Armenian Journal of Public Policy Volume 3, No. 1 March 2008 LOOKING FORWARD : THE GLOBAL COMPETITIVENESS OF THE ARMENIAN ECONOMY CONTENTS David Joulfaian Guest Editor’s Note Mher Baghramyan and Vahram Ghushchyan Implications of Armenian Dram Appreciation for the Competitiveness of Armenian IT, Tourism, and Food Processing Industries Vahe Heboyan and Lewell F. Gunter Exchange Rate Dynamics in Armenia Era Dabla-Norris and Holger Floerkemeier Bank Efficiency, Market Structure, and Foreign Ownership: What Determines Banking Spreads in Armenia? Karen Grigorian and Vahram Stepanyan Productivity and Sources of Enterprise Level Efficiency in Armenia Manuk Hergnyan, Gagik Gabrielyan, and Anna Makaryan Competitiveness of the Armenian Private Sector: Moving to the Next Stage Kenneth Fortson, Ester Hakobyan, Anahit Petrosyan, Anu Rangarajan, and Rebecca Tunstall Armenia’s Millennium Challenge Account: Assessing Impacts on Economic Growth and Poverty Reduction in Rural Armenia A journal of the Armenian International Policy Research Group Armenian Journal of Public Policy A journal of the Armenian International Policy Research Group Guest Editor David Joulfaian US Department of Treasury Editorial Board Richard Beilock University of Florida Ara Khanjian Ventura College Arman Grigorian Swiss Federal Institute of Technology Garbis Iradian International Institute of Finance Lucig Danielian American University of Armenia Armine Khachatryan International Monetary Fund Managing Editor Heghine Manasyan CRRC-Armenia/ Eurasia Partnership Foundation Assistant to Managing Editor Artak Galyan Armenian International Policy Research Group Manuscripts, book reviews, and communication with editors should be sent electronically to [email protected]. Published articles will be available online at www.aiprg.net. The views expressed in the Journal are not to be construed as those of the editors or the publisher, the Armenian International Policy Research Group. The financial support of Eurasia Partnership Foundation in Armenia inpublishing this issue is gratefully acknowledged. Copyright © 2008 AIPRG Printed by TOROS Publishing , Yerevan, Armenia. Armenian Journal of Public Policy Volume 3, No. 1 March 2008 LOOKING FORWARD : THE GLOBAL COMPETITIVENESS OF THE ARMENIAN ECONOMY CONTENTS David Joulfaian Guest Editor’s Note………………………………………………………………………... Mher Baghramyan and Vahram Ghushchyan Implications of Armenian Dram Appreciation for the Competitiveness of Armenian IT, Tourism, and Food Processing Industries………………………………….. Vahe Heboyan and Lewell F. Gunter Exchange Rate Dynamics in Armenia…………………………………………………….. Era Dabla-Norris and Holger Floerkemeier Bank Efficiency, Market Structure, and Foreign Ownership: What Determines Banking Spreads in Armenia?.................................................................. Karen Grigorian and Vahram Stepanyan Productivity and Sources of Enterprise Level Efficiency in Armenia…………………….. Manuk Hergnyan, Gagik Gabrielyan, and Anna Makaryan Competitiveness of the Armenian Private Sector: Moving to the Next Stage…………….. Kenneth Fortson, Ester Hakobyan, Anahit Petrosyan, Anu Rangarajan, and Rebecca Tunstall Armenia’s Millennium Challenge Account: Assessing Impacts on Economic Growth and Poverty Reduction in Rural Armenia…………………………………………………. Armenian Journal of Public Policy Volume 3, No. 1 March 2008 GUEST EDITOR’S NOTE The Armenian economy experienced rapid growth over the past decade, in particular growing at double digit rates since 2001. At the same time the country experienced a number of shocks that may have implications for the country’s competitiveness and sustainability of continued growth. These include the rapid appreciation of the Dram, low financial intermediation, and stalled reforms among others. This timely volume contains six papers that address various aspects of the competitiveness of the Armenian economy. These include the effects of the appreciation of the exchange rate, competition in the banking sector, productivity at the firm level, the overall competitiveness of the private sector, as well as the agricultural sector and the impact of farmer training. The first paper by Mher Baghramyan and Vahram Ghushchyan addresses the appreciation of the Dram and its implications for the competitiveness of the IT, tourism, and food processing sectors. The authors explore the relationship among exchange rates, technical efficiency, and export and profitability of firms operating in Armenia. They find that exchange rate appreciation has serious implications for firm profitability. The appreciation of the Dram also raises the question of whether the exchange rate is misaligned. The second paper by Vahé Heboyan and Lewell Gunter explores the underlying factors that explain the exchange rate dynamics in Armenia. Their results show that the Armenian currency is misaligned from its long-run equilibrium path. However, they also report that the degree of misalignment is sensitive to the set of variables used in the estimation and call for further work. Turning to the banking sector, the third paper, co-authored by Era Dabla-Norris and Holger Floerkemeier, studies the determinants of banking interest rate spreads and margins in Armenia. They find that a large proportion of the variation in spreads and margins can be explained by bank size, liquidity, and market power, as well as the market structure within which banks operate. The results suggest that there is a large potential to increase cost efficiency and competition in the banking system. The fourth paper by Karen Grigorian and Vahram Stepanyan examines firm level evidence on the sources of productivity growth in the Armenian economy. They estimate total factor productivity (TFP) using a sample of firms in the manufacturing and service sectors, and investigate its variation across industries, time and region. They find that technical efficiency is highest in the jewelry, furniture and juice sector as well as mining, and lowest in chemicals, textiles and construction; the service sector operates at the mean of technical efficiency across the economy. However, the authors conclude that Armenia is not experiencing any growth in technical efficiency. Moving to the big picture, the next paper by Manuk Hergnyan, Gagik Gabrielyan, and Anna Makaryan examines the competitiveness of the Armenian private sector. The paper reviews Armenia’s economic achievements and studies the underlying factors and causal links to the country’s competitiveness. It also advances a set of recommendations to position Armenia in the region and globally. The last paper, co-authored by the team of Kenneth Fortson, Ester Hakobyan, Anahit Petrosyan, Anu Rangarajan, and Rebecca Tunstall, reviews the major features of the Millennium Challenge Account program and lays out the methodology on how to study the impact of farmer training. The results of the evaluation will assess the farmer training program’s success in increasing the adoption of effective agricultural practices, increasing cultivation of higher-value crops, improving farm productivity, increasing agricultural profits and household income, and reducing poverty rates. Guest Editor David Joulfaian IMPLICATIONS OF ARMENIAN DRAM APPRECIATION FOR THE COMPETITIVENESS OF ARMENIAN IT, TOURISM , AND FOOD PROCESSING INDUSTRIES Mher Baghramyan, AIPRG Vahram Ghushchyan, Ph.D., AIPRG ∗ Abstract: The Armenian currency appreciated more than 40 percent during 2003- 2006. This sharp change in nominal exchange rate is considered a negative shock for local producers and especially for the exporters. The survey data of fifty eight Armenian companies is used to study how the appreciation has affected the competitiveness of Armenian tourism, IT, and food processing industries. We use the Stochastic Frontier modeling technique to estimate the level of and changes in the technical efficiency of the companies during 2003-2006. The technical efficiency parameters are then included into the regression model in order to reveal the possible impact of the currency appreciation on profits and export levels of the companies. We find systematic and statistically significant impacts of exchange rate changes on the level of technical efficiency of the companies. We also find that work experience is another important determinant of degree of technical efficiency. We study the relationships among exchange rates, technical efficiency, and export and profitability of the companies. We find that a one point appreciation of the nominal exchange rate causes a decrease in the export of an average Armenian IT company by 66 thousand drams (about 200 USD) per year, average food processing company by 12 thousand Drams (about 40 USD) per year, and a loss of profit of an average incoming tour operator and hotel by 112 thousand AMD (or about 340 USD per year). JEL Classification: C1, C3, D2 Keywords: Technical Efficiency, Exchange Rate, Appreciation, Competitiveness ∗ The authors wish to thank Competitive Armenian Private Project (CAPS), USAID, and Norwegian Institute of International Affairs (NUPI) for financial support, AIPRG staff for their dedicated efforts on conducting the survey, and all survey respondents for providing data and making useful comments. The analysis and views presented in this study do not necessarily reflect those of AIPRG or USAID and are those of the authors alone. I. INDUSTRY OVERVIEW 1.1 IT and Tourism Both Armenian information and communication (ICT) and tourism industries experienced rapid growth during the last decade and are considered to be among the most