Reforms of second generation necessity in Armenia

ARKA News Agency, Armenia
Aug 22 2007

Reforms of second generation necessity in Armenia

YEREVAN, August 21. /ARKA/. Armenia must carry out reforms of the
second generation at a very high rate, the Prorector for University
Education Development, Russian-Armenia (Slavonic) University, former
minister of finance and economy of Armenia, Professor Edward Sandoyan
stated in his interview to the ARKA News Agency.

`It is a happy fact that during the parliamentary election campaign
RA Premier Serge Sargsyan repeatedly pointed out the necessity for
reforms of the second generation in the country. All this suggests
that we will have rapid changes.’

Sandoyan expressed his satisfaction over the fact that the
Government’s economic team has been replenished with highly
experienced professionals. Specifically, he believes that the
appointment of Nerses Yeritsyan RA Minister of Trade and Economic
Development is a hope-inspiring factor as Yeritsyan has proved to be
a `first-rate professional not involved in any political games.’

`Everything suggests that the public is mature to realize the need
for professionals, without whom progress, especially in reforms of
the second generation, is impossible,’ Sandoyan said.

According to him, Armenia has not made any headway since 1999,
reforms have mainly slowed down and even stopped, even in the spheres
that are in urgent need for them. The problem is that we can miss a
chance for rapid and essential development if we fail to implement
necessary reforms in certain spheres.

What is the need for reforms of the second generation?

The first stage of reforms, which was launched when Armenia gained
its independence, implies transition from planned economy to market
economy. The transition was chaotic and difficult, accompanied by
serious problems resultant from the collapse of the USSR,
Nagorno-Karabakh conflict, aftermath of the earthquake, loss of all
corporate ties. The situation was so serious that Armenia ranked
first or second among the former USSR republics as to economic
recession.

In those conditions Armenia managed not only to survive, but also
overcome most serious problems, chiefly restore the disaster area,
but also – and this is the most important – ensure the institutional
bases for market economy. This process was most complicated and
accompanied by both faults and effective solutions. However, all of
this is for historians.

What should be done next?

We are now in a situation, when our economy can hardly be defined as
market economy. It has features formally resembling those of market
economy, but they are in essence far from being features of market
economy. This is the reason for public discontent, and Armenia
remains a country of modest means, in the aspect of both per capita
GDP and infrastructure development. The main problem is that we have
low-level economic competition and, consequently, high-level
concentration of business and property, monopolization of various
trade and economic fields.

We have high-level corruption and low-level economic competitiveness
compared to the counterpart countries. The export-oriented economic
sector is not efficiently developed in the country, whereas this is
the only direction of our further development. The institutions of
protection of property right, competition, contract enforcement are
in embryo. The matter concerns inefficient legislation,
administration and judicial power. More complicated tasks involve
reforms of education, science and public health.

We have serious regional, energy, transport and communication
problems, which hinders the country’s further development as well,
especially when the matter concerns regional integration, including
transport and energy integration.

All of this requires reforms of the second generation –
institutional, more essential reforms, which can be most painful and
long-term ones. They cannot be carried out in a year or in three
years, but they should have been started long ago. Strong
authorities, enjoying the population’s confidence, are able to start
such reforms.

I can see this potential now. The parliamentary elections reduced the
number of populists, the degree of destructivism, and we see the
legislative body more logically completed. This can enable us to make
a breakthrough. Therefore, the authorities need the population’s
great confidence to make some, even unpopular, steps, which are
certain to produce results.

What is the importance of economic reforms?

Reforms are necessary for maintaining positive macroeconomic
indicators. At first sight, these indicators are stable in Armenia –
steady economic growth, the second largest growth among developing
countries after Azerbaijan. A rather stable market situation, low
controllable inflation and considerable reduction of poverty and
unemployment.
However, when we look at the quality of economic growth, we can
notice the lack of deep institutional economic reforms.

This is fraught with most serious consequences because we are now
using the natural conditions producing results. If we continue on the
same lines, we may lose all the sources of economic growth.

Over the last 15 years, Armenia’s economic growth has mainly been
ensured due to economic rehabilitation. Among other very strong
clusters of economic growth have been import substitution and
diamond-cutting. However, import substitution cannot be an
everlasting process, and the diamond-cutting industry, which has for
a long time constituted 30%-40% of our exports and imports, is
beginning to decline because of more expensive labor force.

Unfortunately, construction is the principal cluster of economic
growth. Of course, it is good that our construction industry is
developing. But the point is that it is housing construction, not the
construction of enterprises, that is being carried in the country,
which will not result in rapid multiplication of potential of
economic capacities, but only in the improvement of housing
conditions and of the quality of the country’s housing stock. This is
very good and important, but the element of consumption is very
strong here. Using conventional terms, we can say that it is
important for us to develop sectors and clusters, which can create
new potential for further development.

Another cluster is agriculture. This is a good thing, especially in
agricultural produce processing. But its potential is seriously
limited as well.

Moreover, the situation can be complicated due to the fact that,
under the WTO-set terms, we are to make our agricultural sector
taxable soon, which will cause a rise in the price for agricultural
produce and reduce competitiveness on the foreign market. If the
financial bodies fail to ensure adequate taxation, and the Government
fails to find the right mechanisms of backing the agricultural
sector, it may cause serious quasifiscal losses. On the one hand we
will have higher prices, and on the other hand we will not be able to
enhance the efficiency it the agricultural sector by backing it.

Further economic growth may slow down without economic innovations.
Armenia needs the development of economic innovations. This requires
a very high education level, which may take years and even decades.
It would be naïve to believe that rapid development of information
and high technologies is possible in the country. With the domestic
potential lacking, it is only possible when a technologically mature
investor having efficient innovations makes high-quality strategic
investments. However, this requires a proper investment climate.

High-quality human capital is also necessary, which is ensured
through education. Our education system leaves much to be desired,
and the investments we have been making are insufficient and
inefficient. Even if we increase the investments, they will not
produce any results, as structural and institutional reforms are
required, which would ensure the compatibility with the technologies
and mechanisms that are producing results in Europe and the USA. In
any case, if we do not have new economy, the economic growth may slow
down in the future.

Our Diaspora is our oil!

One of our major advantages is a mobile and active Diaspora, which
provides Armenia’s economy with money transfers. Our Diaspora is our
oil. And if financial institutes are efficient and adequate to this
situation, economy will have great advantage. Economy is getting
serious injections from the Diaspora – according to some data, up to
$1.5bln a year. If this sum is compared with Armenia’s GDP and state
budget, it will be clear that this is the most significant factor of
economic growth, source of its financing.

The money flows eventually increase the population’s solvent demand,
which is the major factor enhancing the economic capacity, and if we
properly adjust our economy to financial institutes now, we will get
a great effect without ecological and financial problems.
At present, the Armenian community in Russia is most active. It is
due to them that we can see large-scale construction in the center of
Yerevan. This is a new generation, the ones that left Armenia in
early 1990s, got firmly established and made great progress in
business. This community ensures increase in direct foreign
investments and private foreign transfers.
However, the two components of economic growth create certain
problems. We are under the threat of what is known as `Dutch
disease’.

Dedollarization of Armenia’s economy in progress.

The result of the increase in currency supply in Armenia is that,
over the last three years, we have observed unprecedented revaluation
of the Armenian dram and, therefore, dedollarization of economy and
high-rate enhancement of the Armenian dram’s role in the money
supply.

On the one had, this is a positive factor, which affords ample
opportunities to enhance the efficiency of monetary and credit policy
being implemented by the Central Bank of Armenia (CBA) and of the
channels of influence on the money market.

However, this worsens the conditions for development of most of the
export-oriented clusters. We can also observe the devaluation of the
population’s private transfers and savings as most of them are in the
form of foreign exchange. Since, according to the CBA, about 36% of
the country’s population are dependent on private transfers, in many
cases their real purchasing power is reduced due to the USD
devaluation. This results in the most dangerous phenomenon, namely,
the rise in the cost of living in Armenia. This situation is to
importers’ great advantage, which is bad for economy, as we must have
an opposite situation, which would not contribute to the increase of
exports.

When we face the rise in the cost of living and human capital, that
is, labor force, we must take into account the fact than many
businesses will become unprofitable.

We can already notice a decline in jewelry production, because
diamond production and cutting mainly involve labor expenditures. The
rise in labor expenditures causes a rise in production costs. This
makes many enterprises reduce their output, and unfortunately, they
may very soon stop operating, as it will be much more effective to
establish such production in such countries as China and India.

The same can be observed in the sphere of information and high
technologies. A programmer has become an expensive pleasure in
Armenia. This is not the low-paid labor force two or three years ago.

On the other hand, it should be noted that the future of the
country’s economy must not be built on low-paid labor force as,
sooner or later, this factor come to an end under conditions of
economic growth.

However, labor force became more expensive in Armenia not due to
larger incomes, but because to the rise in cost of living, and the
rise in the cost of labor force was relative, not direct. In the USD
terms our workers receive more, but in the AMD terms their incomes
actually remain the same.

Problems of lack of institutes of financial intermediation.

If these processes had been accompanied by natural changes on the
market, the revaluation of the national currency would have caused a
fall in prices, first of all in import prices, unless any
considerable rise in the world prices for some imported products was
recorded. We do not have this. On the contrary, the prices for many
goods and services are rising.

All this causes a rise in the cost of living and labor force. We are
having an increase in the purchasing-power parity, and the closer it
is to European and American prices, the less efficient our economy
will be, because all this is not the result of economic growth,
related natural processes and the population’s enrichment, but of
only the exchange rate policy.
This is the main danger. We need very serious reforms. Specifically,
when we speak of the money market, we need a developed financial
sector, instruments and financial products, which would allow us to
attract considerable funds from the consumer market and direct them
to longer-term capital and other projects. This function is performed
by relevant institutes of financial intermediation we are lacking.

Steps to create a system of nongovernmental accumulative pension
fund, mortgage crediting market, conditions for development of all
types of insurance, including life insurance, have been necessary for
a long time.

Insurance and pension funds must be come the organizations to come to
the capital market with `long’ money and turn into consumers of debt
instruments, which, in turn, may appear due to the same mortgage
institutes.

A mortgage crediting body with state capital to issue mortgage
securities should have been formed long ago.

Armenia also has to develop corporate securities. Relevant procedures
are under way. Specifically, the entry of the Scandinavian OMX
company to Armenia’s market is a direct way to integration of stock
exchanges and to real-rime entry to European and international
capital markets. This will allow Armenian issuers to attract funds on
foreign markets for developing their businesses, allowing investors
to have foreign securities circulate on Armenia’s capital market.

The banking sector must be engine of the other segments of the
financial sphere.

Armenia’s banking sector remains very small compared to those in many
other countries, which is accounted for by the underdevelopment of
other non-bank financial institutes, whereas Armenia is an undoubted
leader in the efficiency of bank management and banking supervision
in the post-Soviet area.

That is, everything necessary has been done for effective development
of the banking sector in Armenia. But time has shown that it is not
enough, as, being the center of the financial sector, the banking
sector is supposed not only to be supported by other financial
institutes, but also become an engine of the other segments of the
financial sphere.
The lack of these niches results in the banking sector’s further
insignificant role in the country’s economic development.

Therefore, it is most topical when a new Government led by the
Premier states the necessity for reforms of the second generation, as
it is only such reforms that can resolve the country’s current
economic problems. P.T. -0–

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