Republic of Armenia
Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility -Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Republic of Armenia
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International Monetary Fund
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Publication Date:
05 Jun 2008
eISBN:
9781451801682
Language:
English
Keywords:
ISCR; CR; growth facility; Three-Year arrangement; Three-Year; growth; government; prudent monetary policy; transmission mechanism; appreciation pressure; debt service; working capital; Credit
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Macroeconomic performance of Armenia in 2007 has been strong, with double-digit growth and single-digit inflation for the sixth consecutive year. Fiscal policy in 2007 remains prudent, with the central government deficit limited to the programmed level of 1.8 percent of GDP. Monetary growth has accelerated in 2007, fueled by unsterilized foreign exchange intervention, cash dedollarization, and a surge in private sector credit. External developments in 2007 have shaped by large-scale inflows, high food prices, and buoyant domestic demand, amid continued dram appreciation.

Abstract

Macroeconomic performance of Armenia in 2007 has been strong, with double-digit growth and single-digit inflation for the sixth consecutive year. Fiscal policy in 2007 remains prudent, with the central government deficit limited to the programmed level of 1.8 percent of GDP. Monetary growth has accelerated in 2007, fueled by unsterilized foreign exchange intervention, cash dedollarization, and a surge in private sector credit. External developments in 2007 have shaped by large-scale inflows, high food prices, and buoyant domestic demand, amid continued dram appreciation.

I. Introduction

1. Armenia’s performance under its third PRGF arrangement has been commendable. A marked reduction in poverty has been achieved in a high-growth and low-inflation macroeconomic environment. Structural reforms, largely focused on the fiscal and financial sectors, have progressed steadily (Box 1). But important reforms are still needed to sustain and broaden growth, and the country—land-locked and facing two closed borders—remains vulnerable to external shocks and regional instability.

Armenia’s Third PRGF-supported Program—Objectives and Achievements

The program focused primarily on achieving three objectives:

  • maintaining macroeconomic stability through prudent monetary and fiscal policies;

  • generating additional domestic resources to finance poverty-reducing and growth-enhancing expenditures, in particular by strengthening tax and customs administration;

  • boosting private sector activities by fostering financial sector development, and improving public and corporate governance.

To a large measure, these objectives have been achieved. Program conditionality helped the authorities to implement prudent monetary and fiscal policies and accomplish far-reaching structural reforms in an environment of strong growth, low inflation, rising real incomes, and declining poverty rates. While much remains to be done to strengthen governance and tax/customs administration, revenue targets were consistently exceeded, and the tax/GDP ratio was raised by two percentage points amid double-digit GDP growth during the program period. At the same time, substantial financial sector reforms have been implemented, promoting private sector activity and financial deepening.

2. Against this background, the authorities have expressed strong interest in a new Fund arrangement, after the current PRGF expires in May 2008. To this end, they are updating their Poverty Reduction Strategy Paper (PRSP), and have committed to policy continuity during the post-program period (Attachment).

3. Controversial presidential elections in February were followed by a violent crackdown on opposition protests, and a twenty-day state of emergency. In early April, the previous prime minister was sworn in as president, and appointed the reform-minded central bank governor as prime minister. The economic impact of the political crisis is expected to remain limited if the new government takes concrete steps to recover its legitimacy by pressing ahead with economic reforms and fighting corruption.

II. Background

4. Macroeconomic performance in 2007 was very strong, with double-digit growth and single-digit inflation for the sixth consecutive year (Table 1). Real GDP grew by 13.7 percent, driven by nontradables, while remittance and FDI inflows buoyed domestic demand. Surging commodity import prices pushed inflation to 6.6 percent in December, above the end-year inflation target (4 ±1.5 percent). Following further hikes in food prices, 12-month inflation jumped to 9.6 percent in March 2008.

Table 1.

Armenia: Selected Economic and Financial Indicators, 2003–08

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Sources: Armenian authorities; and Fund staff estimates and projections.

The 2004-2006 external current account figures were revised following changes in methodology (see footnote 1 of table 4)

Tax revenues in 2007 include 0.2 percent of GDP in tax arrears paid by Armentel, which were not part of the official target.

Not including the gas subsidy.

Private external debt included since 2006.

Excluding the special privatization account (SPA).

Gross international reserves in months of next year’s imports of goods and services.

A positive sign denotes appreciation. Base year 1995=100. The calculations are based on 1999–2001 average trade weights.

uA01fig01

Armenia: Real GDP Growth

(year-on-year)

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

uA01fig02

Food prices drive up inflation…

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

uA01fig03

…but inflation remains lower than in neighboring countries.

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

5. Fiscal policy in 2007 remained Armenia: Fiscal Indicators, 2006-07 prudent, with the central government deficit limited to the programmed level of 1.8 percent of GDP (Table 2). While capital expenditures surged in the last quarter due to a larger-than-expected loan disbursement from Japan to finance a power plant, high tax revenues and under-execution of current government spending helped contain inflationary pressures. Tax revenues exceeded expectations, largely on account of a 50 percent increase in VAT collections. However, the reported use of ad hoc measures, such as advance tax payments requests and unprocessed VAT refunds, raise concerns about revenue sustainability.

Table 2.

Armenia: Central Government Operations, 2006–08

(In billions of drams)

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Table 2.

Armenia: Central Government Operations, 2006–08

(In percent of GDP, unless otherwise specified)

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Sources: Ministry of Finance and Economy, Central Bank of Armenia, and Fund staff estimates and projections.

Relative to the budget, the staff presentation reclassifies estimated military wages from Other goods and services to Wages.

Projections based on consumption growth for small and large consumers of 20 and 10 percent respectively in 2007.

Overall balance according to program definitions.

As described in the government decree of 6th April, 2006, N449-N, part of privatization proceeds could include a grant element. Assumed to be disbursed evenly throughout the year.

Armenia: Fiscal Indicators, 2006-07

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Overall balance according to program definitions.

6. Monetary growth accelerated in 2007, fueled by unsterilized foreign exchange intervention, cash dedollarization, and a surge in private sector credit (Table 3). Credit growth, driven by mortgage and consumer loans, picked up sharply on the back of buoyant domestic demand, changes in prudential requirements freeing up resources for additional lending (Country Report No. 07/377), and expanded bank funding. In line with the implicit inflation targeting regime adopted in 2006, the Central Bank of Armenia (CBA) gradually raised its refinancing rate from 4.5 percent in June 2007 to 6.5 percent in April 2008 in order to rein in demand-related inflationary pressures and second-round effects of higher food import prices. To promote dedollarization, reserve requirements on foreign currency deposits were increased from 8 to 12 percent.

Table 3.

Armenia: Monetary Accounts, 2006–08

(In billions of AMD, unless otherwise indicated)

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

At program exchange rate of 357 dram per U.S. dollar for 2007 and 304.22 dram per U.S. dollar for 2008.

At actual exchange rates, excluding the Special Privatization Account and foreign currency reserve money.

At program exchange rates, excluding the SPA and foreign currency reserve money.

Defined as reserve money minus NIR plus medium- and long-term liabilities.

Ratio of foreign currency deposits to total deposits (in percent).

Ratio of foreign currency deposits to broad money (in percent).

uA01fig04

Unsterilized forex intervention drives reserve money growth.

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

Armenia: Monetary Indicators, 2007-08

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At program exchange rates.

uA01fig05

Credit growth picked up significantly in 2007, …

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

uA01fig06

… driven by mortgage and consumer lending.

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

uA01fig07

Substantial financial deepening was made possible…

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

uA01fig08

…by increased bank funding from diverse sources.

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

7. External developments in 2007 were shaped by large-scale inflows, high food prices, and buoyant domestic demand, amid continued dram appreciation (Table 4). Notwithstanding robust export growth and substantial remittance inflows, surging imports resulted in a sizeable widening of the current account deficit, while international reserves increased markedly. The dram rose by 16.3 percent against the dollar in 2007, but has stabilized so far in 2008. The debt sustainability analysis indicates that Armenia is at low risk of debt distress, but is sensitive to a long-lasting terms of trade deterioration (Country Report No. 07/377).

Table 4.

Armenia: Balance of Payments, 2005–11

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Armenian authorities; and Fund staff estimates.

Starting from 2004, BOP figures were revised to reflect non-bank private transfers in the current account. In 2005 and previous years, nonbank private transfers are reported in the financial account.

Debt relief from the United Kingdom through 2015 (in respect of IDA credits).

Starting from 2006, based on government, government-guaranteed, and private sector medium- and long-term debt.

uA01fig09

Armenia: International Reserves

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

1/ Gross International Reserves excluding Special Privatization Account (SPA)
uA01fig10

Armenia: Exchange Rate Developments

(Jan. 2004 = 100)

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

8. The PRGF program remains on track, with all reviews completed on time (Tables 5–7). All December 2007 quantitative targets, structural performance criteria, and benchmarks were met (except the indicative target on reserve money), and important fiscal and financial sector reforms were implemented:

Table 5.

Armenia: Status of Measures Under the Sixth Review

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Table 6.

Armenia: Quantitative Targets, September 2006–December 2007 1/

(End of period ceilings on stocks, unless otherwise specified)

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All items as defined in the Technical Memorandum of Understanding.

Indicative target.

Performance criterion.

At program exchange rates (500 dram per U.S. dollar in 2005, 450 dram per U.S. dollar in 2006, and 357 dram per dollar in 2007).

Cumulative flow from the beginning of the calendar year until the end of the month indicated.

Includes debt with maturity of more than a year as well as obligations with maturity of one year or less, excluding normal import-related credit and sales of treasury bills to nonresidents.

Table 7.

Armenia: Indicators of Fund Credit, 2003–11

(In units indicated)

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Sources: Armenian authorities; and Fund staff estimates.

End of period stocks.

Exports of goods and services.

  • Legislation was approved limiting access to the simplified tax regime to the retail and household sectors, and the authorities submitted to parliament the general part of the unified tax code, and legislation moving tobacco products toward the regular tax regime.

  • A risk-based audit selection system is being implemented to reduce discretion by tax officials, and an order was issued by the State Tax Service (STS) to eliminate recording commissions from September 2008, to limit direct interactions between tax officials and taxpayers.

  • The authorities introduced a consumer credit law to increase market transparency and consumer protection; approved the purchase of shares of several existing banks by foreign investors; finalized the takeover of the Armenian stock exchange by the Scandinavian stock market operator OMX; and initiated legislative measures according to program conditionality.

III. Report on the Discussions

Policy discussions highlighted the key challenges currently faced by Armenia: heightened inflationary pressures; medium-term fiscal risks; and the need to preserve external competitiveness against the backdrop of large-scale foreign exchange inflows, continued real appreciation pressures, and a more challenging external and domestic environment.

A. Macroeconomic Outlook and Risks

9. The short-term picture remains positive, but this assessment is clouded by uncertainties related to the post-election turmoil, and the global outlook for commodity prices. Real GDP growth is projected to reach 10 percent in 2008, fueled by continued strong activity in services and construction. But there are downside risks if recent developments result in a slowdown in investment, and a suspension of donor programs. Buoyant domestic demand, together with the announced increase in end-user tariffs after the current gas subsidy expires on May 1, are projected to result in an end-year inflation of close to 7 percent. But inflation risks remain on the upside, given the potential for further hikes in food prices, pressure for wage and pension increases, and larger-than-expected foreign exchange inflows.

10. The medium-term outlook remains favorable, assuming continuity of macroeconomic policies. Robust growth is projected (6–8 percent annually) in view of good prospects for investment and external grants (Table 8). Inflation is expected to moderate to around 5 percent in 2009, notwithstanding a potential hike in gas import prices, and to 4 percent in the medium term, as restrained monetary and fiscal policies help contain second-round effects of higher gas prices.

Table 8.

Armenia: Medium-Term Macroeconomic Framework, 2006–11

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Sources: Armenian authorities; and Fund staff estimates and projections.

For 2007–09, the figures include projections for disbursements under the U.S. Millennium Challenge Account.

Not including the gas subsidy.

Defined as total expenditure on health, education, and social security.

A negative figure indicates an increase.

B. The Policy Mix

Fiscal policy

11. Given the 2007 outcome and the more challenging internal and external environment, staff argued for a lower fiscal deficit than the 2.6 percent of GDP envisaged in the 2008 budget. The deficit of 1.8 percent of GDP proposed by staff would limit the fiscal impulse and help contain real exchange rate appreciation pressures. Data for the first quarter of 2008 suggest that most of the proposed reduction in the deficit could be achieved by saving any revenue overperformance. There is only limited scope for expenditure cuts, given the budgeted 60 percent increase in average pensions and the forthcoming removal of the gas subsidy, which will be partially compensated by increasing social benefits to the poor. The authorities agreed that fiscal policy needs to remain prudent, but noted that achieving a lower deficit will be politically difficult this year, given expenditure commitments and increased political and economic uncertainty.

Armenia: Fiscal Stance in 2008 1/

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Program definition that excludes the gas subsidy and the State Fund for Social Insurance (SFSI).

Including the SFSI, the fiscal deficit for the 2008 budget is 2.9 percent of GDP.

Including the SFSI and the gas subsidy.

12. Looking ahead, a consistent medium-term fiscal framework should be developed to help maintain fiscal discipline, anchor expectations, and improve policy coordination. The authorities believe that their current framework already addresses these issues. But staff argued that a more analytical approach, including estimates of the fiscal impulse, was necessary for an adequate assessment of the stabilization role of fiscal policy and of medium-term risks (such as pension reform and higher gas import prices in 2009), and to improve policy effectiveness and transparency.

Monetary and exchange rate policies

13. The gradual tightening of monetary policy has been appropriate and will have to continue in light of heightened inflationary risks. Increasingly, monetary policy has to deal with inflationary pressures coming not only from the supply side, but also from the demand side, highlighting the need for effective demand management policies.

14. Monetary growth is expected to remain high in 2008, given continued remonetization, capital inflows, and cash dedollarization. Credit growth is projected to moderate slightly by end-2008, as one-time effects from the 2007 regulatory changes taper off. The CBA may need to refrain from large-scale foreign exchange intervention and step up the issuance of its securities, since the higher issuance of treasury securities planned for the year may not be enough to slow down the pace of base money growth.

15. The CBA is moving steadily toward full-fledged inflation targeting. An important step in this direction was its recent commitment to a preannounced three-year inflation target (4 ±1.5 percent). The CBA agreed that money market development will remain key to improving the transmission mechanism and increasing the effectiveness of monetary policy. Analysis of the exchange rate pass-through to domestic prices will be useful in determining the appropriate monetary policy response to exchange rate movements (Box 2).

Asymmetric Exchange Rate Pass-through

Dram appreciation can help contain inflation if exchange rate changes are translated into adjustments in domestic import prices. Preliminary estimates show a significantly higher pass-through for exchange rate depreciations (about 31 percent) than for appreciations (10 percent). This suggests that there is significant downward rigidity in import prices in response to exchange rate movements, limiting the impact of exchange rate appreciation on inflation.

uA01bx02fig01

Exchange Rate Pass-through to Average Import Price

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

Source: Fund staff estimates.

16. The recent sharp pickup in credit growth has not yet raised supervisors’ concerns about financial institutions’ ability to maintain high prudential standards in a higher risk environment (Table 9). The authorities based their views on the still low level of credit and high regulation/supervision standards. In addition, more efficient bank procedures (loan origination, risk assessment) and an improved financial infrastructure (credit bureau) would help mitigate emerging risks. While acknowledging the positive impact of credit growth on financial deepening, staff noted that the related potential risks warrant close monitoring, as incipient problems with loan quality may be more difficult to detect with rapidly expanding credit. Therefore, staff urged the CBA to take a conservative approach regarding prudential standards and the implementation of Basel II, as well as to pursue its efforts to improve financial institutions’ risk management capacity.

Table 9.

Armenia: Financial Soundness Indicators for the Banking Sector, 2003–07

(In percent, unless otherwise indicated)

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Source: Central Bank of Armenia.

17. FDI, remittances, and donor assistance will likely remain strong in 2008, maintaining upward pressure on the dram. The authorities remain committed to a flexible exchange rate regime, but noted the adverse impact of dram appreciation on remittance recipients and export competitiveness. With staff analysis showing no evidence of exchange rate misalignment so far, the authorities were advised to refrain from excessive unsterilized foreign exchange interventions to limit exchange rate appreciation. Such interventions are not only costly, but will fuel reserve money growth and inflation if they go beyond the (hard to estimate) need to accommodate remonetization and dedollarization.

uA01fig11

Armenia: FX Intervention and Exchange Rate

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

C. Structural Reforms

18. Implementing “second-generation” reforms will help remove remaining bottlenecks to growth, diversify the economy, and reduce the size of the shadow economy. Consistent with PRSP objectives, further efforts are needed to strengthen the fiscal framework, deepen financial intermediation, improve the business environment, promote domestic competition, and boost external competitiveness. Obstacles related to tax administration are listed among the top constraints to the operations and growth of businesses in recent World Bank surveys (the 2005 Business Environment Enterprise Performance Survey (BEEPS), and the 2008 Doing Business). Improving tax policy and administration will be crucial for discouraging informality and encouraging financial deepening (Box 3).

19. Tax administration reforms should advance expeditiously to ensure that recent improvements in tax collection are sustainable, and tax collection is transparent and fair. Key measures include adopting a function-based organization structure at the STS and consolidating the large taxpayer’s inspectorates. Staff also recommended introducing a VAT threshold, and eliminating tax holidays and other preferential regimes. While provision of resources in the 2008 budget to clear accumulated and projected unprocessed VAT claims and the ongoing development of risk-based criteria for VAT refunds at the STS are welcome initiatives, paying interest on late refunds would be the most effective way to improve the VAT refunds system. The authorities are still resisting any commitment in that direction.

20. The conversion of many budgetary institutions into noncommercial organizations (NCOs) outside the treasury system—with little emphasis on financial management, supervision, and monitoring—has created macro-fiscal risks and partially undone earlier treasury reforms. In this context, staff welcomes the authorities’ efforts to address the challenges for public financial management that the NCO reform has presented. The amendment recently submitted to parliament aimed at reestablishing treasury controls will help partially address some of these risks.

Informality and Financial Deepening

Despite the recent surge in credit growth, the ratio of private credit to GDP in Armenia (13.6 percent in 2007) is still low relative to other transition countries. The presence of a large informal economy—avoiding the banking sector to evade taxes—is an obstacle to financial sector development. High tax compliance costs, unclear audit rules, political interference, and weak tax administration, all create incentives for tax evasion and informality.

An analysis of firm-level data for 27 transition countries finds a robust negative association between informality and firms’ reliance on bank credit, even after controlling for reverse causality. This highlights the importance of strengthening tax policy and administration in order to reduce the size of the informal economy and encourage financial deepening.

uA01bx03fig01

Weaknesses in the tax system lead to informality, limiting reliance on bank financing.

Citation: IMF Staff Country Reports 2008, 176; 10.5089/9781451801682.002.A001

Source: BEEPS, 2005 DatabaseNote: Relationships are significant at the 1 percent level. Formality is proxied by the percentage of sales reported by firms for tax purposes. Bank financing is measured by the percentage of firms’ working capital financed through the banking system. See Dabla-Norris and Koeda, “Informality and Bank Credit: Evidence from Firm-Level Data.” IMF Working Paper (forthcoming).

21. Regarding the financial sector, the government approved a law on cash transaction limits and electronic payment of salaries, targeting the shadow economy and supporting tax administration. The CBA is implementing several technical improvements to the functioning of the money market, and the authorities adopted a package of capital market development measures, including controversial tax incentives for companies that list in the stock exchange. The CBA is on track with implementing the first stage of Basel II, but plans to establish an independent Financial Supervision Agency will be revised against the backdrop of recent international experience.

IV. Staff Appraisal

22. Armenia has experienced a prolonged period of high economic growth and moderate inflation. Sound macroeconomic policies, a favorable global environment, lower gas import prices than in other CIS countries, and large-scale foreign exchange inflows have all contributed to this strong performance. Going forward, however, Armenia will face a more challenging external and domestic environment. Rising energy and food import prices, recent and planned pension increases, and rapid credit growth will likely keep inflationary pressures high and lead to larger current account deficits.

23. While the current policy mix has been appropriate so far, these new developments will require additional tightening. With monetary policy effectiveness constrained by large-scale foreign exchange inflows and a weak monetary transmission mechanism, fiscal policy will need to play a crucial role in maintaining macroeconomic stability. In this light, and given the upside inflationary risks, the government should save any revenue overperformance and aim for a lower fiscal deficit than envisaged in the 2008 budget. At the same time, targeted support for vulnerable groups to cushion the impact of the gas subsidy’s removal would be appropriate.

24. The capacity for fiscal policy analysis should be strengthened to improve the effectiveness of fiscal policy and help maintain fiscal discipline. In particular, the authorities should consider the impact of government spending on inflation and growth to assess the appropriateness of the fiscal stance. This will become increasingly important because inflationary pressures are likely to arise more from demand-side factors as incomes grow.

25. Monetary policy was appropriately tightened during the past year. The gradual increases in the refinance rate helped contain second-round effects from higher food import prices. But inflation may well turn out to be higher than currently projected, given the potential for further supply shocks and increasing demand pressure. Against this background, the CBA should tighten its stance as needed to anchor inflation expectations. Given the sharp pick-up in credit growth, the CBA should take a conservative approach on prudential standards, while pressing for upgrades in banks’ risk-management capacity.

26. Widening trade deficits and the dram appreciation have raised concerns about external competitiveness. Thus far, however, staff analysis has found no evidence of exchange rate misalignment. The flexible exchange regime remains the best choice for Armenia, as attempts to limit nominal appreciation would simply create additional inflation, rather than improve competitiveness. Safeguarding competitiveness in the context of dram appreciation calls for a more determined approach to structural reforms.

27. Weaknesses in tax administration remain a major constraint to private sector growth. They discourage financial intermediation, since enterprises operate in the shadow economy to evade taxes. Sustaining the recent increase in tax collection requires major tax administration reforms, aimed at improving tax collections in a more transparent and fair way to encourage compliance and ensure a level playing field for all businesses. The provision of tax incentives to foster capital market development would undermine efforts to improve tax administration and would dent policy credibility.

28. Prospects for a successor program are favorable on account of the authorities’ good track record and strong commitment to reform. Reform efforts should focus on strengthening the fiscal and monetary policy frameworks, while deepening productivity-enhancing structural reforms, notably by reducing the cost of doing business, increasing domestic competition, diversifying the economy, and discouraging participation in the shadow economy.

29. On the basis of Armenia’s strong performance under the PRGF arrangement, staff supports the authorities’ request for completing the sixth and final review.

Table 10.

Armenia: Poverty Indicators and Millennium Development Goals, 1990–2015

(In percent of total population, unless otherwise indicated)

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Sources: World Bank; and Armenian authorities. Goal 1: Halve, between 1990 and 2015, the proportion of people whose income is less than $2.15 a day. Halve, between 1990 and 2015, the proportion people who suffer from hunger. Goal 2: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling. Goal 3: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015. Goal 4: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate. Goal 5: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio. Goal 6: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases. Goal 7: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. Goal 8: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the special needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth.

2000 and 2003 poverty surveys based on different methodology than in other years.

Attachment. Republic of Armenia: Letter of Intent

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C. 20431

March 18, 2008

Dear Mr. Strauss-Kahn:

1. In May 2005, the International Monetary Fund approved a three-year Poverty Reduction and Growth Facility (PRGF) arrangement for Armenia. In the subsequent three years, we have achieved a lot: a significant reduction in poverty (from 35 percent in 2004 to 26.5 percent in 2006), along with double-digit growth, single-digit inflation, a prudent fiscal policy, and overall macroeconomic stability. In addition, with the help of the IMF, we have made substantial progress with fiscal and financial sector reforms.

2. Looking forward, a number of challenges remain, and we plan to address them vigorously in the period ahead. First, we need to further reduce poverty, since more than a quarter of Armenia’s population is still living below the poverty line. Second, we need to make growth sustainable by diversifying our economy, since recent economic growth has been driven mainly by construction and services. Third, we need to continue to manage large foreign exchange inflows, while preserving external competitiveness and macroeconomic stability. Fourth, we need to strengthen our medium-term fiscal framework to enhance the effectiveness of fiscal policy and improve expenditure management, and at the same time facilitate the coordination of fiscal and monetary policies. Fifth, we need to broaden the tax revenue base, which is still low in spite of notable progress in the past year. Sixth, we need to further develop the financial sector so as to deepen financial intermediation and strengthen the monetary transmission mechanism. Seventh, we need to proceed with “second-generation reforms” to improve governance, accountability, and the business climate, so as to reduce the cost of doing business and raise productivity. These measures will also contribute to reduce our large shadow economy. Finally, we need to increase domestic competition, so as to ensure that consumers will benefit from dram appreciation through lower import prices.

3. Given the prospects for continued real appreciation pressures resulting from large foreign exchange inflows and potential inflationary shocks, we are committed to further tightening both monetary and fiscal policy in 2008, as needed. We will continue to target an inflation rate of 4 percent (+/- 1.5 percent), while maintaining a flexible exchange rate regime. In order to better anchor inflation expectations, we have committed to multi-year target over the 2008-10 period. While our 2008 budget targets a fiscal deficit of 2.6 percent, we will aim at keeping the actual deficit lower, including by continued efforts to strengthen tax administration. In this connection, we also plan to complete a major organizational restructuring of the State Tax Service by mid-2009.

4. We have met all quantitative targets, structural performance criteria, and benchmarks for end-December 2007, as detailed in our most recent Memorandum of Economic and Financial Policies. Only the indicative target on reserve money was exceeded owing to higher-than-expected foreign exchange intervention in the fourth quarter to offset large-scale foreign inflows related to substantial increases in bank capital.

5. In light of our strong performance and our continued commitment to macroeconomic stability and structural reform, we request hereby the completion of the sixth and final review under the PRGF arrangement and the disbursement of SDR 3.32 million. Further, we grant our permission for the publication on the IMF’s website of the staff report and this letter.

6. Finally, we would like to express our interest in negotiating a new Fund arrangement later this year. To this end, we are currently updating our Poverty Reduction Strategy Paper.

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Cover IMF Staff Country Reports
Republic of Armenia: Sixth Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility -Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Republic of Armenia
Author:
International Monetary Fund
Volume/Issue:
Volume 2008: Issue 176
Publisher:
International Monetary Fund
ISBN:
9781451801682
ISSN:
1934-7685
Pages:
53
DOI:
https://doi.org/10.5089/9781451801682.002

Armenia: Real GDP Growth

(year-on-year)

Food prices drive up inflation…

…but inflation remains lower than in neighboring countries.

Unsterilized forex intervention drives reserve money growth.

Credit growth picked up significantly in 2007, …

… driven by mortgage and consumer lending.

Substantial financial deepening was made possible…

…by increased bank funding from diverse sources.

Armenia: International Reserves

Armenia: Exchange Rate Developments

(Jan. 2004 = 100)

Exchange Rate Pass-through to Average Import Price

Armenia: FX Intervention and Exchange Rate

Weaknesses in the tax system lead to informality, limiting reliance on bank financing.