POVERTY REDUCTION IN ARMENIA IS BEHIND PLANNED PARAMETERS

ArmInfo's interview with new IMF Resident Representative in Armenia, Ms. Nienke Oomes

What do you think about the Poverty Reduction Strategy Paper (PRSP) in Armenia? Could you specify its strong and weak points?

On the whole, the program is developing successfully, al though it has both strong and weak points. The strongest point is that poverty in Armenia is actually being reduced. While in 1998-99, 56% of the Armenians were below the poverty line, by 2004 this figure was reduced to 35%. In 2005 it dropped to 30 percent,- which was substantially lower than the program target of 44%.

Isn't it more expedient then to stop this program and to start some other one?

But there are also weak points. In particular, in AMD terms social spending is in line with the program targets, but in terms of its share in GDP, it is yet much behind. For example, in 2004 the Armenian Government budgeted 83bln AMD or 5.1% of GDP for social protection and social insurance. In AMD terms, the Government actually spent more - 85bln AMD - but this was only 4.5% of actual GDP, because GDP was much higher than expected. Thus, economic growth surpassed all expectations but it did not lead to an adequate increase in social spending.

No doubt that this imbalance is due to poor tax collection, isn't it?

Yes, to some extent. While the share of tax revenues in GDP has been rising, it is still lower than planned. For example, in 2005 the program target for tax revenues was 15.7% of GDP, while the actual outcome was just 14.4%. For 2006 the program target is 16.2%, but we expect just 14.7%. This is quite a big shortfall. And this is, perhaps, the weakest point of the program: state tax revenues are growing slower than expected. But the Government is aware of this problem and is trying to do something about it.

How does the Government explain this deficiency?

The Government argues that the key contributors to GDP growth are construction and agriculture -sectors where it is very hard to collect taxes. Partly, they are right. For example, during the first 9 months of 2006 the construction sector grew by 37%, which is very high. However, until recently the Government had serious problems collecting taxes in this sector. Now, they have drafted a bill that will make it easier to tax construction projects. We think this is an excellent idea, because it is only fair that construction projects are taxed. Moreover, it may be one of the most effective ways to reduce the pressure on the dram-dollar exchange rate, which is caused in part by large foreign investments into real estate.

Recently, the Tax Inspection published the list of the 1,000 biggest tax payers of Armenia. And again, the public saw that it contained a lot of mismatches - when the biggest companies are among the second or even the third hundred of companies?

It is very good that the public is so keenly interested in such information and so actively reacts to it. The publication of the list is an excellent idea that was supported by the IMF, and we consider this to be a very important element of public control. This list puts tax evaders into awkward situation - as they do care about their reputation.

I would still like to ask you about the influence of the AMD appreciation on the Armenian economy. We see that the rate of export growth is declining. Armenia is a small country with a small domestic market and can develop its industry and create jobs only if it exports its goods abroad. Aren't these processes dangerous?

We are a bit worried but it is not that easy to prove that AMD appreciation is having a negative impact on exports. This is a hard problem. If you exclude diamond exports - where there were some structural problems - you will see that other exports are still growing, albeit slowly. In Jan-Sept 2006 there was overall negative export growth compared with Jan-Sept 2005, but non-diamond exports still grew by 3.4%. This figure is still lower than it should be. Unfortunately, the export growth in metallurgy was also negative - due to dropping metal prices in the world. The export of food is also dropping. These processes require deeper analysis but it is quite possible that AMD appreciation has reduced the competitiveness of Armenian products in foreign markets.

Nevertheless, we have already analyzed such macro-economic factors as productivity and the real exchange rate. In most of the countries where the economy gets more productive, the real exchange rate of the national currency begins to grow, which means that the price level starts to approach the price level of more advanced economies. There are two ways to raise the price level - either by raising the nominal exchange rate or by means of inflation. In Armenia we have the following picture: in 1993 the real exchange rate was much lower than its "equilibrium" level (that is, the level you would expect given Armenia's productivity); between 1995 and 1999 it was close to equilibrium; but since 2000 it has been undervalued again. However, in the last 2 years the AMD began to quickly appreciate, and is now approximately in equilibrium. This means that Armenia is still potentially competitive. Even though its competitive ability has dropped a bit, it still can compete. Answering your question, I would like to note that there is actually a risk of imbalance.

The level of dollarization in Armenia is quite high, but is this really a problem for a small country like Armenia, which is strongly dependent on foreign markets and the economic growth of which is due - to a considerable degree - to transfers of money it does not earn?

Dollarization in Armenia is still a real problem. About 65% of bank deposits in Armenia are in USD, and according to some surveys, almost 80% of the population's cash savings are also in USD. Of course, Armenia is a small country and is heavily dependent on foreign markets, but so are, for example, Switzerland or my country, the Netherlands, and they are not highly dollarized. Of course, in case of some force majeure - if the AMD begins to strongly depreciate - USD savings will help the population to survive. But now the AMD is appreciating, while USD savings are depreciating, so it is actually better for people to hold their savings in AMD. When an economy is highly dollarized, it means that the CB's policy is not effective, that the shadow economy is large, and that tax revenues will be small. There is also often an increase in theft and crime when the economy is based on USD cash. In fact, dollarization causes many problems, which is why we support "dramatization" of the Armenian economy.

I think the problem is still in the presence of real rather than statistical inflation and in the growth of prices even for imported goods. Now that the AMD is appreciating, importers are getting excessive profits. Analysts believe that this is due to high economy monopolization. What do you think?

We are concerned about this problem and are monitoring the situation. Particularly, we have done some research into the rise in the sugar prices. During the first ten months of 2006, Armenian sugar prices increased by 35 percent in U.S. dollar terms, compared to the same period in 2005, which may seem high. However, it is actually less than the growth in world sugar prices, which was 50 percent over the same period, because the demand for sugar was higher than the supply of sugar in the world as a whole. So the rise in Armenian sugar prices is not necessarily the result of monopolization. However, world sugar prices actually dropped by 18 percent between May and October 2006, while Armenian sugar prices stayed roughly constant in U.S. dollar terms. This could just be a lag effect and we have to wait and see what happens. If Armenian sugar prices do not fall, this could be because the market is monopolized. The same is happening with gasoline prices. As you know, world oil prices have fallen recently, while Armenian gasoline prices fell a bit in AMD, but remained almost constant in USD.

What does IMF think about the draft budget 2007 and its key parameters?

An IMF mission visited Armenia in September, and we discussed with the Government the parameters of the 2007 budget. In late November we will publish our third review of the current IMF program supported by the Poverty Reduction and Growth Facility (PRGF), and the current draft budget is consistent with our projections for 2007, which we discussed extensively with the Government. We certainly did not assess all the items of the budget, we consider only the main macro-economic figures: the deficit - which is low and this is good revenues and expenditures. We pay special attention to tax revenues. The draft budget plans to increase them by 1% of GDP, which is very ambitious. If this year the share of tax revenues in GDP is 14.7%, in 2007 it will be 15.7%. At first glance, this seems good but, considering that it should have been 16.2% this year, in 2007 the shortfall will be substantial. The most important thing is that the Government should raise tax revenues so that they can further increase social spending and futher reduce poverty in Armenia.

What do you think about the proposal of CBA Chairman Tigran Sargsyan that all foreign cash flowing into the country should be declared? Some experts say that this is a restrictive measure.

Declaration is not necessarily a restriction. Visitors to the US are also required to declare how much cash they bring with them, if they are bringing more than $10,000. This is a normal practice. It is essential for statistics, for making the situation more transparent. This way we can see, for example, if to what extent AMD appreciation is actually the result of foreign cash inflows from abroad, and to what extent it is the result of de-dollarization - Armenians changing their mattrass dollars into dram. We therefore consider this proposal quite reasonable.

Thank you for the interview

Emmanuil Mkrtchyan, ArmInfo, 08.11.06