Armenia-Iran trade relations

The US State Department recently released its 2007 Country Reports on Terrorism. The Armenia section states that:

Armenia’s warming relations with neighboring Iran continued, with Armenia hosting official visits by Iranian President ... In addition to fostering closer diplomatic ties, these visits served to solidify previous bilateral commitments to develop joint energy and transportation projects ...

This is odd. Armenia imported only $133 million in goods from its large southern neighbor Iran in 2006, or 6 percent of its total imports. Combined with exports of $29 million, Iran accounts for 5 percent of Armenia's total trade. Obviously the country has weak economic relations with Iran, and the latter accounts for little of its imports and trade relations.

Even if trade relations were to increase as the report suggests, these would be small and most likely would be energy related and displace imports from Russia. In any event, the country not only imports little but there has been little growth over the past 10 years where they grew from $89 million in 1997 to $133 million in 2006. Interestingly, Turkey imported $4.5 billion of goods from Iran, up from $600 million in 1997. I wonder where State gets its data. I would very much hope that they do not rely on the incompetent reporters at rfe/rl. I have written on the subject last year (see here)!

Why so little foreign investment?

In 2006, foreigners invested about $1 billion in Georgia, $3.7 billion in Azerbaijan, and $20 billion in Turkey. In contrast only $450 million was invested in Armenia. Obviously this represents a tremendous growth, about 100 percent, when compared to the invetsments in 2004 and 2005. But it is low in comparison to the neighboring countries, and very low relative to the country's needs.

For 2007 the final figure may be well over $500 million (350 over the first three quarters). Nevertheless, this is still very low. Obviously, we have come a long way, but don't seem to have gone far enough.



Quarterly FDI figures for 1993-2006 are posted on aea .am







April 1, 2008: Armstat reports FDI of $670 million for 2007.

Interest rate hikes and prices

Last week, the central bank raised interest rates by 25 basis points to 6.25 percent. The CBA stated that continued growth in private consumption and an expansionary fiscal policy will exert upward pressure on prices. It further stated that to the extent that inflationary pressures eminate from external factors, it is impossible to offset them through monetary instruments. The tightening of the monetary policy is intended to moderate the impact of domestic growth in consumption and government spending.

The higher interest rates will boost or at least shore up the value of the Dram. But other than that I am not sure how effective this monetary policy will be.

It is true that government spending is slated to increase, but is it
deficit financed?

As the CBA stated, much of the pressure is from external sources (energy and food I presume). These will have a large impact on prices, and there is nothing that the CBA can do. Rather, the government, by implementing policies that reduce transaction costs and improve competition, and international donors have a much stronger role to play. First and foremost, the government should reform the customs agency and improve governance. Sacking its senior officals would be a good start. Second, there is little if any logistics expertise in the country. Clearly training and education should be a high priority, and funding is an issue. Third, diluting market concentration and monopolistic practices should be a priority for the government. Again training is also critical here; there are no visible IO economists in the country. Obviouly, these changes may not be large enough to offset the increases in import prices, but are nevertheless necessary for the efficient functioning of a market economy.

It is true that the economy has been growing at double digit rates for the past five years, and this may have led to further expectations of growth. But the post presidential election events will very likely result in slower growth. The country may face both higher prices (import driven) and increasing unemployment. I am not sure if there is anything that the CBA can do here.

The economic fallout

The mass violence, the destruction, and the looting that we witnessed on March 1, 2008, in Yerevan, may have serious repercussions for Armenia's once vibrant yet fragile economy. In general it is difficult to gauge the impact of such shocks, and extrapolating from the experience of other countries can be tricky. Fortunately as economists, and unfortunately as Armenians, all that we need is to go to the distant past, some 11 years ago, to be able to speculate on what may lay ahead.

Dram share in bank deposits (see data page of aea .am)

On September 22, 1996, President Ter-Petrosyan sent the tanks to suppress protests by the opposition against the rigged presidential elections, which was followed by arrests and major restrictions on civil liberties. Almost immediately, one could notice a steady drift away from the Dram. Indeed, its share of the residents' deposits in banks sank from about 50 percent in September of 1996, to the mid 30s within a year (dollarization). This slide continued in favor of holding foreign exchange, and the trend only began to reverse itself in early 2002. It was not until the year 2007 that the share reverted to its 1996 level, well almost.

Drams per USD (see data page of aea .am)

Soon after, the next shoe dropped. The flight from the Dram, and the lack of trust in the country's institutions, reflected negatively on the exchange rate. It dropped from about 415 Drams per USD in September of 1996, and peaked at about 590 in mid 2003. It was not until the second half of 2006 that the 1996 levels were revisited.

The impact of the 2008 debacle is likely to be much more pronounced as the financial sector is more developed and the country's economy is more integrated with that of the rest of the world.

Indeed, the Dram already seems to have depreciated by some 5 percent relative to the Euro; it stood at 476 on March 10 compared t0 455 on February 18, and to 450 before February 12). Of course we would have to wait a bit longer to confirm any permanent realignment as was the case in 1996. Further depreciation of the Dram, which is inevitable, may lead to higher prices of imported food and commodities. For those interested in studying future trends in the Dram, the archive page of the central bank is a good source of daily exchanges rates as far back as 1999, and I have placed the daily rates for the years 1995 through 2006 on the data page of the aea .am.

If there is a flight from the Dram, then this can have serious implications for the economy if it turns into a run on the banks, extremely unlikely for the time being. But it will very likely impact the balance sheets of the banking sector in particular if the economy is severely impacted. In 1996, few loans were provided by banks. In contrast, 239 billion Drams were issued in loans by banks in 2006 which jumped to 423 billion in 2007.

Tourism and agriculture are two examples of the economic havoc this political instability may create. Tourism is one of the major sources of revenues to the economy. In 2007, some half a million visited the country, up from 32000 in 1998 and much fewer in 1996. There has been some cancellations already which does not bode well for the upcoming tourist season.

The economy has been growing at double digit rates and the construction sector is the primary source of this growth. But this trend cannot continue with the country's political stability in doubt. An apartment in downtown Yerevan costs about USD 150000. In 1996, it would have cost much less than 10000. Within the Armenian context this is a sizable sum of money. I can't see how these investors, locals or from the Diaspora, will undertake such investments in this risky environment.

It took much effort to get Armenia out of the economic abyss of the 1990s. Of course progress on the economic front without matching progress in governance is not very satisfying. But it is incredibly difficult to be poor and not be corrupt. With this as background, it is amazing that Ter-Petrosyan and his supporters continued with their demonstrations despite the warnings and being keenly aware of the outcome; he once ruled over the same security forces and is responsible for the tenure of the president and the president-elect. In addition he lacks the support of international human rights organizations and the West. So what was his vision for this entire affair, and what did he plan to realistically achieve?

One would hope that reason and common sense will prevail and that the authorities and the opposition will find common ground before the economy takes a major hit.

Income mobility in Armenia, 1989-2006

The contrast of the society's well being today to that of the country's pre-independence is a recurring theme. Were people better off during the pre-independence years? Did the transition years make their lot worse? Have successive governments addressed the transition pains adequately? Equally relevant, at least during this political season, is how the evolving well being of the electorate translates into votes for incumbents and competing candidates.

To address this question, I took a look at the EBRD 2006 Life in Transition Survey to study perceptions of well being now and that enjoyed in 1989. The survey asks participants to rank themselves on where they fall in the income distribution in 1989 and 2006, from the poorest 10 percent of the population to the richest 10 percent. I converted these deciles into quintiles (20 percent) and reported the resulting mobility table below (observations with missing values are dropped -- about 4 percent).

Subjective ranking: income mobility between 1989 and 2006
..1989........... 2006 Quintiles .......
Quintiles ....1.. ..2.. ..3.. ..4.. ..5. All. Households
poorest 20% 26,7% 53,0% 16,9% .1,3% 2,1% 100% 267362
next ...20% .8,8% 27,7% 58,1% .5,4% 0,0% 100% 320140
next ...20% 10,5% 34,0% 44,0% 10,3% 1,2% 100% 506791
next ...20% 11,5% 42,3% 41,0% .5,2% 0,0% 100% 720929
richest 20% 18,5% 30,0% 36,6% 10,6% 4,3% 100% 229474
.... All... 13,6% 38,0% 40,8% .6,6% 1,1% 100% 2044696
Computed from the 2006 LiTS household survey (see data page of aea.am to download)

A striking finding is that the majority of the poorest 20 percent in 1989, the first quintile, consider themselves to be much better off in 2006. Of these 267362 households, 53 percent moved to the next quintile; 2.1 percent moved all the way up to the top quintile, the richest 20 percent. At the other extreme, of those who considered themselves the richest 20 percent in 1989, 229474 households, 95.7 percent of them became poorer by 2006; 13.6 percent moved to the bottom quintile, the poorest 20 percent.

In short, the mobility picture that emerges from above is that those who considered themselves to be the richest in 1989 are now poor, while the lot of the poor has improved considerably. I have studied income mobility using panel data for countries other than Armenia (panel data don't exist for Armenia), but I have never witnessed such (1) "rank" reversal between the poor and the rich in the income distribution and (2) mobility (only 21 percent, the sum of the diagonal, did not change rank). Of course we don't observe income, and survey participants may not correctly rank themselves (otherwise we would have about 400000 households or 20 percent in each row, for a total of 2044696 households in the last column). But nevertheless, perceptions of well being are important and should not be overlooked.

Armenia Exit Polls 2008

The press reports that the British pollster Populus exit polls showed that 57.1 percent of the Armenian voters chose Serzh Sargsian, followed by Levon Ter-Petrosian (17.4 percent), Arthur Baghdasarian (14.6 percent), and Vahan Hovhannissian (5.98 percent); the remaining candidates received 1.6 percent. The interviews were conducted in 126 polling stations (clusters) in Armenia. These are fairly close, and within the poll's margin of error, to the official results where Sargsyan was declared the winner with 52.86% (863,000 votes).

It has been some time since I taught statistics and designed samples (not for polling), but the process of polling and extrapolating to the voting population is conceptually straight forward. First you design/select a sample with some criteria in mind to minimize sampling errors, and next apply appropriate weights to scale up the choice of those interviewed after they have voted to the size and demographics of precincts.

There are a number of problems with exit polls. For instance, the active partisan supporters of one candidate may be more likely than the supporters of other candidates to participate in exit poll interviews (selection bias). In addition, the young are more likely to participate in interviews. Furthermore, the age of the interviewers may matter as younger interviewers do not get high response rates from older voters. Of course, some of those interviewed may lie about the choice they have made (response bias).

Once the interview process is over, the next step is to weigh the sample to the size of the precincts and adjust for the non-responses say based on age and sex. One may rely here on the demographics of voters from previous elections in each precinct. While the size and demographics of the population are pretty well known (with few year lags), that of the voters is more problematic.

Exit polls are powerful indicators of corrupted elections. But without adjustments for sample selection and demographics, the results can be biased and at best meaningless. Consider the hypothetical case where most of those interviewed are old in precincts where the majority are young!

With the above in mind I was surprised to read the exit poll results from what ArmInfo reports as that conducted by the Alliance civil initiative, which I believe is organized by a large number of NGOs. Here is the full article:

Exit poll by Alliance civil initiative gives victory to Levon Ter-Petrossyan
2008-02-19 20:54:00
ArmInfo. Alliance civil initiative has conducted an exit poll at 100 polling stations. They have questioned 4,406 people. 3,550 of them (66%) agreed to answer.

The vice chairman of Alliance Gevork Melikyan says that ...
474 people (15.5%) voted for Artur Bagdassaryan,
40 (1.3%) for Artashes Gegamyan,
38 (1.2%) for Tigran Karapetyan,
8 (0.2%) for Aram Haroutyunyan,
195 (6.4%) for Vahan Hovhannissyan,
90 (2.9%) for Vazgen Manukyan,
9 (0.2%) for Arman Melikyan,
1084 (35.4%) for Serzh Sargsyan,
1152 (37.7%) for Levon Ter-Petrossyan.

Melikyan says that it was an independent survey. They planned to question 0.2% of all voters - 2,300 people.

This is strange. The sample design and selection seem odd. And what are we to make of the sample sizes of 2300, 4400, 3550, and the 3090 (sum of the people voting for individual candidates). Why are the sample estimates (1152, 1084, ...) reported without any adjustment for the size of the voting population (precincts), and seemingly not any of the demographics? What do the above figures tell us about the likely winner of the elections? Clearly, and unless ArmInfo got it wrong somehow, at best this is sloppy work. None of the foreign news services, except for Radio Free Europe (RFE/RL), reported its findings. Instead, they reported those of the reputable Populus.

Remittances and education

Sometime in October of 2007 I read the job market paper of a PhD student from UC Santa Cruz, Migrants' Remittances and Investments in Children's Human Capital: The Role of Asymmetric Preferences in Mexico, which addresses how remittances affects spending on education by the recipients. Using household survey data for Mexico, matched to migrants in the US, the paper finds that the impact of remittances depends largely on the gender of the household head, and they are most likely invested in education particularly if they are sent by migrant fathers to mothers.

Last month the IMF released a new working paper entitled "Microeconomic Implications of Remittances in an Overlapping Generations Model with Altruism and Self-Interest" which addresses the impact of remittances on education expenditures, as well as on labor supply, saving, and borrowing from banks in Armenia. It is authored by two US trained PhDs originally from Armenia but residing in the US. Using the 2004 Integrated Living Standards Measurement Survey conducted by the National Statistical Service of Armenia (Armstat), and in contrast to the study using Mexican data, the authors report that in Armenia "remittance-receiving households ... spend less on the education of their children."

Unlike the Mexican migration data (download from here), the Armenian household survey data is not publicly available. And unfortunately, the IMF authors do not provide any summary statistics on the separate attributes of households with and without remittances. Other than the reported econometric estimates, there is no way to verify or question the validity of the findings. Indeed, it is very difficult to evaluate the intertemporal effects of remittances using cross sectional data, add to this the endogeneity of much that is observed in the data (e.g. housing quality which authors use as proxy for wealth). Also on practical grounds, and in the Armenian context, what does it mean to say that remittance recipients spend less on educating their children? Primary and secondary education is compulsory, private elementary and secondary schools don't exist for the most part, and ... So how are they reducing spending on education (never mind the cross sectional nature of the data and the econometric problems this creates).

As an alternative, I resort to the EBRD Transition in Life Survey (LiTS) 2006 survey data which contains some 1000 Armenian households (check www.aea.am data page to download). Unlike the 2004 household survey, the LiTS 2006 survey identifies the recipients of remittances but not the size of the transfers. Below are sample statistics on each group, restricted to households with children age 6 through 21 -- variable names age3-age12 in the data.

Households with remittances seem to spend more on education; an average of USD 200 per year more than the households not receiving remittances (389 vs 184). They are more likely to be headed by a woman (45 vs 39 percent), more likely to have a college degree, less likely to receive social benefits from the government, and more likely to receive gifts and transfers from others in the country.

I also estimated an OLS regression of the determinants of education expenditures. Consistent with the basic statistics above, households receiving remittances (dummy), spend USD 243 more on education. However, when remittances are the most important source of income, households spend only an additional USD 88 (i.e. 243 - 155). The qualitative results don't change when the observations are weighted, estimated for those reporting education expenditures only, and/or for the entire sample of 1000 observations without age restrictions. Of course this analysis is very simplistic in that it does not control for the endogeneity of remittances or migration, and is plagued with LiTS data limitations. Nevertheless, it would be useful for the IMF study, when revised in the future, to report basic statistics on the households in the 2004 sample and inform the rest of us on the various attributes of households in Armenia.

If you are interested in studying the attributes and behavior of Armenian households, whether you are an economist, a social scientist, and/or a political junkie, you will find the LiT survey very interesting -- in one example it allows you to compare 2006 to 1989. It also allows you to compare households in Armenia to others in all transition economies. Best of all, it is free. But please do keep the pressure on governmental agencies and NGOs to make their survey data available. CRRC is a good role model here.

Is this the best way to provide technical assistance?

I have been concerned for some time about the lasting effects of technical assistance. USAID, EBRD, among many others provide funding for training in many aspects of governance as well as the transition of the country to a market economy. These agencies, and the donor countries in general, have been quite generous. However, a common feature of most of these programs is that universities are by-passed in this process, both in terms of training faculty as well as funding that is devoted to set up new bureaucracies where the training is to take place.

Take the recent announcement for actuarial training to commence in April. There are no actuaries to speak of in the country. And so it is difficult to imagine how the insurance industry will take off without the skilled labor. As such the country is truly lucky to have USAID fund a new program to train actuaries in the country. Granted that this will be the first time such training is made available, but this begs the question of why this is not taking place in the mathematics, statistics, or even the business schools at the various universities in Yerevan who are desperate for training and funding? What happens when the funding is over? Who trains the next generation? Who undertakes research on future developments in the various underlying markets? Who will write the future textbooks?

Faculty salaries are low by any measure, and textbooks in various subjects of actuarial and management sciences, finance, and economics, among many others, do not exist for the most part. Donors have been very generous, but one would hope that they would take steps to more aggressively engage academia, that is if they wish to leave a lasting legacy.

The Armenian Railway Deal -- more is needed

Recently a Russian firm acquired the rights to manage the Armenian railroad system. The Railway Gazette provides a good summary of the background leading to this transaction, with more detail on the Armenia Rail Concession web site. The system has experienced serious reduction in service and is in desperate need of funding.

Cargo and passenger travel, in millions

In general, and for a variety of reasons, the government and the public seem uncomfortable with privatizing publicly owned assets. At the same time, the public enterprises seem unable to raise capital. The public-private partnership model, where ownership remains with the government but management is delegated to a second party, is perhaps a good compromise. In addition to the railways, other examples include Zvartnots airport (Argentina) and the water system (France), among others.

It is wonderful to see the government go through the railways deal. But this raises the question of why it is taking so long for the government to embark on such transactions. The slow privatization process since 1991 has run many productive assets to the ground, and landed others in the hand of oligarchs. Add to this the fact that foreign investments in the form of FDI are small relative to the country's needs as well as to that taking place in the neighboring countries. And so let's hope more such transactions take place.

Where are the survey data?

Almost every study which explores the behavior or attributes of households and businesses in Armenia employs survey data. Virtually all have been funded by international donors. These surveys may provide a window into the preferences of those surveyed with detailed information on the sources of income, expenditures, and demographics in case of households or employment and business activities in case of firms. And if undertaken repeatedly, they may provide a glimpse into how behavior changes over time or how it responds to changes in the economic environment and incentives.

It is important to replicate every study, and challenge every finding, particularly those that may influence policy. Yet researchers, be it in academia or otherwise, with few exceptions, do not have access to such data as most of these surveys are not made available to the public. Armstat has repeatedly refused to release the annual household survey data, and I have yet to see any of the surveys funded by USAID, UNDP, and others in the public domain. In contrast, the annual CPS household survey in the US has its own web page and anyone may download it free of charge. Similarly, household longitudinal panel data such as the PSID are also available. I am not sure that household panel data exist in Armenia!

I have provided a brief description and created links to the various surveys on Armenia on the data page of the Armenian Economic Association. Most are available in STATA format as well as CSV (easy to import into Excel). These include the Word Bank/EBRD survey of the business environment (BEEPS -- some 200 firms in Armenia), and the newly released EBRD household survey (Life in Transition survey for 2006 with 1000 Armenian households).

It is very important that researchers, academics, and the media among many others, be vocal in demanding access to the raw data behind many of the studies. It would be good to know whether anyone has compiled a list of the various surveys, and begin an effort to have them made available to the public.

Web domains registered through 2007

Updating my post over a year ago, the number of domains registered in Armenia (amnic.net) increased almost by 45 percent in 2007. Granted the numbers are small, but one is hopeful that this healthy growth will continue and even accelerate. The issues and concerns I had raised previously may still apply.

Number of Domains
1999 650
2000 1600
2001 2500
2002 2800
2003 2900
2004 3400
2005 4200
2006 6094
2007 8776

I am not sure who or for what purpose these new domains are put to use. It would be good if any of you can shed light on this.

Season's Greetings

This being the season of giving, please consider sponsoring an Armenian student, a teacher, or, if it is within your means, a school.

Happy New Year and Merry Christmas

Շնորհավոր Նոր Տարի եւ Սուրբ Ծնունդ

The Politics of the Dram

The appreciation of the Dram continues to draw attention. Often this is peppered with accusations by critics of deliberate policy by the government to enrich importers. The fact is that there is little at this stage that the government, or the Central Bank (CBA) more correctly, is able to do to reverse this appreciation.

The central bank has been accumulating foreign exchange reserves, in part as a consequence of "de-dollarization" and in part by intervening (small scale) in the market and acquiring foreign currency (increasing the supply of Drams). Indeed, reserves increased by some USD 200 million in November alone. But at the same time, CBA raised interest rates to curb inflationary pressures a move that may have potentially offset the foreign exchange intervention.

International Reserves, in USD millions
Source: Central Bank

Currency appreciation may benefit consumers, but at the same time it may hurt exporters and endanger the country's competitiveness. Given that little can be done to tackle the currency appreciation, unless we stop the flow of foreign exchange to the country or undermine the confidence in the Dram, does not necessarily mean that we are helpless. Improvements in productivity is one way to tackle this, but this will not happen overnight. On the other hand, the government can improve matters by reforming the Customs agency and improving its governance. Certainly, this may go a long way in reducing the cost of trade. Also tackling market concentration and imperfections may enhance the benefits of a strong Dram to consumers. So why are government critics focusing on the Dram, where the government has little control, and not continuously hammering the regime on the other issues?

One would hope that the media will do a better job in covering matters related to finance and economics. On the other hand, the bloggers have been a major disappointment.

[Statistics on the Dram may be obtained from cba. am, edrc. am, and aea. am]

Real estate prices in 2007 through Q3

Real estate developments and the pace of construction through 2006 reviewed in previous posts were the top content of interest to visitors to this blog in November. In response to this growing interest, along with that of a media outlet, I have updated the information on real estate prices, as reported through the third quarter of this year.

While prices are likely to continue rising for the rest of the year, the pace observed from transactions over the first nine months of this year again point to rapid appreciation that matches the gains experienced last year. In Yerevan, the price of a squared meter increased by 27 percent, to a weighted average of 249,700 Drams; close to 50 percent when stated in USD (to about $706). However, the appreciation experienced by the various districts is in many ways unlike that of last year. The largest appreciation is now observed in Erebouni which grew near 50 percent, where the price increased from 155,800 to 219,800 Drams per sq. meter. In contrast, prices in Kentron, the city center, grew by only 17 percent, from 377,600 to 440,700, compared to near 30 percent last year. Below is a summary of the prices in Yerevan districts observed over recent years, both in Drams and USD. While not reported here, prices also grew in all regions. But more on this in a future article and after I update the info on aea .am.

What do these numbers mean? Well if you wanted to buy an apartment of 100 sqm (about 1000 sqf), it would have costed you about 44 million Drams, or about USD 124,500 (143,000 at today's exchange rate) in Kentron. You are looking at close to half that in Malatia - Sebastia.

Average price per sq. meter, in Drams

Yerevan Districts.. 2002.. 2003.. 2004.. 2005.. 2006 2007Q1-Q3
Kentron.......... 187772 222765 246500 288900 377600 440700
Arabkir.......... 114670 161300 193900 235300 298200 354500
Kanaker-Zeitoun... 68802. 98158 119200 143700 186100 258200
Nor - Nork........ 57335. 78538 101700 135100 171100 222300
Avan.............. 61635. 76396. 97000 122800 156200 210700
Erebouni.......... 55902. 83920. 96500 118800 155800 219800
Shengavit......... 61635. 83052 110600 143900 182700 235000
Davidashen........ 63069. 97116 120900 147100 189400 241700
Ajapniak.......... 57335. 84557 109500 138400 171800 226900
Malatia-Sebastia.. 55902. 81779 108600 134500 166800 214400
Nubarashen........ 28668. 36693. 43000. 69600 108000 122300
Yerevan*................ 100415 122500 152500 196700 249700

Stated in USD
Yerevan Districts.. 2002 2003 2004 2005 2006 2007Q1-Q3
Kentron............. 328. 385. 462. 631. 908 1245
Arabkir............. 200. 279. 363. 514. 717 1002
Kanaker-Zeitoun..... 120. 170. 223. 314. 447. 730
Nor - Nork.......... 100. 136. 191. 295. 411. 628
Avan................ 108. 132. 182. 268. 375. 595
Erebouni............. 98. 145. 181. 260. 374. 621
Shengavit........... 108. 144. 207. 314. 439. 664
Davidashen.......... 110. 168. 227. 321. 455. 683
Ajapniak............ 100. 146. 205. 302. 413. 641
Malatia-Sebastia..... 98. 141. 204. 294. 401. 606
Nubarashen........... 50.. 63.. 81. 152. 260. 346
Yerevan*................. 174. 230. 333. 473. 706
* without New Marash

Drams per USD....... 573. 579. 533. 458. 416. 354

Source: Cadastre Commission with some adjustments as reported on aea and my own.

One final word. I am very impressed by the timeliness and quantity of information (prices and number of transactions) reported by the Cadastre Commission on its updated website. It is worth a visit -- you need Armenian fonts (with few exceptions). As in my previous postings, it would be good to see more research in this area.

Armenia's Competitiveness

Competitiveness is not necessarily an indicator for wealth, power and/or economic performance. There is much more to it. In addition to macro-economic evaluation of the domestic economy it also involves things like government efficiency (extent to which government policies are conducive to competitiveness), business efficiency (extent to which enterprises are performing in an innovative, profitable and reasonable manner) and infrastructure (extent to which basic, technological, scientific and human resources meet the needs of business). Basically, competitiveness is the ability of a nation to create and maintain an environment which sustains the competitiveness of enterprises.

Let's start with a glance at economic performance of Armenia. Given the size of the economy and the economic blockade by two neighbors, Armenia has been performing very well in terms of economic growth. But where did this growth come from? It was not a result of export-led competitiveness, as the exports (excluding raw commodities) have been stagnant for several years now. There is not much competition in the domestic economy to be translated to competitiveness of domestic firms on the world markets. And given that the international investments flow to the areas where economic resources are used more efficiently, and Armenia hasn't seen much of it, we can safely assume that Armenia has failed to use its resources (physical, human or any other) efficiently.

Let's now turn to government and business efficiency. Apart from creating competitive environment for enterprises, government intervention in business activities should be minimal. Is that true in Armenia? Of course, not. Many government officials have a direct interest in the business activities of enterprises owned by them. On the other hand, this also hinders efficiency and flexibility (ability to adapt to changes in competitive environment) of the enterprises, as managerial attributes of CEOs, together with the attitude of the workforce, are crucial for the competitiveness of the enterprise. Efficiency of the enterprises is also enhanced by a well-developed and internationally integrated financial sector, as well as a skilled labor force (do Armenian universities prepare qualified specialists that are actually in great demand in the labor market?).

More questions arise in the last category - infrastructure efficiency. Is there a well-developed scientific and technological infrastructure? In other words, do businesses invest in innovative technologies and do scientific inventions find applications in business environment? Do we have an adequate and accessible educational resources that help develop a knowledge-driven economy?

There are many unanswered questions when one tries to analyze the overall competitiveness of Armenia's economy. I am curious to hear your views and of any ongoing research.

Efficiency and competitiveness of banking system

A recent working paper by two IMF economists concludes "that there is a large potential to increase cost efficiency and competition in the banking system."

The paper highlights that Armenia has lagged in financial intermediation and that interest rate spreads (i.e. what banks charge borrowers and what they pay depositors) have remained high compared to other transition economies. It employs quarterly panel data obtained from the financial reports of the 21 banks of Armenia for the period 2002-2006Q3 to explore the determinants of interest rate spreads and margins.

The authors also report other findings on the effects of bank size, market concentration, and foreign ownership among others. Equally important, they provide a good overview of the state of banking in the country.

It would be good to see others replicate this study with more recent data, perhaps using annual rather than the quarterly data employed by the authors, as well as extend the analyses to address the causes of the retardation of financial intermediation.

The Turkish Inquisition, 2007

Almost 65 years to the date, on November 11, 1942, Turkey enacted the most draconian tax ever envisaged. The Varlik Vergisi, the wealth tax, which in effect confiscated the wealth of Jews and Christian Armenians, Assyrians, and Greeks primarily in Istanbul, and sent many male members of these minorities to labor camps in the east of the country. Figuring the religious and ethnic origin of this group was not always a simple task as all citizens were forced to adopt Turkish-sounding surnames in 1935 and because Turks have come to resemble more the Caucasians they conquered and less their Asiatic ancestors from central Asia.

Faik Okte, the administrator of this tax at the Turkish Ministry of Finance wrote a book on the subject documenting all of its features and naming its victims. The book has been translated from the Turkish "Varlik Vergisi Faciasi" into English and is entitled "The Tragedy of the Turkish Capital Tax," by Geoffrey Cox, Croom Helm, 1987.

Exactly 65 years later, history repeats itself with the inquisition extending its reach beyond the borders of Turkey, and that of its citizens. This time the government of Turkey seems to trace the ethnic origin of a partner in a Kazakhstan-based consortium planning to invest $2.1 billion in a privatization project in Turkey, and may have rejected its bid because of the partner's Armenian roots; it accepts a lower bid of $2.04 billion for a loss of $60 million to the taxpayers of Turkey.

As reported to the United States Securities and Exchange Commission on September 6, 2007, Form 424B5 page S-17, the government of Turkey announced "that the consortium of TransCentralAsia Petrochemical Holding made the highest bid of $2.1 billion for 51% of the shares of Petkim." For some unknown reason, the recent press reports a figure of $2.05 billion! On November 12, 2007, the anniversary when the Varlik Vergisi went into effect, the New Anatolian reported that "Turkey's Competition Board has approved the sale of state-run petrochemicals company Petkim to the second highest bidder ... to consortium of the Azerbaijani oil company Socar, Turkey's Turcas and Saudi-based Injaz Projects..." There were 18 prequalifying bids, including European petrochemicals producers INEOS and Basell.

Here is the way information is reported and analyzed by a source in Azerbaijan, the other Turkic state:

The first bidder Kazakh-based Transcentral Asia Petrochemical Holding is reported to be owned by Kazakh national Alexander Matskevich who chairs Eurasian Jews Confederation. He sits in the Forbes List of World’s Richest People.
In the bidding he had been bankrolled by Troika Dialog (commonly referred to as “Troika”), one of the largest investment groups in Russia.
Troika is controlled by Armenian national Ruben Vardanian who owns a 65% stake...

Why the interest in the Jewish or Armenian roots, or that of any other group? Should Israel not allow the imports of Ford Motor products because its former CEO, Nasser of Australia, has Arab roots? Should Arab countries not deal with Citibank because its Chairman of the Board is Robert Rubin, a Jewish American? Indeed, the largest shareholder of Citibank, Prince Alwaleed of Saudi Arabia, a country with no relations with Israel, expressed his trust in the leadership of Rubin and others at Citibank earlier this month. Is it possible that Turkey, with its values and business practices, is perhaps not much more worthy of NATO membership and joining the EU than is Saudi Arabia?

It has been well over five centuries since the Spanish Inquisition. One would think we have come a long way since.

Trade logistics

The Trade Logistics and Facilitation department of the World Bank recently released a new index designed to measure the logistics performance of 150 countries. This measure, the Logistics Performance Index (LPI), consists of 7 key dimensions, and allows for the ranking of countries.

Here is how Armenia is ranked:
1. Efficiency and effectiveness of the clearance process by Customs and other border control agencies – Rank: 118
2. Quality of Transport and IT infrastructure for logistics – Rank: 143
3. Ease and affordability of arranging shipments – Rank: 140
4. Competence in the local logistics industry (e.g., transport operators, customs brokers) – Rank: 121
5. Ability to track and trace shipments – Rank: 113
6. Domestic logistics costs (e.g., local transportation, terminal handling, warehousing) – Rank: 8
7. Timeliness of shipments in reaching destination – Rank: 122
Overall rank: 131

The index reflects the perception of trading partners as well as the logistics environment in the country, and as such should provide a reliable picture of the situation in Armenia. Other than the domestic logistics cost, the country ranks way at the bottom. The performance of Customs is not surprising, but much of the rest was unexpected. While it is easy to quibble over the accuracy of the index (e.g. item related to infrastructure can’t be right), it suggests that much work lay ahead. For the curious reader, the overall rank for war torn Liberia is 105, Zimbabwe 114, Somalia 127, and 130 for Nepal. Belarus is ranked 74, Iran 78, Russia 99, and Azerbaijan 111. Georgia is not ranked, and, again, Armenia is ranked 131.

Trade relations

I have repeatedly read over and over that Armenia has close economic ties with Russia. Yet upon close examination of trends in the pattern of trade, I find the actual volume of trade to be unimpressive, and particularly unremarkable in the case of exports where Germany and the Netherlands are actually the largest trading partners of Armenia (see export and import statistics).

Armenia's imports from Russia were $268.5 and 364.8 million in 2005 and 2006, respectively. These are well below Azerbaijan's imports of $717.2 and 1,181.6 million over the two years; Georgia's imports from Russia were $383.4 million in 2005.


More remarkably, Armenia's imports are a mere fraction of Turkey's imports from Russia; $13.9 billion was reported for 2006, or about 38 times that of Armenia. Equally impressive is the rapid growth in Turkey's imports over the past decade when it was about $2 billion in 1997 (oecd.org), making Russia Turkey's largest trading partner.





As with Russia, Armenia imports "little" from Iran; a total of $133 million is reported for 2006. In contrast, Turkey imported $4.5 billion from Iran, or about 34 times that of Armenia. Also, and unlike that of the latter, Turkey's imports have grown rapidly over the past decade (oecd.org).

Armenia's trade with Russia, as well as Iran, pales in comparison to that of its neighbors. It is not clear why so many hold the opposite view. But more importantly, why trade with Russia (and Iran) is so anemic and remains stagnant particularly in the case of Iran?

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November 6, 2008 -- I should have added the following to further illustrate the weak trade links with Russia whereby its share of Armenia's trade turnover declined from 33 percent in the early 1990s down to 15 percent.

Recent changes in taxing business profits

Last week, the parliament tackled a number of proposed tax law changes including a provision related to Armenian firms incorporated in tax havens. The proposed amendments are briefly "described" in the parliament briefing on October 1, but the text is not very helpful. I was not able to locate any of the specific details on the various proposals presented and discussed at the parliament, which eventually adopted the proposed changes on October 11. In addition, I could not find anything on the ministry of finance and tax services websites. Also, the information reported in the press is very confusing and provides little meaningful information, which, unless I read incorrectly, suggest that the profit of Armenian firms incorporated offshore will be taxed at 10 percent as of July 2008; the general profit tax rate is 20 percent.

Governments levy taxes to fund their expenditures. In general, their goal is to ensure that taxpayers comply with the tax laws of the land and pay their assessed tax liabilities. At times, they extend preferential treatment to particular groups or specific industries to encourage an expansion in economic activities. Taxpayers, of course, are not passive economic agents. Putting aside tax cheats, they are able and willing to legally exploit tax provisions to minimize their tax bills. While each tax law provision may have a specific predictable consequence, when combined they may have unintended consequences that may work to the advantage of taxpayers.

Consider the case of foreign businesses investing in Armenia. They are accorded tax holidays whereby firms investing a minimum of 500 million Drams (1 USD=333 Drams) benefit from 100 percent forgiveness from the profit tax in 2008 and 2009; 2007 is the last year when new investments qualify for tax holidays in Armenia. The benefit of the tax holiday is not available to domestic firms. But this does not mean that a local firm cannot avail itself to this benefit. A start up firm may incorporate itself in a tax haven country where no or very low taxes prevail, and taxpayers' privacy is respected, and invest in Armenia as a foreign entity. With some planning, an existing firm may reincorporate itself as well. I believe, there are no tax consequences to this reincorporation (zero capital gains taxes). Once incorporated offshore, and in addition to the tax holiday on investments in Armenia, the parent company may be able to exploit other provisions in the tax laws. An example is the case of interest allocations whereby the local firm is able to claim interest expenses on loans from the parent company (not sure what type if any earnings stripping rules apply); before incorporating, such deductions may not exist as there would be one local company (inter-company loans).

Such tax motivated incorporations and inversions have been around for some time. Again, and as eluded to above, in an inversion, a firm reincorporates itself outside its home country, typically in a country with low or no taxes. The reincorporation, notwithstanding its tax implications, has little effect on how the firm is operated. (see here for a description and tax implications of inversions).

I continue to be amazed at the swiftness with which proposed changes to tax laws get adopted. Little information about the revenue effect and the distributional implications of the changes or on the number of affected taxpayers are provided. Also, there is a general lack of public discussions which may help flush out problems in the proposed legislation.

Anyway, returning to the inversion issue, taxing capital in a global setting is very difficult, and requires considerable expertise and careful design. From the little I have read, it is not clear how the inversion problem will be solved. And, perhaps more importantly, the adopted changes may have the reverse effect in that they may encourage inversions where the profits of firms incorporated offshore will be subject to a tax rate of 10 rather than 20 percent.

Again, it is not clear what if any effect the proposed changes will have. But I really wish for the process to be slowed down a bit and modified so as to allow for greater discussion and feedback from the public. I am confident that every foreign firm operating in Armenia with shares traded on a stock exchange in the west carries a warning on its financial reports related to taxation contingencies. HSBC bank, for instance, reports in its 2006 financial statement (arm p. 40, eng p.34) that "The taxation system in the Republic of Armenia is relatively immature and is characterised by numerous taxes and frequently changing legislation which is often unclear, contradictory, and subject to interpretation. Often, differing interpretations exist among numerous taxation authorities. ..."

I am not sure if anyone is writing on this subject, and so your comments and corrections are welcome.