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Money transfers provoked Dutch disease in Armenia

news.am, Armenia
Jan 6 2010

Money transfers provoked Dutch disease in Armenia

17:01 / 01/05/2010Below is an interview with RA Deputy Minister of
Finance Vardan Aramyan

NEWS.am: According to international financial agencies, Armenia was
among to the countries that were most seriously affected by the global
economic crisis. Can we conclude that during the pre-crisis period the
Armenian Government failed to accurately calculate its steps, and its
initial actions did not produce the desired results?

V. Aramyan: It is usually much easier to voice opinions ‘ including
critical ones ‘ of the past than to make forecasts for the future. But
we could approach the issue considering the lessons we have drawn. The
latest developments have shown that our economy was not so flexible
nor was it capable of resisting external shocks. What we have now is
the previous years’ heritage.

Before the pre-crisis period the Armenian economy was indirectly
infected with the Dutch disease, which, in its classical form, was
obvious in the Russian economy, Armenia’s major partner and main
source of money transfers. The Dutch disease is typical of the
countries exporting raw materials. They do not have any labor
productivity problems ` they export raw materials and receive huge
funds, which are later accumulated in the construction and services
sectors. As a result, theses sectors start developing, with prices
there rising. Instead, the exporting sectors are ousted from the
economy, with a lower price rise recorded there than in the
non-exporting sectors. The result is that all the resources (both
financial and human) flow into the non-exporting sector, which is much
more vulnerable to external shocks, as productivity growth is normally
limited there.

Armenia has no oil or gas reserves, but it received huge funds as
money transfers, mainly from Russia, which indirectly provoked Dutch
disease in the Armenian economy. Businessmen saw that the construction
and services sectors were highly profitable. Instead of thinking of
manufacturing export products, they rushed to the construction and
services sectors and made them engines of our economy.

What is the right policy? Both theory and international experience
show that symptoms of the Dutch disease are signals for improving
administration and taxation of the highly productive non-exporting
sector. Also, while most of the budget tax revenues are saved, the
rest are directed to the development of economic infrastructures. That
would be indirect assistance to the exporting sector and enhance
economic efficiency. That is, an active business cycle policy would be
launched.

I can say that the tax policy was not properly implemented during the
previous years. Now aggressive reforms in this field must be one of
the Armenian Government’s tasks, and the Armenian Premier has
repeatedly stated the fact. Specifically, tax and customs
administration must be improved at a higher rate. That is the funds
formed by money transfers were finally accumulated in the
non-exporting sector, which was prospering. The Government must find
and develop mechanisms of proper taxation and direct part of the extra
tax revenues to infrastructure development, which, as I have said,
would enhance economic efficiency.

We cannot say that the tax policy was entirely wrong, but the reforms
must have been slow. The lessons of the past show the need for the
Government to implement a more aggressive policy of economic reforms.
The Armenian market must become a diversified one.

NEWS.am: If the construction industry is not so efficient and proved
to be one of the causes of economic decline, why did the Government
provide a considerable part of the Russian stabilization loan to the
construction companies?

V. Aramyan: I would like to note that a fire in a flat may be caused
by an appliance out of order. The priority task is to put out the
fire. Then the appliance can be repaired. This principle was
incorporated in our short-term anti-crisis program. We also assisted
both the construction and the services sectors by issuing mortgage
loans by means of a newly established lending agency.

In fact, the Government did not allocate funds from the Russian
stabilization loan to developers. Some companies were completing their
construction projects. But, lacking circulating assets, they were
unable to complete the projects. Banks did not want to provide
funding, or issued credits at very high interest rates. The Government
provided guarantees to several construction companies, which enabled
them to receive credits at relatively low interest rates. Thus all the
three sides gained: the banks, because they utilized their funds; the
companies, because they resumed construction and created jobs; the
Government, because it ensured GDP growth and relieved social tension,
as it is citizens that are owners of the housing.

NEWS.am: Is economic recovery possible in Armenia, can the pre-crisis
level be reached during a medium term?

V. Aramyan: I am sure that our economy will recover and the previous
years’ indicators will be reached. First, our economy depends on
global and regional developments, which are signaling stabilization
and progress. The economic decline in Armenia reached the bottom in
2009. We forecast 1.2% economic growth for next year in the context of
1.5% economic growth planned in Russia ` our economy is closely
dependent on the Russian market. The International Monetary Fund
(IMF), HSBC Group, and the Asian Development Bank (ADB) made
optimistic forecasts for the region as well.

NEWS.am: How does the Government plan to restore the financial
balance, considering a sharp decrease in the amount of money
transfers? Want was the effect of this decrease on the Armenian
economy?

V. Aramyan: Money transfers are really of high importance for the
Armenian economy. They are rather equally distributed among the
economic sectors thereby reducing social polarization. Transfers
received in Armenia used to constitute up to 13-14 per cent of GDP
yearly. The year 2009, however, saw a 30% decrease, which was evidence
of decrease in the populations’ incomes. One of the Government’s tasks
was attracting foreign funds to the economy and thus stimulating the
demand, which actually depended on money transfers. In this aspect, I
think, the Armenian Government, assisted by the IMF, Russian
Government, World Bank, ADB and other donors, managed to make up for
the decrease in the amount of money transfers. As a result, more
budgetary funds were injected into the economy that the Government
collected as taxes. So we should expect 7% budget deficit instead of
1%.

NEWS.am: Much less funds come to Armenia now than before. Under the
circumstances, should the Central Bank of Armenia (CBA) revise its
monetary policy, particularly, create new mechanisms of crediting
small-to-medium businesses?

V. Aramyan: Indeed, the CBA’s priority task is price stability, which,
in the case of Armenia, is a legal provision. This allows the CBA to
assist the economy. The CBA achieves its aim by means of its monetary
policy, with the financial market members ` and through them the real
sector ` benefiting from this. When we say that the CBA should revise
its monetary policy and render direct assistance to small-to-medium
businesses, we should take into account that it is not so much
encouraged, as quite a number of absurd phenomena can be observed on
the market. Other nations’ experience shows that, even as an
anti-crisis measure, Governments’ assistance to small-to-medium
businesses is much more effective, while the Central Banks help the
Governments by reducing interest rates. We adopted this experience.
The CBA should keep its interest rates down for some time more, while
the Government will be supporting small-to-medium businesses. If the
CBA launches a policy similar to that of the Government, the two
policies will come into conflict. I think that the Government and the
CBA, especially during the crisis, should coordinate their policies.

NEWS.am: What export promotion measures does the Government plan for 2010?

V. Aramyan: Businessmen engaged in export receive help today as well.
They are exempted from customs duties and other taxes. Also, the VAT
is returned to them. Businessmen importing expensive production
equipment enjoy a 3-year VAT deferral. Nevertheless, I think that
improving the economic system, particularly tax and customs
administration reforms, is one of the best mechanisms now. The
Armenian Premier has focused his attention on it. The economic
environment will not improve until the tax and customs policies have
been reformed. No matter what export promotion mechanisms are
invented, they will prove to be stillborn if the structural problems
of the economic system remain unresolved.

NEWS.am: No increase in wages and pensions is budgeted for 2010. What
are guarantees against inflation, and will the population retain its
purchasing power?

V. Aramyan: First of all, we should not link inflation to purchasing
power. Our purchasing power depends on price rise. I would like to
note that one of our anti-crisis measures is full-scale execution of
all the social expenses. If we expect a 5-5.5 pct price rise this year
(and we aim at 4±1.5% for next year), we can say that the real social
expenditures or the purchasing power of this amount will be maintained
at the pre-crisis level.

T.P.

Tambiyan Samvel:
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