RESPONSE: IMPACT OF RISING FOOD/AGRICULTURAL COMMODITY

UNCLAS SECTION 01 OF 03 YEREVAN 000357 SIPDIS STATE FOR EEB/TPP/ABT/ATP Janet Speck SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EAGR EAID ECON PGOV AM SUBJECT: RESPONSE: IMPACT OF RISING FOOD/AGRICULTURAL COMMODITY PRICES - ARMENIA REF: A) STATE 39410 B) 2007 YEREVAN 1324 C) YEREVAN 316 SUMMARY ¶1. (SBU) Food prices have risen significantly in Armenia over the past year. Despite some public discontent over those increases, there have been no reports of food shortages or food-related political disturbances. While prices have increased largely in step with world markets, food import monopolies have also likely played a role. Despite some recent proposals by the GOAM to encourage agricultural development, Armenia is likely to remain a net food importer. It lacks the arable land, infrastructure and professional expertise necessary to increase production significantly or to achieve any degree of self-sufficiency. End Summary. FOOD AND AGRICULTURAL COMMODITY DEMAND -------------- ¶2. (SBU) Staples of Armenian diets include bread, pasta, potatoes, meat, dairy products, fruit and vegetables. While Armenia is largely self-sufficient in the production of fruit and vegetables - at least in-season - Armenia is a net importer of agricultural products. Primary exports are fresh and processed fruits, wine and brandy, while primary imports are meats, sugar, grain and dairy products. While exports are increasing, and domestic production of meat and dairy is improving, Armenia still has a slightly negative agricultural trade balance. ¶3. (SBU) Wheat is Armenia's leading agricultural import, as domestic production covers only 35-40 percent of domestic demand of about 30,000 metric tons per month. Russia, Kazakhstan and Ukraine are the primary suppliers. However, Ukraine's poor recent harvest eliminated most of their exportable supplies while Russia and Kazakhstan have restricted wheat exports through prohibitive export tariffs and export bans. SUPPLY -------------- ¶4. (SBU) Domestic agricultural production has been increasing in recent years, as the country recovers from economic hardship resulting from the breakup of the Soviet Union. Domestic and foreign investment are contributing to agricultural growth, but are unrelated to rising food prices. However, domestic production is unlikely to respond significantly to rising food prices in the short-to-medium term, as the country lacks basic inputs and appropriate agronomic conditions to implement sudden shifts in production. Arable land accounts for less than 17 percent of total area, and only two percent of the country's land is dedicated to crop cultivation. Although agriculture will remain important to the Armenian economy, it will not be the engine for growth over the long term. Armenia also has no obvious comparative or competitive advantage in any crop or product. Exports will largely serve "niche" markets. ¶5. (SBU) While new President Serzh Sargsian in March proposed a self-sufficiency program in wheat and corn production (Ref C),the situation with regard to agricultural production is unlikely to change: While high market prices may encourage some additional grain production, suitable land, inputs and storage are limited, and producers in some traditional wheat-producing areas are beginning to cultivate (often with assistance from USDA/CARD, USAID, MCC, and other international donor agencies) high-value crops such as fruits and vegetables, which offer greater potential returns. ¶6. (SBU) The development of the agriculture and agribusiness sector in Armenia is limited due to a variety of factors including: - The average plot size is between one to three hectares. Such small farm plots are inefficient and unable to realize any economies of scale; - Armenia's rocky, mountainous topography and arid climate are poorly suited to large-scale, commercial grain cultivation. - Investment in agricultural technology and equipment is lacking; - Food processing, one of the more promising sectors, suffers from dilapidated equipment and needs capital investment; - Lack of adequate transportation infrastructure and the high cost of transportation; - Structural financial market impediments hinder development of suitable financial instruments; credit term lengths are largely insufficient and interest rates too high; YEREVAN 00000357 002 OF 003 - The relatively high cost of inputs at both the farm and the processing levels; - The lack of sufficient grain storage and cold chain systems; - Shortage of experienced managers in the agribusiness sector; - Lack of governmental support (including a lack of applied research information); - Poor quality control at the farm and processing levels; - A shortage of qualified farm managers; and - Minimal domestic demand as a function of low per capita incomes and a declining population. DOMESTIC POLITICS -------------- ¶7. (SBU) There have been no reported food shortages or food-related disturbances. Recent public unrest in Armenia has been related to the disputed February 19 Presidential election. The unrest, while prompted by a disputed election, also had its roots in general dissatisfaction with the government. Food price inflation is an often-mentioned element of that popular discontent, exacerbated by exchange rate changes. A high percentage of Armenian household income, especially at the lower end of the economic scale, comes from remittances from family members abroad. The steady appreciation of the Armenian Dram has added to consumer discontent, because foreign currency remittances have lost purchasing power. Consumers have been hit by an anomalous double-whammy: at the same time that the Armenian dram has appreciated (roughly 40 percent in the past two years against the USD; about 10 percent against the Euro),the dram prices of imported staple foodstuffs have also risen. ¶8. (SBU) One possible explanation for this anomaly (a rising dram at the same time as rising dram prices of imported foods) is that the importation of many basic foodstuffs - in particular wheat, flour, sugar, cooking oil and butter - is monopolized by a small group of politically-connected businessmen (the so-called "oligarchs"). Many are either elected officials themselves or enjoy considerable political influence, and to date they have managed to forestall the entry of competition into these markets. In late 2007 there was a brief spike in sugar prices seemingly uncorrelated with any increase in world market prices, although for the year sugar prices actually fell. (NOTE: An otherwise passive government commission launched a highly-publicized inquiry into sugar prices after a public outcry, which may have induced the monopoly sugar-importer to reduce prices (Ref B). END NOTE) ECONOMIC IMPACT -------------- ¶9. (SBU) According to IMF data, food prices increased overall by 13.1 percent between March 2007 and March 2008, in AMD terms. This included a 33.4 percent increase in prices for bread and cereals (grains or products derived from grains) and 32.1 percent for oil and fats (butter increased 41 percent year-on-year). Furthermore, consumers complain that bread products today are often inferior to those of previous years as the base ingredients seem to have been cut or reduced as the price of inputs has risen. The same may be true for cereals. During the same period, prices for sugar decreased 13.8 percent. ¶10. (SBU) Overall inflation from March 2007 to March 2008 was 9.6 percent. Of that, 7.1 percentage points were accounted for by food price increases, 5.0 percentage points of which were caused by increased prices for bread and cereals. While most food prices have increased in step with international prices, the State Customs Committee reports that import prices of sugar, vegetable oil and butter did not change in March 2008, while those of flour increased by five percent. This suggests that local importers may be anticipating higher world market prices in the coming months. ¶11. (SBU) Surprisingly, while certain staples, including sugar, flour and oils/fats are imported largely by informally government-protected monopolies, the impact of monopolies on recent food price increases is somewhat mixed. Armenian sugar prices have exceeded world market prices for approximately the past 18 months, but they have recently converged, and prices fell over the past year. Butter prices have significantly lagged behind European Union prices over the past year. One exception is sunflower oil, import of which is 80 percent controlled by oligarch (and member of parliament) Samvel "LFik Samo" Alexanian. Its price over the past five years has typically exceeded the U.S. price. YEREVAN 00000357 003 OF 003 ENVIRONMENTAL ISSUES -------------- ¶12. (SBU) Thus far there have been no visible environmental impacts as a result of increased food prices. However, efforts to produce more food (particularly wheat and corn) could result in environmental impacts related to the use of unsuitable land or the introduction or expanded use of fuel, pesticides, irrigation or other inputs that might have environmental consequences. HOST GOVERNMENT POLICIES -------------- ¶13. (SBU) The GOAM plays a relatively limited role in agricultural production, as the Ministry of Agriculture's scarce funding limits its effectiveness. Its most extensive activity is providing seeds and fertilizers to farmers. The GOAM also does not register farms or require that they be incorporated; consequently, most farms do not pay the 20 percent value-added-tax on the sale of their production. This is due to change by 2009, in accordance with WTO requirements. However, the GOAM seems unlikely to meet this deadline. ¶13. (SBU) Armenia maintains import-friendly regulations, and does not ban GMOs or impose significant sanitary or phytosanitary barriers. However, as alluded above, government agencies are complicit in enforcing de facto monopolies for many imports, including foodstuffs. In the face of soaring world market prices for corn and wheat, new President Serzh Sargsian in March proposed a program to make Armenia self-sufficient in wheat and corn production (Ref C). POST PROGRAMS -------------- ¶14. (SBU) There is likely to be a direct impact on USDA/CADI projects as a result of recent political developments. Post expects to have USD five million in FSA Performance Funds cut for FY09. USDA was expected to receive part of this money to enhance their FY09 projects. This affects the GOAM as they rely heavily on foreign intervention to meet their strategic goals in agriculture. POLICY PROPOSALS -------------- ¶15. (SBU) The GOAM's agricultural situation would benefit considerably were it able to resolve political disputes with neighboring Azerbaijan and Turkey, thereby opening the countries to trade. If the situation in Armenia deteriorates significantly, USG may want to consider humanitarian assistance, preferably through NGOs. PENNINGTON