ARMINFO news agency:news

home

foto-gallery

Digital Armenia

news

ARMENIAN ECONOMY: ACHIEVMENTS AND CHALLENGES

Interview with Mr. Garbis Iradian, IMF Resident Representative in Armenia. July 26, 2002

- What is your assessment of the recent economic developments?

- The overall macroeconomic situation in 2001 and the first half of 2002 was satisfactory. Real economic growth remains strong, around 9 percent, driven mainly by industry and construction. Average inflation was 3.2 percent in 2001 and is projected to remain around 3 percent in 2002. The dram has remained broadly quite stable during the past two years. The trade and the external current account deficit continue to narrow significantly as a result of the continued strong growth in exports. There has been some progress in improving the tax revenue collection during the first half of this year. However, the stock of budgetary arrears remains high at about US$ 80 million, equivalent to 3.5 percent of GDP.

As to structural reforms, the financial performance of the energy sector deteriorated further in 2001, reflecting in part the failure to privatize the energy-distribution companies and weaker than anticipated collection and loss rates. Some improvement has been made in the energy sector during the first 6 months of this year as reflected in higher collection rates, reduced excess losses, and lower primary deficit.

The overall fiscal deficit is still one of the highest among the former Soviet Union Republics. To reduce the deficit the tax revenue collection should improve further since the scope for further reduction in government expenditures are limited. Also improvement in tax revenues would provide additional resources for increasing government expenditure on social sectors, including education and health, and also enable the government to reduce the stock of expenditure arrears. Armenia cannot go on forever relying so heavily on budgetary financing form external sources.

The government needs to make it absolutely clear that it is not only morally wrong to knowingly understate or to fail to honour one's tax liability, but that it is illegal and it will be punished, without favoritism. Moreover, tax liabilities must be calculated according to the law, and not negotiated between the government and taxpayers. Such negotiations typically lead to a loss of revenues, as well as involving corruption.

- What are your views on the status of the banking system in Armenia?

- The recent positive macroeconomic developments in Armenia have not been matched by expansion and strengthening of the financial sector. The inability to bring about some fundamental changes in the conditions affecting the banking system could endanger the sustainability of the economic growth.

Bankruptcy procedures are common in every market economy, including developed countries with established banking systems. Most bank failures may be traced to poor internal management.

The fact that a bank or few banks are under bankruptcy procedures does not necessarily mean that the whole banking system's stability is at risk. There has been an ongoing consolidation process in the banking system, which is to be expected in a transition economy. Many banks that are currently undergoing conservatorship arrangements have not been placed under this regime over-night, it has been a long process that trails several years. So far, the impact of the banking system on the economy has been limited and has not reduced the public's confidence in the banking system.

The primary responsibility for keeping individual banks sound lies with each bank's owners, directors, and managers. Of course banks in Armenia operate within a framework of strict supervision and enforcement of prudential regulations by the Central Bank of Armenia. Together they must establish a framework of internal controls and practices to govern the operations of the bank and ensure that it functions in a safe and sound manner.

- Many Armenians believe that the privatization experience in Armenia has failed. What are your views on this issue?

- Mass privatization has not worked very well in Armenia primary because the government did not make major advances in improving the business environment. Insider privatization did not lead to self-induced restructuring of firms. The World Bank is now emphasizing that the way to go is with well thought out case-by-case privatization, particularly with strategic investors. The privatization of the brandy factory and the diamond factory were actually success stories, in part also because the investors were well placed in international markets. While case-by- case sales have clearly produced positive results, insufficient attention was paid to such key issues as transparency and public relations. The result was lesser degree of public acceptance for privatization than perhaps was deserved. The poor handling of the ArmenTel privatization is the strongest reason for public dissatisfaction. The monopoly granted to OTE as one of the terms of the sale has been the cause of much controversy. The common public perception is that the sale has not resulted in sufficient improvements in the quality of service, while prices, especially for long distance calls, have remained high by international standards. As telecommunications issues touch most of the population, this single transaction has engendered widespread mistrust of the privatization process, a sentiment that the government can only mitigate by way of a series of high profile, well-managed sales.

- What are the economic implications of peace in the region?

- Economic benefits of peace in Nagorno-Karabakh would be enormous. High transportation costs and the lack of security for trade flows are serious impediments to economic growth in Armenia. Economic activity in Armenia remains severely affected by civil and ethnic conflicts that have lingered since independence.

The peace dividend resulting from a resolution of the Nagorno-Karabakh conflict could significantly improve Armenia's medium term growth prospects (as well as those of the other parties involved in the conflict), in at least five ways:

It would facilitate the process of regional integration. The integration of key infrastructure networks in transport, oil and gas would enhance the competitiveness of all countries in the region.

It would lead to an end of the blockade on some trade markets and routes, reducing transport costs, enhancing prospects for sustained export growth, and inducing a significant reallocation of resources within the economy toward tradable.

Turkey would become a major market for Armenian goods including cement, light manufacturing, food processing, etc.

It would reduce uncertainty for investors by securing trade routes, eliminating the threat of renewed military conflict, and easing regional tensions. This would improve prospects for total investment and foreign direct investment.

It would reduce direct costs associated with the conflict, including military expenditures and other national security related costs. The resources saved could then be channeled into more productive areas, or reduce the government's external borrowing requirements.

A recent World Bank study estimated that Armenia could double its exports and halve its trade deficit within few years, and Azerbaijan could also increase its exports substantially, if the economic blockade were to be lifted. Georgia could face some reduction in transit fees in the short-term, but would eventually gain from increased cooperation and stability in the region.

- How would you assess the role of Diaspora in the development of the Armenian Economy?

- Between 1990 and 2001, based on various surveys it is estimated that about 900,000 Armenians (equivalent to one-fourth of the population) have left the country. Almost two-thirds of the emigrants are well-educated men of active working and reproductive age (20-44 years). If such an emigration trend does not slowdown it could deprive the country from its major long-term development resources.

According to a survey conducted in early 2002 by the USAID:

Most Armenians are worried that continued emigration and a low birth rate will undermine Armenia's ability to survive.

Forty percent have thought about going abroad to live and work, and 16 percent say they are likely to do so in the next five years. The proportions are much higher among young adults.

With low wages, high unemployment, and continued hardship for more than half of the population, only 30 percent feel that young people can expect much of the future.

The public's unwillingness to compromise on Nagorno-Karabakh contributes to a sense of deadlock and malaise.

While depriving the country of a professionally qualified and economically stable population, emigration is a substantial source of income support. About US$250 million (equivalent to 12% of GDP) is privately transferred annually to Armenia. Also Diaspora investors and entrepreneurs could play a critical role in attracting foreign direct investment, setting up joint ventures, and promoting export of domestic companies.

For a small country like Armenia (about 3 million inhabitants in 2001) the Diaspora presents an extraordinary source of development resources. Most Diaspora Armenians are successful economically and professionally. Also they have established a good track record of successful political and humanitarian mobilization. Armenian-American billionaire, Kirk Kirkoryan, has allocated a grant to the Armenian Government in the amount of US$150 million (equivalent to 7 percent of GDP) to rebuild the country's infrastructure. This grant will be disbursed fully before the end of November 2003.

The inflow of Diasporan investments to Armenia has so far been much below expectations. In total during 1995-2001, Armenia received on average less than US$30 of FDI per capita, while other transition economies in Europe attracted more than US$100 per capita. Surprisingly large part of Diasporan investments came from Russia but not from North America and Western Europethe West, where Armenian communities have more business experience and a large overall investment potential.

The Diaspora's attempts to invest mostly failed due to the hostile attitude of insiders. During the May 27-28, 2002 Armenian Diaspora conference in Yerevan, most participants underlined the corrupt bureaucratic system and clannish Armenian economy as a major constraint for FDI in the country. Investment by Daspora Armenians could increase significantly in the next few years if the business environment improves further including the provision of reliable legal guarantees, setting of stable rules of game, and if corruption is being reduced.

- What is the role of the private sector in the Armenian economy?

- Armenia has made substantial progress toward creating a viable private sector through such policies as early privatization of agricultural land, housing, shops and restaurants; employee buy-outs of small enterprises; and privatization of larger enterprises through cash sales. Some 75 percent of GDP is produced by the private sector, a high figure by regional standards. Pressing policy issues concerning private sector development include: a) privatization of the electrical sector; b) completing the privatization of the remaining large state-owned enterprises; c) strengthening financial markets through improving banking supervision and regulation; and d) addressing the factors that limit the development of small and medium-sized enterprises (SMEs).

Armenia still suffers from some host of unfavourable conditions that limit private sector development and discourage foreign direct investment. These include: (i) closed land borders with/Turkey and Azerbaijan as a result of the failure to reach a comprehensive peace agreement on Nagorno-Karabakh; (ii) limited capacity road/rail links with Georgia and Iran; (iii) a small domestic market; (iv) a difficult business environment.

SMEs in Armenia generally lack the resources or contracts to attain the political patronage that drives access to resources and reduced risks. These are the businesses that benefit most from rational government policy development and enforcement, while larger ones are more able to draw upon various advantages that can balance poor policy development and enforcement. SME development should be given careful nurturing attention, as it is widely recognized than an additional dollar invested in SME development generates significantly greater employment than a similar investment in large enterprises. The main barriers to the establishment and growth of SMEs in Armenia include the following: (1) poorly paid civil servants who frequently avail themselves of opportunities to supplement their salaries from businesses with patronage and a biased judiciary; (2) limited purchasing power of the domestic population; and (3) difficulties faced by entrepreneurs in gaining access to credit.

A number of sectors are of particular interest in the Armenian context with respect to SMEs. Agriculture is the largest employer in the country, and accounts for up to one-third of GDP. The country produces a wide variety of high quality fruits and vegetables. Moreover, many of the more promising industrial activities, such as wine and brandy, beer, and mineral water, are in food processing

A second promising sector for SME activity is information technology (IT), which seems well placed to take advantage of the country's specialization in electronics in Soviet times and the involvement of the Armenian Diaspora in IT enterprises in such places as California's Silicon Valley. Moreover, IT exports are among the few which are hurt relatively little by Armenia's transport bottlenecks, given the possibility of exporting software products electronically. The software industry currently has annual sales of about $20 million. Third, Jewellery and diamond processing will continue to prosper. The diamond exports is expected to exceed $150 million in 2002 and could increase to more than $400 by year 2005. Foreign investments have largely contributed to this development.

- Armenia is considered as one of the most corrupt countries among the Former Soviet Union Republics. Do you agree?

- In a transitional society such as Armenia, where the newly established institutions and laws are not functioning properly, the incentives and opportunities for corruption grow and its effects on country's social-political life and economy become more pervasive. The analysis of economic performance in transition economies has increasingly focused on the impact of pervasive corruption in inhibiting investment, deterring competition, reducing fiscal revenues and more broadly in restraining economic growth and poverty reduction.

Surveys in Armenia, and in most transition economies, indicate that administrative corruption involving side payments is widespread and that the public and enterprises view state institutions as having a high level of dishonesty. Cross-country surveys place Armenia in a group of high corruption countries with the post-Soviet space, particularly in terms of administrative corruption.

A survey undertaken by the IMF Office in Armenia assessed perception of corruption by 95 major businesses and senior public officials. Most respondents ranked police, tax and customs authorities, and the judiciary as the most dishonest institutions from a list of 12 public and civil society structures. Businesses reported the highest average bribes for tax inspections and customs clearance. There exists a high level of distrust towards courts, more than 80% of the surveyed consider the judiciary the least trusted institutions.

No matter how improved the laws regulating market relation can be, the legal infrastructure (both institutions and personnel) in Armenia is not sufficiently equipped to cope quickly and effectively with major legal changes in this domain and cannot deal with the rising legal problems effectively. There is also a high level of distrust toward the professional qualifications of judges.

There can be many causes of corruption in Armenia some of them quite common for transitional countries. The studies investigating the causes of corruption in these countries point to various factors ranging from weak rule of law, public versus private wage differential, and level of structural reforms. The results of the IMF office survey in Armenia indicate three major reasons for corruption: (1) impunity of high-level authorities; (2) low wages in the public sector; and (3) absence of law enforcement mechanism. Low wages are perceived as a major cause of corruption. Low wages of civil servants create additional incentives for them to take bribes or to be engaged in other rent seeking activities.

Law enforcement, which is an important indicator of good governance, is to a large extent ineffective in Armenia. More 70% of the surveyed enterprises in Armenia strongly disagreed with the statement that "businesses in Armenia are protected from government's arbitrary interference".

- Priorities for Future Economic Growth and Poverty Alleviation

- The medium-term prospects for the Armenian economy are encouraging. The strong economic growth of the past few years if sustained would reduce poverty and unemployment noticeably. In order to sustain the relatively high growth rates and reduce poverty, Armenia will need a higher level of new entry, including foreign direct investment, in relatively labour intensive industries and strengthening of the financial sector to play its intermediary role in the economy. At the same time it will be necessary to reduce corruption to ensure that the fruits of rapid growth are spread more widely among the population. In general, a major improvement in public governance is needed to manage more effectively public resources, accelerate a broad range of structural reforms, and to fight corruption.

The government needs to continue to take a broad range of measures to strengthen the environment for private investment, especially in small and medium-sized business.

Armenian state institutions remain weak despite continuing donor support for judicial reform, efforts to streamline administrative procedures, and the government's stated commitment to develop an anti-corruption strategy. Entrepreneurs frequently complain about non-transparent regulation, cumbersome administrative procedures, and the uneven application of the rule of law. On the more positive side, state intervention in enterprise decisions is relatively low by comparison with other transition economies, the privatization program is far advanced, progress has been made in simplifying tax procedures, and the country maintains a very open trade regime.

Nonetheless, while some progress has been made in reducing regulations and other sources of petty harassment and corruption, important steps are needed to reform the judicial system so as to strengthen the environment for implementing bankruptcies and contracts, including the ability of banks to collect collateral. This should be undertaken through further Legislative changes, public administration reform, and capacity building efforts. Assisting small and medium-sized businesses obtain much needed bank credit at lower interest rates would also be helpful.

Finally, further energy sector reform is important in order to reduce financial losses, increase efficiency, and attract investment for much needed rehabilitation. A fully competitive and transparent privatization of the country's four distribution companies will help increase the financial strength and management capacity of the distribution utilities and attract investors for the next stage of reform, the sale of generation assets. The privatization efforts should be complemented by a deepening of reforms in the sector, including, inter alia, further adjustment of energy tariffs, strengthening of the independence of the energy regulator, and improved budget and payments discipline in the public sector with respect to energy consumed by public entities.

18 Jule
Alexandr Melkumyan, ARMINFO