Armenia finance minister seeks to move on from macro stability

Q: What is your overall assessment of the Armenian economy, and what are your forecasts? 

A: Over the past two years we have been faced with external shocks, which have not been unique to Armenia. One was  continuing decline in commodity prices since 2012, which affected us as Armenia is an exporter of metals.

This was compounded by the strengthening dollar, which put pressure on local currency exchange rates. In the middle of 2014, there was a second negative shock: the economic sanction war between Russia and Europe and the US, which impacted the whole region. It affected Armenian economy through three transmission channels. First, Russia is the major host country for our remitters, and due to the deterioration of Russia’s economic conditions, the inflow of remittances began to decline dramatically. Second, the Armenian dram bilateral exchange rate with Russian rouble appreciated, harming our exports to Russia. Third, direct investment inflows from Russia also began to step back. However, as a result the Armenian dram depreciated vis a vis the US dollar by 17%.

To cope with these externalities and to absorb these shocks, in 2014 we made a decision to keep fiscal policy flexible and pursue a fiscal countercyclical expansionary policy. With regards to monetary policy, we tried to be more conservative in order to anchor the speculative expectations of the agents in the foreign exchange markets, as the behaviour of some countries’ local currencies vis a vis the US dollar in the region created fear of a continued depreciation of the Armenian dram.

Now we do not see any discrepancies between the real equilibrium exchange rate and real actual exchange rate; all our analyses show that we are in equilibrium and there is no major issue with our macro-economic environment. It means that we are now graduating this phase, and upcoming news for economic conditions is much more promising, although still there are uncertainties in the world.

For two consecutive years we were obliged to keep our fiscal policy expansionary – and, of course, this has its costs, it’s a debt. With expansionary policy you need to increase your deficit in order to compensate the negative effect on aggregate demand and smooth the fluctuation of the foreign exchange rate. There is no free lunch in life; sometimes you need to make a sacrifice for gaining something else. At the end of the day we gained a stable macro environment without major shocks in the local financial markets.

Let’s compare with other countries. Even for 2016, I think almost all countries in the Eurasian Economic Union are going to end up with negative economic growth. But our economic growth is positive because we followed prudent macro policy. Now it's time to reverse, as you cannot move forward by only increasing your debt; somehow you need to have an exit strategy – and this is precisely what we are going to do in 2017, i.e. embark upon a strong fiscal consolidation, while keeping monetary policy expansionary as inflation conditions are very modest.

In the short term, I think we are going to end up with positive economic growth for the year 2016 and later on see an acceleration of this important indicator... Our economic growth is modest but we think that, due to our prudent policy, we can achieve 3.2% growth in 2017 and then plan much higher growth in coming years.

Q: What are your most immediate continuing economic challenges, given where you are in the recovery phase?

A: The most important aspect is economic growth, but then you have to think about what type of economic growth you want. We target 'supply-push' economic growth because, if you look to the history of Armenia until the year 2008, we have had 'demand-pull' economic growth, which was not sustainable. There was a strong foreign exchange inflow, because of the positive terms of the trade shock and the increase in remittances, so the non-tradable sector reacted positively, stealing factors of production from the tradable sector. Sustainable economic growth comes from the tradable sector through productivity upgrades. And for productivity upgrades you need reforms. We as a government need to do something to have an influence on the private sector firms’ cost curve pushing them to remain productive and competitive.

But as a rule of thumb, long-term macro stability must be in a high priority as a major precondition for economic growth. The experience of many countries shows that even if you have a well-designed reform agenda, you are going to fail if there is no macro stability in your country. You need to also signal to the private sector that the government is in good shape to undertake necessary actions in case an additional wave of idiosyncratic shocks again intervenes into a local economy and that everything is under control.

For permanent economic growth, macro stability alone is not enough. You need to do something more, which is the micro-level policy. [And this involves] what we call, using my favourite piece of terminology, ‘competitiveness’. What does it mean? There are three major pillars for competitiveness: economic competitiveness (business environment), human capital competitiveness and strength of institutions (institutional competitiveness). And these three major pillars that enhance competitiveness are in line with each other and you need to target them all.

In these three fields, you need to take bold actions, and what we have incorporated in our government programme are bold actions that will support competitiveness in each of these areas.