An Interview with Vache Gabrielyan, Ph.D., board member of the Central Bank of Armenia

- The appreciation of the Armenian dram against the U.S. dollar continues to worry our society. The various economic explanations for this process given by representatives of the Central Bank of Armenia (CBA) are essentially incomprehensible. What are the factors involved in the appreciation of the dollar?

- First, I would hope that CBA representatives are offering various but not dissimilar explanations for this process. Naturally, there are several factors at play here. Foremost is the significant growth in the amount of remittances, which have almost tripled in the last four years. The second main factor would be exports. Contrary to popular belief, the exports are growing in absolute terms, not decreasing. Exports have risen during each of the past years, albeit at various rates. During the first six months of this year 60% more has been exported compared to the first half of 2004 (2004 being the first year of the dram’s appreciation). Of course, one has to remember the 120% rise in imports during the same period. However, when it comes to understanding the dynamics of the supply and demand of foreign currency in the domestic market we cannot overlook these trends. Thirdly, there’s the phenomenon of dedollarization, a process when parallel with the rise in the Armenian dram population’s savings are changed from foreign currency to the dram.

Generally speaking, we have a similar phenomenon here as it has been recorded in a host of foreign countries, when, concurrent with economic development, appreciation occurs as a result of the rise of productivity and investments. Let me present some statistics that will underscore the aggregate influence of remittances in this matter.  The growth of such remittances is evident to all. You will remember the time when we were being told that it’s impossible for Armenians overseas to suddenly become rich and to suddenly start sending more money back here. But the numbers don’t lie; there’s a real growth of remittances. (See Table ?) The main inflow is from Russia where, based on the rise of global oil prices, there has been an overall rise in wages, including the construction and trade sectors. It is in these sectors where most Armenian guest workers in Russia work.

Based on the figures for the first eight months of 2007 we’ve already seen a larger net inflow of such remittances than in all of 2005. The total inflow for these eight months is only 25 million dollars less than the total amount of inflows for the entire year of 2006, which was around 450 million dollars. To put this into perspective let me note that this approximated the average amount of dram currency existing in Armenia in 2006 and surpassed the amount of foreign currency or dram deposits. If we’re talking about gross inflows, then the figure is more than one billion dollars or the equivalent of about 20% of our Gross Domestic Product. If we look at the rates of growth, we see that they’re enormous. While we witnessed a slowdown of inflow growth rates during the past two years, as yet nothing similar has occurred this year. This signifies that the pressure continues at unabated rates. In addition, the numbers we’ve presented only reflect remittances made by individuals. In addition to this pressure from individuals, we also have investments, which are not only of a personal nature, say investing in real estate or construction, but also in factories or other businesses. Let me bring an example from the financial sector. This year the HSBC bank opened a new headquarters and two branch offices and they’ll invest more by expanding their operation in the marzes. Of course the bank enjoys high profitability, they earn large profits that also leave the country, but everything being equal, this is still a growth in investment and a decrease in profit outflow. Besides the HSBC bank, in the banking sector we expect yet tens of millions of foreign investment in the coming months.

These flows in turn also create pressure on top of what we already have. As a result, there’s an increase in incomes and when this happens at increasing rates there’s also a rise in inflationary pressure. According to the Constitution it’s the role of the CBA to prevent inflationary pressures from triggering actual price inflation. The limits placed on us are quite stringent. Both the Constitution and the laws states that the main role of the CBA is to maintain a low rate of inflation and in this context the biggest problem for small, open economies that have a price stability goal is appreciation. 

For cases like ours there’s a well-known economic axiom stating that for small, open economies with free-flow of capital conditions the authorities can have as an objective either the inflation or the exchange rate. In this context the Constitution of the RoA declares in fairly stark terms that only the inflation must be the objective of monetary policy. Additionally, when we say inflation we mean the Consumer Price Index (CPI) calculated in Armenian national currency. Our primary problem is keeping inflation in check. If it’s possible to mitigate the exchange rate fluctuations within the 3-4% CPI range (the level set by the National Assembly), than we will do it. Given that we have a floating exchange rate, what’s important for us is not to haphazardly fix the exchange rate at certain level and then raise it due to mounting pressure, but to mitigate the fluctuation process. Fluctuations create real distortions for economic agents as they can’t formulate business plans nor operate efficiently.

In this case we are confronted with a problem - the significant growth in incomes from abroad. We are faced with this choice of inflation or exchange rate when using only monetary policy measures to tackle the undesirable inflationary consequences of this growth in incomes. There are other methods as well, such as fiscal policy. Let’s say collecting more in taxes, spending less, making certain structural changes, making purchases from overseas, etc. Each method has its negative and positive aspects. It’s desirable to clearly analyze all of them, not just the monetary policy methods.

- What are the possible consequences to the economy of this appreciation, negative or positive? What would be the specific negative and positive consequences?

- Naturally, the growth in incomes would be a positive consequence. This income growth, in turn, could be redistributed to the most vulnerable strata of society. This would also serve to lighten the national debt burden. This is because the bulk of the national debt is in foreign currency while taxes are collected in Armenian drams.

On the negative side, it naturally adversely affects exports-- making them more expensive and thus either non-competitive or less competitive. Secondly, problems arise with financial flows from abroad entering Armenia for a variety of purposes, for example funds destined for the government form the Lincy Foundation or the World Bank. These currency inflows no longer have the purchasing power as before. Furthermore, a large segment of the population that works overseas and sends money back to Armenia is also affected. A comparative evaluation of the positive and negative effects is an entirely different matter.

- Let’s pose the question differently. On balance, are there more positive consequences or negative ones?

- I’d say there are more positive ones since the total picture is one of significant economic growth. This growth enables us to prepare for the future. At the same time we should understand that quick changes are painful. The problem is a two-sided one. We must do everything possible to ensure that the positive consequences outweigh the negative.

- To what extent does the economic growth you mention affect the appreciation of the dram?
A - Economic growth also signifies a rise in incomes. This increase in incomes also brings about a certain rise in the price of resources. There are countries, Singapore and Japan for instance, where there’s been a steady decades-long appreciation of the national currency due to economic growth. It’s also a question of productivity growth, etc. Today, however, the dominant influence is external - transfers and investments. Very often you hear the explanation that transfers are also increasing due to the fact that everything here is becoming more expensive. In reality, this isn’t the case.

- That’s exactly why people are saying that they no longer can make ends meet on the $100 they used to receive. Now, their relatives must now send $200.

- They’re correct in stating that more is being sent. But it’s a cycle where cause and effect are mutually reinforcing. If you’re interested I can show you a study where it’s statistically proven that money remittances are at the root of the problem (a study by the International Money Fund, November 2006; Prepared by David Hauner and Ruben Atoyan). In other words, the fall of the dollar in Armenia has been the result of large cash flows into the country and not due to a rise in prices or any other domestic factor. Only afterwards were larger amounts of foreign currency needed to cover the same costs as before.

- Couldn’t the Central Bank of Armenia (CBA) have taken steps to prevent such a sharp decline of the U.S. dollar?
 
- In a small, open economy the price of preventing sharp appreciation is high inflation. Had we done so we would have allowed, say, a 10% rise in the Consumer Price Index.

- In hindsight, could the Central Bank have done certain things but didn’t?

- From a strategic viewpoint I don’t see what the CBA could have done. During the past few years we’ve made purchases in the market. Rather than selling dollars we’ve been purchasing hundreds of millions of dollars in the market and replacing them with Armenian drams. However, we can only flood the market with drams up till the point where such a strategy won’t have an effect on overall price levels. If through high interest rates we were to abruptly withdraw the total amount of money we’ve injected the effect on economic growth would be very negative. To say that we didn’t take steps to alleviate the situation at all would be wrong, because, and I repeat, we bought several hundred million dollars a year. In terms of tactical measures of course certain things could have been done more smoothly.

- During interviews with “Hetq” many exporters have claimed that the appreciation of the dram has dealt the most damaging blow to their bottom line. Many companies have been forced to close as a result.

- I’ve also heard many similar stories but I’m not aware of any specific cases.

- Have you conducted any studies that quantify the decrease in exports due to the appreciation of the dram and the resultant losses to exporting companies?

- That’s impossible to accomplish. I’ve reached out to all those exporters with complaints with the following message: “Given your complaints, please perform a cost-structure analysis specifically noting the foreign exchange rates when your operation is profitable and when it isn’t.” I can assure you that I haven’t received any specific responses. Have you ever come across such data from any exporters or have they ever discussed their profitability levels with you? Have they ever shown you a cost-analysis of their business? We’ve requested such information from them in order to better understand the situation but none have expressed a desire to do so. The CBA has to make decisions based only on aggregate data since we cannot judge about the actual cost data for exporting enterprises, and I have seen none that came forward and offered us such data. When we look at the aggregate numbers we see that exports are up this year. I won’t say it’s a large jump, but it’s an increase nevertheless. Included in this increase is the food-processing sector, which is quite sensitive to exchange rates.

Even if the Central Bank wanted to exert an influence on certain specific sectors it couldn’t do so. We can’t implement an industrial policy since the tools we possess are of a general nature. What we can do is to secure, or fail to secure, certain things that comprise the general macro-economic situation. Figuratively speaking we have a large hammer to work with. However, to implement industrial policy for specific sectors the use of a screwdriver would be much more effective. Regarding other problems, I’m really interested in sector-by-sector economic analyses. To date, I haven’t seen any.

- The Armenian Copper Programme CJSC, for example, states that its losses due to the appreciation of the dram amount to $2 million per year. Other firms also point to specific losses.

- The Armenian Copper Programme is a profitable enterprise. The price of copper on the world market has gone up. When they talk about losses they mean lost profits. But is it really the task of the government to guarantee another $2 million in profits for them?

- Maybe the example I brought wasn’t the best. Let me cite another. Firms producing dried fruit say they can’t export their product due to the rise of the dram.

- Let me state again that I can’t comment until I see a cost analysis. But that’s not important. Let me put it this way. It is not the role of the government to secure an export market for any sector of the economy. The government’s task is to secure economic growth. Even in small countries it’s not always the case that exports serve as a basis for economic growth. The government can set priorities and promote them. But monetary policy is a poor tool for such a promotion since it’s very large and blunt. It’s impossible to use monetary policy to stimulate this or that industry. The stimulus or its reaction is felt across the board in all sectors. In particular, stimulating exports and economic growth through cheap domestic currency in conditions where natural resources are scarce essentially means suppressing domestic incomes, regardless of sector or production priorities. While this strategy often has been efficiently implemented in many countries at various times, no one can claim that this is the best policy in all situations.

Let’s move on to the next issue. When we take a look at the overall situation do we see a problem or not and is the dram overvalued or not? This is where various macro-economic   assessments are used and we’ve also done so at the Central Bank. In terms of a more neutral assessment I can recommend you two documents prepared by the International Monetary Fund. These are professional analyses and I don’t know of any other independent organization or individual that has conducted such an in-depth analysis of the data. These studies by the IMF were prepared at the end of 2006 and they deal with two issues: What’s been at the root of developments in the currency market, its dynamics and fluctuations? In addition, do all of these have an effect on competitiveness or not? What is being analyzed here is the equilibrium real exchange rate. The analysis shows that one cannot speak of the Armenian dram being highly appreciated in value.

We must comprehend two important issues here. Firstly, what can we do generally? Secondly, what can we accomplish specifically through monetary policy? We face of capital inflows, and in these conditions the use of monetary policy is limited. I don’t say that its potential or effectiveness is absolutely zero, but it’s only so much. Whatever we’ve been capable of doing, we’ve done. We have absorbed at least one-third of the inflows and have made expenditures to that effect. The Central Bank as an institution has experienced losses because the bulk of our assets are in foreign currency and our obligations in drams. But the law is quite strict. It states that the prime objective of the Central Bank is price stability and this is our guiding operational principle. Of course you can ask just how rational such a structure is, but it’s the law. Let’s agree not to debate its merits right now. I really don’t see what more could have been done within the legal existing legal framework by using monetary policy.

- Economist Tatul Manaseryan, in an interview given to “Hetq”, stated that he doesn’t rule out money laundering as one of the reasons for the dram’s appreciation. What is your take on this?

- I disagree. Let me repeat that remittances comprise most of the currency inflows. The bulk of these remittances range from several hundred to a few thousand dollars, and not one or two million.

- But they’ve also been in the millions. During the Converse Bank case they talked about millions of dollars.

- I really don’t know what specific Converse Bank figures you’re talking about. Large amounts can’t be ruled out. The Central Bank has a Financial Monitoring Center where all large sums over a certain limit are reviewed - their legal documentation, the source of the money, where is it going, etc. According to the law, all banks must report such large sums to the Central Bank in order to insure that money laundering isn’t taking place. There have been cases when we’ve passed on information to the relevant law-enforcing authorities after the Financial Monitoring Center has looked at data forwarded us by various banks.

- Have criminal proceedings ever been brought based on the information presented by the Central Bank?

- Perhaps, I’ve never really followed up on this. These were rare cases involving small amounts and not instances where large amounts of cash could have been laundered. I refute the statements of Mr. Manaseryan. Of course you’ll have individual cases of money laundering, but in my opinion to state that it occurs on a wide-scale, or that it’s the core reason for money transfers, is absolutely groundless.

- Hrand Bagratyan, Armenia’s Former Prime Minister, once declared that the nation’s banking system was in need of serious reform, not only structurally but in terms of personnel. Do you share this view? Is there a crisis within the Central Bank?

- Were there a crisis in the banking sector, banking assets would not grow at high rates. When you have 50-60% growth in assets without an increase in bad loans then there is no banking crisis. From the viewpoint of the personnel, if there were a crisis, you wouldn’t see banking sector employees finding better paying jobs in other commercial, non-banking sectors.

- Is it true that there’s lately been an exodus of staff at the Central Bank? If so, what are the reasons?

- There has been an exodus and the reason is wages. Other firms, commercial banks pay more than banks. It’s that simple. We know of former Central Bank employees who at other firms are getting paid three times more their Central Bank wages.

- The appreciation of the dram particularly affects the income of those Armenians working abroad who support relatives here. They are being forced to send more money to keep their families afloat. In your opinion, will this lead to a decrease in remittances?

- It’s a complex question but in my view there’s no danger of this happening. Look at where the bulk of remittances are coming from - 75% from Russia. These transfers essentially repeat the income pattern of residents of Russia. We will always have a mobile work force and in Russia, as opposed to other countries, there are no restrictions placed on our work force. Wages are higher in Russia. In a way this is a global phenomenon because when you look at the data the fastest growing international financial flows during the past few years haven’t been flows of international capital or direct investments, but of remittances. We are witnessing the same occurring here as well. And if they continue to receive higher wages there, whatever the social dynamic might be (let’s say they no longer support their families), that’s a totally different issue. Again, it will depend on a host of other factors besides the appreciation of the dram.

- To what extent is it true that the role of safeguarding against inflation has been entrusted to the Central Bank of Armenia? Hasn’t the Central Bank become a much more powerful institution as a result? Don’t you believe that this policy role should have been entrusted to the government instead?

- First and foremost, the function of the Central Bank is to implement monetary policy. The task of controlling inflation isn’t only the purview of the Central Bank. The government is also responsible for inflation since fiscal and structural policies also impact inflation. In terms of the Central Bank this isn’t a statement of sole authority but rather a limitation on our discretionary powers. The primary aim of the Central Bank is to maintain price stability. In other words, it’s not only the Central Bank that’s responsible for inflation, but for us at the Central Bank, price stability has the highest priority. The Bank is duty-bound to give priority to the maintenance of low inflationary levels. In this context the operational latitude of the Bank is severely limited. It doesn’t have the freedom to choose amongst a variety of objectives to pursue nor can it define target goals or levels for itself when pursuing objectives as set by the legislature. The central Bank only has the discretion to choose what methods to employ to achieve predefined goals. In this regard the legal statues of the Republic of Armenia are quite strict. Briefly stated, of course the government is also responsible for inflation. It would appear to me that the government has never denied this.