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70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
865
FINANCIAL SUSTAINABILITY: THEORY AND AZERBAIJAN
APPLICATION
Nurkhodzha Akbulaev
Azerbaijan State Univeristy of Economics (UNEC), Faculty of Economics of Turkish World,
Department of Economics and Business Administration,
UNEC Turkish World Economic Research Center, Azerbaijan
Baku, Istiqlaliyyat str.6, AZ1001, Azerbaijan
nurhoca@gmail.com
Leyla Tahirzade
Student at Azerbaijan State University of Economics (UNEC)
Baku, Istiqlaliyyat str.6, AZ1001, Azerbaijan
leylatahirzade7@gmail.com
ABSTRACT
In addition to providing macroeconomic balances for the economies of the country,
sustainability of these balances has become an important issue. One of the issues raised in the
recent period regarding sustainability is the concept of financial sustainability, which covers
the sustainability of budget deficits and debts. Financial sustainability is recognized as a
necessary condition for the co-ordination of a sound and consistent economic policy and
monetary policy. An unsustainable fiscal policy carries risks that may cause economic growth
to slow down due to high interest rates in the future. Azerbaijan left the USSR on October 18,
1991 and announced its independence. The main reason for the sound functioning of all
institutions in the market economy is the regulations in banking and other financial institutions.
The reason for this is that the market economy consists of banks and financial institutions. It is
not correct to talk to the market system from a healthy transition without creating healthy
financial institutions and realizing free banking system in the country. This study begins with
the development of economic policies in Azerbaijan since 1991. For this purpose, the economic
crises and policies implemented over the last twenty-seven years have been read from the
example of Azerbaijan. The aim of the study is to empirically analyse the financial sustainability
in Azerbaijan for the period 2006-2020. Firstly, unit root test was applied to the data used in
the study and the results showed that the data were not stable at the levels. All variables were
found to be static at first differences. The long-term co-integration relationship was then
investigated using the Johansen (1988) test. Finally, Engle-Granger cointegration test were
used to test financial sustainability. This study for the first time in the financial sustainability
literature includes an innovative view. For the purpose of revealing the effects of public
revenues and public expenditures separately, the analysis was performed by separating these
items. The results show that the financial sustainability in Azerbaijan for the period 2007-2020.
Keywords: Azerbaijan Economy, Fiscal Policy, Sustainability, Financial Sustainability,
Financial Competence, Government Budget Constraint, Unit Root Test, Co-integration Test
1. INTRODUCTION
The concept of sustainability nowadays means different things to different people, and a large
part of humanity around the world still live without access to basic necessities. Sustainable
development is often an over-used word, but goes to the heart of tackling a number of inter-
related global issues such as poverty, inequality, hunger and envirnomental degradation. In
theory, development that is not sustainable and not damaging to the planet is very possible
(Augaitytė, 2013). In a world where environmental pollution has accelerated over the past 15
years, the philosophy of sustainability has become one of the most often debated topics.
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
866
Sustainability is described as achieving stability and economic development while saving the
environment. Another concept of sustainable development is "meeting today's needs without
jeopardizing future needs fulfilment" (Yeni, 2014). For more than 15 years, the idea of
sustainability has become a major concern in many aspects of our lives. The term "financial
sustainability" is a crucial part of the meaning of the term "sustainability." This idea is critical
for future stability and economic development (Chapman, 2008). Following the global financial
crisis, the topic of financial sustainability has become increasingly relevant, especially in
developed and developing countries. Financial stabilization ensures that the country will be able
to fulfil its loan repayment obligations as quickly as possible. Fiscal sustainability refers to how
the government can finance its deficit in the future (Ilgun, 2015). The financial policy should
be in line with current macroeconomic targets such as economic growth, inflation, payments.
The purpose of this study is to define the concept of financial sustainability and to investigate
whether financial sustainability is being achieved in Azerbaijan. This paper would look at how
successful Azerbaijan's financial policies have been since independence. The paper contained
a literature summary, an explanation of the principle of financial sustainability, and the analysis
results in the final chapter.
2. FINANCIAL SUSTAINABILITY CONCEPT
Financial sustainability means that financial policies are also applicable in the future (Emirkadi,
2017). In recent years, most developing countries have increased public spending and have led
to a significant increase in the public debt measured according to GDP. This debt accumulation
questions the sustainability of budget imbalances in these countries after a major recession
(Paniagua, Sapena, & Tamarit, 2017). The overdebt of the state restricts its choices, such as
lending, printing money and taxation. That's why the state's overdebt savings are a problem.
Therefore, fiscal sustainability is the issue that governments must always keep in mind (Akram
& Rath, 2020). Financial sustainability does not have a single theoretical measure. In general,
if the state is unable to pay its debt in the long term, it can be said to be unsustainable. The most
commonly known and most commonly used definition is that the state cannot organize a
pyramid chain (Rajan, Giap, & Yam, 2014). The state's total debt stock is often found in the
way that the state's expenditures within a year are removed from revenues. Public expenditure
is more than public income, which can result in a budget deficit. For financial policies to be
sustainable, the budget deficit must be at a long-term payable level, but these policies should
not create more debts (Yavuz, 2011). According to Ayshe Kaya (2013), fiscal sustainability is
equal to one of the state's budget expenditures and revenues today. So, the budget deficits that
can arise during a certain period and the budget surplus are balanced. Financial sustainability
analysis is the discovery of the findings by investigating whether any financial and monetary
policy set by the state is sustainable. If these policies are causing the debt to not be repaid, they
are unsustainable. This time goes to state policy change (Emirkadi, 2017). Governments, on the
whole, strive to find a financially viable direction that allows them to keep their debt under
control. Although macro economists agree on the need for manageable debt ratios, they differ
on the thresholds below which national debt becomes a threat to the economy (OECD, 2015).
Fiscal sustainability is the ability of the state to obtain or maintain its own expenditures and
revenues without Bording (Bolat, 2013). In some of the various studies on this issue, they are
focusing on public income to ensure financial sustainability, while in other studies, they are
focusing on public expenditure and expenditure. In this way, discussions are still being
discussed about the definition of the concept of financial sustainability (Kokcu, 2016). There
are many definitions of the concept of financial sustainability in the literature. The concept
seeks to answer the question of whether current fiscal policies can continue in the future.
However, research has concluded that it is difficult to measure financial sustainability.
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
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If the current fiscal policy distances the state from the payoff force in the future, it can be
perceived as unsustainable. Therefore, to measure the sustainability of finance, it is necessary
to check the government's terms of affordibility (Croce & Juan - Ramon, 2003). The concept
of financial sustainability in literature is often used. If state policies can manage the country's
budget correctly, the country is sustainable financially (Bolat, 2013). Financial sustainability
policies can affect state income and expenses, private sector savings and investment behavior.
To determine whether the current fiscal policy stance is sufficient to ensure sustainability,
certain assumptions about the behavior of each of these variables are needed. Factors impacting
income and interest rates, on the other hand, can limit the opportunity to begin financial
restructuring in order to satisfy budget constraints (Croce & Juan - Ramon, 2003). But we need
to know that the budget restriction has been provided is not necessary for financial
sustainability, but not a sufficient requirement (Kokcu, 2016). There are factors that influence
financial sustainability. Changes in the stock market are one of these effects. If the stock price
increases, people start to consume more. Because these increases in stocks make consumers
feel richer. Increased consumption means more sales. That means increased sales tax revenues.
However, housing markets are one of the factors that influence financial sustainability. The
increase in housing sales also leads to increased sales tax revenues. Of course, the decrease in
stock prices and housing sales will also affect fiscal sustainability as it will reduce tax
(Chapman, 2008). We face financial sustainability as the capacity to sustain the current
financial situation without the need for regulations in tax or expense policies. In other words,
financial sustainability can also be expressed as budgetary stability protection without serious
deterioration in the balance of income and expenditure of the budget (Eroglu, 2019). Fiscal
sustainability refers to how public debt evolves over time and where it is based as a percentage
of GDP. In this scenario, one might argue that as long as the real interest rate exceeds real GDP
inflation, the government's debt will continue to rise indefinitely. On the contrary, it is true. To
reduce the debt-to-GDP ratio, economic growth must surpass interest rates if a government
expects to offer a primary opening (Rajan, Giap, & Yam, 2014). As countries have some
economic goals to do, it is important that they continue to achieve these goals. Financial
sustainability is realized by continuing the economic goal in the long term (TUNA, 2017).
Because the world debt crisis occurred in early 1980, various studies on the issue emerged
during the 1990 years, and discussions on public debt have started to grow significantly. Fiscal
sustainability is a mandatory analysis used by a state against excessive debt build-up (BOLAT,
2013). A few steps are taken to know if a country is financially sustainable. Fiscal sustainability
is estimated based on several years of macroeconomic data (usually 5 years). Inflation, money
supply, income, expenses, investment in this macroeconomic data, imports and exports and
other factors are the property. Another step to measure sustainability is to estimate debts. The
increased debt rate is one of the main reasons for concern. In this case, alternative scenarios
will be required (Chalk & Hemming, 2000).
3. LITERATURE REVIEW
Recent concerns about global climate change, people in poverty, tensions brought by increasing
social inequalities among societies have given more importance to sustainable development.
Because the concept of sustainability exists in many places, different definitions have been
introduced over time (Giovannoni & Fabietti, 2013). The concept of sustainability that is used
in many areas means that it is about the human future and that the resources of its space are
saved and protected (Ozer, 2015). Financial sustainability, which is the subject of the article, is
defined differently by different researchers, so there is no definitive definition of the word (Rai,
2012). According to Ulf Papenfub (2014), public agencies and other entities are particularly
expected to report accurately regarding money, tax, loans, and financial statistics deposited for
financial sustainability.
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
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According to Kuriyan and others (2006), the poor's wellbeing and the private sector's benefit
can all be improved by financial sustainability. However, there is still the question of political
danger. This vulnerability is a political charge that the government only supports the needs of
special interests. If the government places so much emphasis on financial sustainability,
merchants will be forced to deal with consumers who are able to pay a high price in exchange
for high income. In the other hand, if the state places too much emphasis on the project's social
growth path and entrepreneurs fulfill the poor's development needs, the state will be compelled
to fund these entrepreneurs. According to Meltem Koylu (2017), the development of the
economic system is undergoing strengthening of the financial structure. The financial system
creates financial institutions that mediate financial markets and trading transactions. Payment
terms and systems must be effective in order to improve financial relationships. Different
financial institutions, banks, have a big role in this. Financial sustainability, according to
Ibrahim Can (2019), is the long-term financial performance that allows a business to recover
more than its financial resources that value each stakeholder, and the confidence to prevent
financial problems that threaten it. According to Mirat Gecim (2020), good financial
sustainability contributes positively to the country's well-being. It is essential that the
management and control committees of the institution are completely transparent, responsible,
reliable and fair, and that the institution is able to provide financial sustainability. Financial
resilience, according to Eppich and Grinda (2019), can be evaluated in five categories: revenue
identification, cost analysis, monitoring, strategic planning, and project support. The financial
sector's growth, according to Memmedov and Ahmedov (2021), involves both financial
expansion and financial deepening. The Azerbaijan state has created a financial support system
for entrepreneurs to influence the country's financial sustainability. The Republic has begun to
receive the results of its regulations. Since 2013, scientific studies on finance and economic
structure have also seen a visible increase (Koylu, 2017). Mammadov (2020) has tried to show
how exchange rate and stability in financial markets can stimulate the economy and
entrepreneurship. In the research, the monetary policies used by the state were determined and
discussed to see that the policies developed against devaluation were successful.
4. FINANCIAL SUSTAINABILITY ANALYSIS
Although several theoretical and empirical studies have been carried out on fiscal sustainability
in recent years, it is observed that the number of studies carried out in Azerbaijan is very limited.
However, monitoring financial sustainability in a country is a very important issue for a country.
The target of monetary policy cannot be achieved without financial discipline. Unit root tests
and cointegration testing are often used in financial sustainability research. We can assume that
financial stabilization has been provided if the series are constant and there is a cointegration
relationship between budget revenues and budget expenses (Al, 2019).
4.1. Method
In the analysis of financial sustainability, there are two basic methods: The method of economic
indicators and the econometric method (Shen at al, 2010). In this study, it is preferable to use
the econometric method because the results obtained have shown more precise findings in the
analysis of financial sustainability. Unit root test (ADF and PP) and cointegration test (Engle-
Granger) were used to analyze whether financial sustainability was achieved in the study.
Studies using econometric methods, of course, require analysis of a long period (Al, 2019). The
study used data for the period 2006-2020 on budget revenues and budget expenditures as a ratio
to GDP. This data is quarter data and is obtained from the official site of the Azerbaijan Central
Bank.
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
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4.2. Unit root analysis
This method is a standard approach to testing the sustainability of budget deficits and has been
used in many studies. The unit root test method can be applied to series as well as the budget
deficit series, as well as to series of budget deficits for the past years and total interest payments
that constitute a significant part of public expenditure, to test whether financial sustainability
exists. The following are the Augmented Dickey-Fuller (ADF) and Phillip-Perron (PP) unit root
tests for the series selected to test whether there is financial sustainability in Azerbaijan. The
ADF and PP tests use a method that controls high-degree autocorrelation in the series. The PP
unit root test has been developed as a method that takes into account the impact of a structural
change (structural break) in the series (Shen at al,2010). Therefore, the series have been tested
for ADF and PP unit root respectively. Unit root tests have been applied to the corresponding
series and the findings obtained are presented in Table 1;
R = Income
G = Spending
ADF
PP
Intercept
Trend and
intercept
Intercept
Trend and
intercept
R
Level
-6.084274
[0.0000]
(0)
-6.374004
[0.0000]
(0)
-6.033437
[0.0000]
(2)
-6.339188
[0.0000]
(2)
1st
difference
-11.33275
[0.0000]
(2)
-11.23390
[0.0000]
(2)
-26.77329
[0.0001]
(25)
-27.27736
[0.0001]
(24)
G
Level
-6.669761
[0.0000]
(0)
-2.109616
[0.5292]
(3)
-6.669778
[0.0000]
(2)
-7.355506
[0.0000]
(2)
1st
difference
-11.93266
[0.0000]
(2)
-11.81549
[0.0000]
(2)
-25.36225
[0.0001]
(14)
-25.06086
[0.0001]
(14)
Table 1: Unit root test results
(Source: compiled by the authors on the basis of: stat.gov.az, cbar.az, http://etsim.az/
(accessed on 10.04.2021))
Figure following on the next page
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
870
.15
.20
.25
.30
.35
.40
.45
06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
R/GDP
Figure 1: Unit Root Graph R/GDP
(Source: compiled by the authors on the basis of: stat.gov.az, cbar.az, http://etsim.az/
(accessed on 10.04.2021))
.16
.20
.24
.28
.32
.36
.40
.44
06 07 08 09 10 11 12 13 14 15 16 17 18 19 20
G/GDP
Figure 2: Unit Root Graph R/GDP
(Source: compiled by the authors on the basis of: stat.gov.az, cbar.az, http://etsim.az/
(accessed on 10.04.2021))
In the table, the values in the brackets show the probability values and the values in the other
second parenthesis show the appropriate lag lengths. Both variables are constant. Therefore, the
Engle-Granger cointegration test can be used to investigate the cointegration relationship
between the relevant variables.
70th International Scientific Conference on Economic and Social Development – Baku, 25-26 June, 2021
871
4.3. Engle-Granger test
In the case of a constant combination of two universally integrated series at the same level, the
Engle and Granger test is often used in the literature for testing the cointegration relationship
that is stated to exist between the two series (AL, 2019). The long-term relationship between
budget revenues and budget expenditures has been tested by Engle-Granger cointegration
testing and findings have been presented in Table 2;
Dependent
variable
Independent
variable
t-Statistic
Probability
R
G
-8.794014
0.0000
G
R
-13.71920
0.0000
Table 2: Engle-Granger test results
(Source: compiled by the authors on the basis of: stat.gov.az, cbar.az, http://etsim.az/
(accessed on 10.04.2021))
The empty hypothesis in the Engle-Granger cointegration test is “H0: No cointegration between
the series”, while the alternative hypothesis is “H1: cointegration between series”. According
to the data in the table, H0 hypothesis is rejected. Therefore, the series in question are
cointegrated. This result shows that financial sustainability has been achieved in Azerbaijan.
5. CONCLUSION
Fiscal sustainability demonstrates that the government's available fiscal policies can continue
to be effective in the future. The government, which cannot pay its debts in the long term with
existing policies, is deemed unable to provide financial sustainability. In this study, it has been
investigated whether financial sustainability is maintained in Azerbaijan. The quarterly data on
GDP, budget revenues and budget expenditures that are relevant to the research purpose 2006-
2020 was taken from the official website of the Azerbaijan Central Bank and included in our
work. The existence of a cointegration relationship between budget revenues and budget
expense sequence has been investigated in this regard. The ADF and PP unit root tests were run
first, and the series concluded that they are constant. Due to the constant of both factors, the
Engle-Granger cointegration test was determined to be feasible. According to the findings
obtained from this cointegration test, these variables are cointegrated. The fact that there is a
cointegration between budget variables is interpreted as providing financial sustainability.
According to the Engle-Granger cointegration measure, Azerbaijan is financially sustainable in
this sense.
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