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

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.