ARMENIA INVESTMENT CLIMATE STATEMENT, 2007

UNCLAS SECTION 01 OF 06 YEREVAN 000044 SIPDIS SIPDIS DEPT FOR EB/IFD/OIA, EUR/CARC, EUR/ACE DEPT PLEASE PASS TO USTR E.O. 12958: N/A TAGS: EINV EFIN ETRD ELAB KTDB PGOV OPIC USTR AM SUBJECT: ARMENIA INVESTMENT CLIMATE STATEMENT, 2007 REF: STATE 178303 ¶1. (U) Following is our submission per reftel for the 2007 Investment Climate Statement for Armenia. -------------- BEGIN TEXT -------------- Foreign investment in Armenia has steadily increased from USD 70 million in 2001 to USD 297 million as of September 2006, according to data from the National Statistical Service. From January to September 2006 Foreign Direct Investment (FDI) in Armenia totaled USD 149 million, an 8 percent increase over the same period in 2005. Major foreign investments were from Greece, France, US, Argentina, Russia. Gross domestic product (GDP) growth remained strong at approximately 13 percent for 2006, slightly down from 14 percent in ¶2005. The IMF projects GDP growth of approximately 9 percent in ¶2007. The largest foreign investors in Armenia are those who purchased interests in valuable Soviet-era state assets. Privatization of Yerevan's largest hotels, two historic braQ factories, the Zvartnots International Airport, the telecommunications network, several mining assets and much of the energy generation and distribution system accounts for the bulk of foreign commercial presence in Armenia. Some of these companies, including the telecommunications network and electrical distribution network were recently sold to new foreign investors. There are also significant foreign investments in construction, the primary driver of Armenia's continued economic growth. Greenfield investments are made up of mostly small and medium enterprises. More than a dozen U.S. information technology (IT) firms have established subsidiary operations in Armenia. There have also been new foreign investments in the mining, chemicals, and telecommunications sectors. The Armenian dram continued to appreciate significantly, especially against the dollar, in 2006, contributing to an increase of almost 6 percent in year-on-year inflation. The Central Bank and IMF both cite increased remittances as one of the primary drivers of the dram appreciation trend. According to the IMF, by September 30, 2006, nominal appreciation of the dram was 33 percent against the U.S. dollar. Dram appreciation in recent years seems to have had have some impact on external competitiveness, and appreciation and the undiversified structure of exports may limit future potential for export-led growth. -------------- OPENNESS TO FOREIGN INVESTMENT -------------- Despite significant obstacles to investment, particularly problems with corruption, Armenia's investment and trade policy is relatively open. Armenia ranked 34 out of 175 economies-the highest ranking among CIS countries-in the "ease of doing business" index according to the World Bank's Doing Business in 2007. The Armenian Government continues to work to attract additional investment. Foreign companies are entitled by law to the same treatment as Armenian companies (national treatment) and in some cases may benefit from temporary preferential tax treatment including a two-year profit tax exemption. The Armenian Government plans to phase out this exemption in 2007 with the aim of creating a level playing field for local and foreign businesses. Basic provisions regulating American investments are set by the Bilateral Investment Treaty (BIT),signed by the United States and Armenia in 1992, and by the 1994 Law on Foreign Investment. In addition to providing for national treatment and most-favored nation treatment, the BIT sets out guidelines for the settlement of disputes involving the government of either party. Armenia's 1997 Law on Privatization (amended in 1999) states that foreign companies have the same rights to participate in the privatization processes as Armenian companies. Nevertheless, recent important privatizations of Armenia's large assets have not been competitive or transparent, and political considerations have in some instances trumped Armenia's international obligations to hold a fair tender process. Under the Constitution, foreign individuals are prohibited from owning land in Armenia, but this prohibition does not apply to foreign businesses. Armenia is a member of the following major international organizations: IMF, World Bank/IDA, IFC, WTO, OSCE, Council of YEREVAN 00000044 002 OF 006 Europe, UN/UNCTAD/UNESCO, MIGA, ILO, WHO, WIPO, INTERPOL, European Bank for Reconstruction and Development (EBRD),the Asian Development Bank (ADB),IAEA, World Tourism Organization, World Customs Organization, International Telecommunications Union and the Organization of the Black Sea Economic Cooperation. Armenia became the 145th member of the WTO in February 2003. -------------- CURRENCY CONVERSION AND TRANSFER POLICIES -------------- There are no limitations on the conversion and transfer of money or the repatriation of capital and earnings, including branch profits, dividends, interest, royalties, or management or technical service fees. Most banks can transfer funds internationally within 2-4 days. The Government of Armenia maintains a freely convertible currency, the Armenian Dram, under a managed float. According to the 2005 law on "Currency Regulation and Currency Control," prices for all goods and services, property and wages must be set in Armenian Drams. There are exceptions in the law, however, for transactions between resident and non-resident businesses and for ceQain transactions involving goods traded at world market prices. The new law requires that interest on foreign currency accounts may be calculated in that currency, but be paid in Armenian Drams. -------------- EXPROPRIATION AND COMPENSATION -------------- Under Armenian law, foreign investments cannot be nationalized; they also cannot be confiscated or expropriated except in extreme cases of natural or state emergency, upon a decision by the courts and with compensation. While we are not aware of any confirmed cases of expropriation, a local subsidiary of a U.S.-based mining company is engaged in an ongoing dispute with the Armenian Government and has accused the latter of expropriating company assets. To date, there has been no court assessment of the company's claims. -------------- DISPUTE SETTLEMENT -------------- According to the 1994 Foreign Investment Law, all disputes that arise between a foreign investor and the Republic of Armenia must be settled in Armenian courts. In late December 2006, however, the Armenian Parliament passed, and President Kocharian is expected to sign, a new Law on Commercial Arbitration, which will provide investors with a wider range of options for resolving their commercial disputes. The Bilateral Investment Treaty (BIT),signed by the U.S. and Armenia, provides that in the case of a dispute that arises between an American investor and the Republic of Armenia, the investor may choose to submit the dispute for settlement by binding international arbitration. As an international treaty, the BIT supersedes Armenian law, a point which is acknowledged under Armenia's constitution and in actual practice. Many Armenian courts suffer from low levels of efficiency, independence, and professionalism and there is a need to strengthen the Armenian judiciary. While there have been a few investment disputes involving U.S. and other foreign investors, there is no evidence of a pattern of discrimination against foreign investors in these cases. The government has recently honored judgments from both arbitration and Armenian national courts. Disputes to which the Armenian Government is not a party may be brought before an Armenian or any other competent court, as provided for by law or by agreement of the parties. There is a special Economic Court that hears commercial disputes. The verdict of an Economic Court can be appealed to the Court of Cassation, the highest judicial authority of Armenia. The Law on Arbitration Courts and Arbitration Procedures provides rules governing the settlement of disputes by arbitration. The Armenian Constitution was amended in November 2005 to, among other things, increase judicial independence. In line with these amendments, the Minister of Justice has proposed a judicial reform package aimed primarily at restructuring the courts of first instance. According to the proposal, the Economic Court would be replaced by new bankruptcy courts and a new specialized administrative court. While implementation of the proposal is underway, the timeline for completion remains unclear. Armenia is a party to the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the Washington Convention) and the New York Convention of 1958 on the Recognition and Enforcement of Foreign Arbitral Awards. -------------- PERFORMANCE REQUIREMENTS AND INCENTIVES YEREVAN 00000044 003 OF 006 -------------- Armenia currently has incentives for exporters (no export duty, VAT refund on goods and services exported) and foreign investors (income tax holidays, and the ability to indefinitely carry forward losses). The government amended the VAT law in November 2005 allowing companies to delay VAT payments for one to two years on certain imported goods used in production and manufacturing. Also, in accordance with the Law on Foreign Investment, several ad hoc incentives may be negotiated on a case-by-case basis for investments targeted at certain sectors of the economy and/or of strategic importance to the economy. The Government of Armenia has imposed performance requirements for investors as part of privatization agreements, especially for the privatization of large state assets like mines or the telecommunications network. There are no performance requirements for de novo investment. -------------- RIGHT TO PRIVATE OWNERSHIP AND ESTABLISHMENT -------------- The Constitution of Armenia protects all forms of property and the right of citizens to own and use property. Foreign individuals, who do not hold special residence permits, cannot own land, but may lease it and companies registered by foreigners in Armenia as Armenian businesses have the right to buy and own land. There are no restrictions on the rights of foreign nationals to acquire, establish or dispose of business interests in Armenia. -------------- PROTECTION OF PROPERTY RIGHTS -------------- Armenian law protects secured interests in property, both moveable and real. Armenian legislation provides a basic framework for secured lending, collateral and pledges, and provides a mechanism supporting modern lending practices and title registration. While nearly all lending is secured, the mortgage market has been slow to develop. The German Development Bank (KfW) recently approved a USD 21 million mortgage lending program to help develop the Armenian mortgage market and the National Assembly is considering new legislation for primary and secondary mortgage market development. Domestic legislation, including the new Law on Copyright and Related Rights which was adopted in 2006, provides for the protection of intellectual property rights on literary, scientific and artistic works (including computer programs and databases),patents and other rights of inventions, industrial design, know-how, trade secrets, trademarks, and service marks. Armenia's legislation is in compliance with Trade Related Aspects of Intellectual Properties (TRIPS) Agreement. In January 2005, the government created an IPR Enforcement Unit in the Organized Crime Department of the Armenian Police. In July 2005, the Unit took significant action against three companies allegedly marketing unlicensed cassettes, CDs and DVDs. It is not yet clear, however, whether the action taken represents the beginning of stronger IPR enforcement efforts or whether it was a case of selective enforcement. There is also an Intellectual Property Agency in the Armenian Ministry of Trade and Economic Development responsible for granting patents and for overseeing other IPR related matters. While Armenia has made some progress on IPR issues, strengthening enforcement mechanisms remains a priority. -------------- TRANSPARENCY OF THE REGULATORY SYSTEM -------------- The Armenian regulatory system pertaining to business activities still lacks transparency in implementation. A small group of businesses dominate several sectors that should be competitive. The inconsistent application of tax, customs (especially valuation) and regulatory rules, especially in the area of trade, undermines fair competition and adds uncertainty for small- and medium-sized businesses and new market entrants. Banking supervision is relatively well developed and largely in-line with the Basel Core Principles. In early 2006, the Armenian Central Bank became the primary regulator for all segments of the financial sector, including banking, securities, insurance and pensions. Safety and health requirements, mostly remaining from the Soviet period, generally do not impede investment activities. Bureaucratic procedures can nevertheless be burdensome and discretionary decisions by individual officials still provide opportunities for petty corruption. Despite persistent problems with corrupt YEREVAN 00000044 004 OF 006 officials, both local and foreign businesses assert that a sound knowledge of tax and customs law and regulations enables business owners to deflect a majority of unlawful bribe requests. -------------- CAPITAL MARKETS AND PORTFOLIO INVESTMENTS -------------- Armenia's financial sector is not well developed. As of September 2006, total bank assets were USD 1.2 billion (28 percent of GDP). IMF estimates suggests that banking sector assets account for 97 percent of total financial sector assets. Financial intermediation is poor: commercial lending rates range from 11.7 percent to 22 percent. In December 2006, the official bank lending rate was 14 percent. Nearly all banks require collateral located in Armenia and large collateral requirements often prevent potential borrowers from entering the market. Armenia's securities market is not well developed although there is a system and legal framework in place. The Armenian stock market (ArmEx) introduced foreign exchange trading in November of 2005 and the first commercial paper was issued in September 2006. The main trading on ARMEX is in the form of privatization vouchers' trading, but there was also significant foreign exchange trading in 2006. Remittances constitute a significant share of Armenian's total GDP. According to the latest data released by the Central Bank, the volume of private (non-commercial) remittances for Jan-September 2006 has increased by 43 percent compared to the same period in ¶2005. A recent Central Bank survey states that 37 percent of Armenian households regularly receive remittances. Seventy-two percent of remittances originate in Russia and the remainder come primarily from Europe and the US. -------------- POLITICAL VIOLENCE -------------- We know of no incident involving politically motivated damage to commercial property in Armenia. In 2006, however, there were unconfirmed reports of harassment and intimidation of journalists, many of whom are alleged to have ties to opposition parties. There also were a number of reported attacks against individuals related to prominent members of the Armenian business community. National Assembly elections are scheduled for May 2007 and a Presidential election is scheduled for 2008. Armenia's ceasefire with Azerbaijan has held for more than 10 years: there have been no threats to commercial enterprises from skirmishes in the border areas. It is unlikely that civil disturbances, should they occur, would be directed against U.S. businesses or the U.S. community. -------------- CORRUPTION -------------- Corruption remains an obstacle to U.S. investment in Armenia. The Armenian Government introduced a number of reforms during the last four years, including the simplification of licensing procedures, civil service reform, a new criminal code, privatization in the energy sector, anti-corruption laws and regulations, and in 2004, establishment of an Anti-Corruption Council tasked with coordinating the government's anti-corruption activities and improving policies aimed at the prevention of corruption. Nevertheless, corruption remains a problem in critical areas such as the judiciary, tax and customs operations, health, education and law enforcement. Petty corruption is widespread throughout society. In November 2003, the GOAM adopted a National Anti-Corruption Strategy paper which contained an action plan aimed at introduction of tax and customs reforms, harmonization of legislation and improvement of public access to information. The plan, scheduled for completion in 2007, has been widely criticized by local and international observers. The Armenian Government has circulated a draft of a new anti-corruption strategy, but it has not yet been adopted. Relationships between high-ranking government officials and the emerging private business sector encourage influence peddling between officials and the private firms from which they benefit. Powerful officials at the federal, district, or local levels acquire direct, partial, or indirect control over emerging private firms. Such control may be exercised through a hidden partner or through majority ownership of a prosperous private company. The involvement can also be indirect, e.g., through close relatives and friends. These practices promote protectionism, encourage the creation of monopolies or oligopolies, hinder competition, and undermine the image of the government as a facilitator of private sector growth. YEREVAN 00000044 005 OF 006 The Law on Civil Service, in force since January 1, 2002, restricts participation by civil servants in commercial activities. The new Law on the Disclosure of Property and Income for heads of state authorities has increased transparency in government officials' decision-making and influence. Corrupt practices exist widely within private companies as well, mostly in the form of tax fraud and unregistered business activities. -------------- BILATERAL INVESTMENT AGREEMENTS -------------- Armenia has bilateral investment treaties (BITs) in force with 21 countries: the U.S., Argentina, Austria, Belarus, Bulgaria, Canada, China, Cyprus, France, Germany, Greece, Georgia, Iran, Italy, Kyrgyzstan, Lebanon, Romania, Switzerland, Ukraine, the United Kingdom and Vietnam. According to the U.N. Conference on Trade and Development, Armenia has also signed BIT agreements with Belgium, Egypt, Finland, India, Israel, Russia, Tajikistan and Turkmenistan, but these agreements have not yet entered into force. Armenia is a signatory of the CIS Multilateral Convention on the Protection of Investor Rights. The Treaty between the Republic of Armenia and the United States of America Concerning the Reciprocal Encouragement and Protection of Investment (the Bi-lateral Investment Treaty or BIT) was ratified in September 1995. The BIT sets forth investment conditions for investors of each party to be no less favorable than for national investors (national treatment) or for investors from any third state (a Most-Favored-Nation clause). It protects investment against expropriation and nationalization, and regulates dispute settlements between foreign companies and the governments of each party. Armenia does not have a bilateral taxation treaty with the United States. -------------- OPIC AND OTHER INVESTMENT INSURANCE PROGRAMS -------------- The "Investment Incentive Agreement between the Government of the Republic of Armenia and the Government of the United States of America," signed in 1992, provides a legal framework for OPIC's operations in Armenia. OPIC offers political violence insurance in Armenia and insures against expropriation. OPIC insures against currency inconvertibility only on a case-by-case basis. Armenia is also a member of the Multilateral Investment Guarantee Agency (MIGA). -------------- LABOR -------------- Armenia's human capital is one of its strongest resources. The labor force is generally well educated, particularly in the sciences. Almost one hundred percent of Armenia's population is literate. Enrollment in secondary school is 92.8 percent and enrollment in senior school (essentially equivalent to American high school) is 85.6 percent. According to a survey by U.N. Development Program, approximately 20 percent of Armenians have completed some sort of higher education program. Much of new foreign investment in Armenia is in the high-tech sector. High-tech companies have established branches or subsidiaries in Armenia to take advantage of Armenia's pool of qualified specialists in electrical and computer engineering, optical engineering and software design. Pilot training programs have increased the supply of qualified software programmers, and Armenia's IT sector is growing based on its qualified pool of inexpensive labor. The amended Labor Code came into force in June 2005 and is considered to be largely consistent with international best practices and international conventions to which Armenia is a party. The law sets a standard 40-hour working week, with minimum paid leave of 28 calendar days annually. The draft 2007 budget, which has been approved by the National Assembly, increases the legal minimum wage to AMD 20,000, which, given the ongoing appreciation of the Armenian national currency, exceeded the formerly prevailing de facto minimum wage of 50 U.S. dollars monthly. Most companies also pay a non-official extra-month bonus for the New Year's holiday. Entry-level skilled professionals (such as software engineers) command wages of about USD 500 per month. Wages in the public sector are often significantly lower than those in the private sector and, while all wages must be paid in drams, many private sector companies continue to use a fixed exchange rate to denominate employee salaries. -------------- FOREIGN TRADE ZONES/FREE PORTS YEREVAN 00000044 006 OF 006 -------------- Armenia has no foreign trade zones or free ports at present. The company that took over management of the Zvartnots airport in June 2002 discussed with the Armenian Government the possible establishment of a free trade zone on the territory of the airport, but such a zone has yet to be established. -------------- FOREIGN DIRECT INVESTMENT STATISTICS -------------- The Armenian National Statistical Service reported that total foreign direct investment (FDI) in Armenia at the end of 2005 was approximately USD 1.27 billion. Net FDI (According to IMF data) Years 2001 2002 2003 2004 2005(Act) 2006 (proj.) Vol(USD M) 70 111 121 217 252 267 In 2006, some of the most significant foreign investments for the Armenian economy came from Russia, Great Britain and Greece. The Russian Mobile Telephone Operator Vympelcom (operating under the Bee Line brand) purchased 90 percent of the Armenian National Telephone operator Armentel previously owned by Greek OTE company for USD 480 million. The company announced plans to invest around USD 100 million in 2007 and has agreed to give up its monopoly position over international calling and access to the internet. British Rhinoville Property acquired 90 percent of the shares of a previously-government owned artificial rubber plant for USD 40 million. In late 2006, Dutch Haypost Trust Management entered into a concessionary management agreement of the Armenian postal service and announced plans to invest USD 10 million in upgrading the postal system and establishing local postal bank branches over the next two years. The Armenian National Statistical Service reported total foreign investment of USD 297 million for the first nine months of 2006, up by 31.8 percent from the same period in 2005. Of that foreign investment, USD 149.1 million was foreign direct investment (FDI),up 8 percent compared to the same period in 2005. FDI accounted for 5.8 percent of GDP growth in 2005 and 3.4 percent of GDP growth for the first nine months of 2006. GODFREY