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Credibility amid the crisis

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  • Credibility amid the crisis

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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.
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