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Armenia Trade Diagnostic Study
June 28, 2002
Poverty Reduction and Economic Management Europe and Central Asia Region The World Bank
Currency
(exchange rate effective May 31, 2002) Currency Unit = Dram 1 Dram = US$0.002
US$1.0 = 581.82 Dram
Weights and Measures Metric System
Abbreviations and Acronyms
ADA Armenian Development Agency AMS Aggregate Measure of Support ASYCUDA Automated System of Customs Data and Management CC Customs Committee CIF Cost, Insurance & Freight CIS Commonwealth of Independent States CPI Consumer Price Index DFID The United Kingdom Department for International
Development EBRD European Bank for Reconstruction and Development ECMT European Council of Ministers of Transport EPZ Export Processing Zone EU European Union FDI Foreign direct investment FIATA Federation International des Associations de Transitaires et
Assimilies FOB Free on board FSU Former Soviet Union FTZ Free Trade Zone GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product GOA Government of Armenia IF Integrated Framework ILCS Integrated Living Conditions Survey ISO International Standards Organization IT Information technology LDC Least Developed Country MFN Most Favored Nation MNC Multinational corporation MTED Ministry of Trade and Economic Development SITC Standard International Trade Classification TBT Technical Barrier to Trade TEU Twenty Foot Equivalent Unit TIR Transport Internationale Routiers
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TRACECA Transport Corridor Europe, Central Asia TTFSC Trade and Transport Facilitation in the South Caucasus TTFSE Trade and Transport Facilitation in South east Europe VAT Value Added Tax WTO World Trade Organization
Fiscal Year January 1 to December 31
Vice President Johannes Linn Country Director Judy O'Connor Sector Director Cheryl Gray Sector Manager Samuel Otoo Task Manager Kris Hallberg
Contributors
Macroeconomic background Gohar Gyulumyan (ECSPE Armenia) Karen Grigorian (ECSPE Armenia) Evgeny Polyakov (ECSPE)
Structure of trade and investment Beata Smarzynska (DECRG) Francis Ng (DECRG)
Trade policy and market access Evgeny Polyakov (ECSPE)
FDI promotion institutions Gagik Yeghiazarian (Consultant, KPartners, Armenia)
Exporter survey Alex Poghossian (Consultant, AlphaPlus, Armenia)
WTO accession Gagik Gabrielyan (Consultant, Armenia) Ruben Kalashyan (Consultant, Armenia)
Trade facilitation Gerald Ollivier (ECSIE) Michel Zarnowiecki (ECSIE) Gevorg Sargsyan (ECSIE Armenia) Martin Humphreys (Consultant, The Halcrow Group Ltd.)
Business environment, enterprise finance, industry analysis
Paul Holden (Consultant, Enterprise Research Institute)
Trade and poverty M. Ihsan Ajwad (PRMEP) Burcu Duygan (PRMEP) Baris Sivri (PRMEP) Paul Holden (Consultant, Enterprise Research Institute)
Research support David Davtian (ECSPE) Damika Somasundaram (ECSPE)
TABLE OF CONTENTS
Executive Summary............................................................................................................. i Chapter 1: Background .................................................................................................... 1
A. Introduction................................................................................................. 1 B. Political Context.......................................................................................... 3 C. Physical and Human Resources .................................................................. 4 D. Macroeconomic Trends .............................................................................. 4
Chapter 2: The Structure of Trade and Investment........................................................ 12 A. Introduction............................................................................................... 12 B. Structure of Trade ..................................................................................... 14 C. Factor Content of Exports......................................................................... 25 D. Trade in Services....................................................................................... 29 E. Foreign Investment and Participation in Global Production Chains ........ 30 F. Conclusions............................................................................................... 34
Chapter 3: Trade Policy, Trade-Related Institutions, and Market Access..................... 36 A. Introduction............................................................................................... 36 B. Institutional Framework for Trade Policy Formulation............................ 36 C. Import Regime .......................................................................................... 36 D. Regional Trade Agreements ..................................................................... 40 E. Export Regime and Market access............................................................ 40 F. Export and Foreign Investment Promotion............................................... 43 G. WTO accession ......................................................................................... 49 H. Conclusions............................................................................................... 53
Chapter 4: Trade Facilitation ..................................................................................... 55 A. Introduction............................................................................................... 55 B. Infrastructure............................................................................................. 55 C. Customs..................................................................................................... 59 D. Logistical Costs......................................................................................... 69 E. Recommendations..................................................................................... 75
Chapter 5: The Business Environment and Enterprise Finance..................................... 83 A. Introduction............................................................................................... 83 B. Characteristics of the Private Sector ......................................................... 83 C. Privatization .............................................................................................. 85 D. Property Rights ......................................................................................... 86 E. The Legal Basis for Contracting ............................................................... 88 F. Doing Business in Armenia ...................................................................... 89 G. Foreign Direct Investment and Business Practices................................... 91 H. Enterprise Financing ................................................................................. 93 I. Donors and the Private Sector................................................................... 96
Chapter 6: Trade and Poverty ........................................................................................ 98 A. Introduction............................................................................................... 98 B. Data ........................................................................................................... 99 C. Poverty Profile ........................................................................................ 100
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D. Sources of Household Income ................................................................ 105 E. Sources of Household Expenditures ....................................................... 107 F. Labor Market and Unemployment.......................................................... 109 G. Simulation Results .................................................................................. 113 H. Conclusions............................................................................................. 119
Bibliography ................................................................................................................... 120 Annex 1: Industry Overviews ...................................................................................... 124
Transportation ............................................................................................................. 124 Energy Industry........................................................................................................... 126 Jewelry and Diamond Processing ............................................................................... 129 Information Technology Industry ............................................................................... 132 Agricultural and Food Processing Industry ................................................................ 135 Mining Industry .......................................................................................................... 138 Construction................................................................................................................ 141 Tourism....................................................................................................................... 143 Telecommunications ................................................................................................... 146 Chemicals Industry ..................................................................................................... 147 Light Industry.............................................................................................................. 150 Machinery and Electronics Industry ........................................................................... 153
Annex 2: Exporter Survey ........................................................................................... 156 A. Sample and Methodology ....................................................................... 156 B. The Original 21: What Has Changed..................................................... 158 C. Export Structure ...................................................................................... 159 D. Export Constraints .................................................................................. 162
Annex 3: Statistical Tables .......................................................................................... 165
LIST OF TABLES Table 1.1 Real GDP Growth, 1996-2001.................................................................... 5 Table 1.2 Composition of GDP, 1996-2001 ............................................................... 6 Table 1.3: Indicators of Openness................................................................................ 6 Table 1.4: Balance of Payments................................................................................... 7 Table 2.1 Geographic Distribution of Armenia's Foreign Trade, 1995-2000........... 16 Table 2.2: Composition of Armenian Exports 1997-2000......................................... 18 Table 2.3: Armenia's Export Concentration Index, 1997 and 1999........................... 19 Table 2.4: Measures of Export Concentration ........................................................... 20 Table 2.5: Manufacturing Share of Total EU-destined Exports in 1999 ................... 23 Table 2.6: Armenia's Exports and Imports by Factor Intensity, 1997-99 .................. 26 Table 2.7: Comparator Countries’ Exports to CIS Countries .................................... 28 Table 2.8: Trade in Services....................................................................................... 30 Table 2.9: Net FDI inflows to Comparator Countries................................................ 31 Table 2.10: Recent Changes in the Comparator Countries Trade................................ 34 Table 3.1: The taxation of imports, 1998 – 2001....................................................... 38 Table 3.2: FDI inflows by selected host country, 1989-2000 .................................... 44 Table 4.1: Main export commodities by mode at border and destination.................. 57
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Table 4.2 Main import commodities by mode at border and origin ......................... 58 Table 4.3: Productivity Indices for the Armenian Customs Service.......................... 61 Table 4.4: Revealed Demand for the Bagratashen Market ........................................ 67 Table 4.5: The logistical cost of moving one TEU from N. Europe to Yerevan ....... 74 Table 5.1: Transactions Costs .................................................................................... 90 Table 6.1: Armenia Poverty Indicators VII/98-VI/99.............................................. 101 Table 6.2: Poverty in Armenia in 1996 vs. 1998/99 ................................................ 102 Table 6.3: Incidence and Destination of Migration in Armenia .............................. 104 Table 6.4: Migration Incidence rates by Education level ........................................ 105 Table 6.5: Labor Force Participation in Armenia 98/99 .......................................... 110 Table 6.6 Impact of a 25 Percent Reduction in Transportation Costs .................... 116 Table 6.7: Impact of a 15 Percent Decrease in the Price of Wheat.......................... 117 Table 6.8 Impact of a 10 Percent Increase in Irrigation Charges............................ 118
Table A3.1: Basic Statistics on Comparator Countries........................................... 165 Table A3.2: Geographic Distribution of Foreign Trade ......................................... 166 Table A3.3: Major EU-destined Exports ................................................................ 167 Table A3.4: Fastest Growing Exports by Commodity............................................ 168 Table A3.5: Sunrise Exports in EU by Product ...................................................... 169 Table A3.6: Export Share in CIS Markets .............................................................. 170 Table A3.7: Major Exports by Commodity ............................................................ 171 Table A3.8: Exports to the EU by Factor Intensity ................................................ 172 Table A3.9: Major Exports to the EU by Factor Intensity...................................... 173 Table A3.10: Major Exports to CIS by Factor Intensity........................................... 174 Table A3.11: Inflows of Foreign Direct Investment................................................. 175 Table A3.12: Organizations Involved in Credit Lines .............................................. 176 Table A3.13: Household Income Structure by Expenditure Quintile....................... 178 Table A3.14: Components of Household Expenditure ............................................. 179 Table A3.15: Determinants of Per-Capita Household Expenditures for Farmers .... 180 Table A3.16: Probit Model Results........................................................................... 181 Table A3.17: Farm Cash-Cost Structure by Expenditure Quintile ........................... 182
LIST OF FIGURES Figure 1.1: Real GDP (1990=100) ................................................................................ 5 Figure 1.2: External Resource Flows ............................................................................ 8 Figure 1.3: The Domestic Deficit and Its Financing ..................................................... 9 Figure 1.4: Nominal Exchange Rate and Inflation...................................................... 10 Figure 1.5: Real Effective Exchange Rate .................................................................. 10 Figure 1.6: Real Exchange Rates in Major Export Markets........................................ 11 Figure 2.1: Armenia's Foreign Trade .......................................................................... 14 Figure 2.2: Export Growth 1995-2000 ........................................................................ 15 Figure 2.3: Net FDI Inflows ........................................................................................ 31 Figure 4.1: A Ranking of Countries in the Logistics Friendliness Survey.................. 71
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Figure 5.1: Credit to the Non-Government Sector/GDP............................................. 93 Figure 5.2: Interest Rate Spreads................................................................................. 94 Figure 5.3: Official Development Assistance ............................................................. 96 Figure 5.4: Official Development Assistance Per Capita............................................ 96 Figure 5.5: ODA and Private Transfers Per Capita ..................................................... 97 Figure 6.1: Sources of Income................................................................................... 107 Figure 6.2: Probability of Being Unemployed .......................................................... 110 Figure 6.3: Input Cost Structure Faced by Self-Employed Farmers ......................... 118
LIST OF BOXES
Box 2.1: Diaspora-Driven Exports .......................................................................... 17 Box 2.2: Taking Advantage of Old Contacts........................................................... 24 Box 2.3: Product Standards ..................................................................................... 25 Box 3.1: Problems with VAT Refunds.................................................................... 41 Box 3.2: FDI Success Stories .................................................................................. 46 Box 4.1: Customs Processing Fee ........................................................................... 62 Box 4.2: The Process of Clearance.......................................................................... 63 Box 4.3: Endemic Bureaucracy ............................................................................... 64 Box 4.4: Regulatory Inflexibility............................................................................. 65 Box 4.5: The Impact of High Logistical Costs on Exports...................................... 70 Box 4.6: The Official and Unofficial Costs of Importing ....................................... 73 Box 4.7: Current Facilitation Projects in Armenia .................................................. 76 Box 4.8: Free Customs Warehouses........................................................................ 80 Box 5.1: Cyprus and Mauritius - Successful Small States ...................................... 85 Box 5.2: The Case of Vanishing Processing Equipment......................................... 87 Box 5.3: Notary Discretion...................................................................................... 89 Box 6.1: A Snapshot of Poor Households in Armenia in 1998/99........................ 102 Box 6.2: Comparing Poverty Between 1996 and 1998 ......................................... 103 Box 6.3: Growth Potential for Selected Industries in Armenia ............................. 112
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EXECUTIVE SUMMARY
Despite Armenia's relatively strong growth performance in recent years, the patterns of production and trade still bear the legacy of Soviet times. The country has failed to expand its exports significantly in a diverse range of products and to a diverse range of markets, and as a result has not become well-integrated into the global economy. Although the openness of the economy is higher than the average for low-income countries, it is below that of most transition economies in Central and Eastern Europe and the Baltics. And despite its large-scale privatization program, Armenia has not managed to attract large inflows of foreign direct investment.
Armenia's lack of integration with the world economy is partly due to geography -- its landlocked location and subsequently high transportation costs -- as well as regional political conflicts. A decade-old dispute between Armenia and Azerbaijan over the Nagorno-Karabakh region has closed the border between the two countries, as well as the Turkish border. As a result, Georgia and Iran provide the only land routes to the outside world.
Despite the difficulty of Armenia's geographic and political constraints, some of the constraints to greater trade integration are both under the country's control, and possible to deal with in the short to medium term. The country does have the potential for greater export-led growth and foreign investment thanks to its free trade regime with the rest of the CIS and non-discriminatory access to world markets; a liberal trade policy and attractive investment legislation; a stable currency; a well-educated workforce with specialized technical skills; and a worldwide diaspora of Armenians living outside the country, providing access to investment and links to international markets.
The purpose of this report is to identify the constraints to, and opportunities for, greater integration of Armenia with the global economy. It is hoped that the report will help bring trade issues to center stage in Armenia's development strategy, provide background for the upcoming Development Round of WTO negotiations, and identify priorities for future trade-related technical assistance from the World Bank and other donors. Balance of Payments and Real Exchange Rate Armenia is a country which as received large aid and remittances, leading to large and persistent trade deficits. These external inflows directly (through remittances) and indirectly (through pensions, humanitarian aid, etc.) constitute about 45 percent of the income of individuals.
These inflows have allowed the exchange rate to remain stable despite external shocks. While Armenia has maintained a liberal exchange system with unrestricted
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access to foreign exchange, and officially announced a floating exchange rate regime, in practice it pegged the dram to the U.S. dollar. During the Russian financial crisis, this stability came at the price of considerable appreciation of the dram relative to the currencies of many regional trade partners. After some real depreciation in 1999-2000 that reversed the effects of the Russian crisis, the real exchange rate has remained relatively stable.
Between 1995 and 2002, imports grew 53 percent in nominal terms while exports to CIS markets fell due to the Russia crisis. The past two years (2000-01) have seen something of a rebound in exports, and the trade balance improved by 14 percent in 2001. However, the export orientation of the economy remains low by international standards, and exports have not been a major engine of growth. The Structure of Trade and Investment Russia and the other CIS countries remain important markets for Armenian exports, accounting for a quarter of the total; the EU and U.S. together account for another 50 percent. The remainder of exports go to other countries including Iran, Switzerland, United Arab Emirates, Cyprus, and Turkey. The large volume of exports sold to EU countries is somewhat misleading, since the majority of these exports are processed diamonds with very low domestic value added.
Exports are highly concentrated in a few products, and they have become increasingly concentrated over time. Armenia exports fewer products than nine out of sixteen landlocked comparator countries including Burkina Faso, Malawi, and Tajikistan. Because of high transport costs and the blockade of borders with Azerbaijan and Turkey, Armenia tends to export products with low import content or a high ratio of value to weight. Such is the case with jewelry and diamonds, which are transported by air and thus are not affected by the blockade. On the other hand, the blockade is detrimental to the competitiveness of large-volume, low-value items such as apparel, which have a high transport cost component. Unfortunately for Armenia, the costs, delays, and unreliability of transport preclude the country from participating in outward processing arrangements for clothing destined for EU markets.
The excessive concentration of exports in diamonds and jewelry on the one hand, and commodities such as ferro-alloys and crude minerals on the other, makes Armenia vulnerable to demand and price shocks. However, some encouraging changes are taking place in the composition of exports. In 1999, some new skilled-labor-intensive products (automotive and machinery parts, tires, and components of optical instruments) appeared in EU markets.
Exports to the CIS have a very different composition than sales to the EU and are much less concentrated. Many Armenian firms find it easier to sell foodstuffs and brandy to Eastern markets where Armenian standards and certifications, which are based on the old Soviet system, are recognized. Thanks to their knowledge of the language, local tastes and culture, as well as previous business contacts, Armenian exporters enjoy an
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advantage in CIS markets over competitors from outside the region. However, without continued upgrading, it will be increasingly difficult for Armenian producers to withstand increasing competition from Western goods. The factor content of exports to the CIS differs from that of exports to the EU. Sales to the latter destination are intensive in skilled labor and natural resources, while exports to the CIS are mainly natural resource-based and capital intensive. The factor content of CIS exports reflects the legacy of the Soviet Union, when heavy industry and research and manufacturing complexes serving the military were established in Armenia. Overall, the export structure seems to mirror the incomplete restructuring of the Armenian industrial sector.
Despite its large-scale privatization program, Armenia has not managed to attract large inflows of foreign direct investment. In addition, the country has not taken advantage of opportunities to participate in global production networks through production of parts and components and assembly operations. This finding is yet another indication of the detrimental effect of the border blockade, as well as the large volume of remittances and foreign aid, on the structure of production and trade.
While the removal of the border blockade may not be politically feasible at this
time, there are other measures that the Government could take to promote an expansion in trade and investment, including improvements in the business environment, trade-related institutions, and infrastructure (below).
Trade Policy and Institutions
Armenia has a liberal trade regime, with low statutory tariffs, minimal non-tariff barriers, and few controls on exports. The value-added tax (VAT), though set at a high level, applies equally to imports and domestic production. The same is true for excise taxes, with the exception of those on tobacco products.
Although nominally Armenia's trade policy is liberal, there are some severe and persistent problems with its implementation. For example, although imported inputs for export production are supposed to receive VAT reimbursements, frequently this does not happen in practice and creates a problem for export competitiveness. And in contradiction to WTO rules, the Customs Service often applies minimum reference prices to value imports, allowing customs officials to use discretion and creating opportunities for corruption.
Armenia participates in a free-trade regime with most of the other CIS countries, and enjoys reasonably favorable market access conditions in other markets with the exception of Iran. However, the industrialized countries could do more to offer preferences to Armenia on par with those offered to developing countries.
The Ministry of Trade and Economic Development and the Armenian Development Agency are the main bodies responsible for export and investment
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promotion. Although much progress has been made, the effectiveness of these institutions leaves room for improvement. Neither organization has the capacity to provide prospective exporters with the information and support necessary to enter new markets or deal with standards and regulations in target markets, particularly the EU and U.S.
The WTO accession process is at an advanced stage. Bilateral market access negotiations on goods and services have been finalized with all negotiating members. The remaining issues center on customs valuation methods and agricultural subsidies. The main challenge in the post-accession period will be the proper implementation and enforcement of WTO-compliant legislation. Transport Costs and Trade Facilitation
The border blockades with Azerbaijan and Turkey mean that, at present, the only land access to and from Armenia is via Georgia and Iran. Iran is under embargo by most of the rest of the world, and transport through Georgia is plagued by bribery, restricted travel time, insecurity, and the poor quality of roads and railways. Because of the situation in Georgia, trucking companies based in Armenia cannot transport goods competitively to the Black Sea or to Russia.
The Government awarded a monopoly to Armentel, the telecommunications company, until 2013. As a consequence, internet connections are slow and expensive. This restricts the country's communication with the outside world and reduces the competitiveness of important exports such as computer software. Recognizing the problem, the Government is evaluating regulatory changes in the telecom industry.
The most important institution in the trade facilitation process is the Customs Administration, which is regularly criticized for causing difficulties, delays, and high costs in trade processes, although these criticism are usually targeted at the entire spectrum of public sector institutions involved in clearances. A large share of the total logistical cost of consignment movements into and out of Armenia are "avoidable" costs associated with border procedures and official and unofficial facilitation costs. The report recommends several urgent customs reforms, detailed below. Business Environment
Many of the constraints that limit Armenia's integration with the world economy have to do with the unfavorable business environment. As such, they are the same as the factors that constrain domestic investment and commerce. • Most firms are small because entrepreneurial opportunities are limited by the small
size of the domestic market. Small firms are generally not attractive business partners for foreign investors, and certain laws governing business formation provide poor incentives for joint ventures.
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• Substantial emigration has eroded the supply of skilled labor, entrepreneurs, and innovators. In addition, the country does not have a tradition of marketing, selling campaigns, contracting, and customer service, so that potential foreign trade opportunities are often missed.
• Property rights governing moveable, immovable, and intellectual property are
generally poorly protected. The result is that fixed property purchases are not financed (although fixed property is used as collateral against loans), movable property cannot be used as collateral for business borrowing, and intellectual property is weakly protected (a disincentive for Armenia's software industry).
• There are deficiencies with the legal basis for contracting and contract enforcement,
increasing the complexity and risks associated with commercial transactions.
Although the Government has made progress in improving the business environment over the past few years, the country has some distance to go before it could be described as "business friendly". As is common in many countries with weak institutions, facilitation payments are frequently used as a means of ensuring that dealings with the public sector proceed without undue delay. The system has evolved into one in which interlocking obligations, arising from favors and interventions, govern much of the interaction within the business community as well as between businesses and the legal system. Although many domestic investors have established channels through which they can work relatively comfortably, these non-transparent and irregular business processes create severe disincentives for foreign investment.
The level of financial sector development in Armenia is low, even when compared to other countries at a similar stage of development. One indicator -- the ratio of credit to the non-government sector as a share of GDP -- is only one-fourth that of the average for low-income countries. Bankers cite problems on the demand side: a lack of bankable projects and high lending risks. One factor impeding financial sector development may be the dominance of donor-funded credit lines which seems to have segmented the credit market.
Trade and Poverty
Despite its strong economic growth over the last decade, the Armenian economy is faced with widespread poverty and inequality. About 54 percent of Armenians are poor and about half of those are defined as living in extreme poverty. The incidence of poverty is even higher in urban areas, which contain two thirds of the population.
Unemployment is a serious problem in Armenia and is a major determinant of poverty. An estimated 25 percent of the population is unemployed, and labor force participation rates are low. An analysis of household data suggests that transfer income (remittances, benefits, and foreign aid) account for a very large portion of household income, and may lead to greater unemployment by increasing the reservation wage. This is a very striking observation and requires further investigation.
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Trade expansion, especially in labor-intensive industries, would help create job
opportunities, reduce unemployment, and thereby reduce poverty. A rough analysis using existing industry studies suggests that jewelry/diamond processing, information technology, and agriculture/food processing hold the greatest potential for export expansion and job creation. Other industries that could be considered for strategic investments include energy (with high export potential but low job potential) and mining (high job potential but moderate export potential).
In the absence of a Computable General Equilibrium (CGE) model or household panel data, a single household survey can be used to estimate the short-run impacts of policy changes under rather restrictive assumptions. The report presents the results from simulating the effects of proposed policy changes such as improvements in infrastructure, reductions in transaction costs, and an increase in input costs. More specifically, it simulates the effects of a decrease in the price of wheat (an imported good that is produced primarily by the rural poor and is consumed widely in Armenia), a reduction in transportation costs faced by self-employed farmers, and an increase in the cost of irrigation faced by self-employed farmers. Unfortunately the household survey does not identify the sectors of employment of the respondents. Had this data been available, a more detailed assessment of the impact of trade expansion on employment would have been explored.
The results suggest that a fall in wheat prices increases the welfare of urban
households, and especially of the poor, while rural areas lose marginally. Decreasing transportation costs lead to an increase in the welfare for all households. Finally, an increase in irrigation costs has a particularly negative impact on the poor. Recommendations
In many other developing and transition economies that have poor trade performance, the main explanations are an overvalued exchange rate, protectionist trade policy, and/or restrictions on foreign investment. In such countries, policy recommendations to improve trade integration are fairly straightforward: reduce tariff rates and tariff dispersion; remove export taxes; allow market forces to determine a competitive exchange rate; and open borders to foreign investors. In Armenia, these first-generation policy reforms are already in place. Trade and investment policies are already quite liberal, the exchange rate is not overvalued (given current inflows of aid and remittances), and the country is moving quickly toward WTO membership along with its compliant legislation. The constraints to trade integration in Armenia are more complex -- as are their solutions -- extending beyond the narrow scope of trade policy to the broader institutional and legal framework for a market-based economy, and the nature of the relationship between the public and private sectors.
While this report does not provide a comprehensive list of policy and institutional reforms needed to improve the functioning of markets and increase private sector-led growth, a number of recommendations emerged from the report's field work and analysis.
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Most are the responsibility of the Government of Armenia, while others require cooperation from other governments in the region, as well as actions by the donor community.
Obviously, Armenia's isolation from global markets will not be eliminated until borders with its neighbors are opened. The normalization of relations with Turkey may be more realistic to achieve in the medium term than a solution to the Nagorno-Karabakh conflict. One can only hope that the promise of higher incomes and employment from trade will provide an incentive for earlier resolution of Armenia's political conflicts.
Even in the absence of solutions to these political conflicts, there are many areas for action that could expand trade: • Infrastructure. Improvements in the quality of roads and railways, particularly in
Georgia, is urgently needed to move goods to Turkey and Europe. This is an area where a regional initiative, at a minimum involving infrastructure investments in Georgia, could facilitate trade and domestic transport for Armenia and the rest of the South Caucasus. In Armenia, improvements in the Yerevan air terminal would also facilitate trade, tourism, and visits by foreign investors. In order to provide faster and lower-cost internet service, the Government should move quickly to evaluate its options with respect to the Armentel telelcom monopoly, at a minimum increasing the efficiency of the sector through regulation.
• Customs. The problems of the Customs Service are well-known, and the
Government should place high priority on implementing recommended institutional reforms. These would include improvements in the consultation process between the Customs Committee and the trading community; simplification of customs procedures; improved valuation practices, avoiding the use of minimum reference prices; better monitoring and incentives to reduce corruption; and organizational and staffing changes in the institution. Currently the Bank is preparing with the Governments of Armenia, Georgia, and Azerbaijan a regional initiative (Trade and Transport Facilitation in the South Caucasus) to accomplish these objectives. In addition, the Armenian Government may want to consider establishing bonded warehouses or free customs warehouses, logistic centers, and/or industrial zones.
• VAT reimbursements. Although value-added taxes on imports account for a large
share of fiscal revenues, the Government cannot afford to let this tax put Armenian exporters at a competitive disadvantage in global markets. VAT reimbursements on imported inputs for export production need to be made promptly.
• Export and FDI promotion. Foreign investors have the potential to be a dynamic
force for change, and it is important that the Government pay close attention to their specific concerns. The Armenian Development Agency needs a clear mandate and strategy, with support from the highest political levels. Greater efforts need to be made to attract foreign investment in support of strategic priorities -- generating employment, using and developing the technical skills of the labor force, and
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strengthening inter-firm linkages. Given Armenia's inherent size and locational disadvantages and current political conflicts, the promotion of FDI needs to be more proactive than would be justified under normal circumstances. The Government will need to offer foreign investors specific incentives and co-investments, remove specific constraints in the business environment, and selectively share risk. The development of professional associations of Armenian businessmen around the world could accelerate FDI and export development.
• The legal framework for business. Property rights policies, including secured
transactions law, need to be reformed urgently. The property rights issue requires careful review to determine the exact measures that will need to be taken and the priorities for change. Company law needs to be reformed to ensure that minority rights are protected. In addition, the law of contracts needs to be reviewed to bring it into line with modern best practices. Since all of these issues require legislative action, the involvement of the Government and the legislature at an early stage is advisable.
• Donor intervention. Foreign aid can be a blessing and a curse. In a small economy
like Armenia's, donor funds can overwhelm both the absorptive capacity of the economy and the management capacity of local institutions. Donor funds can create perverse incentives and inhibit the development of markets. This seems to have happened in the financial sector, where donor-funded credit lines have segmented the market for enterprise credit. Donor should be careful when designing projects, aiming for smaller, well-targeted assistance that leads to sustainable improvements in institutions and markets.
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CHAPTER 1: BACKGROUND A. Introduction
Like other transition economies of the former Soviet Union, Armenia suffered a dramatic decline in output after independence. Real GDP fell 50 percent between 1991 and 1993, but growth resumed in 1994 and has remained positive since then. The Government launched a major structural reform program in the early years of transition, liberalizing the prices of most goods and services, setting up a liberal trade and foreign exchange regime, privatizing state-owned enterprises, and breaking up the collective farm system. After a period of high inflation in the early 1990s, macroeconomic stabilization policies beginning in 1994 achieved low inflation, a relatively stable exchange rate, a sufficient level of international reserves, and a manageable fiscal deficit.1 Despite Armenia's relatively strong growth performance in recent years, poverty remains a problem. In 1996, 55 percent of the population was classified as poor or very poor, and poverty probably worsened after the 1998 Russian financial crisis and severe droughts in 1999-2000. Unemployment is high -- officially 26 percent in 1999 -- and most of the unemployed are not registered as such and therefore ineligible for public assistance. The lack of job opportunities has led to the emigration of large numbers of people, particularly the young and well-educated.
The patterns of production and trade in Armenia still bear the legacy of Soviet times. The country has failed to significantly expand its exports in a diverse range of products to non-CIS markets, and as a result has not become well integrated into the global economy. The openness of the economy -- measured by the ratio of merchandise exports and imports to GDP -- is higher than the average for low-income countries but below that of most transition economies in Central Eastern Europe and the Baltics. Merchandise exports declined by about 15 percent in U.S. dollar terms between 1995 and 1999, and accounted for only 13 percent of GDP in 1999. In comparison, in the same year exports amounted to 40 percent of GDP in Moldova and more than 30 percent in the Kyrgyz Republic, Tajikistan, Turkmenistan, and Ukraine. Armenian exports are concentrated in a few products (e.g., processed diamonds), and a large share of trade is informal "shuttle trade".
The purpose of this report is to identify the constraints to and opportunities for greater integration of Armenia with the global economy, and suggest ways that such integration could occur in a way that would open opportunities for the poor and unemployed. It is hoped that this study will help bring trade issues to center stage in Armenia's development strategy, provide background for the upcoming Development
1 World Bank (2001).
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Round of WTO negotiations, and identify needs for future trade-related technical assistance from the World Bank and other donors.
The report is part of the Bank's expanded work program on trade in low-income countries, following the model of studies conducted under the Integrated Framework (IF) for Trade-Related Technical Assistance for Least Developed Countries (LDCs). It is the first of a series of trade diagnostic studies for the low-income countries in the Europe and Central Asia Region. The objective of the Bank's expanded trade agenda is to address trade concerns of low-income countries formulating Poverty Reduction Strategy Papers (PRSPs), as well as other low- or middle-income countries with serious poverty problems in sub-regions that are isolated from world markets.
Until now, the Bank had not done a comprehensive review of trade issues in Armenia, but there are several reports by the Bank and other donors -- on growth, private sector development, the financial sector, and poverty -- that tell part of the story and give us a base to start with. These reports include the recent Growth Study,2 a FIAS report on constraints to foreign investment,3 a series of reports on trade and transport costs in the South Caucasus,4 and a Financial Sector Review.5 The Bank is also preparing a framework paper on trade issues in the CIS- for a multi-donor seminar in October 2002.
Other donors have funded work on various aspects of Armenian trade (e.g., USAID work on customs). The European Union's TRACECA Programme (TRAnsport Corridor Europe Caucasus Asia) provides trade and transport facilitation technical assistance to Central Asia and the Caucasus. The program is intended to increase these countries' access to European and world markets through alternative transport routes, and to encourage further regional co-operation. Finally, a number of subsector studies have been commissioned by donors including TACIS, UNDP, and USAID.
This report is organized as follows. In the remainder of this chapter, we give background on Armenia in terms of the country's political context as well as its physical and human resources. We also review recent trends in the macroeconomy, paying particular attention to the behavior of the real exchange rate.
The next chapter describes trends in Armenia's external trade and foreign investment inflows -- in terms of overall volume, product composition, and origins/destinations. The chapter also examines the factor content of exports. The purpose of this review is to suggest hypotheses that would explain Armenia's patterns of trade and investment, that will be examined in later chapters. To gain perspective on trade opportunities and constraints from the point of view of firms, a survey of exporters was conducted for this report, and is summarized in Annex 2.
2World Bank (2001). 3 FIAS (2000). 4 Polyakov(2001) and Trade Facilitation Initiative reports on the World Bank ECA website. 5 World Bank (2000).
3
Chapter 3 assesses the importance of internal and external barriers to trade that result from Armenia's trade policy as well as potential barriers that Armenian exporters face when trying to access foreign markets. It also analyzes the Government's strategy and institutional framework for promoting exports and foreign direct investment, using the lessons of other countries. Finally, the chapter reviews progress in WTO accession and the remaining issues to be resolved.
The next two chapters analyze other issues that constrain trade and investment. Chapter 4 deals with trade facilitation, focusing on two major constraints to Armenia's external trade: transport and other infrastructure problems, and the operation of customs. Chapter 5 discusses the business environment and enterprise financing. The final chapter of the report analyzes links between trade and poverty, showing how an expansion of trade might affect the poor through changes in consumption, wages, and employment. B. Political Context
Armenia is a landlocked country strongly affected by regional conflicts. Besides the physical factors of high transportation costs, conflict-induced border closures distort the physical geography forcing trade flows to travel via circuitous routes. This further elevates transport costs. Among many regional conflicts, two are of paramount importance for Armenia:
• a decade-old dispute between Armenia and Azerbaijan over the Nagorno-Karabakh
region had led to a war between the two countries. An armistice was reached in 1994, but the borders between the two countries are closed and trade, officially at least, does not exist.
• seriously strained relations between Turkey and Armenia dating back to World War I,
when large numbers of Armenian population perished triggering a mass exodus out of the country. Currently, the Turkish-Armenian border is closed, forcing trade to the west to take place via a circuitous route through Georgia.
Armenia maintains reasonably good relations with its other neighbors, Georgia
and Iran, which provide its only routes to the outside world. However, its most defining relationship is that with Russia, despite periodic tensions (for example, over unpaid energy bills), and Armenia remains Russia's strategic ally in the Caucasus region.
4
Armenia
C. Physical and Human Resources Eighty percent of the territory of Armenia is mountainous, and the country has few natural resources. It is highly dependent on energy supplies from other former Soviet republics, mainly Russia, with about 80 percent of primary energy consumption dependent on imports at the end of 2000.
Official estimates put the total population at the end of 2000 at 3.8 million, up from 3.3 million at the time of the last census in early 1989. However, this is widely believed to be an overestimate, given the collapse in living standards that followed the break-up of the Soviet Union, which resulted in high levels of emigration, and dislocations due to the conflict with Azerbaijan. Many estimate that the current population is nearer to 3 million.
There is a large Armenian diaspora, of whom 1.5 million live in other republics of the former Soviet Union (mainly Russia) and a further 2.5 million in the U.S., France, and the Middle East.
According to official estimates, total registered unemployment in 2000 accounted for about 12 percent of the labor force; the inclusion of non-registered hidden unemployment could bring the unemployment rate up to around 35 percent.
Armenians are well-educated, despite a fall in education expenditure since independence. The adult literacy rate is almost 99 percent. The labor force is considered to be technically skilled. D. Macroeconomic Trends GDP Growth Following the cease-fire in 1994, macroeconomic stabilization, and a series of structural reforms, economic activity in Armenia began to revive. Real GDP has grown nearly 6 percent per year during the past six years (Table 1.1). Nevertheless, real GDP in 2001 was still only 65 percent of its 1990 level (Figure 1.1).
5
Table 1.1 Real GDP Growth, 1996-2001 (percent change over the previous year)
1996 1997 1998 1999 2000 2001 Gross domestic product 5.9 3.3 7.2 3.3 6.0 9.6
Industry 1.1 1.3 -2.2 5.2 6.4 3.8 Agriculture 2.0 -4.5 12.9 1.3 -2.3 11.6 Construction 25.2 3.9 10.6 7.7 28.4 14.5 Transport and communication 17.1 9.2 1.4 0.8 -0.6 16.0 Trade 12.5 5.0 6.7 9.8 8.3 15.5
Other services 14.6 3.2 2.6 4.5 9.1 5.3 Source: National Statistical Service, Annual Statistical Report, 2001.
Figure 1.1: Real GDP (1990=100)
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90 91 92 93 94 95 96 97 98 99 00 01
Aggregate economic performance in 2001 was the strongest in ten years -- real GDP grew 9.6 percent. During the first quarter of 2002, GDP grew another 7.4 percent, driven by an almost 14 percent increase in industrial output and a 12 percent rise in construction.
The composition of GDP has shifted away from agriculture, with a corresponding increase in the service sector. Between 1996 and 2001, the agriculture share of GDP fell from 33 percent to 20 percent, and services rose from 20 percent to 29 percent; the industrial share of GDP remained stable at 24 to 25 percent (Table 1.2). The share of transport and communication, and construction increased dramatically (Table 1.1). Following mass privatization in the industrial sector, the private sector share of GDP rose from 63 percent in 1996 to 80 percent in 2001. A sectoral analysis of growth in a previous World Bank study showed that post-stabilization industrial growth was strongest in mining and metallurgy (driven by a recovery of exports in ores after the cease-fire) and construction materials (pushed by an expansion in public investments), and to a lesser extent power generation and food
6
processing.6 Yet growth in these sectors may be difficult to sustain. At the same time, the performance of sectors in which Armenia is expected to have a comparative advantage -- labor- and skill-intensive sectors and low-weight products -- was disappointing. This is a concern both for the sustainability of recent growth rates, as well as for trade expansion.
Table 1.2 Composition of GDP, 1996-2001 (percent)
1996 1997 1998 1999 2000 2001 Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0
Industry 23.8 23.9 21.6 21.5 22.1 20.5 Agriculture 33.0 30.4 30.8 25.4 23.1 24.8 Construction 9.6 8.0 8.4 9.4 10.2 10.6 Transport and communication 4.7 5.4 5.1 7.5 7.2 7.5 Trade 9.6 9.1 8.6 8.9 9.2 9.7 Other services 19.7 23.3 25.4 27.2 28.5 29.2
Source: National Statistical Service, Annual Statistical Report, 2001.
Until recently, the export sector has not been a significant source of aggregate economic growth, in contrast to a number of countries where the acceleration of economic development has been export-driven. Exports of goods and services fell to 19 percent of GDP in 1999, recovering since then to about 23 percent. This is low compared to other CIS countries; the ratio is almost 40 percent in Moldova and more than 30 percent in the Kyrgyz Republic, Tajikistan, Turkmenistan, and Ukraine.7
Table 1.3: Indicators of Openness
1995 1996 1997 1998 1999 2000 2001
X/GDP 23.9% 23.2% 20.3% 19.0% 20.8% 23.3% 26.0% (X+M)/GDP 86.1% 79.2% 78.5% 71.8% 70.6% 74.1% 71.0% Exports (X) and imports (M) of goods and services. GDP in current prices. The external sector has been characterized by large and persistent trade deficits (Table 1.4), rising to US$577 million in 1998. Since then the trade balance has improved, both as a result of export expansion and a decline in imports. As a proportion of GDP, the current account deficit fell from 26-28 percent in 1996-97 to 22 percent in
6 "Armenia: Growth Challenges and Government Policies." Report No. 22854-AM, November 2001, pp. 34-36. 7 ibid., p. 40.
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1999 and 15 percent in 2000. During the latter year, exports increased by almost 16 percent and imports fell 5 percent; in 2001, exports grew another 14 percent and imports fell slightly (1.2 percent).
Table 1.4: Balance of Payments (US$ million)
1994 1995 1996 1997 1998 1999 2000 2001 Merchandise exports 209.3 270.9 290.4 233.6 228.9 247.3 309.9 354.1 Merchandise imports 401.2 673.3 759.6 793.1 806.4 721.3 773.4 770.3 Trade balance -191.9 -402.4 -469.2 -559.5 -577.5 -474.0 -463.5 -416.2 Exports of services 47.8 34.0 77.7 96.6 130.7 135.8 136.9 187.5 Imports of services 116.5 123.0 128.5 159.4 193.6 197.8 192.7 201.8 Net trade in goods and services -260.6 -491.4 -520.0 -622.3 -640.4 -536.0 -519.3 -430.5 Net income receipts -6.8 -9.8 44.7 98.6 60.4 54.9 52.9 61.5 Net private current transfers 11.2 18.4 67.5 67.8 64.7 80.3 85.6 108.0 Net official current transfers 94.4 149.9 117.1 149.4 112.7 93.8 102.5 67.9 Current account balance -161.8 -332.9 -290.7 -306.5 -402.6 -307.0 -278.3 -193.1 Net private investment 2.6 19.1 24.8 67.7 205.0 123.7 85.3 80.9(e) Net LT borrowing 59.4 73.4 173.2 184.1 88.2 94.5 90.9 62.3 Other capital flows, net -75.7 223.5 51.2 31.9 158.0 90.0 130.0 128.6 Reserves, net change 6.6 n.a. 58.9 71.0 52.5 20.6 19.2 20.0
Armenia receives a large amount of private remittances, foreign aid, and humanitarian assistance, which offsets to a large extent the deficits in trade of goods and services (Figure 1.2). In 2000, net private current transfers (remittances) amounted to almost US$86 million, and net official current transfers (mainly foreign aid) to over $100 million (Table 1.4). In 2000, official transfers and concessional aid amounted to 11 percent of GDP, or about US$70 per capita. External borrowing and grants also finance a large part of the domestic fiscal deficit (Figure 1.3). While international assistance has been substantial in all years since the 1988 earthquake, it expanded significantly since 1994 following the IMF agreement. The effect of these external inflows on incomes is striking: as shown in Chapter 6, remittances and foreign aid, along with pensions, account for about 45 percent of household income.
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Figure 1.2: External Resource Flows
Total External Resource Flows
100150200250300350400450500550
1993 1994 1995 1996 1997 1998 1999 2000
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Note: Total external resource flow is calculated as the sum of net flows on debt including IMF loans, FDI, portfolio equity flows, total grants, workers' remittances and current private transfers. (Source: IMF and World Bank). Private transfer is calculated as the sum of current private transfers and workers' remittances.( Source: IMF and World Bank).
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Inflows from remittances and foreign aid have allowed the exchange rate to remain stable despite large trade deficits and external shocks including the Russian financial crisis. Since 1996, both the nominal exchange rate and the real effective exchange rate have remained quite stable (Figures 1.4 and 1.5). The fact that the real exchange rate is kept "artificially" high by remittances and foreign aid is a problem for the long-run competitiveness of exports, and makes it even more imperative for the Government to address the high costs and constraints to trade in other areas -- the topic of subsequent chapters.
Figure 1.3: The Domestic Deficit and Its Financing (billion dram)
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94 95 96 97 98 99 0 01(e)
Other Grants External borrowing
Other = Net monetary system credit, net domestic borrowing, external capital grants. Source: Central Bank of Armenia
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Figure 1.4: Nominal Exchange Rate and Inflation
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Source: IMF, International Financial Statistics Yearbook 2001. Notes: Inflation calculated as the twelve-months percentage change of the Consumer Price Index. All interest rates are annualized.
Figure 1.5: Real Effective Exchange Rate
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Trade-weighted average; 1995 average = 100. Source: IMF.
Trends in real exchange rates of the dram versus the currencies of the main export destination markets (Russia, the U.S, and the EU represented by Germany) are presented in Figure 1.6. After strong real appreciation of the dram vis-à-vis all three currencies in 1993-1994 caused by initial exchange rate overshooting and gradual macroeconomic stabilization, the paths of the exchange rates in question diverged.
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The dram traded lower in real terms against the ruble in the period from 1995 to
the first half of 1998, then strongly appreciated in the wake of the Russia crises, and returned to the January, 1995, level in 2001. The appreciation of the dram in 1998-2000 caused a significant slump in Armenian exports to Russia, along with a negative income effect on the Russian market. Real appreciation versus the dollar in 1995-1995 gave way to depreciation, and by 2001 the dram returned to the January, 1995, level, as in the case of the ruble. The dram appreciated against the Deutsche mark (Euro) and stayed at high levels until the end of the period, thanks to the stability of the nominal dram exchange rate versus dollar and a strong depreciation of the Euro vis-à-vis the dollar since the introduction of the Euro. Nevertheless, the impact of dram appreciation versus the European currency did not negatively affect exports to Europe thanks to the composition of Armenia exports to Europe dominated by cut diamonds (see Chapter 2).
Figure 1.6: Real Exchange Rates in Major Export Markets Armenian Dram vs. Russian Ruble, U.S. Dollar, and Deutsche Mark (Euro),
1993-2002 (Jan. 1995 = 1) Source: IMF and World Bank staff estimates.
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CHAPTER 2: THE STRUCTURE OF TRADE AND INVESTMENT A. Introduction
Increasing globalization of the world economy and fragmentation of the production process provide ample opportunities for developing and transition economies to participate in the international division of labor. By becoming part of supply chains centered around multinational corporations and therefore indirectly suppliers of multinationals’ clients around the globe small countries with skilled and inexpensive labor have an opportunity expand their markets and enjoy the benefits of scale economies that may not otherwise be available to them.
Despite its endowment of skilled labor force and strategic location, external and internal constraints have prevented Armenia from taking advantage of these opportunities and integrating into the global trading system. Armenia’s transition from central planning to a market-based economy has been accompanied by a only a small increase in the export volume and limited progress towards creating a sustainable trade structure for the future.
The purpose of this chapter is to examine developments in Armenian trade since 1995 and shed some light on the factors that shaped them. In order to put Armenia’s trade performance into perspective, we will compare it with the performance of two other small members of the Commonwealth of Independent States (CIS), Georgia and Moldova. Similarly to Armenia, Georgia is located in the Caucasus region and has been involved in a military conflict over the past decade. We will also make comparisons with two small Baltic economies – Lithuania, which is quite advanced in its transition process yet lags behind Central European countries, and Estonia, which has been very successful at embracing free market and integrating into the global trading system.
The findings of the chapter can be summarized as follows: • Since 1995 Armenia’s imports have grown faster than exports leading to an
increasing trade deficit. • The on-going blockade of borders with Azerbaijan and Turkey, resulting from the
Nagorno-Karabakh conflict, has heavily distorted Armenia’s trade patterns by increasing transport costs faced by both importers and exporters. As a result, the structure of Armenia’s exports is biased towards goods with high value relative to weight and discourages sales of bulky low costs products of light industry. Unlike in other transition economies, Armenia’s exports of textiles, apparel and footwear have been limited.
• The share of sales to the EU and US in total exports has increased to the level above
that found in Georgia and Moldova, but it remains below the shares enjoyed by
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Lithuania and Estonia. Once the high import content of diamond exports is taken into account, the share of sales to these two markets drops significantly and becomes comparable with the outcomes achieved by the two CIS countries.
• There is a clear difference in the structure of EU- and CIS-destined exports; the
former rely mostly on diamond cutting and polishing while the latter are heavily affected by the historical patterns of trade under the Soviet Union; the former consist mostly of skilled labor intensive activity (diamond processing) and natural resources, the latter rely heaving on natural resource based products and capital intensive goods.
• Armenia’s exports are excessively concentrated in a few product categories with the
concentration increasing in recent years. • Despite its very liberal trade regime Armenia is not closely integrated into
international production networks. High transport costs hinder Armenia’s participation since bringing semi-processed materials for further processing or manufactured parts and components for assembly, as it is the case in many Central European countries, is not economically viable.
The effects of the border blockade are further exacerbated by domestic
constraints. Deficiencies in the operations of the Customs system and the inability of exporters to obtain VAT refunds for imported inputs hinder international trade. Moreover, weak governance and poor business climate coupled with limited export opportunities discourage entry of both domestic and foreign firms. The domestic supply response is weak because the small domestic market is unable to sustain large firms and attract foreign direct investment.
While the policy recommendations presented in subsequent chapters of this report could stimulate supply response, Armenia’s exports will continue to be hindered by the existence of the border blockade. Without a change in this area, the country will not be able to take a full advantage of the opportunities offered by the increased globalization and enjoy export-led growth, which it urgently needs.
This chapter is structured as follows. First we discuss recent developments in trade volumes and the geographic reorientation of foreign trade. Next, we examine export concentration and changes in export structure focusing first on the EU and then on CIS markets, followed by a discussion of factor content of trade and fastest growing export products in the two markets. Then we concentrate on Armenia’s participation in international production and distribution networks and FDI inflows. The last section concludes.
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B. Structure of Trade Overall Trade Volume
Armenian foreign trade since 1995 has been characterized by persistent trade deficits. Between 1995 and 2001 imports experienced a dynamic growth increasing by 53 percent in nominal terms, and their value was more than double the value of exports. Export growth failed to keep up with the import surge (see Figure 2.1 below). As a result of the Russian crisis, exports to CIS markets dropped by 30 percent during 1998-99 and it was not until the year 2000 that total exports to that destination rebounded to their 1996 level. The past year brought some improvement in the trade balance as a 14 percent rise in exports was accompanied by a slight drop (1.2 percent) in imports.
Figure 2.1: Armenia's Foreign Trade
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1995 1996 1997 1998 1999 2000 2001
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Exports
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To put Armenia’s performance into perspective we compare it with that of two other CIS countries – neighboring Georgia which has also been engaged in a military conflict and Moldova. Additionally, we make comparisons with two Baltic states – Lithuania, which has been lagging behind Central European countries in terms of transition progress, and Estonia, a transition success story.
Annex 3, Table A3.1 presents basic statistics for the five economies. Georgia and Moldova have larger populations than Armenia. Lithuania is very similar in size and Estonia’s population is equal to about 36 percent of the Armenian size. In terms of GDP per capita, the figures for Lithuania and Estonia are six and sevenfold larger than that for Armenia. Georgian GDP per capita is 20 percent higher while that of Moldova is 40 percent lower. Estonia is the most open country in the group, as measured by the ratio of foreign trade to GDP. The value of its exports and imports is almost 80 percent higher than the total GDP. The openness index for Armenia is equal to 62 percent, which is almost double the figure for Georgia but below the figures for Moldova and Lithuania.
15
Figure 2.2 compares the export growth in four countries (data for Georgia are not available) during the period 1995-2000. We find that while Estonia more than doubled its exports and Lithuania increased them by 40 percent, Armenian foreign sales went up by only 20 percent. However, when we consider the 1995-2001 period, Armenia’s exports increased by 37 percent. Moldova performed quite poorly as its exports declined by 40 percent during the years in question.
Figure 2.2: Export Growth 1995-2000
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Estonia Lithuania Armenia2001
Armenia2000
Moldova
Origins and Destinations
As far as the geographic orientation of trade is concerned, Russia and the CIS remain important markets for Armenian exports. Their shares in 2001 were equal to 17.6 and 8.3 percent, respectively (see Table 2.1 below). Exports to these markets went down after the Russian crisis and while sales to Russia have rebounded since then, exports to CIS remain at 91 percent of their 1995 level. Armenia is less reliant on sales to CIS than Georgia and Moldova but much more dependent than the Baltic states (see Annex 3 Table A3.2).
The European Union (EU) has been growing in importance as a market for Armenian exports, which increased from 70 million in 1995 to 107 in 2000 and then went down to 89 last year. Nevertheless in 2001 Armenian exports to the EU were 26 percent higher than in 1995. Overall they accounted for more than a quarter of total exports, which is equal to the combined share of sales to Russia and CIS.
A notable characteristic of Armenian trade is the importance of the US market. Armenia trades much more with the US than any of the comparator countries. Sales to the US, to a large extent driven by the presence of Armenian Diaspora, registered more than a fivefold increase between 1995 and 2001 rising from 8 million to 53 million dollars. Last year they accounted for more than 15 percent of total exports. This is the most dynamic market for Armenian exports, albeit growing from a low initial base. While relying only on supplying overseas Armenians is not a viable long-term strategy,
16
using Diaspora contacts as a way of reaching new customers holds a lot of promise for the future (see Box 2.1 for a case study of an exporter to the U.S. market).
Table 2.1 Geographic Distribution of Armenia's Foreign Trade, 1995-2000
1995 1999 2000 2001 1995 1999 2000 2001 2001 Export Value ($ million) Export Share (%) 1995=100
Russia Fed. 57.7 33.9 44.6 60.5 23.0 14.6 14.8 17.6 104.8CIS (excl. Russia) 31.5 21.3 28.8 28.6 12.6 9.2 9.6 8.3 90.7EU15 70.1 106.5 107.0 88.6 27.9 46.0 35.6 25.8 126.4USA 8.2 16.0 37.9 52.3 3.3 6.9 12.6 15.3 638.9CEEC+Baltics 1.2 1.8 2.4 1.7 0.5 0.8 0.8 0.5 147.1Others 82.1 52.1 79.8 111.1 32.7 22.5 26.6 32.4 135.3World 250.8 231.7 300.5 342.8 100.0 100.0 100.0 100.0 136.7
Import Value ($ million) Import Share (%) 1995=100 Russia Fed. 142.1 149.9 137.2 170.4 24.9 18.5 15.5 19.5 119.9CIS (excl. Russia) 55.3 37.2 36.5 44.7 9.7 4.6 4.1 5.1 80.8EU15 124.0 252.4 302.8 252.2 21.8 31.1 34.2 28.8 203.3USA 86.6 88.6 102.7 84.2 15.2 10.9 11.6 9.6 97.2CEEC+Baltics 21.4 22.6 16.8 17.4 3.8 2.8 1.9 2.0 81.3Others 140.3 260.1 288.7 305.4 24.6 32.1 32.6 34.9 217.7World 569.8 810.9 884.7 874.3 100.0 100.0 100.0 100.0 153.4 Source: Based on country direct reporting from UN COMTRADE Statistics.
The combined share of EU and US destined exports was equal to 48 percent in 2000 (and 41 in 2001), which is more than double the corresponding share for Georgia and Moldova and close to the corresponding figure for Lithuania. However, it is well below the 70 percent figure found in Estonia.
Note, however, that these figures may be somewhat misleading as a large part of EU-destined exports from Armenia consists of exporting diamonds brought to Armenia for cutting and polishing. The value added in this activity is equal to only about 15-17 percent of the final product’s value. If we restrict our attention to the value added rather than the total value of diamonds exported, the share of EU in total exports drops from 35.6 to 12.4 percent in 2000 and the combined share of EU and the US declines to 28 percent. That puts Armenia more or less on par with Georgia and Moldova and very much below the two Baltic countries.
About one-third of Armenia’s exports falls under the “other” category, which includes Iran, Switzerland, United Arab Emirates, Cyprus and Turkey. Note that according to official statistics trade between Armenia and Azerbaijan is zero. Yet in reality goods exchange takes place between the two countries via Georgia where the goods are relabeled.
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On the import side, the largest share of purchases (29 percent) comes from the EU. Imports from the EU more than doubled during the 1995-2001 period. Imports from Russia increased in absolute terms by 20 percent, but their share in total imports declined from a quarter to a fifth during the same period. About ten percent of imports were sourced from the US in 2001, while only 5 percent came from CIS countries other than Russia. Other major sources of imports included Iran, United Arab Emirates, Turkey, Switzerland, Panama and Israel.
Box 2.1: Diaspora-Driven Exports Company A was founded in the early 1990s on the basis of an existing farmers’ association. It is a private enterprise producing and selling 18 varieties of canned goods, including fruit preserves, jams, juices and syrups. The number of products has been growing over time. The company employs 20 full time workers. During the processing season (May - November), the number of employees usually increases to over 100 people. In 2000, of total production worth several hundred thousand dollars exports made up 95 percent and in 2001 about 100 percent. That is an outcome of long term, stable and profitable collaboration with its Diaspora partners, mainly in the US. As the whole production is exported, the Company does not see expediency in selling the products in the domestic market, where the purchasing power of the population is low. Foreign sales are run by two trading companies located in Los Angeles and Washington and run by overseas Armenians. There is also a small group of agents operating in the Russian market. About 70 percent of exports are directed to the US and the remainder to Russia. While in the US, 80 percent of buyers are Armenian, Company’s products have been slowly gaining non-Diaspora customers as well. In 2002 first orders were received from France and due to already concluded contracts of 2002 the production volume will be higher than in the previous year. Products are shipped to the US in 20’ containers, with 25,000-28,000 jars (0.35-0.5 liters volume) in each container. The jars and lids are imported from Italy. It takes 45-50 days to deliver the products to Los Angeles at the cost of $3,500 - $3,800. The deliveries to Russia are made in the same containers. It takes 30-35 days to deliver the product and it costs $1,800 (to Moscow). Letter of credit is used as payment in both markets. The Company has found its customers at fairs and exhibitions in which it periodically participates. In 2000 the Company was awarded a gold medal for 6 products in a US exhibition.
Source: Poghossian (2002).
Concentration of Exports
There has been little change in Armenia’s export composition over the recent years. The correlation between export shares of 21 product groups in 1997 and 2000 is quite high (0.82). In both 1997 and 2000, the top five product categories included precious stones, minerals, machinery, base metals and food. During the whole period these five product groups accounted for more than eighty percent of Armenia’s total
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exports. However, there has been some shift in the contribution of each group to the total. While in 1997 base metals accounted for about a quarter of total exports, their share fell to one-tenth in 2000. At the same time, the share of precious stones rose from less than a quarter to over 40 percent (Table 2.2).
Table 2.2: Composition of Armenian Exports 1997-2000
Export value('000s US$) Export share (%)
Product 1997 1998 1999 2000 1997 1998 1999 2000
Precious stones and metals 55215 53062 99879 121452 23.7 24.1 43.1 40.4Mineral production 17873 30757 30996 37194 7.7 13.9 13.4 12.4Machinery and equipment 32175 40849 17488 31020 13.8 18.5 7.5 10.3Base metals and articles thereof 57679 38630 30163 29837 24.8 17.5 13.0 9.9Products of prepared food 24621 16778 15917 27334 10.6 7.6 6.9 9.1Textile articles 10566 13574 13586 13184 4.5 6.2 5.9 4.4Plastic, rubber 9198 8050 9110 9049 4.0 3.7 3.9 3.0Chemicals 4337 2158 1891 3373 1.9 1.0 0.8 1.1 Sum of the above 211663 203858 219030 272444 91 92 95 91TOTAL 232495 220516 231669 300487 100 100 100 100 Source: Armenian Statistical Office. The table includes only product groups whose share exceeded one percent in 2000.
Armenia’s exports have become increasingly concentrated over time. A popular way of measuring trade concentration is to use Hirschmann index, whose values range from zero to unity, with higher numbers corresponding to greater concentration.8 As is evident from Table 2.3 below, the Hirschmann index for Armenian exports increased from 0.237 in 1997 to 0.349 in 1999. During the same period the number of items exported declined from 93 to 80. Armenia has by far the highest concentration of exports among the comparator countries, and it exports the smallest number of items. For instance, Lithuania exports 210 different product categories (2.6 times Armenia) and its concentration index is equal to 0.113 (as compared to Armenia’s 0.349). While Moldova’s trade is far from diversified when the number of exported products is considered, it is much less concentrated than that of Armenia when export shares are taken into account, i.e., Hirschmann index is used.
8
n
nX
x
H i
i
i1
1
12
−
−
=∑
where xi is the export value of commodity i, X is the value of total exports,
and n is the number of products at the 3 digit SITC level (239 product groups).
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Table 2.3: Armenia's Export Concentration Index, 1997 and 1999
1997 1999 No. of Items Concentration No. of Items Concentration Country Exported Index Exported Index Armenia 93 0.237 80 0.349 Russia 224 0.270 222 0.261 Moldova 123 0.307 97 0.250 Latvia 192 0.162 188 0.211 Estonia 207 0.092 201 0.124 Lithuania 213 0.122 210 0.113 Source: Based on country direct reporting from UN COMTRADE Statistics.
One may argue that the above comparison is not very informative since unlike
Armenia, other countries in the group have access to water transport routes. Therefore, we also use figures from Ng and Yeats (2002) to examine Armenia’s export concentration relative to that of other landlocked developing countries. All of these countries are small, with populations not exceeding 11 million and GDPs ranging from 440 to 3,104 million dollars in 1999 (as compared to Armenia’s GDP of 1,845). The number of exported four-digit SITC products is considered. This time, however, the UNCTAD approach is followed and items with sales below 100,000 dollars or three-tenths of a percent of total exports are excluded. This is done so that items that are marginal and are not traded at regular basis do not influence the index value.
In addition to the simple count, Table 2.4 below includes the share of total exports accounted for by the single largest, three largest and five largest products. Thus, a lower count index and a higher share are associated with greater concentration of exports. As is evident from the table, Armenia exports fewer products than 9 out of 16 landlocked comparator countries, including Burkina Faso, Malawi and Tajikistan. Its largest export item accounts for 68.7 percent of exports as compared to 51.2 percent for other landlocked countries considered. Armenia’s exports also appear to be quite concentrated when the other two share measures are used.
Relying on such a narrow range of export products is very risky as it makes the country vulnerable to major adverse developments in international supply or demand. For instance, worldwide demand for diamonds, the largest export category, may drop as the public begins to associate them with civil war in Angola and other parts of Africa. The importance of this point is reflected in a recent World Bank study (De Ferranti et. al. 2001), which showed that countries with more diversified export structures are more likely to experience higher growth rates.
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Table 2.4: Measures of Export Concentration for Armenia and Landlocked Comparator Countries, 1999
Share of total exports (%)*
Country
Number of Products
Exported* Largest Product
Three-Largest Products
Five-Largest Products
Armenia 57 68.7 75.2 78.7 Landlocked Countries Bhutan Burkina Faso Burundi Central African Rep. Chad Kyrgyz Republic Lao PDR Lesotho Malawi Mali Moldova Mongolia Niger Rwanda Tajikistan Zambia
29 62 17 40 12
102 91 21 81 80
189 86 57 23 79
111 67.5
39.7 66.4 69.9 72.0 83.3 55.7 13.0 36.4 60.0 84.1 13.6 45.2 51.1 57.9 32.9 38.3 51.2
69.9 74.3 83.9 79.2 95.3 65.0 23.1 86.8 67.7 86.5 36.4 56.5 90.6 74.3 64.0 56.0 69.3
75.1 79.4 92.3 85.4 97.7 74.1 33.1 95.4 75.4 88.9 30.3 64.1 93.2 81.8 74.3 63.1 75.2
* The higher the value of this index the lower the concentration of exports. ** The higher the value of this index the higher the concentration of exports. Source: Ng and Yeats (2002, Table 15).
In this section we focused on the concentration of total exports, which obscures large differences in the composition of Armenia’s sales destined for different markets. In the following sections we take a closer look first at EU-destined exports and then at sales to the CIS. Exports to the EU
Armenian exports to the EU consist mainly of diamonds (three quarters of the export value in 1999), gold jewelry and mineral commodities. The fifth largest export group is metal scrap, certainly not a commodity with bright export prospects. Notable is the absence of textile and apparel exports, which constitute a large share of EU-destined sales in other transition countries. For instance, these two categories accounted for one-third of Lithuania’s sales to the EU in 1999. As is evident from Annex 3 Table A3.3, the only light industry product accounting for more than one percent of EU exports is SITC 8465, corsets and brassieres. This bias toward high value goods with low weight and small volume, such as diamonds and jewelry, is likely to be a result of the border blockade. Both diamonds and jewelry are transported by air and thus not affected by the
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blockade, and since they are high value items, the transport costs constitute a small share of their price.9
The blockade, however, is detrimental to low value large volume items such as apparel, where transport costs constitute a significant share of the price and adversely affects the competitiveness. Moreover, since a large share of clothing trade between transition economies and the EU takes place through the so called outward processing arrangements, under which the EU buyers supply their partner firms in transition countries with designs, fabrics and other inputs, transport costs are incurred in both directions. In order to receive higher prices for their services, it is important for clothing producers in transition countries to offer flexible production system and to respond quickly to changing demand patterns in the EU. The delays and unreliability of transport routes from Armenia makes it difficult for Armenian producers to enter into this type of arrangements. It is quite likely that in the absence of the blockade Armenia could take advantage of its inexpensive labor and proximity to the EU and become a supplier of apparel to those markets under outward processing arrangements.
Since raw diamonds are imported and cutting and polishing taking place in Armenia constitutes only a relatively small percentage of the value of exported diamonds, looking simply at export shares of different product categories may be misleading. Therefore, the last two columns of Table 2.5 present the export shares calculated taking into account only the value added to diamonds during their processing in Armenia (assumed to be equal to 17 percent). Note that with this modification, the value of all EU-destined exports drops by 62 percent. Yet even now, diamonds and gold jewelry account for more than 60 percent of exports to the EU.
With the above mentioned adjustment for diamonds, exports of manufactured goods account for 51 percent of Armenia’s sales to the EU. This much higher than the corresponding figure for Georgia (30 percent), slightly below Moldova’s 53 percent and much below Lithuania’s 68 percent share. As mentioned above, notable is the absence of textiles and clothing exports, which in Moldova and Lithuania constitute 47 and 33 percent of all EU-destined exports, respectively.
The excessive concentration of exports in diamond and jewelry and heavy reliance on sales of commodities (such as ferro-alloys, crude minerals, etc) makes Armenia vulnerable to demand and price shocks and is not a viable long-term strategy. There are, however, some encouraging changes have taken place in Armenia’s export structure. For instance, in 1999 some new skilled labor and capital intensive products appeared in EU-destined exports. These are automotive and machinery parts (SITC 7929 and 7649), tires (SITC 6253) and components of optical instruments (SITC 8841). With the exception of automotive parts, whose exports amounted to 1.6 million dollars, the exports of the other three categories were very small, less than a quarter million dollars.
9 Note that, for instance, the shipment of one ton of quartz sand costs 5 times as much as the value of the product itself (Alpha Plus Consulting, 2002, p. 36).
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We now examine explicitly which of the products with EU-destined exports of at least 50 thousand dollars in 1995 experienced the most dynamic growth. Exports to the EU as a whole increased on average by 11 percent annually during the period 1995-99. At the same time, sales of gold rose at an average annual rate of 50 percent (see Annex 3 Table A3.4). The second fastest growing product group was diamond exports with the annual growth rate of 11 percent. It was followed by ferro-alloys (3.5 percent) and parts and components (1.8 percent). These four were the only product groups with significant exports to the EU in 1995 and a positive growth rate during the period in question.
Next, we assess what product are associated with a positive outlook for future sales in EU markets. We narrow our attention to the so called “sunrise markets,” products whose EU external imports increased on average by 5 percent a year during the period 1995-99. Among these there are nine product categories in which Armenian exports experienced a positive growth rate.10 As Annex 3 Table A3.5 indicates, five of these product categories are capital-intensive. Note that in only one of the five, namely telecommunication equipment, Armenian exports to the EU exceeded 100 thousand dollars. Diamonds, the only skilled-labor intensive category in the table, accounted for 90 percent of all Armenia’s sunrise sales to the EU.11 The remaining products are unskilled labor intensive textiles and plastic articles and natural resource based alcoholic beverages. While sunrise sales account for a vast majority of EU destined exports, the situation is not as optimistic as it may seems since almost all of these sales are due to diamond exports with the remaining categories being associated with a very small value of trade flows. Thus yet again the data point to a dangerously excessive export concentration and a limited scope for future increases in exports of products other than diamonds.
An increase in foreign sales of these products in the future would be a very positive sign and is certainly not impossible given Armenia’s highly skilled and competitively priced labor force and experience in production of machinery and equipment during the Soviet era. Should the blockade be lifted (at least as far as Turkish border is concerned), Armenia would be able to take advantage of its proximity to the EU and become part of EU-centered production network, just as it is the case in Poland or Hungary.12
10 Note that this time we do not use the cutoff value of $50,000 dollars of exports in 1995 . 11 Note that the discrepancy in diamond export figures between Annex 3 Table A3.4 and Table A3.5 is due to the fact that the former uses data as reported by Armenia, while the second employed figures reported by the EU. 12 See Kaminski and Smarzynska (2001) and Kaminski and Riboud (2000) for a discussion of the Polish and Hungarian case, respectively.
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Table 2.5: Manufacturing Share of Total EU-destined Exports in 1999
Armenia (with adjustment for imported diamonds ) 51.33 of which products other than diamonds 18.08 Georgia 29.86 Moldova 53.46 of which clothing 47.03 Lithuania 68.17 of which textiles and clothing 32.60 Source: UN COMTRADE Statistics.
Exports to the CIS
Armenia’s exports to CIS markets have a very different composition than sales to the EU and are much less concentrated (see Annex 3 Table A3.6). In 1999, manufactures constituted 43 percent of CIS-destined exports. Exports of machinery alone accounted for 21 percent of sales, while their share in EU exports was negligible. Product categories exported to CIS include electrical apparatus (4.5 percent of all CIS-destined exports), electrical motors and generators (3 percent), other power machinery (2 percent) and others. To a large extent, these exports reflect the division of labor which was present among the Soviet Republics. As illustrated by the case study in Box 2.2, many enterprises exporting to Russia and other CIS countries used to have a dominant position in the Soviet Union. Thus, they take advantage of their relationships from that time period and continue making sales.
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Box 2.2: Taking Advantage of Old Contacts Company B was established in the 1940s. It produces specialized measuring devices used in shipbuilding, energy sector (including nuclear energy), mechanical engineering, military-industrial establishment and chemical industry. Under the Soviet Union, the Company enjoyed a monopolistic position and has continued to do so until the present time. Even after the dissolution of the USSR, when economic links were destroyed, the Company continued to work with its former clients, continuously fulfilling the orders. This situation arises due to the specific nature of the product and because of the monopolistic status of the Company. During the last 10 years there was not any similar type of production established in Russia that allowed the Company to have its small but stable market. In 1998 the Company was split into two enterprises, which continue to cooperate closely. The whole production, except for common consumer goods (knives, scissors and other household supplies) is exported to Russia. Both the sales of goods and purchases of raw materials by the Company depend on the volume of orders coming from Russia. If the order is in place, materials necessary for the production (radio elements, component parts and devices, non-rusting parts and titanic alloys) are imported from Russia. Orders are driven by the activities of Russian shipbuilding as well as current repair of nuclear power plants and hydroelectric power stations. Research institutes servicing Russian military-industrial establishments place orders with Russian enterprises, which in turn source from the Armenian company. Payments are made upon the delivery of products. Final goods are delivered to Russia ones in 2-3 months by air, packed in boxes. Source: Poghossian (2002)
In contrast to EU-destined exports, where their share was negligible, foodstuffs
and tobacco constituted 27 percent of sales to the CIS in 1999. The largest single CIS-destined export category is spirits, which accounted for over 14 percent of all sales in 1999 (see Annex 3 Table A3.7). Armenian brandy had enjoyed a very good reputation in the Soviet Union and continues to do so in Russia and other CIS countries, even though it faces increasing competition from Western products. Other categories include tobacco and cigarettes (almost 6 percent of the total), fruit juices and dried fruit. Many Armenian firms find it easier to sell foodstuffs in Eastern markets where Armenian standards and certifications, based on the old Soviet system, are recognized. Selling the same goods to the EU would require complying with different standards and obtaining new certification, which is what many producers want to avoid (see Box 2.3 for some examples).
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Box 2.3: Product Standards A recent report based on 37 case studies of Armenian firms confirms that exporters in sectors, such as, food processing, mechanical and electrical engineering, electronics, chemicals and light industry face some difficulties in penetrating EU markets due to high product standard requirements. In this respect, exporting to CIS countries is relatively easier. For instance, an Armenian producer of canned food reports that the important advantage of the CIS market is that the Armenian State Standards are recognized there. A company manufacturing machine building equipment states that “Russia is the priority market for the company. … [since] Armenian products are more acceptable in the Russian market in terms of standards. ” A producer of mineral water reports relatively fewer problems occurring in CIS markets with respect to certifications, licensing and quality requirements for the product. Source: Alpha Plus Consulting (2002).
There were many more product categories experiencing rapid export growth to CIS markets than there were in EU markets, despite the fact that exports to CIS declined during the period 1995-99. The largest and fastest growing of these was SITC 3510, electric energy, whose exports accounted for almost 13 percent of all CIS sales (see Annex 3 Table A3.4). In terms of growth rate it was followed by exports of grapes, which however constituted less than 0.3 percent of all sales to CIS. The other categories were mainly different types of machinery, which reflects the Soviet legacy, footwear and fruit. Together all these products accounted for 27 percent of CIS-destined exports.
Thanks to their knowledge of the language, local tastes and culture as well as previous business contacts, Armenian exporters enjoy an advantage in CIS markets over producers from outside the region. Yet as time goes by and incomes in the region grow, Armenian products are likely to face increasing competition from Western goods. Therefore, it is important for Armenian producers to continue to upgrade their products to remain competitive. The fact that currently few product categories sold in CIS are exported to the EU may suggest that these goods are not competitive vis-à-vis Western made goods due to quality, price, or unreliability of delivery schedules. Without continued upgrading it will be increasingly difficult for Armenian producers to continue their sales in CIS markets. C. Factor Content of Exports
In this section, we take a closer look at the Armenian trade structure focusing on the factor content of exports. In order to avoid misleading results we take into account the high import content of diamond sales. We exclude diamond exports from the natural resource category and add the value added resulting from diamond cutting and polishing to the skilled labor intensive group. As before, we assume that diamond process taking place in Armenia accounts for 17 percent of the value of exported diamonds. Moreover, we exclude electric energy from the table since the net exports of electric current are small due to swapping agreements with neighboring countries.
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As Table 2.6 below indicates, even after these corrections half of Armenian exports in 1999 fell into the natural resource based category, which, however, constitutes a decline from the 58 percent share in 1997. Moving away from this type of products is certainly a positive sign. The fact that about one-fifth of Armenian exports was accounted for by skilled labor intensive products (an increase from 14 percent in 1997) is also very encouraging. Exports of capital intensive products have been declining at about 20 percent a year and constituted about 18 percent of total exports in 1999. Finally, the smallest but growing share of exports, about 12 percent, was accounted for by unskilled-labor intensive products. As we will see below, there are significant differences in the factor content of exports to the EU and the CIS.
Table 2.6: Armenia's Exports and Imports by Factor Intensity, 1997-99
Export Value ($ '000) Export Share (in %) Annual %
Growth Rate Export
1999 Index Factor Intensity a/ 1997 1999 1997 1999 1997-99 1997=100
Natural Resources 96,106 61,903 57.8 49.9 -19.7 64 Unskilled Labor 12,105 15,312 7.3 12.3 12.5 126 Capital Intensive 34,766 22,040 20.9 17.8 -20.4 63 Skilled Labor 23,282 24,800 14.0 20.0 3.2 107 All Goods 166258 124056 100.0 100.0 -13.6 75 a/ Diamonds and electric energy exports have been excluded. The 17 percent value added of diamond exports has been added to skilled labor intensive category. Source: UN COMTRADE Statistics.
Next we restrict our attention to Armenian exports to the EU and compare their
factor content with that of exports coming from the other countries in the region (see Annex 3 Table A3.8). Only about 36 percent of Armenian sales to the EU can be characterized as natural resource based, which is exactly the same as the corresponding figure for Lithuania and much lower than the figures for Georgia (79 percent) and Moldova (48 percent). Armenia also compares very favorable with all three countries in terms of skilled labor intensive exports. Exactly half of all Armenian exports fall into this category, as compared to 6-7 percent for Georgia and Lithuania and one percent for Moldova. Note, however, that almost all of these sales (with the exception of 0.4 million dollars) constitute of one activity – cutting and polishing diamonds. Unlike the other countries considered, Armenia sells very little (1.4 million dollars, which is equivalent to a 5 percent share) of unskilled labor intensive products. These goods account for 51 and 40 percent of Moldova’s and Lithuania’s exports to the EU, respectively.
To put these share into prospective, the table also includes the factor content of EU external imports. More than 40 percent of these flows can be characterized as capital intensive, 27 as natural-resource based, 16 as skilled labor and 14 as unskilled labor
27
intensive. Thus, in relative terms, all four transition countries specialize in supplying natural resource based products to the EU. Additionally, Moldova and Lithuania are heavily specialized in unskilled labor intensive goods, and Armenia in products with large content of skilled labor.
What exactly are the products Armenia exports in each of the factor content categories? Table Annex 3 Table A3.9 presents a detailed description. The top three products in the natural resource based category are other ferro-alloys (SITC 6715), crude minerals (SITC 2769) and iron and steel scrap (SITC 2820). All three are associated with little processing, and the last one is probably a result of dismantling post-Soviet factories and thus unlikely to be sustainable in the medium run. These three categories account for more than three quarters of all natural resource based exports and about 30 percent of all exports.
As mentioned above, skilled labor intensive group consists mainly of diamond exports. Other products include rubber tires (SITC 6291) and printed matter (SITC 8929), yet their share in total exports is almost negligible 0.7 and 0.3 percent, respectively.
As for capital intensive goods, aircraft parts (SITC 7349), telecommunication equipment (SITC 7249) and optical elements (SITC 8611) are the top three products. They accounted for 6, 1 and 0.5 percent of total EU-destined exports, respectively. With the exception of telecommunication equipment, these are new items in EU exports as they were not sold in 1997.
Unskilled labor intensive goods also include a new product nonknit textile and clothing accessories (SITC 8412) whose share in total EU exports grew from zero to over 4 percent during 1997-99. Not surprisingly, carpets constitute the second largest export product in this export category. Yet their sales are tiny – about 63 thousands dollars or less than a quarter of percent.
Now let’s turn our attention to CIS-destined exports. Almost 60 percent of these sales are based on natural resources, as compared to only 36 percent of exports to the EU (after adjustment for diamond exports is made). About a quarter of sales directed to CIS can be characterized as capital intensive, reflecting the legacy of the former Soviet Union. And only 9 percent can be classified skilled labor intensive (recall that this was true of half of exports to the EU).
Table 2.7 below compares the factor content of CIS-destined exports of three CIS countries. It shows that the structure of Georgia’s sales to the region closely mirrors that of Armenia. Moldovia, on the other hand, sells very little in terms of capital intensive goods and the vast majority of its exports to CIS (86 percent) is natural resource based.
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Table 2.7: Comparator Countries’ Exports to CIS Countries by Factor Intensity, 1999
Annex 3 Table A3.10 lists main Armenian exports in each group. The largest single export product in the largest factor content category (i.e., natural resource based), is SITC 1124, distilled alcoholic beverages, accounting for over 14 percent of total exports to the region in 1999. It is followed by synthetic rubber (SITC 2312) and electric energy (SITC 3510) constituting 13 percent of exports each. Other products include tobacco, cigarettes and juices.
Capital intensive group consists mainly of machinery (electric power and metalworking machinery, switchgear, pumps, insulated wires, etc). It also includes products of chemical industry, sugar derivatives (SITC 5416) and medications (SITC 5417).
Skilled labor intensive exports include tires, jewelry, paper, parts of motor vehicles and watches. Exports of each of these are quite small constituting two percent or less of all exports to the region. Unskilled labor intensive exports include footwear, textiles and clothing and glass bottles.
Summarizing, the factor content of Armenia’s exports to the CIS differs from the
factor content of sales made to the EU. Sales to the latter destination are intensive in skilled labor (cutting and polishing embedded in diamond exports) and natural resources, while exports to CIS are mainly natural resource based and capital intensive. The factor content of CIS exports reflects the legacy of the Soviet Union, when heavy industry and research and manufacturing complexes serving the military were established in Armenia. Overall the export structure shows little sign of restructuring taking place in Armenian industry.
Factor intensity Armenia Georgia Moldova Export value ($ ‘000) Natural resource based 32679 63543 209466Unskilled labor intensive 2176 7941 14899Capital intensive 14044 24293 16443Skilled labor intensive 5090 6915 3548 Export share (%) Natural resource based 59.2 59.3 85.7Unskilled labor intensive 3.9 7.4 6.1Capital intensive 25.4 22.7 6.7Skilled labor intensive 9.2 6.4 1.5 Source: UN COMTRADE Statistics.
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D. Trade in Services After examining Armenia’s trade in goods, we now turn out attention to trade in
services. The magnitude of services flows is quite significant. For instance, in 2000 the value of services credits received by Armenia was only slightly less that the country’s exports to the EU and the US combined, and during the first three quarters of 2001 it was larger than the value of the year’s exports to these destinations. After running a sizeable deficit in this area during the late 1990s, Armenian trade in services was almost balanced during the first three quarters of 2001. Within services trade, the largest share was accounted for by transport followed by telecommunications. Exports of computer services represent a growing sector, while inflows from personal, cultural and recreational services remain rather modest (see Table 2.8 below).
Information technology has been one of the most dynamically growing, albeit
from a small base, export-oriented sectors in Armenia. There are reasons to believe that a large share of software exports is not reported and thus not reflected in the official statistics of merchandise and services trade. According to unofficial estimates, software exports reached the level of 15-20 million dollars in 1999 which was equivalent to about 7-8 percent of total merchandise exports.13 Given strong worldwide demand for information technology services, relatively inexpensive labor force in Armenia and the fact that these exports are not hindered by high transportation costs, this can be considered one of the sectors with the brightest prospects for the future. For more details on the sector structure and performance, see the information technology industry overview in Annex I.
13 “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p. 47.
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Table 2.8: Trade in Services
1997 1998 1999 2000 2001 1-3Q 1999 2000 2001 1-3Q million US dollars as % of the total
Balance -62.80 -63.26 -62.03 -55.80 -1.22 Credit 96.57 130.31 135.80 136.93 143.65 100 100 100 Debit -159.37 -193.57 -197.83 -192.73 -144.86 100 100 100 of which (selected groups): Transportation -41.21 -57.16 -54.03 -51.99 -36.10 Credit 50.62 52.64 53.09 63.94 50.92 39.1 46.7 35.4 Debit -91.83 -109.79 -107.12 -115.94 -87.02 54.1 60.2 60.1 Telecommunication services 0.00 20.80 11.63 6.73 7.24 Credit 0.00 25.65 31.99 14.98 18.03 23.56 10.94 12.55 Debit 0.00 -4.85 -20.36 -8.25 -10.79 10.29 4.28 7.45 Computer services 0.00 0.00 0.22 1.97 5.57 Credit 0.00 0.00 0.28 1.97 5.57 0.21 1.44 3.88 Debit 0.00 0.00 -0.06 0.00 0.00 0.03 0.00 0.00 Personal, cultural and recreational services -0.46 2.48 1.41 0.03 -1.99 Credit 2.67 6.51 4.81 0.78 1.07 3.54 0.57 0.74 Debit -3.13 -4.03 -3.40 -0.75 -3.06 1.72 0.39 2.11 Source: Armenian Statistical Office
E. Foreign Investment and Participation in Global Production Chains Foreign Direct Investment
Despite its large scale privatization program, Armenia has not managed to attract large inflows of FDI. As Figure 2.3 below shows, FDI inflows into Armenia were very small throughout most of the 1990s barely exceeding 50 million dollars in 1997. The inflows increased in 1998 and became comparable with volumes enjoyed by Georgia but remained much below FDI flows to Estonia and Lithuania. During the period 1995-2000 Armenia attracted 156 dollars of FDI per capita, as compared to 96 dollars in Moldova and over 1,300 dollars in Estonia. The total stock of FDI accumulated during this period reached 590 million dollars and was below the 837 million level registered in Georgia (see Table 2.9).
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Figure 2.3: Net FDI Inflows
0
100
200
300
400
500
600
700
800
900
1,000
1995 1996 1997 1998 1999 2000
mn
of
US
$Armenia
Georgia
Moldova
Estonia
Lithuania
Table 2.9: Net FDI inflows to Comparator Countries
Net FDI inflows
2000 Net FDI inflows
1995-2000
% of GDP Per capita ($) Value ($
mn) Per capita ($) Estonia 8.0 277 1,904 1,307 Lithuania 3.4 102 2,371 640 Armenia 6.9 35 590 156 Georgia 6.5 36 837 154 Moldova 10.0 30 411 96 Sources: World Investment Report 2001 (FDI figures) and World Bank World Development Indicators (GDP and population)
About one-third of FDI accumulated in Armenia during the period 1998-2000 was
directed to telecommunications sector. The impact of these inflows may be though less beneficial than expected, since together with a stake in local telecommunications sector, the Hellenic Telecommunications Organization, a Greek company, was awarded a monopoly in fixed telephone lines till 2013. Thus, little improvement in the quality of service has been registered. Slightly less than a quarter of FDI inflows went into infrastructure (electricity, gas, hot water supply). Other service sectors, such as wholesale trade, hotels, restaurants and commerce accounted for another 16 percent of FDI stock (see Annex 3 Table A3.11).
Inflows into manufacturing have been much smaller. The largest inflows have been registered into food and beverage production (13.7 percent of the total), followed by production of non-metal items, cigarettes, chemicals and furniture (less than 1 percent each). Textile sector received only 1.8 million dollars of FDI or 0.1 percent of the total.
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As discussed in more detail in the business environment chapter, small internal
market combined with high transport costs have decreased Armenia’s attractiveness as an FDI destination. This situation has not been helped by frequently changing rules and difficult business environment. By not being able to attract large FDI inflows, Armenia is missing out on gaining access to new technologies, marketing skills, managerial know-how and exporting channels. Global Production Networks
International trade over the past decade has been characterized by fragmentation of production and creation of distribution networks spanning across continents. Thanks to technological progress and information revolution it has become possible to divide the industry’s value chain into smaller functions that can be contracted out to independent suppliers. This fragmentation of production offers a unique opportunity for producers in small countries to move from servicing their limited local markets to supplying large multinational firms and indirectly their customers all over the world.
This phenomenon is accompanied by an evolution in the nature of competition with its growing emphasis on customization of products, rapid innovation, flexibility and fast response to changing demand. In many cases, managerial and technological skills required to successfully compete in global markets make it impossible to rely on the resources of one country. Under these circumstances, integration into the production and marketing arrangements of the multinational corporations (MNCs) rather than the pursuit of an autarchic national development strategy has become the most efficient way of taking advantage of growth opportunities offered by the global economy.
Incorporation of local producers into production and marketing networks could extend significant benefits to both a small economy, like Armenia, and a MNC. For the latter, it would offers a wider menu of choices in the strategies to expand their position in global markets, as they may become more competitive thanks to lower costs stemming from moving some production segments to the region. For a small economy, this arrangement brings new technologies and managerial know-how as well as direct access to larger markets and thus benefits of economies of scale. It boosts exports without local firms having to incur marketing expenses and provides greater stability in earnings thanks to a global reach of a “parent” company. Fragmentation of production eliminates the need to gain competency in all stages and aspects of production and allows a small country to focus on a subset of activities. At the same time production sharing can broaden the range of final products whose components are produced in the small country and thus protect the country from a demand shock to a particular good.
An example of such labor sharing arrangement is in East Asia where capital intensive electronic components, for instance, micro-chips and transistors, are produced in Japan and are then sent to low wage countries such as Thailand, the Philippines or China for further assembly. The latter process may involve wiring the components into metal boards, or the final assembly of office equipment, computers, or electronic
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machines. These finished goods may then be re-exported to Japan or to third country markets. In 1996, the value of East Asian intra-trade in parts and components intended for further assembly totaled $165 billion.14
Poorer countries tend to be less involved in production of parts and components for exports, but are likely to perform assembly operations based on imported components. Ng and Yeats (2002) analyze this question in the context of landlocked countries. They find that the share of parts and components in total exports of their sample of landlocked countries is tiny, often less than one percent (see Table 2.10). This is also true of Armenia where the corresponding figure was .3 percent in 1999.
They show, however, that a different picture emerges on the import side. The share of components for further assembly exceeds 10 percent of total imports in 10 of 16 countries and is over 15 percent in the case of Bhutan, Central African Republic, Laos, Malawi, Rwanda and Zambia. While some of this trade may involve the replacement of defective parts in existing equipment, or for the further assembly of goods destined for local markets, studies show the assembly of foreign produced parts and components have provided a major stimulus to many developing countries exports.
Armenia has not taken advantage of the opportunity to integrate into global production networks through assembly operations. The share of components in Armenia’s total import is equal to 6.2 percent, which is the second lowest ratio in the sample exceeding only that of Tajikistan. This finding is yet another indication of the detrimental effect of the border blockade on the Armenia’s trade and production structure. High transport cost and unreliability of delivery process are also an important factor that discouraged inflows of foreign direct investment.
14 Ng and Yeats (2002).
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Table 2.10: Recent Changes in the Comparator Countries Trade in Parts and Components
1999 Trade Value Share of Parts and Components of Parts & Components In Total Trade ( %)
Trade Flow/Country ($ '000) 1995 1999
EXPORTS Armenia 357 0.44 0.32 Bhutan 483 0.52 2.32 Burkina Faso 415 0.50 0.24 Burundi 243 0.03 0.35 Central African Republic 854 0.19 0.39 Chad 1,043 0.46 0.97 Kyrgyz Republic 1,095 0.31 0.48 Lao PDR 366 0.10 0.16 Malawi 647 0.16 0.13 Mali 1,609 0.26 0.60 Moldova 1,718 0.47 0.49 Mongolia 316 0.04 0.10 Niger 4,913 0.26 1.63 Rwanda 156 0.31 0.30 Tajikistan 919 0.55 0.59 Zambia 829 0.10 0.14
IMPORTS Armenia 17,513 3.62 6.22 Bhutan 6,996 10.14 21.25 Burkina Faso 41,962 12.07 7.75 Burundi 9,534 11.81 12.49 Central African Republic 13,953 13.51 15.90 Chad 10,920 14.84 12.50 Kyrgyz Republic 33,150 4.73 9.40 Lao PDR 85,969 5.12 15.69 Malawi 61,487 11.89 15.09 Mali 76,153 13.23 10.79 Moldova 31,061 4.35 6.27 Mongolia 30,975 8.93 11.63 Niger 18,588 11.57 6.54 Rwanda 34,781 5.83 18.73 Tajikistan 6,323 11.03 4.69 Zambia 118,655 17.65 18.55
Source: Ng and Yeats (2002, Table 19) F. Conclusions
High transport costs resulting from the blockade of borders with Turkey and Azerbaijan have distorted Armenia’s trade and production patterns. The composition of exports has shifted towards low import content, high value to weight ratio products and
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goods that can be shipped by air. High transport cost associated with exports of bulky products prevent some sectors (e.g., copper processing) from developing by hindering exports and thus making it impossible to enjoy the benefits of scale economies. Transport problems are also one of the factors that make Armenia unattractive to potential foreign investors interested in taking advantage of inexpensive yet skilled labor force and using the country as an export platform. Low FDI inflows in turn prevent Armenia’s fuller integration into international production and distribution networks.
While difficult, it is not impossible for Armenia to increase its exports without removing the blockade. Over the past decades, many countries have increased their reliance on exports brought in by air due to increased importance of fast response to changing demand patterns and just-in-time production systems. In the US, for instance, 30 percent of all trade was air-shipped in 1998. Armenian producers have also an option of increasing their trade in services, which is not associated with high transport costs.
Besides skilled and inexpensive labor force, Armenia enjoys another advantage – large Armenian populations living in foreign countries. For many firms overseas Armenians are a target customer group and many companies already rely on the contacts with the Diaspora to secure product orders. While developing a strategy for the future, it is important to emphasize the latter approach. As a customer base, the Diaspora size is limited, but as way of creating business contacts with potential foreign customers, its help may be invaluable.
While the removal of the border blockade may not be politically feasible at this point, there are other measures that the Government of Armenia can take to promote an expansion in trade and investment: improvements in the business environment, trade-related institutions, and infrastructure. We examine these options in subsequent chapters.
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CHAPTER 3: TRADE POLICY, TRADE-RELATED INSTITUTIONS, AND
MARKET ACCESS A. Introduction
This chapter will review trade policy and trade-related institutions in Armenia and the conditions of the access of Armenian exports to foreign markets. (Note that the operations of Customs will be discussed in Chapter 4). As Armenia is close to becoming a member of the World Trade Organization (WTO), the chapter will describe the progress and remaining problems of the accession process, and will lay out the costs and benefits of WTO membership. B. Institutional Framework for Trade Policy Formulation
The agencies directly responsible for formulation and implementation of trade policies include the Administrations of the President and Prime Minister, the Ministry of Trade and Economic Development (MTED), and the Customs Committee: • The Administrations of the President and Prime Minister provide general policy
direction and supervise the activities of the line ministries in the area of foreign trade. • MTED formulates the main parameters of trade policy -- the import and export
regimes as well as international trade relations and WTO accession. • The Customs Committee is responsible for customs controls, customs procedures,
customs charges, and other customs policy measures. Coordination among the various agencies is rather weak. The MTED, as the primary trade agency, does not receive adequate support from the other agencies. For example, the Customs Committee collects data on export and import transactions, which are recorded in the ASYCUDA15 database. Analysis of this data would allow policymakers to address a variety of trade policy and performance issues. However, the Customs Committee does not share information from this database with other government agencies. C. Import Regime The IMF rates Armenia's trade regime as "1" (the most liberal category) due to the country's low statutory tariffs, minimal non-tariff barriers, and few controls on exports. Armenia has gone a long way of liberalizing its import tariff schedule16. The resulting
15 Automated System of Customs Data developed in installed by the UNCTAD. 16 For instance, the 1995 tariff schedule had five tariff bands – zero, 5, 10, 30, and 50 percent.
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structure is simple and flat. Under the 2001 Customs Code, there are only two tariff rates (0 percent and 10 percent); 64 percent of tariff lines (mostly materials and capital goods) carry the 0 percent rate and 36 percent (mostly consumer and luxury items) carry the 10 percent rate, with a standard deviation of 4.85. The average import-weighted tariff is about four percent.
Excise taxes, sometimes quite high, are applied to imports of tobacco, alcohol, and fuel products. Excise taxes on imports of alcohol and fuel are the same as for domestically-produced substitutes. Excise taxes on domestically-produced tobacco products are lower than those on imports.
The value-added tax (VAT) for both domestic and imported products is 20 percent. A few product groups are exempted from the VAT. Primary agricultural commodities are exempted from the VAT if produced domestically but subject to VAT if imported. This is contrary to Article III of the GATT 1994 (the national treatment principle) and creates a problem for Armenia’s accession to the WTO (see Section H below).
Some imports are subject to VAT collection inside the country after clearance through customs, while others are taxed at the border. Taxation inside the country is preferable for importers, since imported goods are taxed only after use or sale. At the same time, the Government is under pressure to charge all VAT at the border, since the Customs Committee is considered to be a more efficient tax collector than the Ministry of State Revenues, which is responsible for VAT collection internally. Table 3.1 shows the share of total tax revenues accounted for by trade taxes (tariffs, excise taxes, and VAT on imports). The table shows that trade provides just under a half of total tax revenues, and that this share has been stable over the period 1998-2001. The largest share of trade taxes (58-61 percent) was collected as VAT; excise taxes accounted for 22-29 percent and import tariffs for only 12-17 percent. Because of the high ratio of imports to GDP, the VAT on imports accounted for roughly two-thirds of total VAT collection.
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Table 3.1: The taxation of imports, 1998 – 2001
1998 1999 2000 2001 In AMD mil.:
Total tax revenues 130,089 158,464 152,217 168,832 Total taxes on foreign trade
89,870 97,997 101,384 119,137
Total taxes on foreign trade, in 1998 AMD
89,870 97,413 101,561 116,767
Growth rate, percent
8.4 4.3 15.0
In current AMD:
Import tariffs 10,684 8,051 8,671 9,794 Excise tax on imports
13,975 14,252 17,408 24,536
VAT on imports 39,064 32,654 35,460 49,574 As percent of total tax revenues:
Total taxes on foreign trade
69.1% 61.8% 66.6% 70.6%
Including: Import tariffs 8.21% 5.1% 5.7% 5.8% Excise tax on imports
10.7% 8.9%% 11.4% 14.5%
VAT on imports
30.0% 20.6% 23.3% 29.4%
Average effective tariffs (% of merchandise imports)
2.3
1.9
1.8
2.0
Source: The World Bank staff calculations based on data from the Ministry of Finance and Economy of Armenia Armenia has a free trade regime with nine out of eleven CIS partners (see below), so that imports from these countries enter duty-free. The exceptions are Azerbaijan and Uzbekistan. There is no official trade between Armenia and Azerbaijan due to political hostilities, and very little trade between Armenia and Uzbekistan. Non-tariff barriers were eliminated under the Government's trade reform program, with a few exceptions for health, security, and environmental reasons, such as permission requirements for pharmaceutical products, military hardware, components and nuclear materials, and mandatory conformity assessment for agro-chemicals. Three basic documents are required of all imports: a certificate of origin, a certificate of standards, and a quality certificate. Recently-adopted legislation brings technical standards in
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conformity with WTO standards, and Armenia accepts internationally-accredited laboratory results. Food safety and phytosanitary requirements conform to international or CIS standards. The Department for Standardization, Metrology and Certification (SARM) is the leading agency responsible for certification. Conformity assessments are voluntary with minimal exceptions. Armenia signed agreements on the mutual recognition of conformity assessments with all CIS countries, except for Azerbaijan. The Law on Safeguard Measures has been passed in 2001 and the anti-dumping legislature is currently under discussion by the Parliament. There were no instances of the enactment of safeguard measures. The only (rather weak) source of protectionism is a mild tariff escalation of the import tariff schedule: inputs tend to be zero-rated while final products tend to pay the 10 percent tariff. The Customs Code envisions eight customs regimes for imports, three being of the most importance: importation for free circulation (the regular regime with all duties and fees paid) and temporary importation for inward processing (up to one year; outputs should be exported), and temporary importation (for further re-export during one year period) 17. Only goods imported for free circulation pay the customs duties, with exception for goods from free trade countries and humanitarian goods. Most regimes pay customs fees, which a reasonably small (for a full breakdown of the importation costs, see Chapter 4). An important channel of avoiding customs duties is the misclassification of import regime through collusion with corrupt customs officers. A classical example of such a scheme is a wide-spread importation of luxury cars through temporary importation regime. After the stipulated one year period, the car leaves Armenian territory only to be imported again a few minutes later for another year.
As an interesting statistical paradox, the official number of imported automobiles in Armenia in 2001 was 4,317 (customs data) while the number of new registered vehicles in the same year was 9,000 (Traffic Police data). Armenia has a small-scale production of minibuses ( a few dozens per year18), which cannot nearly account for the difference. As a result of deep tariff concessions, the average effective tariffs are about a half of already low nominal tariffs (see Table 3.1). Average effective tariffs fluctuated around 2 percent in the period 1998-2001.
The Customs Code lists six methods of import valuation accepted by GATT/WTO, with the transaction value method as the primary method. In practice, however, the Customs Service often applied minimum reference prices, in clear contradiction with WTO rules. Besides being outlawed by the WTO, the application of reference prices is non-transparent -- the list was neither published nor shared with other
17 Other regimes are: re-importation, transit shipment, importation into a duty free shop, importation into a customs warehouse, and importation into a free customs warehouse. 18 Statistical Yearbook of Armenia, 2001, p. 235.
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Government agencies. This allowed ample room for Customs officials to use their discretion in setting import valuations, leading to widespread corruption in the form of “gratuities.” In the course of WTO accession negotiations, the Government promised to discontinue this practice.
The rules of origin applied by Armenia are in line with the WTO Agreement on
Rules of Origin. The country of origin is defined as the last country of significant processing resulting in change in product classification or constituting at least 30 percent of the ex-works price. D. Regional Trade Agreements
The CIS free trade zone was established by multilateral free trade agreements concluded in 1992 and 1994. In addition, The 1992 multilateral Ashgabat Cooperation Agreement exempts intermediate products included in the mutually agreed production cooperation list from VAT.
These free trade agreements have not yet been ratified by Russia or Georgia, although over the years they have been supplemented by bilateral free trade agreements among almost all twelve CIS members. Armenia has concluded such agreements with all CIS countries with the exceptions of Azerbaijan and Uzbekistan. These bilateral agreements are almost identical, and stipulate potential exclusions from the zero tariff regime for a number of product groups, including sugar, alcoholic beverages and beer, textiles, metal products and machinery. Member countries have the right to introduce positive tariffs for these products unilaterally. Turkmenistan, Ukraine, the Kyrgyz Republic and Georgia did not invoke exemptions from duty free regime. Other CIS countries did so. Also, the free trade agreements stipulate the possibility of temporary protection measures, including the temporary imposition of quotas, for up to two years. Kazakhstan used this provision after the 1998 Russia’s crisis, restricting imports of many commodities including cement, metal pipes, agricultural products and foods19. E. Export Regime and Market access
There are virtually no restrictions or taxes on exports from Armenia, with exception for a few product groups. Textile exports the EU are subject to licensing in accordance with the trade agreement between Armenia and the EU; objects of national heritage and endangered plants and animals are subject to permission requirements; and there are usual controls for health, environmental, and security reasons. In general, non-tariff regulation on exports is similar to that on imports.
The foreign exchange regime is liberal with a single floating exchange rate. All
foreign currency surrender requirements for exporters had been eliminated. There are virtually no restrictions on the movement of foreign currencies. No subsidy of any kind is offered to exporters. The Government has not established free trade zones with duty
19 These measures were caused by weakened Kazakh trade competitiveness due to a relative appreciation of the Kazakh tenge vis-à-vis the currencies of its main trading partners in the CIS.
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privileges of any kind. Exporters using imported inputs for export production may obtain exemption from tariffs and the VAT on imported inputs: • under the temporary import regimes (temporary importation for inward processing
and temporary importation), as explained in the previous section; • reimbursements on VAT paid on imported inputs may be requested for the import
component of export production. However, in practice these reimbursements often do not occur. This is a major problem for firms that do not export 100 percent of their production (see Box 3.1).
Box 3.1: Problems with VAT Refunds The main problem faced by "Company C", and Armenian company that exports all of its production, it related to the implementation of tax legislation. The enterprise pays VAT on imports of raw materials. According to law, Company C is due a reimbursement of these VAT payments when it exports. Each year, the firm accumulates several million dollars' worth of overpaid VAT. These sums are often not reimbursed, despite much time and effort expended by the company. Often, significant sums of money seem to vanish. As a result, Company C is constantly in need of working capital, leading to problems with suppliers of raw materials, disruptions in the production process, and additional costs for the company. Source: Poghossian (2002), p. 10.
Armenia enjoys most-favored nation (MFN) treatment by the EU, the U.S., Switzerland, Canada, Bulgaria, Hungary, Poland, Romania, Iran, China, Cyprus, Lebanon, Syria, Argentina, and Vietnam. It also concluded a trade and investment agreement with the U.S. in 1992, and entered into a partnership and cooperation agreement with the EU in 1999. Armenia is a beneficiary of GDP programs both in the U.S. and EU. However, Armenia is not included in the list of least-developed countries under the U.S. GSP system, which have better access to the U.S. market. Also, the GSP programs provide temporary benefits for participating nations, which can easily be taken away. They tend to concentrate on manufactured products that are not important exports of Armenia, and at the same time exclude sensitive agricultural commodities. Complex and complicated EU rules of origin undermine existing trade preferences, especially for labor-intensive industrial products such as clothing and textiles. These products are excluded from the U.S. GSP altogether.20 Curiously, Armenia is still subject to the Jackson-Vannik amendment pertaining to now irrelevant Soviet policy on restricting Jewish emigration, although this amendment is annually waived by the U.S. President. There is no tax treaty between Armenia and the U.S., which does not prevent double taxation, thus hampering American FDI in Armenia.
20 Brenton and Manchin (2002).
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The members of the NAFTA, Caribbean, and other regional trade arrangements enjoy even deeper preferences. Armenia is not included in the “Everything but Arms” trade arrangement of the EU with 49 least-developed countries, which sets zero tariffs, and it does not have a free trade agreement with the EU as do the CEE countries.
Armenia enjoys weaker preferences than many other developing countries. For example, Armenian exports of tobacco to the U.S. are subject to a 30.8 percent tariff within an initial quota of 3,000 tons a year for the "rest of the world"; beyond this quota the tariff rate triples. At the same time, Malawi enjoys an initial quota of 12,000 tonnes per year. U.S. tariffs are considered to be a constraint for textile and jewelry exports. An 18 percent tariff is levied on the textile of Armenian origin and a 5.75 percent tariff on jewelry. Exporters believe that the GOA does little to reduce or eliminate these tariffs. In the EU, Armenian tobacco is subject to an 18.4 percent tariff and clothing to a 12.4 percent tariff.
Armenia’s textile exports to the U.S. and the EU, while not very large, are not subject to any restrictive quotas. This situation has already drawn the attention of “quota jumpers” -- international firms that arrange to change the stated country of origin for products from quota-restricted countries, such as China and Pakistan.
Armenia has not been a target of anti-dumping actions by any developed country.
While the composition and low volumes of its exports make it an unlikely candidate for such actions, it is vulnerable to such procedures due to its official status as a non-market economy in the U.S. and EU and its current non-membership in the WTO. As a non-market economy, Armenia cannot enjoy the protection of Armeican and Eruopean courts in the case of trade sanctions, and as a non-member of the WTO, cannot resort to the WTO trade dispute settlement mechanism.
Technical barriers to trade (TBTs) in developed-country markets are rather restrictive. As a rule, Armenia does not have agreements with these countries on mutual recognition of quality certificates. This has created problems for a number of potential exports. The MTED quoted a case when potential dairy exports to the EU failed to materialize, since Armenia was not on the EU list of accredited countries whose certificates are honored by the EU. Also, Armenian firms find it difficult to maintain consistent standards and quality due to technological problems. Most certifying institutions used by Armenian exporters are located in Europe, which adds considerable expense and creates extra uncertainty. A few Armenian exporters have gone through the International Standards Organization ISO 9000 certification process, which helps penetrating new markets, especially developed countries’ markets. However, the number of ISO-certified firms remains insignificant. The majority of Armenian exporters to developed countries do nor conduct their own marketing activities but, rather, rely on contract processing or distributors who buy their products on ex-works terms. Armenian exports enjoy an easier access to the CIS and Russian markets than to other destinations. Traditional economic ties still play an important role, albeit less significant than in the past. It is much easier to restore product brands in the familiar
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markets, than to enter new markets. Armenian industries are technologically compatible with Russian and other CIS industries, which presents an important advantage over competitors. Good knowledge of the Russian language and similar cultural background help in communications with both existing and potential customers. Mutual recognition of the trade and standardization documentation, such as the certificates of standards, is another important advantage. The national standards of the CIS countries are still based on the ex-Soviet GOST standards.21
A serious exports constraint in Russia is the recently introduced requirement to
pay the VAT at the Russian border. As most of the goods are exported to Russia on consignment, this creates major problems with cash flow. Exporters have to make all payments – including those for transportation and the VAT – before receiving payments for their products. Too close trade relations with the CIS are sometimes quoted as a possible factor of a technological stagnation, since the CIS economies are technologically lagging behind the developed countries. However, this cannot be an argument for limiting trade relations with the CIS countries. Similar arguments could be made against intra-LDC trade, which has been an a positive and important factor behind trade performance of LDCs in recent decades: the share of LDC exports to other LDCs increased from 17 percent in the mid-1960s to 40 percent in 1995-98 (IMF and World Bank, 2001). Iran and the Middle East are important destinations for Armenian exports. These destinations offer geographical proximity, low transport costs, and relatively high market purchasing power. However, with exception for the free trade zone in the UAE, the conditions of access to these markets are rather restrictive. Iran offers especially difficult access, such as restrictive quotas, high tariffs on selected products, and burdensome document requirements, including licenses. Importers need to receive permission from the Ministry of Trade stating that the import in question is in the best interests of the Iranian economy. Consumer electric appliances from Armenia are subject to a 200 percent tariff in Iran.
Barriers in destination markets as reported by the respondents of the exporter survey commissioned for this report are presented in Annex 2. F. Export and Foreign Investment Promotion
Compared to other countries in the region, Armenia has the lowest level of foreign direct investment over the last decade (Table 3.2). Total cumulative FDI in the period from 1991 to 2000 is about US$ 600 million. Around 80 percent of these investments were attracted after 1998. The significant increase of FDI in 1998 was mainly due to large-scale privatizations of state-run enterprises (telecom was privatized to OTE). 22
21 GOST is a Russian abbreviation meaning "state standard". 22 This section is based on the background paper prepared for this report by Yeghiazarian (2002).
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Table 3.2: FDI inflows by selected host country, 1989-2000 (millions of $US)
Country 1995 1996 1997 1998 1999 2000 Armenia 25 18 52 232 130 133 Ireland 1447 2618 2743 11035 14929 16320 Germany 12025 6572 12245 24277 55940 176055 Azerbaijan 330 627 1115 1023 510 883 Georgia 5 45 243 265 82 197 Kazakhstan 964 1137 1321 1152 1587 1249 Belarus 15 105 352 203 444 90 Czech Republic 2562 1428 1300 3718 6324 4595 Hungary 4453 2275 2173 2036 1994 1957 Poland 3659 4498 4908 6365 7270 10000 Slovakia 195 251 206 631 356 2075
What Armenia Has to Offer
There have been a number of FDI success stories in Armenia, and the country offers several advantages to foreign investors: • Easy access to CIS and Middle East markets: As a member of CIS, Armenia enjoys
free trade regime with the members and non-discriminatory and easy-access to markets; has a better knowledge of the marketplace, people and business mentality; has greater economic and political integration; historical ties, similar economic basis and level of development; close distances (one-two hours flight to Dubai, Black Sea and Caspian region countries, Greece, Italy, Middle East, Central Asian republics, and Russia); is part of the “silk-road” and “Europe and Asia Gateway”; massive infrastructure building and rehabilitation supports development of Armenia into a connecting and servicing hub for the region.
• The Parliament and the Government are committed to continued private sector
development reforms: Bilateral treaties on investment and investment protection have been signed with over 20 countries; double tax treaties signed with over 10; member of Euro-parliament; in the process of accession to World Trade Organization (much of the requirements for eligibility, e.g. from legislation stand point, are present in Armenia, or are in the process of the implementation), member of World Tourism Organization, and large number of other international organizations and conventions; international accounting standards accepted and implemented; low level of crime, especially organized crime.
• Liberal trade policy and attractive investment legislation: equal rights for locals and
foreigners; a five year guarantee from law changes; strong protection from nationalization, up to ten years tax holidays; 5 year loss carry forward provision, deductibility of most of the business costs; the most liberal economy from trade and currency regulation perspective in the CIS – free repatriation of profits and earnings,
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no withholding tax on dividends; liberal trade regime (0 or 10 percent customs duties levied on ~3 percent of goods); no tax on exports; easy to comprehend legislation.
• Small but strengthening banking sector and stable local currency: single digit annual
inflation rate over four years, exchange rate stable for over 5 consecutive years. • Fast growing economy: over 5 percent average growth rate for 5 consecutive years;
most of the farmland is privatized, over 95 percent of small and 80 percent of medium and large-scale enterprises are privatized; open and competitive privatization procedures and practices, availability of multiple privatization mechanisms, including tenders, auctions, open share subscriptions and direct sales.
• Well-qualified work force with specialized scientific skills: almost 100 percent of the
population is literate; 59 percent completed High School, 13 percent have university degrees.
• Infrastructure: During the Soviet times, Armenia has developed comparatively strong
and diverse industrial base, industrialized agro-sector, and highly advanced scientific base and potential. Although largely deteriorated, some of this infrastructure still presents considerable value and if utilized properly, could serve advance and competitive production needs. The country has integrated energy system (production, transmission, distribution), road and railroad systems, airports, properly functioning, industrial estate that could be used (buildings, equipment, machinery), etc.
• Worldwide diaspora: over five million Armenians live outside Armenia, giving
access to investment and links to international markets.
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Box 3.2: FDI Success Stories HSBC Bank Armenia is the only major international bank in Armenia and one of the country's main foreign investors. HSBC provides a wide range of financial services and has grown steadily since its inception in 1996. The loan portfolio, focusing on well-established and diversified local businesses, has more than doubled in the past twelve months. According to its CEO, HSBC's entry into Armenia was facilitated by tax and other concessions as well as by the stability of the economy and the local currency. HPL is a U.S. investment in software development, servicing INTEL, Microsoft, and other multinationals. HPL was established in Armenia to take advantage of highly-qualified software development specialists, many of whom were graduates or former employees of state universities. Tufenkian Corporation is the Armenian subsidiary of Tufenkian Carpets International, a producer and wholesaler of carpets with production facilities in four other locations, principally Nepal. The company employs over 3000 people in various regions of Armenia. The Armenian subsidiary has become an important design base for the entire operation as well as the fastest-growing unit. Government support took the form of concessions as well as eliminating legislative barriers to exports. Source: Yeghiazarian (2002). Main factors limiting FDI
Apart from being an economy in transition, and being a conflict zone suffering from a continuous blockade from the two of the neighbors, numerous factors hinder the attraction of investment to Armenia. Some of the factors limiting investment in the country are under control and some are out of the control of the Government of Armenia.
Non-controllable factors include, on the international side: • global trends in international investment, in which only a small share of total FDI
goes to emerging markets, and the recent trend toward mergers and acquisitions as opposed to greenfield investments.
• recent recession or slowdown in the major economies, both as a consequence of
September 11 attack and due to general market conditions. • financial and economic crises in number of developing countries, including Asia and
Russia in the late 1990s and more recently Argentina. • general perceptions about the region as a whole, including being part of the Caucasus
(a zone of conflicts) and the former Soviet system. • the landlocked nature of Armenia, the small size of the domestic market, low per
capita income, and a lack of significant natural resources.
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Controllable factors include:
• weak institutional capacity, limited incentives, and the lack of a clear strategy for FDI
promotion. • the lack of a clear separation of responsibilities for FDI promotion among
government ministries (of State Property, Finance and Economy, Trade and Economic Development, Foreign Affairs, etc.)
• administrative barriers for investors and businesses in general – large and very poorly
paid bureaucracy, widespread “red-tape” and corruption, non-independent court system, in general absence of the “Rule of Law”, and an absence of commercial arbitration.
• the high cost of doing business, including costs of business inputs, transportation,
energy, skilled labor, and the brain-drain, especially among younger generation.
Despite these limitations, there have been examples of the successful investment projects that have been implemented in Armenia. The country needs to build on these successes and adopt a new strategy to capitalize on them as well as international experience with FDI promotion. Institutional Framework
The MTED and the ADA are the main bodies responsible for export and foreign investment promotion. The MTED contains within its structure the Notification Agency, which has some limited experience in export promotion; its main function is to liaison with the WTO (see below). In 1994 the MTED was given responsibility for trade representation abroad, but this has not been implemented due to a lack of funds. According to the MTED, there is an acute need to implement trade representation in at least three target markets -- the EU, the U.S., and Russia.
The ADA was established in 1998 by the Government of Armenia to support and attractive business environment and, in particular, to encourage foreign direct investment and promote exports. Since its inception ADA has been unable to fulfill its objectives, mainly due to its limited resources and the absence of a clear mandate and strategy. However, ADA has made much progress during the past 18 months: it has become more visible, and has received stronger Government support and budget.
In the area of export promotion, ADA currently provides only some limited match-making services for Armenian companies with export intentions. It also conducts studies and organizes international trade fairs. However, the vast majority of firms approaching ADA for export assistance are not "export-ready", i.e., they have many business development needs that must be met before exporting becomes a viable option. In fact, most of ADA's export promotion clients are importers seeking information on
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sources of equipment and materials. ADA lacks the necessary information on international markets and market access that would be of use to exporters.
Armenian firms still do not have adequate marketing services. According to the exporter survey, less than half of interviewed exporters (representing 42 percent of total exports in 2001) do not employ specialists in marketing. This hinders both market penetration and the optimization of input supply. The geography of export destinations remains fairly concentrated within a narrow range of countries (see Chapter 2).
In recent years, a number of donor organizations have sponsored programs aimed at export promotion, often within the framework of overall business development. Two operational projects -- the UNDP/ITC Export Development and Promotion project and the World Bank’s Foreign Investment and Export Facilitation Learning and Innovation Loan -- are fully dedicated to export promotion. Both projects, however, are of rather limited size. Also, a number of general business development projects have an export promotion component, such as the USAID Agribusiness Small and Medium Enterprise Market Development Project, the Lincy Foundation Small and Medium Business Development Project, etc. Recommendations
Armenia could learn from the experience of other developing and transition economies and industrialized countries that have been successful in FDI and export promotion -- among them Singapore, Ireland, Chile, Hungary, Slovenia, and others. Applying this experience, the following recommendations could be made:
Clear mandate and strategy. Armenia needs to develop a strategic approach to investment promotion if it is to significantly expand the volume and benefits of FDI. There should be a clear division of labor between the Ministry of Trade and Economic Development (focusing on trade policy and diplomatic representation) and ADA (focusing on specific FDI and export promotion). ADA has some distance to go to develop a clear mandate and strategy, actively supported by the President. The focus should be on reducing the risks and costs of doing business in Armenia by improving the business environment, and offering selective incentives to foreign investors. Performance indicators should be defined and measured to monitor the achievement of ADA's objectives. Donors should support the process through technical assistance, e.g., to promote twinning arrangements with FDI/export promotion institutions in other countries.
Proactive approach. ADA could be more proactive in its promotion of FDI by preparing and promoting specific investment projects, identifying target investors, conducting initial negotiations with investors, organizing investment tenders and facilitating assessment of their results, providing investors with pre- and post-investment support, and assisting investors in dealings and negotiations with the Government. Government contributions in the form of risk-sharing, tax concessions, etc. should be allocated on a competitive basis.
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Board, Management, and Staff. The ADA Board should be independent and
consist of full-time members (some from the private sector) appointed by the President. An international board of trustees could be formed to provide support and representation. Management should have sufficient support from the country's leadership and decision-making power to close deals. In many developing and developed countries, this role is given to the most experienced and well-known individuals -- for example, the agency responsible for the promotion of FDI in Germany is run by the former head of Deutche Bank. Staff should be highly experienced with multinational corporations and international markets, with a significant share coming from abroad. Remuneration should be adequate to attract individuals from the private sector.
Overseas locations and networking. To be where the investors are, ADA should
operate in major FDI source countries, perhaps with the support of the diaspora. Initially, such offices could be located in Armenian embassies. The development of professional associations and networks of Armenian businessmen around the world (using the example of the Armenian Jewelers' International Association) could provide Armenia with the necessary vision, resources, investments, how-how, trade and finance links, access to markets, local capacity-building, and other benefits to accelerate FDI and export development. MTED should design and implement a plan to install trade representatives abroad, supported by technical assistance from donors.
G. WTO accession
Since Armenia’s foreign trade regime is already quite liberal, WTO membership would not result in substantial shifts in trade flows or an increase in foreign competition. However, WTO membership may provide Armenia with other benefits, by: • assuring continuity in the trade regime, thus helping the Government withstand
protectionist pressures. • providing certainty with respect to market access in other WTO member countries, as
Armenia will enjoy permanent MFN treatment with all WTO members. • providing a dispute settlement mechanism as well as active participation in the
multilateral trade negotiations within the WTO framework, giving Armenia opportunities for defending its economic interests.
• contributing to the development of economic cooperation with neighboring countries
which are members of the WTO. • encouraging greater transparency in Government support for domestic industries.
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Progress to date Armenia applied for GATT membership in November 1993. The Working Party on Armenia’s accession was formed in December of the same year and accession activities commenced in the fall of 1994. With the creation of the WTO, the GATT Working Party was converted into a WTO Working Party in 1995. Since then, five Working Party meetings and eleven rounds of bilateral negotiations have been held.
On the Armenian side, the Interministerial Committee on GATT (WTO) Matters was established in 1994. In 1996, a WTO Department was formed under the Ministry of Economy and later moved to the MTED. This department has played an essential role in continuous conduct of accession activities under frequent government changes.
The WTO Notification Center was created in 2001 under the MTED. It is
responsible for fulfillment of WTO notification requirements. International donors, including USAID, TACIS, and the WTO, have provided substantial technical assistance and financial support in the area of WTO accession.
At present, Armenia’s WTO accession process is in an advanced stage. Bilateral market access negotiations on goods and services have been finalized with all negotiating members. The Government has accomplished a set of legislative and institutional reforms to fulfill the requirements of WTO agreements. There are, however, number of legislative and institutional topics yet to be addressed for the completion of multilateral negotiations. Within the framework of its WTO accession Armenia agreed to undertake quite liberal market access commitments on trade in goods, with a 15 per cent ceiling bound tariff rate expressed in ad valorem terms, no specific or compound rates, and no tariff rate quotas. Industrial items were bound individually, while a unified approach was used with respect to agricultural products by binding the tariffs on all agricultural products, with the exception of a few items, at a rate of 15 per cent.
Negotiations on trade in services were concentrated on telecommunications services sector and financial services sector, the former being of particular concern since the Government had granted monopoly rights to ArmenTel. According to Article XVII of the GATT 1994, ArmenTel is conducting state trading. The matter has been finally resolved after the Government agreed to remove monopoly rights by 2013. The Government has undertaken extensive activities to bring legislation into conformity with WTO requirements, especially since the last Working Party meeting in June 1999. As a result of these activities, a large package of legislative acts were passed: • Customs legislation was adjusted to bring it to internationally accepted standards.
Since 1999, the ad valorem principle of charging customs fees was abandoned and replaced with a uniform fee for customs processing plus specific weight related fee for
51
freight inspection, thus ensuring the conformity with the provisions of Article VIII of the GATT 1994.
• The new Customs Code enacted in January 2001 stipulates that the primary method
for determination of the customs value is the transaction value method, and provides for the same six methods of valuation laid out in the Agreement on Implementation of Article VII of the GATT 1994 (Customs Valuation Agreement).
• A major change was also introduced in the tax regime applied to imported products.
From 1993 to 1997, Armenia had been applying the origin principle of charging the VAT and the excise tax on imports, which implied that imports from CIS countries were exempt from these taxes, while import of other origin were taxed. In 1997, in order to meet the WTO requirements, Armenia terminated the origin principle and started to apply the destination principle thus ensuring MFN treatment in the application of taxes to imports.
• Legislative acts adopted in the fields of standardization and conformity assessment
incorporate the core principles of respective WTO Agreements. Definitions of standards and technical regulations in these acts were brought into compliance with respective definitions in Annex 1 of the Agreement on Technical Barriers to Trade (TBT Agreement), i.e. a principally important division was made between voluntary standards and mandatory technical regulations. Legislative acts regulating voluntary and mandatory conformity assessment apply non-discrimination principle as it concerns the treatment of domestic and foreign products and services, as well as the principle of equivalency of the other countries’ regulations.
• Substantive improvements were made also in the legislation regulating the area of
intellectual property rights protection. Non-discrimination principle for resident Armenians and non-residents was adopted with respect to rights and fees for legal protection of intellectual property. Pursuant to the TRIPS Agreement, Armenia joined a full range of international conventions23.
Remaining issues
Negotiations on agriculture have been very difficult. After attempts aimed at getting a developing country status, which was not accepted by the WTO, Armenia tried to negotiate for separate advantages with respect to domestic support. Particularly, Armenia claimed to avail itself of the 10 per cent de minimis provision (an advantage provided for developing countries) pursuant to Article 6.4(b) of the Agreement on Agriculture instead of 5 per cent proposed by Members. Negotiations were also intensive with respect to determination of the level of Base Total Aggregate Measure of Support (AMS), including the methodology of calculations of domestic support commitments as
23 Armenia joined Paris Convention for the Protection of Intellectual Property, Madrid Agreement Concerning the International Registration of Marks and the Patent Cooperation Treaty, Protocol Relating to the Madrid Agreement Concerning the International Registration of Marks, Bern Convention for the Protection of Literary and Artistic Works.
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well as interpretations of relevant provisions of the Agreement on Agriculture. Thus, Armenia claimed to have positive base AMS, and included tax exemptions granted to agricultural producers and credit and input subsidy measures in the calculation of AMS in order to give Armenia more room for maneuvering in negotiations.
Another important issue raised at a later stage of negotiations was the compliance of Armenia’s tax regime in the agricultural sector with the national treatment principle of the WTO set out in Article III of the GATT 1994. The case is that the Government, having limited financial resources to support its farmers, widely applies tax exemptions in the agricultural sector. Particularly, the sales of agricultural products by domestic producers are exempted from the VAT, while imported agricultural products are subject to value added tax. The WTO Members argue that this violates the national treatment principle of the WTO, according to which imported and domestically produced goods shall be granted the same treatment in the domestic market of the importing country. According to the officials of the MTED responsible for WTO accession, a compromise on the agriculture issues will soon be reached. Yet another unresolved issue is the implementation of the Customs Code. As was mentioned earlier in this Chapter, the Customs Committee often uses minimum reference prices for import valuation contrary to the Article VII GATT and the Customs Code of Armenia itself. Also, the somewhat excessive documentary requirements posed on importers make the application of transaction value method (the main valuation method recommended by the WTO) rather difficult. In addition, there are some questionable points related to mandatory certification of products and services to normative requirements. It is frequently claimed that the list of products subject to mandatory certification is too large, and that the inclusion of some products in the list was not justified under the criteria of the TBT Agreement, i.e. they should be included on grounds of health, safety and environment, and appropriate risk assessment on scientific basis shall be conducted for their inclusion. Also, institutional changes are needed for the implementation of the WTO-compliant legislation. For example, the Department for Standardization, Metrology and Certification (SARM) is a state agency responsible for both public and private sector functions. Voluntary standardization should be private sector responsibility and need to be conducted outside the SARM. Also, there appears conflict of interest when some units within the SARM control or assess conformity assessment procedures and other units provide services in testing and certification. A number of important issues are still to be addressed in the of area intellectual property as well, including the development of collecting societies (a significant precondition for due enforcement of the legislation on copyright and neighboring rights), establishing a proper legal mechanism for the implementation of the Law on Selection Achievements, and making certain amendments in the Civil Code in compliance with the Trade-Related Intellectual Property Rights (TRIPs) Agreement.
The adoption of laws and regulations is only a part of accession process; proper
implementation and enforcement of the laws is another. Given enforcement problems with other laws and regulations and the weak institutional state of the judicial system, the
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enforcement of WTO legislation may be quite difficult. Institutional changes, the education and the retention of public sector employees working on these issues may present a major challenge to Armenia. In particular, the scarcity of financial resources, inadequate institutions and human resources may cause disruptions and delays in the implementation process. H. Conclusions
Armenia has a liberal trade regime on both the export and import side and offers rather friendly conditions for foreign investment. Import tariffs are low, tariff schedule is uncomplicated, VAT, though set at a high level, is applied equitably towards imports and domestic output. The same is true for excise taxes, with the exception of tobacco products, where domestic producers enjoy protection. However, problems with the implementation of this liberal trade regime are persistent and severe.
Trade taxation is an important source of budget revenues, accounting for about half of total tax revenues. Within total trade taxes, VAT accounts for 60 percent, excise taxes 25 percent, and import tariffs 15 percent. Exporters are offered exemptions from tariffs on import tariffs and VAT on imported inputs. However, Armenian exporters who use mainly domestically-produced inputs have problems with full and timely reimbursement of VAT on inputs.
The Customs Code of Armenia allows only the import valuation methods accepted by the WTO. In practice, however, the Customs Committee often applies minimum reference prices as an alternative method for the valuation of imports, in contradiction with the WTO rules. Valuation practices leave room for Customs officials to use their discretion in setting import valuations, leading to corruption.
In general, Armenia is offered a reasonably favorable market access conditions in its target markets, with exception for Iran. However, developed countries could do more in opening their markets and improving the preferences offered to Armenia, at least on par with preferences offered to LDCs. It is important to further develop the CIS free-trade zone by removing existing free trade exemptions, streamlining the rules and procedures and addressing the implementation of trade agreements, and improving trade climate. Implementation and trade climate issues are the main problems preventing the CIS from becoming an efficient trade bloc.
Despite the liberal trade regime, the stable macroeconomy, and structural reforms of the past decade, as well as attractive incentives for foreign investors, Armenia has attracted little FDI -- even in comparison with other CIS countries. The problem lies in the implementation of incentives and institutional problems. The MTED and ADA are the main bodies responsible for export and investment promotion. The effectiveness of those organizations leaves much room for improvement. Neither organization has the capacity to provide to prospective exporters comprehensive information on entering new markets or applicable standards and regulations of the target markets. Armenia does not
54
have trade representation abroad. On their side, Armenian exporters do not have adequate capacity for efficient marketing activities abroad. To improve FDI and export promotion, the Government should pay attention to the following: • Clear mandate and strategy. Armenia needs to develop a strategic approach to
investment promotion if it is to significantly expand the volume and benefits of FDI. MTED and ADA should have a clear mandate and strategy, actively supported by the President. The focus should be on reducing the risks and costs of doing business in Armenia by improving the business environment, and offering selective incentives to foreign investors.
• Proactive approach. MTED and ADA could be more proactive in its promotion of
FDI by preparing and promoting specific investment projects, identifying target investors, conducting initial negotiations with investors, organizing investment tenders and facilitating assessment of their results, providing investors with pre- and post-investment support, and assisting investors in dealings and negotiations with the Government.
• Organizational issues. The ADA Board should be independent and consist of full-
time members appointed by the President. An international board of trustees could be formed to provide support and representation. Management should have sufficient support from the country's leadership and decision-making power to close deals. MTED should have full-fledged units responsible for providing information services for exporters.
• Trade representaion abroad. Armenia Trade Representatives should be placed in
major FDI source countries, perhaps with the support of the Diaspora and/or international donors . Initially, such offices could be located in Armenian embassies. The development of professional associations and networks of Armenian businessmen around the world could provide Armenia with many resources to accelerate FDI and export development.
At present, Armenia’s WTO accession process is in an advanced stage. Bilateral market access negotiations on goods and services have been finalized with all negotiating Members. The Government has accomplished a set of legislative and institutional reforms to fulfill the requirements of WTO agreements. There are, however, number of legislative and institutional topics to be addressed yet for the completion of multilateral negotiations, most importantly reaching the compromise on agricultural AMS and eliminating customs valuation methods contradicting the WTO rules. The main challenge in the post-accession period will be the proper implementation and the enforcement of WTO-compliable legislature. The World Bank and other donors should develop a program of technical assistance on WTO post-accession trade policy implementation.
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CHAPTER 4: TRADE FACILITATION A. Introduction
This chapter examines the institutional impediments and potential improvements in the process of importing and exporting to, and from, Armenia. The first section reviews infrastructure issues: transport, telecommunication, and energy. This is followed by an analysis of the activities and role of the Armenian Customs Service. The subsequent section provides an indication of the barriers to trade created by high logistical costs, in turn engendered by bureaucracy, administrative corruption, weak institutions, and poor infrastructure. The chapter concludes with a discussion of potential avenues for improvement, including four key recommendations for the Customs Committee, the potential contribution of a free trade zone, and possible trade and transport initiatives in the South Caucasus. B. Infrastructure Transportation
The geographical location of Armenia, with its lack of direct access to the sea, underlines the importance of good transport links through neighboring countries for international trade. The lack of a formal settlement with Azerbaijan over Nagorno Karabakh, and the historical difficulties with Turkey, means that, at present, the only points of access and egress are via Georgia and Iran. However, once resolved, the location of the country could be advantageous for transit operations between north-south and east-west directions.
The road network of Armenia is relatively well developed, extending to nearly 7,700 kilometers, of which 1,400 kilometers are interstate roads, 2,520 kilometers are regional roads, and 3,780 kilometers are local roads24. The total land area of the republic approximates 30,000 square kilometers, with a considerable quantity comprising mountainous terrain. The density of the road and rail networks is 258 km per 1000 square km and 26 km per 1000 square km, respectively.
The nearest seaport is the Georgian port of Poti, which forms a significant
gateway for Armenian imports and exports. However, the condition of the intervening infrastructure on both sides of the border is poor, with a concomitant impact on transport costs, economic growth and consumer prices.
24 Depending on the source, the data may change: Total road network is 7 700 km, including: 1560 km interstate roads, 1800 km state roads, 4340 km local roads.
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Transport through Georgia is plagued by bribery, theft, and poor road and railway quality. This raises the cost of access to Russia and to the Black Sea ports (including Poti). Iran is under embargo by most of the rest of the world. Removal of the blockades needs to occur before the situation can normalize.
Because border conflicts do not affect air travel, it is the most reliable mode of transportation, but the quality of runways and other air infrastructure is low. The quality of the air terminal in Yerevan is not up to international standards.
All of these factors combine to increase the costs of imports and exports, impacting Armenia’s competitiveness and imposing significant economic losses on the country. Because of the situation in Georgia, trucking companies based in Armenia cannot transport goods to the Black Sea or to Russia competitively. Armenians who are in the trucking business generally operate through companies that they have established in Georgia because the amounts that they have to pay to transport goods are more predictable – it was reported that a truck registered in Armenia would have to pay US$1000 more than a truck registered in Georgia. Even for Georgian-registered trucks, the cost of moving a small container to Poti was approximately US$1000. As a result, transportation problems imply that goods with a high weight to value ratio will struggle to compete and unless goods can be transported by air (or services transferred electronically), time-sensitive exports will not be competitive.
Tables 4.1 and 4.2 provide a summary of the main commodity flows and trading partners, and the mode used to cross the border, for the year 2000. The first table presents the main exports by commodity and destination, and by the mode used when crossing the border. Armenia's exports to its other neighbors are relatively small, and despite a reduction in market share, the FSU countries remain a major market for Armenian goods including, inter alia, brandy, synthetic rubber, and engineering products.
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Table 4.1: Main export commodities by mode at border and destination (tonnes)
Country Ores, incl. salt
Construction materials (incl cement)
Ferrous/ non-ferrous metals
Timber Plastics & rubber
Machinery & equipment
Animal products
Food stuffs
Georgia By road By rail
-
654
1053
48272
19
-
- -
53
-
457
-
155
-
160
-
Iran By road By rail
407
-
- -
22712
-
237
-
136
-
9984
-
- -
- -
Russia By road By rail
920
-
649
70
92
-
55
-
3471
-
2228 1005
15
-
2309 1837
Turkey By road By rail
- -
- -
- -
29
-
- -
62
-
- -
- -
Europe W&S By road By rail
480
26143
-
29980
-
39038
684
-
- -
-
45
- -
43 95
Middle East By road By rail
- -
- -
3352 1784
1276
422
- -
413
33
- -
162 121
North America
By road By rail
-
40
- -
-
1733
- -
- -
14 46
- -
196 667
Source: TRACECA Database
The table illustrates the realignment of Armenian international trade, as Armenia
has been withdrawing gradually from Russian and other CIS markets, while increasing its trade with Western Europe and Iran. The latter buys scrap metal, copper concentrate and electric power (on a swap basis). All export movements by rail, for both imports and exports, are transported by the northern route, via Georgia, together with a significant proportion of consignment movements by road, underlined the importance of that corridor for Armenia, with all the inherent disadvantages in terms of higher transport
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costs25. Table 4.2 presents the main import commodities, by mode when crossing the border, and origin Armenia has increased the shares of imports from the EU and Turkey, and it has reduced the shares from Russia and the CIS.
Table 4.2 Main import commodities by mode at border and origin (tonnes)
Country Oil & oil products
Fertilizers Other chemical products
Construction materials (incl cement)
Ferrous/ non-ferrous metals
Animal products
Agricultural products
Food stuffs
Georgia By road By rail
-
38514
- -
1020
21895
8
1699
205 958
33
-
104 354
91 60
Iran By road By rail
31919
-
- -
14640
-
17038
-
1762
-
18967
-
4035
-
8644
-
Russia By road By rail
738
-
25
-
1739 1389
367 575
5172 2093
965
85
266
25
1491
440
Turkey By road By rail
2
7021
- -
5778
-
2317
-
4609
-
486
-
396
-
2759
24956
Europe W&S By road By rail
108 543
11
-
1455
133
537 782
911 206
3445
642
1041
381
26800 28938
Middle East By road By rail
752
-
- -
6124
-
2060
-
1233
-
3898
-
1230
-
110
37
North America By road By rail
14606 52330
- -
99
182
6
180
21
241
1747
11567
390
90
110
1678
Source: TRACECA Database Telecommunications
After independence, Armenia inherited a relatively extensive but low quality telecommunications network. However, the design of the network was not commercially driven, leading to misallocated lines and low call volumes. These elements combined with politically driven low local tariffs (subsidized by high international call tariffs) resulted in low revenues per line. The outcome was outdated equipment, poor network quality and a slow digitalization rate due to chronic under-investment in the sector. The Government further aggravated the situation by awarding a monopoly (in place until 2013) to Armentel, the local telecommunications company owned by the Hellenic Telecommunications Organization, a Greek company. The monopoly has allowed
25 Polykov, E. (2001), “Changing Trade Patterns after conflict resolution in the South Caucasus” Policy Research Working Paper 2593, The World Bank
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Armentel to provide low quality services at high prices, further hampering growth in telecommunications and related sectors (e.g. IT).
There are currently fifteen Internet Service Providers in Armenia. However, they all have to go through Armentel to connect to the Internet, which results in unreliable connections and a limit on their ability to compete on price. Service is also limited to modem connections only. Therefore, connection speeds are slow. This situation must be improved so Armenia can broaden adoption of the Internet, communicate effectively in the modern world and attract Internet-related application development work from other countries. The government recognizes the need for change - some regulatory changes have been and will be made and they are evaluating the Armentel monopoly. Energy26
Following independence, energy supplies in Armenia were seriously compromised by the closure of the pipeline transporting Russian natural gas through Azerbaijan. After a difficult period during which electricity and natural gas availability was limited to two to three hours per day, energy availability has improved to the point where Armenia now has surplus production of electricity and is exporting relatively small amounts to neighboring countries and has considerable potential to expand electricity exports.
There is no room for complacency, however. Part of the improvement was the result of the reopening of a nuclear power station which Armenia agreed with the EU to close in 2004. (Nuclear fuel is still being obtained at subsidized rates from Russia -- but these subsidies are to be phased out by 2004). In addition, the energy infrastructure is aging rapidly and will need replacing in the medium term, which will require very substantial investment. C. Customs
The most important institution in the trade facilitation process is the Customs Administration, which, rightly or wrongly, usually receives the majority of the opprobrium associated with difficulties, delays and increased costs in trade processes. This attribution is often justified, as Customs is often a major cause of delay and additional costs for traders, reflecting the centrality of its role in the customs clearance procedure, and the fact that it is, generally, the most prominent institution in the chain.
However, the Customs Service can also be unjustly maligned for a number of reasons. Firstly, it reflects the greater visibility of the institution, vis-à-vis the other public sector institutions involved in clearance, some of which can also be considered inefficient, but due to their size, manage to hide their inefficiencies behind those of Customs. Secondly, the Customs Service in many emerging countries can be hampered by a limited or ill-defined Customs Code, a lack of legal basis for its role, or even insufficient information on international norms and standards and insufficient equipment. 26 See Annex 1 for a fuller discussion of the energy industry.
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Finally, the Customs Service is often perceived to be an important source of funds for the state budget, which, through the concomitant pressure to raise funds, can prejudice its relationship with the private sector. An introduction to the organization
The Armenian Customs Service was established on the 4th June 1992, following the atomization of the former Soviet Union (FSU) and the establishment of the Republic of Armenia. The organization now employs 800 staff, within a rigid hierarchical structure, reflecting the military template employed for establishment. The following table presents a number of productivity indices, in respect of the organization.
The organization provided approximately 41 percent of the budget revenue of Armenia in 2001, amounting to 84.9 billion Drams (US$150 million), and it processed 31,697 declarations (import and export)27 in the same year, with an average productivity level of 40 declarations per staff member. This figure is lower than one might expect, with a comparative aggregate figure for the Customs Administrations of South East Europe, being approximately 240. The reason is not, entirely, lower productivity per capita, but a further manifestation of limited export and import volumes, as noted in earlier studies28. There is a minimum number of staff necessary to undertake the routine tasks of a Customs administration, and the low volumes of international trade in Armenian preclude the realization of potential economies of scale.
Table 4.3 reveals, albeit implicitly, that the average salary of members of the Customs Administration is approximately US $96 per month, which is itself twice the average per capita monthly income of Armenia. However, this figure includes not only the salary, but also the peripheral social benefits. It also excludes the additional payments received by every officer from the residual fund, derived from Custom user fees and portion of the tax investigation bonuses29. These payments range from an additional payment of 3x the base salary for officials at headquarters, to 2x base salary for officials at Customs points.
27 Figure provided by the Armenian Customs Administration. 28 The World Bank, (2001) Armenia: Growth Challenges and Government Policies, Volume II: Main Report, Poverty Reduction and Economic Management Unit 29 The Barents Report, (2000), “Report of a Diagnostic Workshop Conducted with the Customs Administration of Armenia”, A report for USAID.
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Table 4.3: Productivity Indices for the Armenian Customs Service
2001 Total Customs revenue (USD) 150,437,780Total Customs cost (USD) 1,598,611Total Customs staff 800Total Customs salaries (USD) 926,337Annual number of declarations 31,697Value of recorded imports (Million USD) 684Value of recorded exports (Million USD) 264Trade volume (Million USD) 948
Armenia
Ratios SEE AverageRevenue collected/Customs staff 188,047 308,668Total Customs cost/Revenue collected 1.06% 1.50%Salaries/Revenue collected 0.62% 0.86%Trade volume/Staff (USD) 1,185,250 2,758,821Declarations/Staff 40 250.43
Source: Customs Committee and World Bank calculations30 Weaknesses in the institutional framework
The Customs Administration, which merged with the tax administration in 1999, has now re-gained its independence as a Customs Committee (CC) reporting to the Prime Minister. The sharing of information, or co-operation between the different administrations, was difficult in the merged organization, but the de-merger has further exacerbated the situation. A number of former tax officials have recently moved to the Customs Committee, to try and alleviate these problems.
The Customs Committee is physically divided between headquarters and the field operational units, which are themselves grouped into four regions, which do not necessarily correspond to administrative boundaries. The Customs Service is regarded as a type of "economic border guard", the first step of revenue collection, but the absence of a comprehensive vision for Customs activities hinders, and may preclude, the Customs Committee from becoming a reliable revenue collection agency and respected interlocutor for the trade community.
A further significant impediment to the modernization and improvement of the Armenian Customs Service is the absence of continuity in management. There have been three different management teams since 1999, and the current senior management has
30 The table displays the basic productivity ratios, as used by the countries of Southeast Europe for establishing regional comparisons. The performance of Customs is comparable to SEE countries in terms of salaries compared to revenue collected. It is above SEE standards in terms of cost compared to revenue.
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been in office for only 8 months, with the majority of middle managers having been in post for less than one year. This institutional instability has a corrosive effect on attempts to improve the administration, often leaving development plans and technical specialists inactive, until the members of the new management team have familiarized themselves with their individual roles and responsibilities. The concomitant changes of emphasis, at the operational end, also engenders confusion in the trading community, and provide opportunities for ‘rent-seeking’ behavior. The legal and regulatory framework
The legal and regulatory framework of the Customs Service of Armenia was defined by the Customs Code of the Republic of Armenia (dated 27th August, 1993), which was developed at the establishment of the service. This code was based on FSU norms, and found, subsequently, to be incompatible with the needs of a member of the international trading community. A revised Customs Code was developed, and introduced on January 1, 2001. This new code was developed with significant external technical assistance, and viewed favorably by stakeholders on both sides of the ‘clearance barrier’.
The form of the declaration is the Single Administrative Document (SAD) format, which is utilized widely elsewhere, and the CIS tariff nomenclature, and will build on the partial application of the ASYCUDA software. Customs collect a processing fee on every declaration, designed to contribute to the administrative costs of the Customs Service. The rate and coverage of the fee is defined in Article 110 of the Customs code, and the details are provided in Box 4.1. Box 4.1: Customs Processing Fee Article 110 of the Customs code provides for the user service fee and its rates: • 3,500 drams for carrying out Customs formalities related to goods through the border. • An incremental fee for inspection and recording of goods (except goods transported by
pipelines and electricity transmission) of: -- 1,000 drams for customs control for cargo under 1 tonne of weight; -- 300 drams for each additional ton or fraction of ton.
• 1,000 drams for each document or form provided by Customs, on a list established by the
Government Clearance procedures
Consignments are generally cleared at inland locations according to a two-tiered process: Vehicles report to the clearance facility (usually a warehouse), while the documents are submitted to the corresponding Regional Customs headquarters. Goods
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are inspected at the warehouse. Box 4.2 provides a detailed description of the requisite steps to clear customs at the main customs house in Yerevan. Box 4.2: The Process of Clearance 1. The consignment enters the (privately owned) warehouse, and the gatekeeper will make a
record of the truck number, and date and time of entry. This is the starting point for incurring warehousing fees;
2. A declaration is filled manually by Customs, signed by the importer, and then verified. Article 134 of the Customs code provides for verification of the elements of the declaration by Customs prior to acceptance. Importers must provide numerous accompanying documents, which include the invoice, a power of attorney, certificates of conformity or quality, certificate of origin, and a certified copy of the corresponding export declaration in the country of origin1.
3. The filing of the declarations is subject to a service fee. 4. All accompanying documents are stamped by Customs and the declaration is registered. 5. A Customs official will then key the declaration into the ASYCUDA system, and the
computer verifies the declaration. 6. Valuation is then checked, but is usually determined by Customs. 7. Computerized selectivity is applied to the declaration, which can be routed down red
(physical examination), amber (documentary checks), or green (immediate release) channels. 8. The documents are taken to the warehouse, where the physical examination and sampling for
analysis take place; the goods are then released. 9. Importers pay the duty at one of the four banks operating at Araratian Customs House. Value
added tax is collected at point of clearance, but may be charged on some goods at the border. At inland locations, importers have 10 days to pay the VAT.
10. The transit document is stamped to allow the truck to leave the country and the goods are released.
The problems with the clearance process
The hurdle of the declaration. The absence of a self-assessment system in Armenia is contrary to international best practice, where the client completes his own declaration. The fact that declarations are completed by Customs officials and extensively verified prior to acceptance can lead to (i) unnecessary delay in processing the imports (allowing officials the opportunity to make an arbitrary decision not to accept a declaration, often with little basis), and (ii) introduces the opportunity for Customs Officers to ask for unofficial ‘facilitation payments’ at a number of stages of the process.
Limited use of selectivity. A risk assessment procedure, involving red, amber and green channels, has been in operation for nearly two years. However, 50 percent of all declarations are still physically inspected, i.e. pass through the red channel. Customs routinely examine every consignment from Iran, Georgia, and Russia, and certain special consignments, such as medicines, which require specialised analysis.
The selection of channel, which is only done by the computer system, is based on the record of the individual importer, and the origin and type of goods. In addition, the
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Regional Director of Customs can switch, with written instructions, declarations to a control circuit. Then, processing stations at both the Customs house and the warehouse are informed of the inspection status. However, little research has been undertaken on the results of risk profiles, and there is no feedback mechanism to refine them. Box 4.3: Endemic Bureaucracy One Armenian food producer is based some 40 km from Yerevan, and exports more than 95 percent of his total production. The size of an average consignment is approximately 150 tons. Current clearance procedures require the company to load the 150 tons of cargo in their own premises, prior to unloading it in the Customs terminal for inspection, before loading it again for transportation. This process was so time-consuming that the company investigated the possibility of arranging inspection on their own premises. However, they discovered that the necessary procedural requirements and approvals to obtain such a service, would actually take more time than maintaining the status quo.
Gaps in basic skills and equipment. Yerevan warehouse, like most of the other warehouses in the country, is privately owned and operated. However, a number of stakeholders assert that it is too expensive, and poorly equipped, engendering delay in the clearance processes. At the same time, the application and approval mechanisms for the establishment of new warehouses is considered to be too restrictive, despite explicit evidence of considerable latent demand, particularly from the importers of pharmaceutical products.
In addition, the examination of consignments tends to be cursory, with an over-reliance on x-ray procedures, while basic skills in examining and identifying goods are lacking. In a recent survey of commercial organizations in Armenia, respondents noted that Customs was the least professionally qualified of all the public sector organizations, and their ethical standing was also perceived to be low, relative to the other agencies31.
The increasing problem of documentation. Although there is a simplified procedure for the clearance of pre-approved goods, importers must, in most cases, obtain a certificate, or declaration, of conformity from the certification agency. All medicinal products must be analyzed at the time of import (which takes between four and seven days to complete). Importers consider certification – which is not managed by Customs – as an increasing source of delay. In addition, stamped export declaration from Turkey and Iran are sometimes difficult to obtain, adding to clearance delays.
A range of clearance times. The perception of procedural delays varies between the administration, which claims that standard commodities can be cleared in as little as 30 minutes (with an average of five hours for green channel declarations), and the business community (delays of up to seven or eight days are quoted, but one day is considered to be the minimum). This may be partly due to the fact that the administration
31 Armenian Democractic Forum, (2001) op cit
65
only estimates the time necessary for the processing of declarations once all documents have been produced and the declaration accepted by Customs, whereas importers take into account the whole chain of procedures, from arrival into the warehouse until the final release. In the absence of just-in-time inventory requirements, the importers apply only limited pressure on Customs for expedited clearance (but there are accelerated procedures for express couriers). Box 4.4: Regulatory Inflexibility One company, registered in Yerevan, had a consignment of goods in Meghri town (some 400 km from Yerevan on the border with Iran). The company reached an agreement to export the goods to Iran, but in order to undertake the transaction, the exporter was required to transport the goods 400 kilometers to Yerevan (to the regional customs house, where the company is registered), to clear customs, prior to transporting the consignment another 400 kilometers to Iran.
The problem of valuation. In contrast to normal practice in many countries, the declaration process is not based on self-assessment (i.e., where the importer declares the goods under their own responsibility, and calculate the amount of duty payable based on the declared value). The Customs code follows the principles of the WTO agreement on Customs value, but most of the time, the law is not applied and minimum pricing is often used, based on company or Customs statistical data.
When transaction values are not accepted, Customs assess the value of imports using the fourth WTO method (sale price on the domestic market of identical or similar goods), thus by-passing two other WTO essential preliminary rules. The resulting discontinuity between the collection of duties (at the point of clearance), and the collection of VAT (at the border) creates a risk of inconsistent valuation, as the declaration and supporting invoice are not normally produced until the goods are cleared for domestic consumption.
Valuation checks are normally performed, in Western countries, as part of a post release audit of import declarations, but in Armenia: (i) Customs have limited powers of control once the goods have been released,32 and (ii) the Customs valuation unit in headquarters is understaffed and so does not have the resources to keep statistics of valuation uplifts and offenders, and has lost, since the separation from the tax administration, access to essential information on company activities. When there is a valuation dispute, Customs will allow the conditional release of the consignment (with security corresponding to the disputed amount of duty). While this procedure is internationally accepted, it can easily be diverted, and allows the possibility of ‘informal’ agreements. In addition, there is no penalty for under valuation, because the importer can blame the supplier for the ‘false invoice’. This forms an incentive to commit frauds, as importers know, that even in the worse case scenario, they will only have to pay the legal rate of duty.
32 Although changes in the legislation to allow this activity have been proposed.
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The issue of inadequate enforcement
The modest physical size of Armenia means that informal networks are a frequent avenue for dispute resolution, with most differences of opinion between Customs and traders settled outside of the regular procedural mechanisms, and, as a consequence, there is little or no use made of the judiciary in dispute resolution. Under the law, smuggling is a criminal offence, and penalties vary between 200,000 and 50,000 Drams (approximately US$ 400 and 100), based on the value of the goods. However, enforcement is weak. Customs have no real power of investigation inland, and there is no post clearance capacity to review transactions once the goods have been imported. Although this is acknowledged to be a constraint on revenue collection, and Customs enjoys reasonable cooperation with the police and the border guards, the Government has not, so far, supported the introduction of post release investigations.
However, this appears crucial considering (i) the level of informal imports (up to 30 percent of total foreign trade transactions) which end up in domestic shops with little or no control over possible abuse of traveler allowances or the quality of the product, (ii) the number of cases of misclassification reported by Customs, and (iii) VAT compliance issue, for which joint audits between Customs and the tax administration are essential. Present cases of under declaring or tariff misclassification are mostly detected at the border, but it is probable that more sophisticated frauds would not be found until a declaration and appropriate documents are filed, thus even more justifying post release checks. To address this problem, a specialized Customs anti-smuggling department was established, which reports directly to the head of the Customs Committee. This department has the authority to investigate any declarations from the exit of a clearance terminal, and re-examine the consignment. However, it is not clear whether the rationale for this department is to detect import violations or instances of corruption. The problem of Customs Brokers
The office of the Customs Broker was established under articles 68 of the Customs code, although most importers, excepting diplomatic missions and a few international companies, prefer to use dedicated employees. The law allows the granting of a license to any individual who has passed the Customs Brokerage courses, and the associated exams. The licence is provided for up to three years, subject to participation in additional regular training.
There are fourteen brokers registered currently in Armenia, with their fees ranging between US $30-100 per declaration. The Customs Committee has recently initiated regular meetings with brokers to discuss their problems but still does not provide sufficient tools (such as software for preparing the application and declaration in advance) to operate in a more time-saving manner and since the brokers sign the customs declaration (which is filled by the customs authorities) they can be held responsible for any potential inaccuracies or discrepancies.
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The problem of border markets
A local free trade market was established in 1993 on the Armenian-Georgian border near Bagratashen village, where the Debed River forms the border. The market actually straddles the river, with a pedestrian footbridge providing the link between the two sides. The market was established to try and regulate the informal trade of agricultural goods and foodstuff between the populations of the borderline regions of the two neighboring countries. This has grown significantly, taking advantage of the difference between the respective Customs regimes on the respective sides of the border, and was engendering a number of concerns; the importation of goods, subject to mandatory certification (especially food), which are not certified and other low quality, occasionally counterfeit, goods.
A more substantial concern relates to certain traders transporting large import consignments to the Sadakhlo market, and the nearby districts, prior to splitting the consignments and crossing the border in small quantities, avoiding customs duty and value added tax. The Customs Committee has undertaken some monitoring of the cross border trade, as revealed in Table 4.4:
Table 4.4: Revealed Demand for the Bagratashen Market
Number of Transport Means Day of Week
Big Bus Small Bus Pass. Car
Number of Passengers
Tuesday 110 99 392 3654
Tuesday 70 12 70 2000
Wednesday 50 15 70 1500
Thursday 10 23 47 220
Tuesday 84 23 20 2500
Wednesday 16 10 30 300
Source: Data from the Armenian Customs Service
The monitoring suggests that, on average, 1695 persons are involved, on a daily
basis, in the trade (mainly importation) in this zone. These flows make it impossible to apply the limit regulations set forth in Article 105 of the Customs Code of the RA. This regulation states that the duty free accompanying baggage weight should not exceed 50 kg, while its overall customs values should not be over than dram equivalent of USD 500. If one makes the conservative assumption that, on average, each individual imports 20 kilograms, then the annual import volume would approximate 8-10,000 tonnes. The official estimate is that 22 percent of this total is fraudulent, which would imply that the lost revenue, in Customs duty and VAT33 approximates US $5.6 - 7 million.
33 Assuming a generally applicable rate of 20 percent VAT and 12 percent customs duty.
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A lack of accountability
The efficient facilitation of international trade requires an effective Customs Service, where the incentives provided to staff, and users of the service, encourage compliance, and are sympathetic to the strategic objectives of both the Customs Service and the Government of Armenia. The current incentive structure in Armenia is, at present, primarily negative, engendering ‘rent-seeking’ behavior on the part of officials.
The Armenian Customs Service collected US $150 million in revenue in the year 2001, as revealed in Table 1, or an average of US $187,500 per employee. The average official salary of an Armenian Customs Officer is approximately 45,000 Dram (US $81) per month, as mentioned earlier, which despite being approximately double the average per capita income, is only US $1.70 per day above the defined absolute daily poverty line34. This provides a strong incentive for officials to seek ‘unofficial gratuities’35 from the trading community for ‘efficient processing’. This assertion is underlined by the finding of the same survey36, which noted that Customs was perceived by enterprises to be the most corrupt of all the public sector organizations.
By contrast, there were 31,957 declarations in 2001, with a total value of US $948 million, suggesting an average value per declaration of approximately US $30,000. The payment of an unofficial gratuity of US $50- 100 per declaration, is less than 1 percent of the average value of each declaration, providing a strong incentive towards payment.
The eradication of these practices is a difficult and challenging process, but the initial requirement is to reverse the incentive structure, thereby providing strong negative incentives to both parties to refrain from the practices. On the recipient side, the traditional approach has involved reform of the public sector, with increases in salary and the introduction of training and the introduction of an ‘ethics’ code to counter corruption. This was one of the recommendations of an earlier study37, but in the subsequent Government Decree38, this had been replaced with ‘the implementation of a review mechanism of Customs officers’ behavior’.
On the provider side, the current incentive facing the trading community also needs to be reversed. One potential mechanism could be the introduction of an effective sanction, such as making such behavior a criminal offence, with a concomitant financial penalty for proven violators of sufficient scale, that would, if not reverse the incentive structure in all cases, act as a deterrent to engaging in such behavior.
34 Armenian Democratic Forum, (2001) “The report of the sociological survey on public sector reform (for Households)”, A study undertaken for the Government of the Republic of Armenia and The World Bank 35 Which is how these payments are regarded by the trading community in Armenia. 36 Armenian Democratic Forum (2001) op cit 37 The Barents Group (2000), “Report of a Diagnostic Workshop Conducted with the Customs Administration of the Republic of Armenia”, A Report for USAID 38 The Ministry of State Revenue of the Republic of Armenia, (2001), “To ensure execution of measures subject to implementation and confirmed by RA Government Decision N310, On measures of Customs Administration Reform, dated 16.04.01”, Decree dated 04.05.2001
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A lack of consultation
The lack of adequate consultation between the Customs Committee and the trading community is a problem noted by a number of studies39, with one recent survey of enterprises in Armenia noting that Customs was the least accessible of all the public sector organizations40. The Barents Report (2000)41 proposed the introduction of regular consultation between the Customs Committee and the trading community, and proposed in the Decree of the Ministry of State Revenue, dates 16.04.0142.
This recommendation has yet to be implemented in the desired form, However, in January, 2002, the Customs Committee passed an order, (number 02/03 of the 25th January, 2002) requiring all heads of the departments, and the heads of all regional customs departments and customs houses, to be available every Friday, from 16.00 to 18.00 pm, to answer questions from interested parties on changes in customs legislation, provide clarifications on relationship with customs authorities and other issues, and about necessary steps for starting foreign economic activity to the beginner enterprises. The efficacy of these arrangements is as yet unknown. D. Logistical Costs
One of the most important impediments to the integration of Armenia into the international trading community is the total logistical cost of consignment movements both into, and out of, the country. The total logistical cost of moving a generic consignment includes, the "pure" transport costs for both the domestic and international legs of a consignment movement, the official and unofficial facilitation costs, again by journey stage, the costs of accessing the requisite information, and those costs engendered by diseconomies of scale due to low volumes of international trade or the small size of the domestic market. The national elements of the total logistical cost, despite often only representing a small part of the total logistics chain, can add a considerable amount to the total logistical costs of moving consignments.
39 COWI, (2000) “Trade Facilitation in the Caucasus”, A Report for the World Bank and The Barents Group, (2000) Ibid, inter alia 40 Armenian Democratic Forum, (2001) The Report of the Sociological Survey on Public Sector Reforms (for Enterprises) A Study conducted for the Government of the Republic of Armenia and the World Bank 41 The Barents Group, (2000) op cit 42 The Ministry of State Revenue of the Republic of Armenia, (2001), op cit.
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Box 4.5: The Impact of High Logistical Costs on Exports Bjni Mineral water is located in Charentsavan city of the Kotayk Marz, RA., and is the legal successor to a former Soviet enterprise. In 1997-1998 the plant was re-opened by SIL Bgi and French Castel company and in 1999 production was resumed, and the company produces Bjni Mineral Water, Noy spring water, Jino and Las Vegas lemonades in 0.5 and 1 liter glass and plastic bottles. The company sells in the domestic and, increasingly, international market, reflecting the high quality of the products. In 2001 the company’s total sales were worth 300,000 US dollars, of which 15 percent were exports. The company’s products are also sold in Turkey, Europe and UAE. However, the potential market is much broader and there are a number of current initiatives to enter new markets, particularly the Russian and FIS markets. Despite the obvious potential of the company, at present, only 40-50 percent of the full capacity is being utilized. The main obstacle to further expansion of export volumes is the relatively high sale price of the products, reflecting the lack of current volumes, and the concomitant inability to realize potential economies of scale, and high transportation costs.
A recent survey among international freight forwarders tried to identify the logistical friendliness43 of individual countries, or how “easy” or “difficult” individual countries are perceived to be from a logistical point of view. The concept of logistical friendliness ( or unfriendliness) refers to the ease (difficulty) of arranging international freight operations to/from a particular country. The “friendliness” and “unfriendliness” should be seen as two different concepts (constructs) rather than opposite ends of the same continuum.
The survey was conducted in November-December 2000 by approaching 60 different freight forwarders through e-mail. Among other questions, each respondent was asked to rate a set of pre-determined countries as to what extent he/she perceived the named country as logistically “friendly” or “unfriendly”. The countries included in the e-mail questionnaire were based on the 90 countries included in the Corruption Perception Index (CPI) collected by Transparency International and Goettingen University44. Countries with the lowest level of perceived corruption were assigned 10, whereas countries with highest level of perceived corruption were assigned 1. The results are presented in Figure 4.1.
The combined indicator for logistical friendliness in the survey is the percentage of the responses, which stated that a given country was either logistically “friendly” or “unfriendly”. Hence, the percentage for Armenia (11 percent) indicates that one respondent out of nine viewed Armenia as a “logistically friendly” country, whereas eight did not. One respondent out of six rated Azerbaijan as “logistically friendly”, whereby its
43 Murphy, P.R. and Daley, J.M. (1999) "Revisiting logistical friendliness: perspectives of international freight forwarders", Journal of Transportation Management, Spring 1999, 65-71. 44 see: http://www.gwdg.de/~uwvw/
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value became 17 percent. By comparison, all the respondents regarded Russia as logistically unfriendly; consequently, that country’s ranking is 0 percent.
Figure 4.1: A Ranking of Countries in the Logistics Friendliness Survey Against Corruption Perception Index, 2000
The results are only indicative and somewhat anecdotal, since they are based on a small number of responses (nine for Armenia and six for Azerbaijan), all of which are highly subjective assessments based on hands-on experience. However, despite the somewhat skewed distribution of the respondents, the small number of respondents, and the highly simplified concept used, the results show a striking correlation between the logistics friendliness and the CPI. This is a strong indication that the less perceived corruption there is in a country, the easier it is to trade and arrange logistical practicalities.
The logistical costs of a movement are not just the direct monetary costs, but also involve additional expenditures of time, to physically pass the border, and undergo the associated procedures, and to, eventually, clear customs. The total time and money expenditures represent the total logistical cost of the consignment movement. The different expenditures can also, through the choice of an appropriate metric, be converted into commensurate terms, and termed the ‘generalized logistical cost’ of the movement.
The study collected a considerable amount of information vis-à-vis the time and cost expenditures associated with actual, and generic, consignment movements in the three South Caucasian countries, to provide an indication of the relative size of the different elements of generalized logistical cost. The following section provides the
0 %
1 0 %
2 0 %
3 0 %
4 0 %
5 0 %
6 0 %
7 0 %
8 0 %
9 0 %
1 0 0 %
0 ,0 1 ,0 2 ,0 3 ,0 4 ,0 5 ,0 6 ,0 7 ,0 8 ,0 9 ,0 1 0 ,0
L e a s t c o r ru p t
C o rre la t io n c o e ff ic ie n t = 0 .7 8 4
"L o g is t ic s m o re fr ie n d ly "
A z e rb a ija n
A rm e n ia
E U c o u n tr ie s
T y p ic a l fo r m e r S o v ie tR e p u b lic s
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official and unofficial money expenditures, associated with the movement of a generic commodity between Northern Europe and Yerevan. Official and unofficial costs
Box 4.6 provides a breakdown of the official and unofficial fees at each step of the required process in the importation of a generic consignment. The time expenditures could be converted into commensurate terms, via the use of an appropriate metric, to provide an indication of the generalized logistical cost of the movement. However, this would require the specification of the consignment, and the inclusion of the trade related costs, such as insurance, pilferage and delay costs. These have been included in the example, for reasons of clarity.
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Box 4.6: The Official and Unofficial Costs of Importing At the border. Any consignment arriving at the Armenian border by truck is sealed at the Customs point, at which point the carrier must pay for highway and environment taxes. For a truck with a carrying capacity of 20 - 30 tons, the tax amounts to about US$250. The law requires this fee to be paid in Armenian Dram (AMD), but if the driver has insufficient AMD, he must use one of the few currency exchange offices on the border, where the exchange rate is about AMD 500: US $1, whilst the official exchange rate is about AMD 580: US $1. If this tax were allowed to be collected at clearance, in the regional customs house, it would save the carrier US $35 per truck. Simultaneously the Customs officers will fill in transportation documents. This step usually requires a unofficial payment in the range of US$30-50. After these steps, the Customs officers will telex, or telephone, the Customs house to advise of the cargo passing the border and the approximate date/time of arrival to the Customs terminal. At the terminal. Customs officers will undertake an external inspection of the vehicle and the condition of the seals, prior to weighing the former. Where certification is required, the representatives of the certification bodies will take samples for testing, and the process will last for 1-2 days (with a longer period for medicines), and the official fees will be US $60, depending on the precise number of goods to be tested. This step also usually requires an unofficial payment in the range of US$50 – 100. At the Regional Customs House. The next step involves the completion of the preliminary declaration in the regional customs house. This step usually requires an unofficial payment within a range of US$2 – 10. The following stage involves the valuation of the declared goods. If the goods are subject to the customs duties and VAT and if the required documents are not presented the invoice method for the identification of the customs value will not be used and the customs value and the duty and taxes adjusted accordingly. The importer will also usually pay an informal fee within the range of US$30 - 50, although the stage can be negotiated without this payment. For goods that are not subject to the Customs duty and VAT, the Customs Value usually is calculated as equal to the invoice price. After making all the payments, the Customs officers in the terminal will carry on the inspection and release of the goods. The inspection might be of the following types: through, if the red line is selected; medium, if the amber line is selected; or no inspection or external, if green line is selected. The selection of the line is automatically done by ASYCUDA system. This step also usually requires an informal fee of approximately US$20-50. • The services provided by Customs officers at the terminal are subject to the official payment
of about US$20-30 in rare cases the official payment is higher. The informal fee is usually around US$20. The consignment can then be transported to the customer’s premises.
Source: data collected during the course of the study
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The total logistical cost of a generic consignment movement
Table 4.5 presents a breakdown of the time and official and unofficial monetary expenditures associated with the import of a generic containerized consignment from Northern Europe to Yerevan. The table reveals the significance of the national and regional elements of the total logistical cost, despite their modest part in the total logistics chain.
Table 4.5: The logistical cost of moving one TEU from N. Europe to Yerevan
by road or rail, via Poti (2002 prices)
Road Rail
Expenditures Cost (US $) Time Cost (US $) Time
Official Unofficial Hours Official Unofficial Hours Transport & handling
Terminal to final destination Handling charges, terminal Handling charges, Poti port Armenian transport leg Georgian transport leg Ocean leg45
50 50
175 375 920 925
10-20
500
2
3-4 24-48
5-6 10-15
480
50 50
175 175 190 925
10-20
5
2
3-4 24-48
8-9 15-20
480
Cross border processing Border guards Customs inspection Highway, environmental taxes
250
10
30 – 50
5-6
30 – 50
96-120
Clearance procedures Terminal fees Declaration completion Valuation Inspection
25
20
2 - 10 30 - 50 20 – 50
1 1 1
2-3
25
20
2 - 10 30 - 50 20 – 50
1 1 1
2-3 Total logistical cost
2770 602-710 532-562 1590 92-205 633-689
Source: study data
The table reveals the Georgian leg of the movement, on the road mode, accounts for nearly 40 percent of the total costs, with the Armenian leg accounting for 27 percent and the leg between Poti and Northern Europe accounting for the remaining 33 percent. The total unofficial fees amount to between 22-25 percent of the total costs, whilst the Georgian leg is responsible for over 85 percent of the total unofficial fees and nearly 20 percent of the total costs, due, primarily, to the demands of the traffic police.
On the rail mode, the unofficial fees amount to between 6-13 percent of the total cost, but the time expenditures for the land-based legs increase markedly. This is primarily due to the delay at the border, despite a formal agreement between Armenian Customs and the Armenian State Railway Company that delay should be restricted to a
45 Assuming 20 days from Poti to Rotterdam.
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maximum of 5 hours for cargo wagons, and 3 hours for passenger trains. The reality is that the delay averages 4-5 days, engendered entirely by the Customs procedure detailed above, that requires a Customs official at the border to send a telex to the regional customs house to confirm cargo and delivery time.
E. Recommendations
Box 4.7 summarizes some of the current initiatives in trade facilitation in Armenia and the South Caucasus region. Despite theses initiatives, there is still an urgent need to formalize the reform agenda for Customs. The following section presents four key areas where substantive reform is considered to be overdue.
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Box 4.7: Current Facilitation Projects in Armenia Anti-Corruption IDF grant. The purposes of the Grant are to strengthen central government capacity for coordination and policy development and to put in place a consultative and transparent process for formulating and monitoring the implementation of an anti-corruption strategy involving government, civil society and development partners. The activities for which the Grant is given are as follows: (a) provision of assistance in strengthening the capacity of the Office of Government of Republic of Armenia to develop and oversee implementation of an anti-corruption strategy; (b) provision of support in institutionalizing the civil society involvement in the development, implementation, and monitoring of an anti-corruption strategy including analysis of results of survey of service delivery/corruption prepared under PHRD Grant Agreement (TF ) and publishing the results of said survey; (c) provision of support in developing of a draft anti-corruption strategy and its public dissemination to promote public discussion of the strategy; (d) provision of assistance in preparation of recommendations to the Government of the Republic of Armenia based on discussions on the draft strategy; (e) provision of support in developing of indicators to measure the implementation impact of the anti-corruption strategy. Armenia Public Sector Modernization Project. The project will support the government in the reforms of the public sector aimed at improving the efficiency, effectiveness and integrity of the public sector. It is envisaged to have 4 main directions; i) civil service reforms, ii) institutional strengthening of high priority ministries and agencies iii) e-governance iv) strengthening public expenditure management and accountability. Foreign Investment and Export Facilitation Project. The objective of the project is to examine the effectiveness of different promotion and facilitation mechanisms to attract foreign investment and facilitate export. The project will benchmark appropriate performance and success measures against the norms and outcomes experienced by other similar investment and exports promotion agencies, and will seek to learn lessons from experiences elsewhere. Lessons will also be learned through work to improve the business and investment environment in Armenia, initiated as result of the project and triggered by more effective interaction between the Government and private sector. WTO Accession and EU PCA Implementation Project. This project was commissioned by GTZ and TACIS with a budget of USD 2.8 mill, and started in April 1998 with implementation ongoing. The project consists of the two major stages: In the first stage, the Project was operating within the structure of the Ministry of Industry and Trade and was physically located within the Ministry building. The primary objective of the first phase was to assist in the accession of Armenia into WTO. The project also provides infrastructure support to the overall accession process involving the establishment of a free access library, with books, magazines, journals and articles related to both WTO and general international trade issues, the translation of WTO norms and provisions and Armenian legislation, and the launching a comprehensive web site, with the detailed information about the legal and policy aspects for the integration of Armenia into international organizations. Harmonization of Border Crossing Procedures. This project was commissioned by TRACECA in November 2001, with a budget of Euro 2 million, and scheduled for implementation over a period of 24 months in all the signatory countries, including Ukraine and Moldova. The objective of this project will be to harmonize procedures within the region, and to align them with EU practice, and the emphasis of the project will be on the identification and implementation of new procedures.
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Reform of the Customs Committee
There is little doubt as to the willingness of Customs staff to improve operations. Corruption does not seem to extend beyond the receipt of ‘unofficial gratuities’46, although the corrosive impact of even modest levels of administrative corruption has been noted elsewhere47. Overall, the background for reform appears to be good. However, reform is urgent now that the cross border traffic is still low, since with the eventual re-opening of the Turkish border, the current operating procedures will no longer be sustainable, and could lead to a fall in revenues.
Adequate consultation. An earlier section detailed the recommendations, and concomitant proposals, to establish consultation procedures between the public and private sector, and noted the order of the Customs Committee (number 02/03 of the 25th January, 2002) requiring all heads of the departments, and the heads of all regional customs departments and customs houses, to be available every Friday, from 16.00 to 18.00 pm, to answer questions from interested parties on to inform about changes in customs legislation, provide clarifications on relationship with customs authorities and other issues, and about necessary steps for starting foreign economic activity to the beginner enterprises. The efficacy of these arrangements is as yet unknown, but, a priori, a formal consultative committee, which could organize regular meetings between the Customs Committee and the trading community, would be a preferable modality.
Simplification of customs procedures using ASYCUDA. Present customs procedures are complex and time-consuming. The process is prone to errors and reflects old work habits and an ingrained suspicion that the importer will try to cheat to reduce his tax liability. While there is some truth to this suspicion, there are alternative ways to deal with this problem while at the same time facilitating transactions. Partial solutions are: • Introduce ASYCUDA system on a wider basis, with the target of fully utilizing the
capacities of the system. This would introduce greater transparency, reduce bureaucracy and the opportunity for ‘rent-seeking’ behavior; and
• Introduce more widespread use of selectivity in customs control, possibly combined with greater penalties for fraud and endeavoring to ‘influence’ the decision of public officials.
Improve customs valuation practices. Correct customs valuation of imports is a
crucial element in the determination of duties and taxes due on imports. The valuation practices in Armenia are handicapped by the absence of reliable data on the value of previous or similar imports, the widespread use of de facto reference prices, the practice of under invoicing and of relying on negotiations between custom officials and importers. A strategy to improve current valuation procedures would be multi-pronged:
46 For example, there is no evidence of consignments being allowed in with no control. 47 The World Bank (2000) “Anticorruption in Transition – A Contribution to the Policy Debate”, Washington D.C.
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• Introduce a series of random post release audit of import declarations, with the concomitant changes in legislation to introduce such changes.
• Develop the resources and capacities of the Customs valuation unit in headquarters, to ensure that they are capable of maintaining an adequate statistical database of valuation uplifts and offenders, and undertake the associated inspections.
• Introduce a penalty for under-valuation to increase the negative ‘incentive’ of fraud, or false invoicing, placing the onus on the trader to ensure that the invoice is ‘true’.
Organization, staffing, and resources for customs department. The effectiveness
of customs would be enhanced by:
• The maintenance of stability within the senior management for a defined term, to address the issues associated with ‘short-termism’ and institutional instability, that were discussed earlier.
• Clearly redefining the responsibilities of the various levels in the customs hierarchy,
specifying operational targets and monitoring progress. • Establishing a comprehensive training program for the staff and making successful
completion a condition for promotion. • Prepare an Ethics Code – inspired by the Arusha Declaration of the World Customs
Organization – to be signed by all customs officials. • Establish an internal disciplinary board to punish any violations of this Code as
recommended in the Barents Report.48 Possible Free Trade Zone
A range of options. Although free trade zones are generally considered to be "second-best" solutions to more widespread liberalization of the economy49, there may be a case for establishing them as temporary solutions to trade facilitation problems in Armenia. There are several options:
• the traditional free-trade zone (FTZ) or export processing zone (EPZ): a defined,
usually secure, piece of land, which contains production, display or storage units, and importation to which is free of domestic taxes and duties.
• local free trade zones, or border markets. These tend to be informal affairs, which
have generated a momentum of their own, and which can be formalized in due course. The best known international examples might be those border towns and villages, such as Andorra and Cervigno, on the borders and France and Spain and France and Italy respectively, which offer duty-free shopping to visitors.
48 The Barents Report, (2000) op cit 49 Dorsati Madani, (1999) “A review of the role and impact of export processing zones”, The World Bank
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• more traditional bonded or customs warehouses. This type of facility can be defined
as a secure warehouse, with customs officers on site, where consignments can be stored, free of domestic duties and tax.
• the logistic or distribution center, which is generally located in a particular place to
maximize the logistical advantages of a particular location vis-à-vis another location. These centers represent the optimal point, within a given geographical and institutional framework, for the distribution, or importation and distribution, of a particular commodity or commodities. They can have a bonded warehouse on site, dependent on whether the intended market is national or international.
A sample of private sector organizations, encompassing freight forwarders,
importers, and exporters, indicated a considerable degree of latent support towards the introduction of a range of modalities, including free trade zones to logistic centers. However, the widespread support for the former was qualified, with a number of stakeholders expressing reservations that the establishment of such a facility could be exploited by sophisticated businesses to avoid paying legitimate duties and revenues, and reducing the overall amount raised for the state budget. A secondary concern was that the usage of Free Trade Zone could be restricted to a small group of so called “privileged” (with links to specific political groups or cliques) businesses, whose use of the facility would merely increase their competitive advantage vis-à-vis their smaller and less favored competitors.
By contrast, the support for the establishment of bonded warehouses and free customs warehouses was widespread and unqualified. The latter is a recognized regime in the Customs Code of the Republic of Armenia, as detailed in the following text box, and they can be established and operated by both State and private businesses, and depend only on the permission of the Chief of the Armenian Custom Service. However, there are, currently, no free customs warehouses in Armenia and the regime has been used rarely.
The main impediment to the introduction of such a regime is institutional, reflecting the importance of the revenue raised from customs duties and taxes for the state budget. The lack of stability in the position of Chief of Customs has engendered a certain short- termism in the judgment process, as a particular head is unlikely to take a decision that will have an immediate negative effect on total revenue, because that is the criteria by which he is judged, even if the long-term outlook for revenue is more positive, by increasing total import volumes. This position is doubly unfortunate, as it also precludes traders from realizing potential economies of scale in purchasing and transportation, thereby ensuring higher prices for the Armenian consumers.
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Box 4.8: Free Customs Warehouses Chapter 9 of the Customs Code of Armenia and the “Law on Licensing” of the Republic of Armenia, governs the establishment of warehouses and the storing of goods, and lists them as being a licensed activity. The legislation defines a free customs warehouse as a building, or group of separated buildings or open territories, where the goods, which have been declared under the regime of "importing to free customs warehouse", can be stored without customs regulations. They can be established by individuals in Armenia, according to the provisions set forth by the Law and with a License issued by the State Customs Committee under the Government of Armenia. Article 45 of the Customs Code of the RA also defines the appropriate "importing to free customs warehouse" customs regime. For goods declared under this regime, no other payments, excepting payments for customs formalities are to be paid. Any goods that are imported under this regime can be exported from the territory of the Republic of Armenia under "exporting for free circulation" or "re-exporting" regimes without any customs payments and with no tariff regulations used. Industrial zones initiatives
The Industrial Zones Initiative is a collaborative project between the Government of Armenia and the World Bank about creating an industrial zone in Armenia. The initiative was established during the course of a series of meetings over the period 2000-2001, following a similar successful initiative in Moldova.
The World Bank suggested that an invitation should be extended to a firm of consultants from Moldova, to allow the latter to share their positive experiences in creating industrial zones. By the end of the last year, the Ministry of State Property Management prepared a new "Company reorganization" pilot program, which is planned for implementation with Japanese assistance allocated for the preparation of business communication program. The main goals and problems pursued by the "Company reorganization" program are: • Reorganization of inefficient industrial giants into profitable ventures (through
various reorganization procedures, which could include separation of small and medium companies, creation of industrial zones, liquidation, sale of equipment to create new companies, etc.).
• Reorganization of newly privatized enterprises and those, subject to privatization, development of general entrepreneurial and management knowledge, improvement of business environment and development of the industrial sector.
• Retraining of local managers and consultants, which will take leading positions in the reorganized companies, will actively participate in the important decision making process and will later become the main element of the management system in the industrial sector.
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• Provision of inflow of foreign direct investments, creation of preconditions for the development of small and medium businesses, provision of new work places.
• Estimation of demand for the reorganization services, training of consultants in the enterprise reorganization sector, and an assessment of need for a ‘Marshall Plan’ in Armenia, together with an indication of its scale.
During the pilot program, the plan is to reorganize three companies, to serve as a
template for further projects of this kind. These would also become the basis for the creation of an Armenian Reorganization Agency. Regional Trade Facilitation Initiatives
A possible approach to customs reform is contained in the proposed Trade and Transport Facilitation in the South Caucasus (TTFSC) initiative, modeled after a similar initiative in Southeast Europe (TTFSE)50. The objective of the TTFSC is to promote trade by reducing the physical and institutional barriers to consignment movements, thereby promoting economic development and alleviating poverty. The initiative builds on a number of earlier studies51, and contains a series of concrete measures to enhance regional co-operation and implement ameliorating strategies.
The TTFSC includes the creation of a number of "Pro-Committees" in each of the
countries in the South Caucasus. The committees benefit from a membership drawn from both the trading community and the public sector organizations involved in trade. Their overall objective is to improve dialogue between the different bodies involved in trade, to try and realize real improvements at an operational level, and hence achieve significant reductions in the costs of clearance or border crossing. One of the potential responsibilities involves the production and distribution of a handbook, detailing the procedures relevant to traders and international transporters in the region, supplemented by a shared information database, based on existing sources, and a supporting regional web site displaying all information requirements. In Armenia, the Pro-Committee includes representatives from the following institutions: Union of Manufacturers and Businessmen, Association of Armenian Freight Forwarders, Customs Committee, Ministry of Transport and Communications, TRACECA, Staff of the President, National Assembly, American Chamber of Commerce, Ministry of Trade and Economic Development, and Transparency International/Center for Regional Development.
Another common element is the introduction of regular performance measurement related to the processing time at border crossing points and clearance terminal from the user perspective. This enables a significant increase in awareness among border agencies, which suddenly realize their consolidated impact on users. It
50 see http://www.seerecon.org/RegionalInitiatives/TTFSE/ for details 51These studies are detailed, and available for download at http://lnweb18.worldbank.org/eca/eca.nsf/d1e666886eb626e2852567d100165168/a8bc15c7cda92faa852568f80060ee86?OpenDocument
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also provides management with an incentive to consider facilitation issues in addition to its traditional revenue collection function.
A further element of TTFSC involves the establishment of an independent arbitration service, or ‘Ombudsman’, in each of the three countries. The primary responsibility of the office of the Ombudsman is to protect individuals against the violation of rights, abuse of powers, error, negligence, unfair decision and poor administration by the public sector. The ombudsman usually has powers to make an objective investigation into complaints from the public about the administration of government. Often the ombudsman may also have powers to initiate an investigation even if a complaint has not been registered. To protect people’s rights, the Ombudsman can have various powers: • to investigate whether the administration of government is being performed contrary
to the law or unfairly. • in the event of improper administration, to make recommendations to eliminate
improper administrative conduct. • to report on his activities in specific cases to the government and the complainant,
and, if the recommendations made in a specific case have not been accepted by the government, to the Legislature.
• to make public an annual report of their work.
The ombudsman usually does not have the power to make decisions that are binding on the government. Rather, the ombudsman makes recommendations for change, as supported by a thorough investigation of the complaint. A crucial foundation stone of the ombudsman office is the independence of the office from the executive/administrative branch of government to ensure that any investigations and recommendations will be perceived as independent and credible. The precise relationship between this institution and the Pro-Committee in Armenia has not yet been defined, but a priori thoughts suggest that the former will form an instant point of redress in times of difficulty, whilst the latter, or more likely a sub-working group will identify a sustainable solution, for subsequent introduction.
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CHAPTER 5: THE BUSINESS ENVIRONMENT AND ENTERPRISE FINANCE A. Introduction
This chapter will examine the effect of the Armenian business environment on the traded goods sector and in particular, foreign trade. Because of Armenia’s small economy and the large share of foreign trade relative to GDP, in most cases the factors that impact firms engaged in foreign trade impact the private sector more generally. As a result, many of the foreign trade issues raised will be virtually indistinguishable from those that arise from the more general business environment.
The first section of the chapter looks at some of the economy’s characteristics and outlines issues arising from privatization. It then puts issues of market size into perspective and examines the trade structure implications of high transport costs and other transportation difficulties. The chapter also analyzes the institutions that underlie the private sector including the financial system and property rights for movable, fixed and intellectual property. By examining the legal basis for contracting the implications for the conduct of business, especially foreign trade, are revealed. Finally, the relationship between the private sector and the state is considered, with a focus on such issues as regulation, tax collection and customs procedures and tentative recommendations regarding promotion of the private sector generally and foreign trade in particular are made. In the appendix, an analysis of the most promising Armenian industries is presented along with summaries of each of those industries and a recommendation of industries for future focus and expansion.
B. Characteristics of the Private Sector
Armenia’s economy on the one hand is unique but on the other is typical of small economies throughout the world. Many of these characteristics, however, make it difficult for the economy to compete effectively internationally. Among the most important are: • Limited domestic market. Most firms are small because entrepreneurial
opportunities are hindered by the limited size of the domestic market. Estimates of the Armenian population range from 2 million to 3 million52 -- not large numbers. But whichever number is accurate, there can be no doubt that extensive emigration continues to erode the supply of skilled labor and the size of the local market. The substantial immigration has resulted in many potential innovators leaving the country. In addition, the low per capita GDP results in very low purchasing power, further reducing the size of the domestic market. With some notable exceptions, the small
52 The former number comes from approximations based on the number of telephone users while the latter is based on census data.
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size and isolation of Armenia limits the development of new knowledge and technology.
• Problematic environment for foreign investors. Small firms, which cannot realize
economies of scale, are generally not attractive business partners for foreign investors, particularly because the nascent nature of capitalism in Armenia makes cooperation of this type unfamiliar. In addition, certain laws governing business formation provide poor incentives for joint ventures, an issue that is discussed in greater detail below.
• Geo-political issues. The blockade raises the costs of transporting goods and
increases the costs of doing business. • Monopolies. Small economies often result in local monopolies. Monopolies have low
productivity that is exacerbated by government intervention. In Armenia, the classic example is maintenance of telephone monopoly (Armentel) by the government.
• Limited entrepreneurial skills. Participants in the private sector often lack
entrepreneurial skills because they could not be developed during the country’s participation in the vast centrally planned Soviet system. Armenian entrepreneurs, therefore, are still struggling to develop the skills to compete with imports and penetrate export markets. As a result, the private sector lacks the capacity to adjust to the removal of trade barriers without substantial assistance in making the transition. In addition, the country does not have a tradition of markets, selling campaigns, contracting and customer service so that potential foreign trade opportunities are often missed.
• Loss of human capital. The loss of human capital from Armenia has been driven by
its economic situation but created a vicious cycle as the country looses its precious labor resource – a key foundation for its comparative advantage. Loss of computer specialists in particular has also been encouraged by the need for those skills in countries (such as the U.S. and Germany) where per capita incomes are higher. Furthermore, the military service required of young Armenians has exacerbated emigration of those who potentially form the core of programmers and system analysts for the computer industry.
• Labor supply issues. The combination of low wages, compulsory military service,
and emigration creates a situation where demand for labor with specific skills exceeds supply, yet there is an excess supply of well-educated workers. The risks inherent in the local business environment has also discouraged investment in the general training of employees by employers.
• The Soviet legacy. Armenia also has problems that intensify the disadvantages of a
small economy stemming from its participation in the former Soviet Union. Many of them relate to the fact that industries had been located in Armenia on the basis of planning criteria that took no account of comparative advantage.
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Box 5.1: Cyprus and Mauritius - Successful Small States Like Armenia, Cyprus and Mauritius have small territories and populations. Cyprus has a surface area of 9,300 square kilometers and a population of 753,000 people while Mauritius has 2,000 square kilometers and 1.2 million people. Despite their small size and limited natural resources, Cyprus and Mauritius have achieved remarkable economic growth and excellent social indicators – a track record that over time Armenia could emulate. These outcomes were achieved by ensuring macroeconomic stability, being oriented to exports and open to foreign investment, exploiting international market niches, and providing social services to the entire population—especially the poor. Both countries lack natural resources, cannot exploit economies of scale, face high transportation costs for imports and exports (especially Mauritius with its geographic isolation), like Armenia, experience natural disasters (earthquakes in Cyprus and cyclones in Mauritius). Yet Mauritius has become a major exporter and Cyprus has developed tourism, financial services and transportation to the point where non primary exports dominate both countries trade. By adopting prudent fiscal and monetary policies and flexible exchange rate policies, aggressively pursuing foreign direct investment (Mauritius), participating in the EU Sugar Protocol (Mauritius), exploiting textile preferences for EU and U.S. markets, emphasizing education (Cyprus), building physical infrastructure, promoting the rule of law and inspiring confidence in the judiciary, fostering democratic institutions, promoting public-private partnerships, and encouraging entrepreneurship. Over the past 25 years real annual GDP growth in both countries has averaged 6 percent, resulting in per capita income of $13,000 in Cyprus and $3,800 in Mauritius in 2000. Social indicators have also improved. There is virtual full employment and absolute poverty is rare. In addition, both economies have increased their non-primary exports’ share of total exports. The share of non-primary exports—predominantly financial services, transportation, and tourism—from Cyprus skyrocketed from 13 percent in 1965 to 96 percent in 1996. In Mauritius non-primary exports—mostly textiles—jumped from 14 percent in 1975 to 76 percent in 1997. Another indicator of the transition to a service-based economy, is the development of tourism on both islands - Cyprus’s 1997 tourist arrivals exceeded 2 million and Mauritius reached 500,000. C. Privatization At independence, Armenia inherited an economy that had a structure that was the result of decisions based on central planning criteria. As a result, the country was left with a haphazard agglomeration of industries that were not situated in Armenia on economic efficiency grounds. The most important of these was an extensive group of manufacturing plants serving the Soviet military industrial complex, particularly making components for the construction of nuclear submarines. Many of these plants were not suited for conversion to peace-time production. Therefore large-scale restructuring and a massive reallocation of resources was necessary against the background of an economy that did not have the institutions to support the long-term contracting and risk management that such resource shifts require. Given the necessity of the restructuring process, the war, the closing of borders, the energy cutoff by Russia, hyperinflation and the lack of institutions it is not surprising that GDP declined precipitously. The recovery of the growth rate over the past few years can be viewed as a positive sign that the
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necessary adjustments are underway, although much remains to be done to make the business climate more conducive to private sector activity.
Unlike many countries that undertook large-scale privatizations, privatization in Armenia did not generate much interest from foreign investors. In many cases, former managers ended up being the major shareholders of the newly privatized companies. Usually they possessed good production knowledge but their skills at formulating coherent business plans as well as their abilities to market and sell their products were severely deficient. A disadvantage when a company no longer has centrally defined “markets” and “clients.”
Following privatization, further problems arose because of the small size of the market in Armenia, the dilapidated equipment of these companies and the expense of transporting the products produced by heavy industry. (See below for a discussion the high costs of transportation.) As a result, many privatizations were not successful – a majority of the some 1500 joint stock companies that were privatized are now bankrupt. (Export of scrap metal from the defunct factories forms a significant part of exports.)
Another legacy of the previously centrally-planned economy was that the former Soviet Union was the prime customer for Armenia’s exports Most Armenian companies did not know to whom they were shipping their products. Even so, the economic collapse of Russia following independence combined with the shift in consumption and import patterns in Russia meant that Armenia lost the purchasers of its goods and it has struggled to find replacement markets. In addition, the capital stock of the companies still to be privatized is by now worth little. The standard operating life of equipment in industrialized countries rarely exceeds 7 years and is often shorter than that. Any companies that remain under government control are unlikely to have many valuable assets .
D. Property Rights
Property rights governing movable, immovable and intellectual property are generally poorly protected in Armenia. The result is that fixed property purchases are not financed (although fixed property is used as collateral against loans), movable property cannot be used as collateral for business borrowing, and intellectual property is weakly protected (a disincentive for foreign investment in Armenia’s software industry.) Fixed Property
Immovable property (real estate) in Yerevan and other towns was privatized after independence and privatization certificates were issued. These are converted into registered title upon sale or exchange of ownership. The state guarantees compensation in the event of faulty title having been issued, but not necessarily to the holder of the title. Since the compensation is not based on market value, banks are reluctant to finance property purchases using the title as security. In addition, banks do take real estate as collateral for business loans but treat it as movable property for the purposes of
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evaluating security. They also require that real estate collateral is a minimum of 200 per cent of the value of the loan, which greatly raises the risk of failure for the entrepreneur. Movable Property
While a detailed discussion of issues involved in reforming the secured transactions framework is beyond the scope of this chapter, suffice it to say that movable property is not effective as collateral against loans. Floating pledges are not allowed and there are no registries that allow pledges to be perfected. Repossession is time consuming and costly. A particular problem for financing exports is that use of future production as collateral is not allowed. Therefore, financing against export orders is not feasible. A similar problem arises with imports because there is no provision for pledging goods that are not in the possession of the borrower – goods that are being imported, even though they have been paid for by letter of credit, cannot be seized in the event of default. The inadequacies of the collateral framework extend to the farming sector, which impacts food processing. Since it is not possible to borrow against the value of future crops, investment in an industry which appears to have substantial potential is hampered. Box 5.2: The Case of Vanishing Processing Equipment A producer of tomato paste in Armenia saw export prospects in the canned tomato paste market. He purchased processing equipment from a foreign supplier on credit using the equipment as collateral. Payoff was scheduled over a 5-year term. Although the first few payments were made, the producer began to encounter problems from the outset of operation. The tomatoes that were used were not of international quality and as a result, sales were slow. In addition, a large surplus of Chinese canned tomato paste were sold on international markets at prices that were lower than the Armenian producer’s production cost soon after production began. As a result, the producer was unable to meet his payment obligations on the equipment. However, when the equipment supplier moved to repossess the machinery, he found that the tomato paste producer had sold it to another company. Since there was no way for the new purchaser to determine that the equipment had been pledged as security, he vigorously opposed the suppliers attempts to repossess it. After two years of fruitless efforts in the Armenian courts, the supplier sold the debt to an Armenian company at a large discount – the new owner of the debt continues to pursue it in the courts. Intellectual Property Although the Armenian government has indicated that it is committed to enforcing intellectual property protection, the system is governed by several laws and enforcement is generally weak. In the software industry, piracy is a common problem. While the size of the market is sufficiently small that losses are not great, weak intellectual property protection is a factor that could discourage foreign investors in the software industry. In addition, Armenian law prohibits employers from owning their employees work product. Instead, they are allowed to use it without paying for the right (even if the employer and employee sign an agreement that states otherwise.) Use of the work product, however, is limited to ten years after which the company must purchase the rights from the employee - an arrangement that deters foreign investment. While the rule is enforced only sporadically, copyright laws are also poorly enforced, a further deterrent to development
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of the industry because revenue from software sales is negatively impacted and recouping development costs becomes difficult. E. The Legal Basis for Contracting
When contracts are entered into it is important that the legal basis for those contracts is as transparent as possible. However, this situation does not exist in Armenia. There are numerous problems with the contracting environment including: • Contract enforcement. A legal system in which long term contracts can be made
and enforced. The commercial code is an agglomeration of civil code laws with several overlays.
• Transaction regulations. Many regulations governing business transactions are not
in place. • Legal code translation. Most laws are not available in English, which is a severe
discouragement to foreign investment and joint ventures since many foreign companies are unable to have their attorneys independently verify the judgments of local lawyers - an increased risk for contracting in Armenia. The same applies to the implementing regulations for virtually all the laws governing commercial transactions.
• Opaque legal rules. There are some subtle rules that affect contracting. For
example, contractual agreements are based on an “unless otherwise governed by law” provision rather than an “unless otherwise stated in the contract” provision. Since many commercial transactions are subject to a wide range of laws, rather than a more unified commercial code, this provision requires full knowledge of all the laws and regulations that may apply to an agreement. These complexities compound the lack of legal code translations.
• The role of notaries. The role of the notary needs modernization. Currently notaries
are government employees and are required to validate most contractual documents and procedures are antiquated and slow. Notaries also act as judges and determine the validity of documents (and in many cases insist on preparing the documents). Consideration should be given to privatizing notaries with the proviso that there be competition and that a maximum fee schedule be set.
• The role of arbitration in contract negotiation. Arbitration procedures are used in
Armenia - although they are not widespread features of contracts. While the methods are said to work, in the case of contracts which contain penalty clauses or which allow for repossession of goods, arbitration procedures are less effective because there is no allowance for pre-arbitration attachment. As a result, many feel that the court system provides better protections.
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Box 5.3: Notary Discretion A leading attorney in Yerevan was conducting negotiations on behalf of a foreign client regarding an investment in Armenia. The client gave the attorney a general power of attorney in terms of which the documents pertaining to the transaction could be finalized. When the final contracts together with the power of attorney were presented to a state notary, they were rejected on the grounds that the power of attorney, while valid, was too far reaching and should not have been signed in the first place. As a result, the transaction was delayed several weeks and substantial additional costs incurred while new more limited powers of attorney were drawn up and couriered back to Armenia. F. Doing Business in Armenia53
There has undoubtedly been progress in improving the business environment in Armenia over the past few years. The government has made its commitment to reducing barriers and constraints to doing business known and has implemented some positive steps which are reflected in the results of recent business surveys. Nevertheless, the country has some distance to go before it could be described as “business friendly.”
Many private sector participants in Armenia operate in ways that would be unusual in industrial countries. As is common in many countries with weak institutions, facilitation payments are frequently used as a means of ensuring that dealings with the public sector proceed without undue delay. However, unlike other countries, the system has so far not degenerated into one where massive corruption is pervasive. Rather it has evolved into one in which interlocking obligations, arising from favors and interventions, govern much of the interaction within the business community as well as between businesses and the legal system. A person who acts to intercede on behalf of another is known in local slang as a roof, and the benefactor incurs an obligation to return the favor in one form or another at some point in the future. There appear to be few rules that cannot be modified or adjusted through the intervention of a roof even within the judicial system. It is also noteworthy that foreign investors often do not have the network that would provide them with a roof. So foreign investors frequently have more difficulty navigating their way through the various bureaucracies and judiciary - an issue that has been mentioned in all the Armenian foreign investment surveys conducted.
As a result there is a dichotomy between the foreign investors view of the business environment and those of local investors. The latter appear to have established channels through which they can work relatively comfortably, although not in ways that would be usual or acceptable in a modern market economy. The former, on the other hand, have to deal with the delays and frustrations that are inherent in a system characterized by non-transparent and irregular business processes. And the larger the company, the more such practices are anathema and a disincentive to invest in Armenia.
53 This section draws heavily on: “Regulatory and Administrative Costs Survey, Final Report.” World Bank, September 2001; “Armenia, Growth Challenges and Government Policies, Volume II,” World Bank, November 2001; and “Armenia, Administrative Barriers to Investments.” FIAS, November 2000
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Foreign investors site a number of barriers to doing business effectively: inconsistent application of laws and regulations, poor institutional capacity, and suspicion of private sector activity.
Successive World Bank sponsored surveys have documented changes in key transactions costs (Table 5.1). They show that while the cost of doing business in Armenia is coming down, costs remain high by international standards, especially when considered against the background of a per capita GDP of little more than US$50054.
Table 5.1: Transactions Costs
Cost (US$) Time (Days) Startup Costs 102 21 Registration 489 18 Licensing 260 51 Permits Annual Admin. Costs Import Operations 18770 14 Export Operations 949 8 Product Certification 243 8 Cost of Other Reporting 294 Average no. of inspections/yr. 6 Cost of dealing with inspections 1763
The results of the surveys support information obtained from more informal interviews. It appears, for example, that export operations are generally low cost and relatively quick. The data show, however, that the same does not apply to imports, which are both costly to administer and incur longer delays.
The World Bank survey also investigated the various costs incurred by companies in different sectors, with different ownership structures and of different sizes. One of the striking findings was that joint ventures were singled out for inspection most frequently.
It is important to note that the Armenian Government is taking steps to try and reduce some of the costs associated with doing business. For example, in July 2000, a new law came into effect that limits the number agencies and times that a business can be inspected. It also gives businesses the right to know why they are being visited as well as the likely duration of a visit. In addition, the business can ask the head of the agency whose officials are visiting for an explanation of the inspection.
54 Armenia’s per capita GDP was US$503.6 in 2000. Source: Armenia Economic Trends, Issue: 2001Q3 p. 10
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Company start-up. Starting a formal company in Armenia is relatively costly, amounting to substantially more than the per capita GDP. Table 5.1 gives some detail of the costs involved from recent survey data55. The most recent cost was estimated to be approximately US$850 for registering, licensing and obtaining permits for starting up a company. There are also numerous and complicated steps that are necessary to complete the process. Many of the companies interviewed cited licensing and registration as difficult and time consuming. They also indicated that it was necessary to make “facilitation payments” to expedite the process. Reform efforts are underway and progress is being made but this issue remains a significant barrier to doing business. In addition, foreign companies find the process opaque because of the lack of availability of information on the laws that apply and the regulations are only available in Armenian, a factor that was referred to in an earlier section. Such opinions are supported by surveys in which managers of foreign companies report that they spend about one fifth of their time dealing with regulatory and tax issues.
Customs. Many importers, particularly foreign investors, cite customs delays and practices as being a major irritant (see Chapter 4). Among the most common complaints is the use of reference prices unless extensive documentation accompanies shipments56. If any of the documents are missing, then customs apply reference prices to the shipment, a practice that is contrary to WTO rules. The problem of reference prices is compounded by the relatively high VAT rate (20 per cent) and the extreme difficulty in obtaining drawbacks of VAT payments upon the export of any goods that use imports as inputs.
Regulation. Regulation continues to be an issue in Armenia, but progress is undoubtedly being made, as the results of surveys on regulatory burdens in two consecutive years have indicated. (The issues have become less severe.) Nevertheless, business owners report that government officials looking for extra-legal payments visit them regularly. This practice is particularly pervasive for businesses who are not protected by “roofs” - most foreign companies. While the payments are relatively small, the nuisance value of such visits is high and is a strong disincentive for foreign investors.
G. Foreign Direct Investment and Business Practices
Given the embryonic state of market-oriented entrepreneurship in Armenia, foreign direct investment (FDI) provides a means of introducing modern business practices to the country. Such investment can occur from companies with established brands that enter Armenia to take advantage of local profit opportunities as well as companies that seek to utilize the country’s inherent comparative advantage to export products or services. Examples of the former are such well known consumer products as Coca Cola and the HSBC Bank, while examples of the latter are HPL – a company which
55 See World Bank 2000 Regulatory and Administrative Costs Survey; Armenia, Final Report for a detailed breakdown of the costs and time required for registering and licensing businesses in Armenia. This survey also contains comparative results on business environment issues, the first undertaken in 2000 and the second in 2001. The findings indicate that there is an improving trend in many areas although significant problems remain. 56 Importers are required to present original documents, including the invoice, the contract covering the import, the certificate of origin and an export declaration from the country of origin.
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develops software for computer chips -- and the companies involved in diamond processing. Such investment, especially by multinational firms can play a vital role in training and educating individuals in business processes. It gives employees valuable business know-how, experience, and technical expertise, as well as exposing them to work ethics, business practices, and codes of conduct necessary for the effective functioning a modern economy. Foreign investors attempt to comply with laws and regulations, implement environmental standards, generally pay higher wages than local companies, and give those who deal with them, either as customers or as suppliers, exposure to market-oriented business transactions and legal documentation. Over time, this experience will develop a core group of people who support reform and the development of institutions that underlie the functioning of a market economy. Foreign investors also identify the particular failings of the bureaucracy and legal system and pressure the government to reform these institutions.
Foreign investors in Armenia have the potential to be a dynamic force on the forefront of the push for change. If the goal of legislative and institutional reform is to attract FDI to Armenia, it is important that the government pay close attention to the specific concerns of foreign investors and their advisors. They are placing their own resources at risk and are able to identify specific risks and problems relating to their investments as well as the exact legislative framework changes needed to facilitate FDI and address foreign investor concerns. Once their investment is made, a list of specific complaints usually arises which, if rectified, would greatly facilitate the success and continued viability of their investment. The emphasis of reform efforts should be on the details - the specific and often mundane changes that need to occur.
“Foreign investors are also extremely efficient and effective in providing training and transferring know-how. The impact of investors such as McDonalds in training thousands of young people throughout the region has been much more meaningful and had a much greater impact on the process of creating the appropriate cultural framework for institutional reform than any series of lectures, training videos, or reform programs ever can. 57”
The foreign investment regime in Armenia is open. There are no restrictions on ownership or investments and no prohibitions on the repatriation of profits. The Armenian Development Agency has established a “one stop shop” for foreign investors with the aim of making the process of investing in the country more accessible (see Chapter 3 for more on foreign investment promotion). However, foreign investors, and those who deal with them, still report that the system remains opaque and complicated to navigate given the intricacies of starting a business. The previously discussed issues of opacity of law and regulations, the difficulty of joint ventures, the problems dealing with customs and other branches of the public sector, the high cost of telecommunications and the remoteness of the country and its resulting high transport costs all make it difficult for foreign investors to operate. In addition there are reports that corruption remains a significant problem. A further problem is that the budgetary and trade imbalances, as well as the size of the foreign debt are obvious and foreign investors could be 57 John Hewko, Does the Rule of Law Matter? Carnegie Endowment. Number 26, April 2002
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discouraged from investing in a country that needs to offset the inordinate role aid plays in financing the balance of payments. The largest share of foreign direct investment comes from Russia, Greece (presumably from the investment in the telephone company), and the United States. H. Enterprise Financing
Financial markets in Armenia are severely underdeveloped and finance neither local production nor foreign trade effectively. Much of the banking system is dollarized with some 90 per cent of deposits and nearly 100 per cent of loans being denominated in dollars58. Figures 5.1 and 5.2 show the level of financial market development in Armenia compared to other countries at various stages of development59. Even by the standards of low income countries – those with per capita incomes of less than $1000 – the ratio of credit to the non-government sector is low – only one fourth that of the average credit to GDP ratio in other low income countries.
Figure 5.1: Credit to the Non-Government Sector/GDP
58 Many ATM machines are set up to dispense either dollars or dram. 59 For the countries in the sample, the chart is based on the ratio of credit to the private sector from deposit money banks and other financial institutions. For Armenia it is the ratio of credit to the non-government sector. There was a sample of 47 countries. High income countries are defined as countries where GDP per capita in 1999 was higher than US$10,000; Upper middle income countries are defined as countries where GDP per capita in 1999 was between US$3,000 and US$10,000; Lower middle income countries are defined as countries where GDP per capita in 1999 was between US$1,000 and US$3,000; Low income countries are defined as countries where GDP per capita in 1999 was lower than US$1,000. Source: International Financial Statistics Database and World Development Indicators Database.
0
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Armenia
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Figure 5.2: Interest Rate Spreads
In spite of the low amount of credit to the private sector, there does not appear to be an excess demand for loans. On the contrary, at current rates of interest, there is an excess supply of loanable funds – bankers interviewed indicated that there was a serious shortfall in “bankable projects.” They indicated that many people with business ideas approached them but that either the underlying collateral or the business plans were seriously deficient in most cases. Risks associated with requests for loans were sufficiently high as to discourage banks from lending. Rather, they lowered deposits rates, reducing their cost of funds, and placed money in lower risk securities such as foreign government bonds. For example, the largest bank in Armenia lends only 5 per cent of its liabilities to private business, compared with 60 to 70 per cent of liabilities in other countries in which it operates. This situation can be partially explained by the high interest rate spreads between borrowing and lending rates - they average over 10 percentage points. In the 1995 – 1998 period, interest rates were substantially higher than those in low-income countries. In the 1999 – 2001 period they have decreased, with spreads around 10 per cent. For reasons that are outlined below, however, the decline cannot be attributed to an improvement in financial market development.
The primary source of funds for lending to the private sector are credit lines, currently totaling some US$80 million, from various donors, including the World Bank and the EBRD (see Annex 3 Table A3.12). The World Bank is the largest of these donors with three separate programs that have allocated US$21.5 million. To put the size of
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95
these credit lines in perspective, the total local lending of the largest commercial bank in Armenia is US$6 million, although it has US$40 million in assets that could be lent to local borrowers. Other commercial banks have similarly substantial balances from deposits that are not lent. Most of the credit lines specify the range over which loans may be given and both the interest rates to borrowers and the terms of the loans. The effect of these credit lines appears to have segmented the credit market. Loans using donor funds require weaker collateral, less well-developed business plans, and are made at much more favorable terms than those using local funds - loans using local funds are typically made only if the borrower can offer gold as security. The excess supply of deposits has resulted in deposit rates declining sharply while the spreads between borrowing and lending rates remain high.
With nearly 30 banks operating in Armenia, the banking system is overly fragmented as there are too many banks to be efficient. Consolidation will occur as the higher capital requirements of the Central Bank of Armenia are introduced over the next 5 years but in the meantime the Central Bank has been providing funds to support banks in difficulty, delaying weak banks either going out of business or being bought out.
There are a number of micro credit organizations operating in Armenia, most of which are donor funded. As with the credit lines for commercial banks, many of the donors specify the term, size and price of the micro loans. Some of the commercial banks are also making micro loans using their donor credit lines. There were reports, however, that in some cases, the NGOs running micro credit institutions using donor funds have not fostered a culture of repayment resulting in substantial bad debts.
Financial activity in the foreign trade sector itself is limited. Some importers do use the banking system to raise letters of credit but the practice is not widespread. There is little export financing and the practice of using irrevocable letters of credit to provide funds for fulfilling export orders appears to be non-existent. As a result, the financial system does not support the growth of trade. Essential skills in raising letters of credit are confined to a small number of banks and before exporting under letters of credit can occur, training in the minutiae of the procedures will be required for most.
Other financial market issues include:
• Bank training. Many banks lack personnel with the ability to evaluate proposals
from prospective borrowers. • Borrower training. Most prospective borrowers do not have the ability to prepare
business plans and financial documents to support loan applications for their businesses. One of the large banks, in conjunction with USAID, has prepared instructional material on what banks generally require to process business loan applications effectively but it will take considerable education to foster this ability.
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• Paternalistic lending practices. There were also reports that donors approach financial institutions to make loans to companies due to products that the donors feel have potential. They ignore the core business activities of planning, production, marketing, and selling that are essential for successful sale of the products in foreign markets.
I. Donors and the Private Sector
On a per capita basis, donors are more heavily involved in Armenia than in any of the other country of the former Soviet Union. The combination of official development assistance plus remittances has exceeded foreign direct investment by a substantial margin. Furthermore, gross fixed capital formation is languishing – it is less than the combination of aid and FDI - implying that a substantial amount of the inflows are being used to finance imports or capital flight and unless these flows continue the underlying external disequilibrium will be exposed. In addition, donor funding is affecting the real exchange rate, which in turn impacts the competitiveness of Armenia’s exports.
Figure 5.3: Official Development Assistance
Figure 5.4: Official Development Assistance Per Capita
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Figure 5.5: ODA and Private Transfers Per Capita J. Policy Implications
The analysis confirms that there is no easy fix and there are several elements must change, which will take time and effort by the Armenian government. The most important of these are: • Increase efficiency in the telecommunications sector. The Armentel monopoly is
imposing high costs in sectors that have the potential to modernize the Armenian economy - IT-related businesses. This is an issue that needs to be confronted soon, if hopes for this sector are to be realized.
• Establish property rights for all types of property. Land and buildings, movable
assets and intellectual property rights are weak in Armenia, which is damaging foreign investment, and holding back the development of the financial market. Property rights policies need to be reformed urgently, including the reform of secured transactions, so property rights can be strengthened. The property rights issue requires careful review to determine the exact measures that need to be taken and the priorities for change. Since all of these issues require legislative action, the involvement of the government and the legislature at an early stage is advisable.
• Reform company law. Company law needs to be reformed to ensure that minority
rights are protected. In addition, the law of contracts needs to be reviewed to bring it into line with modern best practices. The advisability of government and legislature involvement outlined in the previous point also applies.
0
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CHAPTER 6: TRADE AND POVERTY A. Introduction
Armenia faces some unique as well as more standard challenges with regard to economic growth and poverty reduction. With a little over a decade of economic reforms, the nation still faces widespread poverty and has one of the most unequal income distributions in the region.60 Rural households are turning to subsistence agriculture, which in turn is hurting growth, while urban households are faced with high rates of unemployment. Furthermore, the persistently high unemployment rate is contributing to unusually low rates of participation in the labor force, underemployment and high rates of migration. Another unique observation about Armenia is the significant role of transfer income coming through remittances,61 foreign aid, benefits and pensions (comprising as much as 45 percent of household income). The links between this high dependence on non-productive sources of income and the labor market are interesting. Some of the more standard challenges confronting the Armenian economy include the strong link between unemployed household heads and poverty; the transition following independence from “Soviet-centered” production to more market based production, as in the other CIS countries; and in particular, the difficulties in creating jobs despite growth.
This chapter analyzes poverty from a trade perspective and assesses the short-run
impact of trade policy changes on income distribution using the ILCS 1998/99 household survey for Armenia. The literature on the impact of trade on poverty62 has identified the following five major mechanisms through which increased trade openness affects the poor: (i) by impacting prices of goods and services the poor consume and produce63; (ii) by affecting the demand for and returns to factors of production that the poor have to offer, such as unskilled labor; (iii) by having an affect on government revenues and the resources available for antipoverty programs; (iv) by influencing the potential for economic growth, which in turns affects poverty; and (v) through design of social protection mechanisms designed to cope with likely transition costs and the possible increased volatility of growth coming from the opening up of markets (G-8 Genoa Summit, July 2001). Here, we focus on three of these mechanisms: the change in relative prices of goods consumed/produced by the poor, change in the demand and returns to factors of production the poor have to offer, and the potential change in overall growth in the economy.
60 World Bank (2002). 61 Throughout this chapter, remittances are used to represent both private transfers from the Armenian Diaspora and workers’ remittances coming from Armenian nationals working abroad temporarily. 62 Some notable references include Nicita et al. (2002), Reimer (2002), World Bank (2001), WTO (2001), Cagatay (2001), Dollar and Kraay (2001), and Winters (2000). 63 Changes in policy where the products become cheaper will make the net consumers of that product better off while policies leading to an increase in the prices of a good will benefit the net producers.
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More specifically, we simulate the effects of the proposed recommendations for trade expansion such as improvements in infrastructure and in the institutional problems regarding the customs, as represented by (i) a decrease in the price of wheat (an imported good produced by the rural poor and consumed by the urban poor), (ii) a reduction in transportation costs, and also (iii) an increase in the cost of irrigation. The simulation results suggest that a fall in wheat prices significantly increases the welfare of the urban households, and especially of the poor, while rural areas lose marginally. It is also shown that decreasing transportation costs lead to an increase in the welfare for all households, while an increase in irrigation costs primarily affect the poor and do so in an adverse way. Finally, our preliminary analysis shows that the existence of large transfers (remittances, benefits, pension, foreign aid) leads to greater unemployment by increasing the reservation wage. This is a very striking observation that requires further investigation.
A comprehensive study of the trade impacts on poverty would require either
comparable household data sets from several years, a Computable General Equilibrium Model, or ideally a combination of these. Furthermore, a more in-depth analysis needs to be done on the employment aspect of the trade expansion in specific industries, as unemployment is a major issue in Armenia and is also a major determinant of poverty. A rough analysis, given below that is based on existing industry studies suggests that jewelry/diamond processing, information technology, and agriculture/food processing hold the greatest potential for export expansion and job creation. Ideally, household survey data can be used to quantify this job creation aspect of trade expansion in specific industries. Unfortunately, we cannot simulate this impact since the survey for Armenia does not provide detailed data on sectors of employment.
The chapter begins in Section B with a brief discussion of the data used in our
analysis. Section C presents some relevant aspects of the poverty profile for Armenia. A summary of the sources of household income and consumption patterns is then presented with a subsection on farmers and the agricultural sector in sections D and E, respectively. As unemployment is a predominant problem in Armenia and is a major determinant of poverty, section F is devoted to the labor market issues and job creation mechanisms through trade. Section G presents our estimates of the impact of trade expansion on the income distribution in Armenia. Finally, section H concludes the chapter.
B. Data
To assess the impact of trade liberalization on poverty one would ideally use household surveys spanning different years. In this study, however, the 1998-99 Integrated Living Conditions Survey (ILCS) serves as the main data source for our analysis since comparable household surveys over time do not exist for Armenia.
The quality of the expenditure data from this survey is good. As discussed in the Armenia Poverty Update report (World Bank, 2002), the private consumption estimates from the survey explain 60 to 73 percent of the estimates based on national accounts, a fraction comparable to other countries. Furthermore, the timing of the largest statistical
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discrepancies are the same in both the ILCS and the national accounts, again supporting the validity of the 1998/99 ILCS results.64
One issue that comes up is the quality of the income data. Due to measurement problems, for example caused by the irregular nature of remittances, which correspond to a significant share of total income, much of the analysis in this chapter uses total expenditure figures as the main indicator of total income instead of the observed income figures. The section on the sources of household income, however, still uses this income data. We believe that useful information can be ascertained from the shares of incomes attributable to different sources, even though the levels of these various sources of income may not be accurate.
To analyze the time trends in income distribution of Armenia, the 1996 Household Survey is used as a benchmark. However, it should be noted that these two surveys are not directly comparable. The two main differences between the surveys are with respect to (i) the differences in the welfare measure—poverty measurements based on the 1996 Household Survey use household expenditures as the primary welfare measure, because the 1996 survey collected information on expenditures, not consumption whereas the poverty analysis here is based on consumption; and (ii) the duration and timing of surveys—the 1996 Household Survey was conducted only during November and December 1996, while the 1998/99 ILCS was carried out throughout the year. Despite this inherent problem of comparability over time, we believe that such a comparison is still useful in understanding the poverty trends.
A more detailed description of the 1998-99 ILCS survey and its comparability to the 1996 Household Survey can be found in the latest poverty update for Armenia.65 C. Poverty Profile66
Before moving on to an analysis of the impact of trade expansion on the poor, this section presents the poverty profile for Armenia. The aim is to define poverty, identify the poor and highlight their demographic characteristics. A summary of the trend in poverty over time and migration incidence rates by income groups are also presented. Counting the Poor
The 1998-99 ILCS suggests that 69.2 percent of Armenians live on less than a dollar a day and 94.7 percent live on less than two dollars a day.67 The prevalence and severity of poverty is very noticeable when compared to the other CIS countries. About 54 percent of Armenians are poor and about half of those are defined as living in extreme 64 Another comparison can be made on the basis of transfers from abroad. ILCS 1998/99 data indicate that remittances represented about US$ 82 million per year (or US$ 100 million if a population of 3.8 million is considered). Official figures based on the Balance of Payments indicate remittances of about US$ 120 million. (World Bank, 2002) 65 ibid. 66 This section draws heavily on World Bank (2002). 67 Monthly exchange rate
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poverty. Unlike in many other parts of the world, poverty is more prevalent and more acute in urban areas. In urban areas, the incidence of poverty in Armenia is 60 percent, and almost a third of all urban dwellers live in extreme poverty.
Extreme poverty incidence was estimated as 25.4 percent. The shortfall (P1/P0) between the consumption of the poor and the poverty line was fairly deep at 29 percent for overall poverty and 22.4 and 19.2 percent for urban and rural extreme poverty, respectively (see Table 6.1).
Table 6.1: Armenia Poverty Indicators VII/98-VI/99 (standard errors in parenthesis)
Extreme (Food) Poverty Line (8,730 drams)
Complete Poverty Line (12,306 drams)
Incidence (P0)
Gap (P1)
Severity (P2)
Incidence (P0)
Gap (P1)
Severity (P2)
Total 25.4% 5.5% 1.8 53.7% 15.5% 6.1 (0.81) (0.23) (0.10) (0.92) (0.36) (0.19) Urban 31.2% 7.0% 2.3 60.4% 18.4% 7.6 (1.11) (0.33) (0.14) (1.14) (0.49) (0.27) Rural 17.7% 3.4% 1.1 44.8% 11.6% 4.2 (1.14) (0.30) (0.13) (1.46) (0.51) (0.26)
Source: World Bank (2002) Trend over time
As discussed above, the data from the 1996 household survey, despite problems regarding exact comparability, provides a benchmark to analyze the trends in poverty in Armenia. Table 6.2 summarizes poverty measures across the two surveys. The numbers suggest that overall poverty in Armenia is persistent as the poverty incidence rates did not change significantly over time. It is also noted, though, that the depth and severity of poverty indices as shown by P1 and P2 have dropped for overall, urban, and rural populations alike. In other words, the poor have been able to increase their consumption over time but not enough to escape poverty. A nearly 10 percent drop in extreme poverty suggests that extreme poverty in Armenia may be subsiding.68
A more detailed comparison is given in Box 6.2 below where the issues regarding
the comparability of data, eg. the seasonal distortions, are corrected for.
68 World Bank (2002).
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Box 6.1: A Snapshot of Poor Households in Armenia in 1998/99 Almost two thirds of the poor population lived in urban areas, particularly in large cities like Yerevan. Poor households had more children under 5 and more elderly but less school age children in both urban and rural areas. The poor suffered from lack of employment opportunities since 15 percent of the household heads were unemployed (compared to 10 percent among the non-poor) and about 40 percent of the heads were non-participants in the labor market. Only 13 percent of these heads completed higher education compared to 23 percent among the non-poor. The poor households had relatively small land holdings (0.4 hectares) and only one fifth of their land is irrigated. A typical Armenian household in extreme poverty had different characteristics in urban and rural areas. In urban areas, an extremely poor household consisted of 4 members: one child below 15, another young member between 15 and 25 year of age, one adult member and one elderly. The extremely poor urban household was headed by a 55 year-old male, although one third of these households were headed by a female. Most of the household heads in extreme poverty attended secondary education, a large fraction of them completed it. Labor market conditions were extremely difficult for these households: 3 out of 4 household heads were either not participating in the labor market (51 percent) or were unemployed (25 percent). In rural areas, extremely poor households were relatively larger. They were less skilled as well. They had five members with 2 children below 18, one elderly, and two prime age adults. The household head was a 57 year-old male (only one fourth were females) with primary or incomplete secondary education in most of the cases. Most of the heads (55 percent) were self-employed either in a small household business or agriculture and a small fraction participated as salaried workers (7 percent). About 31 percent of the heads were not participating in the labor market and less than 5 percent were unemployed. A household in extreme poverty had less than 1 hectare of land, none of which was rented. Less than one third of the land was irrigated. Source: World Bank (2002)
Table 6.2: Poverty in Armenia in 1996 vs. 1998/99
Report Year
Data Year
Poverty line
Poverty headcount
% (P0)
Poverty gap (P1)
Severity of poverty
(P2)
Extreme poverty
headcount
Gini coefficient (income)
World Bank 1999
Household Survey 1996
Absolute line
Overall: 54.7
Urban: 58.8
Rural: 48.0
Overall: 21.5
Urban: 23.0
Rural: 18.9
Overall: 11.0
Urban: 11.5
Rural: 10.3
Overall: 27.7
Urban: 29.6
Rural: 24.4
0.59
World Bank 2002
Household Survey
1998-99
Absolute line
Overall: 53.7
Urban: 60.4
Rural: 44.8
Overall: 15.5
Urban: 18.4
Rural: 11.6
Overall: 6.1
Urban: 7.6
Rural: 4.2
Overall: 25.4
Urban: 31.2
Rural: 17.7
0.57
Source: World Bank (2002)
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Box 6.2: Comparing Poverty Between 1996 and 1998
Migration and the Armenian Diaspora
Migration is an important issue in Armenia. Especially over the last 12 years, there have been as many as 700,000 Armenians who emigrated mostly to Russia and other FSU countries, creating a fairly large Armenian Diaspora.69 Table 6.3 shows that about 4.5 percent of Armenians migrate and that migrants are both the rich and the poor. In other words, the middle classes are less likely to migrate than households in either
69 World Bank (2002).
In this Box, a limited comparison of poverty measures between 1996 and 1998 is presented. To avoid some of the problems mentioned above, several adjustments were made. First, in order to avoid seasonal distortions, poverty measures for 1998 were estimated using only information collected during the fourth quarter of 1998. Second, the 1996 poverty line with proper inflation adjustment was used, hence avoiding changes in the poverty line due to changes in its structure. Third, instead of using per adult-equivalent consumption (used throughout this report), this comparison uses per capita consumption for 1998.
Poverty and extreme poverty incidence in 1996 and 1998:Q4 (percentages)
Extreme poverty incidence Poverty incidence 1996 1998 1996 1998
Total 27.7 15.3 54.7 49.1 Urban 29.6 17.7 58.8 55.0 Rural 24.4 11.9 48.0 40.6
Source: World Bank (1999a) and ICLS 98/99. Based on the adjustments and taking into account all the caveats related to them, the following findings related to poverty in 1996 and 1998 were obtained:
(i) Poverty incidence decreased by more than 5 percentage points, which is consistent with the economic growth recorded in Armenia between the survey periods;
(ii) Extreme poverty decreased even more—by 12 percentage points, indicating an increasingly shallow extreme poverty;
(iii) Poverty changes differ across urban and rural areas: while poverty decreases in both areas, it decreases more in rural (-7.4 percentage points) than in urban areas (-3.8 percentage points);
(iv) Taking into account the relative size of urban population, however, the absolute amount of individuals that escaped poverty is roughly the same in both areas;
(v) While extreme poverty decreases by about 12 points in both urban and rural areas, the number of individuals that escaped extreme poverty, however, is much bigger in urban than in rural areas.
Source: World Bank (2002).
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extreme of the household expenditure quintiles. Table 6.3 presents the migration patterns by expenditure categories. The following are the more striking findings: • Urban households tend to migrate more than rural households, and many of these
migrants migrate to other urban areas. • There is no clear pattern of the incidence of migrants across household expenditure
quintiles. In rural areas, it appears that the incidence of migrants is highest for the extremes of household expenditure quintiles. For urban households, there is no apparent relationship between the incidence of migration and household expenditure quintiles. The poor households living in the urban areas were the most likely to migrate with a migration incidence rate of 6.0 percent compared to the overall average of 4.5 percent. The rural rich were the next likely category for emigration, with an incidence rate of 5.5 percent.
• Men were between 4-5 times more likely to migrate then women regardless of
expenditure quintiles. • Migration destinations varied across income groups and by region as well, but again
no clear pattern is observed. Migration to the urban areas accounted for about 60 percent, and more than a quarter of migrants went to Russia and other CIS countries.
Table 6.3: Incidence and Destination of Migration in Armenia (Percent of individuals)
Population quintiles by consumption per adult equivalent Poorest 2 3 4 5
Total
Incidence of migration Total 5.7% 3.8% 4.0% 3.8% 5.2% 4.5% Rural 4.8% 2.8% 3.8% 2.9% 5.5% 3.9% Urban 6.0% 4.4% 4.2% 4.8% 4.8% 4.9% Females 2.7% 1.4% 1.3% 1.2% 2.1% 1.7% Males 9.1% 6.7% 6.9% 6.5% 8.6% 7.6% Destination of migrants Urban Armenia 61.2% 50.9% 58.7% 56.3% 67.3% 59.6% Rural Armenia 3.4% 5.9% 5.6% 7.6% 4.9% 5.3% Russia and other CIS 27.5% 30.5% 21.4% 30.3% 21.6% 26.0% Other 7.9% 12.7% 14.3% 5.9% 6.2% 9.1% Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Source: World Bank (2002)
There is no discernable relationship between human capital accumulation and the decision to migrate. The highest incidence of migration is observed among individuals with no formal education: almost 11 percent of Armenians with no education migrate (see Table 6.4). The proportion of urban Armenians with no formal education who migrate is about twice as high as the proportion of rural Armenians with no formal
105
education. The incidence of migration among those with secondary, technical and university education is 4 percent respectively.
Table 6.4: Migration Incidence rates by Education level (percent of individuals)
Rural Urban Total Total 3.9 4.9 4.5 No education 7.6 14.2 10.9 Primary 1.0 1.3 1.1 Secondary 3.8 4.3 4.0 Technical 3.9 4.1 4.0 Higher 4.8 3.9 4.0
Source: World Bank (2002) It has often been argued that emigration has led to a loss of skilled labor in the Armenian economy. This argument may be partially true. However, it is also the case that emigration has eased the problem associated with the lack of employment opportunities. In addition, the emigration has led to an inflow of capital through significant amount of remittances transferred to families and hence, has served as a safety net in times of need. As will be shown in the next section, the remittances play a very significant role in household income contributing about 10 percent of total income and also in explaining the high unemployment rates and especially the high non-participation rates observed in the labor market. We leave the detailed analysis of this issue to Section F. D. Sources of Household Income Armenia is unique because a large portion of household income comes from non-productive sources, such as remittances, pensions benefits and humanitarian aid. As a result, trade related policies designed to increase the income from employment and self-employment will have only a limited impact. On the other hand, a large impact can be achieved if the policy is designed to increase participation in the formal and informal sectors. An analysis of the sources of income is crucial in assessing the impact of economic policies on the poor. In this section we look at the sources of household income. The next section presents a description of spending patterns across different income groups in society.
There are some inconsistencies in the 1998-99 ILCS data, especially with regard to the income information. However, it is still useful to analyze the sources of income to get a rough idea especially about the differences across socio-economic groups. The relative importance of household income sources varies across these groups as shown in Figure 6.1 below and Table A3.13 in Annex 3. A few notable observations are presented below:
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• Armenians derive a large proportion of their income from non-productive sources. Approximately 45 percent of all income is derived from sources such as pensions, remittances, humanitarian aid and benefits. We argue later (see Section F) that the high dependence on non-productive sources of income is one of the factors contributing to the high unemployment and non-participation rates observed in Armenia. In other words, if these alternate sources of income are believed to lead to higher reservation wages, the impact is clearly to apply downward pressure on participation rates.
• The role of remittances in the household income is very significant. On average, each
household draws about 12 percent of their income from remittances sent from within or outside the country. For the urban households in the richest deciles this share is as high as 21 percent.
• Households derive their income from different sources depending on whether they
live in urban or rural areas. Income from agriculture and pensions comprise the majority of income in rural areas, while wages from employment, pensions and remittances are the most important sources of income in urban areas.
• The relative importance of each of these sources of income depends on the household
expenditure quintile: Pensions and benefits are pro-poor, in that household in lower expenditure quintiles are more dependent on income from pensions and benefits. On the other hand, income from the sale of agricultural products and income from remittances are more important as sources of income for the richest households.
• Almost 40 percent of the income of rural households can be traced to agricultural
products. The higher the household expenditures, the higher the dependence on agriculture is as a source of income. Encouraging the poor and facilitating their entry into this sector by removing some of the barriers to entry can therefore, enhance the welfare of the poor households. A detailed analysis of these issues can be found in the section on agriculture.
• As expected, the role of government transfers (pension and other benefits plus
humanitarian aid) decreases with household income: The poorest receive close to half of their income through these transfers, while the richest receive about 22 percent.
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Figure 6.1: Sources of Income
Source: World Bank staff estimates using ILCS 1998/99. E. Sources of Household Expenditures
Despite the problems associated with the income data, expenditure information is more reliable in Armenia. As in many other developing countries, a very large portion of expenditures is allocated to food. Therefore, to have a significant impact on household welfare, the focus of the policy should be on food.
The following analysis of household expenditures provides some insights into the
nature of poverty in Armenia. Table A3.14 presents the components of household expenditures using the 1998-99 ILCS. Some interesting results are: • Food spending constitutes the main component of total expenditures at about 65
percent on average. As expected, we observe that the share of food expenditures is inversely related to the household expenditure quintiles.
• Expenditures on durable goods are the next most important component, with a share
of 13 percent of total expenditures on average. • The other two main expenditure items for Armenian households are spending on
education and health. Note that the proportion of income allocated to education and health is positively related to the expenditure quintiles. The relatively high importance of education is reflected also in the structure of the labor force in Armenia in terms of the significant share of skilled labor. It is also interesting to note that the
Figure 1: Sources of income for the rural poor
Wages from employment
7%
Self employment5%
Pension31%
Agricultural products
27%
Remittances __Total
8%
Humanitarian Aid0%
Other income8%
Benefits14%
Figure 2: Sources of income for the rural rich
Self employment8%
Pension19%
Agricultural products
43%
Remittances __Total
7%
Other income2%
Benefits3%
Wages from employment
18%
Figure 3: Sources of income for the urban poor
Wages from employment
28%
Self employment5%
Pension32%Agricultural
products0%
Remittances __Total
11%
Humanitarian Aid2%
Other income7%
Benefits15%
Figure 4: Sources of income for the urban rich
Wages from employment
38%
Self employment8%
Pension16%Agricultural
products1%
Remittances __Total
19%
Humanitarian Aid0%
Other income4%
Benefits5%
4% 5%
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proportion of income allocated to health and education are similar regardless of whether the households are in urban or rural areas.
• Clothing expenditures are only a small portion of the total spending, with the
exception being the richest quintiles. • While spending structures across urban and rural areas are fairly similar, the main
difference is observed in the share of food expenditures, which is higher in the latter areas, as expected. Also, the spread between the food spending of the poorest and richest quintiles is smaller in urban areas than in the rural sector.
• After food, durable goods, and education spending, the poorest households allocate
more of their income on rent and utilities, while the richest do so on health and clothing spending.
Agriculture Sector
Since independence in 1990, Armenia has shifted from industrial production to a more agrarian economy producing crops such as wheat, potatoes, grapes, vegetables, beans, and fruit. However, the post 1994 period witnessed slower growth of the sector because of the shortage of equipment and inputs.70 Despite its problems, the agriculture sector employs the largest share of the labor force (38 percent).
Given the size and importance of this sector, we carry out a brief analysis on the welfare of self-employed farmers. Annex 3, Table A3.15 presents the determinants of household welfare among this sample of households. Education generally has a positive impact on household welfare. This is especially true for household heads that have completed technical school and university. We also observe that grape growers and potato growers have higher welfare in the household compared to growers of other crops. On the other hand, tobacco, vegetable and fruit, and staples growers do not experience a significantly higher level of household welfare. Since grapes are an important source of foreign exchange into the country when converted into Brandy, an exported good, the result of higher household welfare among grape cultivators is not surprising.
Households with larger plot sizes have higher levels of household welfare. Our results suggest that there are increasing returns to scale with respect to the number of workers in the farm71 and owning farming equipment and horses or donkeys both have positive impacts on household welfare. Finally, many of the geographic indicator variables are found to be significant. Households in Yerevan are better off than households outside the city. This may be because households in Yerevan have more access to markets and information related to prices. For the sample of farming households, the lowest per capita household expenditures are observed in Aragatz, Gegharku, Lori, Kotayk, and Shirak. It should be noted that these results are conditional
70 Economist Intelligence Unit (2001). 71 In the EIU report, it is also mentioned that one of the reasons for the halted development of agricultural sector is the small size of the farms, i.e. not exploiting the economies of scale.
109
on all the other included variables, and hence they do not conflict with the finding that poverty in Armenia is an increasingly urban phenomenon. F. Labor Market and Unemployment
Despite consistent growth, the Armenia economy has not been able to generate the expected employment possibilities. Unemployment remains a major issue faced by the Armenian households. The official reported unemployment rate is 11 percent72 for 2000, and the ILO estimates are around 25 percent, the difference being caused by hidden unemployment. The problem is even more pressing in the urban areas where about 43 percent of the population is unemployed compared to the 5 percent in rural areas (Table 6.5).
Unemployment rates of 25 percent are not particularly alarming crisis situations, but sustained rates of 25 percent are rather unusual. Unemployment rates are very high even for the highly educated, and seasonal unemployment is low.73 Furthermore, the Armenians labor market is also characterized by significant non-participation rates (almost 50% of the population over 16 in urban areas, and 28 percent in rural areas). A brief look suggests that while some of the non-participants are mainly students, home care givers, and discouraged working age adults, the majority (47 percent) are pensioners.
These high rates of non-participation can be attributed to the following four
factors: First, the persistent high rates of unemployment may discourage workers and lead to an exit from the labor force. Second, the shift from the industrial based production under the state system, seen before independence, to the privatized system had a significant impact on the nature of the skills needed creating a case of skills mismatch. Third, households appear to be reverting towards subsistence agricultural production using the family plots that were granted during the independence, possibly to reduce the risk of malnutrition in the family. Fourth, the low participation in the labor market may be the result of a low retirement age (around 55) and the dependence on pensions as a main source of income.74
72 IMF Country report/Armenian National Statistical Service. 73 World Bank (2002). 74 IMF (2000).
110
Table 6.5: Labor Force Participation in Armenia 98/99 Total Urban Rural Total population Population under 16 31.5% 27.0% 33.0% Population over 16 68.5% 73.0% 67.0% Total population 100.0% 100.0% 100.0% Population over 16 Not participating in the labor market
39.8% 47.8% 28.2%
Participating in the labor market 60.2% 52.2% 71.8% Population over 16 100.0% 100.0% 100.0% Memo item: Participating in the labor market as % of the total population
41.2% 38.1% 48.1%
Labor market participants Seasonally unemployed 2.6% 0.2% 4.2% Unemployed 24.4% 42.7% 5.2% Salaried worker 32.1% 46.4% 16.8% Self-employed 39.7% 8.6% 72.4% Other employment 1.7% 1.7% 1.4% Labor market participants 100.0% 100.0% 100.0% Source: ILCS 98/99.
While it is believed that there is a general scarcity of jobs in Armenia, the following Probit model results show that income form remittances are also significant in determining the probability of being unemployed.
Figure 6.2: Probability of Being Unemployed vs. Percentage Income from Remittances
-0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
1 11 21 31 41 51 61 71 81 91
Percentage of income from remittances
This result supports our earlier thesis that such transfers lead to lower participation rates by creating higher reservation wages. Households receive their cash
111
income through these transfers while meeting their food demand through own production in family plots and thus they are more likely to be unemployed.
However, it should be noted that one possible explanation behind these results is reverse causality. Unemployed households might be more likely to receive remittances, or higher amounts in the form of remittances. Therefore, we still believe that higher reservation wages is not the complete story behind the high unemployment rates, but is an important factor in economies that are characterized by high rates of non-productive income.
If the number of jobs in the economy can be increased, the poor would be helped considerably to get out of poverty since unemployment is an important determinant of poverty in Armenia.75 The next section of this chapter suggests that the industries that have the highest export and job potential are: jewelry/diamond processing, information technology, and agriculture/food processing. If these industries in fact achieve their potential, it would be interesting to analyze the potential impact on household welfare. However, the 1998-99 ILCS survey does not permit an analysis of this nature because of the unreliable data on the industry of employment.
75 World Bank (2002).
112
Box 6.3: Growth Potential for Selected Industries in Armenia
The following is an assessment of growth potential for a select group of industries in Armenia: • Jewelry/Diamond Processing – This is an industry where foreign investment is dynamic and there is great potential for
Armenia to exploit its comparative advantage of highly-skilled, low paid labor as well as the country’s natural semi-precious stone resources. If this industry can be successful, its potential for poverty reduction is great. (It can also reduce Armenia’s trade deficit through its exports.)
• Information Technology – This industry was rated highly because Armenia has a steady supply of software programmers that are low paid relative to their Western counterparts where the start-up costs are lower than in other parts of the world and given that it is a service industry the ability to expand exports exists.
• Agriculture/Food Processing – Armenia has a history of high-quality agriculture production as well as agricultural products that are produced with little or no pesticides or fertilizers. Therefore, Armenia has an opportunity to expand into the profitable organic food products markets that is gaining momentum in the West.
These industries rated highly on both their potential to expand exports as well as create jobs. Therefore, these are
the industries around which planning should be completed to make the industry environment as favorable as possible. Other industries that could be considered after these industries for strategic investments include: • Energy – This industry rated relatively high export potential but low job potential. Therefore, the industry should be
examined to see whether it is possible to increase its job potential. • Mining – This industry rated relatively high for job potential and in the middle of the scale for export potential.
Therefore, the industry should be researched to determine ways of boosting its export potential.
Jewelry/Diamond
Processing/ Information Technol
Agriculture/
Food
Processing
Mining
Energy Chemicals
Light Industry
Machinery
Electronics
Tourism
Telecom
Construction
Industry Potential for Poverty Alleviation
1
2
3
4
5
1 2 3 4 5
Jewelry/Diamond Processing In
Information Technology Indust
Agriculture/Food Processing In
Mining Industry Energy Industry Chemicals Industry Light Industry Machinery and Electronics Indu
Tourism Industry Telecommunications Industry Construction Industry
HIGH
HIGH
LOW
LOW
Plan and Focus Resources
Consider for Strategic Investments
Consider for Strategic Investments
Re-examine at a later date
Export Potential
Job Potential
Source: Holden (2002)
113
G. Simulation Results Framework
The framework used in this chapter is due to Nicita et al. (2002). The household is the unit of analysis. Total net household income (savings) is defined as the sum of total income minus the sum of total expenditures. Each household has different endowments (for example, land of different qualities, number of skilled and unskilled laborers) that generate income (for example, from agriculture, from labor) and different expenditures patterns (for example, allocation of expenditures to food and non food items). The general formulation is;
( ))1.
)1(
)1()1(
)1()1(
)1()1()1(
...
EqT
tPX
tPXtPX
tWLtWL
tPXtPXtPXNetIncome
p q
qp
o
NonFoodn
NonFoodo
NonFoodo
n
FoodOthn
FoodOthn
FoodOthn
DWheatWheatSWheat
UnSkilledl
l
UnShilledl
UnSkilledl
Skilledk
k
Skilledk
Skilledk
j
Ij
Ij
Ij
i
Oi
Oi
SOi
SWheatWheatSWheat
∑∑
∑
∑
∑∑
∑∑
+
+−
+−+−
−+−+
+−−+−=
where
=SWheatX Amount of wheat of produced by the household
=WheatP Selling price of wheat of produced by the household (gross price). For
internationally tradable varieties, this price is the border price. =w
zt ad valorem tax on good z of the w sector. Alternatively, =wzt is the tax equivalent of
a distortion that affects good z of sector w.
=SOiX Output i (other that wheat) produced by the household (for example cattle,
handicrafts, services) =O
iP Selling price of output i produced by the household (gross price). For an
internationally tradable output, this price is the border price.
=IjX Amount of input j used by the household in production(for example, fertilizers,
land rented, hired labor, hired animals). =O
jP Before tax (or before a tax equivalent domestic distortion) price of input j used by
the household in production.
=SkilledkL Amount of skilled labor sold by the kth member of the household
=SkilledkW Before tax (or before a tax equivalent transaction cost or domestic distortion)
wage of skilled labor supplied by the household.
114
=UnSkilled
lL Amount of un-skilled labor sold by the lth member of the household
=UnSkilledlW Before tax (or before a tax equivalent transaction cost or domestic distortion)
wage of unskilled labor supplied by the household.
=DWheatX Amount of wheat of demanded by the household (including wheat produced by
the household and not sold in the market) =WheatP Buying price of wheat of demanded by the household (gross price)
=DWheatt Import tariff on wheat imports
=FoodOthnX . Amount of non-wheat food n demanded by the household
=OthFoodnP Buying price of non-wheat food n demanded by the household (gross price)
=OthFoodnt Import tariff on non-wheat food n
=NonFoodoX Amount of non-food good o demanded by the household
=NonFoodoP Buying price of non-food good o demanded by the household (gross price)
=NonFoodot Import tariff on non-food good o
=qpT Transfer received by household member p from source q (q could be public or
private).
Here, we will consider all quantities in Eq.1 as fixed in the short run and simulate what the impact of a change in price of wheat, input costs, wages and transportation costs may be.
In reality, after changes in prices, producers would switch to producing the more valuable crops, consumers would in general switch to cheaper goods and away from the now relatively more expensive ones, and the household would adjust its labor supply to changes in wages. Because we assume that the quantities remain fixed, this formulation provides a lower bound for any estimated gain and an upper bound for any estimated loss.
Despite these strong assumptions on quantities demanded and supplied, and on how the prices are determined, these simulations show a first approximation for the potential positive or negative effect of different economic policy scenarios on poor people in Armenia. The specification of equations 1 through 3 are flexible enough to capture key avenues identified elsewhere for the improvement in the livelihood of poor households, like the impact of a variation in the price of wheat that is different for net sellers and net buyers of wheat.
Following common practice in the literature on poverty, we anchor the analysis
on households’ expenditures, and express all results as per cent of households’ expenditures, ordered by decile of per capita adult equivalent total household consumption. That is, the absolute change in net income of household i that is expected to come from a policy change is divided by total household i expenditures. The
115
interpretation in terms of poverty is straightforward: a simulation identifies a pro-poor strategy if the latter provides extra money for the first five deciles. The size of the impact is measure as per cent of household expenditures. Simulation 1: Impact of a 25 Percent reduction in transportation costs on household expenditures
High transportation costs is one of the major issues faced by the Armenian economy. On the internal side, the poor condition of the road network creates a concomitant impact on transport costs, economic growth and consumer prices (Chapter 4). On the international side the blockade make access to both domestic and international markets very difficult. As Chapter 2 notes, “Despite its very liberal trade regime Armenia remains not integrated into international production networks. High transport costs hinder Armenia’s participation since bringing semi-processed materials for further processing or manufactured parts and components for assembly is not economically viable.” In this section, we focus on the internal side of the issue and look at the impact of a reduction in transportation costs of farmers.
Figure 6.3 below shows that 20 percent of input costs faced by self-employed farmers is allocated to transportation. Since the state of the roads has an impact on commute times to access markets and on maintenance costs for vehicles, there is significant scope for reductions in transportation costs through repairs and improvement of the existing road network. Extrapolating further, any improvements in road conditions have a potential impact on the welfare of households through reductions in cost of these services. One reason we focus on only the farmers is the significant role of agriculture sector in the Armenian economy. As discussed above in section 5, agriculture sector has been the leading sector in determining growth and is the largest employer. Furthermore, agricultural products comprise a significant portion of the imports of Armenia and processed food stuff a significant portion of exports.
In order to carry out our simulation of a reduction in transportation costs, we
make three main assumptions. First, it is assumed that the households that grow at least one crop experience a 25 percent reduction in transportation costs. Second, it is assumed that households are able to sell the output at the same price as before the cost reduction and hence, revenues remain the same. In fact, this will not be the case because the higher rents will encourage entrants into farming, eroding rents. Third, we assume that the additional income is spent entirely on the household, and hence enhances the welfare of the household.
The simulated reductions in transportation costs for self-employed farmers are found to improve household welfare (Table 6.6). The results of the simulation show that there will on average be a 0.95 percent increase in welfare in rural households as a result of the 25 percent reduction in transportation costs. However, the impact of this reduction in transportation costs will only be marginal in urban areas. The impact of the change in transportation costs does have a differential impact on the households belonging to each
116
of the household expenditure deciles. In fact, it appears that the biggest beneficiaries are the households in the lowest deciles and those in the upper deciles.
Table 6.6 Impact of a 25 Percent Reduction in Transportation Costs by expenditure quintiles
(Percentage Change in Per Capita Total Expenditures)
1 2 3 4 5 6 7 8 9 10 Average Rural 0.72 1.17 1.05 0.69 1.31 0.75 1.02 1.31 0.77 0.70 0.95 Urban 0.02 0.07 0.10 0.01 0.19 0.07 0.11 0.41 0.02 0.02 0.10 All 0.50 1.03 0.93 0.54 1.03 0.58 0.84 1.10 0.63 0.56 0.77 Source: World Bank staff estimates using ILCS 1998/99. Simulation2: Impact of a 15 percent reduction in the price of wheat
Armenia has little arable land and therefore relies heavily on food imports for its food, including about 60 percent of its grains and 65 percent of its dairy products.76 Moreover, the household expenditure data indicates that wheat consumption forms the majority of the total grain consumption.
Due to the blockade and other issues discussed in the previous section, high transportation costs hinder trade and lead to higher consumer prices. By increasing the costs of imports and exports, such barriers affect Armenia’s competitiveness, imposing significant economic losses on the country. Furthermore, even though the trade regime is fairly liberalized, the difficulties and the delays in the Customs Administration also leads to increased costs in the trade processes (Chapter 4). Through reduction of such costs and hence trade expansion, the cost of imported goods, like the price of wheat could be reduced.
In this section, we therefore look at the impact distribution of a change in the price of wheat by per-capita consumption deciles. Note that the total impact of such a change will depend on whether the households are net buyers or sellers. The net wheat buyer households will benefit from the decrease in wheat prices, while the overall impact will be negative for the net wheat sellers:
Wheat
WheatDWheatSWheatWheat
P
PXXPNetIncome
][)(∆
−=∆
where the sign on a particular household will be given by sign of )( DWheatSWheat XX − .
Note that, we assume the following in our analysis: i. The decrease in the price of
wheat is under no tax and no distortions in the wheat market scenario, ii. The 15 percent decrease on imported flour will decrease the domestic price of bread by the same margin, iii. The 15 percent decrease on imported flour will decrease the domestic price of wheat by the same margin, iv. Sellers will be affected by the price decrease through sold portion
76 Economist Intelligence Unit (2001).
117
of their wheat harvest, v. Top grade flour, high grade flour, top grade wheat and high grade wheat will be equally affected by the price decrease, and vi. There is no switching into production of other crops.
The results, as shown in Table 6.7, indicate that a 15 percent reduction in the price of wheat products (caused for example by trade expansion) benefit all Armenians by about 1.22 percent. 96 percent of urban dwellers are net buyers of wheat and hence, a large proportion of urban households benefit from the price reduction. The highest benefits from the price reduction are captured by the poorest net buyers in urban areas (4.20 percent) compared to the richest net buyers in urban areas (1.31 percent). In rural areas, there is approximately an even split between net buyers and net sellers.
Table 6.7: Impact of a 15 Percent Decrease in the Price of Wheat
Simulation 3: Impact of a 10 percent increase in cost of irrigation on household welfare
As discussed earlier, agriculture constitutes more than 20 percent of Armenia’s Gross Domestic Product and employs 38 percent of the labor force. Since 1991, the trend has been towards small scale farming rather than the larger farms that existed during the Soviet era. Governments often are faced with the choice of pricing utility services at cost recovery levels or of subsidizing consumption. This simulation is for an experiment in which the government would choose to increase prices associated with irrigation by 10 percent. Before describing the simulation, we provide a little background on the input cost structure for the self-employed farmers.
1 2 3 4 5 6 7 8 9 10 AverageUrbanNet Buyers 4.20% 3.79% 3.25% 3.53% 3.11% 2.87% 2.82% 2.52% 2.19% 1.31% 2.96%Net buyers (% of urban population) 98% 96% 97% 94% 95% 95% 96% 94% 99% 99% 96%Net Sellers 0.00% 0.00% -2.29% 0.00% 0.00% 0.00% -1.12% -1.04% 0.00% -5.37% -0.98%All Urban 4.08% 3.68% 3.10% 3.31% 2.93% 2.72% 2.68% 2.27% 2.16% 1.15% 2.81%RuralNet Buyers 3.99% 2.78% 2.58% 3.09% 3.11% 2.65% 2.36% 2.41% 1.99% 1.60% 2.66%Net Sellers -1.50% -3.06% -10.93% -5.18% -4.98% -5.04% -3.25% -3.55% -3.09% -5.82% -4.64%Net sellers (% of rural population) 47.62% 53.40% 54.72% 51.26% 48.46% 48.89% 54.76% 48.00% 40.96% 48.76% 49.68%All Rural 1.24% -1.29% -1.96% -1.09% -1.01% -1.21% -0.61% -0.48% 0.05% -1.85% -0.82%All ArmeniaNet Buyers 4.17% 3.54% 3.09% 3.42% 3.11% 2.81% 2.68% 2.48% 2.11% 1.40% 2.88%Net Sellers -1.29% -4.91% -10.19% -4.39% -4.32% -4.42% -3.10% -3.22% -2.99% -6.08% -4.49%All Armenia 3.30% 1.73% 0.41% 1.52% 1.26% 1.01% 1.11% 0.96% 1.13% -0.25% 1.22%Source: ILCS 1998/99
118
The two biggest cost items faced by farmers are the cost of irrigation and cost of transportation (see Figure 6.3 and Annex 3 TableA3.17). Animal feed and mineral fertilizers are also important expenditures faced by self-employed farmers.
Figure 6.3: Input Cost Structure Faced by Self-Employed Farmers
Irrigation20%
Other costs12%
Transport20%
Seeds9%
Animal feed17%
Mineral fertilizer10%
Equipment Rental
4%
Insecticides8%
Source: World Bank staff using ILCS 1998/99.
In addition to transportation and irrigation costs being important components of
the farm budget, the cost-share of transportation and irrigation costs is especially high for farmers in the poorest quintile (see Annex 3 Table A3.19). The proportion of the budget allocated to irrigation appears to be inversely related to household expenditure quintile, while the share of costs allocated to transportation appear not to vary considerably with household expenditure quintile.
The simulation is carried out as follows: First, we increase the price associated with irrigation for self-employed farmers by 10 percent. We assume that this change has no impact on prices of outputs and hence, the change in the prices have a direct impact on household welfare. Further, we assume that there are no substitutes for irrigation and hence, that there is no change in the amount of irrigation consumed by farmers in response to the higher prices. Under these restrictive conditions, Table 6.8 presents the cash-loss self-employed farmers would face in the event of an increase in irrigation costs.
Table 6.8 Impact of a 10 Percent Increase in Irrigation Charges
to Farming Budget Households, by Expenditure Deciles (Percentage Decrease in Per Capita Total Expenditures)
1 2 3 4 5 6 7 8 9 10 Average Rural 2.48 2.42 1.91 2.40 2.12 1.94 1.92 1.37 1.49 1.28 1.93 Urban 2.90 1.66 4.18 1.30 2.19 2.38 0.97 1.22 1.89 2.91 2.16 All 2.55 2.33 2.05 2.25 2.13 2.02 1.78 1.35 1.55 1.50 1.95 Source: World Bank staff estimates using ILCS 1998/99.
119
H. Conclusions
In this chapter, we focus on the following three main issues: the high
unemployment rates, high transaction costs associated with both domestic and international trade, and the challenges faced by the self-employed farmers in the agriculture sector.
The high unemployment rates are caused mainly by the lack of employment
opportunities and also by high reservation wages, as shown in our preliminary analysis. The latter in turn is attributed to the role of high rates of remittances and pension payments in the household income: For instance, it appears that non-productive sources of income constitute about 45 percent of household income in Armenia. Here, we propose that trade expansion, especially in the labor-intensive industries, would help reduce the problem of unemployment through job creation.
The second major issue faced by the Armenian economy is that of high
transaction costs. Land locked countries such as Armenia have an inherent disadvantage in trade related matters due to the high costs of transportation. This problem is further exasperated in Armenia because of the problematic relations with its neighbors. Our analysis shows that a change in the price of wheat, an imported good caused by reductions in transaction costs, is notably beneficial to the Armenian households. It is further observed that the incidence of savings from such an improvement is the highest for the poor. A geographic decomposition indicates that the urban areas where households are net buyers become significantly better off, while the rural areas lose marginally except for the poorest households.
The high transaction costs also prevail at the domestic level. Even though
Armenia’s road network is widespread, the current condition of the roads creates a significant impact on transportation costs. In this chapter, we simulate the impact of a reduction in the transportation costs faced by self-employed farmers. We choose self-employed farmers as our focus because of the central role of the agriculture sector in the Armenian economy and the pivotal role of small holders in this sector. Our analysis indicates that decreasing transportation costs would improve household welfare for all. We therefore believe that improving the current state of the transportation network and the trade relations with neighboring countries would help improve the well-being of Armenian households in general, and the Armenian poor specifically.
Finally, the agriculture sector faces several challenges. Having led growth in the
early 90s, the agriculture sector is now characterized by a shortage of equipment and lack of vital inputs. A further problem is that the government is not recovering costs from irrigation. We show that an increase in irrigation costs will lead to some welfare loss among households. More importantly, the loss will be higher for poor households.
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World Bank (2000). "Trade Facilitation in the Caucasus." Report for South Caucasus Regional Initiative, October.
World Bank (2000). "Armenia: Targeted Financial Sector Review." December.
World Bank (2001). "Armenia: Growth Challenges and Government Policies." Report No. 22854-AM, November 2001.
World Bank (2001), Chapter of Trade Policy and Poverty, in Poverty Reduction Strategy
Paper Sourcebook, Washington DC.
World Bank (2001). "Mauritania: Integrated Framework Diagnostic Study: A Poverty-Focused Trade Strategy." Draft, October 4.
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World Bank (2001). "Leveraging Trade for Development: the World Bank Role." Development Committee, April 9.
World Bank (2002), “Armenia Poverty Update.”
World Trade Organization (2001) “Trade and Poverty: Is There a Connection?”
Armenia
ANNEX 1: INDUSTRY OVERVIEWS
Transportation The foreign trade sector of the economy has been severely impacted by the ongoing transportation problems in Armenia. Regional conflicts and infrastructure problems continue to plague Armenian transportation and have strong implications for foreign trade. Armenia is a landlocked country and relatively isolated from major export markets. Therefore, transportation is an important element of any economic activity in the country that involves imports or exports. Unfortunately, the country is plagued by high transportation costs brought about by a number of factors:
• Physical Constraints. The transportation infrastructure within Armenia is old and
needs significant improvements. This infrastructure includes the railways, roads and air transportation. Rail transport is not reliable, slow and severely limited by the border closings (see below for a discussion.) It is not only the equipment (locomotives and wagons) that needs improvements but all the basic physical infrastructure of bridges, railway beds and communications systems. The main Armenian roads are in decent condition because of the Highway and Transport Projects. However, Armenia has limited funds for maintenance and therefore, road quality could deteriorate. Armenian air transport is impacted by the low quality of the available runways and the associated infrastructure (e.g. landing lights.) Furthermore, the air terminal in Yerevan is not up to international standards. However, the government is prioritizing air transportation – border conflicts do not impact air travel and is therefore the most reliable mode of transportation in Armenia.
• Geo-Political Issues. The Nagorno-Karabakh conflict between Armenia and
Azerbaijan is a decade old land dispute resulting in a number of wars, border closures, and cessation of trade between Armenia, and Azerbaijan and Turkey – two-thirds of the Armenian border. A cease-fire was declared in 1994. However, trade has not resumed in an official capacity. Therefore, Armenia is dependent on Georgia and Iran as trade routes. However, transport through Georgia requires the payment of numerous bribes, which has raised the cost of access to Russia and to the Black Sea ports, and Iran is under embargo by most of the rest of the world. Removal of the blockades needs to occur before the situation can normalize.
• Other. There are a number of other issues that indirectly impact the cost of
transportation in Armenia. These issues serve to increase the cost of transportation even further and include:
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o Georgia Situation: Transportation issues within Georgia including bribery, theft, and poor road and railway quality impact any transportation that must travel through it.
o Government control of transportation modes: Many of the modes of transportation within Armenia are either government owned or not fully commercialized resulting in poor management and inefficiencies.
o Intermediaries: Due to the conflict with Turkey and Azerbaijan, passage of goods through either country must be arranged through an intermediary
o Armenian Corruption: Bribes paid to customs and government officials, and road, district and tax police raise the cost of transporting goods.
All of these factors combine to increase the costs of imports and exports, impacting Armenia’s competitiveness and imposing significant economic losses on the country.
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Energy Industry
The Armenian energy industry plays a major role in the country’s economy contributing 8.4% to GDP in 1999. But Armenia has no sources of oil, natural gas or coal. It does, however, have a large capacity to produce electricity because of the production capacity that was built during the Soviet era. Lack of other sources of energy, however, have forced Armenia to be dependent on imports. After independence in 1991, Azerbaijan shut down the pipeline transporting Russian natural gas (used for electricity generation and heating) into Armenia. The shutdown was precipitated by the conflict over the Nagorno-Karabakh region. Armenia was therefore forced to switch to the smaller and unreliable Georgian pipeline as a source of natural gas. This change was aggravated by the already reduced supply due to the shutdown of the Armenian Nuclear Power Plant (safety concerns forced the shutdown after an earthquake in 1988,) three consecutive harsh winters and sabotage of the energy infrastructure due to the conflict. As a result, Armenia suffered an energy crisis that severely impacted the industrial sector, economic input of the country, as well as the daily lives of Armenians. (Electricity output was limited to one to three hours per day.) The situation led to a re-opening of the nuclear plant in 1995. Reopening the plant alleviated the shortfall and the Armenian government has since prioritized the energy sector for liberalization. The government established an independent Energy Regulation Commission as well as adopted a new energy law. It is attempting to privatize the sector and has reorganized the state enterprises to make them more attractive to foreign investors77. Increased payment discipline and electricity tariffs combined with better budgeting have also improved the financial viability of the sector. Electricity is now available 24 hours a day78. In 1999, the energy industry produced $155 million USD in sales – 29.26% of industrial production and 8.4% of GDP. There are now approximately 24 companies in the industry that employ 30,000 people making up 14% of industrial employment.
77 Initial attempts to privatize the sector were stalled in April 2001 when the government announced that they had no offers for the first and second privatization tenders. 78 Annual electricity sales were $155 million USD (8% of GDP) and employed 30,000 (14% of total industrial employment.) . “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p. 166
Table 1. Energy Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
121.6 142.2 155
Share of total industrial production (In current prices) 25.60% 29.35% 29.53% Ministry of Statistics, State Register and Analysis of the Republic of Armenia
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Excess capacity exists and Armenia is a small exporter of electricity. But Armenia has a considerable Opportunity to expand exports to Turkey, Azerbaijan, and Georgia79 since all are suffering from energy shortages. Given Armenia’s lack of natural sources of most energy, however, the country is a large importer of energy. In 1999, $159.1 million USD of energy was imported into Armenia. Despite this dependence on foreign sources of energy, Armenia’s economic growth should not be greatly impacted by energy shortages in the short-term. However, some issues could impact the situation in the not too distant future:
o Investments. Armenia’s generation capacity will need to be replaced in 4 to 5 years and the transmission and distribution systems will need modernization80. Investment in the range of $1.4 billion USD is needed if Armenia is to maintain the current situation and not have economic growth impacted by energy shortages81.
o Geo-political Issues. Armenia has no natural sources of oil, natural gas or coal. Therefore, all of these products must be imported into the country82. The imports have been and could continue to be impacted by the geo-political conflicts in the region83. Furthermore, if in the future Armenia wishes to export energy to others in the region, resolution of these conflicts will need to be reached.
o Power Sources. Armenia has significant hydroelectric power potential and the country has tapped this source of energy. However, in doing so, the water levels of the country’s largest lake (Sevan) have been reduced to ecologically dangerous levels. In addition, Armenia is heavily dependent on nuclear energy. (The Armenian plant produces 40 - 45% of the country’s energy84.) However, all fuel for the plant is
79 Georgia has low purchasing power and a reputation for non-payment. Therefore, should be considered with caution. 80 “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p.169 81 Based on the Report by the Armenian Energy Commission and estimates of the EBRD. It should also be noted that once these plants are replaced, electricity exports would be less competitive due to the increased cost of energy generation. 82 Imports of energy inputs made up 8% of GDP and 20% of total imports in 1999. “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p. 166 83 Reduced consumption and improved energy efficiency could help to reduce reliance on imports to a certain extent. 84 Energy Information Administration, US Department of Energy. “ Caucasus Region Country Analysis Brief.” http://www.eia.doe.gov/emeu/cabs/caucasus.html
Table 2. Exports of Energy 1997 1998 1999 Percentage of Total Exports N/A N/A 3.19%* * Numbers are for the first half of the year only Ministry of Statistics, State Register and Analysis of the Republic of Armenia
Table 3. Trade Balance 1997 1998 1999
Total Imports (In million USD)
N/A N/A 159.1
Total Exports (In million USD)
N/A N/A 7.4
Difference N/A N/A -151.7
Ministry of Statistics, State Register and Analysis
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imported from Russia at preferential terms (Subsidies that will be decreased over time) and the government has planned to shut down the plant in 200485.
• Further Liberalization. District heating remains government owned and subsidized, leading to poor financial performance and tax contributions by the sector.
85 The government may be trying to negotiate an extension of the shut down with the European Union until 2008 or later.
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Jewelry and Diamond Processing
Please Note: The data for this sector needs improvement, as there are inconsistencies between production and trade data
The jewelry and diamond processing industry in Armenia is one of the best examples of the potential skills of the Armenian workforce. It is also one of the few industries that has continued to expand after independence. Often referred to as the “shining jewel” of the Armenian economy, both jewelry and diamond processing have registered steady growth over the past several years. Second only to food processing, the jewelry industry has the potential to decrease Armenia’s overall trade deficit, create jobs, and attract foreign direct investment from countries with higher labor costs. The diamond processing and jewelry industry in Armenia enjoyed prominence under the Soviet regime. One out of six processing plants in the USSR was located in Armenia and Russia provided a reliable supply of rough diamonds. The country developed diamond-cutting expertise and obtained the necessary production technology and machinery. With independence, Armenia has looked to the industry as a source of growth. In the late 1990’s, the industry expanded through support from the government, which used tax breaks to encourage foreign investment. Currently, the industry employs approximately 4000 people (with 2000 in diamond processing86.) The main activity within the industry is the processing or cutting of rough diamonds. Other products include87:
o Gold (unwrought or semi- manufactured)
o Gold jewelry
o Jewelry articles
o Semi-precious stones At this time, Armenia’s jewelry industry imports raw materials (in particular rough diamonds) for these products. However, the industry is one of the few sectors in the Armenian economy to have
86 ”Jewelry and Diamond Processing Industry Profile.” Tacis p. 4
87 Ibid. p. 5
Table 1. Jewelry and Diamond Processing Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
30.2 16.9 33.0
Share of total industrial production (In current prices)
5.6% 3.3% 6.2%
Ministry of Statistics, State Register and Analysis of the Republic of Armenia
Table 2. Exports of Diamonds, Semi-Precious Stones & Precious Metals 1998 1999 2000 Percentage of Total Exports 22.7% 42.8% 48%* * Numbers are for the first half of the year only Ministry of Statistics, State Register and Analysis of the Republic of Armenia
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a positive trade balance. While underutilized at this point, local supplies of semi-precious stones could represent a potential future development, which would directly benefit Armenia. Furthermore, Armenia could benefit from foreign expertise in jewelry design so it can compete in the international market as well as expand an area that provides more value-add to the raw materials. At the time of independence in 1991, four of the largest diamond processing companies in Armenia (Shoghakn, Diamond Company of Armenia, Yerevan Jewelry Plant, and Sapphire) were government owned. As part of the 1995 privatization scheme introduced by the government, however, the first two were privatized and are now foreign owned – by Israeli and British companies respectively. The second two were made available for privatization in 2000 and 2001 respectively. Additional foreign investment in the other large diamond processor was received from an expatriate now based in Belgium. This foreign investment resulted in an influx of capital to the sector and allowed for machinery updates, access to more reliable raw materials, and training for the sector’s labor force88. The jewelry and diamond processing industry, poised for expansion, draws its strength from:
• Highly qualified and experienced labor at low cost
• Access to modern equipment and production capacity.
• All inputs and exports are transported by air. Not having to rely on land transportation routes, the cost of which are a major hindrance to other exporters, allows it to avoid one of the major constraints to foreign trade in Armenia.
• Since virtually all production is exported, the small size of the local market is not a disadvantage.
• Government support through tax breaks on imports of raw materials, exports of finished products and repatriation of profits. (A 100% tax break for the first two years and 50% for years 7-10.)
• The future potential of local resources in semi-precious stones. The opportunities that are available to the industry include:
• Breaking into the international market with the high quality but lower cost products.
• Attracting capital transfers from countries with high labor costs (e.g. Israel) Despite its strengths, the industry faces four major obstacles, which reflect some of the problems faced by others in the foreign trade sector:
88 There has been approximately $8 million in investment in the sector.
Table 3. Trade Balance 1997 1998 1999
Total Imports (In million USD)
47.4 45.5 86.7
Total Exports (In million USD)
55.2 53.1 99.9
Difference 7.8 7.6 13.2
Ministry of Statistics, State Register and Analysis
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• Lackluster jewelry design, which prevents Armenia from competing internationally
• Limited access to financing for the smaller producers: currently Armenian companies depend primarily on foreign investment or personal savings for financing
• Industry focus on diamond processing, which does not add as much value as jewelry design
• Lack of diversified sources of raw materials. (Armenia used to rely almost exclusively on imports from Russia, which stopped exporting to Armenia for a period. While supply has resumed, diversifying risk by finding other suppliers should remain a priority)
With easier access to local financing, increased foreign investment, and foreign cooperation Armenia could find itself on the forefront of the international jewelry market.
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Information Technology Industry In 1957, the Soviet Union Institute of Mathematical Machines was established in Yerevan to produce computer hardware and software - the only one in the USSR and directed towards building military infrastructure. In the mid-1980’s the Soviets established a computer-training program in Armenian secondary schools and technical colleges to support its military efforts. The limited market, low overall computerization, and the energy crisis, however, hampered industry growth after independence in 1991 despite Armenia’s specialization in the area. Because of the small market, people with programming skills emigrated, and as a result, Armenia’s talent earned both recognition in the industry and foreign investment in the country. In the late 1990s, Armenia became home to many foreign software company subsidiaries taking advantage of the relatively cheap and qualified labor force.
Given that growth in the industry has mostly occurred since independence, government agencies only control 5 of the 35 to 40 software development companies89. Of these companies, at least 12 are foreign and 23 are locally owned90. (See Sidebar 1) The industry employs approximately 2000 people91.
The sector focuses on six different types of software products92:
• Business and statistics: 46%
• The Internet and e-commerce: 15%
• Teaching: 12%
• Entertainment: 11%
• Art and Design: 9%
• Other: 7%
According to local experts, for the period between 1999 and 2001, estimated investment in this sector was USD 4-5 million and investment is expected to increase to USD 20-22 million within five years93. Software exports, comprising about 5% of total exports ($15-20 million USD94,) have had a positive effect on the Armenian trade balance, with foreign subsidiaries exporting 100%
89 “Armenian Software Industry, Analysis of Sectoral Trends.” p. 7 Please note, however, that most of the data for the industry is unofficial or anecdotal. 90 Ibid. p. 8 91 Armenian Development Agency 92 “Armenian Software Industry, Analysis of Sectoral Trends.” p. 9 93 US Foreign Commercial Service and Department of State, Armenia: US owned software development companies 94 “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p. 36
Sidebar 1: Armenian Software Companies There are approximately 35 to 40 larger scale software development companies in Armenia. The largest software engineering companies are HPL, Epygi Labs, Credence, Lega, Boomerang Software. HPL Armenia, a subsidiary of the Silicon Valley-based HPL Technologies, has become the largest software firm in Yerevan employing approximately 100 employees1. HPL’s software integrates data sets from the design, fabrication and test stages of the semiconductor production process. This integration enables semiconductor companies to synthesize that data into a unified format, conduct analyses to suggest yield enhancements, and view and manipulate the information through a user-friendly interface. HPL is pointed to as a success story in the Armenian IT industry given their recent growth. The company as a whole has seen revenue grow from $3.7 to $13.4 million USD in 2001 and is expecting revenue of $77 to $80 million USD in 20032. 1 Source: BISNIS, US Department of Commerce. “Brief Overview of Software Market in Armenia”
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of their products and local companies exporting between 10% and 50% of theirs95.
Armenia’s inexpensive skilled labor, a strength of the industry, reduces start-up and research and development costs, attracting foreign investment. Average starting wages for local software companies are between $150 and $400 USD per month and between $300 and $1,200 USD per month for foreign subsidiaries96, although top programmers are now demanding (and getting) upwards of $2000 USD per month. (These salaries, however, are still 20 times less than their US counterparts.) Some estimates claim that Armenia has approximately 15,000 available computer specialists and the Armenian universities graduate around 300 computer specialists per year97. Therefore, the supply of qualified labor should be maintained.
In addition to Armenia’s labor advantages, products of the IT industry are transported by air or the Internet and therefore do not rely on the expensive – and frequently unstable – ground transportation.
Armenia has an opportunity to attract capital transfers from countries with high labor costs, but must first overcome five obstacles:
• Human Resource Issues. In Armenia there is a two-year military service requirement of all youth that results in lost and/or obsolete skills by those trained in computers. The military service requirements have combined with chronic emigration to create a destructive downward trend as the country loses its precious labor resource – a key source of its comparative advantage and economic potential. Emigration of IT specialists has been encouraged by the demand for IT skills in countries such as the U.S. and Germany where salaries are much higher than in Armenia. Therefore, there is a growing shortage of highly skilled programmers. A shortage that is likely to increase given increasing demand, making it more difficult for local firms to
95 “Armenian Software Industry: Analysis of Sectoral Trends.” p. 96 Ibid. p. 12 97 Some question the skills of Armenian computer degree graduates, pointing to the lack of programming training in those degrees as well as the need for extensive on-the-job training of many graduates once they are employed.
Sidebar 2: Armenian Telecommunications
After independence, Armenia inherited a relatively extensive but low quality telecommunications network. However, the design of the network was not commercially driven, leading to misallocated lines and low call volumes. These elements combined with politically driven low local tariffs (subsidized by high international call tariffs) to result in low revenues per line. The outcome: outdated equipment, poor network quality and a slow digitalization rate due to chronic under investment in the sector. The government further aggravated the situation by awarding a monopoly (in place until 2013) to Armentel, the local telecommunications company owned by the Hellenic Telecommunications Organization. (A Greek company.) The monopoly has allowed Armentel to provide low quality services at high prices, further hampering growth in telecommunications and related sectors (e.g. IT.)
There are currently 15 Internet Service Providers in Armenia. However, they all have to go through Armentel to connect to the Internet, which results in unreliable connections and a limit on their ability to compete on price. Service is also limited to modem connections only. Therefore, connection speeds are slow. This situation must be improved so Armenia can broaden adoption of the Internet, communicate effectively in the modern world and attract Internet-related application development work from other countries.
The government recognizes the need for change: Some regulatory changes have been and will be made and they are evaluating the Armentel monopoly.
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compete with foreign subsidiaries in attracting and retaining employees as well as reducing the appeal of Armenia for foreign investors. In addition, managers of software companies lack the necessary skills to handle company marketing and finances as well as employee issues all leading to mismanagement of fledgling companies.
• Small Domestic Market. The small domestic market means that Armenian software companies must look to export their products. However, they have limited marketing capabilities and financial resources and face stiff competition in the international arena.
• Financing. Many local companies lack access to financing because Armenian banks are wary of lending to a company with intellectual as opposed to physical capital.
• Intellectual Property Rights. Armenian law prohibits employers from owning their employees’ work product. Instead, companies can only use it without paying for the right. (Even if the employer and employee sign an agreement that states otherwise.) Use of the work product is also limited to 10 years, after which the company must purchase the rights from the employee, an arrangement that deters foreign investment. While the rule is sporadically enforced, copyright laws are as well - further deterring industry development with the risk of losing sales to software piracy and therefore increasing development costs.
• The Armentel Monopoly. The low quality services and high prices charged by the telephone monopoly (See Sidebar 1 above) increase the barrier to entry for local software development firms as well as hinder existing firms by increasing operating costs and making “production” unreliable due to erratic connections to the Internet.
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Agricultural and Food Processing Industry The Armenian agricultural and food processing industry has continuously expanded its share of total industrial output since 1997. Agriculture and food processing has the largest share of GDP (39%) of any other sector98, despite the scarcity of arable land in Armenia (17 percent or 1.2 million acres99.) Armenia, however, has unique soil and favorable climatic conditions for agricultural production.
Prior to independence, Armenia’s arable land was broken out into large state-run collective farms. The bulk of Armenia’s agricultural production -- including large quantities of fruit, canned food, juices, wine and brandy -- was exported to the Soviet Union. After independence, the state quickly privatized the agricultural sector, transferring most arable land to family farms and offering processing plants for privatization. (As of 1999, there were only 5 small plants left to privatize.) Subsidies were quickly removed and only exemption from VAT and land taxes, irrigation water subsidies and seed loans now remain. International trade was also liberalized with between 0 and 10 % import duties imposed on agricultural and food products. Initially, the sector struggled. Production dropped by more than 60%100. But since 1997, production has steadily increased (see table 1) and now it is the only sector that has exceeded 1990 output levels. The increase in agricultural output and corresponding increase in share of GDP, however, has made the Armenian economy vulnerable to instability in agricultural output. Furthermore, even with this level of output, most agricultural processing plants are operating at between 10 and 20% capacity.
As of 1998, the industry was the largest employer in Armenia with 15,994 people with an average monthly salary was $37 USD101. Agricultural products include:
• Grains - wheat, barley, oats, and corn
• Fruits – grapes, apricots, peaches, plums, apples, pears, cherries, pomegranates, figs, walnuts, persimmons, melons, watermelons, and pumpkins
• Vegetables - potatoes, beans, tomatoes, cucumbers, eggplant, cabbage, onions, garlic, carrots, beets and, peppers
• Meat - cows, pigs, sheep, goats, and poultry.
• Tobacco
98”Food Processing Industry Profile.” Tacis p. 3 99 Armenian Development Agency 100 ”Food Processing Industry Profile.” Tacis p. 5 101 Ibid. p. 3 and 4 Because of excess capacity, it is thought that the number is smaller than officially reported.
Table 1. Food Processing Production
1997 1998 1999 Production – In million USD (Based on year average exchange rate)
191 198 204
% share of total industrial production (In current prices)
36.8% 38.3% 38.9%
National Statistical Service of the Republic of Armenia
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Approximately 150 large and medium enterprises process food. Most activity is oriented around canned food, wines, vodka, flour and cigarettes. Other products include102:
• Beverages (fruit juice, beer, brandy, champagne, mineral water)
• Milk and dairy products
• Meat and meat products
• Bread
Despite the scope of local production, Armenia imports large quantities of food products (see table 3,) partly because Armenians consider local goods of poor quality. The local industry, however, has made great quality improvements in recent years. The improvement of local products could mean a place in the international market for Armenia, increasing exports and thereby a reduction of the normally large trade deficit. Furthermore, imported food products are often of poor quality, expired, or bearing incorrect labels, which has led to an increase in gastrointestinal and oncological problems, and allergic reactions. An issue that producers must publicized more widely to gain acceptance of local products by Armenians.
In the late 1990’s the industry -- the canning, brandy, and tobacco sectors in particular -- attracted foreign investment. While the industry’s excess capacity makes it attractive, upgrading the machinery of these companies will be necessary for any foreign investor.
Besides increasing exports (in particular of organic product, see sidebar1,) the industry could reduce the trade deficit through:
• Encouraging purchases locally (for import substitution) by marketing the quality of food products.
• Encouraging foreign investment by advertising its low cost, experienced labor and excess production capacity.
• Despite the industry’s compelling strengths, it must address:
• The limited supply of agricultural products because of scarce arable land. • The limited access to financing particularly for the smaller producers: currently
Armenian companies depend primarily on foreign investment or personal savings for financing.
102 Ibid. p. 5
Table 2. Exports of Mining Products 1997 1998 1999 Percentage of Total Exports*
11% 7.6% 6.9%*
* Data was extrapolated
Table 3. Trade Balance 1997 1998 1999
Total Imports (In million USD)
170 186 114.8
Total Exports (In million USD)
25.4 16.9 16
Difference -144.6
-169.1
-98.9
National Statistical Service of the Republic of Armenia
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Sidebar 1: Armenian Organic Agricultural Products
The USDA recently conducted a study of the feasibility of developing organic farming in Armenia. The recommendation was that “there is a tremendous opportunity to develop organic agriculture in Armenia.” The reasoning being that many in Armenia are already involved in various aspects of organic agriculture development. (e.g. organic composting, government research into organic farming, development of an Organic Farmers Association.) Furthermore, Armenian farmers have used chemical inputs (i.e. pesticides and fertilizers) sparingly – since independence availability of these products was limited. Additionally, the rapidly growing export market for organic products has raised the appeal of organic farming for Armenian farmers. If Armenia can increase the production of organic products, they could potentially have an opportunity to develop the agricultural sector, increase exports and in so doing improve the trade deficit.
• The blockade that imposes high transportation costs on exports and therefore, impacts competitiveness. However, the blockade also protects local producers from more cost-effective producers in neighboring countries (Azerbaijan, Georgia, Turkey.) Exports will benefit if the blockade is lifted, however, local producers will face much stiffer competition in the local market.
• The outdated, substandard processing and packaging equipment and technology that can really only be improved through foreign investment and expertise.
• The demand for imported goods due to the inherent bias of Armenians towards imported goods, which prevents the growth of the domestic market for agricultural and food processed products. In addition addressing problems with local procurement and distribution will bring prices down and make local products more attractive to Armenians.
• The need for improved marketing of Armenian products to not only grow demand abroad but also open new markets so exports can increase.
• The black market of agricultural products such as brandy and vodka. Companies violate awarded trademarks and this activity threatens foreign investment in the sector. (Pernod Ricard has suspended development of the Yerevan Cognac Company for this reason.)
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Mining Industry Please note: There are data issues for this industry and some elements do not add up.
The mining industry in Armenia is the third largest producer of industrial output (after food and diamond processing) and since 1996 has grown consistently. While many observers of the Armenian economy consider the mining industry to be dynamic, its success ultimately depends on foreign investment. Reluctant to relinquish control of the sector, the government is sensitive about privatization of mining and has yet to determine a coherent strategy.
Prior to independence, the USSR dominated Armenian mining operations. Armenia supplied the USSR with copper, molybdenum, zinc, and gold concentrates primarily for the Soviet defense industry. Needs that have led to a large Armenian production capacity. After 1991, that capacity was largely unused. The Armenian mining industry operated sporadically and produced less because:
• They no longer had the Soviet defense industry as a primary market.
• Azerbaijan and Turkey blocked trade with Armenia thereby blocking imports of inputs.
• The energy crisis of the early 1990s crippled the industry that has large energy needs.
The government has also been unwilling to allow foreign companies exploration licenses to evaluate the mineral resources of the country and there is limited data available as it is. Despite these constraints, since 1996, mining production has begun to recover. As of 1999, the industry shared 3.9% of total industrial production and employed 5,723 people at wages of approximately $100 USD103. (Significantly higher than other industries where the average salary is $44 USD104.) However, many companies are still working at well below capacity – between 30 and 80%105.
The primary products of the sector are copper and molybdenum ores and concentrates, and poly-metallic ores. Other products include:
• Gold, Silver Lead and Zinc
• Semi-precious stones (agates, jasper, amethyst, serdoliks, turquoise, marble onyx)
• Salt
• Construction materials (tuff, granite, marble, gypsum, and limestone)
103 ”Mining Industry Profile.” Tacis. p. 4 and p.5 104 Ibid. p. 5 105 Ibid. p.6
Table 1. Mining Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
18.2 20.2 20.7
% share of total industrial production (In current prices)
3.5% 3.9% 3.9%
National Statistical Service of the Republic of Armenia
139
Of the mining industry production, 86.8% is metal ore extraction and 13.2% are other sub-sectors106. Mining is the only other industry besides diamond processing that has a trade surplus. Exports declined 47% between 1995 and 1997. However, they recovered, are ranked second and make up 13.2% of Armenia’s exports107. Gold exports increased by 288% between 1998 and 1999, but the main export remains copper and molybdenum. Imports have increased over the same period due to gold but regardless the amount is small.
Despite their reluctance to privatize, the government put seven major state companies up for privatization in 1999. However, by October 2000, privatization of the 3 major copper processing companies had yet to commence. It seems, based on the actions of the government so far that they have no intention of relinquishing control of extraction, only processing. The lack of a definitive plan by the government, combined with their reticence to allow foreign companies to survey the mining resources of the country, has limited the amount of foreign investment in the sector. Most of the investment that has occurred is in copper and gold. For example, Manes and Vallex (an Armenian- Liechtenstein joint venture established in 1997) with starting capital of $4.8 million USD was established to mine and process copper. The American Gold Recovery Company (a joint venture between the Canadian company First Dynasty Mines and Armenian state producer Hajoski in 1998) with $12 million USD was started to mine and process gold. The government expects $608 million USD of foreign investment between 2003 and 2010108. However, investment will depend on improvements in the investment environment including:
• Improving the data that is available for the industry and on mining reserves.
• Developing a new Mining Code that is more international competitive incorporating elements such as increasing mining rights beyond the current limit of 25 years.
• Developing a proactive Foreign Direct Investment policy that provides special incentives to foreign investors.
Notwithstanding these obstacles, Armenian mining is attractive to foreign investors because of:
106 Ibid. p. 5 107 National Statistical Service of the Republic of Armenia. The exact amount of exports is difficult to determine because exports exceed output values – probably due to differences in product coverage. 108 Armenian Development Agency
Table 3. Trade Balance 1997 1998 1999 Total Imports (In million USD)
2.9 3.9 6.2
Total Exports (In million USD)
16.4 24.1 30.6
Difference 13.5 20.2 24.4
National Statistical Service of the Republic of Armenia
Table 2. Exports of Mining Products 1997 1998 1999 Percentage of Total Exports 7.1% 10.9% 13.2%* National Statistical Service of the Republic of Armenia
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• The availability of mining reserves109 including large deposits of copper, molydbedum, zinc and gold.
• Low cost, experienced labor and excess production capacity.
If the industry can develop further, it has the opportunity to reduce the trade deficit of the country even more, to contribute to regional development and thereby reduce emigration by providing employment in areas outside of the cities. Moreover, by developing local processing further, more value is added to the products. However, there are a number of obstacles to overcome:
• The limited access to financing that is particularly needed for the updating of equipment and technology – a further reason for foreign investment. Financing is also needed because of the debt that the industry incurred during the idle period after independence. The lack of working capital has also limited production and the development of exports.
• Transportation is costly and difficult because of the blockade by Azerbaijan and Turkey of two-thirds of country’s border. The blockade has had a particularly severe impact on the companies in the northern part of Armenia since the blockade completely limits access to trade routes out of the country110. These high transportation costs are a major reason why Armenia’s comparative advantage in the industry is limited and its long-term viability is potentially questionable.
• Instability of world prices has an inordinate impact on the industry and the weakened economy of the region is unable to absorb mining products.
109 The extent of the reserves is considered by some to be insufficient to last for a long period of time and an additional reason for Armenia’s limited comparative advantage in mining. “Armenia, Growth Challenges and Government Policies, Volume II: Main Report.” p.36 110 The companies in the southern part of the country have had an easier time because of their access to Iran and the Persian Gulf.
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Construction An overview of the Armenian construction industry has to begin with the impact of the earthquake more than a decade ago on the country and the industry. In 1988 Armenia suffered a devastating earthquake in which more than 25,000 people were killed and approximately 100,000 households destroyed111. More than 12 years later, there are still thousands of families that are living in temporary or inadequate shelter because of the inability of the industry to catch up despite intense efforts to rectify the situation. Between 1993 and 1997 annual new housing averaged around 4,000 units and even after a 20% increase in 1998 in housing production investment in the housing portion of the sector remains below 2.5% of GDP. Between 1993 and 2000, the housing construction sub-sector grew by 98.2% but housing construction is only at 1946 levels112. The amount of housing is also considered low when compared with countries with similar incomes (e.g. Moldova.) It is thought that a large amount of the construction growth in recent years has been related to the development surrounding the Christianity Anniversary in 2001 and the activities around that anniversary. The government is investing $10-15 million a year in housing construction, which should be sufficient if it weren’t for the government’s misguided housing strategy; a strategy that results in more focus on construction intensification in stead of more appropriate allocation and distribution of the existing housing stock. In addition, the situation is partially driven by the low demand for housing contributed to by emigration, low housing prices, low levels of cost recovery, high construction costs and property rights issues113 - all disincentives to investors. However, it is thought that if the current market problems are addressed, the situation will rectify in this sub-sector of the industry. Privatization in Armenia has brought with it, foreign investment and with that, more money into construction projects, particularly in industry. Despite the evidence of inequities and slow rectification of damage from the earthquake, construction activity has made an important
111 USAID 112 Armenia Economic Trends 113 Growth Challenges and Government Policies in Armenia, p. 184. There have been weaknesses in enforcement of property rights, which exacerbates the situation.
Table 2. Breakdown of Construction Production % of total 1997 1998 1999 Industry 6.4 12.9 7.2 Agriculture 4.1 8.3 14.0 Transport and Communications
32.9 15.7 19.6
Housing 28.9 39.3 34.6 Public Utilities 3.1 8.8 6.0 Other 24.6 15.0 18.6 Armenian Economic Trends Calculations of Data received from the National Statistical Service of the Republic of Armenia
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contribution to Armenia’s economic growth over the last decade. Furthermore, the industry employs 22,500 people at an above average wage of $66 per month. It is thought that there are 2275 Armenian construction companies. The industry is, however, heavily dependent on outside sources (aid agencies, foreign investors) for investment and trends in the industry correlate with fluctuations in the money received from these sources. Large portions of this foreign aid has gone towards construction and repair of structures as well as infrastructure projects with large construction components. (e.g. roads, irrigation networks, urban development.) But construction carried out by the state has decreased by more than 25% to 14.2% of the total and construction financed by local or private entities has increased by nearly 20% to 44%114. The industry has contributed 20 % to GDP at factor prices between 1994 and 1999 and the industry has seen growth of 46.5%. It is estimated that the industry imported approximately $50 million USD of building and finishing materials in 1998115 Raw materials that are available locally for construction include: tuff, granite, marble, gypsum, and limestone
114 Armenia Economic Trends. 115 Armenia: The Imported Building and Finishing Materials Market http://www.bisnis.doc.gov/bisnis/country/000110arco.htm
Table 1. Total Construction Production
1997 1998 1999 Production – In million USD (Based on year average exchange rate)
106.5 141.7 147.4
% of GDP (In current prices)
6.5% 7.5% 7.9%
National Statistical Service of the Republic of Armenia
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Tourism Please note: The data available for the tourism industry are very limited.
Tourism is often pointed to by local and international experts as one of the best prospects for the country and an industry that should be attractive to foreign investors. Given Armenia’s location in the south Caucasus (a mountainous region,) the country has many natural attractions including mountains, rivers, and lakes. The country has existed since the beginning of modern civilization – the time of ancient Egypt and Babylonia. Therefore, it is host to numerous historical and cultural attractions. Armenia also has many spas, which would be attractive to tourists. Armenia’s tourism facilities however, remain well below international standards and need to be improved. Significant opportunities exist for upgrading existing hotel facilities in Yerevan and in the regions or creating new ones. In addition, transportation, particularly in areas outside of Yerevan, needs improvement. The condition of these resources has meant Armenia has had a difficult time attracting tourists to the country. During the Soviet times, Armenia had a large tourist industry, attracting 700 to 800 thousand visitors per year. Armenia had been designated as one of the official vacation destinations for the people of the USSR. However, after independence, tourism to the country decreased drastically to between 4 and 5 thousand per year between 1990 and 1993 because of:
o The geo-political conflicts in the area discouraged visitors
o The economic instability of the region was a disincentive to tourists and was aggravated by the energy crisis of the early nineties.
Since that time, the number of tourists visiting the country has rebounded slightly (to 40,000 tourists per year for 1999) but still remains well below the levels of the Soviet period. The government was hoping that the 1700th anniversary celebration of the adoption of Christianity as a state religion would provide a significant inflow of tourists. (Mostly Armenians from the diaspora.) However, the celebration occurred shortly after September 11th, 2001 when international travel was reduced and the number of tourists did not live up to expectations. It is thought that there are 1042 companies oriented towards providing tourism services in Armenia116. However, the number of people employed in the industry and their average wage is not available. Revenue from tourism is estimated to be around $31 million for 1999. (1.7% of GDP.) But $23.4 million of that was from business travelers – mostly associated with aid organizations. It is thought that capacity in Yerevan is around 1,754 beds and 200 beds near Lake Sevan. By 2000, about 80 hotels had been privatized. This has stimulated foreign investment to a certain extent. But no one is interested in buying tourism facilities outside of Yerevan. Nevertheless, it is
116 Armenia Economic Trends
Table 1. Tourism Revenue
1997 1998 1999 Revenue – In million USD (Based on year average exchange rate)
N.A. 31 N.A.
National Statistical Service of the Republic of Armenia
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thought that up until 1999 there had been about $53 million USD of foreign investment in the industry.
There are multiple sub-sectors within the Armenian tourism industry that could be developed:
o Cultural and Religious Tourism. Armenia has over 5000 cultural, religious and historical attractions from monuments to churches and fortresses. (The monasteries of Haghpat and Sanahin in the Lori district have been listed as World Heritage sites.) Armenia is also on the Silk Route and should be included as a stop for those exploring this ancient trade corridor.
o Eco- and Adventure Tourism. The mountains (skiing, hiking and mountain climbing) and lakes of Armenia would be attractive to those interested in the environment and pursuing adventure sports.
o Diaspora Tourism. Armenians who have left the country already form a large part of those traveling to Armenia. By marketing specifically to these groups, however, this sub-sector could be stimulated even further.
o Health Tourism. There are a number of spa resorts in Armenia that include mineral springs that are known to have health benefits.
The government has made a commitment to developing the sector by establishing a State Program for Tourism Development. A target of 150,000 tourists by 2003 was set and a National Tourism Agency was established in 2000 to help with achieving this goal. Despite the too ambitious goals, the government has at least put some of the institutions in place that will assist in engendering the industry. However, the industry does still face some significant obstacles that include:
o Poor Infrastructure. Transportation in Armenia is difficult, which makes tourist exploration of the country problematic. The roads, other than the main highways, are in bad repair. Cars are difficult to rent. Public transportation is in poor repair or non-existent. The main Armenian airport as the capability of handling all modern types of passenger and cargo plains but the airport infrastructure needs to be modernized. Furthermore, Armenian Airlines (AAL) has a virtual monopoly on air travel, which makes air access to Armenia expensive and limited. The government is considering privatization of AAL but as of yet no tenders have been offered. Tourist facilities are not up to international standards or don’t exist at all.
o Political Instability. The geo-political conflicts that have simmered in the region must be resolved if the tourism industry in Armenia is to have a hope. The international press provide a view of local conditions that scare international tourists and until this bad press can be subside, tourism will be forever hindered.
o Poor Marketing. Armenia is not marketed abroad and this area will need great improvement if the world is to come to know the advantages of the country. The lack of marketing will not only limit Armenia’s ability to attract tourists but foreign investors as well.
o Poorly Trained Human Resources. Armenia has, until recently, not had to cater to an international audience. Therefore, the training and mind-set, necessary to deal with that audience, of those providing tourist services (of hotel staff, guides, restaurateurs etc.) is not in place. This lack of training means that the services provided are not up to international standards and this situation could be off-putting to visitors.
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The industry, if it can overcome these obstacles, has the potential to provide significant revenue for the country as well as for foreign investors. Tourism on average internationally provides a four-time return on investment within a year. Therefore, this is an industry that the government has an incentive on which to focus. However, there will be a need to invest a significant amount of money if the industry is to have a real hope of developing.
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Telecommunications After independence, Armenia inherited a relatively extensive but low quality telecommunications network. However, the design of the network was not commercially driven, leading to misallocated lines and low call volumes. These elements combined with politically driven low local tariffs (subsidized by high international call tariffs) to result in low revenues per line. The outcome: outdated equipment, poor network quality and a slow digitalization rate due to chronic under investment in the sector. The government further aggravated the situation by awarding a monopoly (in place until 2013) to Armentel, the local telecommunications company owned by the Hellenic Telecommunications Organization. (A Greek company.) The monopoly has allowed Armentel to provide low quality services at high prices, further hampering growth in telecommunications and related sectors (e.g. IT.) Production in the industry has been on the rise over the 1997 to 1999 period, including a corresponding increase in share of GDP, despite the poor service provided by Armentel. The industry employs approximately 7,400 people at an average wage of $66 per month. It is estimated that there has been approximately $62 million investment in Armenia’s telecommunications industry. There are currently 15 Internet Service Providers in Armenia. However, they all have to go through Armentel to connect to the Internet, which results in unreliable connections and a limit on their ability to compete on price. Service is also limited to modem connections only. Therefore, connection speeds are slow. The low quality services and high prices charged by the telephone monopoly increase the barrier to entry for local software development firms as well as hinder existing firms by increasing operating costs and making “production” unreliable due to erratic connections to the Internet. This situation must be improved so Armenia can broaden adoption of the Internet, communicate effectively in the modern world and attract Internet-related application development work from other countries. The government does recognize the need for change: Some regulatory changes have been and will be made and they are evaluating the Armentel monopoly to see what can be done to improve the situation.
Table 1. Telecommunications Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
43.73 66.35 74.47
% share of GDP (In current prices)
2.67% 3.5% 4.04%
National Statistical Service of the Republic of Armenia
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Chemicals Industry The chemicals industry in Armenia is composed of five sub-sectors: basic chemistry, synthetic and plastic materials, paints and other surface treaters, rubber and latex, and pharmaceuticals. Some look to the chemicals industry has holding promise because of the inputs that are available in Armenia including limestone, salt, mineral paints and tuff-stone as well as the ferrous metals industry. However, before assuming that the availability of these resources makes it viable it is important to evaluate the industry’s history of and trends.
During the Soviet period, Armenia was a major source of chemical production with many companies holding a monopolistic position in the USSR (primarily those serving military needs.) The industry was established around 1927 with the construction of a carbamide production plant in Yerevan. As of the 1970’s Armenia controlled nearly 50% of the region’s gross volume in chemical production. As is typical with many of the industries in Armenia, these activities led to a dependence on inputs from the Soviet Union and its market as well as large production capacity that has more or less lain idle since independence in 1991117. Many of these companies have been offered for privatization through international tender by the government. However, there has been little interest except in the Armenian pharmaceutical companies and joint ventures have been established between Bristol-Myers and Glaxo-Wellcome for pharmaceutical production. The industry has been unable to recover from the loss of the market and remains heavily dependent on inputs imports and energy. (A dependence that crushed the industry during the energy crisis of the early 1990s and continues to be impacted by the higher than normal energy prices due to the blockade situation.)
There are 28 companies in the industry but all but 3 are SMEs and the 3 large companies represent more than two-thirds of production and employment in the sector. Since 1985, the industry’s share of total industrial production has reduced from 6.6% to 2.8%. (SMEs control about $4 million USD of the 1999 production numbers.) As of 1998, the industry employed 7880 people (down from 24,200 in 1985) at wages of approximately $24 USD118 (well below the overall industry average of $44 USD per month.) Despite the large reductions in staff over the course of the 1990’s the industry is still over-staffed and there is unlikely to be any employment expansion.
The primary product of the sector is chloropene rubbers. Other products include119: 117 Armenian Development Agency 118 ”Chemicals Industry Profile.” Tacis. p. 4 119 Ibid. p. 5
Table 1. Chemicals Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
15.9 13.2 14.8
% share of total industrial production (In current prices)
3.1% 2.5% 2.8%
National Statistical Service of the Republic of Armenia
148
o Chloropene latex
o Caustic Sodium
o Pharmaceutical Products
o Detergents and Soaps
o Paints and Pigments
o Recently discontinued: Plastic Products, Synthetic Fibers, and Tires
The industry saw an increase in production in 1999 primarily because of rubber production. But the industry as a whole has been unable to face international competition both internationally and in the domestic market. The rubber company is hoping to increase its production level from 8,400 tons per year to 25,000 tons. Their production capacity is 50,000, which is equal to a third of the world’s current demand for rubber. The chemicals industry currently runs a large trade deficit. ($77 million USD as of 1999.) This deficit is despite exports making up 80% of total sales in the sector. (82% of these exports is rubber120.) Exports declined up until 1998 but have since seen an increase of 6.9%. The local market is worth about $90 million USD. But relies primarily (97%) on imports to satisfy demand121. This percentage is despite a significant increase in local sales – 29%. However, the industry is heavily dependent on imports of inputs because few are available locally, in particular, crude oil and natural gas hence the trade deficit and as a result imports remain 6 times higher than local production.
Privatization in the industry is most relevant for the three main companies - Nairit, Polyvinilatsetat, Doghagorts – and the government has offered these up for tender as of December 1999. However, there has been limited interest by foreign investors in the chemicals industry beyond the pharmaceuticals sub-sector.
The industry does have the advantage (like most the Armenian economy) of low-cost and high-skilled labor, excess production capacity as well as the availability of some inputs locally. But many weaknesses remain that would have to be addressed including:
o Obsolete equipment, old technology, and non-compliance with international standards will have to be addressed by the industry or a foreign investor.
o The industry has a lack of knowledge of foreign markets and has undertaken little marketing in an industry with intense international competition.
120 “Chemicals Industry Summary” Tacis. p. 7. The average price per ton of rubber exports in 1999 was 2010 dollars, an amount that is insufficient for the company to cover its operating costs. 121 Ibid. p. 6
Table 2. Exports of Chemicals Products 1997 1998 1999 Percentage of Total Exports 7.1% 10.9% 13.2%* National Statistical Service of the Republic of Armenia
Table 3. Trade Balance 1997 1998 1999 Total Imports (In million USD)
108.7 101 88.2
Total Exports (In million USD)
13.5 10.2 10.9
Difference -95.2 -90.8 -77.3
National Statistical Service of the Republic of Armenia
149
o Transportation is costly and difficult because of the blockade by Azerbaijan and Turkey of two-thirds of country’s border. These high transportation costs are one of the reasons why Armenia’s comparative advantage in the industry is limited and its long-term viability is potentially questionable.
o The need to import most inputs for the industry means the industry has limited ability to reduce the country’s trade deficit. In particular, there is the reliance of the industry on energy inputs that are expensive due to the blockade.
o Chronic emigration in Armenia has led to a drain of skills and labor. The industry laying idle has also led to deterioration of labor skills. These are both critical issues that must be addressed if the industry has a hope of surviving. If the industry can respond, however, there is an opportunity for it to has a positive impact on regional development in Armenia and provide more employment to those outside of the metropolitan areas.
o The lack of financing has constrained the industry and some of the companies have large debts.
o The instability of world prices and glut of chemicals products on the world market has an inordinate impact on the industry and the weakened economy of the region would be unable to absorb the excess chemical products.
150
Light Industry The Light Industry in Armenia currently comprises less than 2% of total industrial production. Textiles and clothing are a major sub-sector of the industry made up of both knitted goods and sewing activities. However, during the course of the 1990’s sewing activities have gradually replaced knitted goods in the industry as it has taken on sub-contracts from US companies. The industry has not managed to maintain production levels despite taking on these new activities. But the industry has become vulnerable to extreme fluctuations in production and employment as these foreign orders change over time. During the Soviet period, light industry was well-developed and robust, representing a quarter of industrial production and employing 115,000 people. As with other industries, it was oriented towards supplying the USSR with textile and clothing goods. Since independence, Armenia lost the traditional CIS markets and could not face international competition and the industry subsequently collapsed. Since 1991 employment has dropped by 80,000 to 27,764 people122 and production 1.4% of industrial production from 24% in 1985123. The average wage of the industry as of 1998 was $38 per month124. In 1999, industry production stood at $7.5 million USD. Production dropped because the industry has neither the ability to face international competition in the domestic market nor the initiative and/or facility to find replacements for traditional CIS markets abroad. The industry includes about 6 large companies and then many small producers. (As of 1998 the number stood at approximately 38 companies125.) The primary products of the sector are textiles and clothing (fabrics, knitwear, socks). Other products include:
o Leather
o Shoes
o Carpets
122 These are official numbers but it is thought that the number could be less than 10,000 in 1999 based on production numbers. 123 ”Light Industry Profile.” Tacis. p. 4. The employment number is for 1998. 124 National Statistical Service of the Republic of Armenia 125 “Light Industry Profile.” Tacis. p. 4
Table 1. Light Industry Production 1997 1998 1999 Production – In million USD (Based on year average exchange rate)
7.9 8.9 7.5
% share of total industrial production (In current prices)
1.5% 1.7% 1.4%
National Statistical Service of the Republic of Armenia
151
Recently sewing activity has more than tripled in volume and accounted for some of the improvement in the sector since 1997. As a result of this increase, production of the other industry products has reduced drastically. (e.g. carpet production in 1999 was 1% of the level it was in 1985.) Light industry is completely dependent on imports of raw materials. These imports combined with the large increase in the early to mid-1990’s of finished textile and clothing product imports into Armenia has resulted in a significant trade deficit for the industry126. Imports have decreased a little in recent years but still remain high. (10% for textiles and 41% footwear127.) Exports improved by 46% between 1996 and 1998 but then declined slightly in 1999. 80% of those exports are made up of non-knitted (sewn) goods and nearly 70% is sent to the United States128. With all its eggs in one basket, Armenia faces considerable risk and must quickly diversify products and export countries. The small size of the domestic market (given the small population and its low purchasing power) means, however, that the industry is forced to export. With limited data on foreign markets, little experience in marketing themselves, and insufficient financing companies in this industry will struggle to undertake these activities. Privatization in the industry has proceeded along quickly and already half of the industry is privatized. In December 1999, the government offered an additional 13 companies up for privatization. In terms of foreign investment, however, there has been relatively limited activity. A US-Armenian investment group purchased two companies but then the only other foreign involvement in the market has been the subcontracting activities of other US companies. As with most Armenian industries, light industry is attractive because of the availability of cheap but skilled labor, and the excess production capacity with equipment that is in decent condition. Because light industry must adapt to sub-contracting activities, however, it has the added advantage of flexibility. Furthermore, Armenia has GSP status,
126 Armenia is even a net importer of carpets – a traditional Armenian product. This situation reflects Armenia’s difficulties in competing abroad but also Armenian’s preference for lower cost imports due to their limited purchasing power. Ibid. p.14 127 Ibid. p. 12 128 Ibid. p. 8
Table 2. Exports of Light Industry Products 1997 1998 1999 Percentage of Total Exports 4.9% 6.6% 6.3%* National Statistical Service of the Republic of Armenia
Table 3. Trade Balance 1997 1998 1999 Total Imports (In million USD)
44.1 37.7 35.8
Total Exports (In million USD)
11.3 14.6 14.7
Difference -32.8
-23.1
-21.1
National Statistical Service of the Republic of Armenia
152
no quota access to the EU, and free access to the CIS market. However, there are a number of obstacles that must be overcome:
o Despite the sub-contracting activity having a positive impact on employment and production, there is limited value added to the imported raw materials and it could harm the industry’s ability to design and produce their own products and brands in the future. Also, by sub-contracting, companies are not obtaining any experience or developing relationships with the end-clients. Therefore, they do not learn the skills that are necessary for the industry to grow.
o The industry needs help in improving its finishing and packaging of products so that it can take part in the extremely competitive international market.
o Lack of financing inhibits the industry by limiting its ability to expand and explore opportunities abroad.
o The high price of good quality raw material imports also means that smaller producers are stuck with lower quality inputs.
o The blockade makes energy and transportation costly and therefore Armenia’s competitiveness is reduced, particularly against products coming from China and Turkey.
o Instability of world prices has an inordinate impact on the industry and the weakened economy of the region is unable to absorb light products.
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Machinery and Electronics Industry
During the Soviet period Armenia’s machinery and electronics industry was the fastest growing industry in the country and third only to Russia and the Ukraine in the USSR as a whole. Armenia produced 30% of the USSR’s computers and electronic equipment and parts for the defense and space industry. It also had multiple education institutions and laboratories that were oriented around supporting the industry and its research. But because of the industry’s dependence on the Soviet market, independence brought collapse. Since then, the industry has remained mostly idle: its equipment obsolete, its workers unemployed. Many in the industry have tried to adapt to the new global market but have had little success as it is unable to produce competitive products for export. As a result of the lack of activity over the last decade a large technological gap exists. However, the industry has a large supply of cheap, skilled labor that is ready to be deployed in the event of foreign investment. The best opportunities in the industry that have been identified are those companies that produce chips and other electronic equipment given the predominance of the IT industry in the global economy. Since 1985, production in the industry has declined 30% and now shares only 2.2% of total industrial production as of 1999. Production has not been able to rebound and continues to drop – by 35% over the course of 1999 alone – to $11.7 million USD. The industry employed 68,766 people as of 1998 at wages of approximately $28 USD per month129. (This number is well below the industrial sector average wage of $44 USD per month.) The official number of enterprises for the industry is 108. However, most of these companies remain idle or only work at 10% capacity. Therefore, the number of active companies probably much lower as well as the number of industry employees. The main sub-sectors of the industry include:
o Tools and Machine Tools
o Electrical products: motors, mobile power stations, electro pumps, accumulators, batteries, transformers, alternators, bulbs and lights, household appliances, and heaters.)
o Electronics: PCBs, relays, integrated circuits, electronic devices, semi-conductors, resistors, electrical power counters, high frequency and TV cables, connectors, and telephone parts)
129 ”Machinery and Electronics Industry Profile.” Tacis. p. 4 and p.5
Table 1. Machinery and Electronics Production
1997 1998 1999 Production – In million USD (Based on year average exchange rate)
28.0 19.1 11.7
% share of total industrial production (In current prices)
5.4% 3.7% 2.2%
National Statistical Service of the Republic of Armenia
154
Since independence, the electrical products sub-sector has been the hardest hit in the industry given this sub-sector’s particular inability to respond to the new market conditions. Most raw materials for the entire industry are available locally or parts and components are imported from CIS countries. Most products are exported to CIS countries. However, exports declined by 57% in 1999 alone130. Imports declined in 1998, but increased again in 1999 to 7 times the amount of local production131. Therefore, the industry contributes significantly to Armenia’s trade deficit. Many of the companies in the industry have been privatized already and those that remain should be in 2002132. But ownership has primarily been transferred to employees and company managers. Furthermore, restructuring has not taken place post privatization. Therefore, the companies have not benefited from the change in ownership. Foreign investment in the sector also remains limited (as of 1999 investment was $0.4 million USD) and future interest seems low. Given this situation, the positives of the industry include:
o Availability of qualified and high-skilled workers at low cost.
o The availability of production capacity
o Local resources in raw materials for the industry (copper, molybdenum, iron, gypsum, dolomite, zeolite, barite, bentonite, diatomite, sulphur, quartz, mineral dies, pigments)
However, there are major obstacles for the industry to overcome that may be insurmountable, including:
o The obsolete technologies and aging equipment of the companies that have done little over the last decade during which there have been large technological advancements
o Absence of international quality and standards will limit the ability of the industry to compete in the global market.
o The blockade makes transportation and energy costly. Therefore, Armenia’s competitiveness is negatively impacted in a very competitive global market.
130 Ibid. p. 8 131 It is thought that local production could cover most of the Armenia’s domestic market needs. However, Armenia continues to import electronics and machinery goods. 132 US Embassy in Armenia.
Table 2. Exports of Machinery and Electronics Products 1997 1998 1999 Percentage of Total Exports 13.8% 18.5% 7.5% National Statistical Service of the Republic of Armenia
Table 3. Trade Balance 1997 1998 1999 Total Imports (In million USD)
102.2 65.8 81.4
Total Exports (In million USD)
32.2 40.8 17.4
Difference -70.0 -25.0 -64.0
National Statistical Service of the Republic of Armenia
155
o The limited access to financing that is particularly needed for the updating of equipment and technology – a further reason for foreign investment. The lack of working capital has also limited production and the development of exports.
o Emigration continues to sap Armenia’s comparative advantage in skilled, cheap labor.
o Lack of marketing capabilities, limits Armenia’s ability to penetrate other markets and the ability of the regional markets to absorb Armenia’s products is extremely limited.
ANNEX 2: EXPORTER SURVEY In this annex we review the results of a survey of exporters undertaken for this report. The purpose is to obtain insight into the problems and opportunities for expanded trade from the perspective of firms. The full survey results and summaries of individual interviews are available in a background paper to this report.133 A. Sample and Methodology
A previous survey of exporters in Armenia was carried out in May 1995 by a team led by Elliott Hurwitz.134 Their report contained case studies of 21 Armenian exporters, primarily based on interviews with top management of these companies. The purpose of the work was to assess the ability of these firms to expand exports, and to identify the most important obstacles to export expansion.
For the current report, we interviewed the surviving firms from the 1995 sample --
to see how their experience had changed since 1995 -- as well as an additional set of firms chosen to extend coverage to smaller exporters. A total of 37 firms were interviewed (the 21 original firms plus 16 new firms). The structured interviews were guided by a questionnaire prepared by Bank staff and consultants. Information was sought on a wide range of topics including the firm's performance, products, markets, opportunities, and obstacles. For the 21 firms that were included in the previous survey, specific attention was paid to changes in export performance since 1995. To the extent possible, the questionnaire sought quantitative as well as qualitative information. Characteristics of the sample (by industry, location, sales, and capacity utilization) are shown in Tables A2.1 - A2.4.
133 Alpha Plus Consulting (2002). 134 Hurwitz (1995).
157
Table A2.1 Firms Surveyed by Industry
Number of firms Industry First 21 firms “New” firms
Electronics, electrical engineering, electromechanics 6 0 Mechanical engineering and machine tools 3 1 Mining and metallurgy135 1 1 Beverages (hard liquors, beer, soft drinks etc.) 1 4 Agroprocessing (canned food, grocery-ware etc.) 1 2 Pharmaceuticals and chemical industry 4 0 Light industry 1 2 Tobacco (cigarettes and fermenting) 0 2 Diamond cutting and jewelry 2 0 Information technology 1 2 Wood processing 1 2 TOTAL 21 16
Table A2.2 Firms Surveyed by Location
Located in Yerevan Located in other regions
First 21 firms 15 6
“New” firms 6 10
The total volume of sales of 37 firms in 2000 and 2001 was US$130 million and
US$170 million respectively, which is a 30 percent increase. As shown in Table , during 2001 two firms increased their sales significantly enough to sell more than US$500 thousand worth of goods. The number of firms that had sales between US$2.0 million and US$10.0 million increased by three. Only one large firm sold in 2001 less than in 2000 and fell into a lower category.
Table A2.3 Annual Sales of Surveyed Firms, 2000-2001136
Annual sales In 2000 In 2001
No sales137 3 2
Less than $500 thousand 16 13
$500 thousand -$2.0 million 7 9
$2.0 million - $10.0 million 5 8
More than $10.0 million 4 3
135 Including one producer of cables and one stone-cutting firm 136 Data is available for 35 firms. One company just rents out its physical facilities, which were formerly used for the production of semi-conductors, PCBs etc. Data for one other company was missing 137 Either just recently established or not operating
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Total exports of those firms in 2000 and in 2001 were US$110 million and US$145 million, respectively. These volumes account for 36 percent and 42 percent of total exports of goods from Armenia in these years. This also attests that these firms are primarily export-oriented, since around 85 percent of their cumulative sales in both 2000 and 2001 were exported. In particular, 15 companies exported 100 percent of their output.
Nine companies out of 36 were recently operating with a very low capacity utilization rate (0 to 20 percent).138 Nevertheless, some of them were either established or restructured quite recently. They are currently building up sales and export volumes quite quickly. Six of the nine firms are those from the previous study. Another nine companies are in the range of 20 percent to 50 percent (of which three are firms from the previous study); ten firms utilize up to 80 percent of their physical capacity (six from the previous study), and eight firms operate at virtually full capacity (five of which-firms from the previous study).
Table A2.4 Capacity Utilization of 36 Surveyed Firms
(2000-2001 average)
Range of capacity utilization Number of firms of which X firms from the
previous study Nil or below 20% 9 6 20-50% 9 3 50-80% 10 6 Under 100% 8 5
Although ten companies were established after 1990, the average age of the
companies was still 37-38 years. Virtually all companies in the initial list of 21 firms were founded in 1930s through 1970s. Eight firms were privately set up, and five firms are still owned by the state. The remaining 24 companies were privatized in 1994-2001. In total, the 37 companies currently employ around 13,000 people, as opposed to 11,500 in 2000. B. The Original 21: What Has Changed
One of the objectives of the current survey was to identify the major changes and developments that the firms in the previous World Bank report experienced since 1995. The first impression is that the management of majority of the firms had a much more professional approach toward figures and facts within their own firms than in the past. The fact that most of them are now privately owned may have played a significant role.
In May 1995, almost all of the 21 companies were state-owned. Since then, however, 16 of them have been privatized. Only eight of these are now controlled by 138 The term capacity utilization rate is mostly referred to the maximum physical production capacity. This is particularly important for agro-processing firms, where they have maximum procurement capacity, storage capacity and so on, each of which could potentially be several times as much as the production capacity of final goods. It should be noted that software developing firms tend to always work at 100 percent of capacity utilization and rarely have excessive assets.
159
insiders - i.e. former directors of those companies. The others were either privatized through international tenders, or were bought/spun off by outside investors after their privatization. Five companies are still controlled by the State. Most of the privatized companies have now the legal status of open joint-stock companies. However, their corporate governance tends to be weak: normally these firms are controlled by a small group, with minority shareholders having limited access to both the information on internal developments and any dividends.
Total sales of the 21 firms increased significantly, by US$86.0 million between 1995 and 2001. However, this growth was provided by the substantial increase in sales volumes of only two companies (a diamond cutting firm and a brandy company). For the rest, sales either dropped or rose insignificantly. Since almost all companies are export oriented (with an average share of exports in total sales of 85 percent), the trend applies to export volumes as well (Table A2.5).
Table A2.5 Change in Sales and Exports of Original Firms139 (1995-2001, number of firms)
Change in sales and exports Sales Exports Increased by $1.0 million and more 6 5 Increased by less than $1.0 million 3 4 Remained at the same level 0 0 Dropped by less than $1.0 million 7 7 Dropped by $1.0 million and more 4 4
One of the most interesting findings of the survey was the change in employment in the original 21 firms. The total number of employees in all 21 firms fell between 1995 and 2001, despite growth in sales and exports. This may have been the result of privatization and subsequent restructuring and layoffs. In fact, the number workers that are actually perform either production or sales functions in those companies is estimated to have grown by 10 to 15 percent.
C. Export Structure The following tables show export destinations, sources of input supply, market penetration, and export financing for the 37 firms in the current survey. Destinations
Table A2.6 shows that 37 companies export their products to CIS countries (mainly Russia), and ten export solely to these markets. Half as many firms (11) regularly export to the countries of European Union, of which only two rely exclusively upon that particular market. Another ten firms export to the USA, as well as to other countries in
139 For a total of 20 firms (one was excluded).
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the Middle East and Asia. No company exports or even plans to export goods or services to Turkey, reflecting the transportation embargo.
Table A2.6 Export Destinations (number of firms)
Destination Exporting to this destination Exporting exclusively to this destination
CIS140 24 10 EU 11 2 USA 10 0 Other countries141 9 3
Fifteen firms export to only one destination, reportedly due to limited information on other markets or to the specific features of products (e.g. certain type of tires can be only sold in Russia). Thirteen firms export to two countries and only four firms export to three or more countries. Nevertheless, most enterprise managers appreciate the principle of market diversification and the desirability of avoiding either single-customer or single-market dependence. Sources of Inputs
The domestic market remains the main source of input supply for firms in agro-processing, food and beverages, mining and metallurgy, tobacco, and some other industries. Understandably, software development does not depend on imported raw materials either. All other industries, represented by 25 enterprises from the surveyed 37, use imported inputs. Table A2.7 shows the consolidated breakdown of countries/group of countries from which these firms import material inputs.
Table A2.7: Sources of Inputs
Source of imported material inputs Number of firms EU countries 14 CIS countries 11 Other countries (including Turkey) 9
Surprisingly, countries of EU are the most common countries of origin for imported inputs. Out of fourteen firms, eight use raw materials imported only from EU along with domestic inputs. The CIS is the main source of raw material supply for 11 companies; four of these also use domestically-purchased inputs. The remaining eight firms import inputs from other countries including Taiwan, South Africa, Iran, and Pakistan. Only one firm imports inputs (packaging materials) from Turkey (via Georgia), and reportedly can easily shift to importing from other regions.
140 Primarily Russia 141 Mainly countries of Middle East, Israel, Iran and others
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The management of most of companies admit that they have an uninterrupted supply of raw materials, and that they invest very little time to find the cheapest and most convenient supplier. Nine companies believe that if they searched for better suppliers they would be able to reduce their costs. The transportation share of cost of raw materials sometimes reaches 40 to 50 percent, and firms consider these costs to be the main factor inhibiting expansion of exports. Marketing and distribution
After transportation cost, market penetration is the most important issue for the exporters surveyed. Although the mentality of the managers that inherited Soviet plants has been gradually changing, there are “presidents” or “general directors” of some of the firms that act as “production managers” only. The survey found evidence that managers have a passive approach to marketing and distribution. For example, only fifteen of 36 companies142 have either a special unit or a dedicated person to deal with marketing and, except for two firms, none of the fifteen had such a person when they began exporting. Many managers admitted that they would rather pay high commissions to intermediaries that bring orders than invest in marketing experts to promote their products. Table A2.8 shows the distribution channels used by exporters in the survey.
Table A2.8 Distribution Channels (number of firms)
Own representatives Agents Occasional customers/intermediaries Others 14 13 23 4
Export growth forecasts
Firms were asked to forecast their sales and export performance assuming all major factors remain unchanged. Most companies were quite optimistic about their export performance in 2002 and 2003. Beyond that timeframe, practically no company gave any particular forecast..
Six firms (all of which had been either recently established, acquired, or privatized) predicted that their exports would more than double over the next few years (Table A2.9). Their expectations were based on signed contracts and/or the current pace of growth. Seventeen firms were confident that their export volumes would rise by 20 to 100 percent. Another ten firms were less optimistic, admitting that maintaining current levels of exports was their goal, and one predicted a decline in exports.
142 excluding one company.
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Table A2.9 Export Growth Forecasts
Export growth forecast Number of companies Will rise by 100% and more143 6 Will rise by 20-100% 17 Will be the same 10 Will decline 1 D. Export Constraints Constraints in destination markets CIS. Exporting to CIS countries, mainly to Russia, has certain advantages compared to other destinations. Traditional economic ties play some role, albeit less significant than in the past. For example, for food processing companies it is much easier to restore their brands in the familiar markets than to enter completely new markets. Another aspect of exporting to Russia is the technical integration and compatibility with Russia’s military-oriented establishment, which makes them buy certain devices and components from Armenian firms. This cannot be, however, a long-term source of growth for exporters in that industry, since the orders from the Russian companies are not market-oriented and are contingent upon availability of funds and bureaucracy. The fairly good knowledge of the Russian language by the management and salespersons of practically all Armenian exporters, including the surveyed ones, helps in communicating with both existing and potential customers. One of the main advantages of exporting to Russia and other CIS countries reported by the respondents was the mutual recognition of the mandatory trade and standardization documentation, such as certificates of standards (based on the old GOST) and others.
The cost of transportation was reported to be a major problem for exporting goods to the CIS market. Although to export a consignment of any product to Russia by all transportation modes or a combination of those is less costly than to ship off the same product to EU or the USA, it still is 30 to 50 percent less expensive for the neighboring countries to export similar goods to Russia. Thus the products of food processing, light industry, construction materials and other sectors become less competitive.
All firms confirmed that one of the most serious constraints to exports goods to Russia is the recently introduced requirement to pay the VAT at the border. As most of the goods are exported to Russia on consignment, this creates major problems with cash to make all payments – including those for transportation and the VAT – before the receiving payment for goods sold. EU. The countries of the European Union have traditionally been and now are quite a difficult market for both new entry and even for maintaining sales volumes. Besides high requirements set by the EU for imported goods in almost all product categories, consumers in this market are perceived by most Armenian exporters to prefer
143 Including recently established/restructured ones planning to start selling and exporting fairly rapidly
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domestically-produced goods. Companies in electronics and machine building, for example, categorically believe that trying to promote their products in the EU is an exercise in futility.
For food processors, compliance with quality standards in the EU is considered to be the main constraint. For example, wine reported to have 11 percent alcohol will be cleared for import at the Russian border even if it deviates by 2 percentage points from the reported parameter. In the EU, products with such deviations will not be accepted. This means that exporters to the EU must make investments in quality control and transportation to become competitive. Some firms that have made such investments, or have obtained ISO 9000 certification, have succeeded in penetrating EU markets.
U.S. Many goods of Armenian origin exported to the U.S. target local Armenian communities, particularly in California144. They include such goods as beer, spring water, hard liquors, fruit jams and preserves. The requirements for quality standards seem to be less tight than in the EU. High tariffs are reported to be a major constraint for textile and jewelry exporters. An 18 percent tariff is levied on textiles of Armenian origin and a 5.75 percent tariff on jewelry.
Iran and the Middle East. Except for free economic zones in the UAE, most of these countries have closed economies and impose high tariffs on goods that might compete with domestic production. For example, Iran levies a 200 percent tariff on imported electronic devices. Imports of some goods, e.g., in the chemical industry, are totally banned. Exports to Syria require significant paperwork. One of the surveyed firms had to collect and submit a number of permissions and certificates from such Syrian agencies as the Ministry of Justice, Ministry for Foreign Affairs, and Chamber of Commerce. Nevertheless, due to the low transport costs, large markets, and relatively low quality standards, these markets remain a top priority for Armenian exporters. Internal constraints
Financing. Lack of working capital to support necessary expenses for the purchase of raw materials, paying the transportation and other export-related costs was reported to be the major problem for Armenian exporters. Very few firms were financially strong enough to ensure uninterrupted production and sales cycles. Most belong to financial-industrial holdings, which have larger financial capacity to redirect resources among members.
Taxation. The VAT refund issue remains extremely difficult for many Armenian exporters. It is practically impossible to get the refund from the Government, due to the chronic deficit of the central budget. High rates of social security payments and individual income tax were reported as catastrophic by textile companies. However, neither the profit tax nor any other tax rate was perceived as too high.
144 The number of Armenians residing in California is believed to exceed one million.
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Table A2.10 Main barriers of firms in the destination markets, by industry
MEEE145 Metallurgy Food
processing Chemical industry
Light industry Information technology
Diamond cutting and
jewelry
Destination Market E
U
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
EU
CIS
Iran
USA
and
Can
ada
Oth
er:
High tariff on products exported from Armenia
- - 3 - - - - - - - - - - - - - - - - - 1 - - 2 - - - - - - - - - - -
Low quota allocation - - - - - - - - - - - 3 - 2 - - - - - - - - - - - - - - - - - - - -
Subsidies to local firms 2 - 3 - - - - - - - - - - - - 2 - - 2 - - - - - 2 - - - - - - - - -
High product standard requirements
2 - - 2 - - - - - - 2 1 - 2 - 2 1 - 2 - 2 1 - 2 1 - - - - - 3 2 - 3 3
Local content requirements/ rules of origin requirements
3 1 - 1 - - - - - - 3 1 - 2 - 3 1 - 3 - 3 1 - 2 - - - - - - 3 2 - 3 3
Shipping and transport cost 1 3 - 3 - 2 - - - - 2 2 - 2 - - - - - 2 2 3 - 3 - - - - - - - - - - -
1-could easily be overcome 2-serious problem 3-very difficult
145 Machinery, electrical engineering, electronics and other related industries
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ANNEX 3: STATISTICAL TABLES
Table A3.1: Basic Statistics on Comparator Countries
Population
(mn) GDP (mn US$) GDP per capita (US$) Trade/GDP 2000 2000 2000 2000 Armenia 3.8 1,914 503 61.9 Georgia 5.0 3,029 603 32.2 Moldova 4.3 1,286 300 96.0 Lithuania 3.7 11,314 3,062 82.5 Estonia 1.4 4,969 3,630 178.8 Population GDP GDP per capita Armenia=100 Armenia=100 Armenia=100 Georgia 132 158 120 52 Moldova 113 67 60 155 Lithuania 97 591 608 133 Estonia 36 260 721 289
Source: World Development Indicators
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Table A3.2: Geographic Distribution of Foreign Trade 1995-2000
Reporter Partner 1998 1999 2000 2001 1998 1999 2000 2001
Export Value ($ million) Export Share (%)
Armenia World 221.1 231.7 300.5 342.8 100.0 100.0 100.0 100.0
EU15 + USA 69.0 122.5 144.9 140.9 31.2 52.9 48.2 41.1
CEEC+Baltics 1.0 1.8 2.4 1.7 0.5 0.8 0.8 0.5
CIS (incl. Russia) 78.7 55.2 73.4 89.1 35.6 23.8 24.4 26.0
Rest of the World 72.4 52.1 79.8 111.1 32.7 22.5 26.6 32.4
Georgia World 0.0 238.2 329.9 0.0 100.0 100.0
EU15 + USA 0.0 58.9 77.7 0.0 24.7 23.5
CEEC+Baltics . 4.9 8.5 . 2.1 2.6
CIS (incl. Russia) 0.0 107.2 132.4 0.0 45.0 40.1
Rest of the World . 67.1 111.3 . 28.2 33.7
Moldova World 600.5 428.1 456.3 100.0 100.0 100.0
EU15 + USA 90.8 102.9 112.9 15.1 24.0 24.8
CEEC+Baltics 71.8 65.6 58.5 12.0 15.3 12.8
CIS (incl. Russia) 417.7 244.4 271.0 69.6 57.1 59.4
Rest of the World 20.3 15.3 13.8 3.4 3.6 3.0
Lithuania World 3710.7 3003.8 3809.2 100.0 100.0 100.0
EU15 + USA 1514.9 1637.7 2008.7 40.8 54.5 52.7
CEEC+Baltics 661.3 636.7 924.6 17.8 21.2 24.3
CIS (incl. Russia) 1324.1 546.6 619.2 35.7 18.2 16.3
Rest of the World 210.5 182.8 256.7 5.7 6.1 6.7
Estonia World 3244.8 3017.2 3828.9 100.0 100.0 100.0
EU15 + USA 1851.5 1970.0 2692.8 57.1 65.3 70.3
CEEC+Baltics 489.1 415.1 456.3 15.1 13.8 11.9
CIS (incl. Russia) 669.6 406.9 367.6 20.6 13.5 9.6
Rest of the World 234.7 225.1 312.1 7.2 7.5 8.2
Source: Based on country direct reporting from UN COMTRADE Statistics.
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Table A3.3: Major EU-destined Exports by Commodity in 1999
All Adjusted a\
SITC-4
Product (Revision 2) Export value ('000s US$)
Export share (%)
Export value ('000s US$)
Export share (%)
Total 106,543 100.00 40,607 100.00
6672 Diamonds, unwork.cut/otherwise work. 79,440 74.56 13,505 33.26 9710 Gold, non-monetary 11,789 11.06 11,789 29.03 6716 Ferro-alloys 2,994 2.81 2,994 7.37 2789 Minerals, crude, n.e.s. 2,673 2.51 2,673 6.58 2820 Waste and scrap metal of iron 2,328 2.19 2,328 5.73 7929 Parts of transport equipment 1,640 1.54 1,640 4.04 8465 Corsets,brassieres,suspendres 1,175 1.10 1,175 2.89 6891 Tungsten, molybdenum, tantalum etc 873 0.82 873 2.15 0360 Crustaceans and molluscs, fresh, chilled 416 0.39 416 1.02 2882 Other non-ferrous base metal waste 319 0.30 319 0.79 7649 Parts of apparatus 227 0.21 227 0.56 6253 Tires, pneumatic, new 149 0.14 149 0.37 8841 Lenses, prisms, mirrors, other optical 132 0.12 132 0.33
Above categories as % of total exports to EU 97.76 97.76
a\ Only 17% of value added included in diamond exports Source: UN COMTRADE Statistics.
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Table A3.4: Fastest Growing Exports by Commodity 1995-99
Fastest Growing Exports ($ '000) Annual
%growth rate
Share in total exports SITC-4 Product (Revision 2)
1995 1997 1999 1995-1999 1999 Exports to EU Total 27,092 23,257 40,607 10.6 100.00
9710 Gold,non-monetary 2,435 2,090 11,789 48.3 29.03 6672 Diamonds,unwork.cut/otherwise work. a\ 8,807 7,560 13,505 11.3 33.26 6716 Ferro-alloys 2,610 2,241 2,994 3.5 7.37 7649 Parts of apparatus 212 182 227 1.8 0.56
Above categories as % of total exports to EU 52 52 70 Exports to CIS Total 89,253 76,618 55,195 -11.3 100.00
3510 Electric energy 190 163 7,003 146.5 12.69 0575 Grapes,fresh or dried 75 64 166 22.0 0.30 7758 Electro-thermic appliances,n.e.s. 51 44 103 19.4 0.19 6259 Other tyres,tyre cases,inner tubes 73 63 138 17.2 0.25 7712 Other electric power machinery,part 621 533 1,122 15.9 2.03 5416 Glycosides;glands or other organs & 237 203 420 15.4 0.76 8510 Footwear 437 375 678 11.6 1.23 6954 Interchangeable tools for hand & ma 52 44 75 9.9 0.14 8748 Electrical measuring,checking,analy 260 223 368 9.1 0.67 7849 Other parts & accessories of motor 278 238 382 8.3 0.69 6595 Carpets,rugs etc.of man-made textil 52 44 69 7.4 0.12 2782 Clay and other refractory minerals, 80 69 105 7.1 0.19 0579 Fruit,fresh or dried, n.e.s. 509 437 604 4.4 1.09 1110 Non alcoholic beverages,n.e.s. 214 184 249 3.8 0.45 6991 Locksmiths wares,safes,strong rooms 56 48 63 3.2 0.11 7721 Elect.app.such as switches,relays,f 2,207 1,895 2,453 2.7 4.45 6651 Containers,of glass,used for convey 286 246 315 2.4 0.57 2925 Seeds,fruit & spores,nes,of a kind 58 50 64 2.2 0.12 7284 Mach.& appliances for spezialized p 341 292 360 1.4 0.65
Above categories as % of total exports to CIS 7 7 27
All export categories with a positive growth rate have been included in the table a\ only value added from cutting and polishing has been included Based on the annual average growth in 1995-99 and export values are greater than $50,000 in 1995. Source: UN COMTRADE Statistics
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Table A3.5: Sunrise Exports in EU by Product 1995 and 2000
SITC-4 Product Category EU Imports ($ '000)
1999
Average Annual Growth (%)
1995-99
Average EU External Import
Growth (%) 1995-99
Factor Intensity
8412 TXTL CLTHG ACSRY NONKNIT 872 218.1 7.1 UL 7221 ELECTRIC POWER MACHINERY 72 76.6 9.3 CI 7249 TELECOMM EQUIPMENT NES 188 71.9 9.5 CI 8613 OPTICAL INSTRUMENTS 97 65.5 10.6 CI 8611 OPTICAL ELEMENTS 65 64.2 5.4 CI 6672 DIAMONDS NONINDUST,UNSET a\ 13,116 32.1 3.3 SL 8930 ARTICLES OF PLASTIC NES 102 16.8 6.3 UL 7198 OTH MACHINES NONELECTRIC 55 7.1 5.0 CI 1124 DISTILLED ALCOHOLIC BEVS 38 5.3 7.7 NR All above products 14,606 34.3 Diamonds as % of the above 90
NR=Natural Resources, UL=Unskilled labor; CI=Capital Intensive; and SL=Skilled Labor a\ SITC 6672 includes only 17% of the export value assumed to be the value added in Armenia Source: Based on EU as reporter from UN COMTRADE Statistics.
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Table A3.6: Export Share in CIS Markets
by Selected Product Category, 1995-99
1995 1996 1997 1998 1999 Product (SITC-4 Rev. 2) Share in Total CIS-Destined Exports (%)
Manufactures (5+6+7+8-68) 59.66 59.66 59.66 59.66 43.04Leather goods (61) 0.00 0.00 0.00 0.00 0.51Textiles and fabric (65) 0.57 0.57 0.57 0.57 0.33Clothing (84) 4.34 4.34 4.34 4.34 1.33Footwear (85) 0.49 0.49 0.49 0.49 1.23Wood products (63) 3.03 3.03 3.03 3.03 0.08Furniture (82) 0.01 0.01 0.01 0.01 0.03Iron and steel (67) 3.00 3.00 3.00 3.00 0.97Metal products (69) 0.67 0.67 0.67 0.67 0.83Scientific instruments (87) 1.19 1.19 1.19 1.19 1.17Machinery (71+72+73+74+77) 25.16 25.16 25.16 25.16 21.42Office machines and telecom (75+76) 0.83 0.83 0.83 0.83 0.26Transport equipment (78+79) 0.49 0.49 0.49 0.49 1.49Chemical elements (51+52) 0.76 0.76 0.76 0.76 0.60 Foodstuff (0+1+22+4) 27.45 27.45 27.45 27.45 27.52Agricultural raw matl (2-22-27-28) 9.27 9.27 9.27 9.27 13.51Petroleum (33) 0.01 0.01 0.01 0.01 0.00All goods (0 to 9) 100.00 100.00 100.00 100.00 100.00 Source: UN COMTRADE Statistics.
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Table A3.7: Major Exports by Commodity 1995-99
Export value ('000s US$) Export share (%) SITC-4 Product (Revision 2) 1995 1996 1997 1998 1999 1999 Exports to CIS Total 89253 95645 76618 78697 55195 100.00 1124 Spirits;liqueurs, other spirituous 21097 22608 18110 18602 7965 14.43 2331 Synth.rubb.lat.;synth.rubb.factice 8150 8733 6996 7186 7265 13.16 7721 Elect.app.such as switches,relays,f 2207 2365 1895 1946 2453 4.45 1223 Tobacco,manufactured (inc.smoking,c 0 0 0 0 2132 3.86 0585 Juices;fruit & veget.(incl.grape mu 0 0 0 0 1951 3.54 7162 Elect.motors & generators,generatin 3603 3861 3093 3177 1674 3.03 8973 Jewellery of gold,silver or platinu 5367 5751 4607 4732 1185 2.15 7712 Other electric power machinery,part 621 665 533 548 1122 2.03 6251 Tyres,pneumatic,new,of a kind used 10 11 9 9 1063 1.93 1222 Cigarettes 0 0 0 0 988 1.79 6612 Portland cement,ciment fondu,slag c 2644 2833 2270 2331 965 1.75 7731 Insulated,elect.wire,cable,bars,str 5501 5895 4722 4850 918 1.66 7711 Transformers,electrical 3028 3245 2599 2670 842 1.53 8510 Footwear 437 468 375 385 678 1.23 7371 Converters,ladles,ingot moulds and 0 0 0 0 670 1.21 6415 Paper and paperboard,in rolls or sh 0 0 0 0 619 1.12 0579 Fruit,fresh or dried, n.e.s. 509 546 437 449 604 1.09 7422 Centrifugal pumps,other than 742.81 902 967 774 795 550 1.00 7373 Welding,brazing,cutting,soldering m 1228 1316 1055 1083 539 0.98 6716 Ferro-alloys 0 0 0 0 518 0.94
Above categories as % of total exports to CIS 62 62 62 62 63 62.87 Exports to EU Total 70089 75108 60167 61799 106543 100.00 6672 Diamonds,unwork.cut/otherwise work. 51803 55513 44470 45677 79440 74.56 9710 Gold,non-monetary 2435 2609 2090 2147 11789 11.06 6716 Ferro-alloys 2610 2797 2241 2301 2994 2.81 2789 Minerals,crude, n.e.s. 0 0 0 0 2673 2.51 2820 Waste and scrap metal of iron or st 6639 7115 5699 5854 2328 2.19 7929 Parts of transport equipment 0 0 0 0 1640 1.54 8465 Corsets,brassieres,suspendres and t 0 0 0 0 1175 1.10 6891 Tungsten,molybdenum,tantalum & magn 18 20 16 16 873 0.82 0360 Crustaceans and molluscs,fresh,chil 9 10 8 8 416 0.39 2882 Other non-ferrous base metal waste 1427 1529 1225 1258 319 0.30 7649 Parts of apparatus 212 227 182 187 227 0.21 6253 Tyres,pneumatic,new,of a kind used 0 0 0 0 149 0.14 8841 Lenses,prisms,mirrors,other optical 0 0 0 0 132 0.12
Above categories as % of total exports to EU 93 93 93 93 98 98 Source: UN COMTRADE Statistics.
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Table A3.8: Exports to the EU by Factor Intensity 1999
Factor intensity Armenia Armenia adjusted a\ Georgia Moldova Lithuania
Exports to EU ($ '000) Natural resource based 89,583 10,137 38,718 42,385 648,117Unskilled labor intensive 1,374 1,374 1,016 44,877 701,174Capital intensive 2,433 2,433 6,171 476 296,783Skilled labor intensive 411 13,917 3,041 705 119,849 All the above 93,801 27,861 48,946 88,443 1,765,923
Composition of Exports to EU (%) Natural resource based 94.5 36.4 79.1 47.9 36.6Unskilled labor intensive 1.4 4.9 2.1 50.7 39.6Capital intensive 2.6 8.7 12.6 0.5 16.8Skilled labor intensive 0.4 50.0 6.2 0.8 6.8 All the above 99 100 100 100 100
Export Specialization Index in EU b\
Natural resource based 3.48 1.34 2.91 1.76 1.35Unskilled labor intensive 0.10 0.34 0.15 3.55 2.77Capital intensive 0.06 0.21 0.31 0.01 0.41Skilled labor intensive 0.03 3.16 0.39 0.05 0.43
Memo: Composition of EU's External Imports (%) Natural resource based 27.2 Unskilled labor intensive 14.3 Capital intensive 40.7 Skilled labor intensive 15.8 a\ Excluding diamonds (but including 17% value added of diamond exports into skilled labor intensive products) b\ Export specialization index is calculated as a ratio of export share to EU to the share of EU's external imports Note that the totals may be lower that those in other tables, as it is not possible to assign factor intensity to all 4 digit SITC codes Source: UN COMTRADE Statistics
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Table A3.9: Major Exports to the EU by Factor Intensity 1997-1999
Factor Product (SITC-4) Exports ($ '000) Exp Share (in %) Share in export category Intensity 1997 1999 1997 1999 1997 1999 Natural 6715 OTHER FERRO-ALLOYS 2241 2994 10.9 10.7 19.6 29.5 Resources 2769 MINERALS CRUDE NES 0 2673 0.0 9.6 0.0 26.4 2820 IRON AND STEEL SCRAP 5699 2328 27.7 8.4 49.9 23.0 6894 TUNGSTEN,MOLYBD,TANTALUM 189 883 0.9 3.2 1.7 8.7 0313 SHELL FISH FRESH,FROZEN 8 416 0.0 1.5 0.1 4.1 2840 NON-FERROUS METAL SCRAP 1225 319 6.0 1.1 10.7 3.1 6673 PREC-,SEMI-PR STONES NES 21 73 0.1 0.3 0.2 0.7 2112 CALF AND KIP SKINS 207 70 1.0 0.3 1.8 0.7 2312 SYNTHETIC RUBBER ETC 0 65 0.0 0.2 0.0 0.6 1222 CIGARETTES 0 61 0.0 0.2 0.0 0.6 All Natural Resources Products 11425 10137 55.5 36.4 100.0 100.0 Unskilled 8412 TXTL CLTHG ACSRY NONKNIT 0 1175 0.0 4.2 0.0 85.5 Labor 6576 CARPETS ETC UNKNOTTED 142 63 0.7 0.2 62.5 4.6 8414 CLOTHING,ACCESSORYS KNIT 0 63 0.0 0.2 0.0 4.6 8930 ARTICLES OF PLASTIC NES 0 26 0.0 0.1 0.2 1.9 6575 CARPETS ETC KNOTTED 0 19 0.0 0.1 0.0 1.4 6648 SHEET GLASS METAL-COATED 0 10 0.0 0.0 0.0 0.7 8510 FOOTWEAR 0 4 0.0 0.0 0.0 0.3 6569 OTHER TEXTILE PRODUCTS 0 4 0.0 0.0 0.0 0.3 8210 FURNITURE 0 3 0.0 0.0 0.0 0.2 6665 COARSE CERAMIC HOUSEWARE 0 2 0.0 0.0 0.0 0.1 All Unskilled Labor Products 227 1374 1.1 4.9 100.0 100.0 Capital 7349 AIRCRAFT PARTS,ETC 0 1640 0.0 5.9 0.0 67.4 Intensive 7249 TELECOMM EQUIPMENT NES 183 269 0.9 1.0 22.8 11.1 8611 OPTICAL ELEMENTS 0 132 0.0 0.5 0.0 5.4 7299 OTH ELECTRICAL MACHINERY 0 65 0.0 0.2 0.0 2.7
8619 MEASURNG,CONTROLNG INSTR 29 57 0.1 0.2 3.6 2.3 7221 ELECTRIC POWER MACHINERY 0 53 0.0 0.2 0.0 2.2 5611 CHEM NITROGENOUS FERTLZR 0 33 0.0 0.1 0.0 1.4 7151 MACHINE TOOLS FOR METAL 27 24 0.1 0.1 3.3 1.0 5417 MEDICAMENTS 0 22 0.0 0.1 0.0 0.9 7193 MECHANICAL HANDLING EQU 16 18 0.1 0.1 2.0 0.7 All Capital Intensive Products 801 2433 3.9 8.7 100.0 100.0 Skilled DIAMOND POLISHING 7679 13506 37.3 48.5 94.4 97.0 Labor 6291 RUBBER TYRES,TUBES 0 192 0.0 0.7 0.0 1.4 8929 PRINTED MATTER NES 0 72 0.0 0.3 0.0 0.5 8971 REAL JEWELRY,GOLD,SILVER 1 26 0.0 0.1 0.0 0.2 6743 IRN,STL THIN UNCOATED 0 25 0.0 0.1 0.0 0.2 8911 SND RECRDRS,PHONOGR,PRTS 1 19 0.0 0.1 0.0 0.1 6299 OTH RUBBER ARTICLES NES 0 19 0.0 0.1 0.0 0.1 7294 AUTOMOTIVE ELECTR EQUIP 0 13 0.0 0.0 0.0 0.1 6923 COMPRESSED GAS CYLINDERS 0 13 0.0 0.0 0.0 0.1 7321 PASS MOTOR VEH EXC BUSES 0 9 0.0 0.0 0.0 0.1 8960 WORKS OF ART ETC 0 6 0.0 0.0 0.0 0.0 All Skilled Labor Intensive Products 8133 13917 39.5 49.9 100.0 100.0Note: Diamonds are excluded from the Natural Resources category; their value added (17%) is included in skilled labor intensive category. Source: Based on UN COMTRADE Statistics.
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Table A3.10: Major Exports to CIS by Factor Intensity 1997-1999
Exports ($ '000) Exp Share (in %) Share in export
category Factor Intensity
Product (SITC-4) 1997 1999 1997 1999 1997 1999
Natural 1124 DISTILLED ALCOHOLIC BEVS 18110 7965 23.6 14.4 48.6 24.4 Resources 2312 SYNTHETIC RUBBER ETC 6996 7265 9.1 13.2 18.8 22.2 3510 ELECTRIC ENERGY 163 7003 0.2 12.7 0.4 21.4 1223 OTHER MFD TOBACCO 0 2132 0.0 3.9 0.0 6.5 0535 FRUIT OR VEGETABLE JUICE 0 1951 0.0 3.5 0.0 6.0 1222 CIGARETTES 0 988 0.0 1.8 0.0 3.0 6612 CEMENT 2270 965 3.0 1.7 6.1 3.0 0519 FRESH FRUIT NES 418 600 0.5 1.1 1.1 1.8 6715 OTHER FERRO-ALLOYS 0 518 0.0 0.9 0.0 1.6 6842 ALUMINIUM,ALLOYS WORKED 723 305 0.9 0.6 1.9 0.9 All Natural Resources Products 37293 32679 48.7 59.2 100.0 100.0 Unskilled 8510 FOOTWEAR 375 678 0.5 1.2 5.6 31.2 Labor 6651 BOTTLES ETC OF GLASS 246 315 0.3 0.6 3.7 14.5 8414 CLOTHING,ACCESSORYS KNIT 327 304 0.4 0.6 4.9 14.0 8412 TXTL CLTHG ACSRY NONKNIT 1300 233 1.7 0.4 19.5 10.7 8411 TEXTILE CLOTHES NOT KNIT 1656 169 2.2 0.3 24.8 7.8 8930 ARTICLES OF PLASTIC NES 212 104 0.3 0.2 3.2 4.8 6576 CARPETS ETC UNKNOTTED 44 69 0.1 0.1 0.7 3.2 8942 TOYS,INDOOR GAMES 73 64 0.1 0.1 1.1 2.9 6538 GLASS FIBRE WOVEN FABRIC 204 56 0.3 0.1 3.1 2.6 8124 LIGHTING EQUIPMENT 398 54 0.5 0.1 6.0 2.5 All Unskilled Labor Products 6678 2176 8.7 3.9 100.0 100.0 Capital 7221 ELECTRIC POWER MACHINERY 6519 3643 8.5 6.6 28.7 25.9 Intensive 7222 SWITCHGEAR ETC 1908 2482 2.5 4.5 8.4 17.7 7152 METALWORKING MACHNRY 996 1170 1.3 2.1 4.4 8.3 7192 PUMPS,CENTRIFUGES 1344 985 1.8 1.8 5.9 7.0 7231 INSULATED WIRE,CABLE 4722 918 6.2 1.7 20.8 6.5 7198 OTH MACHINES NONELECTRIC 292 569 0.4 1.0 1.3 4.0 7199 MACHINE PARTS,ACCESR NES 1223 558 1.6 1.0 5.4 4.0 5416 GLYCOSIDES,GLANDS,SERA 203 420 0.3 0.8 0.9 3.0 5417 MEDICAMENTS 860 416 1.1 0.8 3.8 3.0 7295 ELEC MEASURNG,CONTRL EQU 223 368 0.3 0.7 1.0 2.6 All Capital Intensive Products 22704 14044 29.6 25.4 100.0 100.0 Skilled 6291 RUBBER TYRES,TUBES 75 1205 0.1 2.2 0.8 23.7 Labor 8971 REAL JEWELRY,GOLD,SILVER 4607 1185 6.0 2.1 46.4 23.3 6415 PAPER ETC IN BULK NES 0 619 0.0 1.1 0.0 12.2 7328 MOTOR VEHICLE PARTS NES 238 383 0.3 0.7 2.4 7.5 8641 WATCHES,MOVEMENTS,CASES 617 317 0.8 0.6 6.2 6.2 7321 PASS MOTOR VEH EXC BUSES 3 266 0.0 0.5 0.0 5.2 5310 SYNT DYE,NAT INDGO,LAKES 8 158 0.0 0.3 0.1 3.1 7250 DOMESTIC ELECTRIC EQUIP 46 109 0.1 0.2 0.5 2.1 7323 LORRIES,TRUCKS 29 95 0.0 0.2 0.3 1.9 6952 TOOLS NES 62 78 0.1 0.1 0.6 1.5 All Skilled Labor Intensive Products 9921 5090 12.9 9.2 100.0 100.0Source: Based on UN COMTRADE Statistics.
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Table A3.11: Inflows of Foreign Direct Investment into Armenia, 1998-2001
Value ($ ‘000) Share (%) Economic Sectors
1998 1999 2000 2001,
9 months Total
1998-2001 1998 1999 2000
2001, 9 months
Total 1998-2001
TOTAL 247,228 147,428 190,130 88,448 673,233 100.0 100.0 100.0 100.0 100.0
Post office, telegraph 87,905 17,338 78,209 27,739 211,191 35.6 11.8 41.1 31.4 31.4
Electricity, gas, hot water supply 43,293 42,048 42,000 24,856 152,196 17.5 28.5 22.1 28.1 22.6
Food, beverages production 13,163 46,349 28,307 4,596 92,414 5.3 31.4 14.9 5.2 13.7
Wholesale, commission merchandise, excl. vehicles 22,877 10,909 15,739 3,366 52,891 9.3 7.4 8.3 3.8 7.9Mining 29,037 2,009 3,150 651 34,847 11.7 1.4 1.7 0.7 5.2
Hotel and restaurants 8,633 6,756 7,017 5,578 27,985 3.5 4.6 3.7 6.3 4.2
Trade/Commerce 19,800 766 2,969 1,246 24,781 8.0 0.5 1.6 1.4 3.7Quarrying 0 8,791 228 96 9,115 0.0 6.0 0.1 0.1 1.4
Other activities 0 0 3,000 3,670 6,670 0.0 0.0 1.6 4.1 1.0
Computer technology and services 1,583 954 1,918 1,605 6,060 0.6 0.6 1.0 1.8 0.9Construction 447 1,570 758 3,284 6,059 0.2 1.1 0.4 3.7 0.9
Other non-metallic production 4,110 1,476 145 0 5,730 1.7 1.0 0.1 0.0 0.9
Cigarettes production 2,131 1,962 1,400 0 5,494 0.9 1.3 0.7 0.0 0.8
Sport and leisure 2,282 1,289 983 2 4,556 0.9 0.9 0.5 0.0 0.7Research and dev’t 145 270 0 3,907 4,322 0.1 0.2 0.0 4.4 0.6
Chemistry 2,715 260 236 630 3,841 1.1 0.2 0.1 0.7 0.6
Education 1,174 717 1,087 703 3,681 0.5 0.5 0.6 0.8 0.5
Metallurgy 580 500 350 2,151 3,581 0.2 0.3 0.2 2.4 0.5Furniture 2,066 177 1,139 11 3,392 0.8 0.1 0.6 0.0 0.5
Forestry 2,477 50 99 74 2,700 1.0 0.0 0.1 0.1 0.4Vehicle sale and service 110 1,958 349 7 2,424 0.0 1.3 0.2 0.0 0.4
Publishing 553 559 268 168 1,547 0.2 0.4 0.1 0.2 0.2Other transport services 256 128 140 987 1,512 0.1 0.1 0.1 1.1 0.2Retail trade excl. vehicles 544 165 149 530 1,389 0.2 0.1 0.1 0.6 0.2Other services 296 5 50 1,805 2,156 0.1 0.0 0.0 2.0 0.4Textile production 312 60 301 216 888 0.1 0.0 0.2 0.2 0.1Other machinery 276 234 6 45 561 0.1 0.2 0.0 0.1 0.1Insurance 0 73 0 320 393 0.0 0.0 0.0 0.4 0.1Rubber 278 0 0 0 278 0.1 0.0 0.0 0.0 0.0Financial services 147 0 66 0 213 0.1 0.0 0.0 0.0 0.0Agriculture 0 0 0 207 207 0.0 0.0 0.0 0.2 0.0Land transport and pipelines 17 35 0 0 52 0.0 0.0 0.0 0.0 0.0Leather production 0 0 34 0 34 0.0 0.0 0.0 0.0 0.0Office machines 0 22 13 0 34 0.0 0.0 0.0 0.0 0.0Paper products 19 0 19 0.0 0.0 0.0 0.0 0.0Other electric equip. 15 0 0 0 15 0.0 0.0 0.0 0.0 0.0Metal products 5 0 0 0 5 0.0 0.0 0.0 0.0 0.0Health, social services 0 0 1 0 1 0.0 0.0 0.0 0.0 0.0
Source: Armenian Statistical Office
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Table A3.12: Organizations Involved in Credit Lines
Organizations Involved in Credit Lines
Organization
Loan Size
Average Loan Size i Rate to Banks
i Rate to Clients Term Total Funds
Partners Banks and Location (as applicable)
Eurasia/Izmirlian Foundation USD 5,000-100,000 28,000 12% p.a. 18% p.a. Up to 3 years USD 5,000,000 Lend, Armagro, Anelik, Credit Service
World Bank (WB) Enterprise Development Project (EDP)
USD 100,000-500,000 (regulated by CBA: max 20% of the bank’s capital)
156,000 LIBOR+2% 21%p.a. 2-6 years USD 13,600,000 Ardshin, Armagro, Armimpex, Armeconom, Anelik, Converse, Lend, Gladzor, Ineco, Trust, Credit Yerevan, Shiraknivest
Shorebank SME USD 10,000-75,000 USD 45,000 21% p.a. 9 months Loans Approved USD 1,379,000
ADB (Armenian Development Bank), Ineco, Credit Yerevan Bank
Shorebank DEL USD 1,000-10,000 USD 3,860 42% p.a. 11 months Loans Approved USD 639,100
SEF (Small Enterprise Fund International/ non-bank credit lending institution)
Shorebank Direct Lending USD 1,000-30,000 USD 5,200 27% p.a. 1 year Loans Approved USD 117,550
UMCOR ACP (Agricultural Credit Program)
USD 2,000-30,000 USD 9,000 19% p.a. 1.5 year n/a
UMCOR/ Aregak (Micro-credit program)
USD 100-1,000 USD 420 24% p.a. (2% flat per month)
Up to 1 year USD 4,000,000 Direct lending program
WB ARSP (WB portion) USD 1,000-75,000 Above USD 50,000 with special approval of IDA(the max credit of USD 500,000 given through Armagro)
USD 30,000 6.5% p.a. 11-18% p.a. Up to 5 years USD 6,000,000
Armagro, Ardshin, ADB, Credit Yerevan, Credit Service, Converse, Trust
WB ARSP (Govt.) USD 500-1,500 USD 1,000
1) LIBOR 2) LIBOR+1% 3) 6.5% p.a.
14-19% p.a. Up to 1.5 year
1) 650,000 2) 450,000 3) 750,000 Total: USD 1,850,000
ACBA
GAF/ KfW Up to USD 60,000 Euro 5,000
n/a 19-24% p.a. Up to 3 years DEM 14 mln (another Euro 5 mln in the beginning of 2002)
Anelik, Armagro, ACBA, Armeconom
Lincy Foundation (Kerkorian) (credit line only)
100,000 – 1,000,000 n/a 6% p.a. 15% p.a. Up to 3 years USD 30,000,000 More than 10 Banks
EBRD Up to USD 100,000 (regulated by CBA: max 20% of the bank’s capital)
USD 77,000 LIBOR + 3% 18-20% p.a. Up to 5 years EUR 10,000,000 Armeconom
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MICRO CREDIT
Organization
Loan Size Interest Rate Loan Term
Save the Children Up to USD 500 3% per month Up to 4 months
FINCA (SAS) USD 500-1,000 5% per month
USDA (ag only)
World Vision USD 500-10,000 1.5-2.5% per month
Up to 3 years
CRS USD 100-600 4% per month Up to 6 months
CARE (ag only) USD 300-15,000 20% p.a. Up to 1 year
Int. Org. for Migration 24-36% p.a. Up to 1 year
OXFAM Up to USD 10,000
24 p.a. Up to 1 year
178
Table A3.13: Household Income Structure by Expenditure Quintile Poorest 2 3 4 Richest All All Wages from employment 22.67% 30.49% 27.40% 27.41% 31.35% 27.86% Self employment 5.28% 5.58% 5.03% 5.83% 8.41% 6.03% Pension 32.20% 24.64% 24.45% 22.17% 18.19% 24.33% Agricultural products 7.17% 13.35% 15.90% 18.45% 18.39% 14.65% Rent, Interest and Dividend 0.00% 0.04% 0.14% 0.15% 0.15% 0.10% Remittances Total 9.52% 9.22% 11.85% 12.70% 15.22% 11.70% Humanitarian Aid 1.34% 0.70% 1.13% 1.21% 0.38% 0.95% Other income 7.20% 4.72% 5.48% 4.60% 3.73% 5.15% Benefits 14.61% 11.26% 8.61% 7.49% 4.18% 9.23% Rural Wages from employment 7.35% 15.01% 11.41% 15.20% 18.15% 13.42% Self employment 5.25% 6.02% 3.44% 6.06% 7.52% 5.66% Pension 31.10% 25.23% 22.47% 21.92% 19.06% 23.96% Agricultural products 27.13% 37.57% 45.68% 40.73% 42.76% 38.78% Rent, Interest and Dividend 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Remittances __Total 7.56% 3.83% 5.41% 4.39% 7.42% 5.72% Humanitarian Aid 0.00% 0.75% 0.54% 1.90% 0.24% 0.69% Other income 7.97% 3.83% 4.97% 3.78% 2.12% 4.53% Benefits 13.63% 7.75% 6.09% 6.02% 2.72% 7.24% Urban Wages from employment 27.96% 38.26% 35.11% 36.18% 40.64% 35.63% Self employment 5.17% 5.38% 5.79% 5.65% 9.06% 6.21% Pension 32.84% 24.34% 25.43% 22.36% 17.59% 24.51% Agricultural products 0.07% 1.20% 1.53% 2.44% 1.21% 1.29% Rent, Interest and Dividend 0.00% 0.06% 0.21% 0.26% 0.25% 0.16% Remittances __Total 10.55% 11.86% 14.94% 18.67% 20.72% 15.35% Humanitarian Aid 1.81% 0.67% 1.41% 0.72% 0.47% 1.02% Other income 6.53% 5.19% 5.74% 5.19% 4.86% 5.50% Benefits 15.06% 13.04% 9.82% 8.53% 5.20% 10.33% Source: World Bank staff using ILCS 1998/99.
179
Table A3.14: Components of Household Expenditure Poorest 2 3 4 Richest All
All Food 68.5% 68.9% 68.2% 66.3% 56.8% 65.7% Clothing 0.6% 0.8% 1.9% 3.6% 6.8% 2.7% Household Goods 2.0% 2.1% 2.4% 2.5% 3.5% 2.5% Transportation 0.9% 1.6% 1.5% 2.0% 4.3% 2.1% Utilities 2.9% 3.7% 3.4% 3.6% 3.9% 3.5% Rent 3.1% 2.3% 2.0% 1.7% 1.6% 2.1% Health 1.1% 1.6% 1.7% 2.9% 7.9% 3.0% Education 3.8% 4.3% 5.3% 5.9% 6.5% 5.2% Household Durables 16.9% 14.7% 13.5% 11.6% 8.6% 13.1%
Rural Food 75.2% 75.9% 74.0% 71.2% 64.5% 72.1% Clothing 0.6% 0.5% 1.5% 3.1% 5.9% 2.3% Household Goods 1.7% 1.8% 2.1% 2.0% 2.3% 2.0% Transportation 0.2% 0.5% 0.8% 1.3% 3.1% 1.2% Utilities 0.8% 1.2% 1.2% 2.0% 2.4% 1.5% Rent 2.5% 1.9% 1.9% 1.4% 1.2% 1.8% Health 1.0% 1.3% 1.5% 2.9% 7.2% 2.8% Education 3.6% 4.5% 5.3% 5.4% 5.5% 4.9% Household Durables 14.3% 12.5% 11.8% 10.6% 7.9% 11.4%
Urban Food 66.2% 64.9% 64.4% 61.9% 49.7% 61.4% Clothing 0.7% 1.0% 2.2% 4.0% 7.6% 3.1% Household Goods 2.1% 2.3% 2.7% 3.1% 4.6% 3.0% Transportation 1.2% 2.2% 2.0% 2.6% 5.6% 2.7% Utilities 3.7% 5.1% 4.8% 5.0% 5.3% 4.8% Rent 3.3% 2.5% 2.1% 1.8% 1.9% 2.3% Health 1.1% 1.8% 1.8% 2.8% 8.5% 3.2% Education 3.9% 4.2% 5.4% 6.4% 7.4% 5.5% Household Durables 17.8% 16.0% 14.7% 12.4% 9.3% 14.0% Source: World Bank staff using ILCS 1998/99.
180
Table A3.15: Determinants of Per-Capita Household Expenditures for Farmers
Variable Name Coefficient (Constant) 9.43 *** HH head is male -0.01 Primary educ. 0.20 * Secondary educ. 0.27 ** Technical school 0.46 *** University educ. 0.50 *** Tobacco grower -0.51 Grape grower 0.19 *** Vegetable and fruit grower 0.01 Staples grower -0.02 Potato grower 0.07 ** Land size (cultivated) 0.11 *** Land size 2 -0.01 Age 0.00 Number of farmers -0.14 *** Number of farmers squared 0.01 * Own farming equipment 0.31 *** Own horse or donkey 0.10 *** Urban 0.05
Source: World Bank staff using ILCS 1998/99. Notes: Geographic dummy variables have been omitted for brevity
181
Table A3.16: Probit Model Results
dF/dx(!) age 0.026 *** age2 0.000 *** male 0.020 ** educsec* 0.182 ** eductech* 0.176 ** educuniv* 0.052 urban* 0.191 *** ararat* -0.009 vayots* -0.159 * yerevan* 0.029 aragatz* 0.029 armavir* -0.062 gegharku* -0.127 * lori* 0.061 kotayk* 0.110 shirak* 0.090 syunik* -0.035 rempc -0.139 rempc2 0.429 ***
Notes: Dependent variable: 0-1 dummy indicating whether or not unemployed. (!) dF/dx is for discrete change of dummy variable from 0 to 1. (*) Significant at 10%, (**) Significant at 5%, (***) Significant at 1%. Source: ILCS 1998/99
182
Table A3.17: Farm Cash-Cost Structure by Expenditure Quintile Rural Poorest 2 3 4 Richest All Organic fertilizer 3% 3% 3% 3% 2% 3% Mineral fertilizer 7% 12% 11% 11% 11% 10% Insecticides 6% 7% 9% 11% 11% 8% Herbicides/pesticides 0% 1% 1% 2% 2% 1% Seeds 11% 7% 8% 10% 10% 9% Bags 1% 1% 1% 1% 1% 1% Irrigation 24% 22% 20% 17% 14% 19% Spare parts 0% 0% 1% 1% 2% 1% Hired Labor 2% 3% 2% 1% 3% 2% Transport 19% 20% 18% 21% 18% 19% Animal rental 0% 0% 0% 0% 0% 0% Equipment Rental 6% 3% 3% 3% 5% 4% Tools 2% 1% 0% 1% 0% 1% Repair / maintenance 0% 0% 0% 0% 1% 0% Animal feed 17% 18% 18% 15% 17% 17% Veterinary services and medicine 3% 2% 3% 2% 3% 3% Urban Poorest 2 3 4 Richest All Organic fertilizer 3% 3% 0% 3% 8% 3% Mineral fertilizer 9% 12% 17% 14% 7% 12% Insecticides 15% 16% 17% 12% 15% 15% Herbicides/pesticides 0% 0% 0% 5% 1% 1% Seeds 16% 9% 10% 3% 16% 11% Bags 4% 3% 0% 2% 0% 2% Irrigation 24% 28% 23% 11% 24% 22% Spare parts 0% 0% 0% 0% 0% 0% Hired Labor 0% 1% 0% 0% 0% 0% Transport 14% 4% 5% 13% 2% 8% Animal rental 0% 0% 0% 1% 0% 0% Equipment Rental 0% 0% 1% 1% 1% 0% Tools 5% 0% 1% 0% 0% 1% Repair / maintenance 0% 0% 0% 0% 0% 0% Animal feed 8% 23% 22% 35% 24% 22% Veterinary services and medicine 1% 1% 4% 2% 2% 2% National Poorest 2 3 4 Richest All Organic fertilizer 3% 3% 2% 3% 3% 3% Mineral fertilizer 7% 11% 12% 12% 11% 11% Insecticides 7% 8% 10% 11% 11% 9% Herbicides/pesticides 0% 1% 1% 2% 2% 1% Seeds 11% 7% 9% 9% 11% 9% Bags 1% 1% 1% 1% 1% 1% Irrigation 24% 22% 21% 16% 15% 20%
183
Spare parts 0% 0% 1% 1% 2% 1% Hired Labor 1% 3% 1% 1% 3% 2% Transport 19% 19% 16% 20% 16% 18% Animal rental 0% 0% 0% 0% 0% 0% Equipment Rental 5% 3% 3% 3% 4% 4% Tools 2% 1% 0% 1% 0% 1% Repair / maintenance 0% 0% 0% 0% 1% 0% Animal feed 15% 19% 19% 17% 18% 18% Veterinary services and medicine 3% 2% 3% 2% 3% 3% Source: World Bank staff using ILCS 1998/99.
