OECD EURASIA COMPETITIVENESS ROUNDTABLE PEER REVIEW OF ARMENIA BACKGROUND INFORMATION AND SUMMARY OF RECOMMENDATIONS This note provides background information for the peer review of Armenia, to be held in Paris on 27 November 2014. The note includes: 1. The project context and approach; 2. A summary of key recommendations on two policy areas: o Supporting the internationalisation of SMEs in agribusiness (Item II of the agenda); o Attracting multinational enterprises and maximising their impact on SMEs (Item III of the agenda). For additional information, please contact: Antonio Somma, Head of the OECD Eurasia Competitiveness Programme, antonio.somma@oecd.org. 1
1. CONTEXT AND APPROACH Since its launch in 2009, the OECD Eastern Europe and South Caucasus Initiative has been working to enhance competitiveness and Small and Medium-sized Enterprise (SME) policy development in the region. Armenia has been an active participant in the initiative and its follow-up activities, including a country-specific project on SME development that is submitted for peer review on 27 November 2014 at the second meeting of the OECD Eurasia Competitiveness Roundtable. 1.1 Context: Armenian participation in the project Supporting SME Competitiveness in the Eastern Partner Countries Armenia s results in the SME Policy Index 2012 Since 2010, the six Eastern Partner countries (Armenia, Azerbaijan, Belarus, Georgia, the Republic of Moldova, and Ukraine) have been part of a regional effort to improve their SME policy frameworks and to develop specific and targeted measures to address key policy priorities and critical issues faced by SMEs. One of the key instruments in that process is the Small Business Act for Europe (SBA). To measure convergence with the SBA, the SME Policy Index was developed as a tool by the OECD, the European Commission, the European Training Foundation, and the European Bank for Reconstruction and Development. It serves as a benchmarking tool for emerging economies to monitor and evaluate progress in SME policy implementation. Armenia s results in the SBA Assessment are summarised in SME Policy Index: Eastern Partner Countries 2012: Progress in the implementation of the Small Business Act for Europe. These results show the positive effects of a pro-active approach to supporting SME growth. Challenges are also presented, especially in skills development, innovation and SME internationalisation (see figure 1 below). Figure 1. Armenia's results in the SBA assessment, 2012 1. Entrepreneurial learning and women's entrepreneurship 5 2. Bankruptcy and second 10. Internationalisation of SMEs 4 chance for SMEs 9. SMEs in a green economy 8B. Innovation 3 2 1 0 3. Regulatory framework for SME policy making 4. Operational environment for SMEs 8A. Enterprise skills 5A. Support services for SMEs and start-ups 7. Standards and technical 5B. Public procurement regulations 6. Access to finance for SMEs Source: EU, ETF, EBRD, OECD, SME Policy Index: Eastern Partner Countries 2012. 2
Supporting SME Competitiveness Reforms in the Eastern Partner Countries - Armenia (2014) In 2014, building on the results of the SME Policy Index 2012, the OECD Eurasia Competitiveness Programme (ECP), in partnership with the German Agency for International Cooperation (GIZ) and with the financial assistance of the European Union, proposed a targeted and practical approach to improving SME policies in Armenia. The OECD advised on policy reform implementation in two specific areas: Supporting the internationalisation of SMEs focusing on agribusiness; Attracting multinational enterprises and maximising their impact on SMEs focusing on construction materials. As a result of this work, two action plans for reforms were developed and are submitted for peer review on 27 November 2014 at the second meeting of the OECD Eurasia Competitiveness Roundtable. 1.2 Project approach and peer review preparation Two public-private working groups were established with the support of the OECD ECP and GIZ to develop reform action plans based on OECD guidelines and recommendations. A series of public-private working group meetings in the two focus areas were held in Yerevan, Armenia, with the support of the OECD ECP, GIZ and experts from OECD member countries: 25-27 March 2014: first meeting of the working groups; 17-19 June 2014: second meeting of the working groups; 6-8 October 2014: third meeting of the working groups and preparatory work for peer review. The results of this work will be peer reviewed today. The items for peer review and the lead reviewers for discussion are summarised in the following table. Areas for review Policy area for review Lead reviewer Overall area Specific focus SME internationalisation FDI attraction and SME linkages Supporting the internationalisation of SMEs Focus on agribusiness Attracting multinational enterprises and maximising their impact on SMEs Focus on construction materials Czech Republic EU Germany Italy Today s discussion will help the government of Armenia define next implementation steps. Progress in the implementation of these recommendations will be discussed in two years time at the 2016 OECD Eurasia Competitiveness Roundtable meeting. 3
2. SUMMARY OF KEY RECOMMENDATIONS The recommendations summarised below are based on OECD guidelines and good practices, research conducted in Armenia, discussions within public-private working groups, and surveys undertaken as part of the project. A detailed description of the work and specific recommendations on how to implement selected reforms are described in the two draft policy reports. 2.1 Supporting the internationalisation of SMEs Focus on agribusiness Global value chains can benefit small and medium-sized Armenian agribusinesses The policy report focuses on reinforcing small and medium-sized Armenian agribusinesses by better linking them to global agribusiness value chains. Today, around 80% of global trade in goods and services takes place within the international production networks of multinational enterprises. In 2013, the value of the global agribusiness value chain (from input suppliers to retailers) equalled some USD 9 trillion, with the global agribusiness fruit and vegetable processing value chain alone worth USD 180 billion and growing at a stable 1.9% over the past five years. Linking to global and regional value chains provides the best opportunity for profitable growth and technology transfers for companies, especially SMEs. Armenia could become part of the global agribusiness value chain, leveraging its suitable climate for the production of high-value agribusiness goods and its processing capabilities. Agribusiness is already a strategically important sector the agriculture and agro-processing industries combined represent about 21% of GDP and employ close to 40% of the total labour force. In particular, the export of high-end processed fruits and vegetables has potential for growth. Agribusiness exporting success stories already exist, especially in the area of alcoholic beverages. Further policy reforms, however, are needed to encourage Armenian agribusinesses to achieve profitable links to global agribusiness value chains. Groundwork is needed to strengthen the agribusiness sector, in particular addressing the fragmentation of primary production. In parallel, three export-specific challenges must be dealt with to allow Armenia to link to the global agribusiness value chain: limited export promotion, export knowledge and export skills such as the ability to do business with foreign partners; export infrastructure and regulatory environment obstacles; and limited information, currency, political, and legal risks. Addressing export challenges First, Armenia has limited export promotion, export knowledge and export skills. Armenian processed fruit and vegetables are primarily known in Russian and CIS markets, with limited awareness in other markets (the European Union, and to a lesser extent in the Middle and Far East), and the authorities have done little country or product branding. Moreover, local SMEs lack the information on foreign markets they need to successfully export. Agro-processing SMEs have limited export-related skills, and the existing export promotion agency provides insufficient support. Second, the export infrastructure and regulatory environment needs to be improved. Armenia has a small domestic market and its exporting options are limited by the fact that it is a landlocked country with only two borders open for trade. Its own export-related infrastructure has to be of high quality to compensate for these difficulties. Long-term road and railway network developments go well beyond the scope of the report, but storage facilities and point-of-sale warehouses are identified as areas for 4
improvement. Central storage would allow smaller producers to agglomerate their produce, overcoming some of the disadvantages of a fragmented and small-scale agribusiness sector. On the regulatory side, crucial days are being lost obtaining the right grading and export certificates, adding extra cost to exporters. Enhanced and streamlined processes would reduce the time needed to clear customs and provide exporters with access to quality certification. Third, exporters, in particular SMEs, face risks related to limited information on foreign buyers reliability, currency risk, political risk and complicated legal procedures in case any issues arise. Exporters may also need more working capital to meet export orders, which are often larger than domestic orders. Small-scale Armenian agribusiness processors are often not able either to cover themselves against the export risks or to access additional credit lines. The private sector provides virtually no export finance products. A newly-formed export insurance agency offers export finance support to Armenian agribusiness SMEs, but it is nascent. The agency needs to be promoted, expanded and its product offering widened. The report provides recommendations on how to overcome these three challenges. Policy actions needed on export promotion, export infrastructure and export financing International experience suggests that an integrated, umbrella approach to export development is most conducive to linking SMEs with global value chains. Such an approach has to focus on the three pillars that underpin successful export promotion policies: in-depth marketing and skill-development efforts, export infrastructure creation, and export credit provision. Based on international good practice and the current situation in Armenia, the government should: Improve existing export promotion and export knowledge dissemination. The relevant government bodies should build their knowledge of targeted foreign markets and potential foreign buyers, and then transmit it to both existing and potential exporters through training on export-related topics. Working closely with the private sector, Armenia s export promotion agency should develop a country- and/or sector-specific branding approach to marketing the country s exports. Improve key export-related infrastructure. Reforms should streamline regulatory procedures for exports and introduce a single window for customs and export certification. Building on existing small-scale logistics facilities, the government should investigate the creation of a single warehouse facility and marketplace, grouping products from smaller producers and providing facilities for the storage, grading, packaging and auction of goods. Further develop export financing. In close partnership with domestic banks, the government should fully support the newly-launched export insurance agency and ensure appropriate legislation is in place. In the medium term, the agency s capital could be opened to the private sector and its range of export finance products could be expanded. 2.2 Attracting multinational enterprises and maximising their impact on SMEs Focus on construction materials Armenia s construction materials sector could tap into the expanding construction industry in the region neighbouring Armenia The report focuses on how Armenia can modernise one step in its construction value chain by attracting foreign direct investment (FDI) to the construction materials sector. This would allow Armenia, 5
which has a small domestic construction market, to benefit from the growth of larger regional construction markets. The construction value chain covers large and growing global markets. It spans several economic activities, such as the development of investment projects, design, production of materials, construction of buildings and infrastructure, and facility management. The global construction sector was estimated to be worth USD 8.7 trillion in 2012. Driven by population growth, economic growth and urbanisation, the industry is expected to expand by more than 4% annually until 2025. Armenia could integrate with the global construction value chain by leveraging its competitive advantages in construction material production, including endowments of non-metal mineral resources and low energy and labour costs. However, high transportation costs constrain the tradability of certain products. Armenian construction materials companies can therefore only benefit from the growth of regional and global construction markets if they develop high-value products that can be traded at a profit beyond domestic borders, or else find attractive niche markets in the national economy. Energy-efficient construction materials offer an example of a high-value product for both domestic and foreign markets, while decorative materials have already proven profitable exports. Local basalt and perlite could be used to produce insulating materials, and travertine and tuff for decorative items. Foreign direct investment can play a major role in supporting development of the construction material sector and local SMEs In Armenia, the construction materials sector consists largely of SMEs. It is still small and accounted for between 1% and 2% of GDP in 2012. The sector covers several economic activities, from mining of raw materials (e.g. travertine and basalt) to the manufacturing of intermediate goods (e.g. cement and insulators) and final products to be used in construction (e.g. ceramic tiles and windows). Construction materials firms face limited technology, lack of export knowledge, and low investment capacity. The levels of innovation and ability required to develop high-value, exportable construction materials in Armenia are unlikely to be met by domestic investment alone. Foreign direct investment can help address these issues. Indeed, FDI has played a major role in the country s economic development, accounting for over 20% of total investment in the period 2000-2013. Beyond its direct contribution to national income, FDI improves SME access to international export markets, skills and technology. In the case of Armenian construction materials, therefore, a focused approach to attracting FDI could contribute to developing the sector and seizing growth opportunities. However, the construction materials industry also faces significant challenges in attracting multinational enterprises and maximising their impact on local SMEs, including limited access to large construction markets, the existing FDI track record in the sector, and local SME capabilities. First, limited demand from the small domestic construction market, coupled with existing constraints to exports, may discourage foreign investors from locating their operations in Armenia. Second, FDI in the sector has historically been low and no leading global firm has made flagship investments in Armenia. Low participation from foreign investors and limited sector-specific promotion activities may prevent Armenia from realising its potential as an investment destination for construction materials, in spite of its natural resources. 6
Finally, the local industrial base lacks capabilities such as skills and technology. Over the past 25 years, the processing of non-metal materials has decreased tenfold. This has resulted in low capabilities among sector SMEs, including limited skills, technologies and investment potential. In the short term, foreign investors may find it difficult to identify the local business partners they need to operate profitably in Armenia. Based on international good practice, three sets of actions could help attract more FDI and develop local SMEs in the construction materials sector A review of relevant international good practice provides inspiration for the Armenian reform process. The report recommends that the government act in the following areas: Unlock demand for construction materials produced in Armenia. Upgrade regulations on energy-efficiency requirements in buildings and support their enforcement, promote awareness of the economic benefits of energy-efficiency in construction, and streamline procedures for obtaining construction permits. Regarding foreign demand, the government should enhance export intelligence and promotion and support SMEs engaging in export activities. Attract more FDI to the construction materials sector. Upgrade the national investment promotion agency to support a strengthened sectoral approach and to act as a one-stop shop for investors through all phases of the investment cycle, while engaging in ad hoc interactions with key selected potential investors. Further, the government could devise actions to target the diaspora as a potential source of FDI through a network of influential Armenians abroad, and develop mentoring and matchmaking initiatives to link SMEs with potential investors. Increase SMEs capabilities to work with foreign investors. Create an FDI-SME linkage programme designed to maximise technology and knowledge spillovers into the local economy. This could involve skills development among local firms as well as business development activities, based on an assessment of existing skills and business needs. It could begin with a pilot project in the construction materials sector. 7