Report No. 24890-AZ Azerbaijan Republic Poverty Assessment (In Two Volumes) Volume I : Summary and Conclusions June 4, 2003 Human Development Sector Unit South Caucasus Country Unit Europe and Central Asia Region Document of the World Bank Azerbaijan Republic: PovertyAssessment Acronyms ADB Asian DevelopmentBank MED Ministry o f EconomicDevelopment AIDPS Azerbaijan Intemally DisplacedPeople Survey MICS Multiple IndicatorsCluster Survey ARRA Azerbaijan ReconstructionandRehabilitationAgency MLSPP Ministry o fLabor andSocial ProtectionofPopulation ASLC Azerbaijan Survey ofLivingConditions MMR Maternal Mortality Rate ASSC Azerbaijan State Statistical Committee MOE Ministry o f Education AZM Azerbaijan Manats MOF Ministry o fFinance BEEP Business Environmentand EnterprisePerformance MOH Ministry of Health CDF CumulativeDensityFunction MTP ManagementTraining Program COM Cabinetof Ministers NBFI Non-BankFinancialInstitution CPI ConsumerPrice Index NGO Non-GovemmentalOrganization DFID Departmentfor IntemationalDevelopment OECD Organization for Economic Cooperation andDevelopment DOTS Directly ObservedTreatmentStrategy OPEC Organization ofPetroleum Exportng Countries DPT Diphtheria, Pertussis, Tetanus PPP Purchasing Power Parity EBRD EuropeanBank for ReconstructionandDevelopment PRSP Poverty ReductionStrategy Paper ECA Europeand Central Asia RDF Revolving Drug Fund EPI ExpandedProgramofImmunization SCR StateCommittee for Refugees EU EuropeanUnion SFDI Social Fundfor Development ofIDPs EXCOM ExecutiveCommittee SME Small- and Medium-SizedEnterprises FSU Former Soviet Union SPF Social ProtectionFund GDP Gross Domestic Product SPPRED StateProgramon PovertyReductionandEconomic GNI GrossNational Income Development GOA GovemmentofAzerbaijan ssc State Statistical Committee HBS Household BudgetSurvey SSPF State Social Protection Fund IDA InternationalDevelopmentAssociation UNDP UnitedNationsDevelopment Program IDP Intemally DisplacedPeople UNESCO UnitedNationsEducational, Scientific and Cultural IFC InternationalFinanceCorporation Organization IFRC InternationalFederationof RedCross andRedCrescent UNFPA UnitedNationsFundfor PopulationActivities Societies UNHCR UnitedNationsHighCommissionerfor Refugees 1LO lntemationalLabor organization UNICEF UnitedNationsChildren's Fund IMC InternationalMedical Corps UNIDO UnitedNationsIndustrialDevelopment Organization IMF InternationalMonetaryFund USAID United States Agency for IntemationalDevelopment IMR Infant Mortality Rate WFP World Food Program LFPR LaborForceParticipationRate WHO World HealthOrganization MDG Millennium DevelopmentGoal Vice President: Johannes F. Linn Country Director: Donna Dowsett-Coirolo Sector Director/Sector Manager Annette DixodMaureenLewis Task Manager: Michael Mills i PREFACE Azerbaijan has experienced impressive economic growth over the last seven years, butthe limited data available suggest that the impact on poverty has been only modest and mixed in nature. It is very likely that there has been some overall reduction in income poverty, especially in the rural areas, due to the successful farm and land reform program and the resulting expansion in agricultural production, At the same time, most non-income indicators o f poverty, including the quality o f health care and schooling, and also access to basic services, appear to have deteriorated. Inurban areas, there may not have been any significant reduction in income poverty, while the non-income indicators of poverty have clearly worsened, albeit to a lesser extent than inthe rural areas. The rapid expansion o f the oil sector has not generated much employment. Growth inthe non-oil sectors has been comparatively slow. As a result, many find themselves working in relatively low productivity and low income occupations. Also, unemployment has remained high, especially among the youth. However, the growth prospects for the country are strong, particularly with the expansion of the energy sector. But a substantial reduction inpoverty inthe future will require (i)the further development o f the non-oil economy, (ii) measures to increase employment and raise the productivity of the poorer members o f the community, (iii) the reform and strengthening o f basic services, includingeducation and health, and (iv) social assistance for those who are in need and who for various reasons are not able to take advantage of the opportunities offered by general economic growth. The Government has recently published the State Program on Poverty Reduction and Economic Development (SPPRED). This is a very welcome development and shows the commitment o f the Government to try to ensure that the country's projected economic growth is accompaniedby significant poverty reduction. The SPPRED and the World Bank's Poverty Assessment were compiled in parallel and in a participatory fashion, with considerable sharing o f data and analysis. There is, therefore, considerable consistency between them. However, they are each distinct documents with varying scope and focus. The PovertyAssessment Report is also accompanied by a separate Public Expenditure Review by the World Bank. It is my hope that these reports will complement the ongoing discussion in the country about the nature of poverty in Azerbaijan and the appropriate strategies for addressing it effectively. While it is our intention that these reports will prove helpful for the Government o f Azerbaijan, they are also intended to inform the broader civil society in the country as well as orient members o fthe extemal donor community. DonnaDowsett-Coirolo Country Director for Republic o f Azerbaijan SouthCaucasus Country Unit Europe and Central Asia Region The World Bank 1 AzerbaijanRepublic POVERTY ASSESSMENT Tableof Contents Volume I. andConclusions Summary PREFACE ................................................................................................................................................. .. 11 ACKNOWLEDGEMENT ........................................................................................................................ vi I. TakingStockofPovertyinAzerbaijan Summary and Conclusions ....................................................................................................................... 1 .............................................................................................. 1 A. Recent Trends.............................................................................................................................. B. The Challengefor the Future....................................................................................................... 2 3 11. A Strategy for Poverty Reduction A. BuildingOpportunities 1. Macroeconomic Policiesto Support Poverty Reduction ................................................................................................................ ...................................................................................................... 4 4 2. Private Sector Development B. Strengthening HumanAssets ...................................................................................................... 3. The Rural Sector................................................................................................................... 7 9 9 C. Protectingthe Vulnerable 2. Health.................................................................................................................................... 1. Education .............................................................................................................................. 12 14 D MonitoringofLivingStandards.................................................................................................. . 2. IntemallyDisplacedPeople 1. Social Protection................................................................................................................... ............................................................................................................ 14 .................................................................................................. 16 18 Volume II TheMainReport . PARTA. TAKING STOCK .................................................................................................................... 1 CHAPTER I:THE MAGNITUDEAND CAUSES OF POVERTY ...................................................... 1 Monetary Indicators ofPoverty 1. Measurement ofMonetaryPoverty....................................................................................... ................................................................................................... 1 2. Extent of Poverty.................................................................................................................. 1 3. Characteristics of the Poor.................................................................................................... 3 5 Correlates of Poverty ................................................................................................................... 12 Non-Monetary Indicators of Poverty ........................................................................................... 17 2. Malnutrition ..........................................................................................................................19 1. Health.................................................................................................................................... 18 4. Access to Basic Services....................................................................................................... 3. Education.............................................................................................................................. 19 5. Perceptions of Poverty.......................................................................................................... 21 22 IntemallyDisplacedPeople 1. The context andBackgroundto the IDPSituation ......................................................................................................... 23 23 2 . ............................................................... The PovertyProfile of IDPs ................................................................................................................................. .................................................................................................. 25 Conclusions 32 iii ..................................................................... AND LIVINGSTANDARDS INTHE 1990s......................................................................................... CHAPTER11: MACROECONOMIC DEVELOPMENTS 34 A. 34 Macroeconomic Developments 34 1. The 1990-1995Period........................................................................................................... ................................................................................................... 2. Developmentsin 1995-2001 34 . ................................................................................................. 36 B Employment ................................................................................................................................ .3 The PatternofGrowth in 1995-2001 .................................................................................... 38 2. Unemployment...................................................................................................................... 1. Labor ForceParticipation..................................................................................................... 41 41 43 45 4. Structural Changes inthe Labor Market 3. Labor Hoarding..................................................................................................................... ................................................................................ ............................................................................... 46 47 C. Trends inPoverty 5. Wages andIncomesfrom Employment ........................................................................................................................ 50 2. RuralTrends 1. National Trends......................................................................................................................... ..................................................................................................................... 50 52 CHAPTER 111: THE CHALLENGE A. Increasingthe Incomesofthe Poor: Macroeconomic Framework............................................. ....................................................................................................... 53 B. Meetingthe MillenniumDevelopmentGoals............................................................................. 53 58 PARTB: RESPONDINGTO THECHALLENGE ................................................................................ 61 CHAPTERIV: BUILDING OPPORTUNITIES A. Macroeconomic PoliciesandPrivate SectorDevelopment......................................................... .................................................................................... 61 61 2. Development of Small-, Medium-Sized and Micro Enterprises 1. MacroeconomicPoliciesto SupportPovertyReduction...................................................... 61 3. Legal, Regulatory andAdministrative Framework ........................................... 62 64 4. ............................................................... 5. ImprovingAccessto Basic Services: Electricity Access to Finance. BusinessDevelopment andTraining 66 6. Advocacy GroupsandAssociations ..................................................................................... .................................................................. ..................................................... 68 68 B The RuralSector.......................................................................................................................... . 7. Labor RedeploymentPrograms ............................................................................................ 69 2. EnsuringSustainableIncome Growth from Farming 1. ImprovingPublic Services....................................................................................................70 71 72 3 Advisory Servicesand Agricultural Research 73 4 5. Micro Credit Facilities for Farmers...................................................................................... .. ........................................................... Agricultural Marketing andLandMarkets ........................................................................... ...................................................................... 73 6. Irrigation............................................................................................................................... 74 7. Non-agricultural Employment inthe RuralAreas 74 8. Agriculture andthe ExchangeRate ...................................................................................... ................................................................ 76 77 9. Public Spendingon Agriculture ............................................................................................ 78 CHAPTERV: STRENGTHENING HUMANASSETS A. EducationSector.......................................................................................................................... ........................................................................ 81 81 1 Overview 81 2 Spendingon Education ......................................................................................................... 82 3... ............................................................................................................................... .......................................................................................................... 4. Determinants andPatternso fEnrollments Educationand Poverty 85 5. Major Issues.......................................................................................................................... ............................................................................ 87 89 iv B Health.......................................................................................................................................... 92 . . 2. Access to Health Services..................................................................................................... 1 HealthStatus......................................................................................................................... 92 3. Primary HealthCare 99 101 4. Health ServiceManagementand Financing ......................................................................... 103 CHAPTER VI: PROTECTING THE VULNERABLE .......................................................................... A. SocialProtection.......................................................................................................................... 106 1 SocialProtectionandPoverty............................................................................................... 2 SocialAssistance .................................................................................................................. 110 3 113 B. Internally DisplacedPeople......................................................................................................... 4.... 106 106 Social Insurance .................................................................................................................... Government Strategy ............................................................................................................ 115 120 2. LandandRelocation............................................................................................................. 1 Public Expenditurefor IDPAssistance................................................................................. . 120 3. Employment Programs .......................................................................................................... 121 122 V ACKNOWLEDGEMENT This Poverty Assessment Report was produced by a team led by Michael Mills. The sectors covered by the team members were as follows: poverty profile, Cornelia Tesliuc and Grazina Binkauskiene; macroeconomic analysis, John Holsen (in conjunction with Christian Petersen, Nina Budina and Thilakaratna Ranaweera for the macro-economic projections); labor market, Arvo Kuddo; private sector development, Gerhard Botha and Zeynep Kudatgobilik; agriculture and the rural sector, KarinFock andDavid Sedik, education, Halil Dundar; health, John Holley, RasulBagirov and Cornelia Tesliuc; social protection, Arvo Kuddo and Cornelia Tesliuc; and internally displaced people (IDP)s, Steve Holtzman, SubramanianJanakiram, Attila Hancioglu and Cem Turaman. The report was jointly compiled by MichaelMills, Cornelia Tesliuc andJohnHolsen, with support from CarmenLaurente. The mission would like to extend its sincere thanks to the Government, and especially to the PRSP Secretariatand the PRSP Working Groups, all of which interactedvery intensively with the World Bank team. It would also like to commend the State Statistical Committee particularly for its strong collaboration, and especially for the carrying out of the Household Budget Survey, upon which many of the findings of the poverty assessment are based. The team would like to thank all o f the other Government officials and national experts, who contributed so generously o f their time and ideas to assistingtheteam to tryto understandthe poverty situation inthe country. The mission would also like to acknowledge with many thanks the other international agencies which collaboratedclosely with this work. Inparticular, the Asian Development Bank andUNICEFwere both partners insupporting the Household Budget Survey carried out by the State Statistical Committee. The UNDP worked very closely with the Poverty Assessment team and in particular co-sponsoredthe survey of InternallyDisplacedPeople, which was also supported by the UNHCR. The FA0 Cooperative Program played a major role inthe analysis of the rural sector, and the WHO coordinated its Health In Transition Reportwith the review ofthe health sector. vi AzerbaijanRepublicPovertyAssessment Summary and Conclusions I.TakingStockofPovertyinAzerbaijan Poverty remains a major challenge in Azerbaijan. Azerbaijan is a country with about 8 million population and per capita gross domestic product (GDP) in 2001 of $709 (current dollars). Almost 4 million people or about 50 percent of population of Azerbaijan lived in poverty in 2001, consuming less thanAZM 120,000 per capitaper month. Among these, a group of 1.3 million persons, or 17percent of the total population, lived inextremepoverty, with monthly consumption below AZM 72,000 per capita per month. Income poverty is spread throughout all parts of the country, although the provincial towns appear to be of increasing concern. The results o f the Household Budget Survey in Year 2001 suggest that the incidence of income poverty among urbanhouseholds may perhaps be even greater than among rural households, with the majority ofthe poor now livinginurbanareas where poverty is associatedwith limited employment opportunities inthe formal economy. The current low level o f public services in rural areas of Azerbaijan has led to substantial rural-urban migration, but the migrants are not usually immediately employableandfind employmentonly inlow-payingjobs. Within the urbanareas, there are significant differencesbetweenthe poverty rates inthe capital city and the rest, with a poverty risk being higher inthe provincial towns than inBakuCity (although Bakuhas the largest group o f poor due to its size). Inthe rural areas, income poverty rates may be somewhat lower, due largely to the benefits o f the land reform program. The risk o fbeingpoor is fairly similar acrossthe nineregionso fthe country. The available household data suggest some particular demographic characteristics of the poor, althoughthepattern ofpoverty is mostly quite d i m e . The risk of poverty increaseswith householdsize, for both total poverty and extremepoverty. Specifically, the poverty headcountis higher for a household with six or more members. Incontrast, the number of children per household is a weak discriminator o f the risk ofbeingpoor, as householdswith children tend to live inextended households, where the elderly take care of children. The age o f the householdhead is also a poor predictor of the risk of poverty, with two notable exceptions: the households headed by younger and older heads. There are no significant differences inthe poverty rateby gender ofthe householdhead; while there is a negative, but so far rather weak, relationship betweenpoverty and the educational achievemento f the householdhead. The risk of income poverty is higher for households headed by unemployed workers though the largest number of poor live inhouseholdsheaded by employeesandbypensioners. vulnerablepeople, as they lack assets and their livelihood depends heavily on state transfers and donor It is clear is that the Internally Displaced People (IDPs) are a core group of particularly assistance. It also appears that the IDP population in Baku is o f particular concern, as they tend to be significantly worse-off than the rest of the population in the capital city. However, there is some uncertainty about the extent of income poverty among the IDPs compared to the general population. According to the national household survey results, individuals living in a rural IDPhefugee household are more likely to bepoor thanthe average. A possible reasonfor this may be because IDPsandrefugees did not receive land and other agricultural assets inthe farm privatization process. However, the results of a more detailed survey focused on IDPs suggest that they do not seem to have significantly lower incomesthanthe other groups inthe same areas with whom they were compared, although the survey did find some substantialdifferencesamongthe income levels ofIDPs. There are also serious concerns about the non-income indicators of poverty, including the quality of health care and education,and access to basic services. Azerbaijan's official health indicatorsare still mostly better than in many countries of a similar per capita income, but there are major doubts about the quality o f the official statistics especially with the increasing reluctance of many people to use government health facilities. Survey data suggest that the actual rates o f infant and maternal mortality may be considerably higher than officially reported. A recent survey also found that in Year 2000, nearly 20 percent o f the children were suffering from stunting, with rates as high as 27 percent for the children from the poorest quintile, down to 13 percent for those belonging to the richest quintile. Although Azerbaijan is still very close to achieving universal primaryeducation, school enrollment rates decreased a little duringthe period 1995-2000 and almost 50 percent o f children now drop out of school by the age of 16-17. In particular, the quality of schooling needs to be improved. Rural households in particular have poor access to public services, especially electricity and gas supplies for heat. A. Recent Trends The economy of Azerbaijan has been growing quickly in recent years due to the Government's reform program and the signing of the production sharing agreements with foreign oil companies. Overall labor force participation rates are now relatively high, and there have been some significant structural changes in the labor market, with a rapid movement o f workers from the state to the private sector. However, labor force participation rates are significantly lower in the urban areas than in the rural areas, and unemployment has remained high. The rapid expansion of the oil sector has not generated much employment and there has been comparatively slow growth in the non-oil sectors of the economy.. Unemployment is particularly high among the youth and those with secondary special and vocational education, and non-participation in the labor force has become more widespread. Labor hoarding has also beensubstantial inmany firms, where productivity and income levels remainvery low. While data limitations preclude direct comparisons and rigorous analysis, rough estimates and anecdotal evidence suggest that the economic growth has probably had some modest impact on income poverty. Inthe first place, it is clear that real per capita consumption has been increasing in the last few years. Second, some very limited comparisons can be made between the results o f the 1995 Survey o f Living Conditions and the data from the ongoing Household BudgetSurvey (HBS) now beingcarried out by the State Statistical Committee, even though these surveys are not comparable inseveral major ways. Specifically, the results o f the H B S survey in Year 2001 suggest that there may have been only a small increase in overall inequality since the mid-1990s. Ifcorrect, then one can estimate the extent of poverty in 1995 usingthe data from the 2001 survey and the economic growth performance in the period 1995- 2001. Compared to a poverty rate of 50 percent in2001, the simulation for the comparable rate six years earlier would have been considerably higher, at about 76 percent. Third, the results o f another simulation exercise for the agricultural sector suggest that from 1995 to 1998 real rural expenditures per capita increased by nearly 10 percent, lowering the poverty headcount by 3.9 percentage points; and that from 1998 to 2001 expenditures per capita increased 5.7 percent and the poverty headcount decreased by 2.2 percentage points. These simulations are only indirect evidence on likely income poverty trends, and so the results of the HBS in Year 2001 need to be used as a benchmark for measuring future poverty changes. Whether or not income poverty has indeed decreased in recent years, it is clear fiom consultations with thepoor that manypeople are still very dissatisfied with their income levels and living conditions. Poverty is associated in the minds o f many people as being due to a variety of factors, including the Karabakh war and the subsequent displacement o f families and communities, the introduction of a market economy in Azerbaijan and the slow adjustment to new commercial practices, 2 andthe closure or reduction of the Government's centralizedcontrol over production and services. While the loss of employment opportunities is the primary concern of the poor, there is also clear evidence of a continued deterioration in many public services (notably gas, water supplies and heating, in the second halfof the 1990s,just as they hadfrom 1990 to 1995. This is especially the case in the rural areas. B. The Challenge for theFuture signiJicant impact on poverty over the next decade if appropriate policies arefollowed. The oil and gas The macro-economic outlook for Azerbaijan is positive, and it should be possible to have a windfall should be of major benefitto the country and its citizens and could contribute to lasting poverty reduction andraising incomes. As a base or "middle" case, the World Bank is projecting that the average annual growth rates during2001-2010 for total GDP could be 13 percent, with oil GDP growing at 21.5 percent and non-oil GDP growing at 6.3 percent. In this base case, the proportion of the population falling below thepoverty line would dropfrom 50percent to 36percent, assuming no change in income distribution. However, in contrast to the projectednon-oil GDP growth rate o f 6.3 percent, it needs to be remembered that value added in the non-oil sectors grew at an annual rate of only 3.8 percent in the period 1995-2000. Thus both policy improvementsand institutional strengtheningwill be needed if this 6.3 percent growth rate for the non-oil sectors is to be accomplished. It should also be noted that even with this rate of non-oil sector growth, there would still be over one third of the population below the poverty line inYear 2010. If rateofgrowthinthenon-oilsectorweretocontinuetogrowatonlyabout4.0percentinthe the period up to 2010, then the growth rate of total private consumption would only be 1.9 percent, and the per capita private consumption growth rate would drop to 1.0 percent, andtotal poverty would still be as high as 44 percent in2010. Incontrast, for the proportion of the population below the poverty line to be reduced to 22 percent by the end of the decade, the growth rate o f the non-oil economy would need to average9 percentthroughout the 2002-2010period. This would permittotal private consumptionto grow at an averageannualrate of 5.7 percentandper capita consumption byhouseholdsto grow at 4.8 percent. Ifthis9percentgrowthratefornon-oilGDPcouldbesustained,theproportionofthepopulation classified as in "extreme poverty" would fall to 4 percent. Forpoverty tofall even to one third of the population by the Year 2010, it will be necessaryfor the Government to take active steps to ensure that the growth rate of the non-oil economy does accelerate, and thatparticular measures are taken to ensure thatpolicies are adopted in specijkfavor of thepoor. In addition to the targetsfor reduction in incomepoverty, Azerbaijan has a challenge to meet all of the Millennium Development Goals.' For some targets, such as infant mortality, maternal mortality, the prevalenceofHIV, progresswill be difficult to measure, unless a major effort is madeto improvethe accuracy of the statistical data-base. For example, administrative and survey data tend to disagree about the extent to which infantand maternal mortality have been reducedsince the 1990s. Similarly, there is uncertainty about the true extent of HIV/AIDS. One particular area where progress is clearly insuflcient is in access to safe water in rural areas. In largetowns, about 96 percent of households have access to safe water, and in small towns, the figure is about 81 percent. Incontrast, in the rural areas, only 11percent of the households have access to treated, pipedwater and virtually no progress has been achievedinthe lastten years. ' Between 1990 and 2015, the Millennium Development Goals (MDGs) include: halving income poverty and hunger, achieving universal primary education; gender equality in primary education; reducing under five mortality by two thirds; reducing matemal mortality by three quarters; reversing the spread of HIV/AIDS; ensuring environmental sustainability (includinghalvingthe proportionofpeoplewithout access to safe water); anddevelopingaglobalpartnershipfor development. 3 11. A StrategyforPovertyReduction Reducing poverty in Azerbaijan is a substantial challenge, but it can be achieved through increased employment andproductivity in the non-oil economy, measures to strengthen and improve the provision of basic services and inffastructure, and theprovision of well-targeted social assistancefor the lessfortunate members of the society who are less able to take advantage of the opportunities offered by the growth of the economy. The sustaining of economic growth will be critical, but it has to be accompaniedby targetedprograms,focused on education and health programs and social assistancefor those most in need. A. BuildingOpportunities. 1. MacroeconomicPolicies to SupportPoverty Reduction. Poverty reduction in Azerbaijan requires continuing theprogress being made in increasing total GDP, and also changing thepattern of growth so that it makes a greater contribution to improving living standards. Key to this will be the generation of sufJicient employment opportunities in the more highly productive economic activities, especially in non-oil industry. Growth inaverage productivity per worker will depend on "within-sector" productivity increases and also on the movement o f workers from lower productivity to higher productivity activities. Unfortunately, in recent years, the movement o f labor has been in the opposite direction. Between 1995 and 2001 employment in agriculture and service activities (where output per worker is well below the level innon-oil industry) increased by 28 percent, while employment innon-oil industrydeclined by 7 percent. Employment innon-oil industrywas, in2001,less than half o f the level in 1990. This "deindustrialization" trend characterizes the 1995-2001 period, when the economy was recovering, as well as the 1990-1995 period of economic decline. To reduce poverty will therefore require macro-economic policies that have two objectives: to promote internal and extemalJnancia1 stability and also to encourageficrther structural change in the economy. The first objective is needed as inflation adds to social inequities and also reduces the efficiency o f entrepreneurs and markets in mobilizing and allocating resources. The income from oil exports also creates serious issues in the management o f foreign exchange inflows, due to the potential effect on the manat (AZM) exchange rate and the danger o f "Dutch disease".* This means finding the rightbalance between increasesinthe money supply, increases in internationalreserves, net credit to the budget, and increases incredit to the enterprise sector. However, macro-economic policies will also need to encourage further structural change in the economy, as the growth o f the non-oil sector will require productivity gains through resource shifts to more productive firms and activities. Such structural change will be needed even to accelerate the real growth rate in non-oil output from the recent figure o f 3.8 percent annually to the base case target o f 6.3 percent annually, which would be required for poverty to come down to 36 percent o f the population by the Year 2010. Policy change would need to be extremely strong and determined for the structural changes to be sufficient to increase the growth rate inthe non-oil economy to 9 percent throughout the 2002-2010 period, which would reduce the proportion of the population inpoverty to 22 percent by the end o fthe decade. Policv Recommendations on Macroeconomic Policies Poverty reduction in Azerbaijan requires both continuing the progress being made in increasing total GDP and, at the same time, changing the pattern o f growth so GDP growth will make a * The impactof oil revenuesonthe budget is examinedinthe PublicExpenditureReviewReport. 4 greater contribution to improving living standards. The growth strategy should emphasize creatingproductive employment opportunities inthe non-oil sectors o fthe economy. Macro policies will have to continueto promote internal financial stability, as inflationboth adds to social inequities and reduces the efficiency o f entrepreneurs and markets in mobilizing and allocating resources. 0 More attention needs to be given to both`the costs and the volume o f credit to the enterprise sector, as restoring the volume and reducing the cost of banking system credit to the enterprise sector could make a major contribution to the expansion o f non-oil GDP. Improving credit to small and medium commercial and industrial activities could be important in restoring output, employment and productivity inthese relatively labor intensiveactivities. 0 Due to the potentialdanger of "Dutch disease" on the non-oil economy, resulting from the foreign exchange earnings from oil exports, it will be important to manage the Oil Fundina manner that ensures that the country's producers are competitive with imports and in export markets for a wide range of import substitutes and exported goods. The growth o f both agriculture and non-oil industry will depend substantially upon improving their competitiveness, which in turn will depend uponbothstructural reforms and an appropriate exchange rate. 2. Private Sector Development. Sustainable poverty reduction in Azerbaijan will depend on positive economic growth based on a vibrant private sector, resulting from a more liberal business environment, betterfinancial intermediation and the availability of credit to the enterprise sector, a clear legal framework, the implementation of the privatization program, the elimination of critical infrastructure bottlenecks, and investment in human as well asphysical capital. Poverty in Azerbaijan is associated with insufficient employment opportunities and earnings in the formal economy, and reflects the unfinished restructuring agenda of the industrial complex inherited from the Soviet era. The private sector can provide the necessary employment creation and higher incomes, and also the tax base for the sustainable funding o f key public services which impact positively on the poor. So far, however, the emerging private sector is too small to compensate for the collapsed industrial base. Private sector development will only occur in a favorable business and investment environment. Improvingthe business environment for local entrepreneurs and for non-oil sector foreign direct investment is essential for broad-based growth. The overall business environment inAzerbaijan is important to all entrepreneurs. However, certain aspects of the business environment impact disproportionately on small- and medium-sized enterprises and micro enterprises, which in turn impact disproportionately on poor people, due to presently restricted employment opportunities (including self- employment opportunities) inthese sectors. To develop Azerbaijan 's micro, small- and medium-sized enterprises, including in agro- processing, tourism and manufacturing, measures need to be taken to improve the business climate, increase access to credit and address some of the infrastructure constraints. Specifically, steps also need to be taken to reduce the administrative barriers, especially in simplifying and speeding up the processes for the registration and licensing o f new legal entities, NGOs and non-bank financial institutions. To reduce corruption, there also needsto be a strict limit on the number o f inspections by officials, as well as enforcement of the administrative policies with criminal provisions against officials who abuse their authority duringinspection. The tax and customs rules need to be applied in a guaranteed, consistent and uniform way, and the forms and the processes used for the submission o f taxes should be simplified. Finally, it will be important for the Government to liaise further with representative entrepreneur groups business advocacy groups. 5 Policv Recommendations on Private Sector Development 0 The Government should, in close consultation with all interested role players, develop a comprehensive strategy for the promotion o f the SME and micro enterprise sectors, with due consideration o f the specific constraints which exist for these sectors. However, the Government should, as far as possible, limit its role to creating a favorable environment and not become dominant inthe commercial sphere. 0 There is need for the Government to streamline the business registration procedures, including simplifyingand speeding up the processesfor the registration and licensing of new legal entities. The number o f inspections o f all levels o f officials should have strict limitations in terms o f frequency, supported by an effective monitoring system and enforcement. There is also need to enforce the administrative policies and criminal provisions in respect to officials who abuse their authority duringinspection, particularly inrespectto rent seeking. 0 The essence o f the tax legislation needs to be made available in an easy and understandable fashion, inwriting and inwell publicized locations. Guidelines and interpretative administrative provisions need to be issued for assisting tax administrators in the application o f the tax code. These provisions should be made available to the public. Even the simplification o f the forms andthe process for the submissiono ftaxes would be of substantial help to smallentrepreneurs. 0 The customs legislation should be made available in an easy and understandable fashion, and again there should be a guaranteed, consistent and uniform application o f this legislation. Professional chartered agents should be licensed to facilitate the process of importing goods, supported by a strictly enforcedCode of Conduct. 0 The Government should refine and enforce the procedures to speed up the registration o f collateral in respect to privatized enterprises. Preferably, there should be no distinction between various classes o f property, and all property should be registered in a central registry. The efficiency and transparency inrelationto the registration and execution o f collateral also needsto be improved; and legislative changes shouldbe made to allow crops to be collateralized. 0 The authorities should work with all parties, including the service providers, to ensure that electricity is supplied to consumers in the business community in a consistent and predictable manner, even ifa permanent supply cannot be guaranteed. 0 The Government is encouraged to liaise with representative entrepreneur groups, business advocacy groups, such as the Business DevelopmentAlliancs! and the National Confederation for Employers (specially in relation to matters affecting SMEs), but particularly those representing the microenterprises andmicroentrepreneurs. 0 The Micro Finance Forum presently being formed, should be encouraged and have regular and official accessto appropriate Government officials. 0 The regulatory framework governing the access o f SMEs to the services provided by natural monopolies and utilities needsto be strengthened; and the tariffs o f monopolies (such as railways and the energy sector) need to be transparent, fair, well published and accessible, and without any prejudice to the particular interests o f small entrepreneurs. The Government should also proceed 6 with the corporatization and privatizationof any state-owned enterprises which presentlyact as a barrier to the entry of new business. 0 The Government is encouraged to develop a favorable environment for managerial training capacity in Azerbaijan to meet the demand o f the S M E sector in upgrading managerial skills. Such training programs should be targeted to practicing managers and to solving the current managerial problems of SMEs, provided by trainers who have managerial and consulting experience, be fee-based to reflect demand, provide opportunities for foreign internships, and be longer-term (couple of months) executive education as well as short-term (one-two weeks and less) awarenesscourses. 0 Inmany cases, local governments also needto take actionto deal with policy issues and barriers to private sector development, particularly inthe areas o f localregulations and govemance and in promotingtrainingand education locally. 0 An evaluation of labor market programs should be carried out to examine whether the resources currently being spent by the Government are being efficiently utilized, and whether the programs are having the intended impact on the reduction of poverty and unemployment. In general, the employment programs shouldbereorientedtowards counseling andjob search assistance. 0 There is need for a nationwide labor force survey, so that the labor market can be thoroughly analyzed as part o f a move from supply-driven to demand-driven employment policies. 3. The Rural Sector. The ruralpoverty reduction strategy should aim at improving the incomes +om agriculture of the poor rural population. However, it should also emphasize the development of non-agricultural activities, such asfood processing and services in rural areas. Out o f the poor population o f 4 million individuals in Azerbaijan, 1.7 million live in the rural areas and the rural population is heavily dependent on agriculture. In the rural areas, much o f the population avoids income poverty through the production and home consumption o f food. However, many people are still below the poverty line, and there i s a general lack o f adequate access to basic services and infrastructure. As agriculture is the major source o f income for rural households, and as the contribution o f agricultural income to total income is higher for non-poor rural households, reliance on agriculture as major source o f income is associated with a lower risk o f poverty. However, as market forces continue to shape Azerbaijan's agricultural sector, there may also be further consolidation o f land and farming to increase agricultural productivity, with possible implications for both unemployment and income inequality in the rural areas. Accordingly, a rural poverty reduction strategy also needs to emphasize the development o f non-agricultural activities, such as food processing and services in rural areas. For poverty reduction, actions in several areas are now needed. First, investments are needed to address the deficiencies in the supph of public services in the rural areas. These are an obstacle to poverty reduction because the inconvenience of life without heat, electricity and sewage systems in rural areas discourages both people and businesses from locating there and from carrying out new economic activities. Improvements are also needed in the technology of agricultural production and marketing in private and householdfarms. Most farms use few inputs, have low and quite variable yields, and usually market only locally. This constrains net revenue generation. It is also very risky, as a dry season can cause a crop failure, which can plunge even a successful farmer into poverty. However, Azerbaijan produces fresh fruit and vegetables, which could be sold for higher prices in Russia or other northern countries by selling either through marketing cooperatives or through direct contracts with exporters or 7 processors. The main irrigation canals o f Azerbaijan have deteriorated since Soviet times and the smaller canals and distribution systems are often unusable. Moreover, farm privatization has meant that farmers themselves are responsible for the upkeep and control of the water distribution system through water user associations. Since 75 percent of cropped land in Azerbaijan is supposed to be irrigated, the deterioration of the irrigation system is of vital importancefor farming in Azerbaijan. Such deterioration needs to be reversed. Theprospectsfor non-agricultural employment in rural areas also needs to be enhanced. This will require similar measures to be taken in improving the business climate, increasing access to credit and addressing the infastructure constraints as discussed abovefor small and medium-sized enterprises generally. Non-agricultural employment ranges from retail stores, to food processing industry, to trade and other industry. An important part of non-agricultural employment could come from food processing, which used to be an export industry in Soviet times. However, production fell further than that of agriculture, and the industry has been slow to recover. Now many rural households in Azerbaijan are dependent on the recovery o f food processing, both as demand for agricultural production and export, and for employment. Thus, problems inthe food industry impact on rural households directly. There is also concern about the loss o f the competitive position o f domestically produced tradable goods as a result of currency appreciation connected with the oil boom. Since agriculture is a potential export sector and since foreign food products compete with domestic food products on Azeri markets, an excessive exchange rate appreciation would have a depressing effect on incomes in rural areas, due to losses of domestic and foreign food markets. Public spending in the agricultural sector also needs to be reviewed to assess in more detail its efficiency and impact on the poorest groups. Some o f the key priorities for poverty reduction relate to establishing information and advisory services for private farming, reforming the existing agricultural research system, rehabilitating the irrigation system where economically justified, supporting the development o f the rural credit system, consolidating the system o f land registration to support land market development, and establishing and strengthening veterinary diseasecontrol. Policv Recommendations for The Rural Sector 0 There is need to test a variety o f models for providing advisory services to farmers and for establishing such centers in each economic region. These could include private sector involvement, and should allow for a high rate cost recovery o f service though with special provisions to protect the poorest so that they could also benefit from them. Market information systems need to be set up for farmers and the information disseminated through the press and other outlets such as the advisory service system. Apart from technicaltraining, businesstraining and marketing shouldbe included inthe spectrum o f advisory services. Consideration could be given to sponsoring trade promotion fairs and seminarswithinand outside Azerbaijan to introduce Azeri products to new markets. 0 The system of agricultural research needs to be restructured in accordance with the needs of private farmers. Sufficient public funding should be allocated for agriculture research perhaps through a competitive research grant system. The dissemination o f agriculture research results should be ensuredthrough the extension system. 0 There is need to develop a feasible plan to restructure and rehabilitate the irrigation system and pursue irrigation rehabilitation on the basis o f economic viability. User charges for irrigation systems need to be applied and extended without excluding the poor from using them. Inparallel, an institutional reform should be carried out o f irrigation management systems at the community, 8 district, regional and central level. Private specialized technical support is needed for the formation of water user associations. 0 The performance of micro-finance schemes in Azerbaijan and in the region should be reviewed, and a strategy designed for the provision o f micro-finance services that are financially and operationally feasible and targeted to the poor. Ifthe analysis justifies it, State funds could be allocated to the establishment o f a revolving fund for privately implemented and financially feasible micro-credit schemes. 0 Steps need to be taken to ensure that land titles actually reach land owners, rather than local officials. 0 The veterinary services to be delivered publicly should be defined, and the state services restructured accordingly. 0 To generate more off-farm employment, there is need to improve the business environment, such as through simplifying the business licensing process for agro-business, reducing the processing time, and makingthe system more transparent. In addition, steps need to be taken to break the prevailing culture of individual rent seeking at local and central levels, and the malfunctioning judiciary system. 0 The present situation and needs of agro-processor's need to be presented to officials from the Government, banks andother services suppliers, as well as raw material suppliers and clients. 0 Business training programs are needed to increase non-farm employment in areas such as handicrafts, wood products, rural tourism, etc. Such training programs could involve grants for market studies for such products and services. 0 Investments are required in improving rural infrastructure (electricity, heating, roads, drinking water, social infrastructure, communication) with clear priority setting and coordination with lower level entities to ensure an impact on rural areas. In addition to large-scale infrastructure investments, small-scale investments could also improve living conditions. Even poor communities can afford some of these investments and would benefit directly. Technical assistance needs to be provided to municipalities to improve the delivery of municipal services and infrastructure incompliance with economic principles and community priorities. B. StrengtheningHumanAssets. Ifa relatively high growth rate can be maintained long enough to largely eliminate "disguised employment" and if the incomes of the less skilled and relativelypoorly paid workers therefore increase, the economic growth will contribute SigniJicantly to the reduction in poverty. But even so, some individuals-because of factors such as age, geographicallocation, health, skills and culture-will not be able to take aa'vantage of the opportunities offered by general economic growth. Another element of the national poverty reduction strategy therefore needs to be programs which focus particularly on the education and healthof the children inpoorfamilies, so when these children grow up they will be better able to take advantage of the opportunitiesavailable. 1. Education. Increasing the level and qualily of education is a key strategyfor thepoor to move out of poverty. Azerbaijan still maintains a highlevel o f e.nrollment rates incompulsory education 9 (grades 1-9) across the country, regardlessof gender, socioeconomic status, or ethnicity, but the quality o f education has deteriorated considerably inrecent years. Student and teacher absence rates have become a serious problem in compulsory basic education, affecting the quality of basic education, but this problem has not been captured by official enrollment statistics. The quality of basic and secondary education has also deteriorated sharply due to the lack o f textbooks and basic teaching and learning materials, poor teacher training, and poor physical infrastructure. The enrollment rates at the non-compulsory levels (including preschools, upper secondary education, and VET) have declined sharply, especially in poor regions and rural areas, and the poor are likely to be affected most from these sharp declines. Poor students are also likely to be excluded from attending higher education institutions because o f the increased direct costs of higher education. The main bottleneckfor the poor is at the upper secondary and higher education levels. The poverty reduction strategies through education therefore need tofocus on improving the access of the poor to upper secondary (including selected post-secondary VET programs) and higher education through targetedpolicy intervention. At the basic education level, the main problem appears to be the rapid deterioration of the quality o f teaching and learning environment in which poor children are disadvantaged due to the lack o f basic teaching and learning materials and poor teaching staff, especially inrural areas and poor regions. The low quality ofbasic education is not only affectingthe probability of the access of the poor to upper secondary and higher education, but it is also affecting labor market outcomes, since the poor are less likely to be equipped with the right skills and knowledge demanded ina market economy. As a consequence, poverty reduction strategies through education also need tofocus on the preservation of traditionally high access rates in basic education, while improving the quality of teaching and the learning environment. Policy Recommendations on Education 0 Although primary and secondary education institutions are still available across the country, particular attentionneeds to be given to maintaining the coverage and quality o f upper secondary education becauseo f sharp declines inthe number o f students duringthe transition. 0 The public system o f basic education should be maintained fully and should be protected from cuts in education spending. Where necessary, improvements inprimaryand secondary education could be achieved through reallocation o f public resources from vocational education, boarding schools, specialized secondary, and higher education institutions to primary and secondary education. 0 To address the educational financial needs o f the poor, consideration could be given to: (i) free basic teaching materials (for example, textbooks and school uniforms) for the poor; and (ii) the introduction of a reformed assistance program to provide financial support to needy students to increasetheir enrollment inpost-secondary education. 0 The budgetary allocation mechanism should be reformed to address regional variations in the adequacy of fiscal capacity for education funding. If funding is provided to schools on a per pupil basis, consideration should be given, for example, to weighting the capitation formula according to the poverty level of the local community. 0 Efforts should continue to be made to reform the school curricula and teaching methods to meet the new skills needs o f a market economy. Curricula for vocational, specialized secondary and higher education institutions should also be reviewed and revised. The new curricula and 10 teaching methods also need to be accompanied by appropriate textbooks and instructional materials. 0 The Government should carry through with its proposalsto reform teacher training, recognizing that the new teaching methodologiesrequire significant changes. 0 School rehabilitation and minor repair should become a priority, because of the considerable future cost of deferred maintenance and the danger of unsafe buildings. Because o f the substantial cost of school improvementprograms, a nationwide school rationalization plan should be prepared, and parental and community resource mobilization should be continued through establishment ofparent-teacherassociationsinall rayons. 0 The country's educationalmonitoring and evaluation process should be reoriented from inputs to a system which monitors inputs, teachingand learningandalso outcomes. 0 There is a need to strengthen the linkages between education and the labor market. The output mix of the educational system o f Azerbaijan is inappropriate for the current labor market. The reform of curricula and teaching methods is especially important for vocational technical educationandhigher education, which remain closely linkedto the former plannedeconomy. 0 The efficiency with which available funds are used could be improved in a variety o f ways, including reduction o fexcess staff, reducingduplication o f services, coordinating institutions, and removingvertical and/or horizontal barriers (different ministries providing similar services). 0 The budgeting and utilization of financial resources available to education could be improved considerably through improved budgeting and resource allocation processes, strengthened financial management, focusing increasedallocations on providing basic education materials and supplies for primary school students, removing direct social welfare provisions and responsibilities from the educationbudget, andreplacing these subsidies with benefits targetedto the poor. 0 The excessive reliance on state funding should be reduced through making increased use o f student fees in higher and upper secondary education, targeted financial support being available for poor families, reviewing the effectivenesso f stipends in ensuring access to professional and higher education, creating a program of student loans, and encouraging more parental and community contributions to schools. 0 Considerationcould be givento increasingthe educationaland financial autonomy for specialized secondary ("teknikum") and higher education institutions, by reducing Ministerial control over inputswhile increasingmonitoring studentoutcomes. 0 A larger role for the private sector could be induced through the removal of tax disincentives and PremovingArticle28ofthe1992EducationalLaw(whichprohibits . . for-profit private schools). 0 Radical reform and considerable strengthening of education management is required for the creation of a more decentralizedsystem of flexible managementwhich responds to labor market and other changes and local conditions. 11 0 A new system of student assessment and monitoring should be introduced, based on the monitoring of inputs, teaching and learning processes, and also outcomes. 2. Health. As in the case of the education sector, there is also a key rolefor the health sector to play in the national poverty reduction strategy. For this to happen, however, major reforms will be needed in thefkrther development of the primary health care system, the management andfinancing of the health services, and interactionswith other important agencies and ministries that regulate or provide services which impact on heath services, like education, the environment, water and housing. Azerbaijan is at the beginning o f the demographic and epidemiological transition, with a young and growing population. The country experienced a worsening o f the health status o f its people in the period immediately following independence from the FSU; but since the mid-1990s,the official statistics have indicated an improvement in most o f the health indicators,, bringingthe situation to the same level or even better levels than at independence. However, the evidence from social assessments and household surveys suggests that much o f the apparent improvement is due to non-reporting, as many households do not use public health facilities from which the official statistics are generated, as they have to pay for nearly all the healthservices, either formally or informally. The mainhealth problems faced by the poor are communicable diseases such as tuberculosis, diarrhea, and other maladies which are best and most cost-effectively approachedon an ambulatory basis. Major reforms are now needed in the health sector as part of a poverty reduction strategy, in particular in improving accessibility to high quality primary care services. The present health care system emphasizes hospital and specialized services, is fragmented particularly between in-patient and ambulatory services, has primary care services provided by multiple physician specialists with low productivity, and i s expensive and difficult to sustain. From the experience so far, it would appear that most o f the primary health care reforms already implemented have had a positive impact on the health care o f the population in terms o f access to better quality care, particularly for the poor. Chief among those reforms have beenrevolving drug funds, training inup-to-date clinical procedures for primarycare, the provision o f basic equipment, and health education. Major reforms are also needed in the management of health services, including financing, resource allocation, the information system, and interactions with other important agencies and ministries that regulate or provide services which impact on heath services. The public health budget needs to be enhanced and allocated in a manner that better reflects population needs and distribution. Consideration also needs to be given to defining a basic health care package free o f charge to all residents. Currently, the delivery o f basic health services i s jeopardized because there is only a limited provision in the budget for basic health service, and most o f the population is exempt from the official fees charged. It would be more advisable to define a limited core set o f basic services, make adequate provision inthe budget for it, and provide it free o f charge to the whole population. Inparallel with the development o f primary health care, the hospital sector should also be rationalized. Many o f the existing hospitals have low occupancy rates and pose a cost burden on the health sector. As equipment is generally old and technologically out-dated, the consolidated establishments would offer the opportunity not only to reduce costs but also to provide higher quality services. There is already a strong foundation for the health information system at the national level, but there is urgent need for an accurate system o f vital statistics uponwhich to basethe critical indicators o f the impact and efficiency of the healthsector. Without such a system, it is difficult to target specific populations, principally the poor, to better direct activities. Interactions also need to be strengthened with other important agencies and ministries that regulate or provide services which impact on heath services, like education, the environment, water and housing. 12 Policy Recommendationson Health The health reform efforts o f the Ministry o f Health need to continue to focus on improving the capacity to provide accessible and good quality primary care services. The key reforms include revolving drugfunds, training in up-to-date clinical procedures for primarycare, the provision of basic equipment, andhealth education. In parallel with the development of primary health care, the hospital sector should also be rationalized. To make better use o f limited resources, some hospitals could be closed or limited in function, consolidating services in centralized units. Usually, some refurbishment would be required as well as the purchase o f professional equipment. Staff would also need to be reallocated andrationalized inorder to better meetthe needs o fthe population. Given the importance o f immunization as an effective health measure, it would be advisable for the state to show a separate budget for vaccines ina protected sub-category of the budget which would be financed annually through the state budget. The WHO-promoted Directly Observed Treatment Strategy (DOTS) for tuberculosis should be continued, to halt the hidden epidemic and decrease mortality inthe next few years. Inorder to expand this program nationally, considerable resources would be required to train health care personnel, provide drugs, and expand the educational component. However, these costs could be somewhat offset by consolidating some o f the existing tuberculosis hospitals which are currently functioning at low capacity. Good prescription practices need to be promoted including through the formulation o f standard druglists, the revision o f standards oftreatment, the education o fphysicians and patients, andthe monitoring o fdrugusethrough rapid survey techniques. Revolvingdrug funds should be continued and then evaluated for nationwide application. To protect the poor from the costs and suffering o f abortions, modern methods o f contraception should be made available to them. This entails active promotion, education and accessibility to modernmethods to a degree not presently available. A key strategy for improvingall health services, includingthose for the pooris to makebetter use o f existing resources. This means improving management on all levels, particularly at the regional level. This involves not only financial management, but also expert planning and decision-making based on adequate information, the anticipation o f problems and creative problem solving, and the management, supervision and motivation of humanresources. One o f the main areas for improvement o f Government efforts in the public health sector is assuring access of the poor to health care services. While under the current system, there exist at least twelve groups o f citizens that are supposedly exempt from paying fees in public facilities, this policy does not seem to work in practice since the health care system i s plagued with informal payments. There is a needto address the issue o f unofficialpayments in the sector since they disproportionately affect the poor. 13 0 The public health budget needs to be enhanced and allocated in a manner that reflects population needs and distribution. This increase should only proceed inparallel with reforms inthe sector to improve the efficiency o fresource use. 0 Consideration needs to be given to defining a basic health care package free o f charge to all residents. The basic services should include: (i)education concerning prevailing health problems; (ii) matemal and child health care, including family planning; (iii)immunization against the major infectious diseases; (iv) prevention and control of locally endemic diseases; and (v) provision o f essential drugs. 0 At present, there are some significant differences inthe amount o f money the regions receive per capita. The resources of the poorest regions should be increased to bring them at least up to a scale with the others. As the available funding for health services is so limited, however, these small increases may not be expected to have much impact nor to benefit the poor necessarily. Over the longterm, it will be important for the budgetary system to allocate resources taking into account the diseaseburdenandpatterns. More flexibility inreallocating funds between line items should also be considered. 0 The existing strong foundation for the health information system at the national level needs to be extended by improvementsinthe system o f vital statistics. 0 The MOH and other sectors and institutions all need to participate in an effort to address public health problems due to the unhealthy lifestyles o f the population. Housing is o f critical importance as a measure for reducing disease, particularly tuberculosis. Health education also needsto be introducedinto the curricula o fthe schools. C. Protectingthe Vulnerable. 1. Social Protection. An efective anti-poverty program will need to include social assistance for those in special need and who are not able to benefit signijkantly >om the other programs designed to create more employment and a high rate of general economic growth, and programs to strengthen basic services and priority infrastructure for the poorer members of the community. Unfortunately, the existing social protection system does not make a major important contribution topoverty reduction due to lack of targeting and the low level of benefits. The current social protection system is built on two components: a social insurance system that provides mandatory insurance for old age, illness, disability and unemployment; and a social assistance that provides non-contributory, tax-financed cash benefits targeted to certain categories assumed vulnerable or poor. Inprinciple, the first componentprovides the meansto mitigate social risks, while the second provides enhanced coping capacity for the poor and the vulnerable. While pensions do reduce substantially the poverty gap, the social assistance programs have only a modest impact. Most o f the social assistance benefits are too small to reduce the consumption deficit o f the poor. Also, inmost cases they do not target the poor and there is significant leakage o f resources to the non-poor. While public spending on social protection is still substantial, it has declined considerably inrecent years and it is not realistic to increase transfer payments to the extent that would be necessaryto raise all households up to even a very modest poverty line. Nevertheless, improvingthe social safety net needs to be a central part o fthe poverty reduction strategy, and Government spendingneeds to be maintained at a suficient level to allow a reformed and targeted program to be developed for those genuinely in need o f support. These programs are, therefore, inurgent need of reform. 14 The Government has made a good start to the process of pension reform with the transfer of the Jinancing of social pensions to the state budget. The challenge now is for the Government to follow through on the reform plans andfor the draft legislation to be approved and implemented. The draft Law on Pension Provision is commendable, in that it aims to enhance financial sustainability, improve contribution incentives, enhance the pension system's transparency by eliminating discretionary rules, eliminate existing inequities within the systemby rationalizing early retirement provisions and equalizing the male and female retirement age, and would establish a greater distinction between contributory and non-contributory pensions. The Government acknowledges that there are targetingproblems with the existing social safety net, and is committed to revise social assistance benefits and to improve targeting, along with improvements in poverty monitoring and evaluation capabilities. The development o f targeted social assistanceinstrumentsto alleviate the impact on the poor of the new public utility policies will be o f the utmost importance, as the new energypolicies will definitely impact households, some o fwhom are poor. There are several options which could be considered by the Government: life-line tariffs, the burden limitation approach, and/or compensationto poor households for part of their utility bills above a given share o f household income. Given the particular circumstances o f the Azerbaijan economy, efficient targetingwould not be simpleto achieve. This is becausepoverty is pervasiveand diffuse, and informal income tends to be a large part o f total income. However, there are several possible main targeting mechanisms, such as means testing, proxy means tests, geographic and demographic targeting, which could be considered. Of these,proxy means testing is probably the best approach in the short term, and the Government may wish to explore itspossibilitiesfurther withtechnical assistance. While public spending on social protection is still substantial, it has declined considerably in recent years, and it is not realistic to increasetransfer payments to the extent that would be necessaryto raise all householdsup to even a very modest poverty line. Nevertheless, improving the social safety net needs to be a central part of the poverty reduction strategy, and Government spending needs to be maintained at a suflcient level to allow a reformed and targeted program to be developed for those genuinely in need of support. It is, therefore, encouraging that social protection expenditures are projected to increase as a proportion of budgetary expenditures over the coming three years from 16 percentin2000 to 18.6percentin2005. Policv Recommendationson Social Protection 0 Dueto lack oftargetingandlow level ofbenefits, the existing social protection systemdoes not make a major important contribution to poverty reduction. While pensions do reduce substantially the poverty gap, the social assistance programshave only a modest impact. Most o fthe social assistance benefits are too small to reducethe consumption deficit o fthe poor. Also, inmost cases, they do not target the poor and there is significant leakage of resourcesto the non-poor. These programs are, therefore, inurgentneedofreform. 0 The level of the pensions needs to be adjusted to reflect contribution history. All non-pension benefits also need to be separated from the social insurance system. The minimum pension guaranteed inthe labor system needs to be differentiated from the social pension. The non-targeted flat allowance for pensioners, financed from the state budget, should be reassessed; and for current pensioners, the labor pension and the flat allowance could be consolidated into a single benefit and the minimum pensionguarantee could incorporate the value o fthe allowance. 0 The Government has made a good start to the process o f pension reform with the transfer o f the financing o f social pensionsto the state budget. However, further revisions to the pensionsystem are 15 needed, and they should pay particularattentionto the principlesof fmancial viability, transparency (to enhance the system's credibility and minimizedistortions), and fairness (so that individualswith similar contribution levels receive similar benefits, each contributionyear receives an equal value, and those retiring at higher than the minimum statutory age are properly compensated). Early retirementprovisionsshould beminimizedor eveneliminated. Regardingthe social safety net, it is also very encouragingthat the Government acknowledges that there are targeting problems and is committedto revise social assistance benefits and to improve targeting. It is hoped that the planned comprehensive social assistance reform strategy would be developed urgently, along with the planned improvements in poverty monitoring and evaluation capabilities. The development of targeted social assistance instruments to alleviatethe impact on the poor of the new publicutility policieswill be ofthe utmostimportance, as the newenergy policieswill definitely impacthouseholds, someof whom are poor. There are severaloptionswhich could be consideredby the Government: life-line tariffs, the burden limitation approach, and/or compensation to poor householdsfor partof their utility billsaboveagivenshareofhouseholdincome. Given the particular circumstances of the Azerbaijan economy, efficient targeting would not be simpleto achieve. This is becausepovertyis pervasive and diffuse, and informal income tends to be a largepart of total income. There are several possiblemaintargeting mechanisms, such as means testing, proxy means tests, geographic and demographic targeting. Of these, proxy means testing is probablythe best approachinthe short term, andthe Government maywishto explore itspossibilities further with technical assistance. 2. InternallyDisplacedPeople. Theassistanceprovided by the Govemment in support of IDPs represents the single largest social protection program in the country. In recent years, there have been some important new pilot initiatives to support the return of IDPs to their original homes, through rehabilitation and income generation activities. Govemment supportfor IDPs does reduce the extent of poverty amongthem, but it does not rely on any evaluation of individual vulnerability or need and there is need to increase the eflciency of targeting of the support to IDPs. The approach to poverty reduction among IDPs needs to involve a range of Govemment ministries and agencies, state-owned enterprises, international donorsandNGOs. The IDPs are presently entitled to a range of benefits, but the two most important are the provision of bread money and the across-the-board exemption of IDPs from utility payments (most importantly, for electricity). Inaddition, for severalyears, IDPshavebeenprovidedwith temporary land as part of the Government's strategy to reduce povertyamong them. This is clearly very important, due to the correlationbetweenaccess to landand povertyreduction, and it has had some impact on poverty among the IDPs. However, not all IDPs, even inrural areas, have accessto land. Inrecent years, there have beensome importantpilot initiativesto support the return of IDPsto their originalhomes, although this programis, by its nature, limitedto those who came from areas which are under Azerbaijan's control. Beginning in 2001, the Government initiated a new strategy of providing more permanent provisionof land (with tenure of ownership), together with relocation and construction of houses and other infrastructure. This represents a major step for the IDPswho remaindisplacedand with no immediate opportunities to return home. It is too early to tell how successful these programs will be, but the initiativehas very strong merits. However, the resettlementof large groups of people is a very complex multi-sectoralprocess and requires close attention and monitoring. While the recent expansion of the landdistributionprograms for IDPs is likely to helpto address this problemfor some of the IDPs inthe rural areas, it will not be insufficientto reducepovertyamong other IDPssettledinurbanareas. This is a critical issue, asthe rateof extreme povertyis higheramongIDPsinthe urbanareas, particularlyinBaku, 16 than in the rural areas. Another strategy adopted by the Government to address the unemployment problem has been through the Social FundDevelopmentInitiative (SFDI), which was originally designed to rehabilitate small-scale infrastructure for IDPs. While also beingan important initiative, infrastructure rehabilitation does not necessarily address the key unemployment problem. Efforts are now being undertakento shift the emphasisto the establishment of micro-credit facilities and support existingefforts of internationalNGOs, as well as through the financing o f businessand other training for IDPs. Nevertheless, current Government policy, for the most part, does not distinguish between differing degrees of poverty of individual IDP households, but instead makes a group determination in terms of eligibility for benefits. In order to improve the efJiciency of targeting and to channel existing resources to firther enhance the quality of life of the most vulnerable among the IDP population, an alternative methodology is required to identifi those who are most in need. For the future, it is unlikely that the objective of employment generation for IDPs can be dealt with solely by programs which explicitly target the IDPs. It is perhaps more important for the IDPs in the long run for there to be investment in the general socio-economic development o f the regions below the national level, in line with the priority placed by the Government in expanding non-oil sector employment. Indeed, the IDPs need to be integrated into the mainstream society, before their skills and entrepreneurial behavior are underminedfurther and lost. Itwill also be important that efforts are focused particularly on those IDPs who fall below the poverty line. Finally, the approach to poverty reduction among IDPs will need to involve a range o f Government ministries and agencies, state-owned enterprises, international donors and NGOs. Whether the nature of IDP strategies inthe coming years involves the planningof reconstruction and return initiatives following an eventual peace accord, or whether it continues along its present course of working invarious ways to invest in the self-reliance o f IDPs during displacement, many actors will continue to be involved within line ministries and in a range o f other institutions inside and outside o f Government. The coordination of all of these diverse actors is essential ifopportunities for helping IDPs are to be maximized. Policv Recommendations Relatedto IDPs 0 There should be regular monitoring o fthe living standards and poverty rates amongIDPs, both to test the conclusions o f the current poverty assessment (including the relatively higher level o f poverty among urbanIDPs) andto contributeto the future planningo f IDP strategies. Eventually such monitoring should be integrated with existing quarterly household surveys through special samplingo f IDPsto ensure comparability of data. A first step would be to repeat the July 2002 IDPsurvey duringthe winter months to ensurethat the current survey resultswere not affected by distortions due to seasonal employment strategies of IDPs. Poverty monitoring should also include IDPs who have returned home in Fizuli and other rayons, as well as IDPs and refugees who have been relocated under provisions o f recent presidential decrees to ensure that programs are achieving their objective o f buildingself-sufficiency. 0 The Government should review its current entitlement programs for IDPs and implement measuresto base public transfers to IDPson vulnerability criteria to maximizethe impact on the living conditions o f the most vulnerable IDPs. Inparallel with a restructuring o f transfers, and priority should be given to ensuring that IDPs have full access to basic health and education services, andthat suitable publicity is given to the support measures. 0 Existingsafety net and employment strategies for IDPsshould re-evaluate their regionaltargeting and look more closely at the situation o f IDPs (and refugees) inBakuand other urban centers due to the highlevels o f poverty among IDPsinurbanareas. 17 Programs such as SFDI and other initiatives supported by the Government and donors should emphasize the generation of sustainable employment opportunities for IDPs in their activities. This might include the reprogramming of existing resources. The specific obstacles causing higher levels o f IDPunemploymentneed to be explored through both quantitative and qualitative methodological tools. Programs to relocate IDPs and provide secure title to agricultural land should be expanded where possible to provide new opportunities for rural based IDPs and for those urban-based IDPs who wish to voluntarily take advantage of such opportunities. However, it is also critical that early programs be viewed as pilots and include intensive monitoring and consultation with IDP participants to maximize the chance o f success and to learn lessons useful for expanded programs . Approaches to IDPsshould maximize the support o f existing social organizations among the IDP communities and seek to empower IDPs. While many IDP communities have been fragmented by displacement, many communities from specific rayons o f origin have been able to settle together and keep inclose contact. There should be a review o f the role o f the SFDI, including ways to improve its operational efficiency, to expand partnerships with international NGOs already involved in micro-level programs, and to learn from the experiences and find channels to directly invest in an expansion o fpromising activities. IDP employment strategies cannot be confined to IDP-specific programming but also need to feed into national strategiesfor investmentinthe regions with highIDPconcentrations. There is need for the Government to develop capacity to coordinate and monitor the progress of IDP initiatives; integrate the lessons from existing initiatives into future IDP programming; plan for future programming and design IDP strategies, taking into account the appropriate roles of the line ministries, the SFDI, ARRA and the State Committee for Refugees. It is further recommended that a small unit with specialized professionals be placed at a senior level in the Government, ideallywithinthe office o fthe Deputy Prime Minister or at a similar level. Itmay be advisable for the Government to acquire international technical assistance to develop systems to implement and monitor relocation programs. The international experience with resettlement programs demonstrates the high risk of complications arising in such programs and international technical assistance may help to avoid problems which have occurred in other countries. The Government is also encouraged to promote contacts with counterparts in other countries to share experiences and contribute to the development o f innovative approaches to the self-reliance o f IDPs in Azerbaijan, as well as to permit other countries to benefit from the experience ofAzerbaijan inits efforts to improve the situation o fIDPs. D. Monitoring ofLivingStandards Poverty monitoring. Both to monitor the egectivenessof the Government'sprograms, and to be able to target support to those most in need, it will be necessaryforfirrther steps to be taken to strengthen the capacity to collect and analyze the necessa?y data. The effort to improve data collection for the monitoring o f living standards that began in 1999 with the implementation o f the Household Budget Survey (HBS) needs to continue. 18 0 The Government needs to ensure that the collection of data on the labor market, education and health follow internationally accepteddefinitions to allow better comparability between the living standards o f Azeri people and other countries, and facilitate monitoring o f progress towards the Millennium Development Goals (MDG). 0 Some strengthening o f the H B S is needed. Consideration could be given to the collection of the data only during a particular period o f the year, or organizing the survey as a two-period panel. The measurement o f welfare should move from the current definition o f expenditures toward the economic concept of consumption. The labor market, education and health information should be collected using internationally accepted definitions. The training of the interviewers should also be improved, andthe survey should have a flexible design that can quickly respondto the demand for policy analysis inany period. 0 Insome dimensions of well-being, such as consumptionpoverty, access to safe water, infant and maternal mortality, Azerbaijan face serious development challenges and needs steady and significant progress to achieve the related MDGs. 0 For some targets, such as infant mortality, maternal mortality, prevalence of HIV, progress towards the MDGs is difficult to measure, and efforts are needed to improve the collection o f accurate information. 0 One particular area where progress towards the MDGs is clearly insufficient is inaccess to safe water inruralareas. To advancetoward the achievement o f this particular target, the Government shouldgive highpriority to rural water investments inits public investment program. 19