Major pressures on Armenian currency have been avoided – EBRD country director

Tert.am has interviewed Mark Davis , Head of Armenian Resident Office of The European Bank for Reconstruction and Development (EBRD/The Bank).

Prior to taking up the position at the EBRD, Davis was an Executive Director at Goldman Sachs (2010-12), and Morgan Stanley (2007-10), focusing on debt capital markets, derivatives, distressed debt and structured commodity finance. Prior to working in the private sector, Davis served as an economist, policy advisor and development policy loan leader at the World Bank (1996-2006), with assignments in Moldova, Ukraine and Kazakhstan. Davis holds PhD in Economics from Tulane University and is fluent in English, Russian and French.

For the year 2015 EBRD predicted -1.5% economic growth, while Government forecasts positive growth and CBA’s forecast for current year economic growth is 2.8-3.6%. What you can say about this?

First, please note that while I am an economist by training and many years of experience, for the last several years I have lived and breathed as a banker.  As a banker, I am not into the detailed numbers and analysis leading to EBRD macroeconomic forecasts.  That said, I do represent an active market observer of economic and financial developments.  Please take my comments in this perspective, which I hope will be useful. 

Second, let’s be clear that any forecast is ultimately just an educated guess based on the available information about economic fundamentals at the time of the forecast.  We are now in September, so we have data through July 2015 which can tell us more about how this year as a whole will likely turn out.  EBRD economists will visit Yerevan in October to prepare a formal update to our 2015 & 2016 forecasts, but in the meantime, it is fair to point out that the latest available data are showing some positive trends. 

Armenia’s 'Index of Economic Activity' shows 4.2% growth January - July over 2014.  This is more positive than we expected, led by 34.% growth in mining - in particular a new mine went on-line earlier than expected, so some of this may be one-off, but still very positive-, and a 15.4% increase in agriculture, which is coming off a lower base in 2014 - due to poor weather conditions last Spring especially-, but also potentially reflecting more permanent improvements  in the agricultural sector, such as sale of grapes for winemaking, other fruits and vegetables, agro-processing and greenhouse products for domestic consumption and exports.  We in EBRD Armenia have experienced somewhat lower demand for commercial bank credit lines so far this year, but now we see that real (that is, inflation-adjusted) commercial credit across the economy was up by 5% through July.  We earlier expected investment would be down somewhat for the period, which is not a surprise given pressures earlier in the year around the exchange rate which generated uncertainty and led to higher interest rates.  But the increase in credit to the economy suggests more investment strength than we earlier thought.  We will have to see how things shape up for the rest of the year on that front.  The Russian downturn has affected remittances more or less in line with expectations – they are off by 35.4% in the first 7 months, which puts downward pressure on domestic consumption. 

But I think the good news here is that so far consumption has held up relatively well, having fallen by only 1.8% in real terms, while exports haven’t decreased at all, at the same time that imports are down by nearly 27%.  This is really interesting, because if imports are down by that much, and consumption is holding up, it means there must have been a relative shift of consumption to domestic production and sales.  This is pretty good news for the economy and shows some nice resilience to external shocks like the oil price decline and the knock-on effects across the region.  Also, improvements in net exports (that is, exports minus imports) should help reduce the current account deficit, which means relatively higher demand for Armenian Dram; which is also naturally supportive of the exchange rate and/or central bank reserves.  

It is anticipated that Remittances will decline by 30-35% for this year. What kind of affects this decline will have on local exchange markets?

Remittances support an important share of Armenia’s GDP, so yes, this is one of the variables in the exchange rate equation. But if you look at the Balance of Payments, there are many other variables. There are export of goods and services, income, capital and the financial account. It is usually difficult to say how all these bits of a puzzle play out in the grand scheme of things. The fall in remittances, for instance, may be offset by higher net foreign direct investments, or by improvement in trade balance. We are following all these trends closely, and as I noted, imports of goods and services are indeed down significantly, while exports are holding up, which is positive in terms of diminishing pressures on exchange markets.

Is there probability for Dram’s massive depreciation for this year, as it was during the end of November and beginning of December last year?

Major pressures on the Dram have been avoided and the Dram depreciation has been less than in other countries.  EBRD is not in the business of predicting the course of currencies.  What we can say is that responsible and adaptive fiscal and monetary policies contribute to stability, just as structural reforms usually make economies more productive, more open, and more resilient.  This in turn helps to generate foreign exchange which serves as a buffer against currency pressures. But then, there is also the regional context, and it is rather challenging right now.  Russia is in recession and this strains trade, investment and financial linkages between Russia and its neighbouring countries.  It is difficult to identify with much certainty the extent of a pass-through of various global trends on the Armenian economy.  But as I said, responsible domestic economic policy formulation can always help to absorb such exogenous shocks and retain stability.

What do you think how and when the developments in the world financial markets can have an impact on Armenia?

Armenia is part of the global economy, and increasingly so, so it is difficult to remain immune from global developments. We must distinguish between underlying fundamentals, news about those fundaments - which become available only over time, and sentiments which are often affected as that news comes out. For a short-time sentiments often lead to overreactions in international markets, but in the longer run, underlying fundamentals prevail.  So the key is to focus on the fundamentals. 

A good example I came across recently is the stock price of a discount brokerage in the USA.  In the latest round of volatility, the S&P index fell around 3% in one day, and this stock price fell by almost 4.5%.  That doesn’t make any sense at all when you consider that higher volatility means more trading, and more trading means more revenues for this discount brokerage.  I mean, this company makes money whether markets are going up or down; they are not highly levered and the more markets move, the more money they make!  Emotions seem to have been the order of the day, but over the longer term, those increased revenues due to volatility will definitely help that stock price.  Markets are crazy that way, and over the short term they are near impossible to forecast.  It is much safer to avoid short term emotions and stick to fundamentals, and I think this applies to market participants of all kinds.
Speaking of global trends, let’s see the big picture:

Concerns about China mounted over the summer despite its otherwise impressive 7% growth.  China’s exports growth has been decelerating markedly and we saw weaker PMI (Purchasing Managers Index)  index (manufacturing orders) in July-August. On August 11, China moved to a more flexible exchange rate, and this triggered a 3% depreciation of yuan against US$, in contrast with its long-term trend of appreciation.  Then on August 24, a further correction in China’s stock market sparked a global sell-off.  Overall, China’s stock market has dropped 39% since its peak from June 12th, yet remains more than 40% up on a year ago.

So global equities lost ground, with emerging markets – already under pressure in anticipation of the US monetary tightening – additionally impacted.  In parallel, and linked to this, on August 24 Brent oil declined to US$ 43 per barrel. China’s demand slowdown is likely one of the factors, together with supply growth.

The spillovers of these global interconnected trends on the EBRD region are diverse, and for Armenia, are clearly hard to forecast at this stage.  It is worth pointing out though, that, at least over the short term, the relative absence of hot money in Armenia makes it less sensitive to global financial market volatility, like the global stock market adjustment that just happened.  Our economist will continue to watch the situation closely and I am sure the Armenian Authorities will as well.

Is there anything more you want to add?

I think the resilience of Armenia so far this year to global trends is reassuring, but it does highlight the importance of effective policies and policy implementation. We hope the next review under IMF program will be completed soon.  This will provide an anchor and send a positive signal.  More generally, and in some sense over the longer term, we also continue to work with the Authorities on ways to further encourage private investment and private sector-driven growth, improve the quality of public sector infrastructure and service provision, strengthen and deepen local capital markets, and as always, we will continue to have a big focus on SME development and supportive policies which we think can really deliver results for Armenia.  Thank you very much – I appreciate these questions.