Oil wealth could meet social needs

Kenan Aslanli
Public Finance Monitoring Centre (PFMC)

Sixteen years after regaining its independence and moving to a market economy, Azerbaijan has yet to establish an adequate new system of social security. Large numbers of refugees and internally displaced persons create an even greater demand for social protection, while an ageing population is putting pressure on the pension system. The recent massive influx of oil revenues means the country can afford to meet social needs more effectively, but the share of state expenditure allocated to social spending remains highly insufficient.

Formerly a Sovietrepublic with a comprehensive state-financed social security system, Azerbaijanregained its independence 16 years ago and moved to a market economy, yet hasbeen unable to establish an adequate new system of social protection. People whoonce had access to all essential goods and services (albeit mainly of lowquality) must now confront the severe rules imposed by the market. The weakenedrole played by the state and the absence of a developed administrativeinfrastructure meant that in the post-Soviet era, the majority of thecountry’s people were largely left to solve their socioeconomic problems ontheir own. It is only during the last few years that the state has takensignificant steps towards ensuring the population’s social security needs, butuntil now these have failed to provide a full solution.

Soon after regaining its independence, in the early 1990s, Azerbaijan was thetarget of Armenian military aggression which led to the capture of 20% of thecountry’s territory. As a result, roughly one million Azeri citizens becamerefugees and internally displaced persons, forced to settle in new areas andcities. Today Azerbaijan has one of the world’s highest per capita proportionsof refugees and internally displaced persons, and it is expected that in 2007,social security expenditures targeted specifically to this sector of thepopulation will amount to AZN 150 million (USD 164.3 million), more than 2% oftotal state budget expenditures.

Another challenge that has faced Azerbaijan in recentyears as a result of a range of different factors – demographic composition,population/territory imbalance due to the military aggression, etc. – is thesurplus labour force and consequent high unemployment rate. At present, one outof every three economically active Azeri citizens is working in the RussianFederation or other Commonwealth of Independent States countries, where they arewelcomed as ‘cheap labour’. Expatriate workers send home an estimated USD 1billion a year, and these remittances are believed to comprise up to one quarterof the income of the average Azeri family.

Paradoxically, Azerbaijan has also begun to attract immigration as a result ofthe recent oil boom. The sudden influx of huge oil revenues has sparked fears of‘Dutch disease’, particularly with regard to such effects of this‘disease’ as rampant inflation. The establishment of a State Oil Fund toredistribute oil wealth through the national economy is aimed at counteractingsuch negative impacts. Nevertheless, the sting of rising inflation rates isalready being felt by the most vulnerable members of society: those with lowincomes and without social security.

Social protection expenditure: risingamounts, declining share

Between 2003 and 2007, budget expenditures on social security and socialassistance programmes increased almost threefold, reaching AZN 612.8 million(USD 671.2 million) in 2007. From 2003 to 2006, the average annual increase insocial security expenditure was 15% and represented the lowest rate of increaseamong all budget items. However, in 2007, social security expenditure increasedby a whopping 79.5% over the previous year. Despite this impressive growth inthe amount of money allocated, however, the share of budgetary expenditurerepresented by social spending tells a somewhat different story.

TABLE 1. Main indicators of socialsecurity and social assistance expenditure







Amount of social security and social assistance expenditure (AZN million)






Increase in amount of expenditure compared to previous year (%)






Share of total budget expenditures (%)






Share of GDP (%)






As can be seen in Table 1, the share of total budget expenditure allocated tosocial security and social assistance actually decreased from 16.8% in 2003 to9.0% in 2006. Although this figure rose once again in 2007, to 9.7%, this isstill a significantly lower share of budget expenditure than in 2003.

Social security and social assistance expenditure as a proportion of GDP alsodeclined annually between 2003 and 2006, until rising in 2007 to come close tothe 2003 figure, as illustrated in Table 1 and Figure 1.

During the last four years, 32% of the increase in social security expenditure,or AZN 127 million (USD 139.1 million), corresponded to an increase in pensionexpenditure, while 17.5% or AZN 70 million (USD 76.7 million) representedincreased allocations to social security measures for refugees and internallydisplaced persons. The remainder was related to increased spending on varioussocial assistance programmes and benefits targeting people with low incomes.

In 2003 the combined state expenditure on the four sectors considered tocomprise ‘social spending’ in Azerbaijan – namely education, socialsecurity and social assistance, health care, and culture and the arts –totalled 43% of all budgetary expenditures. In the 2007 budget, however, theshare of spending accounted for by these four sectors has fallen to 27.7%. Inthe meantime, the budget share allocated to investment expenditure has risenfrom 7.9% to 31%. In other words, more funds are being allocated to investmentsin 2007 than to the four major sectors that constitute social spending.

Pension reforms aimed at financial sustainability

Pensions are financed from the budget of the State Social Protection Fund(SSPF). The revenues entering the SSPF budget in 2006 totalled AZN 590 million(USD 646.2 million) while expenditures totalled AZN 562 million (USD 615.5million). The SSPF revenue sources are compulsory social insurance contributionspaid by employees and employers and state budget transfers. These transfersdecreased 10.2% in 2006 in comparison with 2005, but were subsequently increased67% in the 2007 state budget. The SSPF main expenditures are so-called labourpensions for retired workers.

Pensions are currently regulated by the Law on Labour Pensions that wasadopted on 7 February 2006. Workers are required to pay a mandatory socialinsurance contribution, which entitles them to old age pensions, disabilitypensions, or survivors pensions, paid to their families in the event of theirdeath. For those who have never worked, the state provides ‘social’ old age,survivors and disability pensions.

Like many countries in the world, Azerbaijan is faced with an ageing populationand thus an increasing proportion of pensioners. To confront this challenge, thePension Reform Conception wasapproved on 17 July 2001 by presidential decree. The stated goal of pensionreform is to develop a new pension system that is fair, financially sustainableand transparent, and in which the social services provided correspond to thelevel of participation of individuals in the social insurance system. The meansof fulfilling this objective was the introduction of individual social insuranceaccounts.

The ultimate goal is to establish a multi-pillar pension system with threecomponents. The first pillar is a pay-as-you-go (PAYG) system, based onintergenerational solidarity. In other words, the pension benefits paid out toretired workers are financed from the contributions of those who are currentlyworking and their employers. The second pillar would be a defined contributionscheme, based on individual accounts, as opposed to the defined benefit schemetraditionally implemented in Azerbaijan, while the third pillar would involvevoluntary private pension funds. Because the implementation of a multi-pillarsystem is a totally new undertaking for the country, it has sought the supportof the United Nations Development Programme and other internationalorganizations.

Social insurance contributions financewide range of services

The social insurance contributions paid by employees and employers also helpfinance
sicknessand maternity benefits, temporary disability benefits, funeral grants,unemployment benefits and child care benefits, while government fundingsubsidizes these and other social protection measures.

The Ministry of Labour and Social Protection provides general oversight ofsocial security services. Local branches of the Ministry are responsible foradministering social benefits, while the SSPF collects and manages contributionsand finances benefits.

The responsibilities of the SSPF include financing the following social securityand social assistance benefits and programmes, among others:

• Social assistance for temporary work disability
• Social assistance during pregnancy and childbirth
• Social assistance for childcare for preschool children
• Full or partial payment of hospital expenses for insured individuals
• Implementation of employment activities
• Implementation of social security measures for disabled persons
• Social assistance for funeral expenses
• Financing of social pensions with transfers from the state budget
• Social assistance for people with low incomes.

While there is no unemployment insurance system per se in Azerbaijan, monthlycompensation benefits are available to some unemployed people. The number ofunemployed people in the country on 1 October 2006, according to officialstatistics, was 54,700, which leads to an official unemployment rate of 1.4%. Ofthe total number of unemployed, 51.3% were women. Of the total number of peopleofficially registered as unemployed, 5.2% (2,864) were receiving socialassistance under the provision of the 2001 Law on Employment of the Population.The average monthly amount of social assistance paid for unemployment was AZN53.5 (USD 58.6), which is equivalent to 36.3% of the average monthly salary ofthe working population in September 2006.

Targeted assistance for vulnerablesectors

For the last two years the government has been implementing a system of targetedstate social assistance to strengthen the social security of families with lowincomes. This targeted assistance is financed from the state budget. It isprovided to families whose total combined income is lower than the minimumliving wage determined for the number of persons in the household, for reasonsbeyond their control, for instance, because of disabled family members, thedeath of a family member, a family member considered lost or dead by the courts,imprisoned family members, or the absence of information on the location of afamily member.

According to data from the first quarter of 2007, there were 45,527 families or207,148 people receiving targeted social assistance, and 4,740 of them werefamilies of refugees and internally displaced persons. At present, the averagetargeted assistance benefit payment is AZN 58.4 (USD 64) per family and AZN12.80 (USD 14) per family member.

Despite the efforts made in recent years to bolster the social security system,including initiatives like the pension system reform, the need for institutionaland financial reforms has not weakened. The country’s vastly increasingfinancial opportunities as a result of the influx of oil revenues means it canafford to meet social needs in a more comprehensive manner. However, the statebudget continues to lack an adequately social orientation.


Cabinet ofMinisters, <www.cabmin.gov.az>.

Capacity Building for the State Social ProtectionFund, <www.pensionreform.az>.

National Bank of Azerbaijan, <www.nba.az>.

Public Finance Monitoring Centre(PFMC),<www.pfmc.az>.

State Social Protection Fund, <www.sspf.gov.az>.

State Statistical Committee, <www.azstat.org>.


* One of the BCI components was imputed based on datafrom countries of a similar level.