Our Analytics 18 april — 16:32

How to save Azerbaijani economy (Our analysis, Article four)

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BY MAMMAD EFENDIYEV, ELDAR ALIYEV, ELNUR MAMMADOV, ECONOMICS SECTION

Article 1

Article 2

Article 3

In our previously articles, we have also pointed out the vital importance of harmonising the principles for the compilation of individual elements of 'Macroeconomic Financial Statistics.' Because the harmonisation of the principles for the compilation of individual elements of such statistics provides an opportunity to coordinate among themselves indicators of various areas of financial statistics.

Only this way it is possible to achieve consistency between different sections of macroeconomic financial statistics, on the one hand, as well as between financial statistics and other areas of macroeconomic statistics, on the other, to create a fundamentally new opportunity to deepen the country's economic analysis with a view to clearly articulating its adequate economic policies. At the same time, it is impossible to construct such a model without coordinating individual variables characterising the macroeconomic financial system - the balance of current operations of the balance of payments, the deficit or surplus of the state budget, net foreign assets, international reserves, monetary base, money supply, etc.

On the problem of harmonisation of statistics

Gross Domestic Product (GDP) is a familiar indicator for all of us, but let's think about what this indicator means in general. GDP is the aggregate market value of all final goods and services produced in the economy (domestically) within one month/quarter/year. And now let us consider separately the meaning of each word of this definition.

Aggregate. GDP is an aggregated indicator that characterises total output, aggregate output.

Market. The cost of GDP includes only official market transactions, i.e. those that went through the process of buying and selling and were officially registered. Therefore, GDP does not include:

a) work for themselves (a person builds his own house, repairs an apartment, repairs his own TV or car, etc.);

B) work on a gratuitous basis (make a repair for a friend, bring a friend to the airport by car, etc.);

C) the value of goods and services produced by the shadow economy. The shadow economy includes those types of production and activities that are not officially registered and are not accounted for by national statistical and tax services.

Shadow economy, thus, covers not only illegal kinds of activities, but also quite legal kinds, whose profit is shadowed from payment of taxes. There are no direct counting methods for estimating the share of the shadow economy, and for this, indirect methods are usually used, one of which is additional money (cash) in circulation, that is, the amount of money in excess of those required for servicing official transactions. We wrote about this in detail in the second article.

Three methods are used to calculate GDP: by value added (production method), by income (distribution method), and by expenditure (end-use method). But regardless of the method used, the GDP indicator should be the same, since in the economy the aggregate income is equal to the aggregate expenditure, and the total value added is equal to the cost of the final output - these are the indices of GDP.

At the same time, the value of the final product cost is nothing more than the sum of the final consumers' expenses for the purchase of the aggregate product. For an in-depth economic analysis, the cost method is applied, since this method shows the relationship between the SNA - the system of national accounts, the SPF - the statistics of public finances (state budget) and the BOP - the balance of payments.

GDP, calculated by the end-use method, is the sum of expenditures of all macroeconomic agents, since in this case it is taken into account who acted as the final consumer of goods and services produced in the economy, who spent the funds for their purchase during a certain period. When calculating this method, GDP is determined by summing up expenditures:

GDP = consumer spending of households + public expenditure on the purchase of goods and services + domestic investment costs + expenditures of the foreign sector (balance between exports and imports of goods and services) (equation 1).

But we must take into account that during this period we are spending not the aggregate indicator of GDP, but the aggregate indicator of gross national disposable income (GNDI).

Let us understand the essence of the formation of the GNDI

In the creation of GDP, along with citizens of our country, foreign citizens also participate. In addition, our citizens participate in the creation of other countries' GDP. And all of their workd is paid in the form of a salary. In parallel, foreign companies invest in our economy in order to generate income. In turn, our companies also invest abroad to generate income. The total balance of all these factors is called 'the balance of primary incomes received by residents of the country from abroad' and is recorded in the 'current account' of our balance of payments in the column 'primary incomes.'

At the same time during this period we transfer abroad and receive from there on a free basis certain amounts. We receive goods and services from abroad as well, and we ourselves also render the same assistance abroad to others, etc. The difference between such operations is called 'current account balance received by the country's residents from abroad' and is recorded in the 'current account' of the balance of payments in the 'secondary income' column. It turns out that the GNDI is the indicator of the GDP, but adjusted for the amount indicated in the column of primary and secondary revenues in the current account of the balance of payments.

Let's resort to the help of mathematics, from which it is known: if we add equal values to each part of the equation, the equality does not change. Proceeding from this, we add the indicators of the balance of primary and secondary incomes to the left and right side of the equation:

1. If we take into account that on the right side of the equation the amount of 'balance between export and import of goods and services', 'primary incomes' and 'secondary incomes' by definition is a 'current account balance' of the balance of payments, we get:

GNDI = consumer spending of households + government spending on the purchase of goods and services + internal investment costs + current account balance (equation 2).

Let's take into account that, according to the SNA definition, gross national saving is defined as the difference between GNDI and final consumption, that is, the amount of consumer spending by households and government spending on the purchase of goods and services. Then, after simple mathematical calculations, we get:

Then equation 2 can be written in the following way:

GNDI - final consumption = domestic investment costs + current account balances. (equation 3)

From here it turns out: gross national saving = internal investment costs + balance of current operations of the BOP. (equation 4)

Therefore, the balance of current operations of BOP = gross national saving - domestic investment costs. (identity)

This identity, ultimately, means that the current account balance is the difference between gross national saving and domestic investment.

And now, based on the official figures of national savings and domestic investments from the 2014 SNA (the statistics of subsequent years suffers from a lack of completeness), we will calculate the balance of current operations of the balance of payments using this identity: 24.6 billion manats (national savings) - 16.2 billion manats (Internal investments) = 8.4 billion manat (current account balance).

At the then rate of the manat, 8.4 billion manats was about 10.4 billion US dollars. By the end of 2014 (according to official statistics of the CBA), the balance of current operations of the balance of payments was the same. At first glance, it seems that it turns out that harmonisation between the SNA and the PB exist, and we can only state this as a positive fact. Indeed, for the sake of fairness, we note that the State Statistics Commitee keeping statistics in the SNA complies in principle with the recommendations of the IMF, harmonisation within this system has been achieved. But in itself this identity is not of interest for deep analytical calculations that require a sectoral approach.

What is distorting the picture?

Azerbaijan's balance of payments for a number of years (2006-2015), compiled by the CBA, showed a stable and significant current account surplus (relative to GDP). This shows that the savings of residents of Azerbaijan were not fully invested in the country's economy. From the corresponding indicators of the financial account of the balance of payments, it can be seen that a large part of these savings was used to accumulate foreign assets by the private sector, in particular, the accumulation of cash foreign currency mainly US dollars. And this is already the least effective form of investment of assets, so we are actually financing the deficit of the US state budget.

Speaking about the structure of national savings, it should be mentioned that it is, on the one hand, the savings of government, and on the other - the savings of other sectors of the economy. It is known that investments in the economy are divided into state and private. Comparison of savings and investments carried out by public authorities and savings and investments of other sectors of the national economy allows one to explore how the economic activities of institutional units of various sectors of the national economy affect the balance of current transactions of the balance of payments. Taking into account the last two relations, the identity takes the following form:

National savings - investments = balance of current operations of BOP = (state savings - state management investments) + (savings of other sectors of the economy - investments of other sectors of the economy).

This identity linking the indicators of the systems of the national accounts (SNA), the balance of payments (BOP) and public finance statistics (SPF) shows that the balance of current transactions of the balance of payments consists of indicators reflecting relatively independent processes of saving and investing in various sectors of the economy.

In particular, this shows that even if the state administration implements domestic investments that exceed their savings, it does not necessarily lead to a reduction in the current account surplus, since domestic investments by other sectors may be significantly less than their savings.

In fact, this is the situation in the Azerbaijani economy. However, our SPF, which is maintained by the Ministry of Finance, is not compiled in full compliance with international standards. Thus, it is not only the magnitude of the difference in the savings of the state administration bodies and their domestic investments that remains unclear, but also its sign. With this in mind, the difference between savings and investment of government bodies over the period under review is likely to have a negative sign or a negligible positive value.

At the same time, as the SNA shows, all the above-mentioned years, the savings of the state administration were positive and reached enormous proportions. This is due to the fact that the compilers of these statistics also included state enterprises in the institutional sector of the state administration. True, the 1993 SNA compilation manual did not have a clear division of the 'general government' and 'public sector.' But since 2008, in a new edition, they are clearly separated in a new chapter designed to provide communication with public finance statistics, methods for determining the budget debt and budget deficit. And although in general for the economy, its savings do not depend on where indicated indicators are indicated, for the analysis of the balance of payments, the correct indication of the graph of the indicator has a huge analytical value.

Even more, in our view, the overall picture may be distorted by direct expenditures of the Oil Fund aimed at solving various state social problems that are not taken into account in the state budget. Although the fund is a separate institutional unit, it is essentially a state investment fund, which is managed by the head of state. The fund has a single function - the accumulation and management of financial assets. Spending its means on solving social problems is also the competence of the country's leadership. Therefore such expenses should be indicated together with official transfers from the fund to the state budget. So the IMF prescribes, so simple logic dictates.

(to be continued)

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