeking enterprise;

- improvement of regulating environment (predictability of the behavior of state structures, decline from adoption of decisions affecting expenses and incomes; coming these changes into effect upon expiration of minimum 6 years after their adoption, etc.);

- competitive environment and effective application of bankruptcy institutions;

- expansion of economic freedoms and entrepreneurship;

- reforms in state enterprises and effective management of state-owned property, etc.

I"d like to emphasize that the state budget is a mirror of government"s economic policy. The state budget is reflective of the management of country"s economy and the state as a whole!