Armenia
Recent Economic Developments
Author:
International Monetary Fund
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Publication Date:
19 Dec 1995
eISBN:
9781451801408
Language:
English
Keywords:
ISCR; CR; exchange rate; capital expenditure; banking system; central bank; broad money; first quarter; foreign currency; current account; market price; balance of payments; supply schedule; trade surplus; standard of living
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This paper reviews economic developments in the Republic of Armenia during the 1990s. Real GDP declined by a cumulative 60 percent in 1992–93; price changes reached hyperinflation levels in late 1993; and real wages declined by nearly 50 percent in the course of that year. In the fall of 1994, the authorities formulated a comprehensive program of stabilization and structural reform that was supported in December 1994 by a first purchase under the Systemic Transformation Facility.

Abstract

This paper reviews economic developments in the Republic of Armenia during the 1990s. Real GDP declined by a cumulative 60 percent in 1992–93; price changes reached hyperinflation levels in late 1993; and real wages declined by nearly 50 percent in the course of that year. In the fall of 1994, the authorities formulated a comprehensive program of stabilization and structural reform that was supported in December 1994 by a first purchase under the Systemic Transformation Facility.

I. Introduction

With the collapse of the Soviet Union in 1991, Armenia, a land-locked, small mountainous nation of under 4 million inhabitants, saw its earlier standard of living deteriorate constantly for the following three years,. Among former Soviet republics, Armenia had enjoyed a better-than-average standard of living, primarily thanks to a well-educated labor force, a strong industrial base supported by cheap energy, and the entrepreneurial spirit of its people. Since independence in September 1991, a combination of political conflict and the lingering effects of natural disaster led to a serious decline in the economy and the social conditions for the people.

A dispute over Nagorno-Karabakh resulted in ethnic violence and a blockade of transportation routes through Azerbaijan and Turkey. The 1988 earthquake in the northern part of the country created a massive need for reconstruction and rehabilitation. The closing of the Medzamor nuclear power plant caused energy shortages that are still being felt today. And civil conflicts in Georgia have repeatedly disrupted Armenia’s remaining major trade route.

Economic management has also suffered from the legacy of the central planning system and the disruption of regional payment arrangements. As a result, real GDP declined by a cumulative 60 percent in 1992–93, price changes reached hyperinflation levels in late 1993 and real wages declined by nearly 50 percent in the course of that year. For much of 1993 monetary policy was largely determined by the Central Bank of Russia while Armenia remained a member of the old ruble area. In November 1993 Armenia introduced its own currency, the dram.

The year 1994 started auspiciously, with the authorities determined to reverse the downward slide that the economy had experienced during the previous two years. The July 1994 agreement that formalized the de facto ceasefire for the Karabakh conflict gave the Government the opportunity to focus on pressing economic issues. In the fall of 1994, the authorities formulated a comprehensive program of stabilization and structural reform that was supported in December of that year by a first purchase under the Systemic Transformation Facility (STF). At the same time, the World Bank agreed to a Rehabilitation Credit. In 1994 real GDP grew by over 5 percent.

As the political situation stabilized in early 1995 with the extension of the ceasefire and the opening of an air corridor over Turkey, the authorities began discussions on a stand-by arrangement (SBA), which was approved by the Board on June 28, 1995, along with the second purchase under the STF. The SBA, in the amount of SDR 43.875 million (65 percent of quota) is in support of an economic program that aims at further stabilization and the deepening of structural reforms over a period of one year. Initial progress is encouraging. On July 5, 1995, following general elections, the ruling party returned to power with an enhanced majority.

Developments so far during 1995 indicate that stabilization is taking hold and that progress toward a market economy has been made in the legal, the institutional, and the economic areas. Real GDP growth for 1995 is expected to be at least 5 percent, with annual inflation under 30 percent. While the fiscal situation remains fragile, Central Bank of Armenia (CBA), improvements in sterilization procedures, and a markedly improved collaboration between the Ministry of Finance and the CBA, helped the authorities to implement, by and large, the monetary program agreed under the SBA. The balance of payments reflects serious uncertainties about external financing in the near future, and the Government is aware that over the medium term the mobilization of domestic resources is the best guarantee for the success of the reform efforts.

This paper provides background information to the Staff Report on the first review under the SBA and the 1995 Article IV consultation, which took place in Yerevan between July 31-August 14, 1995 (SM/95/155). Developments in the real sector and structural reforms are discussed in Chapter II. Fiscal, monetary, and external developments are discussed in Chapters III-V. Several appendices, including an appendix on statistical issues, are attached.

II. The Real Economy and Structural Reforms

1. Overall trends 1/

Like other FSU countries, Armenia suffered from the post-Soviet slump between 1990–1993, with recorded output declining by a cumulative 75 percent during this period. The authorities estimate that real GDP increased by 5.4 percent in 1994 and the trend is expected to continue in 1995 (Tables 1 and 3). Industrial output increased by 10 percent in 1994 and by 13 percent in the first six months of 1995 (Table 2 and Chart 1). 2/ This growth has occurred from a very low base and for 1994 and the first half of 1995, it represents a more favorable energy supply schedule and efficient use of energy supplies. Inflation performance has improved throughout the period, with the very high levels of late 1993 and early 1994 being replaced by single digit inflation in 1995 (Chart 2). The average real wage, after reaching a trough in the second quarter of 1994, began an upward trend, but at the end of the second quarter of 1995 remained at only one third of its 1993 level.

Table 1.

Armenia: Derivation of Gross Domestic Product, 1993–95 1/

(In millions of current drams) 2/

article image
Source: State Department of Statistics

Figures for 1995 are for the first and second quarters only.

Figures for 1993 have been converted to drams at dram 1 = 200 rubles.

Includes travel expenses, research and development, and cultural services to employees

Mostly scrapped construction.

Table 2.

Armenia: Net Material Product by Origin, 1992–94

article image
Sources: State Department of Statistics, and Fund Staff estimates

Figures for 1993 have been converted to dram at dram 1 = rubies 200

Table 3.

Armenia: Basic Economic Indicators, 1993–95 1/

article image
Sources: State Department of Statistics, and Fund staff estimates

Figures for 1995 are for the first and second quarters only

In millions of current dram Figures for 1995 are the authorities reported figures The Staff Report (/../) uses adjusted figures.

Index, average 1994 = 100

Monthly, within period

Monthly, in dram, state sector only

Index average January 1994 = 100

Monthly in dram

Index average January 1994 = 100

Chart 1
Chart 1

ARMENIA: Growth and Composition of Real NMP

(1992 - 1994)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Chart 2
Chart 2

ARMENIA: Inflation

(Monthly percentage changes) 1/

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

1/ Consumer prices increased by 138 percent in November 1993.

Structural reforms have continued at a brisk pace, and substantial progress has been made in price liberalization, enterprise restructuring, privatization and the establishment of a market-oriented legal framework. By the middle of 1995, most prices had been liberalized, and those remaining under government control reflect cost recovery policies. Small-scale privatization is on track, but privatization of medium- and large-scale enterprise has fallen behind schedule. The Government has initiated an “isolation” program for ten important enterprises, following the passage of the bankruptcy and collateral laws in June 1995.

2. Inflation

After averaging over 150 percent per month in the final quarter of 1993 as old Soviet rubles flooded in and as Armenia struggled to introduce its own currency, inflation fell to somewhat over 40 percent per month during the first six months of 1994. The effects of tighter monetary policy, fiscal restraint, and the seasonal increase in supply of agricultural goods was reflected in a reduction to single digit monthly inflation from June to September 1994. Monthly inflation picked up in the final months of 1994 as administered price increases were announced and compensation payments were made. Monthly inflation rose to as high as 61 percent in December, largely as a result of the increase in the price of bread.

Inflation in 1995 has been much more restrained, averaging just 2 percent per month in the first quarter with prices of some food items, such as eggs, coffee, and flour, actually registering a decline. Increases in administered prices, notably those of sewerage services and water (accompanied by compensation payments), and partially sterilized increases in government expenditure gave rise to monthly inflation of over 7 percent in both April and May. But subsequent improvements in monetary policy, and increases in the seasonal supply of agricultural goods helped reduce the rate to under 1 percent in June. Mostly due to higher aggregate supply as a result of seasonal factors, there was a decline in prices in July and August, amounting to −4.6 percent and −2.1 percent, respectively. The deflation in both months was mainly caused by a fall of about 6.5 percent in food prices, which have a weight of about 70 percent in the Consumer Price Index (CPI).

3. Wages

After declining by 60 percent in 1992, real wages in the state sector decreased by 48 percent in 1993 and by a further 66 percent in the first half of 1994. They increased by 58 percent in the second half of 1994, but have since remained stable. However, the disparity between wages in the budgetary and nonbudgetary sectors has increased over this period. Real wages in the budgetary sector fell by 70 percent between 1992–93 and by 87 percent between 1993–94, while those in the nonbudgetary sector fell by 47 and 69 percent, respectively, in the two periods. Also, the speed of recovery of real wages in the nonbudgetary sector was much faster (Chart 3).

Chart 3
Chart 3

ARMENIA: State Sector Real Wages

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

4. Unemployment

Official unemployment figures continue to paint a deceptively reassuring picture with only 97 thousand persons or 4.9 percent of the labor force registered as unemployed in 1994. This was up from 4.4 percent registered in 1993 and 2.9 percent registered in 1992 (Chart 4). Although the percentage change in the number of people registering as unemployed increased by 52 percent between 1992–93 and 11 percent between 1993–94, the figures are still very low, especially in view of the overall changes in the economy and it is possible that a significant number of unemployed people are not being captured by the figures. In addition, enterprises may prefer to keep workers on unpaid leave so that they can avoid severance pay, and workers may also prefer to remain on enterprise payrolls even though they may not be receiving salaries because they may be able to obtain some nonpecuniary benefits like health services which exceed the value of unemployment benefits they would receive from the Government.

Chart 4:
Chart 4:

ARMENIA: Labor Force (In percent), 1993 - 1994

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Unemployment in the cities is significantly higher than in the rural areas where most people are at least able to do subsistence farming.

5. Sectoral developments

a. Agriculture

Since 1990, the agricultural sector has played an increasingly important role in the economy. Agricultural production now makes up close to half of national income. In addition, while income from agriculture constituted only 4 percent of household income in 1990, by 1993 this had increased to 12 percent, although it subsequently fell back to 8 percent in 1994.

Although Armenia is not self sufficient in food, and needs to import wheat, it is starting to meet an increasing share of its demand for other products from domestic production of agricultural goods. For example, the production of potatoes, one of the staple foods of the population, increased from 322 thousand tons in 1993 to 417 thousand tons in 1994, while the production of grapes at 212 thousand tons in 1994 has superseded pre-independence levels. This is a significant development given that Armenia produces high quality cognac, which is being exported to both FSU and non-FSU countries.

While agricultural land is mostly privatized, distribution of agricultural inputs and also most agro-processing plants are still under state control. This delay in privatizing the distribution system is a major hurdle in a more rapid growth of this sector. The lack of agricultural credits also seems to be hampering growth as farmers are unable to buy much needed farm equipment like tractors.

b. Industry

After continuously declining between 1990–1993. industrial production increased by 10.2 percent in 1994 and by 13 percent in the first half of 1995. The industries showing the highest growth were the metallurgical, chemicals and hardware industries. However, the share of industry in net material product has declined from almost 46 percent in 1990 to 36 percent in 1994 as a result of the output collapse experienced by this sector. The principal reason for this performance has been the heavy reliance of industry on energy. The rebound in output in 1994 and the first half of 1995 was a result of production modifications away from energy intensive goods.

c. Energy sector

Armenia continues to be heavily dependent on imported energy. It imports gas from Turkmenistan and mazut mainly from Russia. The production of thermal energy depends critically on these imports. In 1993, Armenia imported 801 million cubic meters (MCM) and in 1994, 868 MCM of gas, respectively (Table 4). 1/ Gas imports have increased dramatically in the first half of 1995, totalling 808 MCM during the first seven months of the year. Imports of mazut totalled 312,000 tons in 1993. 163,000 tons in 1994 and 51,000 tons during the first half of 1995. Although the energy situation has been improving, especially in the first half of 1995, gas supplies continue to be disrupted by sabotage and financial disputes between Turkmenistan and transit countries.

Table 4.

Armenia: Total Energy Sources 1993–65 1/

(In thousands of tons of energy equivalent, unless otherwise noted)

article image
Source: Armenian authorities

Figures for 1995 are for the first and second quarters only

Sum of natural energy fuel energy and hydroelectric energy

In view of this, the Government has made energy production a priority this year to improve the country’s dependence on domestic resources. After the 1988 earthquake and the closing of the Medzamor nuclear power plant, the only major domestic source of energy in Armenia has been hydroelectricity. In 1993, the total production of electricity was kwh 6,278 million, of which 68 percent came from hydroelectric sources. In 1994, kwh 5.658 million of electricity was produced, of which 62 percent came from hydroelectric sources. However, hydroelectricity has not proved to be a good alternative because it has caused environmental problems, especially in the Lake Sevan region, which has caused the water level in the lake to decrease substantially in recent years. The Razdan hydroelectric station is also being upgraded with loans from the EBRD.

Given the country’s acute fuel crisis, the Government has decided to re-open the nuclear power plant which will meet 27 percent of the country’s energy demand. Much of the recommissioning work has already been completed, and the first reactor is due to be restarted in September. The Government is also planning to open the second reactor at a later date.

Another major problem plaguing the energy sector is the inability of the electricity and gas companies to enforce payment discipline on users of electricity, both households and enterprises. It is currently estimated that while households use 40–50 percent of the electricity generated, Armenergo, the electricity company, is only able to collect about 10–20 percent of outstanding bills. The collections rate from enterprises is similarly very low. Recently, Armenergo has started to supply electricity to local districts and then making the districts responsible for collecting payments from individual households. Armenergo guarantees electricity to such districts for certain prespecified hours a day, provided these units make advance payments. This system seems to be working and in some cases the collections rate has gone up to 60–70 percent.

d. Transport and communications

Armenia is a landlocked country and has traditionally depended on railways as the main mode of transport; other kinds of land transport have also been used extensively, but the political instability along the borders with Azerbaijan and Georgia has made this difficult. Currently, this is a major hurdle to the development of trade because transportation costs are almost prohibitive. The Government is trying to develop air transportation and Air Armenia currently owns 25 airplanes. The EBRD is providing US$22.8 million to develop a cargo terminal at the Zvartnotz airport in Yerevan. The project is due to begin soon and will take 18 months to complete. It is also upgrading existing roads, with assistance from the European Union (EU) under the TACIS program, the World Bank and other international creditors are also providing loans amounting to US$35 million for highway reconstruction. A total of 1,420 kilometers of road will be built or reconstructed under this project, which will take four years to complete. Urban transportation is also in a state of disrepair, mainly because current transit fees are not adequate to cover maintenance and operating costs.

Communication facilities are being upgraded in collaboration with foreign companies both with respect to traditional modes like the telephone and also more recent technology like the internet.

e. Construction and investment

After declining for several years, construction activity has picked up, especially in the first half of 1995. Most of the projects have been financed from external sources such as the World Bank, the EBRD and the Armenian diaspora. A large part of the construction activity has been in the earthquake zone, mainly in housing and infrastructure improvement.

The Government has put together a blueprint -Public Investment Program-which outlines investment projects for 1996–98. Among the projects included are projects to improve electricity generation by using more domestic resources and by reducing technical losses, upgrading the transport system including railways, and investments in the health and education sectors. However, internal resources for investment projects are minimal, so that the majority of capital expenditures will have to be financed from external sources in the next several years.

6. Structural developments

a. Price reforms

Although price liberalization began in Armenia in January 1992, by early 1994 the price of bread and a variety of public utility prices remained controlled, as were profit margins of a few products (milk, baby food, medicines). Since then the Government has made efforts to eliminate these remaining controls. To this end, on July 1, 1994, charges for international telephone services, except for communications with CIS countries (where prices already reflected full pass-through of costs) were liberalized. Effective October 1, 1994: (i) price subsidies on gas to households were eliminated; (ii) tariff controls and profit margin regulations for milk, baby food, aviation services, intercity transport and liquified gas were eliminated; (iii) urban bus transportation tariffs were liberalized but remained subject to profit margins with a full pass-through of costs; and (iv) rents and charges on communal services were increased between two and eight times. On December 1, 1994 the Government increased the administered price of bread from 6 dram per kilogram to 66 dram per kilogram and also removed the cross subsidies for electricity to households and for irrigation (Chart 5 and Appendix I, Table 7).

Chart 5
Chart 5

ARMENIA: Regulated Prices for Main Commodities and Services

(Current drams)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

On June 15, 1995 the price of bread was liberalized and bread coupons were abolished. 1/ On July 15, 1995 the Government removed the cross subsidies on drinking water for households and direct subsidies on garbage removal, sewerage and interrepublican telephone services. A decision has also been taken to remove direct subsidies on hot water and district heating, however, the Government has still not approved the tariff on hot water. Most prices have now been liberalized with the prices of only a few services (utilities and urban transport) being controlled by government. These follow cost recovery policies, although electricity prices cover only direct input costs. The Government, with the assistance of the World Bank, is trying to assess tariffs on electricity so that these will also cover operations and maintenance costs. All administered prices are reviewed and adjusted periodically, sometimes even monthly, by the Ministry of Economy.

b. Privatization

(1) Agriculture

The privatization program began in 1991 with agricultural land. Today, land privatization in agriculture is nearly complete with 93–95 percent of total agricultural output coming from private farms. As of July 1, 1995, there were 313,000 private farms and 1,200 collective units. Most of the existing collective units are formed by mutual agreement between the families, to simplify distribution of output produced, which is still controlled by state enterprises. Since February 1994, land sale between individuals has been permitted, although there has not been much activity in this market.

(2) Enterprise sector

Progress in enterprise privatization has been uneven. To establish a legal framework, the first privatization law for enterprises was passed in June 1992 but little progress was made for the next two years. To reiterate its commitment, in early 1994 the Parliament passed the “Program for Privatization and Denationalization of State Enterprises and Non-finished Construction in 1994”, which listed about 5,000 state enterprises and unfinished construction projects to be sold through a combination of cash and voucher sales. On June 18, 1994 the Parliament passed a further privatization law granting employees the right to free shares in their place of work with the upper limit being set at 20 percent. In October 1994, distribution of vouchers began, and by March 1995 all the vouchers (over 3 million) had been distributed. These vouchers are freely tradeable for stocks in companies that are being offered for privatization. They have a face value of dram 20,000 although the latest market price is between dram 3000–3200 and appears to be on an upward trend.

While small-scale privatization is on track with 1,093 small-scale enterprises having been privatized by August 1, 1995, only 35 medium-scale enterprises were offered for sale of which 26 have been privatized so far this year. With the assistance of the World Bank, the Government has worked out a plan setting monthly targets for privatization of both small-scale and medium- and large-scale enterprises. This plan is very ambitious and calls for privatization of 3,000 small-scale, 700 medium- and large-scale and 600 unfinished construction sites by year-end 1995. In order to expedite the process, the Government has reduced the subscription period for shares from two months to two weeks and also increased the number of evaluators. The process from start to finish can be described as follows.

Any enterprise, large or small, has to be approved by the Privatization Board as a possible candidate for privatization. Following Board approval and asset evaluation, the name of the candidate enterprise is sent to Parliament for final approval. Once this step is completed, the enterprises are advertized in at least one national newspaper as “offered for sale” at least ten days prior to the subscription period.

The 1996 Privatization Program is due to be approved by October 1995, and will include privatization of most bakeries and mills. Privatization will also focus on the health and education sectors. In the health sector, in particular, the Government is considering adopting a fee-for-service system so that it can concentrate on supplying medical services only to the needier sections of the population.

(3) Housing sector

Privatization of housing is due to be completed by end-1995 with approximately 60 percent of the housing stock already privatized. A law on condominia in the form of a government decision was adopted on May 30, 1995.

c. Legal environment

The Government early on realized the importance of an appropriate legal framework as a necessary condition for the establishment of a market economy. However, this has turned out to be one of the most difficult areas to reform, due to the lack of experienced lawyers and judges in civil procedures. The progress made in this area includes the passing of the bankruptcy and collateral laws on May 18, 1995, although they have not been effectively used so far. An anti-monopoly law is being considered.

d. Arrears in the economy

According to estimates made by the CBA, the total stock of enterprise arrears in January 1995 stood at dram 47.8 billion with the 55 largest debtors accounting for 70 percent of the total arrears. Moreover, evidence suggests that arrears were concentrated in the energy sector - notably gas and electricity - where they accounted for more than 40 percent of the total, mainly because suppliers find it difficult, both for political and technological reasons, to suspend delivery for nonpayment. Arrears on taxes 1/ to the State budget accounted for 10 percent of the total. The remaining arrears were incurred on raw materials mainly by the industrial sector and on bank credits and salaries to employees. It is estimated that arrears increased by about 12 percent between December, 1994 and May, 1995 amounting to dram 60 billion at end-May. However, the CBA abolished an accounting system that had been used until early 1995 to track interenterprise arrears, and developments in this area will be difficult to follow in the future.

III. Fiscal Developments 1/

1. Structure of government

The State budget covers the operations of the republican (central) government and the 58 local authorities. 2/ The State budget is combined with the operations of the main extrabudgetary fund, the Pension and Employment Fund, to create the Consolidated State Budget. Under the recently approved constitution, the State budget must be submitted to Parliament by November 1, to allow ample time for its approval prior to the beginning of the fiscal year on January 1. The budget is prepared by the Ministry of Finance, with assistance from the State Tax Inspectorate and the Ministry of Economy.

a. The republican and local government budgets

Revenues are allocated among the republican and local budgets according to a formula that contains both fixed and discretionary elements. Local authorities receive 100 percent of income taxes collected from within their jurisdictions, profit taxes from enterprises they own directly, profit taxes from nonstate enterprises located within their jurisdictions, land taxes, state duties, and some categories of nontax revenues. The discretionary element consists of a direct subsidy from the state budget as well as percentage shares of the Value Added Tax (VAT) and Enterprise Profit Tax (EPT) from enterprises owned by the republican government. This revenue sharing scheme is referred to by the authorities as “regulated revenues.” The size of the direct subsidy and of the share of regulated revenues is established by Parliament as part of the process of approving the republican budget, and will vary among local authorities. Typically these revenues have been split more or less evenly between the republican budget and the local authorities, although some local authorities (notably Yerevan) receive a significantly smaller share.

Local authorities are responsible for expenditure on health, education, the social safety net and cultural matters. In addition, they are responsible for any budgetary financing of enterprises or organizations they own. Local authorities are not eligible to borrow from the banking system but have at times accumulated expenditure arrears in the face of insufficient revenues to cover expenditure commitments.

As part of the recent constitutional reform, legislation has been prepared that would significantly alter the structure of local government in Armenia. Instead of the present system of 58 local authorities, the country would be divided into about ten large regional authorities, although a number of small municipalities would exist within each region with the ability to levy fees and rents and apply them toward local expenditures, such as road repairs. Under the new arrangement, only the republican budget will have the authority to tax. This legislation is expected to be approved before the end of 1995.

b. The Pension and Employment Fund

The Pension Fund was created in August 1991 and expanded in 1992 by the incorporation of the Employment Fund to become the Pension and Employment Fund (PEF). The PEF is responsible for the payment of most pensions and of unemployment compensation, although pensions for retired military officers are paid directly by the budget. Until the end of 1992 it was also responsible for payments of child allowances, which are now paid by the state government.

At present approximately 643,000 individuals receive pensions through the PEF. The number of pensioners has remained fairly constant over recent years, rising from 634,446 on January 1, 1993 to 652,327 on January 1, 1994 before falling to 636,073 on January 1, 1995. Of the 643,000 pensioners at the beginning of July about 471,000 were receiving old age pensions and about 105,000 were receiving disability pensions. Most of the remaining 67,000 were receiving death benefits after the loss of a provider (Appendix I, Table 13).

The PEF operates strictly on a pay-as-you-go basis. The average pension is based on the number of years a retiree has worked. The minimum retirement age is 60 for men and 55 for women, with a minimum number of years of service of 25 for men and 20 for women. For each additional year of service the retiree receives 0.6 percent of the average of his five highest monthly salaries. However, salaries from prior years are not indexed, and the recent rapid inflation in Armenia has therefore rendered the income-based component of pensions negligible. As a result, the difference between the average old age pension (dram 2,259 per month as of July 1) and the minimum old age pension (dram 2,250 per month on that date) is only about 2 U.S. cents per month.

The PEF is financed primarily by a payroll tax, which is currently assessed at 36 percent (with 35 percent paid by the employer and 1 percent by the employee). Private farmers are expected to contribute 12 percent of their incomes, but in practice many are legally exempted from participation. Even nonexempt farmers seldom pay their obligations to the PEF. This Fund also experiences compliance problems with enterprises that operate primarily on a cash basis. In addition, the PEF has difficulty collecting from small traders and other entrepreneurs, who are difficult to locate and whose incomes are hard to document.

When employers transfer funds to the PEF, they do not provide information identifying the individual employees for whom they are contributing. When an individual registers for a pension, he need only provide documentation from his employer stating that he has worked for at least 25 years. The PEF, therefore, has no independent means to verify the tenure or wage information the retiree provides. As a result, the potential scope for fraud is great. Even if the PEF could prove that an enterprise had more retirees claiming pension benefits than it ever had employees, the PEF would not be able to identify which retirees were filing fraudulent claims.

A draft law has been submitted to Parliament for reform of the PEF and is expected to be passed later this year. The law will increase the minimum retirement age by five years to 60 years for women and 65 years for men. The change is intended in part to allow the PEF to build up surplus funds and ideally to free it from the need for budgetary support, which it received in 1993, 1994 and 1995. The reform will also reinstate reductions in pensions for working pensioners, which were eliminated when the pension law was last reformed in 1992.

Unemployment benefits are normally payable for up to 36 weeks, with the size of the benefit depending on unemployed worker’s previous job tenure and wage. Any individual who is unemployed and was not fired for “just cause” is eligible for unemployment benefits, including those who have never been employed, although after the relevant payment period has expired the recipient must normally wait one year before he is eligible to reapply. Moreover, benefits are limited to 12 weeks for those who have been unemployed for over a year. However, there is no time limit on eligibility for single mothers, even after 36 weeks. Approximately 34,600 Armenians received unemployment benefits in the second quarter of 1995, up from approximately 27,500 in the first quarter of the year. The number of individuals receiving unemployment benefits has fluctuated considerably in the recent past, falling from an average of 27,309 per month in 1993 to 22,516 per month in 1994 before rising again this year (Appendix I, Table 16). The limited duration of the benefit implies that at any given time over the last two years only about one-quarter to one-third of unemployed Armenians would have been receiving unemployment benefits.

2. Fiscal developments. 1993–1995

a. Overview

Over the last two years, Armenia has moved from a highly expansionary fiscal policy marked by extremely large budget deficits financed primarily by central bank credit to a policy featuring much smaller deficits that are financed primarily by other sources. The consolidated state government budget deficit on an accrual basis decreased markedly in 1994, falling from about 56 percent of GDP in 1993 to about 16 percent in 1994, with total revenues and grants remaining fairly constant as total expenditure declined significantly as a percentage of GDP (Tables 5 and 6). In the first six months of 1995 the accrual deficit declined even further, to about 10 percent of GDP, with a dramatic decline in expenditure as a percentage of GDP outstripping a sharp decline in revenues and grants.

In both 1993 and 1994 the deficit was financed primarily from domestic sources: in 1993, domestic financing was nearly 36 percent of GDP (including expenditure arrears of 2 percent of GDP) versus about 21 percent of GDP for external sources; in 1994 domestic financing (including expenditure arrears of 6 percent of GDP) equalled about 10 percent of GDP while external sources accounted for about 7 percent of GDP. Although the ratio of domestic to external financing remained relatively constant, central bank credit as a percentage of the accrual deficit declined from 60 percent in 1993 to 21 percent in 1994. During the first six months of 1995 central bank credit to the Government was negative, with rapid disbursements of external financing leading to a buildup of Government deposits at the CBA. In addition, the net reduction in the stock of arrears equalled about 3 percent of GDP. Thus, in the first half of 1995 external financing substantially exceeded the fiscal deficit.

b. Revenues and grants

After remaining roughly stable in 1994, total revenues and grants fell sharply in the first half of 1995 (Chart 6). Total revenues and grants equalled about 29 percent of GDP in 1993 and about 28 percent of GDP in 1994 but dropped to only about 17 percent of GDP in the first half of 1995. Tax revenues declined from about 16 percent of GDP in 1993 to 13 percent in 1994, in part because the penalty on overdue obligations was negative in real terms, which hampered collection efforts and led to a build-up of tax arrears. Tax collections were also hurt by administrative difficulties and by a failure to expand the tax base to keep pace with the expansion of output in new sectors of the economy. As a result, tax revenues in the first and second quarters have declined even further, to about 11 percent of GDP.

Chart 6
Chart 6

ARMENIA: Public Finance

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

1/ Figures for 1995 are actuals for the first half of 1995 and fund staff estimates for the second half of 1995.

Nontax revenues declined from nearly 8 percent of GDP in 1993 to only about 3 percent of GDP in 1994 and the first half of 1995, reflecting in part the loss of interest income from net lending operations after 1993. Nontax revenues also declined in 1994 because of a change in the composition of humanitarian assistance from a mix of grants and loans to purely grants. (When this assistance is provided by loans, any counterpart funds collected are recorded under nontax revenues.)

Foreign grants to the budget—mostly flour and grain used for bread—totalled 12 percent of GDP in 1994, a substantial increase from 5 percent of GDP in 1993. For the first six months of 1995 grants have equalled only about 4 percent of GDP, reflecting both exchange rate developments and a reduction in demand for bread after the authorities liberalized bread prices in three stages beginning in December, 1994.

Over the last few years the largest sources of tax revenues for the budget have been the EPT (44 percent of 1994 tax revenues), the VAT (21 percent), the Payroll Tax (12 percent), and the Personal Income Tax (PIT) (9 percent) (Table 7 and Chart 7). Collections from excises, customs and other taxes have typically been somewhat smaller. Despite recent efforts to broaden the tax base, the state sector of the economy remains by far the primary source of tax revenues: in both 1994 and the first half of 1995 state sector enterprises or employees accounted for about 90 percent of tax revenues. It seems likely that the private sector contributes more than 10 percent to total output, implying that the tax burden is inequitably distributed at present. 1/

Chart 7.
Chart 7.

ARMENIA: Composition of Tax Revenues, 1993 - 1995 1/

(In percentage of total tax revenues)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Source: Armenian authorities.1/ Other taxes include customs duties, excise and land taxes.Figures for 1995 are for the first and second quarters only.
Table 5.

Armenia: Cons lidated State Government Operations, 1993–95 1/

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Sources: Armenian authorities: and Fund staff estimates.

Consolidated Accounts of the Republican government, the 58 local authorities, and the PEF.

For 1994 includes dram 1.003 billion clearing trade profits.

In 1995, NTR includes $0.9 million in Q1, and $0.9 million in Q2 for the sale of an embassy property to Russia to offset interest due. External interest is reported in gross terms.

Grants of wheat and wheat flour and of olive oil.

Includes stipends and military pensions paid by the budget.

In 1995, includes dram 675 million in net lending to Nagomo Karabakh.

Includes privatization receipts and, in 1994, sales of gold to the Central Bank.

Table 6.

Armenia: Consolidated State Government Operations, 1993–1995 1/

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Sources: Armenian authorities: and Fund staff estimates.

Consolidated accounts of state government operations and the Pension and Employment Fund

Fourth quarter 1994 includes 0.9 percent of GDP in clearing trade profits.

For 1993, includes counterpart funds from distributon of wheat and medicines acquired via loans

Explicit and implicit subsidies

Includes treasury bill sales and privatization receipts. For 1994 also includes 0.5 percent of GDP in gold sales to Central Bank.

Table 7.

Armenia: Distribution of Tax Revenues, 1993–1995

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Sources: Armenian authorities; and Fund staff estimates.

Collections under the VAT have declined-from 5 percent of GDP in 1993 to about 3 percent in 1994 and to a little more than 2 percent in the first half of 1995, despite the recent elimination of a large number of exemptions. 2/

As with most taxes, the state sector accounts for most VAT collections, with state sector enterprises accounting for 86 percent of revenues in 1994 and 83 percent of revenues in the first half of 1995. The share of VAT in total tax revenues declined from 31 percent in 1993 to 21 percent in 1994, but has remained constant in the first six months of 1995. Beginning in 1995, the VAT (and all other taxes) has switched to an accrual basis, meaning that firms are liable for tax payments 90 days from the date that goods are shipped, regardless of whether they have received payment from clients. The authorities instituted this change because they believed that many firms were evading taxes by hiding payments they had received, but the change has not alleviated the problem of tax arrears.

Collections from the EPT 1/ increased from about 5 percent of GDP in 1993 to about 6 percent in 1994, before falling to just over 4 percent of GDP in the first half of 1995. Collections from the EPT have been hampered by the build-up in tax arrears, and as with most taxes, revenues come almost exclusively from the state sector: in 1994, 94 percent of EPT collections arose from state enterprises, and in the first half of 1995 about 90 percent did so. The share of the EPT in total tax revenues increased from about 28 percent in 1993 to 44 percent in 1994. Part of this increase is due to the fact that rapid inflation and the depreciation of the dram in late 1993 and in 1994 led to substantial nominal inventory and foreign exchange gains that were subject to the EPT. In addition, the EPT has a clause that prevents firms from deducting for tax purposes any wages that exceed ten times the minimum wage. The inflation induced rapid increases in the nonbudgetary sector wage, and the relatively slow growth of the minimum wage, combined in 1994 and 1995 to make this "excess wage tax " a significant component of EPT revenues. The share of EPT revenues in total tax revenues has fallen slightly in 1995, to about 40 percent, reflecting the more stable inflation and exchange rates.

Payroll tax collections have declined from nearly 3 percent of GDP in 1993 to less than 2 percent of GDP in 1994 and 1995, reflecting a decline in real wages in the state sector between 1993 and 1994. For the same reasons, PIT collections declined from nearly 2 percent of GDP in 1993 to just over 1 percent in 1994 and the first half of 1995. 2/ Payroll and personal income tax revenues come almost exclusively from the state sector: in 1994 more than 98 percent of PIT collections and more than 99 percent of payroll taxes came from state sector enterprises or their employees. Payroll taxes constituted about 17 percent of total tax revenues in both 1993 and the first half of 1995, but slipped to 11 percent in 1994. The share of the PIT declined from 10 percent in 1993 to 9 percent in 1994, before increasing slightly to 11 percent in 1995.

Excise taxes had formerly been a reasonably large source of revenue for the budget, but despite adjustments to both the base and the rates charged, excise tax revenues have declined as a share of GDP. In 1993 excise tax collections equalled 1.2 percent of GDP, but by 1994 that figure had fallen to just 0.4 percent of GDP and in the first six months of 1995 it declined further to 0.3 percent of GDP. In 1994, about 93 percent of excise tax revenues came from state enterprises, although for the first six months of 1995 this figure fell to about 86 percent, reflecting a near-doubling of the share of excises collected on imports. 1/ In 1994, the largest collections came from cognac (38 percent of revenues on domestic production), gold (23 percent) and cigarettes (22 percent). In the first six months of 1995 the share of cognac increased to 62 percent of excise taxes collected on domestic production. Cigarettes and gold and jewelry were still the next two largest categories, but their shares had fallen to less than 10 percent. Reflecting the increase in excise rates on imports to match the rate on equivalent domestic products, the share of excises on imported goods increased from 6 percent of total excise revenues in 1994 to 10 percent in the first six months of 1995.

Collections on customs increased from 0.2 percent of GDP in 1993 to 0.4 percent in 1994 and 1995, reflecting increased imports, especially from outside the CIS. The share of customs in total tax revenues increased from just 1 percent in 1993 to 3 percent in 1994 and 4 percent in the first half of 1995. Customs duties were adjusted both in December 1993 and in January 1995. The Land Tax was established in April 1994, but because of the large number of exemptions and compliance problems, collections have been extremely low: 0.2 percent of GDP in 1994 and 0.1 percent of GDP in the first six months of 1995. Collections on various other taxes constituted 0.8 percent of GDP in 1993 and 1994, and 0.1 percent of GDP in the first six months of 1995. The figure for 1994 includes clearing trade profits of 0.5 percent of GDP recorded in that year. The decline in other taxes in 1995 (and in 1994, once clearing trade profits are excluded) reflects both the elimination of some small taxes and the effect of inflation on some asset based taxes. Other taxes constituted 5 percent of total tax revenues in 1993 and 6 percent in 1994, before dropping to just 1 percent in the first six months of 1995.

c. Expenditure

The last year and a half have been marked by dramatic declines in government expenditure, with total expenditure falling from 85 percent of GDP in 1993 to 44 percent in 1994 and to 27 percent in the first six months of 1995. Both current and capital expenditure have declined as shares of GDP, with current expenditure falling from about 60 percent of GDP in 1993 to 34 percent in 1994 and to 20 percent in the first half of 1995, while capital expenditure and net lending declined from about 26 percent of GDP in 1993 to 10 percent in 1994 and to nearly 7 percent for the first six months of 1995. The mix between current and noncurrent expenditure has been fairly constant, with current spending increasing from 70 percent of total expenditure in 1993 to 78 percent in 1994 before declining to 74 percent in the first six months of 1995. Most categories of expenditure have declined as shares of GDP, but some have been relatively better protected than others. Thus, in 1994, spending was reoriented toward subsidies and capital expenditure and away from net lending to enterprises, health, education and wages, while in the first six months of 1995 spending on subsidies has been reduced dramatically while transfers, wages, health and education have been somewhat better protected.

(1) Current expenditure

Expenditure on wages declined from about 8 percent of GDP in 1993 to less than 2 percent of GDP in 1994, before increasing slightly to just over 2 percent of GDP in the first six months of 1995. The real average budgetary wage declined by more than 87 percent between 1993 and 1994, before increasing by about 20 percent in the first six months of 1995. Total employment in the budgetary sphere has been roughly constant, averaging about 410,000 in 1993 and 407,000 in 1994 and declining to about 392,000 during the second quarter of 1995. The share of wages in current expenditure fell by more than 50 percent in 1994, dropping from nearly 13 percent in 1993 to about 5 percent in 1994 (Table 8 and Chart 8). The share of wages has increased to 11 percent in 1995, reflecting in part the increase in real wages during the last six months, but also the decline in overall current expenditure because of the sharp decline in spending on subsidies (see below).

Table 8.

Armenia: Distribution of Current Expenditure, 1993–1995

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Sources: Armenian authorities; and Fund staff estimates.
Chart 8.
Chart 8.

ARMENIA: Composition of Current Expenditures, 1993 - 1995 1/

(In percentage of total current expenditure)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Source: Armenian authorities.

With respect to the distribution of budgetary sector employment, the share of education and culture has remained fairly constant, with around 45 percent of the total. About 20 percent of budgetary employees work in the health, physical culture or social welfare sectors, and a similar share work in defense and law and order.

Expenditure on subsidies has fallen since 1993, with especially sharp declines in 1995. Subsidies (including implicit subsidies from the distribution of products at below market prices) have fallen from about 17 percent of GDP in 1993 to about 13 percent of GDP in 1994 and to less than 2 percent in 1995. Explicit subsidies (on bread production, school books, communal services and transportation) increased from 1 percent of GDP in 1993 to 2 percent in 1994 before falling to less than 0.5 percent in the first six months of 1995 following the authorities’ decision to increase many administrative prices. Implicit subsidies (on bread, and in 1993 on medicine) have declined from about 16 percent of GDP in 1993 to about 11 percent in 1994 and to just 1 percent of GDP in the first six months of 1995. This decline can be traced to two factors: the elimination after 1993 of subsidies on medicines (purchased through a loan from the EU and distributed at a cost that reflected only the interest expense of the loan) and, in particular, the liberalization of bread prices that began in December 1994. The reorientation of current expenditure away from subsidies is apparent in their decline as a share of total current expenditure. Subsidies increased from about 28 percent of current expenditure in 1993 to 38 percent in 1994, but represented just 7 percent of current expenditure in the first six months of 1995.

Interest expenditure, both domestic and external, has increased significantly as a share of GDP since 1993, reflecting both heavy reliance on central bank credit to finance budget deficits in 1993 and early in 1994 and a significant increase in external nongrant assistance, especially for capital expenditure. Domestic interest expenditure increased from 0.4 percent of GDP in 1993 to 1.2 percent of GDP in 1994 and to 1.7 percent of GDP in the first six months of 1995. Because central bank budget financing is provided via fixed loan contracts on which interest is typically payable only in the final three months, interest expenses on central bank credit only appear in the budget with a lag of several months. Thus, much of the interest expense for 1994 reflects domestic borrowing in 1993, while the interest expense in 1995 reflects both additional 1994 borrowing and the effects of the rapid inflation in late 1993 and early 1994 on nominal interest rates. External interest expenditure has also increased, rising from 0.3 percent of GDP in 1993 to 0.8 percent in 1994 and in the first six months of 1995, reflecting both continued use of external financing and exchange rate developments. The share of current expenditure devoted to interest payments has increased by a factor of ten since 1993, rising from just 1.2 percent to nearly 13 percent for the first six months 1995, reflecting the authorities’ success in limiting noninterest expenditure.

Expenditure on budgetary transfers declined from about 7 percent of GDP in 1993 to 4 percent of GDP in 1994, before increasing to about 5 percent of GDP in the first half of 1995. However, these figures mask the extent to which spending on transfers has been protected in the budget. The general decline in expenditure on transfers as a share of GDP can be traced to the decrease in the real value of pensions and child allowances in recent years. Expenditure on pensions decreased from about 4.5 percent of GDP in 1993 to 1.7 percent of GDP in 1994 before recovering to about 2.5 percent of GDP in the first six months of 1995, reflecting an increase in the real value of the average pension during the first half of 1995 after its value was severely eroded by inflation in 1993 and 1994. Expenditures on child allowances—an untargetted social benefit program available to all individuals with dependent children—have fallen from 2.5 percent of GDP in 1993 to 1.3 percent in 1994 and to 1.0 percent in the first six months of 1995. Spending on unemployment compensation in Armenia has been minimal in recent years, averaging 0.1 percent of GDP in 1993 and the first half of 1995, and even less in 1994. The low level of expenditure reflects both the very small benefit (about US$2 per month in 1993 and US$1 per month in 1994) and the fact that very few of the unemployed collect the benefit. 1/

Although spending on transfers declined as a share of GDP in 1994, the share of transfers in current expenditure remained fairly constant at 12 percent in 1993 and 1994 (even though expenditure on pensions and child allowances did decline as a share of current spending). Moreover, the relatively small increase in spending on transfers as a share of GDP in the first six months of 1995 has translated into a doubling of their share of current expenditure in that period (to 24 percent). Most of this was due to the doubling of the share of pensions and child allowances in current expenditure reflecting the authorities’ penchant for increasing the nominal value of these transfer payments each time an administered price is raised.

Expenditure on goods and services has declined markedly in the last two years, falling from 27 percent of GDP in 1993 to 14 percent in 1994 and to just under 9 percent in the first half of 1995. However, the share of goods and services expenditure in current spending has varied less dramatically, falling from 46 percent in 1993 to 40 percent in 1994 before rising to 44 percent in the first six months of 1995. Expenditure was reoriented away from health and education in 1994, with the share of these sectors in total current expenditure falling from 16 percent of current expenditure in 1993 to 6 percent in 1994, but spending in these sectors increased to nearly 11 percent during the first six month of 1995. The share of other goods and services increased from 30 percent in 1993 to 34 percent in 1994 and has remained practically constant in 1995, even as spending on these items fell as a share of GDP from 18 percent in 1993 to 12 percent in 1994 and to less than 7 percent in the first half of 1995. In 1994 and the first half of 1995 about 40 percent of expenditure on “other goods and services” was attributable to defense and law and order ministries, and about 15 percent in 1994 and 18 percent in 1995 to the Ministry of Energy, while Housing and Communal Services accounted for another 11 percent in 1994 and 10 percent in 1995.

(2) Capital expenditure and net lending

Like all other forms of noninterest expenditure, capital expenditure and net lending has declined as a share of GDP over the last two years, falling from 26 percent of GDP in 1993 to 10 percent in 1994 and to 7 percent in the first six months of 1995. As a share of total expenditure, capital expenditure and net lending fell from 30 percent in 1993 to 22 percent in 1994 before recovering to 26 percent in the first half of 1995. However, the decline from 1993 to 1994 was due almost entirely to a virtual elimination of net lending to enterprises after 1993, which fell from about 18 percent of GDP (and 21 percent of total expenditure) in 1993 to less than 1 percent of GDP (and to 1 percent of total expenditure) in 1994 and the first half of 1995. Capital expenditure actually increased from 8 percent of GDP in 1993 to 10 percent of GDP in 1994, before declining to about 7 percent of GDP in the first six months of 1995. However, capital expenditure increased from 9 percent of total expenditure in 1993 to 21 percent in 1994 and to 25 percent in the first half of 1995. In 1994 about 53 percent of capital expenditure was domestically-financed, but in the first six months of 1995 that figure has slipped to about 12 percent, primarily reflecting expenditure restraint on the part of the authorities rather than a sharp rise in external financing: foreign financed capital expenditure has increased only from about 5 percent of GDP in 1994 to about 6 percent of GDP in the first six months of 1995. In both 1994 and 1995 externally-financed capital expenditure has reflected the authorities’ priorities of improving the supply of energy and rebuilding areas still damaged from the 1988 earthquake. In 1994 and the first half of 1995, the largest externally-financed capital expenditure projects have been an EBRD-financed project for the construction of the Five-Block electric power station, a project financed by Russia for repairs to the nuclear power station and the World Bank sponsored Earthquake Reconstruction Loan. Most domestically-financed capital expenditure has been traditionally channelled toward housing and communal services, with smaller amounts spent on education and health care.

3. The social safety net

In addition to explicit budgetary transfers, the population also benefits from humanitarian assistance that is distributed by the Government on an extrabudgetary basis (for example kerosene, which is not included in the budget because donors require that it be distributed free of charge). Although most explicit transfers–which were largely inherited from the Soviet Union–are not well-targeted, there is evidence that the authorities have done somewhat better at targeting humanitarian assistance. According to a 1994 survey of urban and rural households conducted by the Yerevan State University and the State Department of Statistics, humanitarian aid accounted for a far greater share of real consumption of the very poor than of the poor, and of the poor than of the nonpoor.

Child allowances are paid for all children, regardless of family income, at the father’s place of employment (or the mother’s if she is a single parent). Child allowances for children of the unemployed or of pensioners are paid at PEF offices. In 1995, the Government modified the formula for child allowances from a flat amount per child to a scaled system where the per child amount of the benefit increases with the number of children in the family. Although this change was meant to enhance the poverty-reduction aspect of the program, there is no evidence that family size correlates with poverty in Armenia. In fact, in rural areas larger families tend to be better off than smaller ones, partly because the former were awarded more land during land privatization.

Extremely limited benefits are paid by the Social Insurance Fund (SIF). The Fund provides sickness, maternity and other benefits, mostly to public sector employees. Private sector employees are eligible for benefits from the SIF if they agree to contribute. By government decree, the SIF also provides one-time childbirth benefits to all new mothers, regardless of whether they are otherwise participating in the Fund. About 1.2 million public sector employees were covered by the SIF in 1994. For 1995 the planned number is 740,000 but the actual number is likely to be higher. The main source of revenue for the SIF is the 2 percent payroll tax on public sector wages. In 1994, the total revenue and expenses of the SIF were each about 0.1 percent of GDP. Expenditures on sick leave, childbirth and maternity benefits have declined for each of the last three years, reflecting a reduced birth rate and the poor quality of care in hospitals and clinics: in order to qualify for a sick leave benefit, employees must provide evidence that they have been treated at a hospital or clinic, but many individuals prefer to stay home and obtain treatment on their own. Sick leave benefits are also depressed because many firms are not operating, thus making their workers ineligible. Prior to independence the average sick leave in Armenia was five days per year, while presently the average worker takes about two sick days annually.

IV. Financial Sector Developments 1/

1. Monetary developments

a. Overview

The dram was introduced in November 1993 and became sole legal tender in March 1994. This period was characterized by very high inflation and large fiscal deficits, which were largely financed by central bank credit, and the dram depreciated rapidly. To halt the high inflation and to stabilize the currency, the Government significantly tightened both fiscal and monetary policies in the second quarter of 1994. The policies bore fruit in mid-1994, with inflation declining dramatically and the depreciation of the currency gradually turning into a real appreciation. The December bread price liberalization was accompanied by compensation payments, which initially had to be met through increased bank credit. With the significant price shocks out of the way and an improvement in fiscal performance, aided by significant official capital inflows, money and credit policies have been conducive to an improvement in inflation performance since then.

b. Reserve money and its components

Reserve money grew by 389 percent during the first half of 1994 as both cash issued and bank correspondent account balances increased rapidly (Table 9). Reserve money growth was slowed to 27 percent in the third quarter even though the CBA acted to increase its net international reserves by buying gold and foreign exchange. However, reserve money growth increased to 50 percent in the fourth quarter, although at a rate lower than the increase in prices.

Table 9.

Armenia: Accounts of the Central Bank

(end of period in millions of dram)

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Source: Central Bank of Armenia and staff estimates

Reserve money includes cash issue, required reserves on dram deposits and foreign exchange deposits (from end 1994) and correspondent accounts of commercial banks.

Reserve money continued to grow rapidly in the first four months of 1995, due to pre-election government expenditures, the financing of which was helped by official capital inflows, which were not fully sterilized. To halt the consequent increase in broad money and inflation in April and May, the CBA withdrew liquidity by increasing foreign exchange sales and engaging in a much closer dialogue with the Ministry of Finance regarding the timing of expenditures and the drawdown of government deposits with the CBA (Table 10 and Chart 9). These measures succeeded in bringing reserve and broad money growth rates down rapidly and in reducing inflation.

Table 10.

Armenia: Monetary Survey

(end of period in millions of dram)

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Source: Central Bank of Armenia and staff estimates
Chart 9
Chart 9

ARMENIA: SELECTED MONETARY INDICATORS

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

1/ Based on stocks at end-quarters.2/ in 1994Q1, reserve and broad money increased by 181 and 240 percent, respectively.3/ Interest rates are quoted on a simple (uncompounded) basis. Regular credit auctions began in July 1994.4/ The refinancing rate for July 1995 was initially 80 percent, but was reduced to 60 percent in two steps during July.

The composition of reserve money varied dramatically in the first half of 1995. After being relatively stable, bank correspondent account balances with the CBA grew sharply in the first quarter. This occurred because Government had built up significant deposits with the CBA as a result of large official capital inflows. As these deposit balances were drawn down, funds were transferred from the Ministry of Finance account to ministry accounts with commercial banks, which in turn led to a sharp increase of correspondent account balances of commercial banks with the CBA. Subsequently, the drawdown of correspondent accounts was reflected in a sharp rise in cash in circulation. An additional, though less significant factor in correspondent account declines during the second quarter was the closing of commercial banks’ foreign exchange deposit accounts with the CBA.

c. Broad money and its components

While end-period inflation was 1884 percent between December 1993 and December 1994, broad money grew by only 684 percent for the year. In contrast, during the first six months of 1995, as economic activity picked up and the demand for the dram grew, broad money growth outstripped inflation, increasing by 41 percent compared to an inflation rate of 23 percent.

After being reasonably stable throughout much of 1994, the money multiplier dropped toward the end of the year because reserve requirements were tightened and banking system problems became more apparent. The timing of some partially sterilized large official capital inflows, which initially passed through the CBA before being spent by government through the accounts of the commercial banks, distorted the multiplier during March to May 1995. The multiplier has since returned to levels seen at around the beginning of 1995.

Cash in circulation has made up an increasingly larger share of broad money as time has gone on. At the end of March 1994, cash accounted for less than 20 percent of broad money, but this share had increased to just under 50 percent by June 1995. The increase can be linked to a number of factors. First, extensive controls on cash transactions were gradually relaxed. 1/ Second, there has been a continuing reluctance on the part of the public to use the banking system, which is likely to have increased after some well publicized bank failures. Third, the dram’s geographic area of circulation has been widening as it replaces the Russian ruble. Fourth, there are signs of further sales of dollars for drams through exchange bureau though they are subject to discernible seasonality patterns. Finally, there have been suggestions that the banking system will be used to monitor accounts for tax purposes, adding to the desirability of transacting in cash.

The corollary of a faster increase in cash in circulation is that banking system deposits have been increasing at a slower rate than broad money in general. The currency of denomination of deposits has also been changing. The high inflation at the end of 1993 and the beginning of 1994 and the highly negative real interest rates on dram deposits had resulted in a much faster buildup in foreign currency deposits than dram deposits. By June 1994, foreign currency deposits were more than three times the level of dram deposits. This pattern has changed quite dramatically in 1995. Foreign currency deposits have remained stagnant since the end of 1994, while dram deposits have increased by almost 100 percent between December 1994 and June 1995. Dram deposits now comprise almost 45 percent of all banking system deposits.

Taken together, the strong increase in cash in circulation, relatively low inflation, and the change in the currency composition of both deposits and loans provide strong evidence of reverse currency substitution.

d. Credit trends

Large fiscal deficits persisted throughout 1993 and into the first quarter of 1994. Central bank credit to government, the major component of central bank domestic credit, grew by 173 percent. Banking system credit to enterprises grew by an even more rapid 513 percent. Central bank credit to government slowed dramatically in the second quarter as more external financing became available, the budget deficit was reduced as a percentage of GDP, and a monthly credit plan was developed between the CBA and the Ministry of Finance. The composition of central bank lending also changed during the second quarter, with increases in credit to banks becoming more significant. Central bank credit to general government slowed further in the third quarter of 1994 as current expenditure was held in check and external financing became more significant. Credit to banks remained restrained during the third quarter but, like credit to government, expanded in the fourth quarter ahead of the price liberalization and subsequent compensation measures. Bank credit to enterprises continued to grow quickly, increasing by 82 and 52 percent respectively in quarters three and four.

Credit growth was much more subdued in 1995. Central bank credit to government grew by only 17 percent in the first quarter, as large official capital inflows allowed government to build up deposits with the CBA, resulting in a significant reduction in net credit to government during the second quarter. At the same time, central bank credit to banks fell sharply as banks repaid credit and as the CBA withdrew foreign currency deposits with domestic banks.

Although it is still too early to draw any strong conclusions, an interesting development has been taking place with the currency denomination of loans to individuals and entrepreneurs. Although small in absolute terms, dram denominated loans increased significantly in the period May to June, while foreign currency denominated loans declined.

2. Interest rates

a. The refinance rate

The refinance rate is used for determining the interest rate on central bank loans to government, and as the basis for setting the CBA’s penal overdraft rate, which is 30 percent higher than the refinance rate. The refinance rate is also used as the basis for setting the interest rate on some private loan agreements between commercial banks and their clients (Appendix I, Table 20).

The refinance rate was significantly negative in real terms at the end of 1993 and the beginning of 1994. The rate was increased from 210 percent to 360 percent in March 1994, as part of the package of measures to halt the very high inflation in early 1994. 1/ The rate was held at this level until September when it was reduced to 300 percent, before being reduced further in a number of steps to 60 percent at end-July 1995. For most of the period the rate had been set administratively. The increase in prominence of the credit auctions in early 1995 and the change in credit-auction procedures, which effectively allowed for much more interest rate flexibility, provided an opportunity for using the auction rate as the basis for setting the refinance rate. Developments in other market rates and general monetary conditions are taken into consideration when setting the refinance rate, and the CBA has set up a formal procedure whereby its board must review the refinance rate if it is significantly different from the auction rate. Given that the CBA has some discretion in setting the refinance rate, the latter can also act as a powerful signalling device. Measured against underlying inflation, the refinancing rate was positive in real terms throughout the first six months of 1995. 2/

b. Credit auction rates

For most of the period from May 1994 through March 1995 the credit-auction rate was not a particularly good indicator of market conditions as many banks had access to other, less expensive forms of central bank financing. The rate became a better indicator of market conditions after the March reforms, following the policy decision to allow auction rates to lead the refinance rate. Rates could also vary significantly from one auction to the next depending on market conditions and the volume being auctioned. For example, the 28 day auction rate on July 25 was 42 percent, it increased to 75 percent on August 3, and subsequently fell to 46 percent on August 15.

c. Deposit and lending rates

In March 1994, temporary minima were set on commercial bank loans and deposits. The controls on loans were removed during the summer and controls on deposits prior to year-end. Commercial bank lending rates in drams, and U.S. dollars were significantly positive in real terms during the first half of 1995. Margins between deposit and lending rates have remained very high (Appendix I, Table 21). Credit risk considerations, borrowers’ high potential incomes from trade activities, and not just inflationary expectations appear to have played a big role in the determination of nominal rates. This may be inferred from the observation that effective interest rates on dollar-denominated loans, for which inflationary expectations should be relatively well known, were still well in excess of 100 percent per annum in June. On the deposit side, concerns about the soundness of the banking system, and until recently the difficulty and cost of converting deposits to cash, have also placed an upward bias on deposit rates. For banks, however, resource mobilization through deposits remains considerably cheaper than borrowing through the credit auction.

3. Special topics

a. Credit auctions

The auctions have been designed as a transition mechanism for the CBA to inject credit into the banking system as it moves to a more market-based monetary policy. Initially, however, the auctions were not particularly successful, due to a number of contributing factors that tended to undermine their effectiveness. These factors included, among other things, the prevalence of nonauctioned directed credits during 1994, uncertainty about auction volumes, a plethora of maturities, interest rate minima, prudential requirements which effectively excluded a number of banks, and limits on amounts that could be sold to any one bank. These early auctions were also characterized by central bank guarantees to banks which lent to one another via the auction. This feature was later abolished as a number of banks failed.

With the abolition of directed credits from the beginning of 1995, in February 1995, the CBA took steps to significantly reform and improve the auction arrangements by implementing MAE recommendations. In particular, the auction moved to a sealed bid basis; maturities were unified at 28 days, and 7 and 14 day maturities were subsequently introduced in July; auction volumes were announced in advance; and the auction-interest rate was allowed to fall below the CBA’s refinance rate, although the CBA retained discretion not to accept some bids if it considered interest rates were falling too fast. The frequency of auctions was also increased to twice a week. With the removal of central bank guarantees to banks, the CBA became the only seller in the credit auction (Appendix I, Table 20). Although the CBA continues, under some circumstances, to extend credit to banks via penal overdraft arrangements and has also lent directly to some banks, the auction had by July 1995 become the main means for extending credit to banks.

b. Cash regulation

Another component of the package of temporary measures taken in March 1994 to halt the very high inflation rates, was the imposition of a fee of up to 37 percent imposed on some cash withdrawals. 1/ This move did, however, represent a step in the liberalization process as there had previously been a cap on how much cash could be withdrawn. Although there are a number of factors at play, the commission is very likely to have been a significant contributor to the spread observed between the cash and noncash dollar/dram exchange rates (Chart 10). This spread was around 30 percent from April through June 1994.

Chart 10
Chart 10

ARMENIA: Official and Cash Market Rates for USD

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Some major restrictions on cash withdrawals, including the 37 percent fee were removed in mid-November 1994. However, banks were allowed to charge up to 3 percent commission on cash transactions. The CBA in turn charged the banks 1.5 percent to convert noncash balances to cash. Moreover, because of administrative “oversight” by the CBA it was sometimes difficult to obtain loans in cash. The administrative restrictions on cash loans were relaxed in February 1995 and abolished on May 1, 1995. At the same time, the maximum commission on cash withdrawals from commercial banks was reduced to 2 percent and the CBA reduced its fee to commercial banks to 1 percent in May 1995.

c. Reserve requirements

Current account deposits were added to the base for the calculation of reserve requirements in April 1994. In May of that year, the reserve requirement was unified at 15 percent for all dram denominated deposits. By the end of 1994 the base for reserve requirements had been broadened further to capture foreign exchange deposits at the same rate. Banks are, however, able to choose which currency they will use to meet the requirement. In mid-1995, the requirement was essentially relaxed slightly by excluding some nonresident deposits from the calculable base, in an attempt to attract foreign investment. The methodology for determining the reserve requirement was also changed in July, consistent with MAE advice: rather than being assessed at the end of the month, the requirement is now assessed over a two-week period, and is calculated on the basis of daily average balances.

4. Banking system developments

The soundness of the financial system became of serious concern for the authorities in 1994, particularly as a result of the high profile failure of a commercial bank, Bank Armenia. A number of major steps have been taken since then to improve the strength of banks, and the banking supervision and licensing frameworks have been enhanced.

At the beginning of 1994 there were 58 resident banks and 14 branches of foreign banks in Armenia. Between the start of 1994 and July 1, 1995, 19 of these banks had their licenses revoked by the CBA, while another ten voluntarily relinquished their licenses. Although all these banks have been formally closed, only six had been liquidated as at July 1, 1995. As at end-July 1995, there were 41 resident banks, excluding the Savings Bank and four branches of foreign banks.

Two recent CBA resolutions updated the series of prudential norms to be applied to commercial banks. 1/ As at July 1, 1995 new resident banks had to have a minimum statutory capital of dram 50 million. 2/ Existing banks, which were required to have the dram equivalent of US$100,000 by April 1, 1995 have until January 1, 1996 to comply with the requirement. Phased increases in the minimum capital requirement up to the dram equivalent of US$1 million by the year 2000 are also stipulated. The resolutions also redefine the calculation of the measurement of capital to assets, alters the limits on the deposits that banks may take from households, limits the maximum exposure to a single borrower to 20 percent of capital by July 1, 1996 and establishes a transitory liquidity ratio.

A number of other regulations have also been passed: a resident bank’s net open foreign currency position cannot exceed 40 percent of its capital, and stricter limits have also been put in force on loans to insiders. The CBA has completed a review of banks’ loan portfolios and is developing a framework for writing off doubtful debts. A matrix of penalties to be applied in the event of breaches of prudential requirements has also been developed, and the CBA is in the process of implementing an integrated CAMEL rating system for banks. 3/ In addition to these measures, the CBA will soon receive summary balance sheet information from banks on a weekly basis aiding the implementation of both monetary and prudential policy.

Reported banking system profitability in 1994 was high, with profits of dram 3.9 billion representing a return of over 180 percent on statutory capital. 4/ Approximately 60 percent of these profits came from gains on foreign exchange holdings. In general, however, profits were not used to build the capital base of banks as most were paid out as dividends. In addition, the reported profits must be treated with some caution as they do not take into account likely loan losses which are thought to be substantial. In an attempt to build up bank capital, the CBA has since entered into memoranda of understanding with some banks that dividends should only be paid out if certain conditions are met. Despite all these measures, the capitalization of the banking system as a whole remains low. This has become particularly apparent as a subsidiary of a major international bank prepares to begin operations in Yerevan. That bank alone has as much paid up capital as all the other commercial banks combined.

The Savings Bank continues to be treated as a special case and has not yet been subjected to reserve requirements or prudential regulations. With deposits from households at over dram 700 million at July 1, making up over 60 percent of banking system deposits from individuals and a very extensive branch network, the Savings Bank remains a significant institution in the Armenian context.

5. Payments system

A number of measures have been taken to improve the payments system since the beginning of 1994. The establishment of a bank mail system between banks in Yerevan and the CBA settlement center, and the subsequent increase in the frequency of the service to twice a week in November 1994, significantly reduced the average transaction settlement time. A multilateral netting arrangement, with settlement on the books of the CBA, was set up in May 1994. The frequency of clearing sessions increased from once a day to twice daily in December. Some computerization has helped reduce the float, but an electronic payments system will still take time to develop.

V. External Sector Developments

1. Overview 1/

As with other economies in transition, Armenia experienced a severe real contraction in both imports and exports in the three years following independence in 1991. Trade flows were hindered by the breakdown of the payments system with major trading partners, an acute shortage of foreign exchange, and an adverse terms of trade shock. In addition, the economic blockade associated with the conflict over Nagorno-Karabakh has exacerbated the situation. Trade routes with Turkey and Azerbaijan have essentially been closed. For much of the time through 1994 the transit routes through Georgia, which are the primary conduit for trade with the CIS area, were disrupted by civil strife. Due to geographical and logistical reasons, trade with the Islamic Republic of Iran has been restricted to a single trade area at Meghri. While these barriers to trade have in effect muffled international market signals, raised transport costs, and retarded the transformation of domestic industries, trade, and particularly imports, have nevertheless been buoyant during the first six months of 1995.

Clearing trade arrangements were established with Russia and Turkmenistan in early 1992 to: (i) ensure a minimal level of energy supply; (ii) circumvent the problem of currency inconvertibility; and (iii) exploit the economies of scale inherent in the airlifting operations that had to be mounted. During 1994, bilateral clearing trade with Russia and Turkmenistan accounted for about one-third of total exports and one-quarter of total imports.

2. Balance of payments

a. General developments

The current account deficit, excluding official transfers, is estimated to have widened from US$150 million in 1993 to US$231 million in 1994. However, all of the increase in the current account deficit could be attributed to imports associated with official transfers (Table 11 and Chart 11). While the total value of imports remained relatively stable between 1992 and 1994, import volumes contracted significantly as import prices rose sharply to world market levels; most acute were the increases in energy prices. During the same period, exports not only shrank in volume terms, but also declined in value terms. From US$335 million in 1992, exports collapsed to US$209 million in 1993, and stabilized at this level in 1994. Consequently, the trade deficit tripled from US$50 million in 1992 to US$150 million a year later, and widened by another US$45 million to US$192 million in 1994.

Table 11.

Armenia: Balance of Payments and External Financing

(In millions of U.S. dollars)

“Sorry–the quality of the source document is insufficient to render this image into text.”

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Chart 11
Chart 11

ARMENIA: Current Account Balance, Debt and Debt Service

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

1/ Excluding potential financing.2/ Including debt service arising from potential financing associated with the cumulative financing gap and scheduled amortization payments to the EU.

Reflecting a significant improvement in the availability of gas, capital goods associated with the nuclear power plant, and overall economic buoyancy, imports during the first half of 1995 were US$258 million, equivalent to some two-thirds of total 1994 imports. At the same time, exports remained virtually unchanged from the same period in the previous year at US$89 million. As a result, the trade deficit for the first half of 1995 is estimated to have reached US$170 million.

b. Trade with the East

(1) Trade with Russia

In 1994, 70 percent of exports were directed to the FSU area and 55 percent of imports originated from FSU countries (Table 12). Given the historical links and its dominant role as a supplier of fuels, Russia has remained the most significant trade partner of Armenia in the FSU: about two-thirds of Armenia’s exports to the FSU and half of Armenia’s imports from the FSU were conducted with Russia. The main commodities imported from Russia include machines and equipment, oil products, livestock, precious, semiprecious, and nonprecious metals, and goods exported to Russia comprise mainly precious and semiprecious stones, machines and equipment, food products, textile products, and nonprecious metals. The 1995 clearing trade agreement with Russia stipulates that Armenia will import 200,000 tons of mazut and the same amount of oil. However, since late-1994, clearing trade with Russia has been inoperative, as neither side found it anymore advantageous when Russia began charging world-market prices for fuels. During the first six months of 1995, the termination of clearing trade with Russia was replaced by alternative exports to Russia, to other FSU countries, and to non-FSU countries. This development is an encouraging sign of a move toward market-based trade.

Table 12.

Armenia: Direction of Trade

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Source: State Department of Statistics; and staff estimates.
(2) Trade with Turkmenistan

Being the sole supplier of gas, Turkmenistan is Armenia’s second most important trade partner in the FSU. Clearing trade still dominates trade relations with Turkmenistan. In 1993 and 1994, 801 MCM and 868 MCM of gas were imported, respectively. In the first half of 1995, gas shipments totalled 666 MCM, and are projected to reach 1,405 MCM by year-end. At US$80 per thousand cubic meters (KCM), the price of gas includes an “f.o.b.-price” of US$50 and a transit fee of US$30 per KCM. Of these, US$30 is to be paid in hard currencies and the rest in clearing goods. (For details of the clearing trade arrangement, see Appendix V.) Until recently, Armenia had remained current on gas payments, even under difficult external conditions. In recent months, energy sector enterprises have incurred arrears on gas shipment totalling US$19.5 million as of end-July 1995.

Armgazprom is responsible for importing the gas, 80 percent of which is in turn delivered to Armenergo—the electricity concern—to power thermo generators, and the rest to chemical plants, hospitals, other enterprises, and households. Domestic interenterprise arrears have mounted throughout 1994 and 1995, contributing to the nonpayment for gas from Turkmenistan.

c. Trade with the West

Since the closure of the major land trade routes to Turkey and Azerbaijan, Armenia has had only Georgia to the north and Islamic Republic of Iran to the south as conduits for the flow of goods. Of total 1994 exports, 30 percent headed for the non-FSU area. In the first half of 1995 the comparable figure was 42 percent. Belgium is Armenia’s principal trading partner, mainly reflecting large exports of diamonds and other jewelry. Islamic Republic of Iran and Germany follow as the next largest export markets in the non-FSU area.

As regards imports, 45 percent of the total came in from the non-FSU countries in 1994. The main non-FSU import sources include the U.S.A, Islamic Republic of Iran, Germany, Belgium, and France. A great deal of humanitarian aid in the form of wheat is imported from the U.S.A. and the EU. Wheat import from the U.S.A. totalled some 190 thousand tons in 1994 and 140 thousand tons in the first half of 1995.

d. Commodity composition of trade

Prior to independence, leading export products included light machinery, textiles and carpets, footwear, and wine and cognac. Armenia used to be one of the primary suppliers of high-technology components, including sophisticated missile guidance systems, in the former U.S.S.R. It had also provided its technological know-how in the fields of chemistry, physics, gas pipeline technology, and mathematics. The textiles and footwear industries were also very developed, and dominated the market in the former U.S.S.R. during the years prior to its breakup.

Since independence and, subsequently, the economic blockade, the pattern of production has changed dramatically (Table 13 and Charts 12 and 13). With the drop-off in demand for high-technology services and production, and the high transport costs resulting from the blockade, exports have been concentrated in relatively low-technology, high-value added commodities, notably, jewelry. Gold and diamonds are imported from Russia for processing, and re-exported to the West.

Table 13.

Armenia: Commodity Composition of Trade: 1993–95

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Source: State Department of Statistics.
Chart 12.
Chart 12.

ARMENIA: Commodity Composition of Exports, 1993 - 1993 1/

(In percentage of total)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Source: Armenian authorities1/ Figures for 1995 are for the first and second quarters only.
Chart 13.
Chart 13.

ARMENIA: Commodity Composition of Imports, 1993 - 1995 1/

(In percentage of total)

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Source: Armenian authorities1/ Figures for 1995 are for the first and second quarters only.

Jewelry accounted for about one third of total exports during the period 1993 to June 1995. During the same period, machinery and equipment, being the second largest export category, accounted for about 17 percent, followed by textile products, shoes, and hats at another 15 percent. On the import side, imports of food products, related to humanitarian aid, dominate, accounting for some 40 percent of the total. Gas and fuel follow as the second largest category of imports, accounting for about 30 percent of the total.

e. Services and transfers

Due to the blockade, transport costs have soared in recent years—averaging 18 percent of the c.i.f. cost of imports in 1994—and have dominated developments in services. Earnings from transport services are estimated to have been US$40 million in 1994 and US$24 million in the first half of 1995, but transport expenses were US$72 million and US$40 million, respectively.

Private transfers from the Armenian diaspora have been an important source of foreign exchange and disposable income. Given that these transfers are executed via travelers carrying cash (mostly in U.S. dollars) into Armenia, there is very little official information on the size of these transfers. However, anecdotal evidence suggests that they are substantial. Workers’ remittances, which are not shown separately, are also an important source of inflows of foreign exchange. Similarly, official data on them is virtually nonexistent.

Since independence, Armenia has received substantial external financing support in the form of official transfers. In 1994, US$187 million and US$47 million in grants were provided by the U.S.A. and the EU, equivalent to 80 percent and 20 percent of the current account deficit, respectively. Financing from Russia totalled some US$12.1 million. In 1995, total committed contributions have reached US$190 million, including US$122 million from the U.S.A. and US$50 million from the EU. In addition, contributions from Argentina, France, Italy, Japan, Netherlands, and the U.K. amount to another US$18.3 million. Together, these official transfers are projected to cover about half of the current account deficit for the year.

The EU is discussing exceptional financial assistance that could facilitate the repayment of two loans from 1992 and 1993 totalling ECU 58 million (equivalent to US$77 million).

f. Capital account

(1) Private flows

Most private capital flows have been disguised in the aforementioned large private transfers, and have completely bypassed the banking system, which is still viewed as highly risky. Some foreign direct investment (FDI) is likely to have taken place, although it cannot be disaggregated from private transfers. In the balance of payments tables, the staff show only a modest amount of FDI in addition to the sales of embassy buildings to the U.S.A, Russia, and the Islamic Republic of Iran.

Armenia maintains a very liberal policy on FDI, which is set out in the 1994 Law on Foreign Investments. Repatriation of profits or assets is without restrictions. In addition, foreign investors enjoy tax benefits. For joint ventures with foreign ownership of at least 30 percent, and with foreign capital of at least US$100,000, tax benefits include: (i) a profits tax holiday for the first two years, and a 30 percent enterprise profit tax discount for the subsequent five years; (ii) exemptions from import tariffs on selected capital goods and raw materials; and (iii) income tax holidays for the first two years.

(2) Official loans

Since independence, Armenia has contracted a significant amount of official foreign loans for various uses, including reconstruction work following the earthquake, construction of the transport sector, and trade credits. At end-June, 1995, there were 11 loans/credits (including guarantees) from multilateral sources, with commitments totalling US$380 million, of which the World Bank, the EBRD, and the IMF account for US$170 million, US$80 million, and US$121 million, respectively. From bilateral donors, there were ten loans/guarantees outstanding at end-June, with the total commitment amounting to US$175 million. Loans from Russia accounted for US$95 million, those from the EU were US$77 million, and the rest were from other bilateral sources.

During 1994, total disbursements were US$66 million, two-thirds of which came from multilateral sources. US$200 million is projected to be disbursed during 1995, about 90 percent of which will be from multilaterals. ECU 38 million (equivalent to US$50 million) was due to the EU on August 20, 1995, but was not paid.

3. External debt and outstanding balances

a. External debt

Following the breakup of the FSU, Armenia was one of the 11 signatories of the “zero option” agreement with Russia relieving it of any obligations for the former USSR’s external debt by forgoing claims on its external assets. 1/ Armenia’s overall indebtedness increased from US$32 million at end-1992 to US$130 million one year later and finally to US$200 million by end-1994. During 1992, Armenia’s main creditor was the EU. In 1993, Russia provided interest-free loans for the reconstruction work following the earthquake, which accounted for roughly half of Armenia’s external debt. Although these loans carried concessional interest rates, they were disbursed in Russian rubles but denominated in U.S. dollars. The composition of external debt reversed in 1994, when for the first time, disbursements from multilateral creditors, exceeded those of bilateral creditors. By end-June 1995, the total external debt of Armenia had reached US$310 million, equivalent to about a quarter of GDP, which is evenly split between bilateral and multilateral creditors.

The total outstanding stock of external debt is projected to reach US$350 million by the end of 1995. By that time, close to two-thirds of total official debt will be to multilaterals. The World Bank and the IMF are likely to be the largest creditors with possible exposures of US$100 million and US$75 million, respectively. Among the bilateral donors, Russia will dominate at US$100 million.

Total scheduled debt service of the contracted loans, including the undisbursed amount, was 0.5 percent of export of goods and nonfactor services in 1993, rose to 3.0 percent in 1994 and is expected to reach 23 percent by end-1995. 2/

b. Claims on Georgia

Old trade arrears owed by Georgia from 1992 and 1993 were converted into medium-term trade credits of US$10.6 million (signed in July 1993) and US$6.5 million (signed in July 1994). 1/ 2/ As of end-July 1995, there had been no payment made on the scheduled debt service. According to the authorities, at end-August arrears of US$3.2 million and US$1.6 million had thus been accumulated. Negotiations are ongoing to have the arrears and the loans rescheduled.

c. Outstanding balances vis-à-vis Russia and Turkmenistan

During 1993, commercial trade arrears to Russia of US$36 million emerged, reflecting by and large the Russian oil companies’ move to world market prices for crude. Adding interest and penalty charges, and subtracting Armenia’s trade surplus in 1994, the total outstanding late payments to Russia stood at US$34 million as of end-1994. A protocol was signed between Roscontract (Russia) and the Ministry of Materials and Resources (Armenia) on behalf of Armcontract on March 31, 1995, to regularize these claims into debt, which was to be repaid by October 1995. In the subsequent months, only US$1.2 million was paid, leaving a balance of US$32.8 million at end-August. Discussions are currently under way to reschedule the remaining balance.

Prior to 1995, Armenia had been diligent in remaining current on gas payments, having only had US$4.1 million in late payments at end-1994. In light of Armenia’s favorable record in paying for the gas, this modest amount was at first mutually recognized as a trade credit and was tolerated for several months. However, Armgazprom was unable to pay off this debt, and subsequently accumulated new arrears during the first seven months of 1995. As of end-July 1995, cumulative payments (in both cash and goods) fell short of cumulative gas imports by US$19.5 million. Appendix V describes in detail the clearing trade arrangement between Armenia and Turkmenistan.

4. Official reserves

From initial low levels, net international reserves were gradually built up to a level of US$8.2 million by the end of 1994. The gradual build-up in CBA reserves was facilitated by Government’s transfer of all official reserves to the CBA in December 1994 and the surrender of foreign exchange by enterprises. 1/ Gross reserves increased significantly from US$7 million at end-September to US$32 million in December 1994 as a purchase was made under an STF-supported program. Both gross and net reserves continued to increase as disbursements were made under a World Bank Rehabilitation Credit. At end-June, 1995, gross reserves were US$73 million, equivalent to 1.5 months of imports of goods and nonfactor services, and net reserves reached US$46 million. Gross reserves increased to over US$100 million in early July as Armenia made a second purchase under the STF-supported program and also made a first purchase under an SBA.

5. Exchange rate regime and developments

Upon the introduction of the dram in November 1993, the initial exchange rate against the U.S. dollar was set at dram 14.3. The rate proved to be unsustainable given limited reserves, macroeconomic imbalances, and rampant inflation. After early efforts to preserve the rate, it reached dram 230 by the end of March 1994. At that time, the official rate, which was the exchange rate for bank balances as determined in the foreign exchange auction at the Yerevan Stock Exchange (YSE) (“noncash market”), had converged to the rate observed in the exchange bureau market for cash foreign exchange (“cash market”) (Chart 10). 2/ As noted above, part of a package of emergency measures in March 1994 had included the imposition of large transaction fees on the withdrawal of cash from banks. These fees were soon reflected in a widening of the gap between the cash market and the noncash market, so that by end-April the difference between the cash and noncash rates had risen to almost 40 percent after being as low as 2 percent at end-March.

While the cash rate subsequently remained broadly stable through the end of May 1994, the official rate continued to depreciate. The tightening of fiscal and monetary policies in the second quarter helped both the cash and noncash exchange rates to appreciate in nominal terms through the end of the year. At the same time, the relaxation on cash transactions noted earlier helped narrow the gap between the cash and noncash rates.

The official dram exchange rate remained stable throughout the first half of 1995, moving within a band of dram 400–410 per U.S. dollar. At the same time, however, the average cash rate that prevailed in the foreign exchange bureaus had been consistently more depreciated. The stubborn wedge between the two rates was particularly pronounced during a brief depreciation episode in late April of 1995—triggered by a seasonal increase in demand for external current account transactions. However, the spread between the cash and noncash markets had all but vanished by mid-August, when the average auction rate was dram 410.3 per U.S. dollar, compared to bureau cash rate of dram 410.0 per U.S. dollar. During the first six months of 1995, the real effective exchange rate (REER) appreciated by 3.8 percent, reflecting a depreciation against FSU currencies of 3.5 percent and an appreciation against the non-FSU currencies of 6.9 percent. At end-June, the overall REER of the dram was 31.4 percent higher than it was a year ago (Chart 14).

Chart 14
Chart 14

ARMENIA: Effective Exchange Rates and Relative Prices 1/ 2/

Citation: IMF Staff Country Reports 1995, 111; 10.5089/9781451801408.002.A001

Source: IMF, International Financial Statistics; Staff Reports on Armenia. Georgia, the Russian Federation, and Turkmenistan; and staff estimates.1/ Effective exchange rates are calculated using total trade weights.2/ The partner countries included in the calculation are Belgium, France, Georgia, Germany, Iran, Italy, Netherlands, Russian Federation, Switzerland, Turkmenistan, and the United States.3/ Increase implies an appreciation.4/ Relative price movements of Armenia’s trade partners.

As at end-August, there were three auction markets—the YSE, the Gjumry Stock Exchange (GSE), and the Adamand Stock Exchange (ASE). 1/ Until July 1995, if banks wanted to trade with one another outside the auction they had to do so at the auction rate. This important restriction has now been removed.

6. Trade policy

a. Imports

A law on tariffs and a Customs Code approved in August, 1993, which was based on the Harmonized System of tariff classification, provided for the legislative authority for setting tariffs. In January, 1995, a new tariff structure was introduced by Government Decree No. 39. Five tariff bands at 0, 5 percent, 10 percent, 30 percent, and 50 percent apply to 132 product categories. The upper two bands affect only seven product groups, or fewer than one tenth of all imports. 2/ The upper two bands were established primarily to demonstrate an intention to exact higher tariffs on luxury goods. Nevertheless, given the number of products that are either zero-rated or exempted, the weighted average tariff remains below 5 percent.

Tariff exemptions are extended to all goods that originate from CIS countries. Goods associated with humanitarian aid, medical equipment, meat, agricultural and dairy products, sugar, crude oil derivatives and selected industrial raw materials are also exempt from import tariffs. In addition, enterprises with more than 30 percent foreign ownership also enjoy tariff exemptions on basic equipment.

The authorities intend to adopt a dual-band tariff structure with tariffs of 10 percent and zero percent. To broaden the tax base, it was understood that zero-rated products will be limited to staple foods, agricultural products, and raw materials that will be used intensively in the production of exports. Since 1993, import tariffs have been applied according to the “origin-principle.”

Government Decree No. 17 of January 1995, specified that nontariff restrictions remain in place against the importation of weapons, nuclear materials, illegal drugs, and the usual list of other goods that pose health, security, and environmental hazards. Import licensing requirements are limited to medicines, which are subject to approval by the Ministry of Health, and agricultural chemicals, which are administered by the Ministry of Agriculture.

b. Exports

Armenia maintains no export taxes and no quantitative restrictions on exports. Export licenses are required for textiles heading for the EU (in accordance with an agreement with the EU), and also for medicines, and selected live animals and plants for reasons of public health. As an antidumping measure, export prices of basic metals are subject to minimum, or “reference,” price floors, which are determined based on the quotations on the London Metal Exchange.

c. Trade agreements

Signed by nine countries of the CIS in 1993, the Treaty of Economic Union provides the framework for the eventual establishment of a customs union. 1/ Armenia also belongs to the 11-member Black Sea Economic Cooperation Organization. 2/ At present, Armenia is actively pursuing the accession to the World Trade Organization.

In addition to multilateral agreements, Armenia has signed numerous bilateral trade agreements to solidify stable economic ties with these countries. To date, bilateral free trade agreements (FTAs) have been signed with Russia, Ukraine, Moldova, Kyrgyz Republic, and Tajikistan. However, only the one with Russia has been ratified by both Parliaments, and, thus, is the only operational FTA. Clearing trade arrangements are still maintained with Russia and Turkmenistan, though the former has, as noted above, been inoperative since late-1994. The Government has voiced its intention to phase out clearing trade with Turkmenistan.

APPENDIX I

Table 1.

Armenia: Net Material Product by Origin, 1993–95 1/

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Source: State Department of Statistics.

Figures for 1995 are for the first and second quarters only.

Figures for 1993 have been converted to drams at dram 1 = 200 rubles.

Table 2.

Armenia: Labor Force, Employment, and Unemployment, 1992–94

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Source: State Department of Statistics

Excluding students

Includes farm and cooperative sector.

Total employed in state sector as percent of labor force.

Total employed in private sector as percent of labor force.

Registered unemployed as percent of labor force.

Difference between the labor force and total employed as a percent of labor force.

Table 3.

Armenia: Production of Selected Agricultural Commodities, 1992–94

(In thousands of tons)

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Source: State Department of Statistics.
Table 4.

Armenia: Index of Consumption of Various Food Products, 1991–94

(In kilograms/person, monthly average, 1991 = 100)

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Source: Household survey data provided by the Armenian authorities.
Table 5.

Armenia: Production of Selected Industrial Commodities, 1992–94

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Source: State Department of Statistics.
Table 6.

Armenia: Construction Activity, 1993–1995 1/

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Source: State Department of Statistics.

Figures for 1995 are for the first and second quarters only

Table 7.

Regulated Prices for Main Commodities and Services, 1992–95

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Source: Armenian authorities: and Fund staff calculations.

Prices are for Yerevan cits For other regions the price for sewerage services is 1 76 drams per cubic meter and for garbage rcmwal 720 drams per cubic meter.

Table 8.

Armenia: Consumer Price Index 1993–95

(January 1993 = 100)

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Source: State Department of Statistics.
Table 9.

Armenia: Average Monthly Wages in the State Sector, 1992–94 1/

(Current drams)

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Source: State Department of Statistics.

State sector only, budgetary and non-budgetary sphere

Table 10.

Armenia: Income, and Expenditures of the Population, 1992–94

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Source: State Department of Statistics.

Figures for 1993 have been converted to dram at the rate of dram 1 = rubles 200.

Table 11.

Armenia: State Government Operations. 1993–1995 1/

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Sources: Armenian authorities: and Fund start estimates.

Consolidated Accounts of the Republican government and the 58 local authorities

For 1994 includes drma 1.003 billion in clearing trade profits

In 1995. NTR includes $0 9 million in Q1 and $0 9 million in Q2 for the sale of an embassy property to Russia to offset interest due External interest is reported in gross terms

Grants of wheat and wheat flour and of olive oil

For 1994, includes dram 623 million in refunds paid to depositors in Russian hanks Also includes stipends and pensions paid by the budget

In 1995. includes dram 675 million in net lending to Nagorno Karabakh.

Privatization receipts sales of treasury bills, and in 1994 gold sales of dram 952 million to the Central Bank

Table 12.

Armenia: State Government Operations. 1993–19951/

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Sources: Armenan authorities, and Fund staff estimates.

Consoidated accounts of the Republican government and the 58 local authorities

Fourth quarter 1994 includes 0.9 percent of GDP in cleamg trade profits

For 1993. includes counterpart funds from distribution of wheat and medicines acquired via loans

Includes treasury bill sales and pnvatizabon receipts For 1994 also includes 0 5 percent of GDP in gold sales to Central Bank

Table 13.

Armenia: Pension Recipients and Average Pensions

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Source: Armenian authorities.
Table 14.

Armenia: Pension and Employment Fund. 1993–1995 1/

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Sources: Armenian authorities: and Fund staff estimates.

The Pension Fund was created in August 1991, and was augmented in March 1992 by the incorporation of the Employment Fund.

Table 15.

Armenia: Pension and Employment Fund. 1993–1995

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Sources: Armenian authorities, and Fund staff estimates.
Table 16.

Armenia: Unemployment Benefits, 1993–1995

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Sources: Armenian authorities; and Fund staff estimates.
Table 17.

Armenia: Budgetary Sector Employment

(In thousands of employees)

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Source: Armenian authorities
Table 18.

Armenia: Budgetary Subsidies, 1993–1995

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Sources: Armenian authorities; and Fund staff estimates.
Table 19.

Armania: Banking Sector Loans, 1992–95

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Source: Central Bank of Armenia.

Includes households.

Includes foreign exchange loans.

Includes overdue loans and overdue interest These figures differ slightly from the presentation in Table 22 due to coverage and timing differences.

Table 20.

Armenia Central Bank of Armenia Refinance Rales and Credit Auction Rates and Volumes 1/

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Sources: Central Bank of Armenia and Fund staff estimates

All interest rates are simple nominal rates and all volumes are expressed in millions of dram.

Table 21.

Armenia: Commercial Banks’ Interest Rates for Loans and Deposits in Dram, US$, and Russian Rubles

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Source: Central Bank of Armenia.
Table 22.

Armenia: Arrears to Banks

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Source: Central Bank of Armenia.

These numbers differ slightly from Table 19 because of coverage and timing differences.

Table 23.

Armenia: Imports

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Sources: Department of Statistics; and staff estimates and projections.
Table 24.

Armenia: Grain Imports

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Table 25.

Armenia: Energy Imports

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Sources: Ministry of Energy and the Department of Statistics.
Table 26.

Armenia: Gas Imports and Payments

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Source: Ministry of Gas and Energy and the State Department of Statistics.
Table 27.

Armenia: Services

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Sources: State Department of Statistics; and staff estimates.
Table 28.

“Sorry—the quality of the source document is insufficient to render this image into text.”

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Source: Based on amounts pledged at the CG meeting in November 1994 and March 1995, and a donars meeting on June 21, 1995, and a donars meeting on June 21, 1995.
Table 29.

Armenia: Foreign Loan Disbursement and External Debt

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Sources: Ministry of Finance; and staff estimates and projections.
Table 30.

Armenia: Debt Obligations to Russia

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Sources: Ministry of Finance; and staff projections.

Uniform installments during 1996–2000.

No interest charges.

Uniform installments during 1996–1999.

Annual interest rate of 2.5 percent

6- month U.S. dollar LIBOR + 1.

Uniform installments during 1996–2002.

Unofficial categorization into three sub-loans

Table 31.

Armenia: Debt Oligations to Bilateral Creditors Other Than Russia

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Sources: Ministry of Finance, and staff projections.

Principal and interest repayment in a lump sum paid on March 21, 1994.

1-month US dollar LIBOR.

The Loan amount was ECU 38 million.

Principal repayment due August 20, 1995.

6-month ECU LIBOR serviced in April and October.

The loan amount was ECU 20 million.

Principal repayment due April 30, 1996.

6-month ECU LIBOR serviced in January and July.

This is a Government loan guarantee.

Annual interest rate of 4 percent serviced in May.

Table 32.

Armenia: Debt Obligations to Multilateral Creditors

(In Millions of U.S. dollars)

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Sources: IBRD, EBRD; aad stiff projections.

6-month U.S. dollar LIBOR + 0.5 serviced in March and September.

Annual service fee of 0.75 percent.

Includes Social Investment Fund Credit and Highway Credit.

6-month US dollar LIBOR + 1 serviced ia April aad October.

This is a Government loan guarantee.

Annual interest charges of 0.5 percent on ESAF resources and the standard charges on GRA resources.

Table 33.

Armenia: Foreign Exchange Transactions

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Source: Central Bank of Armenia.

These figures only include CBA sales from its own resources.

Table 35.

Armenia: Auction Exchange Rates and Volumes 1/

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Source: Central Bank of Armenia and staff estimates

US$ volumes are in thousands, Russian Ruble volumes are in millions.

Differs from Table 30 because includes transactions on behalf of clients (eg. government).

APPENDIX II: The Government Restructuring Plan

As a prior action under the SBA, the authorities have finalized a plan to restructure the budgetary sphere. The plan calls for the elimination or merging of ministries to reduce their number from 57 at the beginning of the year to 23 by the end of 1995. In addition, the plan calls for an initial reduction of budgetary sector employment from an average of 391,600 in the first quarter of 1995 to 360,000 by the end of the year. A staffing review process will be conducted with an aim of identifying further staffing cuts that will reduce budgetary sector employment to 270,000 by the end of 1998. In concert with these employment reductions, the authorities intend to conduct a review of civil service wages that would lead to a five-fold increase in real budgetary wages by the end of 1998, and to a decompression of the wage structure. Even if the full amount of the authorities’ proposed real wage increase is not feasible, it should be possible to achieve a significant increase over the medium-term in real budgetary wages, which are presently extremely low (averaging less than US$7 per month in the second quarter of 1995). As a result of the continuing decline in real wages, the government wage bill changed from being relatively high by FSU standards in 1993 (7.5 percent of GDP, versus an average of 6.1 percent of GDP among FSU countries for which data were available 1/) to quite low (1.8 percent of GDP versus an average of 5.2 percent.

To put the proposed cuts in staffing in context, it is important to understand the present distribution of budgetary sector employment. Of the average 391,600 budgetary sector employees in the first quarter of 1995, about 38 percent were employed in the education sector, about 23 percent in the power ministries, and about 19 percent in health. Employment in most other sectors was significantly smaller. For example, employment in the legislative, executive and judicial branches (the core civil service) totalled less than 5 percent of budgetary employment. The distribution of the wage bill more or less mirrored the distribution of employment, with 34 percent of total wages going to the education sector, 23 percent going to the power ministries, and 19 percent to health. The highest average monthly wages were in the science sector (dram 2,800 per month) and the core civil service (dram 2,578 per month). Average salaries were lowest in the education sector (dram 1,748 per month).

Although the staffing review process has yet to occur, the authorities have given some preliminary indication of the employment cuts they expect to make. In relative terms, the sharpest reductions in employment would come in agriculture and communal services, where employment would fall by approximately 80 percent. Employment in the social and cultural sphere (predominantly health and education, but also culture, science and the social safety net), and in legislative, judicial and executive bodies is projected to fall by about 35 percent, but employment in the power ministries will fall by only about 5 percent. Employment in the education sector will fall by 32 percent, while employment in health will decline by 37 percent, according to the authorities’ projections.

Although the social and cultural sphere is not shouldering a disproportionate share of the proposed employment cuts in relative terms (the proposed cut in employment in this sphere is 35 percent relative to average first quarter employment, relative to a total projected decline in budgetary employment of 31 percent), because the social and cultural sphere accounts for nearly 70 percent of budgetary sector employment, a significant portion of the absolute number of employment cuts will have to come from this sector. In fact, approximately 80 percent of all jobs to be eliminated are projected by the authorities to come from social and cultural ministries. About 37 percent of all jobs to be eliminated will come from the education sector alone, with an estimated 48,100 jobs being cut. Another 21 percent of the total employment reduction is expected to come from health care, where employment is projected to decline by 26,800.

These employment reduction figures are of course preliminary, and therefore subject to change. However, the fact that about 57 percent of budgetary sector employment is in the health and education ministries will make sharp declines in employment in these sectors inevitable. Thus, it is clear that achieving the targeted reduction in budgetary sector employment by the end of 1998 will require not only a civil service restructuring plan but also significant changes in the way the Government delivers health and education benefits. For example, the Government is now considering adopting a fee for service requirement for some forms of health care, which would allow the responsibility for the wages of some health care providers to be shifted from the budget to hospitals and clinics.

Although the authorities intend to increase wages and salaries generally, some sectors will benefit more than others. For example, the nominal average salary in the education sector, which is currently the lowest, will increase by 1,114 percent between the first quarter of 1995 and the last quarter of 1998 according to the authorities’ plan, while average salaries in the power ministries will increase by only 599 percent. The largest increase will come in the core civil service, where average salaries (which are already the second highest) will increase by 1,391 percent in nominal terms. As a result, although the core civil service will represent only 4.4 percent of budgetary sector employment in the last quarter of 1998, it will account for 8.6 percent of the budgetary sector wage bill. The share of the wage bill devoted to education will increase to 41 percent, reflecting the relatively more rapid increase in wages in this sector, while the shares of the power ministries and of health will fall just one percent from their first quarter 1995 shares, to 22 percent and 18 percent, respectively.

APPENDIX III: Expenditure and Tax Arrears

In 1994 a significant volume of expenditure and tax arrears arose. Although problems with expenditure arrears appear to have been largely temporary, difficulties with tax arrears persist.

1. Expenditure arrears

The tight monetary policy followed by the CBA in 1994, combined with the lack of an adequate Public Expenditure Management system in Armenia to control expenditure, led to the creation in 1994 of significant expenditure arrears. Some expenditure arrears totalling about 2 percent of GDP occurred in 1993. In 1994, however, expenditure arrears increased to more than 6 percent of GDP. Nearly 34 percent of these arrears were related to capital expenditure, and about 14 percent were related to the power ministries. In addition, nearly 9 percent were related to contingent liabilities for the acquisition of grain. Although new arrears of nearly 1 percent of GDP were created in the first six months of 1995, the stock of budgetary arrears has actually declined, with net repayments totalling more than 3 percent of GDP (and the stock of arrears declining by more than 60 percent from its level at the beginning of the year).

2. Tax arrears

As noted in the text, in both 1994 and 1995 tax collections have been hampered by the presence of arrears on taxes. Despite the impression that tax arrears have exploded in recent months, in fact the flow of arrears in the first six months of 1995 is not significantly different than it was for the year 1994: in 1994 arrears equalled 20 percent of tax collections or 2.6 percent of GDP, while in the first six months of 1995 they have equalled 24 percent of actual collections or 2.5 percent of GDP. Moreover, most of the increase in the stock of arrears that occurred in 1995 came in the first quarter of the year: between January 1 and April 1, the stock more than doubled, but the stock on July 1 nearly equalled that on May 1. Nevertheless, certain administrative changes to the tax code that went into effect earlier this year have led the authorities to worry that the stock of arrears could grow rapid in the coming months. According to the new rules, enterprises now incur a tax liability for goods sold 90 days after they are shipped, regardless of whether payment has been received. The authorities adopted this rule because they believed that enterprises might be hiding the payments they receive for goods sold in order to evade taxes. However, the new rule will almost certainly contribute to some tax arrears from firms that are genuinely suffering from interenterprise arrears and therefore lack the funds to pay their tax bills. Although the rule has applied since January 1, the relatively low level of business activity in the first quarter of the year and the 90 day lag means that its full impact will not be felt until the third quarter of the year (or possibly even later in the case of the EPT, which is payable only on a quarterly basis).

Perhaps not surprisingly, the distribution of the stock of arrears by tax reflects the distribution of tax collections overall, with the largest arrears arising on the EPT, the VAT and excises. Much like overall tax collections, tax arrears also arise nearly exclusively from the state sector. In fact, about 80 percent of tax arrears are owed by 50 large state enterprises.

The authorities trace the emergence of tax arrears to three main sources, each of which is closely interrelated: the large stock of interenterprise arrears, the stock of budgetary arrears, and the clearing trade (which, in addition to creating arrears, demonetizes some transactions and thereby reduces the ability of firms to pay their taxes). While these have undoubtedly contributed to the problem, there are also other forces at work. First, the high rates of inflation and the depreciation of the dram have led to large nominal inventory and foreign exchange gains, and consequent increases in tax liabilities, that do not necessarily correspond to any increase in real wealth or ability to pay. Second, the penalty for late payment is fixed at 0.5 percent simple interest daily. At one time this 182 percent rate was significantly lower than bank lending rates, meaning that non-payment of taxes became an inexpensive source of credit that was surely exploited by some firms. With lower inflation and interest rates the 182 percent annual penalty rate is now extremely high in real terms, and there is a danger that the burden of penalties will become unsustainable for some enterprises. Finally, there is no doubt that administrative weaknesses in tax administration, particularly with respect to the audit function, have contributed to the problem of arrears.

As one means of addressing both the problems of budgetary and tax arrears, the authorities have conducted a large volume of netting operations, simultaneously canceling offsetting budgetary and tax arrears. In most cases these operations are conducted on a bilateral basis, where the amount in question is owed both by and to a single firm, but on occasion more complicated transactions have been carried out. Between January and July 1995 about dram 3.2 billion in netting operations had been conducted. However, the decline in the stock of budgetary arrears, which had fallen to dram 3.6 billion by July 1, will limit the authorities’ ability to rely on this resource in the future. The authorities are also contemplating other measures to reduce the stock of arrears, including creating an amnesty period during which firms with the largest arrears will be able to repay them without incurring additional penalties. In addition, they are considering using the new bankruptcy law to seize the assets of firms with large tax arrears, although the legal machinery needed to press charges has not yet been established.

APPENDIX IV: Summary of Tax System

(as at June 1995)

(All values in drams and multiples of the minimum wage)

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APPENDIX V: Gas Imports and Clearing Trade with Turkmenistan

With the imposition of the trade blockade, trading with Turkmenistan for natural gas became more difficult as foreign exchange dried up along with exports. In response, a rather complex system of clearing arrangement was established for trade with Turkmenistan. Sanctioned and supported by the Governments involved, specific contracts for balanced trade were agreed between state enterprises. The arrangement was deemed by Armenia to be not only necessary but also efficient, as the procuring and airlifting of Armenian goods to Turkmenistan could be orchestrated in a centralized manner.

1. The arrangement

The links between state enterprises involved in the clearing arrangements are depicted in Figure 1 (attached). On trade between Armenia and Turkmenistan, Armcontract (Armenia), under the auspices of the Ministry of Materials and Resources, would be responsible for procuring goods as payments for gas. On the other hand, Gosnab (Turkmenistan) would be responsible for receiving these goods, monetizing them, and subsequently turning over the receipts to Nebit (oil) and Gas Export Organization, which is the actual supplier of gas. A list of goods (roughly 160 products in the 1994 agreement) acceptable as payments are first agreed between Armcontract and Gosnab. Prices of these goods are then determined by the Governments of the two countries. Then, as long as Armenia remained in good credit vis-à-vis Turkmenistan, gas would be delivered to the Armgazprom (Armenia), which would in turn direct roughly 80 percent to Armenergo (electricity company), and the rest to chemical plants, enterprises, and households in Armenia. The contract specifies a 45-day grace period for the clearance of outstanding payments for gas, which are checked twice monthly.

2. What determines gas imports?

Currently Armenia receives gas only from Turkmenistan via a pipeline that traverses through Uzbekistan, Kazakhstan, Russia, and Georgia, before terminating in Armenia. For both 1994 and 1995, Armenia had contracted for gas supply equivalent to 6 MCM/day (or 2.2 BCM per year). The unit price is US$80 per KCM, US$30 of which is to be paid in cash and the rest in clearing exports. 1/ 2/ However, the contractual volumes are virtually meaningless, since actual deliveries are determined by a number of exogenous factors, particularly given the fact that Armenia is at the end of the gas pipeline. In fact, actual deliveries totalled only 0.87 BCM in 1994 and 0.81 BCM during the first seven months of 1995. During the first seven months of 1995, Armenia imported as much gas (805 MCM) as it did in the entire year of 1994 (868 MCM). The authorities have offered the following explanations:

a. Armenia has been getting more gas this year than in 1994 because the main thermo power plant in Georgia has been out of order, and thus Georgia needed less gas;

b. Georgia’s domestic demand for gas (and electricity) has declined due to the recent increases in the domestic gas price and the electricity tariff;

c. After the signing of the most recent rescheduling contract with Turkmenistan, Georgia may have decided that it had been consuming too much gas, relative to what it could afford. Also, the domestic civil strife that has plagued Georgia has subsided, and, in turn, has permitted greater discipline in the use of its own gas as well as in preventing the unauthorized use of Armenia’s gas;

d. On the part of Armenia, the depletion of Lake Sevan due to rising demand for irrigation needs and for hydroelectricity generation has caused an environmental problem that calls for emergency measures. Hydropower generation will be partially substituted by thermo (gas) and nuclear power generation. 1/

e. Though thermo power stations could use natural gas or mazut, the latter has been much more expensive than the former.

3. External arrears

As of end-1994, cumulative payments (in both cash and goods) fell short of cumulative gas imports by US$4.1 million, including arrears of US$10.8 million in cash and jewelry, and a net credit of US$6.7 million in clearing goods. Given that Armgazprom had been diligent in remaining current on gas payments, these moderate overdue payments had at first been tolerated and treated as a trade credit. However, by July 31, 1995, Armgazprom’s total arrears on gas payments had burgeoned to US$19.5 million, of which US$21.4 million was in cash, and a net credit of US$1.9 million in goods. Turkmenistan consequently formalized the arrears and began pursuing their collection.

4. Causes of these arrears

One of the factors that contributed to the increased difficulties in remaining current was that the clearing agreement with Turkmenistan in 1995 stipulates that 37.5 percent of the payments be made in cash (including hard currencies, soft currencies, gold, and jewelry) and the rest in goods. Coupled with the increased gas consumption and poor payments rates in Armenia, Armgazprom simply could not generate enough cash. In fact, domestic arrears on gas are substantial. Armenergo alone has at present arrears to Armgazprom of dram 6.9 billion (US$17 million, or 1 percent of GDP).

Second, the “quality” of the gas delivered from Turkmenistan deteriorated during 1995, as the pressure in the pipeline fluctuated too wildly for Armenian power plants and chemical plants to operate efficiently. Fluctuations in the gas pressure is somewhat analogous to varying frequencies and voltages in the electricity. The authorities cited a loss-ratio as high as 30 percent when the gas pressure varied. This, in turn, compromised the abf.lity of Armenian firms to produce efficiently and thus to make payments for gas.

Third, it has been reported that some gas that was destined for Armenia was lost enroute through Georgia. To rectify the situation, in an August 2, 1995 trilateral protocol signed with Georgia and Turkmenistan, Armenia agreed to pay for the gas that crosses the border of Russia and Georgia, and, in turn, Georgia agreed to safeguard the full-delivery of it within its territories for an explicit transit fee. Specifically, the protocol specifies that:

a. Armenia will pay Georgia a transit fee of US$3.6/KCM (equivalent to US$1.5 per KCM per 100 kilometers) in cash;

b. Georgia will guarantee the full delivery of gas, and will pay US$80/KCM in cash for any gas that gets “lost” in transit through Georgia;

c. Turkmenistan will ship 1,082 CM of gas for US$80. This will include 45 CM of gas-equivalent for the transit fee and 27 CM of “free” gas.

Appendix VI: Purchasing Power Parity, Income, and the Real Exchange Rate

This note suggests that, based on illustrative calculations, the current exchange rate for the dram may be significantly undervalued on a purchasing power parity (PPP) basis against the U.S. dollar; and, therefore, there may be considerable scope for real appreciation in the medium-term.

1. PPP

PPP, sometimes referred to as the generalization of the “law of one price,” argues that the real purchasing power of money should be equalized across countries. In this strict form of PPP, known as the “absolute PPF,” the real exchange rate (R), is defined as the ratio of foreign price level (E x P*, where E is the nominal exchange rate and P* is the foreign price level in terms of foreign currency) to the domestic price level in terms of domestic currency (P). If absolute PPP holds, R is equal to unity. However, due to structural reasons related to, inter alia, the relative level of development, market power, trade barriers, and differences in the propensity to trade between countries, price equalization is in practice far from the norm.

A weaker form of PPP, or “relative PPP,” stipulates that, in the absence of shocks, the long-run equilibrium real exchange rate should be constant, though the price levels may diverge. Since R - EP*/P, in terms of rates of change, r - e + p* - p = 0. This implies that nominal exchange rate movements primarily reflect divergent rates of inflation.

2. Absolute PPP and relative PPP

As a simple test of the absolute PPP, a representative basket of goods and services was selected. Goods subject to administrative price controls in Armenia were not included in the basket. CPI weights in both Armenia and the U.S.A. were used to calculate how much it would cost to purchase the basket in each country. 1/ The calculations show that the discrepancy in real purchasing power is large, implying that absolute PPP would be preserved with a significant real appreciation of the dram. A simple test of the relative PPP was also conducted and yielded similar results. However, the usual caveats about PPP apply (see below).

3. Caveats about PPP and implications on inflation

Although PPP is one of the simpler approaches that can be taken in examining the “appropriate valuation” of a currency, it is certainly not without limitations. The “ppp” exchange rate is not necessarily an “equilibrium” exchange rate and the PPP can consistently underestimate or overestimate actual market exchange rates. This is particularly so for low income countries. The absolute PPP is also a static measure and takes no account of the equilibrium adjustment path for the exchange rate. There are also a number of other considerations that must be borne in mind when interpreting the results of such tests. First, the exchange rate implied by a PPP test makes no allowance for, among others, domestic demand and, more specifically, the stance of financial policies. Second, the economic blockade faced by Armenia has added a large transaction cost component to prices. Third, significant quality differentials may exist between the goods consumed in Armenia and those abroad. Fourth, insofar as a discrepancy exists between the productivity growth of the tradables sector and that of the nontradables sector, domestic inflation could diverge from foreign inflation, and the real exchange rate would adjust accordingly. 1/ Although these qualifications regarding the PPP calculations clearly suggest that the issue of the valuation of the dram would need to be revisited, they are unlikely to reverse the conclusion that the dram may be significantly undervalued.

4. Inflation, exchange rates, and income

As another check for the valuation of the dram, the dollar wage rate was also examined. At end-1994, the dollar rate on the dram and the average monthly wage rate stood at 412 drams/U.S. dollar and 4,500 drams, respectively, suggesting a dollar-equivalent average wage of some US$10.9 per month. The relatively low dollar-wage rate in Armenia compared to other FSU countries can be attributed to the low stock of physical capital and the aforementioned undervaluation of the dram. Dollar wages are expected to rise as labor productivity and the capital stock rise.

Appendix VII: The Exchange and Trade System

(Position as of August 15, 1995)

1. Exchange arrangement

The currency of the Republic of Armenia is the dram, which is the sole legal tender. 1/ The official exchange rate against the U.S. dollar is determined on the basis of the average rate prevailing in the interbank foreign exchange auctions held by the YSE. These auctions are held three times a week. Auctions held at the Gjumry and Adamand exchanges ensure that at least a total of five foreign exchange auctions are held every week. Foreign exchange transactions can also he executed in the interbank market outside the auction. On August 7, 1995, the average noncash auction rate was dram 410.01 per US$1, and the midpoint of the exchange bureau cash rates was dram 412.5 per US$1.

The official rate must be used for accounting valuation of all foreign exchange transactions of all economic agents. Exchange rates for other major currencies are calculated either on the basis of quotations on the YSE, when applicable, or solely on the basis of quotations for the U.S. dollar in major international interbank markets against the currencies concerned.

Enterprises or any other physical or juridical persons (including state enterprises) are free to buy and sell foreign exchange without restriction through authorized banks. Forward transactions, futures and options in foreign exchange transactions are permitted.

2. Administration of control

Central Bank Decision No. 33 (May 17, 1994) sets out the principles and procedures for foreign exchange and currency transactions between residents and nonresidents. The CBA has overall responsibility for regulating financial relations between Armenia and other countries in close collaboration with the Ministry of Finance.

Banks are granted two types of foreign exchange licenses. A general license gives a bank authority to conduct any type of foreign exchange transactions, including those with nonresidents abroad and including gold transactions that are licensed separately. Banks with a full license may offer a full range of currency transactions, including gold. A second more restricted form of activity, included in licenses to operate as a bank in Armenia, allows banks only to buy and sell foreign exchange, only on behalf of their clients.

3. Prescription of currency

Settlements with other states are made through correspondent accounts maintained by the central banks or commercial banks of these countries, and can be made through any other channel. Settlements with countries with which Armenia maintains bilateral payments agreements are effected in accordance with the terms of the agreements. 1/ Settlements with all other countries may be made in any currency.

4. Resident and nonresident accounts

Under Central Bank Decision No. 30 of May 16, 1994, residents may open and maintain foreign exchange accounts in banks abroad with a prior notification to the CBA. Residents may also open, maintain, and use foreign currency accounts at licensed banks in Armenia. There are no limits on the amount of foreign currency bank notes that can be purchased with drams from banks, and the bank notes can be deposited in a foreign exchange account or used for transactions with nonresidents. Resident enterprises may maintain and use foreign exchange accounts in banks abroad with the authorization of the CBA. The opening and use of domestic foreign exchange accounts are not restricted, except that residents may not transfer these balances to other residents for make payments for goods and services to other residents.

Nonresident natural and juridical persons may now freely open and use foreign exchange accounts with licensed domestic banks according to Central Bank Decision No. 214 (July 28, 1995). Balances in these accounts may be transferred abroad or sold to the licensed domestic banks for drams. Legislation is being developed to allow nonresident juridical persons to open accounts in drams. Foreign governments and international institutions may freely open dram accounts with banks in Armenia without prior authorization from the CBA.

5. Imports and exports

Imports of a number of products are restricted for public health, national security, and environmental reasons. A license from the Ministry of Agriculture and the Ministry of Health is required and granted on a case-by-case basis, to import medicinal preparations and chemical agents for plant protection (pesticides). Imports of weapons, military equipment and parts, and explosives require special authorization from the Government. The Agreement on Creation of Free Trade Zone signed in April 1994, establishes the legal framework for the signing of free trade agreements between Armenia and other CIS countries. To date, bilateral free trade agreements have been signed with the Kyrgyz Republic, Moldova, Russia, Tajikistan, and Ukraine, but only the one with Russia has been ratified.

Customs tariffs are exempt for products imported from countries in the CIS. Government Decree No. 39, passed on January 27, 1995, established new tariff duties. This decree sets five rate for import duties. While the import rates are zero, 5, 10, 30, and 50 percent, most imports are zero-rated. All exports are zero-rated.

According to Government Decision No. 17 of January 17, 1995, export licenses are required for three product groups: medicines, wild animals and plants, and textile products heading for the EU. In addition, special government permission is required for the export of nuclear technology, nuclear waste, and related non-nuclear products, and technology with direct military applications. Minimum threshold prices for the export of ferrous and nonferrous metals and foreign produced goods thereof remain in force. By Government Decree No. 615, passed on December 10, 1994, all restrictions on barter trade have been removed. Proceeds from exports must be repatriated within 30 days of receipt, and as of January 1, 1995, 30 percent of the proceeds had to be surrendered. Expenses, commissions, and taxes paid abroad relating to exports may be deducted from export proceeds prior to repatriation. As of April 1, 1995, export receipts are no longer subject to surrender requirements.

6. Payment for and proceeds from invisibles

Resident persons and enterprises may freely purchase foreign exchange or use foreign exchange balances in their foreign exchange accounts with domestic banks to make payment for current international transactions respecting invisibles. The CBA is formulating verification procedures. There are no limits on foreign exchange allowances for travel.

Proceeds from cultural activities performed abroad are exempt from the repatriation requirements. Proceeds from other invisibles are subject to the same regulations as those applicable to proceeds from merchandise export.

The importation of foreign currency bank notes is not restricted. At present, the exportation of foreign currency bank notes is not restricted, although a declaration needs to be completed for amounts exceeding US$500.

7. Capital

Foreign investors, including joint ventures, are not required to obtain authorization from the Ministry of Finance. A foreign investment law was passed in July 31, 1994; it reflects current international practices and is liberal in its treatment of foreign direct investment. Other inward and outward capital transfers require approval from the Ministry of Finance.

8. Gold

A license is required to conduct trade in gold. There are no regulations currently in force governing domestic trade in gold, and regulations on purchase, sale and holdings of gold and precious metals by banks have been prepared by the CBA’s International Department, adopted by the CBA Board. The modalities of its implementation will be finalized shortly after which it will enter into force, currently expected in September 1995.

9. Changes during 1993–95

a. Exchange arrangement

March 1, 1994. The dram became the sole legal tender in the Republic of Armenia.

b. Administration of control

1993. The laws on the central bank and on banks and banking activity accorded to the Central Bank the overall responsibility for regulating foreign exchange transactions.

December 1, 1994. Banks with a full foreign exchange license were required to offer at least a minimum set of international transactions services.

c. Capital

July 31, 1994. A Foreign Investment Law was passed.

July 28, 1995. Decision No. 214 allowed nonresidents to open accounts with Armenian banks without restrictions.

July 28, 1995. Interbank foreign exchange transactions are now permitted.

10. Changes during 1995

a. Imports and exports

January 1995. The number of categories for which export licenses are required was reduced from nine product groups to three.

January 1995. The new customs law reduced the number of tariff rates to five, with most imports being zero-rated.

January 1, 1995. The surrender requirement on export receipts was reduced from 50 percent to 30 percent.

April 1, 1995. The surrender requirement on export receipts was eliminated.

APPENDIX VIII: Fund Technical Assistance Missions

Table 1:

Armenia: Fund Technical Assistance Missions: 1992–1995

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Appendix IX: Statistical Issues

The authorities have made considerable progress in improving the compilation and reporting of statistics over the past few months and have consistently shown willingness to follow technical assistance missions’ recommendations. Data on the CPI, exports/imports and overall government balance are now compiled on a monthly basis, 1/ data on interest rates are available twice a week and data on international reserves, base money and exchange rates are available on a daily basis. Summary banking system information will soon be available on a weekly basis. Nevertheless, weaknesses still remain in several areas especially with regard to international comparability of the data.

1. National account statistics

The problems inherent in the national accounts were set out in detail in SM/94/156 dated June 24, 1994. Briefly these problems include incomplete coverage, reporting difficulties, and valuation uncertainties. There is also a dearth of information on GDP expenditure. In addition, methodological problems with the deflator make it impossible to compare real output in one quarter with real output in the next. Given the absence of better estimates, the staff has worked with official annual nominal GDP and real growth data provided by the authorities. Because of the unusual pattern of reporting within a year, however, the staff has made estimates for nominal GDP for the first half which differ from officially reported figures. 2/ Staff estimates are used for analyzing fiscal and external performance in 1995.

The authorities are receiving considerable assistance from the OECD to reclassify and re-estimate the accounts according to SNA methodology and to enhance coverage. Work on re-estimating the GDP for 1993 and 1994 is currently in progress.

The authorities need now to focus on the compilation of an appropriate point-to-point GDP deflator. Although the staff has developed an alternative method of estimating nominal GDP by using expected average inflation and real growth, this method involves using a smoothing process to derive quarterly GDP. While the smoothing process is consistent with the observed seasonality in output, it is likely that this pattern will change as the structure of the economy changes and may yield inaccurate estimates over time.

2. Price statistics

The authorities report a monthly CPI which is fairly reasonable in its coverage and compilation. However, other price indices are not comparable internationally. For example, because of the way enterprises report prices, the current Wholesale Price Index (WPI) reflects changes in the cost of production, rather than the price received by the producer of the product. In line with recommendations made by Fund technical assistance missions, the authorities are planning to replace the WPI with a Producer Price Index based on methodology recommended by the Fund. The Fund is also helping with the development of export and import price measures.

3. Fiscal sector

Government finance data suffer from the following coverage, classification, and methodological deficiencies: (i) most foreign-financed expenditure is not included in the budget; (ii) unlike republican government cash data, which are available monthly with minimal delays, local government expenditure data are available on a quarterly basis only, and with a lag of several weeks; (iii) expenditure data on an accrual basis are available only with a substantial lag, and are subject to frequent (generally upward) revisions. This situation is unlikely to improve before the authorities implement a treasury system; (iv) the present classification code by Articles does not provide sufficient detail to enable a complete classification of expenditure either by function or by economic type. In line with the authorities’ objective of introducing an economic classification of expenditure, the current classification needs to be revised and expanded to generate more details; and (v) the changes in government deposits with the CBA and the commercial banks are not included in the compilation of financing, although for monetary programming purposes, a reconciliation between the fiscal deficit and its financing is typically available.

3. External sector

Despite considerable improvements in the collection and compilation of balance of payments statistics, the quality and coverage of official data remain inadequate in several areas. Of particular concern are services, private transfers, and private capital flows, all of which have to be estimated from scant and tenuous official data and anecdotal evidence. Robust trade data is still lacking due to inadequate coverage of customs for trade along the porous border with Georgia. The basis for estimating trade activities has also changed. Since the start of 1994, customs data has been used. This and other fundamental changes in the methodology of compiling the balance of payments imply that comparisons of post-1994 developments with earlier periods may be subject to qualifications.

While significant improvement has been made in the compilation of balance of payments statistics, weaknesses remain in three main areas. On trade data, the customs coverage of the border with Georgia is still inadequate, as a significant amount of trade crosses the porous border without being captured by official data. Second, private transfers are judged to be large, though, due to its veiled nature, official quantification is difficult. Third, an enterprise survey to measure services and nonbank financial flows needs to be introduced to gather data on important items now missing in the balance of payments accounts.

4. Monetary statistics

Although the quality of monetary data has improved considerably, the authorities have yet to implement, or have only partially implemented, a number of recommendations relating mainly to the classification of foreign currency accounts between resident and nonresident sectors, the definition of Armenia’s official external reserves, the reconciliation of interbank accounts, and the proper recording of IMF-related accounts. MAE has placed an accounting advisor in the CBA to expedite the introduction of a new chart of accounts for the CBA. The accounting chart is being designed to also cover the needs of the users of monetary statistics.

The CBA prepared a detailed annual report for 1994. The report, which was also published in English, discusses economic developments, monetary and credit policy, foreign exchange policy, banking supervision, and the development of the payments system. The report also contains a monthly monetary survey and CBA balance sheet. A summary accounting balance sheet is also provided.

Appendix X: Environmental Issues

Armenia has faced a variety of environmental problems in recent years, and the Government is beginning to take steps to turn them around. The 1988 earthquake in the northern city of Gyumri, Armenia’s second largest city, killed 25,000 people and left 500,000 homeless. Several structures in the city with interiors that were decimated by the earthquake remain standing precariously without guarding walls. Makeshift bungalows now crowd the city landscape, and 19,000 families are still homeless. While a major public housing project (known commonly as “sector 58”) provides reasonable shelter for some 25,000 families, the city is suffering from overcrowding and concomitant sanitation and disease risks. The severe winters and the inadequately insulated housing structures, combined with massive unemployment and expensive and scarce fuel supplies, have caused people to deforest the surrounding landscape and has led to aridity and soil erosion.

The capital city of Yerevan, in the south-center of the country, escaped earthquake damage, but faces a potential environmental threat due to the planned re-opening of the Medzamor nuclear station by end-September. The station, situated 30 kilometers to the west of Yerevan, lies on a seismic fault line, and had been deemed unsafe for operation by several international atomic energy experts. Preliminary testing of the site began in June, and the French government is discussing provision of assistance (of the order of US$5 million) to modernize the safety features of the plant. Given the current shortage of electrical power in Armenia, this station is a crucial resource, providing from 10 to 20 percent of the country’s total electricity needs when fully operational. The urgency for this station to come back on line is exacerbated by the high cost of running the three gas- or oil-powered stations as well as the current (albeit) temporary shutdown of the Gyumush-Ges hydroelectric power station, one of the eight major hydrostations in the country. Repairs on the hydrostation to restore a damming wall--which broke on May 8--will require an investment of US$15 million, and the station should be operational again by the end of this year.

The air quality of Yerevan is less than optimal due to the “crater effect”, i.e., Yerevan’s location in the Ararat Valley surrounded by mountains that trap air pollutants. While only a few cars are driven in the capital city, and limited public transport operates, the low grade of leaded gasoline used in these vehicles creates a degree of smog. The lack of electricity combined with the restructuring of enterprises, has the single advantage that there are few factories operating--and thus contributing to air pollution. The Ararat Valley has also suffered from soil damage due to poor irrigation and water management practices, exhaustion of arable land, and deforestation for winter fuel.

An ongoing environmental concern has been the quantity and quality of the water in Lake Sevan, a large mountain lake situated in the center of Armenia. The water level of this lake fell by 20 meters during the last 60 years due to extensive water usage in the surrounding area, not only for hvdroelectricity generation but also for irrigation and industrial/household use. This depletion of water volume in the lake, combined with fertilizer/pesticide runoff and untreated sewage disposal, has threatened the ecosystem of the lake, which contains some unique species of fish. The Government will soon pass a decision to limit how much water can be taken from the lake, and the world Bank has arranged a grant through the Institutional Development Fund to restore the ecosystem.

Appendix XI: Armenia: Measures under the Programs supported by the STF and the SBA

(as at September 9. 1995)

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1/

For detailed information on developments in the real sector, see Appendix I tables 1-10.

2/

Composition of output is available only in terms of net material product.

1/

The low gas imports were mainly because of disruptions in the pipeline caused by political instability along the borders, rather than demand factors.

1/

Mills and bakeries have not yet been privatized and are still subject to profit margin restrictions.

1/

See Appendix III for details on tax arrears.

1/

For detailed information about the fiscal sector, see Appendix I, Tables 11-18.

2/

The authorities’ presentation of the budget differs from that contained in this report in two important respects: the authorities record most externally financed capital expenditure off-budget, and record under grants only the value of the counterpart funds received by the budget from the distribution of humanitarian assistance, ignoring any implicit expenditure from the distribution of this assistance at below-market prices.

1/

Specific details about tax rates and coverage for each tax are contained in the attached Tax Summary (Appendix IV).

2/

Over the last several months, the authorities have introduced numerous changes to the VAT. In January 1993 the VAT rate was reduced from 28 percent to 20 percent and exemptions–which were already numerous–were increased by exempting several food items. In February 1994 exemptions were removed for gas, electricity, telephone, radio, non-electrical urban transport, school fees, and theatrical, educational and cultural performances. Exemptions were also removed for funeral services, and for goods and services used by diplomatic personnel in Armenia. VAT exemptions for butter, sugar and edible oils were also removed, effective July 1995.

1/

In December 1994 a number of exemptions were removed from the EPT. The exemption for profits arising from increased production of selected goods deemed to be of national importance was removed, as was the exemption for expenditures related to maintaining rest homes, preschools, retirement homes, and educational, health and cultural facilities. The exemption for 30 percent of expenditure on environmental protection, and for 30 percent of payments to the State Employment Fund were also eliminated. Finally, deductions for interest on long-term debt and for profits from lending to finance state capital investments were also removed. The profit tax law has also been amended so that beginning on January 1, 1996 the rate charged on profits of banks and insurance companies will be reduced from 45 percent to 30 percent, the top rate applying to other types of enterprises under the tax.

2/

In January 1995, Parliament approved a new income tax law that went into effect on April 1. Under the new law, incomes lower than ten times the minimum are taxed at a 12 percent rate, incomes between ten and 20 times the minimum wage are taxed at an 18 percent rate, incomes between 20 and 40 times the minimum wage are taxed at a 25 percent rate, and incomes in excess of 40 times the minimum wage are taxes at a 30 percent rate. In addition, the exemption for military personnel was reduced from ten times the minimum wage to eight times.

1/

Effective January 1, 1995 the number of excise tax rates was reduced from 11 to 2, the base was enlarged, and the nominal rates applied to imported products were increased so as to match the nominal rates charged on equivalent domestic products. Because the rates are applied on a tax-inclusive basis for domestic products and a tax-exclusive basis for imports, domestic production is still taxed relatively more heavily than are imports. Excises are currently charged at a 50 percent rate on hard liquor and handmade carpets, and at a 25 percent rate on beer, wine, cigarettes, jewelry, furs, automobile tires, porcelain and crystal.

1/

In 1994 and 1995 transfer payments also increased because of certain extraordinary items: in 1994 the budget paid dram 623 million (0.3 percent of GDP) to reimburse individuals who had lost deposits in Russian banks. In addition, in both 1994 and 1995 the budget incurred liabilities for loans that it had guaranteed and on which the borrowers had defaulted. Liabilities for interest and principal on these loans—which included loans to a flour mill and three bakeries as well as to Armenergo and other entities—constituted about 0.6 percent of GDP in 1994 and 0.9 percent of GDP in the first six months of 1995.

1/

For detailed information on the monetary sector, see Appendix I, Tables 19-22, and Tables 33-34.

1/

These controls are discussed in more detail in Section 3 (b).

1/

In compound terms, the interest rates are 600 percent and 2,200 percent, respectively.

2/

Underlying inflation excludes administered price increases which added approximately 2 percent per month to headline inflation in April and May.

1/

Some cash payments were subject to lower charges. The details are set out in CBA Decision Number 5, March 11, 1994.

1/

These changes are set out in Central Bank Resolution No. 78, April 1995 as amended by Resolution No. 88, May 1995.

2/

As at July 1, 1995 only 11 banks would have complied with this requirement.

3/

CAMEL is an acronym denoting a framework which takes into account Capital Adequacy, Asset Quality, Management, Earnings, and Liquidity, when assessing the soundness of a bank.

4/

A total of 21 banks reported losses for the year.

1/

For detailed information on developments in the real sector, see Appendix 1, Tables 23-34.

1/

The signatories are Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Moldova, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.

2/

Excluding the ECU 38 million repayment to the EU in August, the debt service ratio for 1995 is 10.5 percent.

1/

These trade arrears arose partly from the gas diverted from Armenia and used by Georgia during 1993 and 1994.

2/

These credits carried terms of one year of grace and four years of maturity, and an interest rate of LIBOR(US$) + 1.

1/

The surrender requirement on export receipts was lowered from 50 percent to 30 percent on January 1, 1995, and was subsequently eliminated on April 1, 1995.

2/

An agreement setting up the interbank auction was signed between authorized commercial banks and the YSE on February 24, 1994. The timing of the initial auctions was irregular. By July they were held twice weekly and settlement was being made within two days as compared with the original five days. The auction initially transacted in both cash and noncash, but by the second half of the year almost all transactions were noncash.

1/

Auctions take place thrice weekly at the YSE and weekly at the other two auction markets.

2/

Five product groups, including certain luxury goods and fur clothing, carry a 30 percent tariff, while the 50 percent tariff is applied to only caviar and gourmet pet food. In practice, however, virtually all of the latter two product groups are imported from Russia, and, thus, are exempt from tariffs anyway.

1/

Signatories are Azerbaijan, Armenia, Belarus, Kazakhstan, Kyrgyz Republic, Moldova, Russia, Tajikistan, and Uzbekistan.

2/

The member countries are Albania, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania, Russia, Turkey, and Ukraine.

1/

Armenia, Azerbaijan, Belarus, Estonia, Georgia (for 1994 but not 1993), Kyrgyz Republic, Latvia, and Turkmenistan.

1/

BMC denotes billions of cubic meters, MCM millions, and KCM thousands respectively.

2/

While both the 1994 and 1995 contracts stipulated the 30–50 payment terms, these terms were enforced only starting 1995.

1/

In 1993 and 1994, 1.7 and 1.1 MCM of water was taken from Lake Sevan for various uses, including powering hydro power stations. In 1995, the ceiling of 0.510 MCM of use of water in Lake Sevan has been set. which would permit 0.17 MCM for irrigation, and 0.24 for hydropower stations.

1/

The goods included in the exercise include cereals and bakery products, meats, poultry, fish and eggs, fruits and vegetables, dairy products, sugar, alcohol and tobacco, gas and electricity, clothing, public transportation, and medical care services.

1/

This divergence in inflation rates can still exist even in a fixed exchange rate regime or in a currency board arrangement.

1/

The dram became the sole legal tender with effect from March 1, 1994.

1/

At the end of 1994, Armenia maintained a bilateral payments agreements with the Russian Federation and Turkmenistan and bilateral clearing agreements with other states of the former U.S.S.R., but only the one with Turkmenistan is operative.

1/

Some lag in availability still persists.

2/

This pattern is demonstrated by the official GDP figures for the fourth quarter of 1994 and the first quarter of 1995. The authorities’ data imply a fall in output in nominal terms of approximately 60 percent.

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Cover IMF Staff Country Reports
Armenia: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 1995: Issue 111
Publisher:
International Monetary Fund
ISBN:
9781451801408
ISSN:
1934-7685
Pages:
156
DOI:
https://doi.org/10.5089/9781451801408.002
Chart 1

ARMENIA: Growth and Composition of Real NMP

(1992 - 1994)
Chart 2

ARMENIA: Inflation

(Monthly percentage changes) 1/
Chart 3

ARMENIA: State Sector Real Wages
Chart 4:

ARMENIA: Labor Force (In percent), 1993 - 1994
Chart 5

ARMENIA: Regulated Prices for Main Commodities and Services

(Current drams)
Chart 6

ARMENIA: Public Finance
Chart 7.

ARMENIA: Composition of Tax Revenues, 1993 - 1995 1/

(In percentage of total tax revenues)
Chart 8.

ARMENIA: Composition of Current Expenditures, 1993 - 1995 1/

(In percentage of total current expenditure)
Chart 9

ARMENIA: SELECTED MONETARY INDICATORS
Chart 10

ARMENIA: Official and Cash Market Rates for USD
Chart 11

ARMENIA: Current Account Balance, Debt and Debt Service
Chart 12.

ARMENIA: Commodity Composition of Exports, 1993 - 1993 1/

(In percentage of total)
Chart 13.

ARMENIA: Commodity Composition of Imports, 1993 - 1995 1/

(In percentage of total)
Chart 14

ARMENIA: Effective Exchange Rates and Relative Prices 1/ 2/