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Statement by Mr. Snel, Executive Director for Armenia and Mr. Hadzi-Vaskov, Advisor to the Executive Director, March 7, 2014

Author(s):
International Monetary Fund. Middle East and Central Asia Dept.
Published Date:
March 2014
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The Armenian authorities would like to thank Executive Directors, Management, and staff for their continued support, constructive dialogue, and valuable advice on macroeconomic policies. Armenia’s performance under the recently-completed three-year economic program, supported by arrangements under the EFF and the ECF, was sound. The program’s objectives to restore economic growth, reduce fiscal and external vulnerabilities, and preserve financial stability were largely met, while all six reviews were successfully completed with few delays.

Economic growth has been restored following a contraction of 14 percent in 2009, and the driver of growth has shifted from construction to agriculture, industry, and services. The fiscal deficit as a share of GDP has been reduced by 6 percentage points to well below the debt stabilizing level of 2 percent of GDP in 2012 and 2013, while the external current account deficit as a share of GDP has declined by about 8 percentage points to 8.4 percent in 2013. At the same time, the authorities have followed Fund advice in implementing important structural reforms in the areas of revenue administration and tax policy, the pension system, the financial sector, and the overall improvement of the business environment. On the basis of its income per capita level and the manageable degree of short-term vulnerabilities, Armenia graduated from the PRGT in 2013.

Request for a new program

Notwithstanding the significant progress achieved over recent years, important challenges remain to reduce vulnerabilities related to the still-elevated external current account deficit, the high levels of dollarization, unemployment, and poverty, and to ensure more inclusive, resilient, and sustainable economic growth. Aiming to build on the progress achieved under the previous EFF/ECF arrangement, while recognizing that important medium-term challenges remain, the Armenian authorities request a new 38-month arrangement under the EFF in an amount equivalent to SDR 82.21 million (89.4 percent of quota).

The new program aims at consolidating macroeconomic stability, strengthening buffers against possible shocks, and enhancing medium-term growth through the implementation of further reforms in Armenia’s progress towards a dynamic emerging market economy. Reiterating their full commitment to implementing the measures envisaged under their economic program, the authorities believe that support under the new EFF arrangement will be crucial for achieving their development objectives at the current juncture, while laying the path to a successful exit from Fund support.

Fiscal policy

After a moderate increase in 2014 to support growth and implementation of key infrastructure projects, the authorities aim at a gradual reduction of the fiscal deficit in order to start reducing the level of public debt, while continuing to address social and capital investment needs. In this regard, they are planning to increase revenues in a growth-friendly way, which focuses on addressing tax policy gaps and efficiency- and equity-enhancing tax policy and administration gains. Fiscal measures will aim to stimulate private activity and increase spending on public infrastructure, while maintaining a well-targeted safety net and achieving a debt-reducing deficit path from 2.3 percent of GDP in 2014 to 2 percent of GDP in 2015 and 1.8 percent of GDP in 2016. The authorities’ key objectives include improving the execution of public investment spending and strengthening the institutional arrangements for assessing and managing fiscal risks through the establishment of risk management units at the State Revenue Committee (SRC) and the Ministry of Finance in 2014.

The 2014 budget targets a deficit of 2.3 percent of GDP, well in line with the projected path under the previous Fund-supported program. The budget is expected to provide a positive fiscal impulse through higher capital investment and increased pensions and civil service wages following several years of restraint and real erosion. On capital spending, the authorities plan to step up spending for road maintenance and school rehabilitation following years of restraint, while decisively addressing constraints that have led to fiscal underspending on externally-financed capital projects, most notably the North-South Highway. The increase in pensions and civil service wages seeks to limit the worsening of social indicators among the elderly and to address difficulties in attracting and retaining well-qualified staff given that wages for most categories have been frozen since the crisis. The authorities aim at achieving a more consistent wage policy through structural changes, including introducing a grid structure based on clear job descriptions and standardized salaries across different government agencies and levels. They are also working with the World Bank to strengthen performance assessments, and will seek cost savings where possible. At the same time, the authorities recognize that further developments in this area must be consistent with fiscal sustainability.

Notwithstanding recent progress, the poverty rate remains high, and the authorities continue to place importance on poverty reduction and targeted social spending. Following an increase in the minimum wage by 29 percent in July 2013, they are planning to raise it by an additional 11 percent in July 2014. Moreover, the authorities have made progress with their efforts to modernize the legal framework for social assistance and state benefits, as well as to integrate and streamline the wide range of social services in order to improve efficiency and service quality. Following the completion of the legal framework and pilot projects, the integrated social benefits system will become operational in 2014.

The authorities aim at strengthening tax revenues through efficiency-enhancing tax and customs administration improvements, and through tax policy measures starting from 2015. Following a significant increase in the tax revenue-to-GDP ratio by over 2.5 percentage points in 2012-2013, the authorities’ efforts in 2014 will focus on improving compliance and closing policy gaps to level the playing field and limit adverse business environment effects. Key revenue administration measures envisaged under the program include implementation of a modern tax compliance system, modernization of legislation and procedures, enhancing the coverage and the capacity of the large taxpayer unit of the SRC, and facilitating greater transparency and enhanced dialogue with taxpayers. The authorities will continue to focus on assessing and addressing remaining tax policy gaps. The draft law on transfer pricing, which has been refined to bring it in line with OECD guidelines and international practice, will be submitted to Parliament, as will be other legal changes with application from 2015 on increasing the natural resource user fee for non-metallic minerals, and unification of property and land taxes. In light of the possible adverse effects on the poor and the business environment, the authorities will further assess the incidence of tax policy changes and the scope for possible actions in 2015 and beyond for possible new tax instruments, increases of some tax rates, and reduction or elimination of specific exemptions.

Monetary, exchange rate, and financial sector policies

The Central Bank of Armenia (CBA) will continue to implement monetary policy within an inflation-targeting framework with exchange rate flexibility. The foreign exchange market interventions will be limited to smooth excessive volatility and avoid market instability, and the exchange rate will move according to fundamentals and support external adjustment. Following a decline in reserves during and after the crisis, the CBA has rebuilt their level in 2013 with the Eurobond issuance and net purchases on the FX market. The CBA authorities continue to place high importance on maintaining buffers, and stand ready to use periods when market conditions provide opportunities to build reserves without affecting general market trends. The authorities remain confident that their policies will help in gradually reducing dollarization of savings, thereby providing an additional opportunity to acquire reserves.

The CBA authorities remain committed to continue strengthening the operational framework for monetary policy. They believe that further enhancing communications with markets and the public through periodic press conferences and strengthened content of the inflation report will help in providing more guidance on policy actions and help ensure that inflation stays within the target range. The CBA authorities will continue improving the operation of the interbank money market, will further explore policy options to strengthen liquidity management within the interbank and FX markets, and will assess the remaining impediments to developing the FX derivatives market and FX risk hedging instruments.

Promoting resilience to shocks and further financial deepening remain at the core of financial sector policies. The CBA has prepared a timeline for Basel III implementation, and will issue regulations on capital requirements and prepare the methodology on identifying domestic systemically-important banking institutions by June 2014. In light of the high level of dollarization, the CBA authorities will continue to strengthen the monitoring capacity and cooperation with local banks to enhance their management of FX exposure and risk. The CBA will also undertake the following reforms: improve the quality of information received from banks on potential currency mismatches of large borrowers; amend the regulation on the calculation of large exposures to align it with international practices; introduce measures to strengthen the crisis management infrastructure; implement legal, regulatory, and institutional changes to simplify registration and execution of collateral; facilitate access of foreign participants on Armenia’s capital market; and create a legal and operational environment conducive to the development of a modern mortgage finance system.

Structural reforms

The authorities expect that the membership in the Eurasian Customs Union (ECU) will create significant economic opportunities, including through lower import prices for energy and other inputs, and enhanced access for Armenian exports through the removal of customs and non-trade barriers. Given that the average ECU effective tariff rate is substantially higher than Armenia’s effective rate, the Armenian authorities are seeking exclusions from the common ECU external tariff where possible, or transition periods in order to limit rise in input costs and prices of sensitive goods. For this purpose, they have suggested including over 800 products in an exception list. The Armenian authorities expect that ECU membership will help mobilize new external financing for important infrastructure projects, including in energy and rail and road networks, as well as to improve prospects for FDI. The authorities reiterate their commitment to strictly limit government exposure and use of public funds in new projects and to consult with the Fund and the World Bank in advance of taking on any fiscal liabilities.

The Armenian authorities remain strongly committed to further strengthening its relationship with the EU. To the extent possible, they intend to resolutely move forward with reforms aimed at harmonization with EU standards and institutions wherever they are compatible with ECU membership. The implementation of these reforms is expected to support the modernization of the economy and contribute to export growth and diversification. Expecting to continue cooperation under the Eastern Partnership initiative, the Armenian authorities look forward to continued EU macro-financial support, technical assistance, and twinning projects.

The regulatory guillotine program, which covers legislative packets for improving efficiency, reducing overlap, and streamlining regulations and red-tape, continues to form a core part of the structural reforms agenda. Following progress in the areas of health, road transportation, and public utilities, the authorities currently develop legislative packets in six additional areas (entrepreneurship, tax, customs, social issues, foreign affairs, and culture) from a total of 17 areas that will be addressed by 2015. In accordance with their Doing Business Action Plan for 2014, the authorities plan to focus their efforts on areas that require further improvement, including contract enforcement, payment of taxes, the insolvency process, and facilitation of foreign trade.

The authorities will continue to work on strengthening competition, including by building consensus for providing investigative powers to the State Committee for Protection of Economic Competition (SCPEC), while putting in place memoranda of cooperation between the SCPEC and other state institutions in this area by June 2014. In the meantime, a packet of legislative changes has been submitted to Parliament, including clearer definitions of dominance and market abuse, stronger fines, and procedural changes. The authorities aim at introducing a leniency program and strengthening the role of SCPEC in consumer protection in the course of 2014.

With the goal of reducing business costs, strengthening competitiveness, and enhancing the safety of products and services, the authorities undertook an initiative for a comprehensive inspection reform. Completion of a pilot merger of inspection agencies and initiation of a unified database are expected by the end of 2014, and the authorities aim at reducing the number of inspection agencies by half over the next few years. Armenia’s quality infrastructure is expected to be enhanced with EU assistance. The authorities have worked with the World Bank, other international agencies, and management consultants to develop a new policy framework for the civil aviation sector, approved in October 2013, which aims to increase competition, enhance service quality, and lower costs. The Government has addressed the EU to begin negotiations on a Common Aviation Area Agreement, which is expected to have a significant impact on liberalization in this sector.

Conclusion

The authorities reiterate their commitment to maintaining a close policy dialogue with the Fund and stand ready to take additional actions to ensure the achievement of their social and economic objectives under the Fund-supported program. They remain committed to extend their long track record of sound and prudent macroeconomic policies, address challenges and reduce vulnerabilities through the steadfast implementation of complex policy measures included in the program, and thereby facilitate the advancement to a dynamic emerging-market economy, and trace the path to a successful exit from Fund program support. Emphasizing the crucial role that Fund TA has been playing in supporting their reform agenda, the authorities are looking forward to further broad TA support, which they view as indispensable for the achievement of their reform objectives.

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