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.