QuasiFiscal Sector in Armenia and Government Policies

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• Quasi-Fiscal Sector in Armenia and Government
  Policies
• Instructor Dr. Arthur Drampian
• Student Suzan Hobosyan

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The Economic Background

• Macroeconomics Poverty 1990-94
• Decline of large Soviet industries
• On-Going Effects of Earthquake
• 50 Decline in GDP
• Budget Deficit Explodes to 48 of GDP
• Inflation at 5000 per annum

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Stabilization and Reform after 1994

• Inflation to - 10 by 1996
• GDP growth restored by 1994 (5 p.a. since then)
• Budget Deficit reduced to 3-7 of GDP
• External Balance stabilized by grants
• BUT Growth narrowly based 30 of workers
  inactive, new Exports creating few jobs
• AND Poverty Indicators remain bad (around 50
  in poverty)

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Implications for Policy

• Many post-1994 reforms clearly necessary to
• Stabilise the macro situation
• Improve the efficiency of social support
• Establish the institutions of a market economy
• BUT the Unsatisfactory SHARING of benefits argues
  for change in emphasis involving
• More substantial ex ante analysis of Poverty
  effects of all major reforms
• More explicit pro-poor policies and expenditures

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Why the Water Sector?

• Water is prominent in the structural reform
  agenda
• Numerous social, environmental and other impacts
  low level trap ( finances, delivery, payment)
• Major macroeconomic issues (direct transfers to
  water utilities reaching 2 of GDP in the last
  few years). FY2001 subsidies of 8 million.
• Water reliability and quality is poor and
  extremely variable - both municipal and
  irrigation water.
• Seriously degraded infrastructure cost of
  necessary new investment at hundreds of millions
  of US dollars.

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Declining Water Use
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Example of Problems Water Related Disease
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Water Sector Reform in Armenia

• Started in 1999 with the Integrated Water
  Resources Management Planning (IWRMP) Study.
• High Level Objective Development of a
  comprehensive policy framework to ensure a
  sustainable management and use of water resources
  and development of the water using sectors,
  taking into account economic, financial,
  environmental, social and institutional
  considerations.

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Water Sector Reform in Armenia

• In 2000, foreign management company signed a
  performance management contract for the Yerevan
  Water and Sewage Company this reform led to
  almost 100 collection rates, 87 of customers
  now have installed meters. However, YWSCs
  technical losses remain very high.
• In 2004 primary deficit of water sector reduced
  to 0,3 of GDP.
• In 2005, similar contract has been introduced
  which provides water to customers outside the
  capital.

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Financial Reform
GOA (Decree No.440). Reform Program to improve
the financial sustainability of the companies
responsible for the provision of drinking water
supply/ wastewater and irrigation/drainage

• introduce commercial base for the operations of
  all the water supply companies during 2001-2008.
• The final goal is to eliminate budget subsidies.
  This will require major capital investments using
  (a) loans on favourable terms and (b) increased
  receipts from billing collections. Estimated
  investments needed for the first 5 years is 200
  million.
• To achieve the above it is necessary to review
  and modernise the existing legal and normative
  fields regulating WRM implement tariff,
  institutional and administrative reforms.

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Financial Reform Municipal Water

• Example of Yerevan WSR
• decrease water losses by up to 55 - saving
  around 165 million m3 of water volumes.
• increase in collection rate by about 62 to
  achieve a 3.2 fold increase in revenues
• reduce energy costs by about 25
• increase salaries by about 2.2 times
• improve services by increasing OM
  expenditure by about 1200 million AMD

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Scenarios Tariffs and Collections
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Who Fails to Pay?

• Main Conclusions
• Payments non-compliance is NOT a consequence of
  Poverty
• However, extensive non-payment today means that
  present water charges have only a minimal poverty
  impact.

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Impact of Full Payments Compliance

• Full Payments Compliance (of Existing Tariffs)
  would
• increase the numbers of the very poor by nearly
  18 (18.7 v 15.9) and the poor by 4.6 (36.6 v
  35.0)

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Quantitative Results Key Issues

• Tariffs
• The Price that maximises revenue to the Water
  Utilities - 5 ARD per 10 litres- would achieve
  only 40(Rural) and 65(Urban) payments
  compliance - even with improved Water delivery.
  At higher prices both revenue and the degree of
  usage of the system decline.

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Continued

• Arrears
• Average arrears per family at 9 represent a
  significant proportion of the minimal consumption
  basket
• Meters
• Installation Cost at 30 is very high for poorer
  families

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Qualitative Results Selected Issues

• The policy balance between treating water as an
  economic good (private or public) versus a basic
  human need is particularly difficult and
  potentially very contentious in Armenia (social
  consensus has broken down)
• Resistance to reform is also due to (poorly
  understood) tensions between vested interests
• Getting people to pay for their actual water
  consumption is probably the most complicated part
  of the reform and is fraught with difficulties
  (e.g. problematic role for condominiums,
  perceived unfairness between upper and low floors
  of apartments, paying for the meter)

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Proposed Mitigating Measures

• Phase in the mass installation of individual
  meters on an affordable basis with meters for the
  extremely poor being installed free of charge
• Assist poor households with (a) forgiveness of
  accumulated arrears (b) a specifically designed
  program of allowances. A block tariff, or a
  lifeline tariff, may reduce the poverty impact
  particularly for those who just fall outside the
  eligibility criteria.
• Use a public awareness campaign to (a) to
  underline the importance of the reforms (b) to
  promote the idea of fairness and transparency
  and (c) to explain the concept and progress of
  the latter.
• Recognize explicitly that implementing the
  condominium mechanism in water delivery
  (involving collective organizations to manage
  payments and supply in apartment buildings) is
  going to be a major challenge.

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Irrigation Water The Problem

• 80 of Crop Production is produced using
  Irrigation
• The actual irrigated area has declined hugely
  since 1991 and the usage rate has declined to
  only 70
• Tariffs charged cover only 30-60 of costs
• Yield differences between Irrigated and Rain-Fed
  Agriculture are large
• Soviet delivery systems designed for large
  collective farms are inappropriate for todays
  smaller farms
• Availability and supply costs of Irrigation vary
  greatly by region as do yields of main crops
  (mountainous regions having higher costs and
  lower yields)
• Agricultural growth (and by implication
  irrigation) are key to the Poverty Reduction
  agenda.

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Irrigation Decline and Poverty
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Prospective Irrigation Tariffs
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Reforms in Irrigation Sector

• Progress has been made
• Greater transparency in terms of fiscal support
  as subsidies are explicitly included in the
  budget.
• In 2004, technical losses were almost 23 of
  water distributed, compared with 31
  in1999.Collection rate rose to 77.
• But further reform are needed to reduce
  corruption and ensure long-term financial
  liability of the sector.
• Tariffs remain below cost-recovery levels-despite
  recent increase in tariffs.

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Identified Impacts of Higher Tariffs Improved
Collections

• Big Problem for 25 of Rural Households with zero
  Cash Income
• Variable impact on farm profitability depending
  on Marz and Crop
• Few impacts except on fodder and so livestock in
  Shirak, Armavir and Ararat
• Significant deterioration in Aragatsotn, Kotaik,
  and Sunik
• An already poor farming situation in Tavush and
  Lori would deteriorate further.

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Qualitative Issues

• The concept of the average farm is unhelpful.
  Strong households working well in commercial
  agriculture will have few problems adapting to
  the reforms. But the predominantly subsistence
  farms (especially in alpine and border regions)
  are already extremely distressed
• In difficult areas, focus groups expect a 30-40
  quit rate from farming in the next few years -
  higher water tariffs are just one more pressure
• Corruption is perceived as the root cause of the
  high incidence of non-payment. Reform objectives
  will fail unless this problem is addressed.

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Risks of Irrigation Sector Price Reforms in some
Regions

• Increase in poverty levels, as a result of actual
  farms closures or weaker finances.
• Accelerated population movement from rural to
  urban areas, adding to social tensions in the
  latter and intensifying already uneven economic
  development.
• Security risks as a result of possible
  de-population of some border areas.
• Risks from the acceleration of the already
  dangerous levels of out migration from Armenia.

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Continued

• Social tensions as a result of increased
  polarisation of the rural community. Armenia is
  already characterised with the highest in the CIS
  Gini coefficient.
• Environmental impact, , e.g. the farmers may
  switch to extensive use of drainage water, even
  if it does not match the required standards. This
  will have knock-on effects on health status.
• Endangered food security for the poor part of
  population, as a result of increase in the price
  of agricultural goods. This will hit in the first
  instance the poor urban households ( who would
  have already experienced the impact of increasing
  burden of drinking water tariffs).

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Energy Sector

• If appropriately done, electricity reform is an
  opportunity to re-direct billions of dollars
  toward a sustainable and equitable energy
  future.
• Navroz
  Dubash

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Why do we care about energy in transition
economies?

• Energy sector is the single most important
  contributor to fiscal deficit
• Historical legacy low pricing, high subsidies
  and credits, high consumption, low
  collections-absence of reliable mechanisms to
  enforce payments for received services,
  corruption
• Energy sector reforms are very controversial,
  politically sensitive, and subject to capture by
  influential elites.

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• Over 70 of the electricity demand in Armenia is
  satisfied through nuclear and thermal generation
  that relies entirely on imported energy. That is
  why the energy security of the country is a major
  concern for the Government.

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Electricity reform, the Why question
Electricity was supplied as little as 2-4 hours
per day and interruptions were frequent

• Quality of service
• Fiscal sustainability
• Environmental sustainability

Utilities revenue were low a Combination of low
tariff, subsidies and non-payment
Reduce the use of hydro power (Lake Sevan),
reduce pollution And deforestation
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Reform milestones in Armenia and ECAenergy
strategy (1998)

• Raising prices to cost recovery levels - 1999
• Metering and cutting off non-paying customers
  1999
• (improvement of collection discipline)
• Establishing predictable and transparent
  regulations - 1997
• (Armenias Energy Law )
  
• Introducing competition in generation and
  supply - in process
• Selling industrial assets to private strategic
  investors 2002 (transfer of two main
  electricity generation to Russia)
• Creation of separate midstream companies for
  financial settlements, electricity dispatch and
  high-voltage distribution-2003.
• Removal of Armenergo from all cash transactions
  -2004.

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Household tariffs for electricity and gas,
1994-2002
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Four dimensions of outcomes

• Fiscal
• Efficiency
• Social
• Environmental

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Service reliability and household tariffs
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Budgetary Cost of Social Protection
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Electricity sector deficit
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Electricity generation and sales
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Efficiency indicators
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The use of Central Gas for households
isincreasing

• Access to a working gas connection more than
  doubled in 2001 from 1999
• In 2001 half as many
• households have a
• broken connection as in
• 1996

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Outcomes of Reforms

• Ambient air quality of Armenia has improved over
  the years (high usage of natural gas and end of
  using Mazut since 1997).
• Collection rates improved and the sectors
  deficit fell from 4.1 of GDP in 1998 to 0.6 in
  2003.
• Over the same period, the primary deficit fell
  from 2.6 GDP to zero.
• Reduced Cross-subsidization (which is a critical
  prerequisite for both macroeconomic stabilization
  and enterprise restructuring, and at the same
  time it has a major impact on the credibility of
  the entire reform process).

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Outcomes of Reforms

• At present the energy sector of Armenia is one of
  the full operational and cost-effective branches
  of the countrys economy. Armenia fully covers
  energy demand in the internal market and
• exports electricity to Georgia, as well as
  successfully performs an electricity exchange
  with Iran on mutually beneficial basis.
• Lucking the industrial fuel resources Armenia
  places a high emphasis on the development of the
  own renewable energy sources, such as Hydro, Wind
  and Solar energy

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Remaining Issues

• How to handle debts the sector has accumulated in
  recent years? (in mid-2004 - 35 million)
• Financial rehabilitation plan envisages
• cancellation of cross-debts
• Further privatization
• Repayment of debt through collection of
  receivables.
• Closure of Metzamor (approx. costs 700mill 1.2
  bill.)
• Electricity supply is affected by aging and
  deteriorated thermal and hydro plants (40 of the
  power plants are more than 30 years old).

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Accomplishments (USAID)

• Restructured Energy Sector Armenergo, the
  utility previously responsible for all
  electricity generation, transmission, and
  distribution, has been effectively "unbundled"
  into production, regional distribution, and local
  delivery units.
• Strengthened Armenian Energy Regulatory
  Commission
• Privatized Energy Sector
• Completed a 15 million metering program
• International Accounting Standards adopted across
  the energy sector
• Improved Decision-Making Processes
• Improve Heating Systems
• Supported Dialogue for Regional Cooperation
• Improved Cost Recovery (39 in 1997 to 63)
• Improved Energy Efficiency
• Restructured Tariff System (established
  cost-based electricity tariffs)
• Humanitarian Assistance
• Rehabilitation of hydroelectric power plants

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Households Response (1999 tariff increase)

• Electricity consumption records dropped on
  average 17 percent and reported consumption of
  such substitutes as wood (environmental
  problems-deforestation and increased indoor air
  pollution) and natural gas increased.
• The collection rates fell 9 percentage points,
  and arrears increased four-fold.
• Relative to the non-poor, the poor cut
  consumption more.
• The percentage of households with arrears was
  higher, and the average size of arrears increased
  more.
• The greatest hardship for the urban poor (no
  access to wood).

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