GRIGOR BADALYAN: THE "DUTCH DISEASE" OF THE ARMENIAN ECONOMY: DIAGNOSIS AND TREATMENT
Oct 11 2006
Grigor Badalyan – expert on financial and economic problems of Akos
research group specially for REGNUM
The AMD appreciation in the last two years has long ceased to be
just a topic of narrowly professional interest: for economists and
economy-related government executives only. Today, it is a topic for
all people in Armenia – from top officials down to shopkeepers.
However, collective brain-storming brings little clarity to the matter:
if you read what media write and listen to what politicians say about
the matter, you may get an impression that what they are talking about
is not the specific macroeconomics of a small country but something
from astrology, magic and sorcery.
The most probable reason is that most of the discussants are
ignorant of macroeconomics – be they journalists trying to quickly
cope with the subject they have known nothing about before, or
parliamentarians crying about some global plot and blaming executives,
or top government officials appearing at briefings with the hackneyed
monetarist mantras they in the IMF and WB have successfully used –
for many decades already – for hypnotizing the world community.
Probably, some people think that the present-day Armenian economy
is some anomaly – when statistics keep reporting an economic magic
(that’s exactly how they in the world call over 10% GDP growth), while
specific people and specific companies are finding it increasingly
hard to make both ends meet.
However, we see no paradox in all that we see: this situation has long
been scientifically described and can be found in any macroeconomic
text-book termed as "Dutch Disease" – the negative long-term impact
a disproportional explosion in one economy sector has on the other
ones. You could see such a situation in the Netherlands in the 1960s:
the active development of oil-gas deposits on the Northern Sea shelf
boosted an explosive growth in fuel exports and put the other economy
sectors – industry, agriculture, tourism – on the verge of collapse.
Almost the same is going on in the Armenian economy, today: an
export-oriented explosive growth in the industrial sector (let’s call
it provocateur-sector) is provoking a mass inflow of currency.
Without state interference, the national currency rate is beginning
to grow. As a result, profitability is declining, and the national
producers working outside the provocateur-sector are beginning to lose
their price competitiveness. This situation is hitting not only at
the exporters of finished products but also at the companies selling
goods exclusively inside the country: their products will be gradually
replaced by cheaper counterparts from abroad.
Declining output in processing sectors will logically bring to dropping
budgetary revenues, growing unemployment, stagnating productions, etc..
Only the provocateur-sector companies and importers will benefit
from this situation, but, in the long run, they too would see their
profitability curbed by steadily climbing exchange rate.
That’s exactly what we could see in Russia in 1988: a currency corridor
policy made it unprofitable for local oil companies to sell their
oil abroad – their costs in "expensive" RUR were bigger than their
profits in USD.
And now, let’s look at the Armenian economy and try to draw
parallels. In Armenia the provocateur-sector is construction
(all-time high 42% real growth last year). De facto, this sector is
export-oriented as the key buyers are residents of foreign states
who pay for realty in foreign currency.
Besides the autochthonous, "normal" growth in the Diaspora’s demand for
realty, there is an additional demand, caused by the war in Lebanon,
the expectations of the US military operation in Iran, the tensions in
Georgia and other factors. Consequently, the Armenians living in those
countries are beginning to increasingly often consider repatriation
as a way to ensure their personal security.
The growing demand for realty is generating big foreign currency
inflows, which, in their turn, are raising the demand for AMD. Since
the AMD supply is not changing, this tendency is inevitably leading
to sharp AMD appreciation.
The rest happens according to the above scenario: output declines in
all export-oriented sectors, in agriculture and also in the industries
working for the home market. Today, not only information technologies
– proclaimed by the government as a priority sector – but also light
and food industries and services are faced with a growing snowball
For example, if, as a result of continuing national currency growth,
the price difference between Kotayk and Budweiser beers grows smaller
or disappears at all, the native consumer will certainly prefer
the famous western brand. Or, sooner or later, if not now, the rest
in native Tsaghkadzor or Sevan will become more expensive than the
rest in Egypt, Bulgaria or Turkey, not mentioning Georgia. And this
problem is equally topical for all home producers: exporters and home
market-oriented companies. Already today, we can see this happening:
the export is falling, the trade gap has swollen to all time high
30% of GDP, almost all industries and services are on decline
(including the high-tech sector so much cherished by the people and
the government) – and all this because of the rapid growth of one
sector – construction.
Aggregately, this has resulted in an 11% economic growth in the past
months of this year. We can’t help being glad at the "quantity" of
this growth, but, on the other hand, we can’t help being concerned
for its "quality" and internal structure: the economic blossom of not
so very promising sector leads to the economic fading of the sectors
our nation relies on in XXI.
The first question that comes to mind after the analysis of the
situation is: is there a cure for the "Dutch Disease" or not? In other
words, what should the state do in such a situation? Is it Adam Smith’s
"night watchman" dolefully watching how things are getting worse
and just shrugging his shoulders, existing just for recording and
publishing statistics; or is it a complex organism bestowed with the
sovereignty of a nation for solving (i.e. actively acting rather than
passively watching) specific problems the nation cannot solve alone?
The advocates of the former approach represent the long-out-of-fashion
neo-classical model of economy and can be found in the IMF, WB
and other structures trying hard "to drag" lagging economies onto
I think there is no need to remind you once again of the general
opinion about the counter-productivity of the IMF and WB policies.
Their former executives have written lots of books, where they
shamelessly confess that their key mission was not to provide their
"protege" countries with access to the "golden billion," but, on the
contrary, to actively prevent this "undesirable" scenario. You don’t
even have to read those books, it’ll be enough for you just to look
at the IMF and WB "board of honor": those countries who happened to
accept their recommendations all, sooner or later, got on the verge
of economic collapse: Argentina with its thriving economy, Russia in
1998, Thailand during the Asian Crisis of 1997 and many others. On
the other hand, those who rejected the IMF "help," like Malaysia and
its Prime Minister Mohathir Mohammad (who had immediately become non
grata for the West), have independently achieved the best possible
results and the highest possible economic growth.
Unfortunately, our top executives from the Armenian government and
Central Bank think in other categories. The followers of those theories
are religiously fanatic in their attitude to inflation (the legacy
of Milton Friedman’s monetarist views): they are ready to fight this
"disease" even if it kills the patient.
We, on the contrary, believe that the state should smooth over
the disproportions in the uncontrollable, spontaneously-chaotic
development of the Armenian economy. First, we can and must carry out
a currency policy in order to support the strategic economy sectors,
and the Central Bank, with its full kit of necessary instruments,
can well do it.
Second, we should slightly cool the overheat construction sector –
which is the prerogative of the government and, more specifically,
The goal of the first – monetary – direction is to bring AMD to the
basket of foreign currencies – to the level acceptable for home
producers and exporters, for example, 500-550 AMD/1 USD. One way
to attain this goal is to increase liquidity. First, the CB can buy
USD directly on the currency market. Second, it can use the generally
applied, traditional mechanisms to subtly tune the monetary market by,
say, changing the discount or REPO rates (the rate of refinancing;
the lower the rate the more accessible the sources of crediting),
by reserving or by carrying out operations with the national debt.
In our opinion, the most natural and adequate way to increase
AMD liquidity is to pay AMD to buy foreign currency. By the way,
the Constitution of Armenia gives the CB the right to issue AMD in
unlimited quantity (if need be).
This measure would automatically bring the exchange rate back into
the limits acceptable for all – the secondary sector, services,
population and, why not, the selfsame construction. The only victim
would be importers (including petrol and similar monopolies).
Meanwhile, highly experienced in "saving" developing economies, IMF
experts are strongly warning the seemingly independent authorities
of the seemingly independent Armenia against inflation that will
inevitably follow the CB activity on the currency market.
Such statements remind me of the well-known anecdote that "the best
way to fight dandruff is to cut off the head." Yes, there will be no
inflation, but there will be no economy either.
Even more, the current inflation is due not at all to the excessive
demand but to the growing costs of enterprises: rising gas and
electricity prices, unprecedented oil market situation, consequent
growth in petrol prices and so on and so forth. Under such conditions,
the CB can in no way curb the growth of prices.
On the contrary, our government should do its best to support the
export-oriented industries, like they in China do: for many years
already the Chinese CB has been maintaining the fixed, artificially
undervalued rate of Yuan against USD. Despite the US’ urgent demands
to give up this policy, they seem to be reluctant to let Yuan "afloat"
and will continue preventing Yuan appreciation. Their point is simple:
only with low Yuan rate can China keep its cheap export further
competitive in the US and Western Europe and continue surprising the
world community with the pace of its growing expansion.
Generally, only countries with stable economies and reserve currencies
– the US, the EU, the UK, Switzerland, Japan – can afford tough
currency policy, while the countries with catch-up development policy
– China and very many other developing countries – on the contrary,
prefer to have weak currency for stimulating economy growth.
The logical question is: can it be so that something that is right
for China, Malaysia or India is wrong for Armenia? Or, perhaps, our
leaders see our country among Switzerland, Kuwait or Japan? Patriotic
as we are, we are still far from such thoughts.
We dare to disagree with some top economic officials and IMF and
WB executives. We believe that sensible policy of fixed exchange
rate and moderate AMD depreciation cannot be a strong stimulus for
inflation but can be a new strength for the much wasted promising
industries. The side effect of this policy will be quick accumulation
of currency reserves by the CB – which is quite good.
This solution is right on the surface and we are puzzled to see that
our monetary authorities have not applied it, to date.
Macroeconomically, this solution is absolutely logical, but it seems
that our CB has some non-economic reasons for disregarding it.
We would like to remind you that the foreign debt of Armenia consists
mostly of liabilities to the WB and IMF. And everybody knows that
those organizations lend money upon quite tough conditions. And it
is not a secret that in some countries they even approve or reject
national budgets, not mentioning "less" important documents, like
CB monetary-credit policies, for example. Even vast Russia had to
reckon with them, in its time; no surprise that those "agents" of
globalization can easily keep small Armenia on a short leash.
And so, our government officials may have "secretly" pledged to follow
the IMF and/or WB recommendations – guidelines that are quite dubious
for Armenia’s national interests and priorities.
Unfortunately, Armenia is not the first or the last in the IMF/WB
list of subdued countries.
If our fears are well-grounded and the monetary authorities keep AMD
high just because they have some "secret" commitments to international
financial organizations, our public should do its best to restore
the national sovereignty in the monetary sphere – or, we may lose the
competitiveness of our economy and the economic welfare and security
of our country.
The most essential and urgent steps we should take are as follows:
1. We should liquidate the CB monopoly over deep macroeconomic
analysis. In fact, they in the CE have in hand all the facts and can
see the most comprehensive picture of the economy, and any opponents
trying to dispute with them are doomed to failure because of being less
informed. So, it is necessary to recruit (or hire) an independent group
of researchers who would give an unbiased assessment of the existing
monetary policy in the light of the Armenian people’s strategic goals
for ensuring the long-term development of promising economy sectors.
2. It is necessary to work out a complex of measures to cool the
overheat construction industry. This policy can be carried out by
purely fiscal means: for example, by increasing the taxes on the sale
of primary housing, on land, on the sale of land for construction,
etc. The general logic is – to artificially increase the construction
costs for decreasing the potential demand.
3. It is expedient to enroll representatives of all native sectors
into an action group so they can thoroughly examine the problem and
inform the public, the parliament and the president of the private
sector’s single position on the matter.