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Grigor Badalyan: The “Dutch disease” of the Armenian economy: diagnosis and treatment
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.
Diagnosis
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 of problems.
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.
Treatment
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 “development road.”
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 “protégé” 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, tax bodies.
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.
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