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Credibility amid the crisis
[08:35 pm] 10 March, 2009
Statement of Policy Forum Armenia
The decision of the Central Bank of Armenia (CBA) to return to a de
facto free floating exchange rate regime, announced on March 3, 2009,
has led to a swift reaction from economic agents. Within minutes of
the announcement, some stores in Yerevan were closed, prices across a
wide range of products were adjusted, and the buy-sell margins for
dollar trading by banks ballooned. Following the initial reaction, at
present the risk of escalation appears to have been contained.
In its December 2008 Report, Policy Forum Armenia (PFA) warned about
the serious build-up of external economic/financial pressures and
proposed a gradual depreciation of the Dram as a key element of
government's response strategy. While adopting measures along the
lines of some recommendations, this and other key elements contained
in the proposal were not followed or countered by alternative
measures. What may have been a judgment call regarding the depth and
the duration of the global crisis (and by extension also of the
factors influencing Armenia's economy), should have been weighed
carefully against the potential impact of the delayed response and
should have been reversed early on.
Further attempts to use administrative measures to control either
exchange rate or prices (or both) amid continued external pressures
will prove ineffective and should be avoided given the potential for
overshooting of the uncontrolled variable. Expectations of further
devaluation (and/or inflation) could reduce the demand for real money
balances beyond the decline in the real supply of money being observed
at the moment. Depending on the stance of the CBA, this may either
result in further loss of reserves or in further devaluation of the
Dram. This could have devastating consequences for the domestic
economy but also for Armenia's already embattled current account.
Under these circumstances, re-gaining policy credibility and properly
managing public's expectations should be the cornerstones of the
strategy going forward. To this end, CBA should be candid about the
policy trade-off it was facing since the Fall of 2008 and about any
errors of judgment that may have made the current outcome
inevitable. It may not be easy to build trust now, but to continue to
lose it at this juncture may prove dangerous. It is in every sensible
citizen's interest to stabilize the situation in Armenia and the
authorities should capitalize on this premise and come off as
transparent and forward-looking as possible. This will help rebuild
confidence and trust in policy management. Only with mutual trust, and
if united in their effort, will the government and society overcome
this and future turbulence and move toward stability.
Included in these confidence-building measures are some structural
policy initiatives outlined in PFA's December 2008 Report. Chief among
them were: (1) the establishment of a crisis management team
consisting of experienced economists and finance experts independent
of their political affiliations and views; (2) undertaking credible
measures to reduce the monopoly price-setting powers of key import
companies; and (3) taking swift measures to reduce some well-known
barriers to doing business.
Without credibility, the traditional policy instruments will have a
limited impact on the situation and some are likely to come at
higher-than-expected costs. A monetary tightening could reduce the
pressure on reserves and help dampen inflationary expectations.
However, if not accompanied with sufficient public buy-in, this will
not have the desired effect on the public's willingness to hold local
currency, and in the meantime will suppress economic activity.
Credibility will also be important for the effectiveness of the fiscal
policy response, where targeted social spending will be critical for
reducing the negative consequences of the devaluation on low income
families and of the level of discontent and potential for political
instability.
Policy Forum Armenia (PFA) is an independent professional non-profit
association aimed at strengthening discourse on Armenia's economic
development and national security and through that helping to shape
public policy in Armenia. The reports issued by the PFA within the
past year include those on February 2008 Presidential Election and the
Impact of Global Economic Crisis on Armenia.
Credibility amid the crisis
[08:35 pm] 10 March, 2009
Statement of Policy Forum Armenia
The decision of the Central Bank of Armenia (CBA) to return to a de
facto free floating exchange rate regime, announced on March 3, 2009,
has led to a swift reaction from economic agents. Within minutes of
the announcement, some stores in Yerevan were closed, prices across a
wide range of products were adjusted, and the buy-sell margins for
dollar trading by banks ballooned. Following the initial reaction, at
present the risk of escalation appears to have been contained.
In its December 2008 Report, Policy Forum Armenia (PFA) warned about
the serious build-up of external economic/financial pressures and
proposed a gradual depreciation of the Dram as a key element of
government's response strategy. While adopting measures along the
lines of some recommendations, this and other key elements contained
in the proposal were not followed or countered by alternative
measures. What may have been a judgment call regarding the depth and
the duration of the global crisis (and by extension also of the
factors influencing Armenia's economy), should have been weighed
carefully against the potential impact of the delayed response and
should have been reversed early on.
Further attempts to use administrative measures to control either
exchange rate or prices (or both) amid continued external pressures
will prove ineffective and should be avoided given the potential for
overshooting of the uncontrolled variable. Expectations of further
devaluation (and/or inflation) could reduce the demand for real money
balances beyond the decline in the real supply of money being observed
at the moment. Depending on the stance of the CBA, this may either
result in further loss of reserves or in further devaluation of the
Dram. This could have devastating consequences for the domestic
economy but also for Armenia's already embattled current account.
Under these circumstances, re-gaining policy credibility and properly
managing public's expectations should be the cornerstones of the
strategy going forward. To this end, CBA should be candid about the
policy trade-off it was facing since the Fall of 2008 and about any
errors of judgment that may have made the current outcome
inevitable. It may not be easy to build trust now, but to continue to
lose it at this juncture may prove dangerous. It is in every sensible
citizen's interest to stabilize the situation in Armenia and the
authorities should capitalize on this premise and come off as
transparent and forward-looking as possible. This will help rebuild
confidence and trust in policy management. Only with mutual trust, and
if united in their effort, will the government and society overcome
this and future turbulence and move toward stability.
Included in these confidence-building measures are some structural
policy initiatives outlined in PFA's December 2008 Report. Chief among
them were: (1) the establishment of a crisis management team
consisting of experienced economists and finance experts independent
of their political affiliations and views; (2) undertaking credible
measures to reduce the monopoly price-setting powers of key import
companies; and (3) taking swift measures to reduce some well-known
barriers to doing business.
Without credibility, the traditional policy instruments will have a
limited impact on the situation and some are likely to come at
higher-than-expected costs. A monetary tightening could reduce the
pressure on reserves and help dampen inflationary expectations.
However, if not accompanied with sufficient public buy-in, this will
not have the desired effect on the public's willingness to hold local
currency, and in the meantime will suppress economic activity.
Credibility will also be important for the effectiveness of the fiscal
policy response, where targeted social spending will be critical for
reducing the negative consequences of the devaluation on low income
families and of the level of discontent and potential for political
instability.
Policy Forum Armenia (PFA) is an independent professional non-profit
association aimed at strengthening discourse on Armenia's economic
development and national security and through that helping to shape
public policy in Armenia. The reports issued by the PFA within the
past year include those on February 2008 Presidential Election and the
Impact of Global Economic Crisis on Armenia.