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.
May 21, 2001
1. The following information has become available since the staff report (SM/01/61; 4/30/01) was issued. This information does not change the thrust of the staff appraisal.
2. Economic developments continue to be generally encouraging. Real GDP grew by 12.3 percent in the first quarter of 2001, compared to the first quarter of 2000. Inflation was minus 0.1 percent in April, or 3.6 percent cumulatively for the first four months of 2001. The trade balance was strong in the first quarter, with merchandise exports growing by 30 percent over the first quarter of 2000, and merchandise imports declining by 10 percent. Reserve money remained within the corridor in April and the dram was relatively stable in U.S. dollar terms.
3. Regarding fiscal performance, total revenue and grants in the first quarter of 2001 were slightly higher than envisaged as buoyant nontax revenues (fuelled by higher-than-programmed profit remittances from the Central Bank of Armenia) more than offset a shortfall in grant inflows (related to slower than programmed monetization of commodity grants). These higher revenues were unfortunately reflected in higher than programmed expenditures in the first quarter (dram 1.7 billion, or 4 percent). The staff is concerned about expenditure control and will stay in close contact with the authorities in the immediate period ahead, not only to better understand the reasons for the overspending and help address any identified shortcomings in budget implementation, but also to provide assurances that the authorities will possess the capacity to carry through with their intention to reduce expenditure commitments in June, should this prove necessary.
4. The required documentation under the safeguards framework is currently under review by the staff. The central bank publishes its financial statements in the Annual Report and they are audited by an international external auditor. As part of the safeguards framework staff will ascertain whether the external audit meets internationally accepted standards. The full Stage One safeguards assessment is expected to be completed by the time of the first review of the program.
5. All of the prior actions have been implemented, except for: (i) the cumulative state budget tax revenue target for January-April 2001; and (ii) the requirement that there be no increase in the stock of state budget arrears after end-December 2000. The authorities settled their external payment arrears of $2.1 million to Turkmenistan on May 18. The reason why the authorities did not settle these arrears at least five working days prior to the Board meeting was that there was a good possibility they would receive a comfort letter from the Turkmen authorities which would allow Armenia to settle this payment through the provision of goods at a later date. As this did not come, the authorities settled the arrears through a cash payment.
6. With regard to the first of these two prior actions, April tax revenues (at dram 10.5 billion) fell around 30 percent short of the target agreed with the staff. Consequently, the January-April cumulative tax revenue target was missed by some 8 percent. Revenues from the VAT and excises make up roughly two-thirds of tax revenue in Armenia, and this is where the main shortfalls have occurred. In April, net VAT collections were about 30 percent below the average monthly level for the first quarter. About one-third of this decline appears to be due mainly to lower collections from the energy sector—which the authorities indicate has run up some 0.4 percent of GDP in tax arrears since the beginning of the year—as well as a continuing decline in registered imports of, and thus VAT collected on, gasoline. Roughly, the other two-thirds of the decline in VAT revenues appears to be due to a sharp increase in VAT refunds on exports in April, which reflect requests for refunds by two large companies in early April. Excise collections in April continued to fall for the second straight month. The authorities attribute most of this decline to increased underreporting and smuggling of imported gasoline.
7. The authorities have indicated, in a letter to Management from the Prime Minister, that they have taken actions to deal with what appear to be the major sources of the revenue shortfall, and on this basis remain firmly committed to achieving the state budget tax revenue target for end-June 2001 as specified in the program. Specifically, the Prime Minister instructed the Ministry of State Revenues to take tougher administrative measures related to customs control and smuggling of imported gasoline. As a result, the volume of gasoline imports during the first 11 days of May rose sharply to a level higher than that for the entire month of April. Secondly, the Prime Minister referred in his letter to specific measures which were taken and decided on at a special meeting of the Board of the Ministry of Energy in which he participated, intended to ensure that the state-owned energy companies step up their tax payments in May and June.
8. In addition, the letter states that the Prime Minister is committed to (i) reduce expenditure commitments in June by an amount—should the May revenue outturn be lower than the authorities now project—necessary to keep the stock of domestic expenditure arrears in line with the program; and (ii) submit an amended budget to the parliament should the government decide, in consultation with Fund staff, that in light of actual revenue performance in the first half, further expenditure cuts would be needed to achieve the arrears clearance in the second half of the year specified in the program.
9. With regard to the second prior action, compared to a small programmed decline in the stock of state budget arrears in the first quarter of 2001, arrears increased by dram 3.0 billion. (Since the issuance of the staff report, the staff has learned that a small amount of state budget arrears—less than 0.02 percent of GDP—were accumulated in the first two months of 2001.) According to the Ministry of Finance and Economy, the government kept a roughly equivalent amount on deposit in the central bank as a contingency in the context of ongoing discussions with a major creditor. While this is technically a violation of the staffs understandings with the authorities, it should be recognized that they could have made the payment and avoided the accumulation of arrears and would have complied with the program target. In that sense, the deviation from the target was unfortunate but reversible.
10. The indications given above concerning the recent shortfall in tax revenues and expenditure slippage increase the risks to the program by making more difficult the achievement of the program’s fiscal targets for June, 2001. However, the authorities have provided assurances that they will meet these targets. Therefore, based on the authorities’ assurances, and despite their having not observed two prior actions, the staff continues to recommend Executive Board approval of Armenia’s request for an arrangement under the Poverty Reduction and Growth Facility.
11. An assessment of structural conditionality streamlining is provided in the attached Box 1.
Armenia—Structural Conditionality Streamlining Assessment
1. Coverage of Structural Conditionality in the Current Program
Structural conditionality in the program, listed in paras 54-55 of the MEFP and the attached Tables 1 and 2 (EBS/01/61, 4/30/01, pp. 84-87), focuses on improving public sector governance, strengthening treasury management and tax administration, and bank bankruptcy legislation. The financial performance of the energy sector is addressed by a quantitative performance criterion. Strengthening the performance of the budget and of the energy sector, and dealing with problem banks, are central to the effort to reestablish macroeconomic stability.
2. Status of Structural Conditionality from Earlier Programs
The status of structural performance criteria and benchmarks for end-March and end-June 1999 was presented in EBS/99/181, 9/20/99, Table 2, p. 9. Energy sector reform, which was not implemented, will be covered under the proposed World Bank SAC IV, which includes board presentation and tranche release conditions related to energy sector privatization. The structural conditions for the remainder of 1999, which covered the areas of tax administration, treasury management, the banking sector, and the social safety net, were observed.
3. Structural Areas Covered by Bank Lending and Conditionality
The proposed SAC IV includes board presentation and/or tranche release conditions related to the energy sector and other privatization, improved targeting of poverty allowances, and pension reform. It also includes a number of issues related to public administrative reform, primarily those aimed at improvements in the business environment, as well as improvements in the legal framework for private sector development, further rationalization of the health and education sectors, and measures to develop land markets. The Country Assistance Strategy envisages a separate public sector reform project, preparation of which is scheduled to commence this fall.
4. Other Relevant Structural Conditions Not Included in Current Program
The proposed program does not include energy sector reform measures per se, even though these were in the 1999 program supported under the third annual ESAF arrangement (EBS/98/213, Supplement 1, 12/8/98, pp. 14-15). As noted above, the proposed program includes a quantitative performance criterion on the primary balance of the energy sector, to be monitored in close cooperation with the Bank staff, while the Bank staff will handle structural reform issues in the energy sector in the context of conditions under SAC IV. Measures in the areas of privatization, civil service reform, and the social safety net were included in the 1999 ESAF-supported program but are not included in the proposed program. These areas are important but not critical to the program’s macroeconomic objectives, are outside of the Fund’s core areas, and will be covered under the World Bank SAC IV and its other lending programs (see EBS/01/61, footnote 19, p. 30).