Armenia
Recent Economic Developments
Author: International Monetary Fund
Publication Date:
19 Dec 1995
ISBN:
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/

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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.

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

Mostly scrapped construction.

Table 2.

Armenia: Net Material Product by Origin, 1992–94

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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/

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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)

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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