1.3. Economic Results of the Transition Period

Due to satisfactory solutions of fundamentally strategic problems of the transition period, the current situation in Armenia can be considered as relatively stable. However, to finalize the transition, macroeconomic policies should be refocused on the basic determinants of long-term economic growth, and policies for long-term growth also need to be evaluated in terms of the efficiency with which they promote human development. If disregarded or postponed, they may bring to naught any prior progress and may lead subsequently to a protracted economic stagnation, to the restoration and consolidation of elements of authoritarianism.

After a drastic economic decline from 1990-1993 (Figure 1.2), the macroeconomic stabilization programs and stringent monetary and fiscal policies carried out by the Government starting 1994, brought about a reduction of inflation rates, GDP growth, stabilization of the national currency's exchange rate, and a decrease in budget deficit. The annual average GDP growth rate, 1994 through 1998, was 5.7 % (Figure 1.2). It is worth mentioning that over one third of the growth was accounted for by foreign loans. The inflation rate was 8.7 % in 1998 in contrast to 1,885 % in 1994 and the budget deficit was 3.2 % of GDP in 1998 vs. 10.5 % in 1994.

Despite strides made in the economic arena, Armenia's real GDP in 1998 was only 41% of that of 1989, which is still lower than the average indicator in the CIS¹ (Figure 1.3).

The newly formed Government's program (presented in June 1999 at the NA) endeavors to ensure at least 6% economic growth and to keep inflation at 6%². Yet the concentration of economic policies solely on halting hyperinflation is far too insufficient for securing long-term economic growth.

The impact of external upheavals, especially that of the 1998 Russian financial crisis, can be seen in the decline or even cessation in production demand of a significant part of Armenia's enterprises, on the one hand, and in a drastic reduction of net private current transfers and factor incomes, on the other hand. Net current transfers decreased by 39mln. USD compared with the previous year. Also, private money transfers were reduced, totaling 5-6mln USD monthly¹ in 1998.

Figure 1.2. GDP dynamics in RA (GDP of the year of 1989 is assumed as equal to 100 %)* The calculations were made on the basis of Economic Review, IMF 1995; Report on Transition Economies 1997 and 1998; European Bank for Reconstruction and Development. Global Development Report 1998-1999, World Bank.

Despite certain macroeconomic stabilization achieved as a result of domestic efforts and foreign assistance, the Armenian economy is still in bad shape: the curtailment of production is still in process, the financial, payment and investments crises have not been overcome yet. The share of industry in GDP is shrinking. The balance of payments and foreign trade deficits are still high (26 % and 36.7 % of GDP respectively); and opportunities for export as a primary source of hard currency are dwindling. (Figure 1.4).

However, financial stabilization was achieved owing to high taxes and to further curtailment of the population's already low income. It brought about further isolation of the real sector of the economy, reduction in social infrastructure and the shrinking of educational and scientific-research potential. Besides, keeping the monetary stock within the limits of 9-10% of GDP (whereas the norm is considered to be 60-70 %) leads to the artificial increase in the exchange rate of the Armenian Dram against the US dollar, which creates ideal conditions for imports, deteriorates the exports conditions, prompts the outflow of hard currency and the dollarization of the economy.

Figure 1.3. The Real GDP level in 1997-1999* against 1989 (in percents) *The year 1999 is given in forecast estimates. Source: Transition Economies Report. April 1999, European Bank for Reconstruction and Development.

Foreign debt has been increasing rapidly (Table 1.1), and up to 20% of national budget revenues are used for servicing the debt (in 1998 debt service payments exceeded twice the budget allocations for education and public health care). Budget balancing is mainly sought through significant reduction of State investments and the funding of programs. The budget deficit is to a great extent covered by foreign financing as well as by the sale of short-term Treasury bills and of what is still left of state property. Revenues from material production have been steadily declining.

Figure 1.4. The RA Foreign Trade Dynamics (as percentage of GDP) Source: Calculations were made on the basis of data provided by the RA Ministry of Statistics.

Foreign financing and external assistance have played a key role during the entire transition period. The overall contractual amount of foreign credits given to the RA from 1993-1998 equals 1,250mln. USD. Most of that money has covered the budget and balance of payment deficits, and some of it was used for strengthening the national currency, developing production infrastructure and providing technical assistance.

Prior to 1997, sorely needed direct foreign investments (FDI) into the Armenian economy were yet insignificant. In 1995-1998 foreign investments amounted to 323.0mln USD (together with 229.0mln USD in 1998), including proceeds from the sale of State-owned property. Although FDI in 1998 rose four-fold against the previous year, in per capita terms in 1997-1998, it was still lower than the average index in Central European, East-European and Baltic States.

Humanitarian assistance worth around 800mln.USD has been of crucial importance for Armenia, especially during the difficult years of 1992-1994.

Table 1.1. The RA Foreign Debt Dynamics (as of the end of the year) Source: Calculations were made on the basis of data provided by the RA Ministry of Finance and Economy.

1.3.1. Evaluation Assessment of the Transition Period: Achievement and Failures

Among the achievements of the transition period, it is worth mentioning:

• Obvious improvement of the conditions of life brought about by the restoration of an energy supply, recovery of retail trade, disappearance of the consumer market deficit (primarily owing to foreign goods), remittances sent to families by relatives who left the country (according to expert evaluation, 850mln. USD during 1994-1998), and by the increased number of allocations and grants made by foreign foundations, etc.

• Partial lifting of the transportation blockade, thus contributing to the revitalization of trade and economic relations (particularly with Russia and Iran) and by the growth in air traffic volume.

• Establishment of over 850 joint or foreign companies that operate in the trade and brokerage spheres.

• The recently observed tendency towards growth in investments in industrial production.

• Development of the production infrastructure (energy, main roads and irrigation systems) as well as expansion of telecommunications services and attainment of a rather high level of computerization.

• Implementation of structural reforms conducive to a market economy and the establishment of money and credit, banking, taxation and customs systems (Box 1.4).

It is worth mentioning that achievements were attained thanks to the internal resources as well as international assistance.

Unfortunately, negative consequences of the transition period by far outweigh the achievements described above. The social cost of reforms proved very high. The situation in the social sphere gives grounds to contend that the declared goal of building a socially oriented market economy has not been achieved; what is more, current policies visibly digress from the initially set goal.

• Large-scale privatization of industrial enterprises failed to boost their production efficiency, competitiveness and employment. About 70% of privatized enterprises are either at standstill or face the prospect of bankruptcy.

• Disregard for the issues related to the rational management of government assets responsive to market economy requirements, and the hasty privatization at any cost have led to the erosion of the idea of ownership.

• The transition period is characterized by Armenia's de facto de-industrialization and a tendency of transforming the economy into a mono-contour model with prevalence of circulation (finances, trade) and a small-scale production sphere.

• Armenia's chronic dependency on external financing has become a characteristic feature of the transition period. Foreign debt gradually is becoming self-perpetrating, since the country is forced to seek new loans to be able to repay old ones.

• Financial stabilization has become an end in itself. As a result of current policies, the real sector of the economy is plagued with non-liquidity, lack of money and insolvency leading to a greater share of in-kind exchange economy. Competition is non-existent and monopolies dominate the domestic market. This all testifies to the quasi-market nature of the reforms that are being carried out.

Box 1.4. The Banking and Taxation Systems in Armenia At present, the Armenian banking system comprises the Central Bank of Armenia (CBA) and 31 commercial banks. By the end of 1998, their net foreign and net domestic assets totaled nearly 97.1 billion drams4. Despite the gradual loss of customers' trust in the banking system (aggravated by the financial crisis in RF), the residual deposits by physical entities have increased 1.8 times by the end of 1998 as compared to the beginning of the year. These residuals amounted to 20,962 million Armenian drams (41.5 million USD), 85% of which were the population's deposits in commercial banks. Adoption of a law on insuring deposits would greatly help regain the trust of the people in the banking system. Reserving banking resources in Drams as well as strengthen the foreign currency normative control by CBA in 1999 will contribute to a reduction in foreign currency deposits' share, the level of which still remains rather high. Thus, by the end of December 1998, foreign currency deposits made up 71% of total deposits. **** The taxation system in force until 1997 was complicated. Of its primary functions, including the fiscal, regulating and social functions, only the fiscal function was implemented. The adoption of a number of laws between 1997-1998 essentially affected the tax base extension and tax administration improvement process. Particularly, the tax burden on profit tax, wealth tax, income tax, and social compulsory payments was decreased. Beginning January 1, 1999 the non-taxable income level for physical entities was increased up to 17 thousand drams or 34 USD. The tax burden decrease was considerable, in particular, on low and average incomes. The introduction of the fixed payments system and controlling pay-desk machines was targeted at the reduction of the shadow sector of the economy, strengthening control over the sectors of the economy, hardly controlling for taxation purposes. Further improvement of the tax system and tax burden decrease is necessary for the creation of new jobs and provision of production growth.

¹ Transition Economies Report 1998. "The Financial Sphere in Transition". European Bank for Reconstruction and Development.

² "The Program of Activities of the Government of the Republic of Armenia", Hayastani Hantrapetutyun daily, June 23, 1999.

³ According to the data provided by the Ministry of Statistics, State Register and Analysis (MS).

⁴ Data provided by the Central Bank of Armenia