Republic of Armenia
Recent Economic Developments and Selected Issues
Author: International Monetary Fund
Publication Date:
29 May 2001
eISBN:
9781451801446
ISBN:
9781451801446
Language:
English
Keywords:
ISCR; CR; government; company; cash flow; Armenian authorities; bridge financing; distribution company; financing gap; government deposit; account receivable
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This report provides an overview of the recent economic developments in Armenia by analyzing its output growth, prices, wages, employment, public finances and social safety net, monetary and exchange rate developments, balance of payments, external debt developments, and exchange and trade system. The study evaluates the tax system reforms; outlines the present structure of the energy and other major quasi-fiscal sectors, and reviews the causes of the financial imbalances. The appendix provides a characterization of the publicly-owned utility providers that contribute to the financial problems of the energy sector.

Abstract

This report provides an overview of the recent economic developments in Armenia by analyzing its output growth, prices, wages, employment, public finances and social safety net, monetary and exchange rate developments, balance of payments, external debt developments, and exchange and trade system. The study evaluates the tax system reforms; outlines the present structure of the energy and other major quasi-fiscal sectors, and reviews the causes of the financial imbalances. The appendix provides a characterization of the publicly-owned utility providers that contribute to the financial problems of the energy sector.

I. An Overview of Recent Economic Developments in 1999 and 2000

A. Introduction

Background

1. Following the cease-fire in the conflict over Nagorno-Karabakh, real GDP began to recover in 1994, growing on average by nearly 6 percent a year during 1994-98 (Table 7). Armenia experienced a dramatic decline in inflation since 1994, with period average consumer price inflation dropping from over 5,000 percent in 1994 to near 200 percent in 1995 and to less than 9 percent in 1998.

2. The fiscal deficit declined steadily from 1995-98, with most of the adjustment coming from expenditures. Increases in tax revenues were partly offset by declining nontax revenues and grants. Throughout this period, the deficit was financed primarily by external sources, although net external financing declined over the period in relation to GDP.

3. The external current account deficit declined from 1995-98, supported by the fiscal adjustment during the period. Capital flows strengthened during this period, reflecting increased foreign direct investment (FDI). The net result was a substantial increase in gross official international reserves, from 1½ months of imports at end 1995 to nearly 4 months of imports at end-1998.

4. Following reserve money growth of 700 percent in 1994, monetary policy was tightened significantly, and by 1998 the rate of growth of reserve money had been reduced to 6½ percent. The management of reserve money was complicated by volatile capital flows from abroad.

Overview

5. The Armenian economy experienced a number of shocks during the 1999-2000 period, first in the aftermath of the Russian economic crisis in August 1998, and later as a result of the political assassinations in October 1999. Developments during the period reviewed will generally be divided into the periods before and after October 1999.

6. In the first quarter of 1999, the exchange market came under considerable pressure and the Central Bank of Armenia (CBA) responded by selling foreign exchange in the interbank market, thereby averting a potentially significant depreciation of the dram. Following this, in the run-up to the parliamentary elections in May 1999, revenue shortfalls and slippages in implementation of measures subject to World Bank conditionality led to a build-up of budgetary expenditure arrears. The revenue shortfalls were addressed by means of a package of tax increases and expenditure cuts effective in August 1999.

7. The assassination in October 1999 of the prime minister and the speaker of parliament, along with six other parliamentarians and cabinet members, led to a period of political instability, a decline in economic activity, and a rapid build-up of budgetary expenditure arrears. Political uncertainty continued in the first half of 2000 leading to shortfalls in tax revenues, further slippages in the implementation of measures subject to World Bank conditionality, and a continued rapid accumulation of arrears. The political situation stabilized begining in June 2000, when the president appointed a new prime minister and parliament approved a new government. Since June, tax revenues have shown a steady recovery and, by end-2000, budgetary arrears had stabilized.

B. Output Growth, Prices, Wages, and Employment

8. The economy grew by 6.2 percent in the first nine months of 1999 (compared to the same period of the previous year), led by industry, construction, and trade and services (Table 8). However, real GDP fell by 2.3 percent in the last quarter in the wake of the political assassinations, due especially to contraction in the construction and industry sectors. Real GDP increased by 3.3 percent for 1999 as a whole. In 2000, despite economic stagnation in the first quarter and a severe drought, real GDP grew by 6.0 percent. This growth was led by industry, construction, and trade and services.

9. Consumer price inflation in 1999 was substantially lower than anticipated, with end-period inflation of only 2.1 percent (Table 12). This low inflation reflected both the drop in consumer prices during the first quarter of 1999, related to the sharp contraction in reserve money following the Russian crisis (as described in Section D below), as well as the sharp decline in economic activity in the fourth quarter. Consumer prices during the first nine months of 2000 were influenced by a favorable agricultural harvest (the drought did not begin to affect agricultural prices until the fourth quarter), and to an extent by the appreciation of the dram vis-á-vis the euro which put downward pressure on prices of imports from the EU expressed in local currency. In the event, the consumer price index fell by 2.8 percent cumulatively in the first nine months of 2000. Although consumer prices rose by almost 3½ percent in the last two months of the year due largely to the catch-up in government spending (resulting, inter alia, from dram 8.25 billion bridge financing from the Special Privatization Account (SPA) to clear budgetary expenditures arrears in the fourth quarter), cumulative inflation for 2000 as a whole was only 0.4 percent. The full impact of the monetary expansion that accompanied bridge financing from the SPA in the fourth quarter may not have worked itself fully through to prices by end-2000. Consumer price inflation in the first three months of 2001 was 3.7 percent cumulatively, reflecting both seasonal and special factors, including the impact of the drought on food prices and the increase in health care prices due to the introduction of the VAT on medical goods and the very rapid growth in money in the fourth quarter of 2000.

10. After having doubled between 1994 and 1998,1 real wages in state owned corporations continued to increase by 18 and 14 percent in 1999 and 2000, respectively (Table 15). Wages vary dramatically across sectors. While the wage differential between the highest paid sector and the lowest paid sector had declined gradually between 1994 and 1997, this spread (measured as a percent of the average finance sector wage) increased from 76 percent in 1997 to 82 percent in 1998 and 87 percent in 1999 (Table 16).

11. Estimated total employment declined by 4 percent in 2000, compared to 1998. The unemployment rate (defined as the number of registered unemployed persons as a percent of the actual labor force) increased from 9.4 percent in 1998 to 11.2 percent in 1999 and 11.7 percent in 2000.2 The percentage of total employed persons in the state sector continued to decline (Table 17).

C. Public Finances and Social Safely Net Overview and Background

12. The fiscal sector in Armenia consists of the central government, local governments, and the State Fund for Social Insurance (SFSI). Budget data for each level of government, as well as the consolidated government budget, are shown in Tables 20-26. Local governments and the SFSI are required by law to run balanced cash budgets, so the fiscal deficit (on a cash basis) is the same (except for small changes in deposits) for the central government, whose budget is referred to below as the “state budget,” and the general government (which includes the central government, local governments, and the SFSI).

Fiscal Operations from January to September 1999

13. The 1999 state budget projected an increase in revenues of 2½ percent of GDP in 1999, based on an increase in excise tax rates (Text Table 1), environmental taxes, and fees in late 1998 and early 1999, as well as further improvements in tax administration. However, revenue performance fell short of expectations in the first half of 1999 due to lower than expected inflation and growth, as well as collection problems partly caused by expectations of tax amnesties prior to the May elections.

Table 1.

Changes in Excise Tax Rates and Environmental Fees, 1999-2000

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Source: Armenian authorities.

14. On the expenditure side, the government was confronted with the need to finance unbudgeted energy expenditures of budgetary institutions and quasi-fiscal entities, and increasing domestic interest costs following the Russian crisis. To prevent a further increase of treasury bill yields, the government issued less domestic debt than budgeted. Shortfalls in external financing and grants further aggravated the situation. As a result of these factors, central government arrears increased, by nearly 4 percent of seasonally unadjusted first half GDP, in the first six months of 1999.

15. In response, following the May elections, the government amended the budget in August 1999. The measures in the amended budget focused on expenditure cuts (equivalent to 2.6 percent of GDP) and the following tax measures (equivalent to 1.3 percent of GDP):

Recurrent expenditures increased by 1 percent of GDP in the amended budget, due to higher interest expenditures and higher subsidies to the quasi-fiscal sectors. In parallel, capital expenditures and net lending declined.

16. In response to the increase in the excise rates and increased political stability, tax revenues recovered in August and September 1999, with average collections of more than dram 16.5 billion, compared to average monthly collections of dram 10.8 billion from January to July. The increase in revenues, and the disbursement of $23.5 million under the SAC IE in September, enabled the government to pay down dram 11.4 billion of arrears in the third quarter.

Fiscal Operations from October 1999 to December 2000

17. After the October assassinations, state budgetary tax revenues declined to an average monthly level of dram 16 billion,3 in contrast to the usual improvement in collections toward the end of the year. The revenue shortfall was mainly on custom duties and excises. In particular, the increase in the tax rates for cigarettes did not have the expected revenue effect due to a very strong volume reaction, especially for imported cigarettes, on which excise rates had increased more than 3 times, while domestic (filtered) cigarettes were taxed at a rate one third below the rate on imports. The strong volume reaction was partly caused by import substitution and partly by administrative problems.4 Other tax revenues were in line with the revenue targets. For instance, income tax collections and VAT were as envisaged due to high receipts from the energy sector, financed by higher state budget subsidies. In addition, VAT receipts benefited from the one quarter lag between sales and VAT collections.

18. For 1999 as a whole, compared to the amended 1999 budget, arrears equivalent to almost 2 percent of GDP were accumulated (Text Table 2):

Table 2.

Recent State Budget Developments, 1998-2000

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Source: Armenian authorities and Fund staff estimates.

The build up of arrears resulted from a combination of revenue shortfalls, expenditure overruns, and shortfalls in domestic and external financing.5 The arrears of particular social relevance (family allowances, health, and education) increased by dram 4.8 billion, to a stock of dram 7 billion at end-1999.

19. The projections for tax revenues in the 2000 budget assumed that the drop in revenues observed in October through December would be only a short-term reaction to political instability, and that the overall trend of an increasing tax revenue/GDP ratio would continue. Therefore, the government projected tax revenue equivalent to 16.6 percent of GDP, compared to 16.1 percent in 1999, based on the fact that the increase in the excise tax rates would be effective for the whole of 2000, whereas it had only been in effect during the second half of 1999.

20. In the event, the government’s expectation of a resumption in trend growth of tax revenues in relation to GDP was not realized. First, cigarette imports declined further. In response, the government revised cigarette excises effective in April 2000. The rate for imported cigarettes was reduced by one third and the gap between domestically produced and imported cigarettes narrowed. Consequently, cigarette import volumes increased. Second, gasoline imports declined sharply in early 2000, reaching only 60 percent of import levels in the first half of 1999. In the reform of excise rates in April 2000, the government increased the rates slightly and started to apply excise rates on close substitutes for gasoline. Gasoline volumes increased starting in August, but neither developments in retail prices nor the change in tax rates adequately explain the volatility of volumes. Presumably, administrative problems were at least partly responsible for the shortfall in volumes. Third, VAT revenues were lower than envisaged because of the decline in GDP in the fourth quarter of 1999, the economic stagnation in the first quarter of 2000, and inflation near zero.

21. In total, tax revenues relative to GDP in the first half of 2000 were equal to the level in the first half of 1999 despite the increase in excise rates. Due to the revenue shortfall, arrears of the central government increased, by dram 21.4 billion in the first half of 2000—of which dram 7.6 billion were accumulated in expenditure categories of particular social relevance—to dram 45.8 billion (or 4.4 percent of GDP) at end-June 2000. However, the government decided against proposing an amendment of the budget, thereby missing an opportunity to make adjustments in expenditure commitments to help compensate for the revenue shortfall.

22. Tax collections started to recover in June (albeit with an interruption in September), mainly due to improvements in current collection (tax arrears were broadly unchanged during this period) and the increase of GDP (growth started to increase in the second quarter and tax revenues, in particular the VAT, reacted with the usual time lag in the third and fourth quarters). However, despite the recovery since June, tax revenues as a percent of GDP in the second half of 2000 fell short of the corresponding period in 1999, for a number of reasons. First, revenues in the second half of 1999 included the short period of relative political stability in the third quarter, allowing the revenue measures that became effective on August 1 to show their full impact. Furthermore, comparison of fourth quarter 1999 performance with the corresponding period in 2000 can be misleading because the 1999 fiscal year was extended into 2000 (the 2000 fiscal year was not extended), and the revenue figures underlying the comparison have been adjusted to shift more than dram 5 billion into the fourth quarter of 1999. Finally, tax collections in the fourth quarter of 1999 benefited from high GDP growth in the third quarter of 1999 as well as the payment of arrears by the energy sector, financed by additional subsidies from the budget.

23. State budget expenditure arrears declined by dram 1.5 billion in the second half of 2000, to dram 44.4 billion (4.3 percent of GDP). This decline of arrears was small despite the improvement in tax collections in the second half of 2000, disbursement of the fourth tranche of the SAC III ($5.5 million) in December 2000, reductions in expenditure commitments in the fourth quarter equal to 2.6 percent of quarterly GDP, and clearance of socially significant arrears (such as family allowances, pensions, and wages) amounting to 2.3 percent of quarterly GDP starting in November using bridge financing from the SPA.6 Arrears fell by dram 8.6 billion in the fourth quarter of 2000 due to the SPA bridging. For the year as a whole, arrears grew by almost 2 percent of GDP, largely due to the shortfalls (vis-à-vis the budget) in revenues and grants and external financing,7 which were only partly offset by the rescheduling of debt service to the EU and Turkmenistan, reduced expenditure commitments, and higher domestic financing.

24. In parallel to the state budget, the SFSI was facing difficulties collecting contributions. Therefore, it ended 1999 with arrears of dram 3.4 billion, which increased to dram 7.9 billion by mid-2000, equivalent to around 2½ months of pensions. Due to the recovery of GDP growth which also increased wage payments and reduced accumulation of wage arrears, the increase of the pension contribution rate by mid-2000, and the clearance of pension contribution arrears from the state budget, the SFSI reduced its arrears by end-2000 to dram 4.4 billion, or around 1¼ months of pensions.

Monetary, Exchange Rate, and Inflation Developments during 1998-2000

The CBA has managed to attain rates of monetary growth consistent with virtual price stability for the past few years, despite what would appear to have been a rather rapid rate of monetary growth and sizeable fluctuations in monetary aggregates. Moreover, the value of the Armenian dram vis-á-vis the U.S. dollar remained broadly stable despite a number of external and internal shocks. This box explores the factors underlying this performance, focusing on the 1998-2000 period, since this period was characterized by a combination of rapid monetary growth and low inflation.

Quarterly movements in reserve money generally tracked movements in the net foreign asset (NFA) position of the CBA during the period, especially for quarters in which there were large changes in reserve money, as noted in the text and shown in Figure 1:1/

  • In the first quarter of 1999, NFA and reserve money fell sharply reflecting CBA sales of foreign exchange in the interbank market in the aftermath of the Russian crisis;

  • Reserve money rose by 18.7 percent in the third quarter of 1999, reflecting a $23½ million disbursement under the World Bank SAC III in late September, and

  • The increase in reserve money during the fourth quarter of 2000 was mainly due to the bridge loan from the SPA used to pay down expenditure arrears.

The growth in reserve money for the 1998-2000 period (net of the SPA bridge) was in line with the growth in nominal GDP:

  • Reserve money growth was distorted by the dram 8.25 billion bridge loan from the SPA in the fourth quarter of 2000. Deducting this amount from the end-2000 stock,2/ reserve money grew by 26.9 percent during 1998-2000, or at an average rate of 8.3 percent per annum;

  • Nominal GDP grew by 28.4 percent during 1998-2000, or by 8.7 percent per annum, mainly due to the increase in real GDP (which grew by 17.5 percent, or by 5.5 percent per annum);

Dram broad money increased by 46.7 percent (excluding the SPA bridge) during the 1998-2000 period, or by 13.6 percent per annum, reflecting an increase in the multiplier of about 5 percent per annum. Consumer prices were virtually stable during the period, having increased by only 1.3 percent in 1998-2000. The value of the dram vis-á-vis the U.S. dollar was also relatively stable, despite the Russian currency crisis in August 1998 and the political assassinations in October 1999 (Figure 1). It is apparent that real money demand increased substantially, given the relative price and exchange rate stability.

Broad money grew much faster than dram broad money during 1998-2000, roughly doubling during the period, due to a rapid increase in foreign currency deposits (see Box 2).

1/ However, the decline in reserve money in the first quarter of 1998 was due mainly to an increase in CBA net credit to banks and to the government.2/ As the CBA had anticipated, reserve money declined by around 15 percent in the first quarter of 2001, to a level only 6 percent above the third quarter of 2000.
Figure 1:
Figure 1:

Armenia: Monetary and Exchange Rate Indicators, 1997-2000

Citation: IMF Staff Country Reports 2001, 078; 10.5089/9781451801446.002.A001

Source: Armenian authorities; and Fund staff estimates.1/ Intervention is defined as net interbank sales of foreign exchange by the CBA. A negative figure indicates liquidity absorption and loss of reserves by the CBA.

An Analysis of Currency Substitution in Armenia

The level of currency substitution (CS) in Armenia remained high in 1999-2000. This high level of currency substitution, compared to other CIS countries, has persisted despite the attainment of macroeconomic stability.1/ This box considers trends in CS in Armenia, compares these trends with other OS countries, and discusses possible factors underlying these trends.

In Armenia, the ratio of foreign currency deposits to broad money (or CS ratio), increased from around 20 percent in 1995-1996 to close to 50 percent in 1999-2000 (Table 33), despite the attainment of macroeconomic stability in the mid-1990s.2/ Throughout the past three years, the CS ratio has remained some 15-20 percentage points above the median CS ratio for all CIS countries (Figure 2).

According to the CBA, the following factors contributed to a relatively high level of measured CS in Armenia:

  • The population’s confidence in the banking system was gradually being restored, as in other CIS countries, hence the rapid growth in deposits overall. Therefore, it is possible that “measured” CS increased, since the CBA does not have data on cash foreign exchange in circulation;

  • The banks represent the only real outlet for household savings;

  • About one half of household income came from foreign currency remittances, and households tended to put the balance of these remittances directly into dollar bank accounts. The remainder was converted into dram and spent on subsistence needs;

  • Only dollars were used for large transactions. Businesses tended to keep their dollars in Armenian bank deposits, instead of placing them abroad, in order to earn the higher yield.

  • Apparently there was not much demand for dram credit (Table 47) and, accordingly, banks had little incentive to raise rates to attract dram deposits. This may help explain why the interest rate differential between dram and dollar deposits was insufficient to overcome the population’s reluctance to hold additional dram deposits; and

  • While the exchange rate had been relatively stable in recent years, there continued to be greater trust in dollars as a long-run savings vehicle.

Citing evidence from Latin America, Mongardini and Mueller (2000) note that it may take a long time for CS to decline in the CIS countries, even though macroeconomic stability has been attained.

1/ See Mongardini, J. and J. Mueller (2000) “Ratchet Effects in Currency Substitution: An Application to the Kyrgyz Republic,” IMF Staff Papers, 47 (2): 218-237, for a comparison of currency substitution levels in BRO countries.2/ There was a modest decline in the CS ratio during 2000 owing to the sharp increase in currency in circulation toward the end of the year.
Figure 2:
Figure 2:

Currency Substitution in CIS Countries, 1998-2000

Citation: IMF Staff Country Reports 2001, 078; 10.5089/9781451801446.002.A001

Sources: Armenian authorities; and Fund staff calculations.

D. Monetary and Exchange Rate Developments

25. While monetary aggregates grew substantially during 1999 and 2000, inflation was low, reflecting a rapid growth in real money demand.8 The variability in reserve money growth, especially in the first and third quarters of 1999 and the fourth quarter of 2000, shows that the stated policy of maintaining reserve money within an indicative corridor with a view to using money as a nominal anchor has been implemented flexibly, with reserve money allowed to move outside the corridor in response to unexpected disturbances associated with delays in external financing, external shocks, and unforeseen fluctuations in government expenditures.

Developments from January to September 1999

26. In the first quarter of 1999, the CBA had to contend with the pressures on the foreign exchange market in the aftermath of the Russian crisis. The CBA responded to these pressures by selling $20 million in the interbank foreign exchange market from January through the first 10 days of February, leading to a drop in reserve money of 15.4 percent in the first quarter.9 During this quarter, the dram depreciated by 2.5 percent in dollar terms (it depreciated by 4.4 percent in January and then appreciated during February and March), CPI deflation deepened to 5.5 percent, and the weighted average treasury bill yield reached 54 percent at end-March.

27. Reserve money increased rapidly (by 18.7 percent) in the third quarter of 1999 due to disbursement of the third tranche of the World Bank SAC III ($23½ million) on September 21. Government spending to quickly clear budgetary arrears created monetary management problems and disrupted the smooth functioning of the foreign exchange market. In particular, in the last 9 days of September, reserve money exceeded the upper end of the corridor despite active reverse repurchase operations.

Developments from October 1999 to December 2000

28. During the first half of 2000, the CBA generally succeeded in keeping reserve money within the indicative corridor, although it fell below the lower limit of the corridor at the end of January, February, April, and May. This resulted from a build up of government deposits related to the receipt of a high proportion of tax receipts during the last days of each month.

29. Beginning in July 2000, however, reserve money exceeded the upper end of the corridor due mainly to government expenditure financed through a draw-down of the SPA and inflows of foreign grants.10 Partly offsetting the resulting increase in the net foreign assets (NFA) of the CBA, net credit to government from the CBA fell during July and August, as foreign grant inflows and conversion of privatization receipts from foreign exchange to drams led to a build-up of government deposits in the CBA.

30. Monetary policy in the fourth quarter of 2000 was heavily influenced by government spending from the SPA, both on capital expenditures, and by the dram 8.25 billion bridging operation in November 2000. In the event, reserve money increased by 24.7 percent in the fourth quarter of 2000. In the absence of effective money market instruments, the CBA was unable to keep reserve money within its indicative corridor. While it could have sold foreign exchange in the interbank market, the CBA chose not to because it believed the dram would have appreciated substantially, and because the parliament had only authorized a bridge loan from the SPA through end-March 2001. The dram depreciated by 2.9 percent in U.S. dollar terms during the fourth quarter, after a depreciation of 2.4 percent in the first three quarters.

31. Following the exodus of nonresident investors from the treasury bill market in the wake of the August 1998 Russian crisis, interest rates rose substantially in Armenia. By late 1999, due to improved coordination of monetary and fiscal policy and the record of price and exchange rate stability, interest rates began to fall. In particular, the weighted average yield on treasury bills fell from 53 percent in December 1999 to 43 percent in March, 28 percent in June, and 24 percent in December 2000.

E. Balance of Payments

32. The external current account position continued to improve significantly in 1999 and 2000, with the deficit falling from $403 million (21.2 percent of GDP) in 1998 to $279 million (14.6 percent of GDP) in 2000, in line with a lower (goods and services) trade deficit (Table 38). In 1999, the trade balance (goods and services) improved by nearly 5 percent of GDP, owing to a 6.5 percent increase in exports and a 8.1 percent drop in imports. In 2000, exports increased by an additional 15.7 percent, while imports increased by 5.0 percent.

33. These adjustments were supported by a significant real effective exchange rate depreciation of around 9 percent from end-1998 to end-2000, which more than reversed the real appreciation during 1998 following the Russian crisis in August of that year. New FDI into the mining, diamond cutting, and agricultural processing industries also helped fuel the revival of exports in 1999 and 2000. Indeed, the recovery of exports in 1999 was led by an almost doubling of diamond exports following the sale of a diamond cutting enterprise to a British investor in early 1999. In 2000, merchandise exports increased by 24 percent as agricultural and base metal exports staged a strong recovery and diamond exports continued to expand briskly.

34. Weak import demand has underpinned the adjustment in the external current account. Underlying imports—i.e., total imports less humanitarian imports and imports of uncut diamonds—decreased by 14 percent in 199911 to less than $700 million. Relative to GDP, underlying imports decreased to 37 percent in 1999, reverting about to the level in the mid-1990s. In 2000, underlying imports increased by 4 percent in line with a similar increase in GDP, and overall imports increased by 8 percent.

35. The capital and financial account surplus decreased from around $400 million in 1998 to around $300 million in 1999-2000 in the absence of major privatizations, which had boosted FDI in 1998. Notwithstanding the decrease from 1998, FDI inflows were buoyant in 1999-2000, averaging around 6 percent of GDP during the period. Major FDI inflows were directed toward investments in the telecommunications and energy sectors, including by Greek and Russian investors. In 2000, the capital and financial account surplus was slightly lower than in 1999 in part because disbursements to the public sector were negatively affected by the debt service arrears to Russia, which blocked new Russian disbursements, and problems in securing sufficient budgetary counterpart funds, which slowed down the implementation of World Bank projects.

36. In mid-2000, Armenia rescheduled its debt to Turkmenistan. The agreement included a deferment of interest payments for the second through the fourth quarters of 2000, a re-profiling of ongoing repayments from the second quarter of 2000 through 2002 to 2001-2004, and an increase in the interest rate spread over LIBOR from 0.3 to 1 percentage point. Since late 1999, Armenia has serviced almost none of its debt service obligations falling due to Russia and as of end-2000 external arrears to Russia amounted to $19 million (excluding late interest). Currently, Armenia and Russia are negotiating a regularization of these arrears. Against the background of the difficult budgetary situation, Armenia and the EU agreed in mid-2000 to postpone a planned prepayment and budgetary grant until 2001, resulting in a net cash flow savings of euro 1.5 million.12 Debt service to other creditors (including interest on the EU credit) was serviced in a timely manner during the year. Total debt service paid amounted to about $47 million (the equivalent of about 11 percent of exports of goods and services), compared to $55 million (14 percent of exports) in 1999.

37. Following a $4 million surplus in 1999, the overall balance of payments surplus in 2000 widened to $11 million. This surplus, together with a build up of external arrears of $18 million and debt relief of $5 million from Turkmenistan, allowed for an increase in net official international reserves (NIR) of $34 million. Reflecting also revaluation losses (on non-dollar holdings) and repayments to the Fund, gross official international reserves increased by only $9 million to $314 million. Relative to the following year’s (projected) imports, gross reserves fell from 3.9 months in 1998 to 3.6 months in 2000.13

F. External Debt Developments

38. In 2000, Armenia succeeded in arresting the very rapid build-up of external debt which began in the early 1990s (Table 43). Following a 9 percent increase in 1999, Armenia’s external debt increased by 1 percent in 2000, as modest new net inflows were offset by revaluation adjustments reflecting the strengthening of the U.S. dollar. At end-2000, external debt amounted to $862 million, the equivalent of 45 percent of GDP or 194 percent of exports. The World Bank was the single largest creditor with outstanding credits of close to $400 million, followed by the Fund ($175 million) and Russia ($115 million). From 1995 to 2000, external debt more than doubled, yet the composition of external debt has remained very stable, with about 75 percent of the debt owed to multilateral institutions and the bulk of the remainder to bilaterals. Reflecting in part the large share of Fund and Bank credits, 74 percent of all credits were concessional, 81 percent were fixed interest rate loans, and 67 percent were denominated in SDRs at end-2000 (Table 44).

39. In spite of the higher nominal debt, the external debt in present value (PV) terms is estimated to have fallen to $535 million in 2000 from $549 million the previous year owing to an increase in the level of international interest rates.14 The PV of debt in 2000 was estimated at the equivalent of 135 percent of exports15 down from 154 percent of exports in 1999. However, in terms of fiscal revenue, the PV debt burden increased from the equivalent of 167 percent in 1999 to 179 percent in 2000 as a difficult fiscal position was compounded by the real effective exchange rate depreciation which lowered the U.S. dollar value of fiscal revenue.

G. Exchange and Trade System

40. In 1999-2000, Armenia continued to maintain a liberal foreign exchange system as well as a liberal policy on FDI. There are no current account restrictions and the few minor capital account restrictions are mostly imposed for prudential reasons.

41. The trade regime is also very liberal. There are no export taxes or export subsidies and most imports enter the country duty-free, while goods subject to import duties are assessed a uniform 10 percent import duty. Minor changes in the tariff schedule took place in January 1999.

42. Nontariff restrictions are limited to the importation of goods that pose health, security, or environmental hazards. Import license requirements are limited to medicines (subject to approval by the Ministry of Health) and agricultural chemicals (administered by the Ministry of Agriculture). Export licenses are required for textiles destined for the EU, nuclear and nuclear-related products, military goods, medicines, and selected live animals and plants.

H. Structural Reforms

43. Armenia made significant progress in structural reforms in the 1990s. The Russian crisis and the political turmoil starting in late 1999 slowed these reforms, but the pace of reform started to recover thereafter.

Privatization

44. The privatization process slowed in 1999-2000 as the emphasis shifted from quick sales toward attraction of suitable strategic investors. The government sold 196 additional small enterprises in 1999 and 44 in 2000. In 1999, the government finalized the sale of the Yerevan Brandy factory, and sold its remaining shares in a large commercial bank. In 2000, the government sold a major chemical plant, a precious stone company, and a hotel to foreign investors.

45. To improve the efficiency of the privatization process, the government approved a decree in April 1999 that addressed the issue of the outstanding debt of the privatized enterprises. Also, companies that cannot be sold in three attempts are now liquidated in accordance with the privatization law. In July 2000, the parliament adopted a law that specifies the procedures for privatizing the energy distribution companies (EDCs). Finally, the government established an inter-departmental committee to privatize Armenian Airlines and Armenian Press.

Banking and Payments Systems

46. Armenia’s banking system at end-2000 consisted of the CBA and 31 commercial banks (of which only 29 were operating), including 5 branches of foreign banks and one state-owned bank. Foreign participation in the banking system increased following the removal in June 1995 of the 35 percent limit on foreign ownership of banks. However, with one key exception, foreign investors are mainly Armenian expatriate individuals. The Savings Bank, the only state-owned bank, accounted for only 2½ percent of banking system assets and about 7 percent of household deposits in mid-2000. The government has announced its intention to sell the majority of the bank’s shares in 2001.

47. As discussed in the Financial System Stability Assessment (FSSA), while reported data for the Armenian banking system-indicate a relatively healthy financial system, these may not reveal the extent of weaknesses in the banking system due to shortcomings in the regulatory reporting and supervisory practices.16 Notwithstanding these caveats, reported prudential indicators show a high capitalization of the banking system, a relatively healthy loan portfolio, and adequate liquidity coverage (Table 46). The efforts to recapitalize banks, especially through the gradual increase in the minimum capital requirement, helped to increase the capital adequacy ratio for the banking system between 1995 and 1999, although the ratio fell to 25 percent at end-2000. While Armenia’s commercial banks were characterized by large volumes of non-performing loans prior to 1996, significant progress was made in improving the quality of their loan portfolios in 1996-1997, and as a result the level of non-performing loans fell to around 6 percent in December 2000. Banks appeared to have adequate liquidity, reflecting large holdings of government securities by commercial banks in the absence of sufficient profitable lending opportunities elsewhere in the economy.

48. The level of both off-site and on-site supervision has increased. Following the introduction of a new chart of accounts in January 1998, all banks adhere to International Accounting Standards (IAS). The CBA strengthened the prudential regulations in April 1999, raising the minimum general and core capital-adequacy ratios, respectively, to 12 and 8 percent, changing the risk weighting on some items, and reducing the maximum open foreign currency exposure from 40 to 30 percent after April 1, 1999, and to 25 percent after April 1, 2000.

49. Most payments in Armenia are settled through CBANET, an electronic payments system based on the SWIFT format and covering the entire country. The CBA and major commercial banks also maintain access to international markets through the SWIFT system.

Quasi-fiscal Sectors17

50. Despite some signs of improved financial performance, the energy sector continues to require substantial budgetary resources and more generally impedes efficient resource allocation and economic growth prospects of the Armenian economy. Collection rates of the energy sector have increased since 1995 but remain insufficient, and loss rates (both technical and “excess” losses, the latter including theft) have fallen but remain high. These improvements reflect, inter alia, the financial monitoring of the energy sector starting in 1998, installation of meters financed mainly by foreign donors, establishment of an independent Energy Regulatory Commission that is responsible for setting tariff rates, having secured a reliable source of imported gas, and separation of different segments of the energy sector (generation, transmission, dispatch, and distribution). Nevertheless, the estimated financing gap of the energy sector remains high (nearly 4 percent of GDP in 2000, before budgetary subsidies, restructured debt service, and arrears accumulation).

51. According to the government and the World Bank staff, privatization of the energy distribution network is essential for achieving a significant further improvement in the financial performance of the energy sector. The government has, with the support of the World Bank, been preparing for the privatization of the EDCs, including by consolidating the number of EDCs to four, passing a law in the summer of 2000 that provides the legal basis for the privatization, and establishing a tender committee to supervise the privatization process.

52. The government has also announced its intention to improve the financial performance of other quasi-fiscal sectors (including the irrigation sector, drinking water and sewage companies, district heating, and the Nairit company). The financing gaps of the irrigation and water sectors arise from low collection rates, high loss rates, and tariffs that fall short of full cost recovery. Despite modest improvements in the overall deficits of some of these sectors in 1999-2000, financing gaps in the irrigation and drinking water and sewage sectors remained high in 2000 (around 1½ percent of GDP, excluding budgetary subsidies, restructured debt service, and arrears accumulation). District heating, whose deficit is caused primarily by a low collection rate, also had a significant financing gap (estimated roughly at 0.7 percent of 2000 GDP for the 1999/2000 heating season). The Nairit company, whose output is only about a quarter of the amount demanded during Soviet times, was only able to pay around 30 percent of its electricity bills during January-September 2000, and the energy sector effectively accepted barter payments from Nairit. Financial rehabilitation of these quasi-fiscal sectors is important in macroeconomic terms, because non-payment of energy bills by these sectors are a major cause of the financial difficulties of the energy sector.

II. Tax system reform

A. Introduction and Background

53. Due to the ongoing tax reform efforts since the transition to a market economy, the Armenian tax system is broad based and has a rate structure which is generally in line with international standards. The tax reform in 2000 focused on streamlining the tax system by rationalizing the rate structure, further broadening the tax base and improving administrative procedures. The first step was taken in mid-2000 with the reform of the excise tax and the introduction of the Simplified Tax, a presumptive tax that offers small businesses the possibility of a turnover based taxation. With the 2001 budget, the parliament agreed on the reform of the Personal Income Tax, (PIT) and the Corporate Profit Tax, (CPT) as well as changes in the VAT regime, effective January 1, 2001. On tax administration, the government made progress in consolidating the merger of the inland revenue service and customs administration.

B. Reform of Tax Policy

54. Under the old tax regime, the marginal tax rate on labor varied significantly over income levels. For lower incomes, the rate structure was highly regressive in contrast to the progressive rate structure for some higher income brackets. This was due to the combination of the pension contributions and the income tax. The pension contribution scheme applied a quite substantial minimum contribution for low incomes and a maximum contribution above a certain cap. Between these income limits, a 31 percent rate applied. The limits for the personal income tax brackets of 15, 25 and 30 percent were defined independently from the pension contribution cap so that the combined marginal tax rates varied strongly.

55. In order to rationalize the rate structure and reduce the high marginal tax rates, the government introduced, effective January 1, 2001, tax brackets for social contributions and for the PIT whose combined effect results in a linear tax rate of 28 percent. The government decided against merging the PIT and the social contributions because of its intention to replace the current pay-as-you-go system, under which there is scarcely any link between the contribution and benefit, by a modern pension system within the next 3 to 5 years. The government decided that eliminating the separate pension scheme and transferring it completely into the state budget at this time would have complicated the future reform efforts.

56. The tax base of the PIT has been broadened by including interest income. To keep the administration simple, a final withholding tax18 of 5 percent applies on interest income effective July 2001; this will be replaced by a 10 percent rate by July 2002. The withholding scheme for wages has also been adjusted to allocate the individual allowance proportionately over the year, as is best practice. Previously, withholding only began in the month when the annual income accumulated to date exceeded the individual allowance, which meant that the actual withholding rate increased in the course of the year.

57. The progressive CPT rates of 15 and 25 percent have been replaced by a unified rate of 20 percent, close to the average rate under the old regime and in line with the rate in neighboring Georgia.

58. To offer businesses a simple tax scheme that does not force them into a high tax burden in case they cannot document all expenses, the government introduced the Simplified Tax in July 2000. It offers an alternative to the regular taxation under the PIT, CPT and VAT for businesses below a revenue threshold of dram 30 million. Before the introduction of the Simplified Tax, presumptive taxes applied mainly for small retail businesses. These schemes are to be largely phased out, and indeed, some have already been eliminated.19 Turnover serves as the tax base of the Simplified Tax on which a rate of 4.5 percent applies for shops, and a rate of 7.5 percent for other businesses. A deduction for properly documented business expenses is allowed. However, even if the documented expenses are higher than the turnover, a minimum rate on the turnover applies (2.5 percent for shops, 4 percent for other businesses). Although this rule reduces the administrative advantages of the Simplified Tax, the government included it because encouraging taxpayers to demand written documentation for all their purchases is seen as a major step out of the shadow economy. Further administrative complications occur from the separate treatment of sales and purchases of fixed assets, which are also treated separately for VAT purposes.

59. The new excise tax law, effective August 1, 2000, eliminates numerous “nuisance” excises (e.g., leather and china), which generated little revenue, leaving excises applicable only to the major revenue producers (petroleum products, alcohol and tobacco). It also adopted specific rates for all of these goods in order to facilitate administration. In addition, the administrative procedures for the credit mechanism for alcohol used as an input in the production of alcoholic beverages were tightened to ensure that the excise taxes on the inputs are actually paid before granting VAT credits. There are no differences between excise taxes on domestic production and on imports (other than the tariff element of the cigarette tax), and all excises are to be collected at the factory, as is best practice.

60. With the reform of the VAT, the government abolished numerous exemptions, such as those for medicines/pharmaceuticals, food for children, urban transportation, goods transferred via leases and for normal ongoing sales of companies undergoing reorganization and bankruptcy. In parallel, the VAT threshold has been increased from dram 3 million to dram 10 million in order to reduce the number of taxpayers that are liable for the VAT and to concentrate scarce administrative resources on larger taxpayers. Taxpayers below the threshold are obliged to register for the Simplified Tax if they meet the preconditions (e.g., no tax arrears).

61. On customs, effective January 1, 2001 the government issued a new customs law in line with WTO rules. These changes do not affect the rates of customs duties, which were already in line with international standards.

C. Tax Administration Reform

62. In 1999, the government decided to create a separate Ministry of Revenues (MSR), which combined the Tax Inspectorate and Customs Department. Therefore, administrative efforts focused on merging the two administrations.

63. Reform efforts have focused on the VAT, which generates around 40 percent of tax revenues. In 2000, the MSR, with support of the Barents Group, started to work on an audit system, in particular, on a system of VAT cross checks which is expected to begin in operation by end-June 2001. As a first step, the cross checks will include receipts from audits. In the second phase, planned for the third quarter of 2001, records from the importation of goods and transactions above a certain limit (to be determined by the government) will be included. In addition, effective January 1, 2001, the obligation to pay VAT at the border was extended from only goods that are subject to customs duty (mainly consumption goods) to all goods except those on a list defined by the government. The government expected that the share of goods on which VAT is already collected at the border would increase in 2001 from 30 to 50 percent (based on 1999 trade data).

64. The customs administration reform is closely linked to VAT administration (since around 50 percent of VAT is collected at the border). Based on the results of a diagnostic workshop conducted by the government in March 2000, with Barents Group and DFID assistance, the government has started to reform administrative procedures, including by streamlining customs procedures and by improving risk assessment and valuation practices. In addition, they have developed a data base to ensure that the valuation is in line with the new customs code.

III. Selected Issues in the Quasi-Fiscal Sectors

A. Introduction

65. As in other CIS countries, quasi-fiscal activities and barter payments in Armenia are symptoms of deep-rooted structural problems. Quasi-fiscal operations include implicit subsidies, provision of credit at below-market rates, charging less than commercial prices, and the bailing out of ailing industries and enterprises in distress. In Armenia, these activities have been especially noticeable in the energy sector.

66. The financial imbalance in the energy sector has a tremendous impact on the overall economy, especially since the energy sector has gained in relative importance over the last decade. The sector’s share in industrial production increased from 3.4 percent in 1990 to 30.4 percent in 2000, and the share of the energy sector in GDP almost doubled, to about 10 percent, between 1995 and 2000. The increase in the relative size of the sector can be partly explained by the 60 percent decline in GDP in the early 1990s, which not only was triggered by the collapse of the Soviet Union, but also by the trade and transport blockade imposed in 1991 as a result of the Nagorno-Karabakh conflict and the repeated disruption of Armenia’s second major trade route by a civil war in Georgia in 1991-199320. In addition, the tremendous increase in the relative price of energy21 following the collapse of the FSU contributed to the growth in the sector’s relative importance (Tables 13 and 49).

67. The energy sector also gained in relative importance in Armenia’s foreign trade due to the escalation of energy prices toward world market levels after 1991. Despite a 68 percent decline in the volume of total energy imports between 1992 and 1993,22 the share of energy in total imports increased from 15 percent to 26 percent. In 1994, the share of energy in total imports increased further to 40 percent. As residential gas supply and district heating were discontinued for the lack of reliable fossil fuel imports, electricity became (and remains) the dominant source of energy for the residential sector.23 During these early years of transition, the government’s immediate priority was to increase the supply of electricity to a minimum level necessary to cover essential human and economic needs, and to arrest the fall in output.

68. As the energy sector has been permitted to incur sizable financial losses and arrears, thereby accounting for a major quasi-fiscal deficit which in turn tends to induce arrears also in other sectors, the government has determined that financial rehabilitation of the energy sector is of utmost importance. In addition, the persistence of barter trade in the energy sector reflects the failure to complete economy-wide enterprise restructuring. Since nonpayment and barter trade occur economy-wide and are not confined to the energy sector, energy-sector reform by itself will not rectify these problems. In fact, financial rehabilitation of the energy sector is very much dependent on financial rehabilitation of other budget-related organizations (such as publicly-owned utility providers) which, due to low tariffs, technical and managerial inefficiencies, and theft, are unable to pay fully for their electricity. Hence, the government has expanded its focus beyond the energy sector in its attempt to seriously reduce quasi-fiscal activities as well as the nonpayment and noncash payment problems.

69. Section B outlines the present structure of the energy and other major quasi-fiscal sectors. Section C defines and quantifies these sectors’ two major problems: (i) the flow problem as reflected in financial deficits; and (ii) the stock problem as shown by accumulated debt as the consequence of past operational losses and investment. The causes of the financial imbalances and the progress thus far achieved in solving them are presented in Sections D and E. The last section summarizes further steps that have been announced by the government. The appendix provides a brief characterization of the publicly-owned utility providers that contribute in a major way to the financial problems of the energy sector.

B. The Structure of the Quasi-Fiscal Sectors

The quasi-fiscal sectors

70. The Armenian authorities, assisted by World Bank and IMF staff, have defined the “quasi-fiscal sectors” as the energy sector, the state-owned irrigation and drinking water companies, centralized district heating24 and the state-owned rubber plant “Nairit” (Figure 3). On the basis of this comprehensive definition, a system to monitor cash flows of the quasi-fiscal sectors was introduced in 1999.25

Figure 3:
Figure 3:

Armenia: The Quasi-Fiscal Sectors

Citation: IMF Staff Country Reports 2001, 078; 10.5089/9781451801446.002.A001

71. The extension of formal monitoring beyond the energy sector to the “other” quasi-fiscal sectors (see Appendix II) was based on the following considerations:

  • First, collection rates for billed electricity and thermal energy from these other quasi-fiscal sectors were significantly lower than for other consumer groups, such as households, other industrial or service companies. Due to the accumulation of non-paid electricity bills, the major debtors to the energy sector are the two drinking water companies (Yerevan Water and Sewer Company and Armenia Water and Sewer Company), the irrigation company, district heating, and Nairit. Of a total stock of roughly dram 81 billion in energy sector receivables at end-2000, these entities accounted for some 55 percent

  • Second, these low electricity collection rates in the other quasi-fiscal sectors represent a constant drain on the fiscal budget, since the latter provides sizable explicit and implicit subsidies26 to cover their electricity bills. Moreover, the Armenian authorities have been repeatedly under pressure to increase these subsidies by amending the central government budget if electricity consumption exceeded the amount assumed when the value of the subsidy was initially determined.27 Even though the energy companies are allowed to disconnect non-paying customers if their bills are overdue for 15 days, and managers are held responsible for compliance with this rule, enforcement has proven to be difficult, especially for large-scale enterprises and for budgetary organizations.

  • Third, although disconnection is officially authorized, there are explicit exceptions to this rule. In mid-1995, the government issued a list of preferred customers to which power supply cannot be cut, including Nairit and the drinking water companies.28

The energy sector

72. At end-2000, the publicly-owned energy sector consisted of thirteen enterprises,29 which can broadly be categorized into electricity generation, transmission and dispatch,30 and distribution companies (Figure 4). Since the second half of 1998, natural gas operations have been privatized (see paragraphs 105-06), and these operations as well as gas debts to Russia accumulated after this date are not included in the monitoring carried out by the government.

Figure 4.
Figure 4.

Armenia: The Structure of the Energy Sector

Citation: IMF Staff Country Reports 2001, 078; 10.5089/9781451801446.002.A001

73. There are three types of electricity generation companies: (i) two thermal power plants using gas imported from Russia as an input to produce electricity, (ii) one nuclear power plant using nuclear fuel imported from Russia for electricity production; and (iii) two hydro power plants31 using water from domestic resources32 as an input. About 80 percent of Armenia’s primary energy consumption33 is dependent on imports. The bulk of imports is channeled through Georgia because of the trade embargo. Gas is imported through Itera, the exclusive gas supplier, and passed on to Armrusgasprom, which is in charge of the Armenian gas distribution network. With the gas, thermal power plants produce electricity and by-products in the form of steam and hot water. Steam is used in industrial companies such as Nairit, while hot water (and also gas) is used in local boiler houses to provide district heating (the provision of hot water to end-consumers for heating purposes).

74. The five power generation companies transmit the high voltage electricity through the. High Voltage Electricity Network to Armenergo, the dispatch center. Armenergo is the sole buyer of electricity from the generators following a single buyer model.34 It sells the high voltage electricity at different tariffs to the electricity distribution companies. The tariffs are set by the Energy Regulatory Commission, the regulatory body of the energy sector, and are scaled according to the generation cost. For example, hydro power is less costly than nuclear power or thermal power, which both use imported inputs. Armenergo also exports electricity to, and imports it from, Georgia and Iran.35 While Armenergo is involved in the contracting, for technical reasons the High Voltage Electricity Network receives the electricity first.

75. The electricity distribution companies transform the high voltage to low voltage and deliver it to the end users of electricity. The tariffs for end users are also set by the Energy Regulatory Commission. A law for the privatization of the electricity distribution companies was enacted by parliament in July 2000, and with the assistance of the World Bank and legal advisors, the government prepared the four electricity distribution companies grouped into two packages for privatization in 2001. Upon privatization, a distribution company would no longer be included in the structure of the public energy sector. The end users of electricity are private households, budgetary organizations (e.g., schools, universities, and public buildings), manufacturing industries (e.g., Nairit, and the copper-molybdenum plant), publicly-owned utility providers (irrigation, drinking water and sewage services) and other consumers (e.g., the army,36 the transport sector and private service companies).

C. The Size of the Quasi-Fiscal Deficits and Debts

Overall balance

76. The overall balance measures the difference between total revenues and total expenditures (including investment) for each sector. Grants are not included above the line, as they reflect discretionary financing by donors and are as such included in the cash flow below the line as a source of financing. In 1998, the overall energy sector alone had a deficit of 4 percent of GDP (Text Table 3). Improved collections (especially in thermal energy and in electricity exports) and higher electricity output led to a decrease of the energy sector deficit to less than ½ percent of GDP by 2000. In 1999, the first year for which data were available for the water companies and the irrigation sector, the combined deficit of the quasi-fiscal sectors was estimated to be at least 4½ percent of GDP.37 This deficit was reduced—on the basis of preliminary data and the same subset of quasi-fiscal sectors—to around 2¼ percent in 2000 due to improved collections in the energy sector (as noted above) as well as higher energy output (for detailed cash flows, see Tables 51-55).

Table 3.

Overall Balances and Primary Balances in the Quasi-fiscal Sectors, 1998-2000

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Source: Armenian authorities. Data for 1998 are estimates and for 2000 are preliminary.

77. While the overall balance is an important indicator for assessing the current and capital operations of the quasi-fiscal sector, it needs to be interpreted with care. For example, if current losses are persistent, expenditures will rise because of increasing interest payments on growing debts. Furthermore, grants from foreign donors to finance infrastructure spending by the sector might significantly increase capital expenditures, and may vary significantly from year to year.

Primary balance

78. The primary balance for each sector is defined as the difference between total revenues and total expenditures, but excluding interest payments and externally financed capital expenditure.38 A positive primary balance suggests that the sector can at least finance current expenditures (excluding interest) as well as domestically financed capital projects from its own revenues. It provides an indicator of the adjustment effort in the given quasi-fiscal sector, because interest payments (predetermined by (i) the size of previous deficits and (ii) the terms of rescheduling agreements) and external capital expenditures (financed by foreign donors) are excluded. In 1998 the primary deficit for the quasi-fiscal sectors was at least 3.2 percent (but excluding water and irrigation), but had declined to 2.3 percent in 1999 and 1.3 percent of GDP in 2000.

Financing gap

79. As the overall balance as well as the primary balance both concentrate on items above the line, sole concentration on these items would disregard the macroeconomic impact of financing operations of these sectors. One approach for measuring the financing gap of the quasi-fiscal sectors is to focus on the ex ante adjusted financing gap, which not only takes into account the “above the line” operations of the sectors (i.e. revenues less current and capital expenditures), but also the principal due in any given year on their debt (which can involve budgetary loans, bank loans, payment arrears, and external credits) before (i) subsidies, (ii) rescheduling of debt service or (iii) accumulation of arrears. A positive ex ante adjusted financing gap indicates that such extraordinary financing is necessary. Ex post, of course, the financing gap by definition will be zero, as the combination of a negative overall balance and nonserviceable debts will, as a practical matter, be covered by such financing.

80. Finally, it is necessary—in order to avoid double counting—to calculate a net financing gap for the entire quasi-fiscal sector. For example, the irrigation sector normally accumulates arrears on payments for electricity. If there were no ex ante financing gap for the irrigation sector because this gap would be financed from the budget, irrigation would be able to pay its electricity bills in full, and the ex ante financing gap of the energy sector would be reduced accordingly.

81. In November 2000,39 the joint Bank/Fund assessment of these different ex ante financing gaps, which were agreed with the government were: (i) a gross adjusted financing gap of around 5½ percent of GDP (of which energy, almost 4 percent), and (ii) a net adjusted financing gap of 5 percent of GDP (Text Table 4). It is noteworthy, and an indication of the importance of the “stock” problem, that the preliminary estimated ex ante net unadjusted financing gap (at 5 percent) was almost four times larger than the preliminary estimated combined primary deficit (at around 1¼ percent).40

Table 4.

Ex Ante Financing Gaps in the Quasi-fiscal Sectors, 2000

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Source: IMF/World Bank staff estimates.

The unadjusted financing gap shows the gap after the rescheduling of debt service, the accumulation of arrears and budgetary subsidies to the key quasi-fiscal sectors. The unadjusted financing gaps were agreed during the IMF mission to Yerevan in November 2000.

The adjusted financing gap shows the ex ante financing gap without subsidies, restructured debt services, and arrears accumulation.

The extra payments line summarizes the difference between the billed amount of electricity and the collected amount in the irrigation and water sectors. If there were no gaps in the irrigation and drinking water sectors, they would pay for 100 percent of their energy consumption. In this case the energy sector gap would be correspondingly reduced. The shortfall in energy payments by the irrigation and drinking water sectors needs to be subtracted from the energy financing gap in order to avoid double counting.

Financing of current losses and investments

82. Current losses and investment in the energy sector have been financed through fiscal support in the form of subsidies and budgetary lending, and through quasi-fiscal support such as the accumulation of arrears, bank loans41 and supplier credits.42 In many cases though, these types of financing exhibited a lack of transparency.

83. Despite the fact that the government did not give any explicit subsidies to the energy sector in 1998-2000, the government provided large amounts of fiscal support to the other quasi-fiscal sectors to enable them to pay for electricity. In fact in 2000, 90 percent of all government subsidies were given to state-owned enterprises (in particular, the drinking water and the irrigation sectors). However, as the amount of the subsidy did not cover the full electricity bills during these years, these companies still ran up arrears to the energy sector.

84. Prior to 2000, the budget also provided extensive amounts of budgetary loans, at low interest rates of 1 to 1.5 percent, to the quasi-fiscal sectors. The stock of budgetary loans to all quasi-fiscal sectors accounted for 3.7 percent of GDP at end-2000.43 Since it is questionable whether these loans will ever be repaid, this net lending could well be considered to also have quasi-fiscal implications. Moreover, budgetary lending represents an implicit subsidy as not all enterprises have access to this financing source and it is given at below-market interest rates.

85. As in other CIS countries, the government has tolerated an increase in arrears of tax revenues, wages, social contributions and utility bills to keep the enterprises afloat. The stock of all arrears of the quasi-fiscal sectors amounted to at least dram 9.9 billion (about 1 percent of GDP) in 2000 (Table 51).44 The stock of arrears from other quasi-fiscal sectors to the energy sector accounted for 55 percent of the stock of receivables of the energy sector in 2000. As the energy sector and Nairit are major tax debtors to the budget, growing tax arrears have eroded fiscal revenues. Moreover, given that the more profitable small and medium sized private enterprises are generally not allowed to run up tax arrears, this implicitly has led to a cross-subsidy to the less productive segments of the economy (such as Nairit or the energy sector).

86. Bank loans have played an important role in financing the deficit of the energy sector, while in the remaining quasi-fiscal sectors they do not appear to have been of particular significance. In the energy sector, bank loans still accounted for 22 percent of all payables at end-2000, although their share has decreased from 31 percent in 1998. In earlier years, these loans were primarily given as directed credits. To the extent these loans are still made at below-market interest rates, they could be considered quasi-fiscal operations.

87. Delays in payment to suppliers of goods and services to the energy sector are considered supplier credits if the terms of the late payments have been agreed between the two parties. Given their strong negotiating position, however, energy companies can easily enforce mutual agreements, thus converting such arrears to suppliers into supplier credits. Such agreements have been formalized, but often they do not reflect market terms, and therefore represent another implicit cross-subsidy from more productive to less productive segments of the economy.

Stock of Debt

88. As noted above, the persistence of current (or operational) losses, together with investment needs, has led to significant accumulation of debt. In the energy sector, the stock of payables at end-2000 was preliminarily estimated at $223.7 million (about 12 percent of GDP), of which some 60 percent was domestic and 40 percent was external debt (Text Table 5). While in many other CIS countries energy debt and, in particular, gas debt, accounts for a high share in external debt,45 in Armenia only 10 percent of total external debt can be attributed to the energy sector. This is partly due to the 1998 gas for equity swap under which Armenia received gas from Russia during 1998-2000 in exchange for equity in the Armenian gas company Armgas46 This swap also largely explains the reduction in the size of the total payable debt in the energy sector after 1998. Nevertheless, the large stock of energy sector debt means that energy sector debt service obligations in 2000 were considerable, in the range of 20 to 25 percent of energy sector revenues, according to World Bank estimates.

Table 5.

Stock of Payables and Receivables in the Energy Sector, 1996-2000

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Source: IMF staff estimates; Armenian authorities; World Bank.

Due to lack of data, only the energy sector debt can be considered here.

Also includes the receivables from natural gas (as accumulated before the creation of Armrusgasprom) and thermal energy. Irrigation and drinking water only have electricity debt to the energy sector, because they only use electricity but not thermal energy or gas as an input.

89. The stock of receivables held by the energy sector amounted to the equivalent of $146 million at end-2000, and included electricity arrears and arrears for thermal energy and natural gas. From end-1998 to end-2000, the receivables of the energy sector increased from 8½ to 13 percent of GDP. The receivables for delivery of gas mainly stem from previous years, when the gas distribution network was still a part of the state-owned energy sector. Most of the energy sector’s receivable debt is generally considered as “bad debt”, i.e. it will likely never be collected.

D. Causes of the Financial Imbalances

Technical and Excess Losses

90. Technical losses are defined as losses due to inefficient and wasteful infrastructure and lack of metering, and are typically only subject to reduction through better management, improved maintenance, and new investment. Technical losses have been calculated separately—from excess losses (see below)—thus far only for the energy sector, and there has been only negligible progress in this area since 1998 (Text Table 6). Excess losses essentially refer to theft, and after a reduction in the excess loss rate in energy in 1999, the rate rose again in 2000. While the overall loss rate held roughly constant in irrigation between 1999 and 2000, it deteriorated substantially in the two water companies in 2000. Overall loss rates in water and irrigation are very high, in the range of 30 to 70 percent.

Table 6.

Key Parameters in the Quasi-fiscal Sectors, 1995-2000

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Source: Armenian authorities

Before 1998, only the household tariff is available. From 1998, cash flow data referring to the average tariff are cited.

Some of the overdue bills will be collected during the first three months of 2001. These data was not available in March 2001.

91. Theft is often dependent on seasonal factors; for example, winter months electricity theft is higher than in summer months since electricity is the major heating source. Also, press reports have suggested that some managers in distribution companies as well as in pumping stations have been accused of being actively involved in theft. Moreover, the quasi-fiscal sectors still have inadequate metering, accounting and auditing systems, and the government has sought aid from USAID and the World Bank to deal with these problems. However, progress has proven to be slow.

Low tariffs

92. As noted earlier, during the 1991-94 the energy sector operated in a crisis mode geared to human survival, with little attention being given to commercial principles. Faced with the rapidly increasing price of energy imports, the authorities adjusted tariffs for electricity, gas, and heating (where available) to cover at least most of the fuel costs, but the extent of cost recovery for operations, maintenance, and depreciation was insufficient to maintain plants and equipment. In addition, the government’s ability to raise tariffs in real terms was circumscribed by the high rate of inflation in 1992-1993.

Low collection rates

93. The task of ensuring a secure supply of energy was complicated by the inability of the electricity supply aon rate in the energy sector was preliminarily estimated by the authorities at 88½ percent in 2000, but it is only in the 20 to 40 percent range in the water and irrigation sectors. Since 88 percent of all households pay their electricity bill, nonpayment in the state-owned energy sector is mainly caused by some large scale industrial enterprises such as Nairit, and budget-related organizations such as the drinking water companies and the irrigation company. Among the reasons for nonpayment are the following: (i) the inability of end users to pay; (ii) the reluctance to suspend service to nonpaying customers;47 and (iii) the inability of the government to enforce collection of overdue receivables. The enforcement of financial discipline is also difficult because of the scarcity of metering equipment and of the lack nd distribution companies to enforce payment discipline by end users, including both households and enterprises. Revenues collected have consistently fallen short of energy billed. The collection of technical means to disconnect nonpaying customers. The latter especially holds true for the “other” quasi-fiscal sectors.

Lack of transparency48

94. As noted in the introduction, quasi-fiscal deficits as well as non-cash payments ultimately reflect a failure of economic policy to promote the restructuring of ailing sectors and to impose hard budget constraints on nonviable enterprises. Barter payment is still widespread in the energy sector. While in some cases the energy sector has had to accept barter payment in order to keep an enterprise or factory afloat, in other instances, creditors of the Armenian energy sector (such as Itera) might insist on payment in goods instead of cash. However, the lack of transparency associated with in-kind payments creates opportunities for corruption and fraud. Furthermore, mispricing of goods obscures the financial accounts of the involved enterprises.

95. During 1997-1998, barter made up for 60 percent of all energy payments, but the extent of barter has been significantly reduced since then. In Armenia, recent barter payments to the energy sector have been organized through mediators or trading companies, such as Dvin (see Figure 5, which illustrates a barter payment scheme for Itera). If a consumer is not able to pay its electricity bill in cash, it may offer in-kind payment to the energy sector. If the energy sector agrees to in-kind payment, a contract is set up between the energy sector, the barter trader (here, Dvin), Armrusgasprom, and the consumer concerning the goods to be supplied in exchange for electricity, and the terms of the payment (i.e. deadlines and penalties). Armrusgasprom (and herewith implicitly Itera) only accepts “high-quality goods” in barter trade like rubber, cement/concrete, copper and molybdenum. Upon delivery of the goods to the barter trader, the energy sector’s receivables from the consumer are cancelled. When Dvin delivers the goods to Itera, the energy sector balances the barter share (recently, up to 40 percent) of the accounts payable to Armrusgasprom and Itera.

Figure 5.
Figure 5.

Armenia: Barter Trade in the Energy Sector

Citation: IMF Staff Country Reports 2001, 078; 10.5089/9781451801446.002.A001

96. The involvement of Dvin in the payment chain is especially “advantageous” if the payment schedules for the electricity bill and the delivery of the goods do not coincide. In some instances, the consumer proposes to the energy sector to pay in goods which are not yet produced. In case of such late payment for electricity, the consumer may have an account payable to Dvin but not to the energy sector, since if Dvin pays Itera from goods it has in stock, it can cover the debt of the energy sector to Itera in a timely manner. This advantage also holds true in a case of early payment if an electricity consumer has already produced goods and delivered them to Dvin, but, has not yet consumed the electricity. In this case, the consumer has an account receivable from Dvin.

97. Dvin is also involved in offsetting operations to cover electricity bills for its customers. Since Dvin is specialized in trade with the Russian Federation it may not only arrange the trade on behalf of the energy sector but, if necessary, for much of the industrial sector. For example, Nairit used Dvin as a mediator for its trade with Russia in 1998-2000, and as a result had accounts receivable from Dvin from these transactions. On the other hand, Nairit was not able to cover its electricity bill, and thus Nairit had accounts payable to the energy sector. As a consequence, the Ministry of Industry and Trade (supervising Dvin) and the Ministry of Energy agreed in 2000 on an offsetting operation, which allowed Nairit to cover its debts to the energy sector by drawing on its account receivable to Dvin.

98. As long as the government continues to tolerate quasi-fiscal deficits and barter, enterprise restructuring tends to be delayed not only in the quasi-fiscal sector but also—due to ripple effects—in the entire industrial sector. Given the importance of large-scale enterprises for the economy, implicit subsidies channeled through the acceptance of operational deficits and barter are often a substitute for an effective social safety net. Establishment of a better targeted social safety net, improved incentives to private entrepreneurs, as well as the fight against corruption would all help to overcome quasi-fiscal deficits and barter, and the government has committed itself to reforms in these areas.

E. Reforms

99. Armenia’s isolation from international markets was eased somewhat by the signing of a cease-fire agreement with Azerbaijan in 1994 and by political stabilization and economic recovery in Georgia. This allowed the government to move away from the management of an economy in conditions similar to being under siege and towards the implementation of a comprehensive stabilization and structural reform program. The following steps have been taken to reform the energy sector in Armenia.

Tariff adjustments

100. In an early attempt to reduce operational losses in the energy sector, the tariffs in the electricity sector were gradually increased, from 0.2 Dram/kwh (US cents 0.3 per kwh) at end-1993 to 25 Dram/kwh (US cents 4.4 per kWh) on January. 1, 1999 (Table 13).49 However, the current electricity tariff still does not cover total expenditures, nor do tariffs in the other quasi-fiscal sectors. It is frequently argued that the present tariff in the energy sector would cover current expenditures (excluding interest payments) if all consumers were to pay their bills. Even though this argument is arithmetically correct, from an economic point of view it lacks substance as the collection rate in 2000 was still well below 100 percent. As noted earlier, the low tariff is partly motivated by social considerations, given the absence of a social safety net. Since a non-cost recovery tariff does not signal relative scarcity, however, it is inferior to an increase in tariffs accompanied by direct transfers to needy households to balance the social impact of higher utility costs.

Collection enforcement

101. In an effort to enforce payment discipline, the government implemented a decree in mid-1995 under which the Ministry of Energy was authorized to suspend service to customers in default with the exception of budgetary enterprises and so called strategic enterprises such as Nairit and the drinking water and irrigation companies. This measure helped to improve payment discipline, and the collection rate rose from below 40 percent in 1995 to around 88-89 percent in 1999-2000. At present, households pay 88 percent of their electricity bill in cash. The collection rate for industries is 100 percent due to the acceptance of barter payment. Other consumers (especially service companies), however, pay the full amount for their electricity bill in cash. Major nonpayers to the electricity sector include the irrigation, drinking water and the transportation sectors.

Improvement of monitoring

102. The measure to cut off non-paying private households was accompanied by (i) the introduction of accounting systems making the extent of nonpayment transparent, and (ii) enhanced metering systems provided mainly by international donors. In September 1998, the government published the first official cash flow projections for the energy sector for the years 1998 to 2001. For 1999, cash flows were compiled for the two water companies and the irrigation sector. Since then, actual cash flows have been reported to the government and to parliament.

103. In 1998, the U.S. Government approved a grant of $15 million mainly to improve the metering system in the energy sector. Today, the majority of end-consumers are metered, but the manipulation of meters is frequently reported. Furthermore, lack of metering is still a matter of concern at the transmission and generation level. In the other quasi-fiscal sectors, metering lags far behind the standards of the energy sector.

Improved regulatory framework

104. In 1997 a new energy law was adopted. The energy law: (i) provided the legal basis for the separation of Armenergo, which was then a vertically integrated power company, into generation, transmission, dispatch and distribution companies and, hence, triggered the substantial restructuring of the energy sector; (ii) established an independent Energy Regulatory Commission responsible for issuing licenses, establishing market rules and setting regulated tariffs; and (iii) separated the policy-making (e.g., providing for more competition) from the ownership role of the government. Since 1997, private ownership has in principle been allowed in all parts of the energy sector except in nuclear facilities.

Other Measures: The gas for equity swap

105. In 1998, a joint venture, Armrusgasprom, was formed with Russia’s Gazprom and Itera to finance the continuing operational losses of the energy sector caused by the high loss rates and inadequate collection of energy bills.50 Some 55 percent of the equity in Armrusgasprom, valued at $270 million, was transferred to Russia’s Gazprom (45 percent) and to Itera (10 percent), a U.S. registered private natural gas trading company, mainly in exchange for gas that was to be supplied to Armenia during 1998-2001. The remaining Armrusgasprom shares are owned by the government of Armenia, namely the Ministry of Energy. The joint venture between the government of Armenia and Gazprom and Itera, named Armrusgasprom, was intended to secure gas deliveries to Armenia, as Itera is its exclusive gas supplier. Given a secured gas supply from abroad, Armenia is even able to produce electricity in excess of its domestic demand, making it a net exporter of electricity. However, one of the major Armenian objectives for the joint venture—to export Russian gas via Armenia to Turkey—has not yet been achieved. If Armenia were to become part of a gas transit network, the deal would allow the government to collect transit fees for exported gas. Finally, the Armenian government expected that Itera would have financial resources to invest into the gas network.

106. As the Armenian government considers Armrusgasprom to be an independent company, the official cash flow projections for the energy sector have excluded operations of Armrusgasprom since the second half of 1998. If domestic gas consumers failed to pay Armrusgasprom, this would not trigger budgetary support from the government for the joint venture. Nevertheless, since the state holds 45 percent of Armrusgasprom, it would need to assume an equal part of that company’s liabilities if it went bankrupt. In treating Armrusgasprom as a private company, it remains unclear what the government’s current obligations to the company are. This is complicated by the fact that the government still has not clearly indicated, whether the gas provided to the energy sector on the basis of the gas-for-equity swap would be given as a budgetary loan or as a grant to the energy sector.51 Furthermore, the accounting treatment and the schedule of payments through the chain of energy companies (from electricity generation through the electricity distribution companies) remains to be clarified.

F. Further Steps

107. With the assistance of the World Bank and other international donors, the government has been preparing several steps for the further financial rehabilitation of the quasi-fiscal sectors.

  • Privatization of energy distribution companies: In preparation for strategic investor privatization, the electricity distribution companies were gradually consolidated (from 62 companies in 1996, to 11 in 1997, and to 4 in 1998). Furthermore, a privatization law was enacted in July 2000 and soon after, a tender committee was established to supervise the privatization process. In March 2001, the tender documents were initially sent to potential investors. Privatization of the electricity distribution companies could improve revenue collections at the distribution stage if the government no longer can prevent the supplier from cutting off delinquent customers, or if it agrees to subsidize the distribution companies for the unpaid bills. Privatization of the transmission and generation stages of the energy sector (except for the nuclear power plant) are also being considered for the medium and long term.

  • Targets for the primary balance: The government has set targets for the primary balance of the energy sector in 2001. Furthermore, the government has indicated its intention to publish quarterly data on cash flows in the energy sector and to improve data provision in the other quasi-fiscal sectors. These targets will give the authorities the incentive to push ahead with the restructuring of the quasi-fiscal sectors, and are intended in the meantime to serve also as an incentive for lower losses and increased collections in these sectors.

  • Support for the restructuring of energy sector debt: After the privatization of the electricity distribution companies, the accumulation of new receivables and payables by the energy sector should cease. However, the problem of old payable debt could complicate further privatization. Therefore, the government has been exploring possibilities for restructuring the energy sector’s accumulated external and domestic debt, at concessional terms.

108. As the sector does not earn sufficient revenues to finance necessary investment to replace obsolete plant and machinery, further tariff adjustments to reflect current and capital expenditures may also have to be considered. Over the next decade, the World Bank estimates that about $1.7 billion is needed in the energy sector alone to compensate for the asset depletion since the collapse of the Soviet Union, and to rehabilitate and replace assets that are well beyond their economic life. One of the reasons for the privatization plan noted above was the interest in attracting additional needed investment.

APPENDIX I

Armenia: Summary of Tax System (as of January 1, 2001)

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APPENDIX II Recent Economic Developments in the Other Quasi-fiscal Sectors

Yerevan Water and Sewer Company

1. The Yerevan Water and Sewer Company provides drinking water and sewage services for the population of Yerevan and its vicinity. The overall deficit of the company increased from 0.5 percent of GDP in 1999 to 0.6 percent of GDP in 2000 (Text Table 3). These deficits were caused by high loss rates, low collection rates, and a less than full cost-recovery tariff. In 1999, the overall loss rate was 59.2 percent of all water that was supplied to the network because the technical standard of the company and the grid is very low. Furthermore, the low technical standard contributes to high electricity consumption in order to pump the water. The collection rate in 1999 was 24 percent, mainly the result of inadequate management. In 2000, according to preliminary estimates, the situation deteriorated further. The collection rate declined to 19 percent and the overall loss rate increased to 73 percent of water supply. In 1999, the tariff rate was dram 46 per cubic meter water for drinking water and dram 10 per cubic meter for sewage. It remained unchanged in 2000 as the government attempted to maintain access to water for the poor.

2. To overcome low collection rates and high losses, the government began to compile cash flows to increase the transparency of the company, and reported them to parliament for the first time in 1999. Furthermore, the sales department was fully restructured with a view to increasing collection rates and improving customer service. In this connection, additional discounts to privileged customers, which were mainly intended to subsidize the industrial sector, were also eliminated in 1999. However, in the course of these reforms it became apparent that the government lacked the capacities to restructure the company in a more substantial manner. In February 2000, the government, with assistance from the World Bank, recruited an international water operator to manage Yerevan Water and Sewer Company under a four year performance-based contract. Under the contract, the operator must decrease energy consumption by 25 percent, increase the collection rate to 85 percent and improve the technical standard of the grid. The management contract includes an incentive fee, which is to be disbursed by the World Bank annually if the performance standards are met. Since the international water operator only started its work in June 2000, it is too early to assess the effectiveness of this approach. Even though electricity consumption decreased by 10 percent from 1999 to 2000, as mentioned above, collection rates and loss rates deteriorated.

Armenia Water and Sewer Company

3. The Armenia Water and Sewer Company serves approximately 1.4 million people outside of Yerevan. The overall deficit of the company declined from 0.3 percent of GDP in 1999 to 0.2 percent of GDP in 2000.52 The factors underlying the deficit are similar to the Yerevan Water and Sewer Company: high loss rates, low collection rates, and a less than full cost-recovery tariff. In addition to the problems that the two drinking water companies have in common, Armenia Water and Sewer Company has a larger need for investment because some areas of Armenia are still without access to drinking water (especially in the earthquake zone). These investments have been financed through budget loans and subsidies. Collection rates increased from an estimated 20 percent53 in 1998 to 31 percent in 2000, which is mainly due to a change in the management system that presently awards managers for high collections. However, loss rates increased, from 37 percent in 1999 to 44 percent in 2000. As in the case of the Yerevan Water and Sewer Company, the Armenia Water and Sewer Company started to compile cash flows in 1999 to be reported to parliament. Furthermore, it gradually introduced gravity flow systems to reduce the amount of pumping of water uphill, which led to a 5 percent decline in electricity consumption from 1999 to 2000. In addition, water supply was improved in a number of regions.

Irrigation

4. The Irrigation Company supplies water to communities and irrigation distribution stations, which in turn provide the water to consumers and collect fees. While irrigation was supplied free of charge in Soviet times, a system to collect tariffs has been introduced over the last eight years. In 2000, the company’s overall deficit declined slightly from 1.2 percent of GDP in 1999 to 1.1 percent of GDP. Correspondingly, the primary deficit fell from 0.7 percent of GDP in 1999 to 0.6 percent of GDP in 2000. The reasons for the high deficit resemble those for the two drinking water companies: high loss rates, low collection rates, and a less than full cost-recovery tariff (i.e., at actual loss and collection rates). Furthermore, the company uses a great deal of electricity since the gravity system from Soviet times is defective and is therefore no longer used. In addition, there is still a substantial share of arid land close to the border with Azerbaijan, where the wells were destroyed during the Nagorno-Karabakh conflict and which presently have to be served with water pumped over long distances. The collection rate of the Irrigation Company declined from 50 percent of the billed amount in 1999 to 38 percent in 2000. The collection problem is aggravated because individual metering of customers is not at present technically feasible. Loss rates remain at around 3.0 percent, and the authorities consider that they can only be improved by additional investments. Starting in 1995, the World Bank began providing funding for urgent repairs in the irrigation sector, while operational costs have been covered by fee collections and substantial subsidies from the state budget (1999: dram 6.7 billion, 2000: dram 5.4 billion).54

District Heating

5. In the Soviet period, district heating was the primary source of heating. However, in the aftermath of the 1992-95 energy crisis, the system broke down and presently only relatively modern houses are still supplied with this type of heating. Even though district heating now only covers roughly 15 percent of the population in Armenia, it continues to incur sizable financial deficits. Given the lack of data, it is difficult to form a view regarding the present financial viability of district heating. The Ministry of Finance and Economy estimated the financing deficit (overall deficit plus negative available financing) at dram 7.4 billion (roughly 0.7 percent of GDP) for the heating season of 1999-2000. This deficit was predominantly caused by a low collection rate (for 1999-2000: 19.5 percent) and a low tariff in comparison to alternative sources of heat (e.g., electricity). However, technical losses do not appear to have been an underlying factor for the deficit, as they were estimated at only 9 percent of total thermal energy supply. Since the majority of the population in Armenia has to rely on relatively expensive electricity for heating, the low tariff in district heating is a significant income transfer to households benefiting from this system. Moreover, since mainly modern apartment buildings are served, which are usually rented by tenants with above-average income, the system appears to be highly regressive. For the heating season 2000-2001, the government introduced a system whereby customers would have to pay 60 percent of their heating bills in advance. Since it is technically infeasible to cut-off single households, it remains to be seen whether this measure can be implemented effectively so as to increase the collection rate. The state budgets for 2000 and 2001 made no provision for the subsidization of district heating.

Nairit

6. Nairit is an enormous chemical factory just outside of Yerevan, which produces mainly chloropene rubber and latexes. Most of the customers of Nairit are located in Russia, Ukraine and other CIS countries, and the demand for Nairit’s chloropene rubber declined to 25,000 tons in 2000—a quarter of the amount demanded during Soviet times. As Nairit was only able to pay around 25 percent of its electricity bill in the first nine months of 2000, the energy sector (as noted earlier) effectively accepted barter payments by Nairit. The government announced in 2000 its intention henceforth to treat Nairit as a private company, which would be liquidated if it cannot be operated profitably.

Table 7.

Armenia: Real Gross Domestic Product Growth, 1995-2000

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Source: National Statistical Service.

Includes passenger transport only during 1994-95.

Includes the government sector.

Calculated as taxes less subsidies

Table 8.

Armenia: Quarterly Real GDP, 1997-2000

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Source: National Statistical Service

Includes passenger transport only during 1994-95.

Includes the government sector.

Calculated as taxes less subsidies

Table 9.

Armenia: Gross Domestic Product, 1995-2000

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Source: National Statistical Service.

Includes government.

Table 10.

Production of Selected Agricultural Products, 1995-2000

(In thousand tons; unless otherwise indicated)

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Source: National Statistical Service.
Table 11.

Armenia: Production of Selected Industrial Commodities, 1995-2000

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Sources: National Statistical Service, and Ministry of Energy.
Table 12.

Armenia: Consumer Prices, 1995-2001

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Source: National Statistical Service.