Republic of Armenia: Staff Report for the 2001 Article IV Consultation and Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility
Author: International Monetary Fund
Publication Date:
02 Apr 2002
eISBN:
9781451801514
Language:
English
Keywords:
ISCR; CR; PRGF credit; poverty reduction objective; disbursement of SDR; approval; Executive Board's discussion; debt service; real GDP; exchange rate; balance of payments; banking system; Arrears; Monetary base
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This paper assesses the Republic of Armenia’s 2001 Article IV Consultation and a Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). The economic situation in Armenia has improved since mid-2000 following the deterioration in late 1999 and early 2000. Real GDP began to recover in the second quarter and increased by 6 percent for 2000 as a whole. The authorities have made progress in reforming the energy sector, which remains a considerable financial drain on the budget and the rest of the economy.

Abstract

This paper assesses the Republic of Armenia’s 2001 Article IV Consultation and a Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). The economic situation in Armenia has improved since mid-2000 following the deterioration in late 1999 and early 2000. Real GDP began to recover in the second quarter and increased by 6 percent for 2000 as a whole. The authorities have made progress in reforming the energy sector, which remains a considerable financial drain on the budget and the rest of the economy.

I. Introduction

1. Discussions for the 2001 Article IV consultation and a new program that could be supported by an arrangement under the Poverty Reduction and Growth Facility (PRGF) were held in Yerevan during November 7–21, 2000 and January 16–29, 2001. Earlier missions to conduct PRGF discussions took place in March, May, and September 2000.1 The staff representatives met with President Kocharian, Prime Minister Margaryan, Minister of Finance and Economy Khachatryan, Central Bank of Armenia (CBA) Chairman Sargsyan, and other senior government officials and members of parliament.

2. The 1999 Article IV Consultation was concluded on October 8, 1999, when the mid-term review under the third annual arrangement under the Enhanced Structural Adjustment Facility (ESAF) was also completed (EBS/99/181 and SM/99/246). On that occasion, Directors noted Armenia’s resilience to external shocks, but were concerned about the loss of momentum in the implementation of structural reforms and setbacks in the carrying out of the financial rehabilitation plan for the energy sector. On fiscal policy, Directors emphasized the importance of enhancing expenditure control to avoid arrears buildup, and also called on the authorities to address forcefully the issue of tax arrears. Directors supported the tight stance of monetary policy, but encouraged the authorities to strengthen prudential oversight over the banking system. Directors also stressed the importance of developing a comprehensive external debt strategy for the medium term.

3. In the last few years, Armenia has received extensive financial and technical assistance from multilateral institutions, including the Fund, World Bank, and EBRD.2 The World Bank staff has informed the Fund staff that it is prepared to recommend approval to its Executive Board of a new SAC IV loan in an amount equivalent to SDR 38.4 million ($50 million), including a disbursement of $15 million on Board approval of the SAC IV which is expected in the second quarter of 2001.

4. The Armenian authorities report to the Fund on a regular basis the minimum core data used for surveillance (Appendix IV). The statistics currently produced in Armenia generally meet, and in many cases exceed, the recommendations of the General Data Dissemination Standard (GDDS) with respect to periodicity and timeliness of dissemination. However, with respect to other aspects of data quality and their policy value, further improvements are needed, especially in the national accounts and balance of payments, and socio-demographic indicators, as discussed in the forthcoming Report on Standards and Codes (ROSC) data module for Armenia.

II. Performance under the ESAF

5. Following the collapse in output in the early 1990s, significant progress was made on macroeconomic stability and restoration of growth under the government’s economic reform program during 1996–99, supported by arrangements under the ESAF and by considerable World Bank assistance. Period average CPI inflation declined from 175 percent in 1995, prior to the start of the ESAF, to 0.7 percent in 1999. Real growth, driven by construction and services, averaged around 5 percent over the program period, despite the effects of a drought and the impact of the Russian economic crisis.3 At the same time, however, despite the economic growth performance during this period, there has been very little progress in reducing poverty and income inequality, as reflected in the Interim Poverty Reduction Strategy Paper (IPRSP).4

6. Non-inflationary monetary and fiscal policies contributed to this strong macroeconomic performance. The non-inflationary fiscal stance was facilitated by abundant official external financing. Inflation remained low in 1998–99, even though indicative targets for broad money growth under the program were exceeded in almost every quarter, as money demand continued to respond more strongly than anticipated to the stabilization policies pursued (Table 2). Nevertheless, and despite the fact that external debt at end-1999 was actually below what had been projected at the beginning of the ESAF, there was a worrisome lack of progress in increasing exports, which contributed to the very rapid growth in external debt ratios (the external debt/export ratio increased from 127 percent at end-1995 to 223 percent at end-1999). In addition, real interest rates remained high, and there were frequent budgetary revenue shortfalls and problems with expenditure control, the latter leading to the nonobservance of the 1998–99 performance criteria on budgetary revenues and arrears.

Table 1.

Recent and Prospective State Budget Developments, 1998-2001

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Sources: Armenian authorities and Fund staff estimates.
Table 2.

Armenia: Quantitative Benchmarks and Indicative Targets, 1998/2000 1/

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Sources: Armenian authorities; and Fund staff estimates.

Performance criteria for March 1999. Indicative targets for June, September, and December, 1999. The definitions of quantitative benchmarks and indicative targets used under the program were presented in a technical Annex (TA) to the memorandum of economic and financial policies (MEFP) in EBS/99/181.

Targets for 1999 are as defined in EBS/99/181 Supplement 1. For 2000, the targets are the authorities program i.e, CBA’s monetary program presented to parliament and the approved budget.

Expenditure arrears of the state budget and SFSI budget. For December 1998 and March 1999 arrears refer to core expenditures as defined in the TA to the original MEFP. For June 1999, arrears relate to all verified clamis on the government as defined in the Supplement to the TA. Due to changes in the methodology of reporting arrears and the extent of reporting, these figures differ from those in the previous staff report.

Cumulative from December 31, 1998. Excluding normal import-related credits and sales of T-bills to nonresidents.

Program and actual figures were both equal to zero.

Cumulative from December 31, 1998. The definition and coverage of nonconcessional debt is presented in the TA to the MEFP.

Targets for each year are cumulative from end of previous year.

In 1998-99, includes local government revenue, but excludes land and property taxes. In contrast, the definition of “state budget” in Table 5 refers only to central government and excludes local governments.

Includes expenditures financed with the use of privatization proceeds.

In addition, this target was subject to an upper and lower bound as specified in the supplement to the TA to the MEFP.

7. Substantial progress was made in structural reforms during the period of the ESAF arrangements, albeit somewhat less than was targeted. Progress was achieved on banking system reform, establishment of a treasury, strengthening of the social safety net, and revising tax laws. Reforms were also carried out in the quasi-fiscal sectors (including the energy, irrigation, and drinking water and sewage sectors)—improving collections and production efficiency, beginning the process of eliminating the culture of non-payment, improving the transparency of and budgeting for quasi-fiscal energy subsidies, and initiating the privatization of the sector, although not all targets under the program were met in this area, and progress was greater in some sectors than others. Privatization continued, despite a major slowdown in late 1998 and early 1999 due to the Russian crisis.

III. Recent Developments

A. Political Developments

8. The lack of a permanent political solution of the Nagorno-Karabakh issue continues to complicate the economic and political situation. Armenia went through turbulent times in 1999 and the first half of 2000. Following parliamentary elections in May 1999, a new government was formed by the Unity coalition of two parties that together commanded a strong majority in the parliament. On October 27, the prime minister and the speaker of parliament—who headed the two parties that make up the Unity coalition—were assassinated along with six other parliamentarians and cabinet members. Although a new government and parliamentary leadership was quickly established, in line with the requirements of Armenia’s constitution, domestic political tensions remained high until the president appointed a new prime minister, Mr. Margaryan (Chairman of the Republican Party and Head of the Unity Coalition parliamentary group) in May 2000 and parliament approved a new government program on June 10. Since then, the political turmoil characterizing the period following the political assassinations of October 1999 has largely subsided.

B. Output and Prices

9. The economy grew by 6.2 percent during the first nine months of 1999 (compared to the same period of the previous year), led by industry, construction, and trade and services. 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 economic activity remained flat in the first quarter of 2000 but began to recover in the second quarter. Real GDP increased by 6.0 percent for 2000 as a whole, despite a severe drought affecting part of agriculture during the summer (Figures 1 and 2, and Table 3). Growth in 2000 was led by industry, construction, and trade and services. Notwithstanding the growth performance, the unemployment rate has not come down despite continued emigration.

Figure 1.
Figure 1.

Armenia: GDP, Wages, and Inflation, 1995–2001

Citation: IMF Staff Country Reports 2002, 073; 10.5089/9781451801514.002.A001

Sources: Armenian authorities; and Fund staff estimates.1/ Nominal wages deflated by CPI (January 1995=100).
Figure 2.
Figure 2.

BRO Countries: Average Monthly Wages, 1995–2001

(In U.S. dollars, period average)

Citation: IMF Staff Country Reports 2002, 073; 10.5089/9781451801514.002.A001

Source: IMF, European n Centralized Database.1/ Dollar wages are based on official exchange rates.
Table 3.

Armenia: Selected Economic Indicators, 1998/2003

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Sources: Armenian authorities; and Fund staff estimates.

With respect to the same period in the previous year.

Figures for Q1 2001 are preliminary actuals.

Inflation during the previous 12 months.

Deficit as measured by financing.

Change in percent of reserve money at the beginning of the period.

Based on GDP for the period, seasonally unadjusted for quarterly figures.

Excludes official transfers.

10. Inflation remained low in 1999 and 2000, due to a variety of factors including generally non-inflationary monetary and fiscal policies during the period. Inflation in 1999 was substantially lower than programmed, with end-period inflation of only 2.1 percent compared to an original target of 9.9 percent. 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 by the appreciation of the U.S. dollar relative to the euro which, given the stability of the dram vis-à-vis the dollar, 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, cumulative inflation for 2000 as a whole was only 0.4 percent. Inflation was 3.7 percent cumulatively during the first three months of 2001, 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.

C. Fiscal Policy

11. In the first half of 1999, tax arrears increased and expenditure arrears accumulated in the aftermath of the Russian crisis and the political uncertainty prior to the May parliamentary elections. In August 1999, the government included a set of revenue and expenditure measures in an amended budget. Nevertheless, arrears accumulation accelerated in the fourth quarter of 1999, following the political assassinations, due to a decline in budgetary revenues relative to program projections (reflecting significant shortfalls in indirect taxes) and a shortfall in domestic financing. In addition, the third tranche of the World Bank SAC III was $5.5 million less than anticipated, as a result of the failure to meet full program conditionality. In the event, state budget expenditure arrears rose to 2½ percent of GDP at end-1999.

12. The 2000 budget assumed that the drop in revenues observed in the fourth quarter of 1999 was only short term, and that the underlying trend of increasing tax revenue relative to GDP would continue due to administrative improvements and the increase in excise rates included in the amended 1999 budget. However, tax revenues in the first half of 2000 were only equal to the level in the first half of 1999, which itself had been characterized by difficulties in collection. In addition, until late in the year there were no disbursements under the World Bank SAC III, compared to a total of $45 million of combined SAC III/IV disbursements expected in the 2000 budget, mainly due to continued slippages in the privatization of the energy distribution companies (EDCs). As a result, state budget expenditure arrears increased dramatically in the first half of 2000, to 4½ percent of GDP at end-June 2000. The staff recommended, but the government decided against, amending the budget in mid-2000, and thereby missed a chance to adjust expenditure commitments in light of lower than budgeted revenues.

13. State budget tax revenues have been on an upward trend since June 2000, except for a weak revenue performance in September, and the authorities succeeded in meeting the indicative target for the fourth quarter agreed with the staff. The stronger tax revenue performance in the second half of 2000 (relative to the budget) reflected increasing political stability, a recovery in economic activity, and improved tax administration. While state budget expenditure arrears increased in the third quarter, to 5.1 percent of GDP, they declined in the fourth quarter, to 4.3 percent of GDP at end-2000 (Table 5). The extent of arrears clearance in the second half of 2000 reflected the improvement in tax collections, 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 Special Privatization Account (SPA).

Table 4.

Armenia: Monetary Program, 1998/2001

(In millions of drams; unless otherwise indicated)

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Sources: Central Bank of Armenia; and Fund staff estimates.

NIR is based on the program exchange rate of dram 470 per US dollar for 1998 and of 525 per US. dollar for 1999-2000 as indicated.

NIR is based on the new program exchange rate of dram 552.18 per US. dollar.

NIR is adjusted to exclude KfW loans (which are long term loans) from the liabilities side.

Broad money (M2X) is defined as dram broad money (M2) plus foreign currency deposits.

Quarterly velocity are defined as dram broad money (M2) plus foreign currency deposits.

Compared to the previous quarter.

Compared to the previous year.

Table 5.

Armenia: State Budget, 1998/2001

(In millions of dram)

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Sources: Armenia Ministry of Finance; Central Bank of Armenia; and Fund staff estimates.

The grants are different from the 2001 budget figure due to delays in the monetarization of grants in 2000, which increased the expected receipts in 2001, and the delay in the disbursement of a grant.

Assuming the use of dram 7 billion of privatization proceeds for capital expenditures in 2001.

The allocation of the arrears within the different quarters of 2000 and the stock at end-2000 is preliminary.

Dram 10,396 millions of WB disbursements for SAC III are reported in 1999 as they were used to finance 1999 expenditure. In the BOP, this amount is reported in 2000.