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]
11 comments:
David,
I don't think I have seen many bloggers who are knowledgeable in macro economics and what the interaction of the government and the CB is. Even if the bloggers are knowledgeable, their audience isn't. I've written a few entries but they usually go unnoticed by the readers.
The print media is the same. If there is someone in the media who is knowledgeable about these issues, he or she is not going to waste his/her time on writing articles for. The knowledgeable people have better things to do. Add to that the fact that every single media outlet has an agenda and you will find it difficult to have any objective piece published there. Plus, the appreciation of dram is the most visible symptom of Armenia's problems and when you feed the lowest common denominator, a sophisticated article will not be accepted by the audience.
It's all determined by your audience... This sounds harsh but is close to reality.
Agree, but there is a downside to this. For one, problems don't get resolved. And, two, government critics lose credibility.
Dear David,
Interesting thoughts!
What is the new level of dollarization? Do we have any measure on the deposits in USD versus AMD?
Raymond
re:"But at the same time, CBA raised interest rates to curb inflationary pressures a move that may have potentially offset the foreign exchange intervention. "
Won't raising the interest rates attract more foreign capital to the country and strengthen dram further?
i agree that fixing customs poblems to reduce cost of trade will help in productivity. It is sad that today in Armenia, one is not even able to receive a small size package via UPS, Fedex, DHL, TNT or others, without having to go through a day or more of hassle at Armenia's customs agency, register and pay a "tax" that is usually higher than the product is worth itself. Anyone can go to the customs agency in Yerevan to see the typically 3 employees handling over 500 people waiting to receive packages where in any normal country the package would be delivered right to your door step (except narcotics and guns). In fact two days ago a person who was at customs to receive a 300 gram box of chocolate as gift from Europe, was told that he would have to pay 20000 drams in customs tax, in which case the guy after spending 8 hours at customs, refused and left without retrieving his chocolate. Note that the customs agents were accepting bribes in order to release the products at much lower price. Incident after incident was occuring and it is sad that this situation has been allowed to continue.
The value of AMD, like any other product in a market economy is determined by supply and demand. The value of AMD could stay the same or even depreciate if the CBA increases the supply of AMD significantly. Some of the critics of the CBA expect that the CBA would increase the supply of AMD and slow down the appreciation of AMD. The CBA replies that increasing the AMD could generate higher inflation. Some of the critics of the CBA are not convinced that the CBA is increasing the money supply to the maximum amount and that higher increases in the supply of money would generate inflation. The CBA through empirical research should show that higher increase in AMD would increase the inflation. As long as the CBA doesn’t provide and disseminate such studies, there will be skeptics who justifiable would question whether the CBA is doing enough. The CBA announced that they adopted targeting inflation as their monetary policy strategy. Therefore CBA is biased towards policies that would bring inflation down. One such policy is appreciating the AMD, because appreciated AMD makes imports cheaper, which slows down the inflation. Therefore it is in the interest of the CBA that the AMD is appreciating, because it would bring down inflation. This implies that the burden is on the CBA to show that they are doing enough and are trying to increase the money supply up to the level where the inflation doesn’t go up. Another research topic is to evaluate the usefulness of having inflation targeting as a monetary policy of the CBA. May be inflation targeting is too rigid for a country like Armenia.
Another monetary policy possibility is to increase the supply of AMD and buy more foreign reserves and then to sell government bonds and reduce the supply of AMD, which leaves the supply of AMD and interest rates unchanged. In this case economists would say that the CBA is sterilizing the foreign exchange purchase. When foreign and domestic assets are perfect substitutes, then sterilized intervention would have no effect on the exchange rate. However in the case of Armenia, foreign and domestic assets are not perfect substitutes. Domestic assets are riskier than foreign assets. When foreign and domestic assets are not perfect substitutes, then a sterilized purchase of foreign reserves would leave the domestic money supply and interest rates the same, but would increase the risk premium of domestic assets, which would cause the domestic currency to depreciate. In other words the CBA could implement sterilized purchase of foreign assets, which technically could depreciate the AMD, without generating inflation.
Most probably the CBA is doing some sterilized purchases of foreign reserves. If this is true then are they doing enough? How much sterilized intervention the CBA could/should implement? What are the peculiarities of Armenia’s economy with respect to the sterilized intervention of foreign exchange? Without sterilized intervention, how much the CBA could/should purchase foreign reserves and increase the supply of AMD, which could slow down the appreciation of AMD, without significantly pushing the inflation higher? I think these are interesting research topics.
Ara
I believe over 60 percent of household deposits are in Drams now. http://cba.am/publications/review/com_dep.pdf. Just the reverse of what it was a couple of years ago.
And yes, higher interest rates may attract deposits. But I think the more immediate effect is to reduce money creation through lending/borrowing. But either way, the Dram may strengthen. That is the dilemma for the CBA -- do we want a weak Dram with high inflation!
Ara: what you're describing is sterilzation; CBA buys foreign exchange and by doing so expands the supply of Drams. Next it sells bonds (reduces the supply of Drams) to sterilize its intervention. But CBA can't sterilize its intervention given the state of financial markets in Armenia -- and even if it were able to do so this can be very costly. CBA may earn some interest on its holdings of foreign exchange. On the other hand, it will pay interest on the Dram denominated bonds it issues which are usually higher than the yield on its foreign exchange holdings. Also, an additional cost/gain is the potential depreciation/aprreciation in value of its foreign exchange holdings.
Much is written in the literature about the efficacy of exchange rate intervention and the cost countries incurr as a consequence.
I like to see more research on the subject, in particular more from academia. I know of two good econometricians (PhD level in the US) in the country, one is at CBA and the other at the Ministry of Trade and Dev. I know of no one who has advanced training in macroeconomics.
ARA: as you already know, my PhD is in public econ. So I could be wrong on everything I have said :)
There may be many reasons of natural appreciation of Dram. One can state 10 for each of 1 "manipulation" schemes. That is not important. What is importnant is what is the effect of dram appreciation on Armenian economy. Armenia is not a state that could adopt a full free market approach to this matter. China can't afford it. Why could Armenia? Not when dozens and dozens of Armenian manufacturers, after weathering last 15 years of distruction, are failing because their effective cost basis went up 18% this year alone. This only due to Dram. The problem is neglected further as the manufacturers, as interest group, are not even requested to submit opinion. The importers, the biggest beneficiaries of the Dram appreciation, are very well heard. They are actually members of Parlament. Noy beverages, Artashes fruit products, Armenian cognac and Tufenkian Armenian Carpets are loosing market share to their competitors. Importers are winning. Is Armenia in loss or gain?.
I agree that there is little CBA can do to counter the appreciation process. But one thing the Government can do to help local businesses to stay competitive and somehow offset the export loses, is to support importation of the advanced technologies into the country which is cheaper due to the appreciation.
This will increase productivity, lower costs, and increase competitiveness of local businesses.
The so-called government support could come in the form of stopping harassment of technology importers (ant not only those) by the customs officials and create some financial incentives, such as tax breaks for investing in advanced technologies and lower or even complete elimination of import taxes on the advanced [production, processing, etc.] technologies.
Every developed nation practices this. You all know that the current big thing in US is to provide tax credits to those who invest into energy efficient homes and appliances, hybrid vehicles, solar panels, etc.
I would be surprised if we do not see positive developments for our production and export sector as a result of those 2 changes that are perhaps the easiest things to do within a very short period of time.
Avak,
I am happy to post your comment, but not the entire content of the aricle from a year ago. Please cite the author, title, publisher, and date.
Vahe,
I prefer the government do little in terms of tax incentives. We know very little of their incidence (and effectiveness). I would rather prefer that the government invests more in eductation.
As for the energy tax incentives in the US you cite, these are very small at best. Check the Analytical Perspectives chapter of the Budget of the United States Government.
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