IMF Does Not Propose Universal Recommendations

Aram Gareginyan

2009-04-17 14:58:00

Interview of ArmInfo and several other media with Regional
International Monetary Fund Director for Middle East and Central
Asia, Masood Ahmed, and the IMF Resident Representative in Armenia,
Nienke Oomes

What are the current trends of the global equity market? What’s the
envisaged strategy of IMF for Armenia in particular?

Masood Ahmed: Many countries now start to take action. You are
beginning to see some change in market perceptions. If you look at
what has been happening in equity markets within the last week or
two, you see a little bit of turnaround. I don’t think one should be
too much driven by what is happening week by week in equity markets,
but rather, try to identify the trend of regaining activity, which
is little by little gaining pace. At the G20 summit, a decision was
reached that IMF resources should be increased threefold – to 750
bln. dollars, along with the issuing of 250 bln SDRs.

This enables us to respond to countries’ needs, in a way that
is defined by their needs, rather than by the limits of our
resources. That’s very important, because it gives confidence to

In the case of Armenia, as you know, we had a PRGF (Poverty Reduction
and Growth Facility) program that had been agreed in November. But
then it became clear that the nature of the problems in Armenia was
different – the situation was more severe and the measures to be taken
more urgent than we had anticipated in November. So we cancelled the
old PRGF program and approved a new program, a Stand-By Arrangement,
of $540 mln. Our sense is that this amount responds to the current
assessment of Armenia’s financing needs. Once the assessment changes,
we can go back and reconsider the amount. We could have done so even
with our current resources, because the amount we approved for Armenia
was not constrained by the IMF’s total size, unlike in the case of,
for example, Mexico, which announced they would be coming to the
IMF for $47 bln. We would not have been able to respond to such
a request easily, if our size had not also been increased. In the
case of Armenia, the amount was not constrained by our size, and the
response we came up with was based on our assessment of the needs for
Armenia. But one must keep in mind that the amounts disbursed by the
IMF are intended to help strengthen the foreign currency reserves of
the country and provide it with a cushion – they are neither a grant
nor budget support. Armenia is also discussing with other institutions
and donor countries, including the World Bank and Russia, and their
resources will complement those of the Fund.

Before the transition to the floating exchange rate of the Armenian
dr am, there was a period of state policy of stabilizing the national

How does the IMF view it?

Masood Ahmed: Every country has to find its own time and methods for
elaborating its exchange rate policy. It was clear for the people
who follow the local market, that a lot of problems were becoming
increasingly significant with the previous approach. First, the central
bank was using up its foreign currency reserves, and the market was
actually sending signals in anticipation of a depreciation. Second,
other countries in the region all depreciated their currencies, and
the issue of regional competitiveness was getting more intense. That
is why our view has always been that, for a country with a small
and open economy like Armenia, a flexible exchange rate is the best
solution. Our assessment has worked out well, the Central Bank has
managed the transition to the flexible rate, and at the moment there
do not seem to be any signs of one-way pressure.

Nienke Oomes: What is encouraging is that, since the devaluation on
March 3, there has been very little outflow of deposits, and not much
further increase in dollarization of deposits, which suggests that
confidence in the banking system and the currency has been restored.

What are the limits for central bank interventions that the IMF
will tolerate?

Masood Ahmed: Having a flexible exchange rate does not exclude minor
day-to-day interventions to smoothen the=2 0volatility of the exchange
rate. It is the purpose of the interventions that matters, rather than
their amount by itself. The thing we want to avoid is getting into
a situation of systematic interventions, which are aimed to affect
the exchange rate trend. The trend should be determined by the market.

What are your expectations about the exchange rate of AMD?

Masood Ahmed: Nienke Oomes and her colleagues
recently wrote a paper on the equilibrium exchange
rate of the dram, which is published on our website:
res.cfm?sk=22783.0. Estimating
equilibrium exchange rates is very difficult, but what is interesting
is that several different models gave the same result, which was
that the dram was overvalued by 20 to 30% at the end of 2008. So the
depreciation that has happened since then has been in line with these
models, so that the dram is now approximately in equilibrium. What
happens in the future is hard to say – one cannot indicate a precise
benchmark, as everything is determined by the global market.

In the present situation, what are the main challenges for Armenian

Masood Ahmed: The main challenge for the national economy is
the slowdown in imports – even though it is less than that in
exports. Imports during the first two months of 2009 fell by 21
percent, while exports fell by 45 percent, compared with the first
two months of 2008. And the slowdown in imports leads to shortfalls
in tax revenues. As they slide down, government expenditures have
to be restrained. Our own sense has been that, in those restraints,
one has to take into account that the most vulnerable part of the
population has already been hurt by the reduction in remittances, on
which many families depend, and so we need to protect these people. The
second challenge is the inevitable slowdown in profitability and the
slackening in the corporate sector. This may have a lagged impact on
nonperforming loans in the financial sector. Lastly, the stance of
Armenia largely depends on its major trading partners, particularly
Russia, which in its turn depends on oil prices. Should the oil price
decline for a long time, it will require Armenian government policy
changes in the longer term.

What is the impact of the crisis on different social group of
people? Will it affect the poor more than the rich?

Nienke Oomes: It is all determined by the structure of the consumption
baskets of the poor and the rich. The poorest 10 percent of the
Armenian population spend about 75% of their expenditures on food,
7% on transport and medication, and 18% on other items. The richest
10 percent spend only 44% on food, and have much higher expenditures
on medical services, electronic equipment, and fuel. If we look at
the price changes of the mentioned goods and services, we see that,
between September 2007 and October 2008, inflation was higher for
the poor, as a result of the increase in food prices, which peaked
at 14% in April 2008, raising inflation for the poor to 12%, while
inflation for the rich was only 8%. Nevertheless, if we only look at
the impact of the crisis on prices in March, the crisis seems to have
more affected the rich, since prices for fuel and medication have risen
significantly among others (by 7-8 percent), although prices for butter
and sugar have also increased by 5-7 percent. On the other hand, the
decreased price for fruits and vegetables was more a benefit for the
poor, being a larger part of their consumption. This leads us to the
conclusion that the price increases in March had a larger impact on
the rich than on the poor. However, given the other negative impacts
of the crisis on the poor (for example, the large drop in remittances
and the increase in unemployment), the IMF urges the government to
protect social spending and to increase targeted support for the poor,
despite the fall in tax revenues.

The recently approved IMF program in fact allows for an increase in
social spending.

Is it reasonable for Armenia to increase its budget deficit?

Masood Ahmed: The level of the deficit is a function of what is a
sustainable gap between revenues and expenditures. Tax revenues are
falling (they feel by 17 percent during the first quarter of 2009
compared to the first quart er of 2008) and expenditures will have
to adjust to that. Armenia needs to be careful about how much above
revenues it can spend without having to cover the expenditures with
Central Bank reserves. The government’s IMF program that was approved
in March targets a budget deficit for 2009 of about 3 percent of
GDP, but their program allows them to spend any additional external
financing that may become available, up to a ceiling of US$200
million, which would imply a deficit of 5 percent of GDP. However,
these numbers were based on a projection for real GDP growth of -1.5
percent for 2009, which now already seems too optimistic. An IMF team
is coming to Armenia in May which will study the situation and update
the projections for real GDP growth and the fiscal deficit.

Do you believe in the safety of the social expenditures of the
budget? Is there a danger that the increase in salaries and pensions
will be annihilated by inflation?

Nienke Oomes: Last year pensions increased by 60%. This increase is
not going to be annihilated, unless there is inflation of more than
60%, which is certainly not what we expect. In fact, inflation in
March was quite low – only 1,4% compared to February, and 1% compared
to March 2008. There remains the possibility of a lagged effect of
depreciation on prices.

Because of the depreciation, there is pressure on prices to increase,
but at the same time, there is also a negative effect on prices that
you can expect from the slowdown in demand, which comes from the
slowdown of incomes.

Remittances are falling (gross non-commercial inflows fell by 34
percent in February 2009 compared to February 2008), which means that
people have less money to spend. The only positive effect from that
is that it could lead to lower prices.

I think the State Commission for the Protection of Economic
Competition (SCPEC) has been successful in preventing excessive price
hikes. Following the depreciation on March 3, commodity retailers
immediately increased their prices, well above the reasonable
level. The SCPEC has taken a careful look and prevented undesired
developments. But naturally they cannot prevent any price increases
because, as the dollar becomes more expensive in dram terms, it is
natural for the prices of imported goods to rise. However, if there’s
an appreciation of 20%, that certainly does not mean that all prices
should increase by 20%. Prices of purely domestic goods have no reason
to increase – in fact, they could even fall because of a fall in
demand. Moreover, imported goods in Armenia constitute no more than 20
percent of the consumer price basket used for estimating CPI inflation.

Besides, every imported good has a non-imported component, for
example, the cost of producing and selling an imported good includes
the salaries of sales staff, advertisement, distribution, etc, t he
costs of which are in dram. We estimate this non-imported component
of imported goods at about 20 percent. In addition, we estimate that
domestically produced goods have an imported component of about 30
percent, which is about the share of imports in GDP. The total import
component of consumer prices in Armenia can therefore be calculated
as 20% (the share of imported goods) times 80% (the import component
of imported goods) plus 80% (the share of domestic goods) times 30%
(the import component of domestic goods), which is 40%. Therefore,
we would expect the exchange rate depreciation of 20% to imply an
average price rise of 40% times 20%, which is only 8%. However,
this does not mean that inflation will necessarily increase by 8%,
because at the same time, there is pressure on prices to fall because
of the fall in incomes and fallen demand. Our latest projection for
inflation for December 2009 is 8%, but that was before we received
the low inflation data for March, and the low remittances data for
February, so we will likely revise our inflation forecast downward.

On the day of the depreciation, March 3, the CB announced that the
dram would balance in the range of 360 – 380 dram/$1. What if the
dram falls out of this range?

Nienke Oomes: It is important to understand that the range of 360-380
was just an expectation by the CB, and not a new target. I think
the purpose of the CB statement was to calm down the population
and give some idea of where they think the exchange rate will go,
since the population had been stirred up by some outrageous exchange
rate forecasts that had been published in some newspapers, such
as 850 dram/$1. So this 360-380 was rather an expectation than a
target. Whether the exchange rate may fall below or above the expected
corridor depends on the global market, including oil prices and their
influence on Russian economy.

We have always supported the Central Bank’s inflation targeting
regime that they had in the past and which was interrupted during 2008
because of the crisis. Now they have returned to a floating exchange
rate regime, which also implies that keeping inflation low will again
be one of the main goals of the Central Bank. It is very difficult to
say what is the optimal level of inflation, but experience shows that,
once inflation becomes double-digit, it is very difficult to bring
it down again. Moreover, inflation is bad for the poor, especially
when their incomes are already falling. This is why it is important
to keep inflation low.

What is you view of the actions of the Armenian government to
strengthen mortgage and equity markets, which are considered to have
caused the global crisis?

Masood Ahmed: The crisis had not been caused by the mortgage or
equity markets as such, but by the lack of supervision in some
elements of the mortgage market. The answer to that problem is to
fix the regulatory supervisory framework so that the housing finance
market doesn’t practice excessive lending to people who can’t afford
to pay back. So the goal is not to get rid of housing finance, which
has been an extraordinary lever to enable people to buy their own
houses around the world. In our view, the future of the financial
sector includes a very vibrant housing finance market. We also think
that the equity market will remain an important part of the financial
market structure. Developing both of these in emerging markets like
Armenia is an important part of the agenda. But one must recognize
that in all countries, those markets need to be actively supervised
and regulated. In Armenia, you don’t have the kinds of practices
that created the problem in some elements of the market in the
US. Therefore, I think you can always learn from the experiences of
other countries.

In the joint statement on the 2nd PRSP in Armenia, WB and IMF expressed
reservations against pension reform in Armenia…

Nienke Oomes: In general we do support the view that the pension
reform, e.g. transition to the private mandatory savings system,
is necessary. The current system is hardly able to ensure that there
will be sufficient resources to cover people’s pensions in the next
50 years. Incorporating private investors in the pension savings syste
m is an element of the long-term financial development of the country.

However, there should be clear risk management guidelines, because
people’s pension money should not be invested in assets or markets
that are too risky.

We also had some reservations about the readiness of the tax
administration to deal with the maintenance with individual account
records. That requires a certain amount of time and investments in
their IT infrastructure. They are currently making progress in this
area, but it is not clear yet whether they will be ready by January
2010. If not, then the pension reform may need to be postponed a bit.

Masood Ahmed: I don’t think we have a general view that private
management is more risky than the state one, because both state and
private pension finds often invest in the same markets. The coexistence
of two kinds of pension funds will also help to benchmark them.

The IMF stands for certain rules to be kept, which forbid large
financial interventions by the state, including Armenia. In that case,
how does the IMF tolerate massive US dollar emission?

Masood Ahmed: The IMF does not have any abstract and universal
rules that apply to all countries. Each country in its given
circumstances should find the most appropriate solutions. Today,
the primary danger for the global economy is a prolonged slowdown and
recession. A long-term issue is to regain lost liquidity. The primary
co ncern is to make sure that the functioning of the economy can be
facilitated. To enable that, we need to provide additional liquidity,
large fiscal stimuli, and control over the activities of commercial
banks to ensure their participation in the turnover of capital. This
is a good example of how the IMF’s advice is responding to the current
problems, rather than following abstract rules.