Report No. 47770-AM Armenia Implications of the Global Economic Crisis for Poverty September 2009 Human Development Sector Unit Europe and Central Asia Region Document of the World Bank Table of Contents Acknowledgements ......................................................................................................................... i Executive Summary ......................................................................................................................... 1 1. Introduction ............................................................................................................................. 10 2. Economic Growth and Poverty Reduction .............................................................................. 13 A. The Financial Crisis and Growth ...................................................................................... 13 B. Implications of the Slowdown for Poverty ....................................................................... 15 3. Labor Market and Employment ............................................................................................... 17 4. Price Changes .......................................................................................................................... 21 5. Migration and Remittances ...................................................................................................... 23 A. Remittances to Armenia have Important Peculiarities ..................................................... 26 B. Remittances and Poverty Projections ................................................................................ 28 6. Conclusions and Implications for Mitigation Measures .......................................................... 30 A. Implications for Measures to Mitigate the Impact.. .......................................................... 30 Annex A: Additional Figures and Tables .................................................................................... 33 References .................................................................................................................................... 36 Figures Figure 1.1: Changes in GDP (1989 = 100) and Poverty Incidence .............................................. 11 Figure 2.1: Armenia's Main Trade Partners and the Financial Crisis .......................................... 14 Figure 2.2: Remittances and Capital Flows to Armenia and Projections, 1995-2010 ................. 15 Figure 5.1: Armenian Households with Migrant(s) Family Member and Receiving Remittances from (%) ........................................................................................................................................ 23 Figure 5.2: Incidences of Remittances in Urban and Rural Areas ............................................... 24 Figure 5.3: Share of Remittances in Household Income .............................................................. 25 Figure 5.4: Share of Households with Non migrant Remittances ................................................ 26 Figure 5.5: Share of Non migrant to Migrant Remittances .......................................................... 27 Figure 5.6: Share of Poor and Non poor Receiving Remittances ................................................. 28 Tables Table 1.1: Armenia has made significant gains in poverty reduction .......................................... 11 Table 2.1: Growth Elasticity of Poverty and Poverty Headcount Projections ............................. 16 Table 3.1: Poverty Projections under Alternative Sectoral Growth and Employment Scenarios ........................................................................................................................................ 20 Table 4.1: Poverty projections Based on the Combined Effect of the Financial Crisis through the Labor Market and Price changes ................................................................................ 22 Table 5.1: Migrant Workers Destinations outside Armenia ......................................................... 24 Table 5.2: Projected Poverty Rates with 25% Decline in Remittances and 50% Decline in Non migrant Remittances .......................................................................................................... 29 [i] Annex Figure Figure AI: Remittances as Percent of GDP, Selected Countries, 2007 ..................................... 35 Annex Tables Table AI: Change in the Average Monthly Nominal Salary, by Ownership and Sector (AMD) ........................................................................................................................................... 33 Table A2: Sectoral Composition ofGDP .................................................................................... 33 Table A3: Structural Changes in Employment, by Sector ........................................................... 34 Table A4: Input Data for Poverty Projections ............................................................................. 34 [ii] ACKNOWLEDGEMENTS This note on the potential poverty implications for Armenia of the global financial crisis is a product of the Armenia Programmatic Poverty Assessment TA. The note is prepared by Lire Ersado with critical inputs from Robert Taliercio and Aghassi Mkrtchyan, who assembled the relevant macroeconomic data and sectoral output and employment projections. Mohamed Ihsan Ajwad, Robert Taliercio, and Aghassi Mkrtchyan have read and provided useful comments on an earlier draft of the note. The Armenia National Statistics Services has kindly provided the 2007 Integrated Living Conditions Survey data that formed the foundation for the micro simulations. The task was undertaken under the guidance of Donna Dowsett-Coirolo (former Country Director, ECCU3), Asad Alam (Regional Director, ECCU3), Tamar Manuelyan Atinc (Sector Director, ECSHD) Aristomene Varoudakis (Country Manager, Armenia), and Gordon Betcherman (former Sector Manager, ECSHD). Carmen Laurente provided able assistance with formatting and production of the note. EXECUTIVE SUMMARY Introduction 1. The global economic crisis seriously threatens the economic growth and poverty reduction that Armenia achieved in recent years. The most recent data indicate that the economy is now shrinking, with prospects worsening in 2009 and 2010 when the full impact of the crisis is expected to unfold. These developments are a setback for Armenia after a decade of nearly double-digit growth and substantial poverty reduction. Depending on the depth of the crisis in Armenia, in its main trading partners, and in its migrant workers' host countries, and depending on the effectiveness of policy responses, the crisis could have a protracted negative effect on Armenians' living standards. The economic downturn, coming on the heels of the food and fuel price increases last year, will have particularly difficult consequences for the poor and vulnerable who have limited coping means to deal with these successive shocks. 2. The note identifies the main channels of transmission to households of the current global economic crisis and estimates its potential impact on poverty in Armenia. Given uncertainties regarding the scale of the crisis and how households are likely to cope, the note is intended to provide indicative estimates of the poverty impact of the crisis, rather than precise estimates. These estimates are made by simulating the effects of the anticipated slowdown on household consumption using data from the 2007 Integrated Living Conditions Survey (ILCS). The key messages that come out of the analysis are that the crisis will have potentially serious implications for poverty and that this calls for significant responses by the Government of Armenia and its development partners. The government is taking a number of steps to provide protection to the poor, including the protection of public spending on social protection and other pro-poor programs and to improve the targeting efficiency of the programs. These measures should help lessen the impact of the crisis on the poor and the vulnerable. How will the crisis affect households? 3. There are multiple channels through which the economic crisis could affect household welfare and poverty in Armenia. The most important are through: (a) labor markets (via decreased employment and wages); (b) price changes (exchange rate adjustments; utility tariff increases; and consumer price inflation); (c) remittances (stemming from economic slowdown in source countries); and (d) reduced government (and non-governmental) spending on social services such as education, health, and social protection. The impact through financial markets (e.g., reduced access to credit, erosion of savings and asset values) and product markets (via lower growth, relative price changes) can also be substantial but are not directly considered in this note. 4. Labor Market. One of the main channels for transmission of the economic crisis is loss of employment and earnings. Job losses and the pool of unemployed have increased and will likely continue to increase in the months to come not only because of job losses within Armenia but 1 also because of large flows of returning migrants from Russia and other countries that are facing their own economic downturns. Migrants who would normally head to Russia during the spring are expected to stay home and swell the ranks of the unemployed. Employed workers will face reduced wages and working hours. The effects of unemployment and decreased earnings on households will vary according to sector of employment and on household characteristics such as demographics, educational attainment, and location. For Armenians, the impact of the crisis on construction and export-oriented industries is more severe than on other sectors and is projected to get worse. Reduced labor demand in these sectors could spur costly labor reallocation, including movement into subsistence activities. 5. Price Changes. Armenia abandoned the fixed exchange peg of the dram to the US dollar on March 3, 2009. This led to an immediate depreciation of the exchange rate by more than 20 percent. The prices of basic imported consumption goods have increased accordingly. In fact, the initial price hikes for key imported goods were observed to be as high as twice the rate of exchange rate depreciation. While imported final consumption goods constitute only 20 percent of the consumption basket, as much as 40 percent of the local production of the consumer goods is directly affected by the exchange rate adjustment as their production relies on imported inputs. However, in March, the consumer price index (CPI) increased by only 1.4 percent compared to the previous month. This rather tame price response to the exchange rate adjustment reflects the decline in domestic demand due to the economic crisis. In addition, the planned increase in utility tariffs, although not directly linked with the crisis, is expected to increase inflation by at least 2 percentage points. As a result, the CPI inflation could increase by about 3-4 percentage points in 2009. On the other hand, it should be noted that the exchange rate depreciation could benefit households receiving remittances from abroad, usually in US dollars, by increasing their local currency value. 6. Remittances. The flow of remittances to Armenia increased rapidly during the last several years. About 21 percent of households in Armenia now receive some income from this source. For recipient households, remittances account for 55 percent of income so any decreases will have important welfare effects. The global economic crisis is likely to reduce remittances for several reasons. First, a significant share of remittances to Armenia comes from individuals outside the immediate family who may be less committed in difficult times to maintaining transfers than are migrants who are immediate family members. Second, almost 80 percent of Armenia's migrant workers are in Russia which is facing a severe economic slowdown, including in the construction sector, where many Armenian migrants were employed. Finally, about 20 percent of remittances goes into investment (mainly in construction) and is therefore likely to be procyclical. This portion is therefore sensitive not only to economic conditions in sender countries but also to returns on investments in Armenia. After a steady increase since 2000, recorded remittances are expected to decrease from estimated US$ 2 billion in 2008 to less than US$ 1.6 billion in 2009. Growth and Poverty Linkages 7. Economic growth in Armenia has led to substantial poverty reduction but these achievements are now at risk. Between 2004 and 2007, for each percentage point of growth, the 2 overall poverty incidence declined by 0.60 percentage points. As long as GDP growth remained strong, further gains against poverty could be expected. However, when the economy stops growing, as it has in 2009, there is a lost opportunity to lift more people out of poverty. Based on the recent relationship between growth and poverty reduction, the pre-financial crisis growth path of 9.2 percent, assumed in the 2009 budget, would have led to about another 176,000 currently poor people rising above the poverty line. This would have reduced the poverty incidence by about 5.5 percentage points. Without growth, these potential gains against poverty are lost. Furthermore, in a protracted crisis scenario, with the economy contracting by 8 percent in 2009 and by 2 percent in 2010, the poverty impact of the crisis is not only this lost opportunity but also a large number of currently non poor who will fall below the poverty line, as presented below. Poverty Projections for 2008-2010 8. The poverty simulations are based on the assumptions that: (1) real GDP declines by 8 percent in 2009 and 2 percent in 2010; (2) remittances from immediate family sources decline by 25 percent and by 50 percent from non immediate family sources; and (3) the exchange rate depreciation and planned utility tariffs lead to 3 percentage points increase CPI inflation. These assumptions are then applied to the household level data from the 2007 ILCS. The key results of the simulation exercise are presented below in Figures 1 and 2. Figure 1 presents trends in overall poverty indices (based on the overall poverty line of AMD 23,168 per adult equivalent per month in 2007 prices) along with the predictions for 2008-2010, while Figure 2 does the same for extreme poverty indices (based on the extreme poverty line of AMD 15,573 per adult equivalent per month in 2007 prices). 9. Simulations of the impact of the crisis suggest that Armenia could see an increase in poverty rates in 2009 and 2010. The overall poverty incidence could increase by about 5.2 percentage points between 2008 and 2010 (Figure 1, left axis). That means 147,000 people could fall below the poverty line in 2009 and another 25,000 in 2010 (Figure 1, right axis). The projected poverty incidence in 2010 of about 28 percent is higher than the 2006 level of 26.5 percent, implying that the poverty reductions recorded between 2006 and 2008 would be more than fully offset by poverty increases due the crisis. The increase in the poverty gap would be more pronounced as the already poor become poorer. 3 Figure 1: Overall Poverty Trends and Projections, 2008-2010 40 120a ¥~'F'"'' 35 100a 30 ~ 800 - '" 0 0 .... 25 >- p ... 0 &. .... C ::l ... 0 "tl 20 15 600 - 0 Q. 0 .... QJ .Q f1l ~. ~ E: 1:J 0 5 150 § ..... u "0 m .... 0