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?

--------

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.

Rising food prices

The complaints against the recent rise in food prices don't seem to go away. Often these are peppered with accusations of improper behavior by government officials or collusion among producers and suppliers.

What the media seems to overlook is that the increase in food prices is a global phenomenon. There is an unprecedented increase in demand fueled by increased production of biofuels as well as the rising prosperity of China. Add to this the higher oil price, which drive up production cost, as well bad weather in places like Australia and China.

For example, wheat prices have nearly doubled over the past year. According to the US Department of the Agriculture, US farmers received about USD 7.16 per bushel in September 2007 compared to 3.52 at the beginning of 2006 (36.743 bushels make one metric ton). Add to this the cost of placing the grain at the loading spout, and the price may go up to USD 9 and 10 per bushel before including the buyers ocean freight cost (see US Wheat Associates).



Indeed, referring to the poor nations, Alexander Sarris, director, commodities and trade, of the Rome-based Food and Agriculture Organization (FAO), as a keynote speaker on October 4, 2007, at the Commodities Week Europe 2007 conference in London, said "We are squeezed between increasing oil prices and food price hikes". The government in the short run protected (subsidized) its citizens from higher prices of imported Russian natural gas. But within a year, and depending on the value of the Dram, the people may be faced with the prospect of both higher food and energy prices.

While the finger pointing at government officials by the media may not be totally appropriate given the global nature of the price trend, the implications of this trend particularly on the poor are critically important and should be highlighted. Is anyone studying the impact of this on household budgets? What are its inflationary implications, and would the central bank raise interest rates and dampen economic activity? Also, how much of the appreciation of the Dram has softened the impact of higher global food prices?

[Note: The pattern of retail prices from 2002 through 2007Q2 is not bad at all. But data for the recent quarter are not available yet. See here]

Is the trade deficit overstated?

Armenia's trade deficit is reported to widen over the past few years. For January through July of 2007, the volume of exports and imports stood at USD 631.1 and 1631.8 million, respectively, for a deficit of one billion.


Reported imports have consistently exceeded exports. This should not be surprising given the stage of development of the country and the heavy reliance on imported raw materials and intermediate goods. Reported exports typically include diamonds, metals and mining products, food, and alcoholic beverages.

Perhaps it should not be surprising that the country experiences trade deficits. However, this is not to say that the reported volume of exports and the concomitant trade deficit figures should be accepted at face value. In particular one needs to address how consumption by non-residents visiting the country is treated. Exports are generally defined as purchases of domestic goods by foreigners. It should not matter whether these goods are shipped outside the country or foreigners acquire them while visiting Armenia. With the increasing number of tourists visiting the country -- some 400,000 lately -- this treatment takes on an increasing importance. Think of the hotels, transportation, and the rest of the hospitality industry among other services!

If my thinking is correct, consumption by non-residents is treated as part of total private consumption of residents and is not reflected in the export figures. Of course, the computation of GDP is not affected regardless which treatment is applied. But if this treatment is correct, which I assume is the convention employed currently, then the trade deficit figures are overstated. If true, and besides getting the figures straightened out, this can have interesting implications. For instance, could this be another reason why the Dram continues its upward march? Is the appreciating Dram hurting the country's competitiveness, or is it just the outcome of this additional source of exports?

It will be good to hear your thoughts on this. Also, further confirmation of the treatment of purchases by foreigners would be appreciated. I understand the difficulty of quantifying the volume of purchases by non-residents.

Why so few study abroad?

With looming application deadlines, and admission decisions in some countries, one wonders how many college or graduate school bound students have applied to study abroad. This has implications for capacity building in the country, but perhaps even more important to the individual applicant is the prospect of tremendous personal gain from earning a foreign degree.

The number of Armenian students studying abroad has been growing over the years but remains well under 3000. According to statistics reported by UNESCO, 2762 students were enrolled in foreign institutions of higher learning in 2004. Of these 1239 were hosted by Russia, 412 by the US, 371 by Germany, 290 by France, and the remaining students by mostly European countries. Depending on the data source, this represents about 3-6 percent of enrollments in the country. Of the 412 enrollments in the US, 112 were at the undergraduate level (US Institute of Higher Education). Given the fact that education, in particular graduate education, is mostly free, why don't we see more enrollments in the west? What explains this trend?

A similar pattern is also observed in Georgia, except for the larger number of enrollments in Germany, and in Azerbaijan, except for the enrollments in Turkey. So there is some sort of a regional pattern, but what is driving this pattern of behavior? Language skills should be ruled out given the dominance of Chinese students; they score high in math but do not perform as well in English. Students from Turkey are quite visible as well. Could it be lack of information? I kind of doubt this as well.

..................... Country of Origin, 2004 ....................
Host Country Armenia Azerbaijan Georgia China Israel Turkey Albania
Russia...... ...1239 ..... 1027 ...1357 ...na ....na ....na .....na
US ......... ....412 .......238 ....373 87943 ..3474 .11398 ....916
Germany .... ....371 .......311 ...3000 25284 ..1116 .27582 ....625
France ..... ....290 .......171 ....275 11514 ...343 ..2273 ....369
Belgium .... .....42 .........8 .....22 .1496 ....56 ...292 .....68
Italy ...... .....38 .........7 .....26 ..276 ...923 ...182 ...8494
Turkey...... ....... ......1428 ....143 ..107 ....21 ...... ....591
UK ......... .....36 ........87 .....80 47738 ..1300 ..1960 ....188

It will be good to hear your views on why enrollments continue to be so low, and why so many opportunities are overlooked.

[I have posted the number of the enrollments in Armenia on aea.am. But these are quite different from those reported by armstat. Any help in reconciling the two sets of data is greatly appreciated.]

The Growing Cash in Circulation

The amount of Drams in circulation in Armenia grew by some 46 percent in 2006, from 155 to 227 billion, repeating the growth pace of 2005 (also see my October 2006 post). Most noteworthy, the 50000 Dram note (about USD 125) experienced the fastest growth. It is almost ten times the amount in circulation in 2005, and grew from about one percent of the Drams in circulation to 7 percent.


Millions of Drams outside the Central Bank
Nomination.. 2001 .2002 .2003 ..2004 ..2005 ..2006
10000 drams...... ..... .7295 .25221 .42980 .79443
20000 drams 12351 24155 23042 .21017 .40196 .55515
50000 drams.. 780 .1607 .1386 ...945 ..1612 .15717
......total 66693 92089 96838 105534 155275 226841

Drams per USD 555 ..573 ..579 ...533 ...458 ...416

The back to back growth in currency in circulation is phenomenal and may have significant implications for economic activity and its measurement. I am also very intrigued by the spike in the circulation of the 50000 Dram note. Do we know of any on going research on the causes and consequences of the observed trend?

Travel Patterns

2006 is the first year since the country's independence when more people arrived by air than departed. More specifically, 586,800 individuals arrived in 2006, compared to 585,300 that left, as reported by the Migration Agency. In contrast, 636,900 arrived in 1992, which is 228,600 short of the number of those who left.




Number of individuals arriving by air (in black)
and the difference between arrivals and departures (in red), 1989-2006.





Travel by land also exhibited a similar positive reversal in the trend of arrivals and departures. In 2000, departures exceeded arrivals by some 19,000. By 2006, this was reversed, and arrivals exceeded departures by about 21,000. Most if not all of this takes place through Georgia to the north. A number of factors may explain this emerging pattern. One of the more interesting potential causes of this surge is that perhaps Georgia is being rewarded for abolishing its corrupt traffic police. It is well known that more and more Armenian tourists travel to vacation in Georgia, an unlikely fete before the crackdown on corruption in that country. The travel numbers in 2005 and 2006 are quite telling!

Arrivals and Departures by Land
Year Arrived Left Difference
2000 100805 119331 -18526
2001 120750 138891 -18141
2002 143997 136458.. 7539
2003 147244 132488. 14756
2004 169432 155565. 13867
2005 257652 236261. 21391
2006 375124 354405. 20719

For a population of 3 million, the number of arrivals and departures to the country is quite sizable and may have significant implications for the economy. Is anyone studying the trends in travel and recent migration patterns? What kind of infrastructure is being put in place to accommodate the surge in travel? Is out migration reversed? I am sure there are many other questions.

Real Estate, Up Again in 2006

I reported in my last post on the rapid growth in construction activity which stood at 584.6 billion Drams in 2006, or 35 percent higher than the 435.1 billion level in 2005. Stated in USD, activity grew from 0.95 to 1.41 billion, or an impressive 47 percent.

2006 was also a banner year for the related real estate market. Real estate prices, as reported on sales transactions by the Cadastre commission, increased throughout Yerevan over the past five years. In Kentron, the city center, apartment prices almost doubled from 187772 Drams per square meter in 2002 to 377600 in 2006. With the appreciating Dram, the increase is more impressive when stated in US dollars as the re-stated price almost tripled from USD 328 to 908 in 2006. The greatest appreciation rate was observed in Nubarashen where the price jumped from 28668 to 108000, or USD 50 to 260.

In 2006, prices appreciated by about 30 percent in the most districts of Yerevan. An exception is the Nubarashen district where prices increased by 55 percent. Stated in USD, prices appreciated by an average of 40 percent; 70 percent in Nubarashen.


Average price per sq. meter, in Drams
Yerevan Districts.. 2002.. 2003.. 2004.. 2005.. 2006
Kentron.......... 187772 222765 246500 288900 377600
Arabkir.......... 114670 161300 193900 235300 298200
Kanaker-Zeitoun... 68802. 98158 119200 143700 186100
Nor - Nork........ 57335. 78538 101700 135100 171100
Avan.............. 61635. 76396. 97000 122800 156200
Erebouni.......... 55902. 83920. 96500 118800 155800
Shengavit......... 61635. 83052 110600 143900 182700
Davidashen........ 63069. 97116 120900 147100 189400
Ajapniak.......... 57335. 84557 109500 138400 171800
Malatia-Sebastia.. 55902. 81779 108600 134500 166800
Nubarashen........ 28668. 36693. 43000. 69600 108000

Drams per USD.... 573.35 578.76 533.45 457.70 416.05


Prices increased in all the regions as well. Transactions in the city of Abovian, in the Kotayk region, fetched the highest price of 98100 (USD 236) per sqm, and the city of Shamlugh, in the region of Lori, fetched the lowest of 2800 Drams (USD 7).

What explains this price appreciation? Demographics may explain some of the increase in demand for housing. With children reaching adulthood, combined with the growing prosperity in recent years, they may seek their own housing arrangements. Also, the trend in the net outflow of the population has reversed itself, and now the number of arrivals in the country exceeds that of departures, but only by about 20,000. Some in the country may acquire second residences, again reflecting the growing prosperity. Also I am sure that there are a number of speculators as well.

So, who is buying all these properties? Equally important, who is selling them? Do we know of any ongoing research on the housing market? Also the price appreciation must have dramatically increased the equity in the homes of most households. Are we seeing any traces of this wealth effect in the economy?

Construction activity and future growth

Armenia's economy has grown at double digit rates over the past five years. Construction activity accounted for much of the recent growth in the economy (see recent post). Changes in the underlying trend in construction activity and its composition over the past decade, however, may foretell further growth and expansion in the economy.

Construction activity grew from 33 billion Drams in 1995 to 585 billion in 2006, or from USD 60 million to about 1.4 billion. Activity in the manufacturing and electric and gas utilities grew from 4.6 billion Drams to 92 billion in 2006. Even more impressive, activity in the transportation and communication sectors grew from a mere one billion (i.e. USD 2 million) to 63 billion.

..1995 ...2000 ...2006
32,829 100,990 584,608 Total Construction, in millions of Drams
.4,646 .10,488 .92,147 Manufacturing & Utilities
.1,091 .36,606 .63,392 Transportation & Communications
14,780 .21,098 306,030 Housing/Real Estate

Impressive gains are also observed in the housing and commercial real estate sectors. Construction activity grew from 15 billion in 1995 to 306 billion in 2006. These figures in part may reflect a wealth effect as more and more new and expansive buildings are built and older homes are renovated. Also these activities expand the volume of rental property and office space available in the market place.

Gone are the days when humanitarian aid accounted for 10 to almost 20 percent of construction activity. Indeed, such source of funding accounted for less than 1 percent of the total in 2006, down from close to 20 percent (45 billion Drams or slightly less than USD 100 million) in 2003. Also, it is gratifying to see an expanded construction activity in the education sector, which increased from a mere 360 million Drams (less than USD one million) in 1995 to 10.7 billion (about USD 25 million) in 2006.

These activities are bound to expand the country's productive capacity and add to future growth and expanded employment opportunities. Do we know of any studies on how labor markets are impacted by this? Also, has anyone explored the effects on future growth?

[March 15 -- I have had some difficulty in posting the detailed construction data for 1995-2006 on the aea.am site. Perhaps I'll be able to do so within the next day or two, and the link above will be more useful then]

The Changing Face of Agriculture

There are about 320,000 farms in Armenia, a number that has remained roughly steady over the past decade. Given a population of about 3 million, this is quite sizable and reflects the privatization policy of the early 1990s whereby farms were distributed to the workers and members of the various state cooperatives and collective farms.

The agricultural sector has made significant gains in output over the past decade, virtually in all sub sectors (see here). Grain output as well as that of fruits, vegetables, and eggs grew by over 50 percent between 1995 and 2005. A similar pattern is also observed for available poultry and pigs. Notwithstanding the advances made, the agricultural sector is undergoing serious changes in organizational (or rather ownership) structure.

Local businesses have been making steady inroads into this sector, as suggested by the statistics reported in the various publications of Armstat. For the most part, these commercial enterprises account for less than 5 percent of the output. But they do account for 12 percent of the potato and 20 percent of the grain output. In the case of poultry, however, they account for about 40 percent of the 5 million chicken available to be brought to market. Similarly, they account for about 45 percent of the eggs produced.

The share of Commercial Organizations in Poultry Output


Undoubtedly the commercialization of the agriculture sector has great benefits. [Not sure how many commercial entities are engaged in this sector, but I assume ownership is highly concentrated.] It is potentially more efficient and cost effective to cultivate the land by commercial entities than by the farmers and villagers each with their own small plots. But is there a risk that the latter will be (are already) displaced, thereby exacerbating rural poverty? Are the commercial entities truly more productive? Is anyone writing on the subject?

[March 10: Graph is replaced -- it disappeared again]

On Dual Citizenship

On the 26th of February, 2007, the Parliament approved the bill on dual citizenship. This belated legislation is some 15 years in the making since Armenia’s independence in late 1991, and long overdue. This change, of course, is not enacted without any opposition. Indeed, opponents of this legislation in the ruling coalition and some in the opposition have argued that granting dual citizenship to the Diaspora would increase corruption [sic], and lead to a loss in the country's sovereignty [sic]. These are virtually the very same arguments underlying the policy advanced in the early 1990s, one that is in many ways responsible for preempting the integration of the Diaspora into the fabric of Armenian society.

Contrast this with the Israeli experience. Under the Law of Return, Jews are granted immediate citizenship in Israel. Often they are provided with subsidized housing, language training, and many other benefits upon their arrival. On the eve of its independence in 1948, its population stood at 805,000. This increased to 2.15 million by 1960. Approximately 65 percent of the increase in the population during this period can be attributed to the in migration of 869,400 newcomers (mostly from middle eastern countries). After the breakup of the Soviet Union, about a million arrived on its shores. Few if any spoke Hebrew and, as Soviets, had little exposure to Israel's western ways of business and commerce. Yet, they were all welcome and fully absorbed.

Israeli Population and Immigration (in 1000s)
Source: here, Table 2; also a good summary of Israel's economic history.


Returning to Armenia, what I find truly sad is not the restrictions on voting as much as those related to the economics. Almost immediately after its independence, the government made the integration of the Diaspora into Armenia’s economy an impossible task. Diaspora Armenians, for instance, were prohibited from land ownership, a prohibition that continues to date (the introduction of a special 10-year passport relaxes this constraint). They were also discouraged by sheer intimidation. A member of the Diaspora, and a "supporter" of the then ruling regime, wrote in 1993 that "… Diaspora Armenians who (motivated by patriotism or profit) have tried to start businesses or engage in joint ventures have soon found out that they are being ripped off. But the saddest realization comes when they learn that their corrupt partners enjoy protection from higher echelons in the government ..." (see here, page 38)

In the name of national security and sovereignty, policymakers have inflicted serious damage to the country and exacerbated the pains of its transition to a market economy. As explained in a recent article in the Armenian Law Review, it takes little effort to make the legislative changes necessary to make dual citizenship a reality. However, the final chapter may not be written yet, as little is known how the enacted changes (once signed by the President) will be actually administered.

More on the economic effects in a future posting. These would have been much larger if we were able to turn the clock back to 1991 with the country's institutions of higher education and productive capacity intact. In the mean time, does any one know of a link to the legislative bill that the parliament passed (I checked the parliament's website)? What I read in the press is confusing!

[March 2 -- Table is replaced. I'll replace with plain text if it disappears again.]

Baku, February 19, 1905

Entrepreneurs are often valued for their creativity and contribution to economic growth and prosperity. But at times, and in some countries, minority entrepreneurs pay a very high price for their success. Examples of this include the attacks on Chinese owned shops and businesses in Indonesia , the fire bombings of fishing boats and homes of Vietnamese refugees in Texas, and the treatment of Jews throughout the middle ages.

The contribution of Armenians to the economic development of Baku well over a century ago is another build-and-destroy chapter in history, albeit perhaps an extreme example, where economic success is met with a massive violent reaction. As told by Luigi Villari, an Italian historian and diplomat, who travelled throughout the Caucasus region in 1905 (Fire and Sword in the Caucasus, London, T. F. Unwin, 1906), "... To the Armenians above all is the development of Baku due, for they were the first to work the oil-fields on a large scale and on modern lines; they perform a large part of the skilled labour, and among them most of the managers, engineers, as well as many capitalists, are to be found." (page 187).

The Armenians began to arrive in Baku in the late 18th century as their ancestral lands were being divided between the Persian and Ottoman Empires. Their numbers increased with the rush to develop the oil industry after the control of Baku changed hands from Persia to Tsarist Russia. The first refinery was founded by Melikoff (Melikian) in 1863. Notable Armenian firms included Mantasheff, the Caspian Co., the Moscow and Caucasian Co., and Aramazd who competed head on with the Nobel Brothers and the Rothschild's, as well as Russian, British, and Dutch firms. (page 185-6)

By 1905 Armenians accounted for about a third of the the oil industry. They also accounted for 25,000 of the population; there were 74,000 Russians, 56,000 Tartars (this is what today's Azerbaijanis were called then), 18,000 Persians, plus about 20,000 other nationalities. (page 186) Many of the buildings they commissioned are present in today's Baku, with the church on the fashionable Fountain Square being the most visible.

February 19, 1905, was the date that much of the tremendous wealth and infrastructure that the Armenian community had contributed to Baku came under severe attack by the Tartars (Azerbaijanis). The oil facilities were set ablaze along with homes in the Armenian quarter, as well as a number of the wealthiest Armenians were killed (e.g., Adamoff, Lalaieff -- page 195).

With impunity, the Tartars committed other pogroms in Nakhichevan, Shusha (Shushi), Elizavetpol (Ganja), among others. How were the Tartars able to commit these pogroms and not risk the intervention of the Russian military or incur the wrath of the Cossacks?

Tsarist Russia's policy towards Armenians may explain quite a bit. In the 1880's the Russians suppressed all 500 Armenian schools in the Caucasus. (page 152-3). In an another example, in 1894, Russia protected Turkey from western interference during the Hamidian massacres where over 100,000 Armenians were killed. It feared an autonomous Armenia in Turkey would lead to similar outcome in Russian or Eastern Armenia (page 154). Indeed, and according to Villari (page 154) Prince Lobanoff is reported to have said, "Nous voulons l’Arménie sans les Arméniens," i.e. Russia desires Armenia without the Armenians.

The Russian government weeded out Armenians from public service (page 155). In addition, in 1903, all Armenian church property was confiscated, including Etchmiadzin the seat of the Holy See -- the Armenian Pope (page 156). Prince Golytzin is reported to have said "In a short time there will be no Armenians left in the Caucasus, save a few specimens for the museum." (page (157) It should come as no surprise that the Governor of Baku, Georgian Prince Nakashidze, was seen "openly encouraging the Tartars" (page 195). Indeed, Russia favored the Tartars (Azerbaijanis) who represented the only element that could be relied upon in the Caucasus (pages 170 and 158).

In Villari's words “... In the Caucasus it is popularly said that it takes ten Jews to cheat an Armenian, just as in England it is said that it takes many Jews to cheat a Scotsman.” (page 163) Other authors have used the less loaded term "outwit." I suspect these racial overtones have set deep roots in the Caucasus and the region!

Villari's book is an excellent source on the economic contribution of Armenians to Baku and Tiflis (Tbilisi). It contains beautiful pictures of Georgia, the destruction in Baku, and very sad and disturbing pictures taken in Nakhichevan.


Armenian church in Baku -- picture (L) taken in 1988. More recent picture (R) showing crosses above front door and on top of steeple missing.

Why So Little Economics Research?

Browsing through Econlit in EBSCO Host databases, I could not find a single article written by an author affiliated with an Armenian Institution and published in the top 159 economics journals ranked in a study funded by the European Economic Association.

How do we explain this (other than the pains of transition)? How much of this can be explained by the lack of training, adequate tools (software and hardware), and access to data and research materials? Are there any institutional impediments to doing research? And most importantly, how do we reverse it. It will be good to hear from those of you in the field and face similar experiences.

This is not a trivial matter. Publications are critical in ranking institutions, and by proxy the quality of education. These send critical signals to potential employers and grants makers. In addition, research and publications play an important role in improving the quality of debate and discourse on public policy matters. These potentially have a civilizing effect that is sorely missed in the society.

Of course there are signs of life. For example, I was able to identify 9 papers published in recent years in journals that are unranked or weakly related to economics.

Four were written by authors affiliated with the central bank (3) and UNDP (1) and published in a special issue:

1. Impact of Regulated Price Adjustments on Price Variability in a Very Low Inflation Transition Economy: Case of Armenia, European Journal of Comparative Economics, Spring 2005, v. 2, iss. 1, pp. 17-39.
2. The Measurement of Co-circulation of Currencies and Dollarization in the Republic of Armenia, European Journal of Comparative Economics, Spring 2005, v. 2, iss. 1, pp. 41-65.
3. The Evolution of Competition in Banking in a Transition Economy: An Application of the Panzar-Rosse Model to Armenia, European Journal of Comparative Economics, Spring 2005, v. 2, iss. 1, pp. 67-82.
4. Core Inflation in a Small Transition Country: Choice of Optimal Measures, European Journal of Comparative Economics, Spring 2005, v. 2, iss. 1, pp. 83-110

Three were written by authors affiliated with the American University (2 non-Armenian):

1. Completing Post-earthquake Replacement Housing in Rural Armenia: Did It Induce Further Investment? Housing Studies, January 2006, v. 21, iss. 1, pp. 97-112.
2. Voucher-Financed Privatization: Lessons from the Armenian Experience, Global Business and Economics Review, December 2004, v. 6, iss. 2, pp. 280-302.
3. Viticulture, Wine Production, and Agriculture in Armenia: Economic Sectors in Transition, Journal of Applied Business Research, Fall 2002, v. 18, iss. 4, pp. 13-23.

And one was written by authors from the State Engineering University:

1. A Dynamical Model of Water Recycling in a Mine-Processing Enterprise, Central European Journal of Operations Research, February 2006, v. 14, iss. 1, pp. 45-57.

When I further searched by "Geographic Descriptors" rather than "Author Affiliation," I located two more papers written by authors affiliated with the Russian-Armenian (Slavonic) University:

1. Tax Reforms as Capital Market Development Factor, Transition Studies Review, 2006, v. 13, iss. 1, pp. 131-41.
2. Rating System as a Banking Performance Regulator in the Conditions of Transition Economy, Transition Studies Review, 2005, v. 12, iss. 2, pp. 222-30.

Some progress, but much more is needed. Once again, it will be good to hear the views of others on this important subject.

Preferences for a family size

During the Soviet era, a typical Armenian family had two-three children. One-child families were rare. The current fertility rates (the average number of children born to a woman over her lifetime) are down to 1.3 in 2005 (down from 2.8 in late 1980s). What are the reasons for such abruptly declining fertility rates?

Changes in preferences for a family size might have been motivated by several reasons. First of all, the socio-economic conditions in the country induced families to cut back on the size. Second, the Armenian women, especially in urban areas, became more independent and career-oriented, thus private incentives have undergone major changes. Third, the government does not exhibit pro-natalist sentiments. The child allowance program in Armenia is minuscule: only 0.35 percent of the state budget was spent on child allowance program in 2005. The program itself envisions a lump-sum allowance of 35,000 AMD at childbirth (raised from 5,900 AMD in 2003) and a monthly allowance of 3,000 AMD for children of age two and younger (if the mother is employed, the family gets only 50% of the monthly allowance).

From the 2003 Household Survey, one can identify 86 households (out of 1396 surveyed households having a female married member between ages 18 and 35) who welcomed a newborn to their household in 2003. Unfortunately, none of the households reported to receive a lump-sum child allowance. Could it be that the survey questions were poorly designed and didn’t make it clear that child allowance is one of the income categories the household receives? Or in fact the households didn’t claim their right to receive the allowance in time, therefore losing the privilege? One way or another, after examining total household income per month it becomes clear that the child allowance of even as little as 35,000 AMD could have made a big difference in the lives of many households. The household income varies from 5,000 AMD to 965,000 AMD per month with a mean of 90,315 AMD and a standard deviation of 124,541 AMD. As seen from the graph below, the distribution of household income per month is highly right-skewed (the histogram excludes two outliers with 591,000 and 965,000 AMD monthly income, respectively).

One thing I wish for is better designed surveys that will make it easy to evaluate the link between the social policies and fertility rates in the country.

Banks and Armenia's Economy

Over the past couple of years, the banking sector in Armenia witnessed a rapid transformation and a string of mergers and acquisitions that may lay the ground for further expansion in Armenia's economy. With western ownership of HSBC, Cascade, Converse, and ACBA Credit Agricole Bank, and Russian (Vneshtorgbank) ownership of VTB-Armenia Bank, the landscape has been radically altered.

The maturity and depth of the financial sector is often what separate the wealthy developed economies from the poor developing countries. It is these institutions that regulate the saving/investment process and the relations between lenders (or savers) and borrowers. This financial intermediation is critical to the development of an economy; it is difficult to imagine what form savings may take place and how this can be tapped by businesses to finance their capital expenditures. It is also difficult to imagine how trade, international as well as domestic, is facilitated in the presence of a weak financial system.

Consider some of the many business services that banks may provide:

A. Credit Facilities for Capital Finance,
B. Bank Guarantees such as (1) Advance Payment Guarantees, (2) Tender Bonds, (3) Performance Bonds and others, and (4) Stand-by Letters of Credit,
C. Trade Services in the case of imports such as (1) Bills for Collection and (2) Post-Import Finance, or in case of exports such as (1) Documentary Credits, (2) Bills for Collection, and (3) Pre and Post Shipment Finance.

It is hard to imagine how trade and investments can take place in the absence of such services. However, it is equally difficult to imagine how the financial sector can grow and prosper in the absence of good governance, regulatory institutions, and most importantly trust. If we were to examine total bank deposits, Armenia would have the profile of a poor developing country when expressed relative to GDP. These deposits are about 10 percent of GDP; much smaller when we examine time deposits and other measures of intermediation relative to GDP. But this is much better than the 3 percent observed a decade ago, despite the rapid growth of its economy.


Indeed, the financial sector, and for a number of years, may have had a depressing effect on economic activity. Poor governance and weak institutions may have caused significant damage to the economy. Consider the following excerpt from the financial statement of Hellenic OTE, until recently the parent company of Armentel:

During 2001, an Armenian bank, Haycap Bank, with which ArmenTel had deposited US$4.8 millions, was placed under a conservatorship program. It is uncertain whether ArmenTel’s funds will be recovered. This amount has been fully provided for in our consolidated financial statements. Nevertheless, in order to recover its funds, ArmenTel has initiated a series of actions, including discussions with Haycap Bank’s creditors and legal measures intended to help secure ArmenTel’s position within the framework of Haycap Bank’s conservatorship program proceedings. In 2002, Haycap Bank initiated legal proceedings before Armenian courts against Armentel requesting compensation for losses and damages allegedly incurred as a result of the actions of Armentel. On February 18, 2005, the Armenian Economic Court ruled that Armentel should provide to Haycap compensation in the amount of US$ 5.2 million. On May 31, 2005, ArmenTel appealed against this decision before the Armenian Supreme Court.
Source: US Securities and Exchange Commission Form 20-F, pages 87-88

Not only Armentel may have lost $4.8 million in deposits, but it may have risked losing another $5.2 million in its zeal to recover its losses. Notwithstanding the black eye that Armenia gets for this, poor corporate governance impedes economic activity, and a weak judiciary is not very helpful. So it is gratifying to witness the recent arrival of "giants" at the scene who may contribute to the prosperity of Armenia, and challenge the system if need be. Their presence is bound to improve corporate governance, and deepen financial intermediation.

Armenia's banks today, in particular the foreign owned, are likely to be well governed and "strong." Equally important, they have introduced considerable innovations such as in business services, e-banking, credits cards, money transfers, among many others.

A recent paper provides a nice primer on the many obstacles that Armenia's financial system faces. It will be good to see empirical research in this area.

The Largest Taxpayers

For the past couple of years the State Tax Services agency has published a listing of the largest taxpayers in Armenia, along with the amount of taxes they had paid. In the most recent release on taxes paid in 2006 (in Armenian), the agency reports the total amount paid by the largest 1000 taxpayers and breaks it down by type. The latter include custom duties, direct taxes (profit and personal income), and VAT among others.

The agency should be applauded for making the tax system more transparent, as well as making such data available to analysts and researchers. Further expansion of the reported information may enhance its usefulness. Two suggestions:

1. Is the reported information on a gross or net basis. In other words, is the reported information net of any refunds? It would be good to clarify this. As an example, the German owned Zangezur Copper Molybdenum Combine firm is listed as the largest taxpayer with total payments of about 33 billion Drams (USD 79 million), including VAT payments of 12 billion Dram (VAT tax rate is 20 percent). But because the bulk of the copper and molybdenum output is most likely exported, and as such is exempt from the VAT, (unless I am mistaken) much of the reported VAT tax should be refunded resulting in a near zero liability. Thus, it appears that it is the gross value that is reported. I think the net liability is critical.

2. The reported direct taxes (column 8 of the list), though not clear, seem to reflect business and personal taxes. More specifically, it appears to combine taxes on business profits (including repatriated income of foreign firms) and those on employee wages withheld by the firm. If true, it is not an easy task to untangle these two pieces with publicly available data. For the income tax, one needs information on total wages and its size distribution before the tax rate schedule is applied. Also, the presence of tax holidays for foreign investors complicates matters and makes it difficult to gauge how much of the reported direct taxes are on profits.

Again, the reporting of the tax information represents a major milestone. But it would be good if the reported information were further expanded. The media and analysts also have a responsibility for accurate and objective analysis of the reported information. Many are correct in highlighting the low taxes paid by some local businesses. Others, and despite of the best of intentions, have drawn some outlandish inferences from the tax figures reported over time; it is difficult to draw inferences on the underlying profitability of each firm in the published list.

It would be good to see more research done on the various aspects of the tax system in Armenia. Do we know of any ongoing research?

[Feb 11 -- you may download an xls file of the taxpayer data from here; you need Armenian fonts and can be slow to download. This data as well as data for prior periods is available in pdf format from here.]

Investor Nationality and Rule of Law

On January 8, and pursuant to complaints from Armentel's new owner, Vimpelcom (see earlier post), the Public Services Regulation Commission of Armenia approved the request to disconnect some 300 entities "illegally" providing IP-Telephony services effective January 25, 2007.

Since License no. 60 provides that Armentel is legally the sole provider of telecom services, the Commission's decision is an affirmation of the rule of law and respect for property rights. This is not to say that monopoly is something to admire or protect, but Vimpelcom, and previously Hellenic OTE, have paid for these rights. Indeed, the Armenian government granted itself these rights in 1995 and expanded them in 1997 prior to its sale to OTE.

What is remarkable about the recent decision is its swiftness. The Commission approved the acquisition on November 14, 2006, and the purchase of Armentel was completed on November 20, 2006 (see here). And in less then 40 days, a decision was made to shut down all entities encroaching on Armentel's rights. While the timely decision and respect of property rights should be applauded, the previous owner OTE had failed to garner such support from the Commission and the government despite numerous attempts over the past couple of years.

Is the lesson here that Russian ownership is good for Armenia in that it will improve governance and rule of law? Perhaps the question is bigger than that. The French Pernod Ricard, which acquired the Ararat cognac producer (renamed Yerevan Brandy Company) successfully fought to keep other cognac producers from using the Ararat label, in Armenia as well as in Russia, with the government's backing at each step.

Is it Russia or is it country size? It strikes me that country size is perhaps the critical element at play. I wonder if anyone has written on the subject? Do we have any direct evidence on how firms fare under the law depending on their size and FDI origin? Is their any research on how corporate governance varies by nationality as well as size?

[Perhaps the 2005 World Bank and EBRD survey of business environment BEEPS, when it becomes available, can be useful but only in addressing the question on firm size. The 2002 survey can be downloaded from here; I can email you an extract of the raw data limited to Armenia or with fewer variables if you're unable to download the Excel or Stata files]

Rail Transportation

Rail links continue to be a topic of great interest. Rail transportation shrunk significantly over the past 16 years. On the eve of its independence in 1991, Armenia's railroads handled 12 million tons of freight (see here which also includes similar information on road and air transportation). In 2005, the last year for which data is available, it had dropped to about 2.6 million tons, with more than half of it foreign trade related. Similarly, the number of passengers traveling dropped from 3.5 million to 700,000.



Some of the above steep decline can be explained by the dissolution of the Soviet Union and the traditional markets and trading partners that Armenia had enjoyed. Some can be attributed to the instability in Georgia, particularly in its northern regions. But much should be attributed to the blockade by Turkey.

Indeed, the economic hardship could have been averted by employing rail lines (and roadways) heading west rather than north had it not been for the blockade by Turkey. This is not a trivial matter as the bulk of Armenia's trade is with the west, and not its immediate neighbors to the north and east. In 2005, less than 19 percent of its exports of USD 950 million were destined to Georgia, Russia, Ukraine, and the remaining former Soviet republics to its north and east. Similarly, about 21 percent of its imports of USD 1768 million originated from these countries.

If west is the way to go, then connecting to Kars in Eastern Turkey should be quite cost effective. As the map in my previous post shows, Kars is a stone's throw away from the Armenian border and already has rail links in place connecting the two countries. Open borders and trade are beneficial to Armenia. Undoubtedly, they are also beneficial to Turkey. Obviously economics has little to do with the decision to impose a blockade, which must have cost Armenia billions of dollars in lost economic activity over the past decade.

[March 10: Graph is replaced -- it disappeared again]

Fallout from the Slaying of Hrant Dink

The slaying of Hrant Dink is yet another sad chapter in the history of the ruling regimes in Turkey and the pain they keep inflicting upon Armenians. The continuing destruction of ancient Armenian churches and historical monuments, the confiscation of church properties (Christian foundations), the conversion of ancient Armenian churches to mosques, the prohibitions on the teaching of the Armenian language and training of clergy, the absence from educational textbooks any reference to the 3000 year old Armenian roots of more than half of the country, and instilling an environment of intolerance towards Armenians, have taken their toll.

Not only successive governments have inflicted pain upon Armenians within Turkey's own borders, but they have imposed a crippling blockade on the newly independent and tiny landlocked Armenia. This blockade has caused tremendous suffering and contributed to widespread poverty and unemployment.



In one of his last writings, Hrant asked that the Diaspora turn its energies to the newly independent state of Armenia. The government of Turkey has a tremendous role to play here. This blockade, the ultimate symbol of intolerance towards Armenians, should be lifted immediately and unconditionally.

However, lifting the blockade is not only a political decision. Without dealing with the environment of intolerance towards Armenians, open borders don't mean anything. Would any shopkeeper in Turkey dare to promote or showcase a product with the label Made in Armenia today? Would Armenians feel safe and free to move around?

Recent news from Turkey, and in particular the reaction from the media, are very encouraging. Indeed, I could not believe the 21 January, 2007, statement in the daily Sabah (Morning in Turkish) by an advisor to the prime minister of Turkey, that Hrant Dink "was not entrusted to us as an Armenian; rather he was the real host of this country." This is the closest to an official acknowledgement that Armenians are natives and the original inhabitants of much of the land that is called Turkey today.

The words that I read from the press in Turkey are very encouraging. But actions speak louder. For starters, when will the government of Turkey lift its blockade of Armenia? When will it stop adding fuel and start putting out the flames of intolerance towards Armenians? How many more Hrants have to be sacrificed before the decent citizens of Turkey make their government do the right thing?

[March 13, Map restored, pictures removed. Hope it'll not disappear again.]

Tax Holidays

2007 is the last year when new investments by foreign firms qualify for tax holidays in Armenia. Firms investing a minimum of 500 million Drams (1 USD=365 Drams) benefit from 100 percent forgiveness from the profit tax in 2008 and 2009.

Profits in Armenia are taxed at a flat tax rate of 20 percent, except for firms engaged in agriculture which are exempt. Generous depreciation allowances further reduce the effective tax rate that businesses face. Hotels, for instance, are depreciated over 10 years; 20 years for other buildings. Computers are expensed, and so are investments in structures in the earthquake zone, as well as all investments in Gyumri, Armenia's second largest city and also in the earthquake zone (see here and here for depreciation rates). These allowances have the effect of reducing the effective tax rate on normal profits to zero in Gyumri, and generally to much less than 20 percent for the rest of the country.



Source: Taxes, Investment Incentives, and the Cost of Capital in Armenia

Tax rates, both statutory and effective, are quite low. Even if these low rates are not sufficient incentives, the current tax holiday strikes me as too expensive a tool for a small and impoverished country like Armenia. Consider the case of Armentel, the second largest taxpayer in Armenia (I am not picking on this firm -- it just turns out that it is the most transparent firm operating in Armenia with readily available financial statistics). In 2005, this firm earned pre-tax profits of Euro 49.9 million off gross revenues of Euro 119.1 million. It booked an income tax of Euro 4.9 million, or 10 (and not 20) percent of its taxable profits (see here). Surely this highly profitable firm is able to pay more.

Not only one would object to this tax break on grounds of equity and fiscal soundness, but also object to it on the grounds that it is not directly related to the marginal investment put in place. Consider the case of a firm with pre-tax profits of Euro 10 million. By investing slightly over one Euro million, this firm is able to slash its tax bill by 2 Euro million. The government has cut back in the past on this form of subsidy. Firms with investments put in place in 2002, for instance, were accorded 100 percent exemption in 2003-2004, and 50 percent for tax on 2005 and 2006 profits (see here).

The existing accelerated depreciation provisions act as investment tax credits (they are equivalent), and already provide for targeted investment incentives. Would Armenia be better off with the tax holidays extended?

Are there any statistics on the amount of revenue loss to the government? This has to be in the tens of USD millions. Also, do we know who benefits from this tax break? Is anyone writing on the subject?