Armenia is trapped in "Dutch disease" - economist

ArmInfo. The short-term windfall impacts of human and  financial relocations on the Armenian economy should be expanded and  sustained, giving it a sustainable effect. This opinion was expressed  by Rector of the Russian-Armenian University (RAU), doctor of  Economic Sciences of the Republic of Armenia and the Russian  Federation, Professor Edward Sandoyan, speaking at the International  Scientific Conference at RAU recently.

He noted the importance of discussing the main characteristics of  what has been happening to the Armenian economy over the past 2  years. "This is important because, firstly, the new effect factors  are completely related to the Russian Federation- relocation of  people and businesses, growth of tourism and, of course, re- export  or parallel import," Sandoyan noted.  Therefore, according to the  speaker, it is necessary to understand whether Armenia will be able  to postpone or maintain this short-term unexpected effect for the  economy through the development of economic regulation systems and  give it a more stable effect. "This is not an easy task, the problems  are serious, but while we are on a growth trend, while we are getting  quite an interesting effect from new growth factors, it is necessary  to try to somehow influence these processes in a positive way.

Developing the idea, Sandoyan considered the 8.7 percent economic  growth in Armenia not quite natural for the economy, both from the  point of view of the country's GDP structure and backward  development.  "According to various estimates of our expert  communities, our natural economic growth varies at the level of  4-5%," he emphasized. "When we look at the main drivers of economic  growth, we notice high construction volumes, supported by  government-subsidized mortgages, where the growth rate of mortgage  loans is already significantly higher than the rate of economic  growth and the growth rate of household incomes. This is already a  potential crisis in terms of the solvency of servicing mortgage  loans. And when we look at the growth of trade by 25.7%, given that  in 2022 we had more significant growth rates, and the volume of  services grew by 10.3%, then we understand that there are, relatively  speaking, non-standard factors at work here. And the question arises:  how sustainable is this growth?", the professor asked.

As Sandoyan noted, in terms of nominal GDP, Armenia is in 5th place  among the CIS countries, as well as in terms of purchasing power  parity (PPP). But the situation is changing: "In terms of potential  export competitiveness, Armenia's position began to deteriorate  significantly due to the appreciation of the national currency  compared to Tajikistan, Uzbekistan, Kyrgyzstan, Moldova, Kazakhstan,  Belarus and Georgia. We continue to remain in the risk zone of the  so-called "Dutch disease". 

The unprecedented influx of foreign currency in 2022, despite the  subsequent decline, had a shock effect on the economy, which is  characterized by the appreciation of the exchange rate and a loss of  competitiveness, both in terms of purchasing power parity and in  terms of the presence of Armenian goods and services in foreign  countries, including Russian markets."

Sandoyan named the main factors of the Armenian "Dutch disease".  According to the most approximate estimates, more than 100 thousand  immigrants arrived in Armenia during 2022, about 2,500 legal entities  with Russian participants and about 4,000 businesses registered as  individual entrepreneurs were opened.  Already on March 31, 2023,  their number increased to 6060 and 7771, respectively. The additional  influx of customer funds into the Armenian banking system is  estimated at about $3 billion in 2022 alone. As a result, out of the  total growth of the Armenian economy that year at the level of 12.6%,  relocation provided more than 3%. The effect is calculated at  approximately $100 million per month on average, based on the  assumption that immigrants spend about $1 thousand per month.

In turn, the volume of foreign trade began to show absolutely  unprecedented figures: Exports increased by 79.7% in 2022, - by 55.3%  in 2023; Imports - by 63.7% and 40.2%, respectively. The growth of  exports exceeded imports, which, according to the economist, is quite  good, but on the other hand, here again we see a long-standing  disease of the Armenian economy, when it is not possible to take  advantage of the situation and improve the trade balance through  import substitution. At the same time, the export has increased  significantly, and to Russia - up to 3-fold in 2022 But in 2023,  there was a significant reduction in the growth rate of exports of  goods and services to Russia. Imports from Russia became  significantly less than exports from Armenia and for the first time  the country faced a situation where the trade balance between Armenia  and Russia became positive. "It is clear that this is not a pattern,  but the result of what is happening - temporary factors of economic  growth," Sandoyan believes.

At the same time, he noted that the structure of exports is of great  interest. After all, 34% comes from the UAE and Hong Kong, and this  is gold and diamonds. It is clear that the Armenian economy is not  capable of producing such volumes, and it is clear that here we are  dealing with re-exports, 42% of which are from Russia. Re-exports  account for 28% of exports in 2022 and already 50% in 2023. Moreover,  precious and semi-precious metals and stones have a share of more  than 20 percent.

In order to understand the general situation, according to the  specialist, it is important to analyze the situation related to the  inflow and outflow of private foreign transfers. The volume of  transfers increased 2.55-fold in 2022 (the net inflow increased  7-fold) and 1.8-fold in 2023. These significantly increased  indicators are associated with Russian physical and financial  relocation. And the decrease in flow in 2023 is due to the tightening  of sanctions regimes by the Armenian banking system, which, fearing  secondary sanctions, significantly reduces and limits the  possibilities for carrying out transactions related to the final  beneficiaries - Russian legal entities and individuals.

All these symptoms of the "Dutch disease" could not but affect the  revaluation of the dram exchange rate, which led to an increase in  the cost of living in the country, a reduction in the competitiveness  of exports and the reception of tourists.

Moreover, as Sandoyan noted, if back in 2022 Russia was the main  source of investment in Armenia, then in 2023 this figure decreased  significantly. In the structure of the net inflow of foreign  investment, negative dynamics are noticeable in equity capital,  reinvested income and debt instruments, although the latter cannot be  considered a component of FDI in the classical sense.

If we take the Armenian dram exchange rate for 2000 as a 100% mark,  then in 2023 the dram revalued by about 27%. If we compare the same  with the dynamics of the Russian ruble, the currency of Armenia's  main trading partner, we get multidirectional movements: the  devaluation of the ruble is about 300%, and the appreciation of the  dram is 23%. It is very difficult for many investors and businessmen  to get out of this situation when the ruble is devalued and the dram  is revalued

Speaking about the banking system of Armenia, Sandoyan recalled that  its total net profit totaled 263 billion drams in 2022, which is an  unprecedented figure, and 229 billion drams in 2023 . Banks show very  high profitability, but they earn it not from lending transactions  that create interest income, but from various commissions, opening  accounts, trading portfolios, cashing out funds, converting, etc.  Such growth factors are of an unstable temporary nature. "And it  would be nice for us to hold this back so as not to lose these  opportunities, but unfortunately, when we look at the dynamics of  growth of the system's assets - 12.8% in 2022 and 9.3% in 2023 and  compare it with the dynamics of profit growth, we understand that  that this is not about the banking business, whose main mission is  mediation between the financial market and the economy.

The expert noted with regret that all these natural factors lead to  the fact that the Armenian dram continues to appreciate. Today we are  at a level where the dram exchange rate is stronger than in 2014.  This is a natural process, but on the other hand, it is a programmed  "Dutch disease". "This contains risks of collapse, although on the  other hand there will be no collapse, because professionals know that  in our currency regulation system we use a tool that is fantastically  effective both literally and figuratively. These are unprecedentedly  high levels of mandatory reserve of foreign currency banking  obligations, which makes it possible, in perpetual motion mode, to  prevent the depreciation of the dram exchange rate, because the dram,  on the one hand, is the most necessary, scarce, important product for  the banking system, because it is always needed and in demand to  provide mandatory reserve standard. And on the other hand, this  mechanism, which forces people to sell 14% of attracted foreign  currency bank liabilities, pushes for the revaluation of the national  currency exchange rate. But it turns out that this is about 1.8 - 2.0  billion US dollars of credit resources withdrawn from circulation,  which could contribute to economic growth. If we add to this about 2  billion dollars withdrawn through the funded pension insurance  system, which are postponed for 30-40 years, then all this does not  contribute to economic growth and reduces the real incomes of  citizens and especially the younger generation," Sandoyan emphasized.

However, according to the economist, all these tools, on the one  hand, are useful and important, it is very difficult to abandon them,  on the other hand, they lead to a specific economic situation.  Because if you allow the devaluation of the dram artificially through  sterilization, through mechanisms for absorbing surplus foreign  currency, through interventions, etc., that is, begin to interfere  with the natural process, then you can harm the economy. After all,  in the end, it is clear that the strong exchange rate of the dram  makes it cheaper to service the external debt, which is close to 12  billion US dollars, it is beneficial for importers, beneficial from  the point of view of various innovative technological operations,  renewal of fixed assets, etc.

Speaking about which path of economic growth is important, which is  "good or bad", Sandoyan expressed the opinion that the 'strong' dram  exchange rate weakens the potential of Armenia's economy and creates  risks related to market structural processes. Because according to  him, right now, "God himself would order to expand the export  potential and increase the competitiveness of our goods and services  and develop tourism." But how can this be done without harming  macroeconomic indicators? Here the economist sees a very serious  dilemma, which must be dealt with before it is too late. This is  exactly the essence, the trap of "Dutch disease".