“Liberal Economy And Not Plutocratic oligarchy”

Interview with Vahram Nercissiantz

Chief Economic Advisor to President of Armenia
by “ARAVOT” Daily

 (Published February 24, 2007)

(Translation from Armenian)

 – Mr. Nercissiantz, please tell us briefly what is the Administration’s economic management ideology and the supporting fiscal strategy.

 – We generally subscribe to classical liberal economic ideology, but we clearly avoid ideological absolutes. We have an empirical approach to country economic management and closely follow the international experience. Experience has shown that economic development requires growth and growth requires stability. Experience has also shown that whilst stability is necessary for growth, it is not sufficient. Ultimately, private and public investments generate growth, and poverty reduction is best achieved through growth by investing in people, and promoting a free and competitive business environment so that investments are made and jobs created. Fiscal policy, therefore, must have a long-term growth strategy without impairing macroeconomic stability. This requires increasing efficiency in public expenditure, and efficient revenue enhancement, particularly in tax administration, and efficient use of external aid. This, in a nutshell, is our strategy for country economic management and fiscal policy.

– Briefly, what are the Administration’s overall achievements so far?

 – The results are clear. The economy has been stable as the annual inflation rates since 1998, when President Kocharian was elected, have been around low single digits, and the national currency, Dram, has been the most stable currency in the Region for several years. The economy was growing around 5.5% annually during 1998-2000; and then since 2001 the economy has been growing around 12% annually; in 2005 the economy grew at 14% and in 2006 13.4%. We expect another strong double digit growth rate also for 2007. And most important of all: poverty has declined from 56% in 1998 to around 25% this year and it continues to decline rapidly. We do have problems, however, in distribution of the yields of this impressive growth, and thus unacceptable levels of income disparities and deep social polarization still persist.

 – How would you evaluate the Administration’s performance in fiscal expenditures?

 – During the last several years, we see increasing efficiency in public expenditures through privatization of public utilities and parastatal enterprises, and dramatic reduction and targeting of subsidies. Today, over 80% of the economy is private, and growing, both in terms of GDP and employment. The remaining public sector, mainly physical and social infrastructure, is of top priority and is developing rapidly through the assistance of the World Bank Group’s IDA supported projects, where Armenia’s performance, in both progress of reforms and implementation of project portfolio, is ranked number one amongst all IDA countries. We are told that this IDA score is a composite of many factors, including institutional development, fiscal management and social development. Clearly, the Administration’s expenditure program is the poverty reduction strategy, endorsed by all donors, underpinned by a medium term expenditure framework, and, of course, annual budgets debated and approved by the Parliament. Looking forward, the Administration is strengthening public expenditure management, improving the social safety net, and increasing public investment to support private sector growth. Starting this year, we expect a major boost in the funding of our rural infrastructure investments through the Millennium Challenge Compact approved by the United States.

 – And what about the performance in resource mobilization?

 – With respect to public revenue enhancement measures, particularly taxes, the picture is not as strong. Annual tax collections have been only around 14.5% of GDP (or around 17.5% of GDP if social security payments are included) mainly due to tax exemptions and tax evasion. This suggests that the tax gap in Armenia (difference between statutory and actual collections), although not officially calculated and published, is substantially higher than the internationally accepted levels. This tax collection rate is not adequate for any country to cover the state administrative expenses, defense and infrastructure expenditures, and funding of priority social expenditures. Consequently, we are excessively dependent on foreign aid, which is not a sustainable option for the future. This is why I said earlier that we have problems in distribution of the yields of this impressive growth performance. The issue here is not increasing the tax rates, or introducing new taxes, but rather improving tax collections. In fact, with improved tax and customs administration and substantial increase in tax collections, it may even be possible to gradually reduce tax rates. Otherwise, arbitrary and defective implementation of tax policy will create unequal and unjust environment for competition and deflect the liberal economy towards a corrupt oligopoly. You know, of course, that I have raised this issue to the attention of the authorities and the public during the conduct of my present position.

 Mobilization of private sector savings by the commercial banks have also been rather low as bank deposits are just 10.7% of GDP and bank credits to the private sector are only 8.2% of GDP. There are several reasons for this, including lack of confidence by depositors, and then lack of borrowing interest by creditworthy enterprises, because they finance working capital and investments through internal cash accumulated by evading taxes. The economy is heavily dollarized, relying heavily on foreign currency cash for transactions. Moreover, equity markets have not yet developed, mainly because of closed, family driven and opaque corporate governance, which potential investors do not trust. There are only 197 companies listed in the capital market and stock market capitalization is only 0.85% of GDP.

 – So what is being done to improve revenue performance?

 – The Administration has undertaken measures to improve governance to enhance efficient resource mobilization in both public and private sectors. For efficient mobilization and allocation of public resources, the strategy now calls overhaul of the government machinery through a comprehensive civil service reform program so as to substantially reduce waste and corruption, and to reform administration of taxes and customs. In fact, the 2004-2006 Tax and Customs Reform Plan has already yielded some modest improvements in revenue mobilization, but we recognize more must be done. For mobilization of private resources, the strategy calls for an extensive and coordinated set of measures to simplify administrative procedures and remove obstacles to trade and investment, and encourage development of the banking and enterprise sectors through open and transparent corporate governance, to strengthen regulation and supervision, and thus enhance confidence that is necessary for the financial sector to mobilize savings into investment. While we keep introducing institutional reforms to improve governance, behavioral modification by public officials and enterprise executives are clearly lagging behind, and perhaps, it may take a generation for us to see substantial progress in this sphere, under conditions of democratic checks and balances.

 – How would you evaluate the Central Bank’s performance in monetary management, particularly with respect to the strong appreciation of Dram during the past three years?

 – The Central Bank has done rather well under very difficult circumstances. First, we must recognize that because of rapid GDP growth, and increasing productivity, Dram has and will continue to appreciate in value over the next several years. Moreover, because of high financial inflows, through remittances and investments, estimated to total as high as US$ 2.5 billion last year, equivalent of about 50% of GDP, there is an extra pressure for appreciation of Dram. The Central Bank purchased around US$ 150 million last year to smooth out the exchange rate fluctuations and sterilized it through sale of Central Bank securities and open market operations, totaling around DRM 20 billion. Since Dram’s actual real exchange rate path is very close to the equilibrium path, no economic distortions are taking place in the economy at this stage.

 We realize that appreciation of Dram may initially have adverse consequences on our exporters. The appropriate response by these enterprises, however, should be to enhance competitiveness through improving productivity. Since the level of productivity in Armenia compared to Euro-American markets is still quite modest, there is a significant potential to improve productivity in Armenia further. We know that some exporters have been suggesting either to increase currency emission or to introduce exchange controls. Unfortunately, both of the above measures will cause major economic distortions, undermine investor confidence, and cause major social problems. Increasing emission will cause a substantial increase in inflation and hit hard salaried and fixed and low income groups. Exchange controls will cause resource misallocation in the economy and ultimately reduce competitiveness and slow down economic growth. Moreover, such governmental interventions will introduce uncertainty in the minds of the investors and adversely affect investment decisions. Of course, there may be some exporters, who are producing goods or services that are not within the comparative advantage of the Armenian economy and, thus, can not be competitive under the evolving dynamics of the global economy. Such businesses must approach the problem analytically and redirect their resources to productions that are within Armenia’s comparative advantage. And the Government’s appropriate role here is to provide information and advice on the evolution of the Armenian economy, so that such enterprises can make informed investment decisions. The Armenian Development Agency provides such assistance to interested local and foreign businessmen, free of charge.

 Moreover, I have recommended some fiscal measures that will take advantage of the current impressive economic growth rates and high financial liquidity to set up public and private reserve funds in the social sectors, such as adequately funded retirement and health insurance programs that would improve social safety net and at the same time help to sterilize excess funds in the economy. These recommendations are currently under active consideration of the Economic Coordination Council. Clearly, we now have a unique opportunity to implement reforms in the social sectors, which are lagging behind.

 At any rate, I can assure you that we will maintain the open, mostly private, market based liberal economy and will not introduce any controls that will distort the economy, and undermine investor confidence on the stability of our economic policy. I hope there will be no deviation from policy during the implementation phase.

 – Finally, please tell us how is the economy managed in Armenia?

 – As I mentioned earlier, to a large extent we rely on classical liberal economic control mechanisms, and the state’s role is limited to define strategy and policy, and regulation. Accordingly, the President of the Republic defines the strategic directions and the policy initiatives required for the economy. Then, the Prime Minister and his cabinet implement the policies as defined and prescribed by the President. The Economic Coordination Council, comprised of the Prime Minister as Chairman, President’s Chief Economic Advisor as Vice-Chairman, Minister of Finance and Economy, Minister of Trade and Economic Development and the Governor of the Central Bank, together coordinate the economic policies. Sectoral Ministers are invited to the Council’s meetings depending on the agenda items under review. And through several standing advisory and consultative councils that include representatives of the business community and non-governmental organizations, the views and suggestions of the civil society are taken into account. Here, I must add, although Armenia’s economic strategy and the policy designs flowing from it, are regarded very highly by various international organizations and think-tanks, sometimes there are serious deviations during the implementation phase towards transaction driven obscure directions.

 – And what is your role in all of these?

 – As Chief Economic Advisor to the President I assist the President in definition of economic strategy and policy, and as Vice-Chairman of the Economic Coordination Council I assist the Prime Minister in economic policy coordination, through my prior international experience, so that policy definition and implementation is anchored on proven successful experiences of other countries adapted to the local conditions. In short, my aim and struggle is to see that country economic management is driven by proven successful policies and not by opaque underhand transactions. In other words, I strive so that country development proceeds along liberal economy and not plutocratic oligarchy.

 – Mr. Nercissiantz, finally about the upcoming Parliamentary elections. What improvement in the economic environment do you expect as a result of the elections?

 – We have a unique opportunity to stop entry of the plutocrats into the Parliament and the Cabinet owing to the changes to articles 65 and 88 of the current Constitution, which have been strengthened as a result of the last year’s plebiscite. Accordingly, Parliament deputies and Cabinet members must not engage in private enterprise activities, and according to international norms it does not matter whether the enterprise is registered to his name or to someone else, and it is sufficient to have the proof that he controls, directly or indirectly, the private enterprise or receives remuneration from it. This way, it is possible to stop the conflict of interests between legislative, executive and private sectors. It is worrisome, however, that there are no sufficient legal provisions for implementation and follow-up, so as to prevent arbitrariness during implementation. Moreover, it is unfortunate that in the preliminary electoral rosters of the political parties we see the names of several such entrepreneurs. Although, I hope we will succeed to stop plutocrats’ entry to the legislative and executive structures as a result of the upcoming elections, unfortunately, the prospects for success are not promising, because of the reasons I just outlined.

 February 23, 2007

After a rich 30-year career in the World Bank encompassing four continents and over twenty countries, in both technical and management positions, Mr. Nercissiantz was appointed Chief Economic Advisor to President Kocharyan of Armenia right after the 1998 Presidential elections. Ever since 1990 Mr. Nercissiantz has been one of the intellectual leaders of Armenia\’s post – Soviet reforms and economic transition, assisting directly two Presidents and ten Prime Ministers of the Republic in different capacities.

As Chief Economic Advisor, Mr. Nercissiantz directly reports to the President of Armenia and advises the President on strategic directions for economic transformation, policy design at macroeconomic and sectoral levels, and country economic management. Concomitantly, Mr. Nercissiantz is Vice Chairman of the National Economic Coordination Council, of the Armenian Development Agency, of Armenia’s High Business Council, of the Information Technology Council and of the Armenian MCA Board of Governors, supporting the Prime Minister who is the Chairman for all of the above Councils and Board. Mr. Nercissiantz is also Armenia’s Governor in the World Bank Group’s Board of Governors.