Policy Challenges and Opportunities for Armenia in the Context of Regional and Global Economic Shocks, By Masood Ahmed, Director, IMF Middle East and Central Asia Department

By Masood Ahmed

Director, IMF Middle East and Central Asia Department

June 29, 2015

Leadership School of Armenia

Yerevan, Republic of Armenia

As prepared for delivery

Good evening everyone--–“Bari yereko”

It is a great pleasure for me to be back in Yerevan. I want to thank the Leadership School and our IMF Resident Representative, Teresa Daban for arranging this opportunity for me to address this audience of young, emerging leaders who will take Armenia forward over the next few decades.

In talk today, I will go over the outlook of the Armenian economy, the environment in the region, the challenges Armenia faces, and the great opportunities that Armenia can capitalize on for a better future. Throughout, I would like to emphasize the importance of leadership and collective action in responding effectively to challenges and opportunities. Following my talk, I am looking forward to your questions and discussion.

I frequently travel the region, but it has been six years since I have been in Armenia. I seem to come at difficult times.

I was last here in 2009, when the global financial crisis had a very strong impact. Output declined that year by a staggering -14 percent, as remittances and other external flows dried up and construction—the key growth driver for a decade—collapsed. The Armenian authorities successfully stabilized the economy after the crisis, with support from the international community. But this response left a legacy of higher public and private sector debt.

Now, I am here in the midst of external pressures coming from the slowdown in Russia, lower remittances, lower copper prices, and sluggish growth both globally and in Europe.

Regional and Global Outlook

Let’s look at the external environment that Armenia now faces, with a focus first on key trading partners. The outlook for Russia is for a decline of 3½ percent in 2015, no growth next year, and a pick-up of growth to 1½ percent per year over the medium-term. The Russian authorities see a more optimistic path, with growth of 3 percent over the medium. Turning to Europe, growth is also expected to be modest in the next two years and over the medium-term, around 2 percent. China and other emerging markets are important for Armenia’s commodity exports—metals and minerals. Growth in these countries is expected to slow in 2015–16. Importantly, in both advanced and emerging economies, there are signs that potential growth may have decreased. “Potential growth” is the expected growth rate in the medium term based on the expected contributions of labor, capital and productivity gains. If potential growth is expected to be lower—too low to generate jobs—there is an imperative to implement structural reforms to solve high unemployment, strengthen competition and incentives for private investment, and boost productivity.

With this context, Armenia is likely to grow at a fairly slow pace over the next several years, with a decline this year, flat or slightly positive growth next year, and growth of around 3½ percent in the medium term. This will make it challenging to create jobs, improve living standards, and reduce debt. Forceful reforms are needed to make the Armenian economy more open, efficient, dynamic and connected with the region and the global economy. This is a critical area for decisive leadership.

Let’s look at the geopolitical landscape. The South Caucasus remains a region of significant tensions. Here I have in mind Nagorno-Karabakh, Armenia’s relations with Azerbaijan and Turkey, tensions between Georgia and Russia, and relations of the international community with Iran. These tensions affect interest and investment in the region as they lead to a high financial and psychological risk premium.

As an outside observer, removed from these processes, it is difficult to see Armenia realize its full potential without progress on this front. Again, engaged, creative and decisive leadership is needed, along with collective action by skilled and enlightened individuals.

Armenia’s Response

Let’s spend a few minutes now looking at how well Armenia is prepared to respond to the challenges that I have outlined: slow growth, complex geopolitics, and global transformations

As I mentioned before, during and after the 2009 global financial crisis and in the current external shocks, the Armenian authorities have pursued sound macroeconomic policies and avoided major policy mistakes. Important buffers, like foreign exchange reserves and room for borrowing were built. Inflation was kept under control. Fiscal deficits and spending were kept manageable. Armenia made great use of concessional financing.

An important economic transformation has been underway for the past 5 years. The main drivers of growth have changed. Agriculture is showing signs of vitality, attracting investment in production and processing. Five years ago, conditions in agriculture looked awful, with fragmented output, outdated equipment, limited access to financing, and low product standards. Targeted provision of inputs, support for interest payments on bank loans, and infrastructure helped. Membership in the Eurasian Union will provide a big market food exports.

Tourism and services are also growing. Tourism has benefitted from liberalization of aviation under the government’s “Open Skies policy.” Mining remains an important growth driver. This year, a new copper mine opened and a big new gold mine is being developed. These projects require substantial financing, a strong sense of policy stability, and a strong policy framework to ensure that mining activities do not damage the environment.

The emergence of these new growth drivers has been gradual. And growth is less than it was a decade ago, when it averaged 8.2 percent annually. It is less than half of that now.

This is a big issue. Armenia is not creating jobs fast enough, and there is still high emigration, especially to Russia. 40 thousand people leave Armenia each year—more than 1 percent of the population. While the financial support these workers send home is critical—nearly 20 percent of GDP—high emigration comes with high social costs. Few who leave return with new skills or contacts.

In contrast to macroeconomic policies, Armenia struggles with a slow pace of structural reforms. Like other countries in the region, the Armenian economy should be more open and “contestable,” with more transparency and greater competition. By “contestable,” I mean that sectors and activities should be open to new entrants and new competitors. This will help ensure efficiency and avoid abuse of strong market positions.

Some progress has been made to improve the business environment. Armenia ranks 45th of 189 countries in the World Bank’s Doing Business Rankings. But it ranks 85th of 144 countries in the Global Competitiveness rankings of the World Economic Forum.

These scores are in line with other Eurasian Economic Union countries, but well behind Central and Eastern Europe, which has the benefit of EU membership and proximity to supply chains and markets.

Armenia should move forward aggressively to make up for these advantages and to address the challenges that I described a few minutes ago.

What does all of this mean practically? Let me give a few examples. Information technology or IT is one of the most competitive sectors in Armenia, but Internet access is low, and affordability and speed are far behind the OECD average. Another example is the energy sector. The past two decades have seen remarkable achievements in providing a stable supply of energy. Twenty years ago, Armenia experienced blockades, blackouts, and desperation. The energy system now features balance among gas, hydro, and nuclear sources and exports electricity to Iran. Payment discipline among consumers is high.

However, the energy sector keeps generating losses, due to inefficient management and non-core activities. Financial difficulties have led the state to sell assets and absorb debt. This cannot continue. Major challenges loom, especially replacing Metsamor, at a cost of up to 50 percent of GDP.

Besides IT and energy, there are challenges in other areas critical to high, sustained and inclusive growth. Roads, health, and education. I note once again that the Armenian economy should be more open and more transparent. Public spending should focus on high quality investments in human and physical capital. This would lead to lower costs, more competition, more regional and global integration, more resilience to shocks, more innovation, more growth, and more jobs.

So what does this mean for leadership and leaders in Armenia?

The challenges that Armenia faces are big. Ongoing geopolitical and geographic challenges. Armenia is a small, landlocked country in a touch neighborhood. If these obstacles were easy to overcome, they would have been solved long ago.

Looking forward, the landscape is difficult. Russia, Armenia’s long-standing partner, faces a long period of slow growth, as do Europe and China, emerging partners of the last decade.

Slow growth in Armenia is not good enough. It’s not good enough to generate jobs, stem emigration, or raise living standards.

Leadership by well-trained, well-informed, and dedicated individuals is needed across political and economic issues. Although unemployment is high and Armenians leave in search of opportunities, there are skills shortages and an acute need for talented leaders and managers in the public and private sectors.

Leadership must be open to new ideas, promote innovation, and work in new ways to address challenges and seize opportunities. Armenia’s sound macroeconomic policies provide a strong platform for success for capable leaders with vision.

Agriculture, services, light industry, IT are driving growth. These sectors and others need talented leaders and managers. And skilled and enlightened leaders are needed in public administration—in health and education, in transportation and public works, in tax administration, in management of public spending and finances, and in management and oversight of the financial sector.

I mentioned at the outset that my last visit came six years ago. Looking forward six years, opportunities will surely arise from traditional places—Russia, the Eurasian Economic Union countries, the Caucasus and Central Asian countries. They will also arise from Europe and North America. And they will come from unexpected places, like the Middle East, China, India, Iran, and I hope, from Turkey and Azerbaijan. Be ready to seize these opportunities.

And expect the unexpected. Five years ago, who would have thought that the world’s largest media company would produce no TV shows, no movies, and no music? That the world’s largest lodging company would own no hotels, no casinos, and no ski resorts? That the world’s largest transport company would own no taxis, trucks or buses? That a single entrepreneur would develop a secure global payments system, cutting-edge electric cars, a private space transport company, and solar energy for homes and business? But the experiences of Facebook, Air BnB, Uber, and Elon Musk show us that opportunities come from unexpected places and from new forms of collaboration and collective action.

We have touched on a lot of topics and subjects tonight. Let me close by restating a few messages.

For Armenia’s current leaders: strong and decisive efforts are needed to build on sound macroeconomic performance to improve the business environment, open the economy, and integrate it closely with the region and globally. This will help Armenia’s new leaders—you folks in the room—seize new opportunities, especially those from unexpected places.

For you, the emerging leaders of Armenia: be bold and take risks. Assume the mantle of leadership of your country.

For the IMF: we have been close partners of Armenia for the past two decades. We stand ready and committed to continue our support to policy and reform efforts.

Thank you! “Shnorha kalutsyun”