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INFLATION: OBVIOUS AND INCREDIBLE

Last week the Armenian MPs met to discuss the "Achilles' heal" of our economy - the problem of price growth - a growth that, against all logic, is perfectly co-existing with the official verdict of the statistical service - that there was a 0.2% deflation last year. Quite symptomatically, not long ago the Council of the Armenian Central Bank decided to raise the rate of refinancing by 0.5% with a view to curb the inflation that might follow the rise in the Russian gas import tariffs. By doing this the CB has, in fact, launched its policy of inflation targeting.

Don't you see a direct connection between these two decisions by two different economic departments even though one of them looks back and the other forward?

ARMINFO is asking this question to the critic of the country's economic authorities, one of the informal authors of the above parliamentary hearings, well-known economist Eduard Agajanov.

- I was present at the hearings and cannot but share my impression that their authors were poorly prepared for them. The chief statistician and the chief banker were more convincing to me than their critics. Their rebuff was strong and well- reasoned. You can't get away from facts, in this particular case, from figures. With to lyrical preamble, I should say that the problem as such is that there is a certain conflict between what the official statistics report about the consumer price index and how things are in reality. People see that their life is getting increasingly expensive year in year out, their family budgets are cracking up as the prices are climbing yet higher and higher. Feeling this are you and me and absolutely everybody, while the official statistics keep giving us "surprises." That's why many economists are seriously wondering - why is this happening? Quite simple - the official price monitoring of the almost-400-item consumer basket is simply not what the consumer actually buys. That is, the very base of the consumer price index assessment has gone all out of date, but nobody seems to see that or to try to reassess this minimum consumer basket. But this is indispensable! There are elementary figures that say it really is. In 1997 our average wages were 10,000 AMD, in 2002 - 24,000 AMD, now 52,000 AMD - quite a big difference that could not but lead to as big a change in the consumption standard. It is an axiom that a growth in the nominal wages inevitably leads to a change in the content and size of the consumer basket.

- This is indisputable, this is a fact. But why then didn't they do anything in the last seven years? Only this year did they decide to increase the consumer basket to 480 items. Didn't the international advisors and donors of our statisticians understand this?

- Donors have nothing to do here. We should do this ourselves. If in 2002 the economy growth was 12%, in 2003 - 13.9%, in 2004 - 10.1% and in 2005 - again 13.9%, it means that in the last three years per capita GDP has grown 1.5 times at least - one more proof that the minimum consumer basket assessment criteria must be revised. The revision must be very flexible and dynamic, while inaction leads to popular anger that the official statistics "lie" when they report an average annual drop in prices. This is because they see quite a different picture in reality. That's the whole paradox.

- It would be naive to ask you to make so-called retrospective forecasts. But what do you think - if the statisticians made the necessary revisions in time, what inflation would we have today?

- We would have an at least 1.5 time as high consumer basket cost as we have now and realistic figures by the economic authorities. Do you know what else the experts are wondering at and what else is making them suspicious of the official figures? - the fact that 2005 was a year of skyscraping fuel prices worldwide, a year when no single country showed an inflation less than 2% - except for Armenia, who showed first a drop in the consumer price index and then just a 0.6% growth in prices. Meanwhile, the real inflation figures in the US were 3.4%, in the EU - average of 2.2%, in Russia - 10.5%, in Latvia (a country similar to Armenia in size and other parameters). Such a fantastic rise in fuel tariffs cannot but cause a fall in consumer prices. Why? Because fuel tariffs in countries like Armenia are a direct price-forming factor for a wide group of goods. Petrol and diesel fuel, electricity, gas and wheat - these are the very four commodity groups that, whatever move they make, gear a chain reaction in the whole consumption spectrum.

- Did you consider what share the above price-forming goods have in the consumer basket?

- You see, the point is not so much in the share of, say, petrol or electricity in the basket but how their cost impacts the growth of other prices. Should petrol go up in price, the farmer carrying potato from Gavar to Yerevan will, certainly, include this growth in the price of 1 kg of his potato.

- Do you mean that the statisticians have not fixed this point?

No, they did, but the whole paradox is that either they have miscalculated it or there is inconformity between what is actually consumed and what is listed in the consumer basket and the price monitoring. Recently I went to 7 shops to see if they had non-filter cigarettes. 6 of them had no such cigarettes, 1 had local "Chibukh." The seller told me than buying it was only one old man who did not want to give up his habits. You see - in the last 6-7 years there have been wide changes in the seemingly narrow cigarette group. If in 1997 smoking "Prima" were 1/4 of Armenians, now nobody wants to spoil his health by smoking non-filter cigarettes. I assure you that this list can be continued in all aspects. If formerly the bulk of consumer goods were of Turkish or Iranian manufacture, now we prefer goods of quite different quality. So what we have is a qualitative shift, and that's what we, with our two-digit economic growth, should have been constantly monitoring and recording instead of waiting for years to finally face the fact.

- Well, let's assume that the statistical service is not flexible, but how are we to understand the CB, who also monitors the prices and agrees with the statisticians?

- The CB has no relevant structures or professional skills, while the statistical service has. The statistical service has offices in all the regions and can monitor the prices everywhere, while the CB's monitoring covers just some parts of Yerevan. This is not serious.

- Then let's put it bluntly. May be it just benefits somebody to show such a law inflation? If not, why then the statisticians - people who know their job well - do not see obvious things?

- The point is not whom this may benefit. This may well be a banal lack of resources for work. Our economic authorities do not understand that information is a very expensive product and to collect it one should have money and big money at that - something this sphere always lacks. They in the government think that the statistical service is not as important as the army or the interior ministry and just leave it to live on foreign grants. That's the whole problem.

- Is that why we have such a low inflation?

- Not only that. This medal has another face - the CB policy. Our CB is more than just tough in its financial-credit policy. That is, its policy is the policy of a developed country. One proof - the money supply in Armenia is almost 20% of GDP - a nonsense. No country in the world has such a low monetization rate. Transitional countries like Armenia should typically have a 40%-60% rate of monetization. In some developed countries the index is more than 100%. And so, a tough monetary-credit policy chokes economic activity. Even more, if we look at how much our banks are involved in the economy, we'll see that they are almost not - bank credits make up only 8% of GDP.

- But probably that is exactly why the CB has no big choice of effective monetary-credit instruments and that is why it curbs the money supply so roughly?

- Quite the opposite, the CB has no problems with instruments. What I am saying is that the CB's toughness is not justified and is typical of counties with rich financial and monetary markets - something we don't have. And this makes such a policy illogical.

- Then what would you advise?

- I would advise the CB to be softer in its monetary-credit policy so that the economy could feed on these resources. Today our economy is starving. But we have one typical Armenian peculiarity. Our CB should not fear to increase the money supply and the financial-credit resources in the capital market just because in our country the money supply is ensured by import. There are two ways to fight inflation. The first way is to reduce the money supply, to raise the refinancing rate etc. - that is to narrow the market, and the second way - something nobody mentions for some reason - is to increase the production of goods and services to cover the money supply with goods and services. When does inflation generally arise? When the money supply is bigger than the supply of goods and services.

- That's exactly what scares the CB, who is responsible by law for the rate of inflation in the country.

- The CB has no reasons to fear anything since our money supply is covered by import. If we look at the structure of Armenia's import - which is $1.7 bln and twice as big as the export - we'll see that over $1 bln is food and consumer goods. What to fear if, unable to cover the money supply itself, our economy leaves this to the import. That's why in our country tough monetary-credit policy leads to deflation. I guess there is no need to explain what deflation is and how harmful it can be. Deflation means stagnation. Deflation makes production unprofitable, while normal inflation - up to 8% for a country like Armenia - encourages commodity producers to raise their outputs. Once this has an effect inflation falls back to stability but never to deflation.

- If I am not mistaken the CB is obliged to stick to inflation stipulated by the budget and its own annual monetary-credit program?

- Then why, declared to be 3%, it was 5 times lower.

- The budget says: up to 3% and not 3%.

- Yes, but why 5 times? It turns out that the CB is "lame in both legs" in its monetary-credit policy. Unfortunately, powerful import security is our very "advantage" and we cannot have an inflation burst by definition. And so, I reiterate that the CB should not be afraid of softer policy.

- This year the CB is starting to target inflation. What do you think of that?

This policy is not justified for Armenia. The CB is "forced" to take this step. Why? Because its money supply is less than 20% of GDP and it has no more reserves to reduce monetization in order to curb inflation. And so, the only way is to target inflation by the rate of refinancing. And what does this mean? It means - to raise the rate in order to reduce the share of credit resources in the economy. But it is a nonsense to reduce credit resources in a country where they make just 8% of GDP. By raising the rate of refinancing we make our economy starve even more. The CB's wish to carry out a policy of expensive loans, expensive money, will make things even worse for the penniless economy. This is good when effectively used in developed countries, who have developed financial, credit and monetary markets and whose credit resources are sometimes bigger than GDPs. We have none of these, and what are we to do with the rate of refinancing? Instead, we should direct all our efforts to stimulate commodity and service production.

- I think that just to wish is not enough. I guess this is a more global issue that goes beyond the CB's competence.

- Probably and only partially. For a small three-million country like Armenia domestic demand cannot be a resource for economy development. The only resource is export. We should encourage export by monetary policy, by low rather than high AMD rate. The only way-out for Armenia to ensure stable rather than spasmodic economy growth is to enhance exportability of its products. The whole world has shown how to do this, how to stimulate export, what preferences to give, how to issue soft loans. Russia has allocated $0.5 bln for export support. Many countries have special agencies for export support. We have nothing - a zero. Even more, how can one stimulate an export with such a low rate of national currency, with a bank rate of 18% and with such electricity tariffs.

- But you must admit that the export growth is quite promising.

- But did you look at its structure? The export grew by 31%, totaling some $235 mln. A mind-blowing figure, isn't it? But did you see what it is like? $178 mln of it - that is 75% of the growth - is ferro-molybdenum and copper, $35 mln diamonds and $20 mln finished production, mostly, agricultural processing - tomato paste, brandy and so on. That is, the whole export consists of these three groups. This is not a healthy growth. Even more, the growth in the mining is not a physical growth in output but just a result of the growing world prices. And so, we have a complete disproportion in the export. I dare say this growth has little to do with the concept of economic development. This is just a growth in quantity with no quality implied.

- But in philosophy they say that quantity is inevitably turns into quality.

In economy this is impossible. This requires quite different quality of economic policy - something we don't have. In economy nothing happens just for nothing.

Emmanuil Mkrtchian, ARMINFO 25.02.2006