Republic of Armenia
Second Review Under the Stand-By Arrangement, Request for Waiver of Nonobservance of Performance Criterion, Modification of Performance Criteria, and Rephasing of Purchases: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director and Advisor for the Republic of Armenia.
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International Monetary Fund
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Publication Date:
19 Nov 2009
eISBN:
9781451801767
Language:
English
Keywords:
ISCR; CR; tax reform administration; reform; request; growth; accommodative monetary policy stance; central bank; banking system; debt service; construction boom; GDP deflator; Loans
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This paper discusses key findings of the Second Review Under the Stand-By Arrangement (SBA) for Armenia. The authorities met all quantitative performance criteria for end-June and end-September, with the exception of the end-September fiscal balance. All structural benchmarks for end-June and end-September were also implemented. The authorities request a waiver of nonobservance for the end-September fiscal balance performance criterion given the minor and temporary nature of the deviation. IMF staff supports this request, as well as the authorities’ request for completing this review.

Abstract

This paper discusses key findings of the Second Review Under the Stand-By Arrangement (SBA) for Armenia. The authorities met all quantitative performance criteria for end-June and end-September, with the exception of the end-September fiscal balance. All structural benchmarks for end-June and end-September were also implemented. The authorities request a waiver of nonobservance for the end-September fiscal balance performance criterion given the minor and temporary nature of the deviation. IMF staff supports this request, as well as the authorities’ request for completing this review.

I. Background

1. The effects from the global crisis continue to weigh heavily on the Armenian economy. Starting in late 2008, following the drop in metals prices and the downturn in Russia, economic and financial conditions in Armenia worsened rapidly. In response, the authorities successfully implemented a swift package of reforms, including the return to a floating exchange rate regime, and stepped up measures to maintain financial stability.

2. The second-round effects of the crisis have led to a dramatic fall in output, with the unwinding of the remittance-fueled construction boom that had driven growth in recent years (Box 1). As a result, real GDP fell by 18½ percent through the first eight months of 2009, with about ¾ of this decline due to a plunge in construction output. Other sectors, such as agriculture and services, have been much less affected by the crisis.

uA01fig01

Contributions to Growth

(In percent, production side)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

3. Output appears to have stabilized in the last few months, while inflation has remained low. Preliminary data suggest that the fall in construction output and real estate prices is coming to an end. Rising metals prices, together with a weaker dram, are helping the mining sector to recover. Government support to these and other sectors is also contributing to the recovery (Box 2). Despite the March depreciation, annual inflation has remained at about 3½ percent, given weak domestic demand and low import prices.

uA01fig02

CPI Inflation

(year-on-year growth, in percent)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

4. The external position has also stabilized, partly with the help of Fund resources. The sharp drop in exports, remittances, and foreign direct investment (mostly from Russia, see below) is being offset by a contraction in imports and a substantial increase in external assistance. In that context, Fund financing has been flexibly used to allow a larger fiscal deficit and strengthen the external position.

uA01fig03

Key Balance of Payments Components

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Armenia: Collapse in Construction and Remittances

The construction sector has been the main contributor to GDP growth in Armenia since 2005, reaching 27 percent of GDP in 2008. In the first eight months of 2009, the economy contracted by more than 18 percent, of which 14.2 percent was due to construction, in particular residential construction. During the first half of 2009, real estate transactions and prices fell by 34 percent and 16 percent year-on-year, respectively. Remittances, which quintupled in dollar terms between 2003 and 2008 (reaching almost 18 percent of GDP in 2008) collapsed by about 30 percent during the first seven months of 2009.

uA01fig04

Construction Sector Contribution to Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Construction output and real estate prices are highly correlated with remittances. Official data suggest that Armenian households financed about 70 percent of total construction output during 2008, of which only 3 percent used mortgage loans. Since remittances are a significant source of income for many Armenian households, this suggests that the fall in remittances, rather than in mortgage credit, has been responsible for the drop in construction.

uA01fig05

Remittances and Construction Output

(In billions of drams)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Remittances in Armenia also include an investment component. Remittances are estimated largely based on banking system data on “noncommercial” private transfers, which also reflect flows from Armenian nonresidents—including the Armenian Diaspora—that do not strictly fall in the categories of workers’ remittances, employee compensation, and migrants’ transfers. These flows are often ultimately destined to finance residential construction.

uA01fig06

Remittances and Real Estate Prices

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Armenia: Summary of Anti-crisis Measures Taken by the Armenian Authorities

Since the onset of the global downturn, the Armenian authorities have swiftly implemented a range of measures to help contain the impact of the crisis. Financial support from external partners has played an important role, with Armenia receiving nearly $300 million in budget support for 2009 (from the IMF, World Bank, and ADB), $50 million from the World Bank for on-lending to SMEs, $500 million from Russia, and project support from a number of other donors. Key ongoing or planned measures include:

  • Providing about $37 million to the private sector in the form of direct credit, government guarantees, and equity investments.

  • Providing about $10 million in government guarantees to construction companies with at least a 50 percent complete rate in residential construction projects.

  • Funding a Pan-Armenian bank to help finance large national investment projects.

  • Offering on-lending programs using about half of the $500 million Russia loan (see table below) and $50 million from the World Bank.

  • Establishing a National Mortgage Foundation with mixed public-private capital, initially funded by AMD 5 billion from the CBA, for on-lending to the mortgage market.

  • Creating instruments to help young families purchase apartments, by means of (i) 10–15 year non-interest mortgage loans for up to 30 percent of the required down payment, and (ii) interest rates subsidies for mortgage loans.

  • Offering a subordinated loan facility to banks to support regulatory capital ratios and to encourage bank mergers.

  • Doubling the coverage for bank deposit insurance.

Projects Financed by the $500 mln Loan from Russia

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uA01fig07

Exports

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

uA01fig08

Remittances 1/

(In billions of U.S. dollars)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

1/ Defined as non-commercial private transfers through the banking system.

5. The fiscal position remains weak. During the first eight months, tax revenues fell by more than 18 percent year-on-year, driven by a collapse in VAT collection, as imports declined sharply. Expenditures, especially foreign-financed capital investment, increased significantly during the first half of the year relative to 2008, but remained below budgeted levels.

6. The banking sector is sound, despite a worsening of the quality of the loan portfolio. Capital and liquidity ratios continue to be high and the leverage ratio low, providing a strong buffer to the economic crisis, as reflected by the latest stress tests. However, the downturn could further lead to a deterioration in asset quality. In this setting, lending activity has been weak, reflecting a combination of supply and demand factors.

II. Policy Discussions

A. Macroeconomic Outlook

7. Real GDP growth is expected to contract by more than 15 percent in 2009, but growth should return to positive territory in 2010 (Table 1). This scenario assumes that output begins to recover toward the end of this year, with no further worsening in the Russian economy. Medium-term growth would be expected to recover only gradually under current policies, underpinned by the successful implementation of the authorities’ structural reform agenda (Table 9 and LOI ¶21). Growth prospects would be revised considerably upward if the Turkish-Armenian land border were to be reopened (Box 3). Inflation could pick up toward the end of this year, but is likely to remain within the inflation target band of 4±1.5 percent.

Table 1.

Armenia: Selected Economic and Financial Indicators, 2006–10

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

Including the gas subsidy in 2006–2008.

Based on government and government-guaranteed debt.

Excluding the special privatization account (SPA), but including the Russian project loan.

Gross international reserves in months of next year’s imports of goods and services, including the SDR allocation.

A positive sign denotes appreciation.

Table 2.

Armenia: Balance of Payments, 2007–14

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

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

Gross international reserves include the SDR allocation.

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

Based on government and government-guaranteed debt.

Table 3.

Armenia: Monetary Accounts, 2006–10

(in billions of drams, unless otherwise indicated)

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

At the program exchange rate.

Following the agreement between the CBA and the Ministry of Finance, the issue of new CBA bills was terminated in 2008.

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

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

Table 4.

Armenia: Financial Soundness Indicators for the Banking Sector, 2004–09

(In percent, unless otherwise indicated)

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Source: Central Bank of Armenia.
Table 5.

Armenia: Central Government Operations, 2007–10

(In billions of drams)

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

Includes IMF budget support

The program balance reflects net lending activities and is measured as below-the-line overall balance minus net lending.

Table 6.

Armenia: Central Government Operations, 2007–10

(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.

Includes IMF budget support

2/ The program balance reflects net lending activities and is measured as below-the-line overall balance minus net lending.
Table 7.

Armenia: Public Sector Debt Sustainability Framework, 2004-2014

(In percent of GDP, unless otherwise indicated)

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Source: Fund staff estimates and projections.

Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Table 8.

Armenia: External Debt Sustainability Framework, 2004-2014

(In percent of GDP, unless otherwise indicated)

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Source: Fund staff estimates and projections.

Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, ε = nominal appreciation (increase in dollar value of domestic currency), and α = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and nondebt inflows in percent of GDP.

Table 9.

Armenia: Medium-Term Macroeconomic Framework, 2007–14

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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.

Underlying balance is defined as overall balance before grants and excluding external interest payments.

A negative figure indicates an increase.

8. The external outlook remains in line with projections at the time of the first review (Table 2). Imports will likely not fall sufficiently to offset the fall in exports, while remittances are expected to drop by about 30 percent compared to 2008. The current account deficit is thus projected to rise to about 13½ percent of GDP and to remain at a similar level in 2010, before gradually falling to about 8½ percent of GDP by 2013. Sizable external financing from IFIs and bilateral donors (IMF, World Bank, ADB, Russia, and EU) is expected to remain in place this year, and gradually decline over the medium term. Gross international reserves should remain at a comfortable level with an import cover of about 6 months of imports. The program is fully financed in 2009–10, with the remaining financing needs in 2010 expected to come from the European Union.

Armenia: Economic Impact of a Possible Reopening of the Turkish-Armenian Land Border

There has been progress on talks to reopen the land border between Armenia and Turkey, which has been closed since 1993. A protocol has been signed by the foreign ministers of the two countries, and will also need to be ratified by the Armenian and Turkish parliaments before the borders could be opened, a step that is still far from certain.

The reopening of the Turkish-Armenian land border is expected to have a positive impact on the Armenian economy in the medium term, with the direct impact initially through trade. Were the border to reopen, both countries would gradually establish greater trading ties. The result would be an increase in trade in the goods and services of each country’s comparative advantage. One immediate impact would be a decline in transportation costs to and from Turkey as well as other destinations by as much as 10 to 20 percent, leading to a drop in import prices that could improve the standards of living of the Armenian population. In addition, the Turkish economy would provide an enormous potential market for Armenian goods and services. However, while Armenian consumers and exporters are likely to benefit, some Armenian firms producing for the local market could in the short term feel stiff competitive pressures.

Tourism, FDI, and remittances to Armenia would also likely benefit as a result of the reopening of the land border. Tourism will likely increase in both countries as visitors can move more easily across the border. The reopening of the border could provide a more attractive environment for investment and regional integration, serving to attract FDI to Armenia. Finally, domestic labor markets would potentially be open to both countries over time, thereby increasing and diversifying the sources of remittances to Armenia.

B. Fiscal Policy

9. Fiscal policy will continue to support the economy in the period ahead, thanks in part to external borrowing. The deficit is projected to widen to 7.5 percent in 2009, up from 6.5 percent of GDP at the time of the first review (Tables 5 and 6), reflecting a further decline in tax revenue and a lower projection for grants. Both domestic and external financing constraints, in addition to concerns about debt dynamics, preclude a wider deficit this year, even though nominal spending would rise relative to 2008 levels. As a result, fiscal stimulus—proxied by the increase in primary spending—is projected to amount to nearly 6 percent of GDP for the year.1 The deficit will be financed mainly through external resources, but a small increase in domestic financing may be envisaged as well, subject to favorable domestic market conditions (LOI, ¶9).

uA01fig09

Tax Revenues and Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

uA01fig10

Overall Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

uA01fig11

Public Sector Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

10. Expenditure plans in 2009 focus on (i) undertaking wide-ranging anti-crisis measures, (ii) increasing foreign-financed capital spending, and (iii) protecting social spending. The government’s anti-crisis plan includes the measures summarized in Box 2. New capital spending, financed in part by the Russian loan, would mostly be directed to new housing projects in the earthquake zone. To protect the poor, the program aims at increasing social allowances, including pensions, by 18 percent in nominal terms in 2009.

11. Public debt remains manageable, but its rapid accumulation calls for undertaking fiscal consolidation as soon as the recovery takes hold in 2010. While Armenia’s initial low level of public debt, about 16 percent of GDP in 2008, provided scope for fiscal expansion, the public debt ratio has more than doubled in 2009 (Table 7, Figure 2). Therefore, staff and the authorities agreed that an effort to start reducing the fiscal deficit beginning in 2010 would be desirable, while aiming to secure a higher share of concessional resources from donors.

Figure 1.
Figure 1.

Armenia: Recent Exchange Rate and Monetary Sector Developments

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Sources: Armenia authorities; and Fund staff estimates.
Figure 2.
Figure 2.

Armenia: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.3/ One-time real depreciation of 30 percent occurs in 2009.

12. Accordingly, the authorities plan to tighten the 2010 budget by about 1½ percent of GDP. As growth is projected to remain well below potential, this fiscal stance—which reflects debt sustainability considerations but also financing constraints—amounts to a withdrawal of fiscal stimulus,2 and might be relaxed should more concessional financing become available in the course of the year. The adjustment will rely on revenue increases of about ½ percent of GDP—due to tax administration reforms and some recovery of highly taxed sectors (e.g., mining)3—and expenditure restraint of about 1 percent of GDP, particularly capital spending. Capital spending could be topped up in 2010, only to the extent that additional grants or concessional financing are identified. The deficit will continue to be financed by external resources, albeit less than in 2009, and the rest through domestic resources. Fiscal adjustment will continue beyond 2010 through revenue-enhancing measures and reductions in non-priority expenditure, as the authorities progress with their structural reform agenda.

13. In the fiscal structural area, the authorities have made progress in addressing two long-standing problems in tax administration. In particular, they reduced the large amount of outstanding tax credits in line with program objectives (indicative target), and shortened delays in VAT refund processing to exporters (continuous structural benchmark, and structural benchmark for end-September; LOI ¶18, and LOI Table 2).

14. To strengthen the medium-term fiscal outlook, the authorities are committed to further reforms in the public finance area (LOI ¶18 and ¶19, and LOI Table 2):

  • (i) Introduce e-filing of tax returns by December 2009 for large taxpayers, following the recent successful pilot project;

  • (ii) Implement risk-based audits in VAT refund processing in 2010 (Box 4; structural benchmark for end-March 2010);

  • (iii) Submit legislation to parliament to abolish the presumptive taxation regime for tobacco and fuel products effective January 2011 (structural benchmark for end-December 2009); and

  • (iv) Work closely with the World Bank to develop a strategy to further strengthen the targeting of social safety nets (structural benchmark for end-December 2009), which will help to protect the poor, while enhancing the efficiency of social spending.

Armenia: Structural Conditionality, 2009–10

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15. The authorities are committed to strengthening their medium-term debt management strategy. To meet this objective, they will adopt by March 2010 a ministerial order to develop a time-bound action plan to strengthen public debt management with the aim of developing a comprehensive medium-term debt strategy (LOI ¶20). The authorities will also seek further technical assistance from their international partners. The debt management strategy should be underpinned by a sound medium-term expenditure framework.

C. Monetary Policy

16. Given low inflation and weak credit growth, the CBA has continued to ease its monetary stance, consistent with its inflation targeting framework (Table 3). Since early April, the CBA has gradually lowered its policy rate by 275 basis points to 5 percent in September. It also injected dram liquidity through various channels in an effort to boost credit growth, including by conducting outright purchases of government securities, and increasing the maturity of its repo operations to 90 days (structural benchmark, end-June 2009). As a result, interbank and T-bill rates have fallen and banks reported comfortable levels of dram liquidity.

uA01fig12

Interest Rates

(In percent)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

17. Despite the easing, credit growth has continued to decline, leading the government and the CBA to take additional measures. Bank lending rates, which have remained at around 18 percent, have not been responsive to the drop in both repo and interbank rates, implying that the monetary transmission remains weak. In response, the government and the CBA have arranged to onlend at competitive rates to SMEs and other targeted sectors through the CBA and commercial banks, using resources from Russia and other donors.4 Use of the lending facilities has been slow, however, as banks have tightened their lending standards in the face of economic uncertainty as well as reported weak demand for credit.

uA01fig13

12-Month Credit Growth

(In percent)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

18. The CBA is concerned that the weak transmission mechanism and increased government spending are creating excess liquidity in the banking system. The CBA has drained some of this excess liquidity to keep short-term interbank rates from falling below the policy rate and prevent potential capital flight or speculative exchange rate pressure that could jeopardize the inflation target (LOI, ¶9). The issuance of recapitalization bonds (structural benchmark for end-September 2009, LOI, ¶14) should further enhance the CBA’s liquidity management capacity.5 Part of the challenge for monetary policy is a deposit dollarization ratio that currently hovers above 65 percent. Going forward, once macroeconomic condition stabilizes, it is expected that dollarization will gradually decrease, allowing the authorities to gain greater control of monetary policy.

uA01fig14

Banks’ Liquidity Conditions

(in percent)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

19. Under its inflation targeting framework, the CBA is committed to adjusting its monetary policy stance should inflationary pressures emerge. Inflation so far remains comfortably within the target band of 4±1.5 percent, and in the view of staff, inflation pressures are limited. However, the CBA believes that there are upside inflation risks toward the end of the year, owing to rising international prices, the ongoing expansionary policies, downward rigidities in domestic prices, and speculative exchange rate pressures stemming from excess liquidity. The CBA has signaled the end to the easing cycle in its latest monetary policy committee statement and intends to shift to a neutral stance and promptly react to inflationary signals, if necessary, by tightening monetary conditions (LOI, ¶9).

D. Exchange Rate Policy

20. Following the return to a floating regime in March, the exchange rate initially remained broadly stable (Figure 1). This stability reflected in part improved confidence and relatively balanced daily flows in the foreign exchange market. Exertion of moral suasion on market participants and close scrutiny of banks’ activity may have also played a role. The authorities noted that the thin market and lumpy transactions of key actors require close oversight of market conditions.

21. The exchange rate has recently seen more flexibility, as the CBA has more strictly adhered to its intervention strategy that allows the exchange rate to be largely market-determined (structural benchmark for end-June 2009). The strategy, designed with the help of Fund technical assistance, is designed to limit the use of interventions to rebuilding reserves and to smoothing excessive volatility without targeting a particular exchange rate level or band. The CBA’s interventions (including both purchases and sales) have so far been in line with this strategy. Recent estimates suggest that the exchange rate is broadly in line with fundamentals.

E. Financial Sector Policies

22. Despite a marked increase in nonperforming loans (NPLs), the banking system remains highly capitalized with ample liquidity and appears reasonably well-placed to withstand stress (Table 4). The system-wide capital adequacy ratio (CAR) in July was 29 percent, well above the 12 percent regulatory requirement. Banks are now relatively more exposed to higher credit risk, owing to the economic downturn and to exposure to unhedged borrowers. Nonetheless, the latest stress tests through end-July show that, under all scenarios except for extreme credit shocks, the CAR would decline by no more than 2 percentage points for the system as a whole and would stay above the regulatory norm in all banks. The low leverage ratio in the Armenian banking sector represents a source of resilience, a factor less present in comparator countries.

uA01fig15

Banking System Leverage Ratios

(in multiple of capital)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Source: GFSR. In the GFSR, leverage is depicted by the ratio of capital to total assets. Here, the leverage ratio is defined as total assets divided by capital.

23. The possibility of a further deterioration in the quality of banks’ loan portfolios cannot yet be ruled out. Headline NPLs, as measured by the CBA, have largely stabilized. However, the CBA definition of NPL includes loans in the “watch” category, which are not considered NPLs according to the IMF’s methodology. Using the IMF definition, NPLs are still rising, as more loans continue to migrate to the loss category. The increased loan-loss provisioning could add strains to the banking sector’s profitability, which has turned negative since the beginning of this year, mainly due to foreign exchange losses associated with the March depreciation.

uA01fig16

Nonperforming Loans in Percent of Total Loans 1/

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

1/ CBA methodology includes loans that are 1 to 90 days past due, and excludes loans that are 270 days past due and are written off.

24. The CBA is making good progress in safeguarding financial stability, in particular, through further strengthening the financial safety net, contingency planning, and crisis preparedness (LOI ¶12 and ¶13). The Deposit Guarantee Fund (DGF) is being strengthened considerably, and the bank supervision and regulation framework continues to improve. The CBA is considering additional prudential measures that would (i) restrict banks’ reliance on a single source of funding to ensure funding stability, and (ii) reinstate limits on banks’ net open foreign exchange positions to reduce the potential for destabilizing speculation. The mission and the CBA agreed that the CBA should consult closely with affected parties and thoroughly review the potential impact of these measures to ensure that they are appropriately specified and will not have unintended consequences. The CBA plans to set up a new financial stability department next year, intensifying the focus on macro-prudential risks and macro-financial linkages. An IMF technical assistance mission in late October will work with the CBA on further improving contingency planning.

III. Risks and Capacity to Repay

25. Risks to the program have lessened somewhat, but are in line with those identified at the time of the first review:

  • There is uncertainty to the economic growth projections. While the recent signs of a stabilization of output are encouraging, it is not certain that the downturn has run its course. Opening of the Turkish land border would boost medium-term growth prospects considerably.

  • Balance-of-payments inflows remain volatile and uncertain, although at this stage the risks appear evenly balanced.

  • Fiscal risks remain, most notably whether ongoing tax administration reforms will lead to sustained improvements in revenue.

  • The financial sector appears robust, but continued economic weakness could lead to a continued increase in non performing loans.

26. Armenia’s debt dynamics are still in line with the assessment made at the time of the first review. The external debt stock would increase from 13 percent of GDP at end-2008 to 40 percent in 2011, before declining gradually to 29 percent of GDP by 2014, reflecting the repurchase obligations to the IMF mainly during 2012–14 (Tables 8 and 11). While debt levels are manageable under a strong policy scenario, the outlook is, as noted, subject to risks. The standard bound tests show that the combined shocks lead to an increase in the debt-to-GDP ratio by several percentage points (Figure 3). The effect of a real exchange rate shock is particularly pronounced, reflecting the rising weight of external debt in total public debt.

Table 10.

Armenia: Fund Disbursements and Timing of Reviews Under the Twenty Eight -Month Stand-By Arrangement, 2009-11

(SDR millions)

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Source: Fund staff estimates and projections.

This review is the combination of the second and third reviews under the original program.

Table 11.

Armenia: Indicators of Capacity to Repay the Fund, 2008–15 1/

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Sources: Fund staff estimates and projections.

Indicators cover both GRA and PRGF credit.

Total debt service includes IMF repurchases and repayments.

Figure 3.
Figure 3.

Armenia: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2009, 316; 10.5089/9781451801767.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2009, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

27. Armenia’s capacity to repay the Fund broadly remains good. External vulnerabilities remain significant due to the global credit crunch, higher projected current account deficits, and rising external debt over the medium term. The rise in repurchase obligations to the Fund during the period 2012–14 is significant but temporary, reflecting the relatively short maturity profile of IMF lending and the relatively large share of IMF obligations in total obligations. Nonetheless, indicators of IMF credit still suggest a good capacity to repay the Fund. Given that the June 2009 purchases from the Fund were disbursed to the budget, the CBA and ministry of finance have worked closely to clarify debt service obligations and appropriate accounting treatment.

IV. Program Modalities

28. The attached LOI describes the authorities’ progress in implementing their economic program, and sets out conditionality through March 2010:

  • The authorities request a waiver of nonobservance for the end-September fiscal balance performance criterion, since, on the basis of the available information, there is clear evidence that the performance criterion has not been met, even though the deviation was minor (about 0.4 percent of GDP), and in line with the upward revision of the end-year deficit target agreed with staff.

  • The authorities, following discussion with staff, request a modification of the quantitative performance criteria for end-December 2009 to reflect the revised macroeconomic framework. Given that this review combines what were the second and third reviews under the original schedule, the authorities also request that the amounts scheduled to be available following the second and third reviews become available upon completion of this review.

  • The LOI sets quantitative performance criteria for end-March 2010, indicative targets for the remainder of 2010, and new structural benchmarks.

  • Given the expected deterioration in the debt outlook, the authorities would like to request the addition of an indicative target on contracting or guaranteeing new nonconcessional public debt. The targets under the proposed nonconcessional debt limit largely reflect the contraction of additional loans from the World Bank and the ADB for which framework agreements were already approved, mostly for infrastructure projects.

V. Staff Appraisal

29. The sharp economic downturn induced by the global crisis appears to have run its course, although sizable risks remain. The dramatic fall in output this year signals the end of the long remittance-fueled construction boom. Even as output is now expected to gradually recover in the period ahead, and financial stability has been maintained, growth is unlikely to return to the double digit rates of several years ago. Moreover, downside risks remain, most notably a continued weakness in the external outlook. The challenge ahead will be to balance adjustment to the deteriorated outlook, while not reversing policy stimulus too quickly as a very gradual recovery takes hold.

30. In this context, the authorities’ policies have adapted rapidly and appropriately, and program performance has been strong. The large depreciation in March 2009 helped to improve competitiveness without threatening financial stability. The subsequent monetary and fiscal easing helped mitigate the impact of the crisis on output and the poor, while preserving macroeconomic stability. The authorities have largely adhered to the program targets and continued to implement their structural reform program.

31. The relaxation of fiscal policy has appropriately provided support to the economy, mindful of financing constraints and debt sustainability concerns. While the authorities have largely accommodated the fall in revenues in 2009 without significantly cutting expenditures, they appropriately intend to reduce the 2010 deficit through expenditure restraint to put public finances on a sustainable path, although the program allows for higher spending if additional donor financing becomes available. The reintroduction of a medium-term expenditure framework would be a key element of a sound debt strategy.

32. Efforts to address the chronic revenue weaknesses, notably through strengthening of tax administration, will be crucial to ensuring a fair and equitable tax burden and a sustainable fiscal position. Staff welcome the authorities’ commitment to advance the fiscal structural reform agenda, including through continued improvement in VAT refund processing, introduction of e-filing of tax returns by end-2009 for large taxpayers, and further strengthening the large taxpayer inspectorate. It will likewise be important to move forward on tax policy reforms, notably the elimination of the presumptive taxation regime for tobacco and fuel products by 2011.

33. An accommodative monetary policy stance remains appropriate. In light of the severe output contraction, the authorities should defer tightening the monetary policy stance until clear signs of incipient inflation emerge. At the same time, given the weak transmission mechanism and economic uncertainty, lower interest rates are not leading to an increase in credit, but rather to a build-up in liquidity in the banking system. Mopping up some of this liquidity can be useful to avoid speculative pressures on the exchange rate. Potential inflationary pressures appear distant, although, with the stabilization of output, the authorities will have to be mindful of incipient inflation and adjust policy as needed.

34. Greater flexibility in the exchange rate serves Armenia well. Since the renewed float of the dram in March, CBA interventions intended to smooth volatility have at times unfortunately conveyed the impression that the CBA was targeting a particular level or band of the exchange rate. The CBA should continue to adhere to its intervention guidelines and avoid moral suasion that could hinder the exchange rate adjustment. In this context, staff welcomes the recent greater flexibility of the exchange rate. Staff also supports the CBA’s plans to reinstate limits on net open foreign exchange positions, which should be developed in close consultation with market participants. Finally, staff endorses the authorities’ intention to use their share of the recent SDR allocation to bolster the CBA’s international reserves.

35. Staff welcomes the CBA’s continued strengthening of banking supervision, the regulatory framework, and contingency planning. The financial sector is sound, but continued vigilance is needed. Nonperforming loans could further pick up in the period ahead, eroding the capital buffer. Leverage ratios in the system are low, mitigating potential risks, but the CBA, with the help of Fund technical assistance, should continue to closely monitor financial sector stability and make further progress on crisis preparedness.

36. Risks to the program are broadly balanced. On the upside, the output contraction could be less than envisaged should the decline in the construction sector soften, or if the spillovers to the rest of the economy are weaker. A faster improvement in the global outlook, notably in Russia, would have important positive ramifications for Armenia. Likewise, opening the Turkish land border would present considerable potential for exports and investment, with lower transport costs improving the competitiveness of Armenian firms and the purchasing power of the Armenian population. On the downside, a weaker global outlook would pose a risk. In addition, Armenia’s debt position is sustainable, but the rapid accumulation of debt would pose an important risk if the fiscal position does not improve or growth does not rebound. Armenia’s external partners are encouraged to increase the share of concessional resources in their overall lending envelopes.

37. Staff supports the authorities’ request for completion of the second review under the SBA. Staff also supports the authorities’ request for a waiver of nonobservance for the end-September fiscal balance performance criterion, modification of the end-December performance criteria, setting performance criteria for end-March 2010, a rephasing of purchases, and setting a new indicative target on contracting or guaranteeing new nonconcessional public debt. Finally, staff welcomes the authorities’ renewed commitment to exchange rate flexibility, their commitment to fiscal adjustment, and their willingness to deepen structural reforms.

Attachment I. Armenia: Letter of Intent

October 14, 2009

Mr. Dominique Strauss-Kahn

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Mr. Strauss-Kahn:

1. 2009 has been an extremely challenging year for Armenia. The sharp deterioration in the external outlook beginning in late 2008 led to a substantial weakening of the balance of payments, with pressures on the exchange rate and growing concerns about the financial system. While the return to the floating exchange rate in March 2009 has served the economy well by restoring confidence and reducing concerns about financial stability, the economic decline has deepened. Both the balance of payments and the public finances have likewise weakened further.

2. We have responded forcefully to the crisis, implementing macroeconomic policies and structural reforms aimed at mitigating its impact and setting the stage for a rebound. Timely support from the IMF has been an important element of our strategy, first with the approval of the Stand-By Arrangement in March of this year, followed by an augmentation of resources at the time of the First Review.

3. Program performance has been very strong (Tables 1 and 2). All quantitative performance criteria for end June were met, and all performance criteria for end-September for which data are available have also been met. Given that the final data are not yet available for the program fiscal balance at end-September, we are requesting a waiver of nonobservance for this performance criterion, which we expect to have missed by a small margin. In addition, all structural benchmarks for end-June and end-September were implemented.

Table 1.

Armenia: Quantitative Targets, 2009-10 1/

(in billions of drams, at program exchange rates, unless otherwise specified)

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All items as defined in the TMU. The figures in bold indicate when a target has not been met.

Indicative targets for June, September, and December.

Below-the-line overall balance excluding net lending.

Indicative target up to end-December 2009.

For 2009, cumulative beginning the second half and therefore excludes the Russian loan contracted in June 2009.

Table 2.

Armenia: Proposed Structural Benchmarks for the Second, Third, and Fourth Reviews

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4. This letter of intent outlines the policies we intend to pursue in the remainder of 2009 and in 2010 to achieve our program objectives, namely to help adjust to the worsened outlook, maintain confidence, and protect the poor. These policies supplement those outlined in the memoranda of economic and financial policies dated March 2, 2009 and June 5, 2009.

5. We welcome the Executive Board’s decision to back the US$250 billion general SDR allocation. We intend to use our share of the allocation to bolster the CBA’s international reserves.

I. Recent Developments and Outlook for 2009-10

6. The contraction in economic activity in Armenia has deepened. Growth has fallen by more than 18 percent in the first seven months of 2009 driven by the collapse in the construction sector as remittances from abroad, notably Russia, slowed down. We anticipate some improvement in the economy by the end of 2009 with a pick up of activity in industry, as the mining sector benefits from the weaker exchange rate and rising metal prices, and the construction sector stabilizes. Nonetheless, real GDP is now projected to fall by around 15 percent in 2009. Inflation remains contained on the background of weak domestic demand, but could increase moderately in the coming months as international commodity prices strengthen. Falling exports on account of feeble external demand and significantly lower remittances have widened the current account deficit, despite the significant decline in imports.

7. We expect the economy to gradually recover during the next year, supported by a rebound in services, agriculture, and industry, particularly mining. However, prospects for recovery in Armenia will depend crucially on improvements in external conditions, and in particular on a turnaround in the Russian economy.

II. Monetary, Exchange Rate, and Financial Policies

8. Our monetary policy continues to be underpinned by an inflation targeting framework. However, in the context of falling output and weak price pressures, the CBA’s stance has so far continued to focus on easing credit conditions. Credit to the private sector has been declining since end-March, as borrowers wait for the economic uncertainty to clear and banks continue to keep tight lending criteria in light of the heightened credit risk. With price pressures still contained, the CBA can focus on overcoming the credit crunch consistent with the inflation target. In light of this, it has gradually lowered its policy rate to 5 percent in September, down from its peak of 7.75 percent in the aftermath of the return to the floating exchange rate regime. We expect credit to start rising again toward the end of the year as a result of the loose monetary conditions and of our various programs to support bank lending to the private sector. These include the CBA’s foreign-financed on-lending window to finance SMEs through commercial banks and the mortgage refinancing facility offered by the newly-created mortgage operator.

9. We stand ready to adjust the monetary stance in line with inflation developments in the coming months. Besides the possible increase in international commodity prices, the abundant dram liquidity resulting from our expansionary policies could weaken the exchange rate and further add to price pressures. To preempt excessive liquidity buildup, the CBA has suspended the outright purchases of government securities, and is relying more on the available monetary operations instruments, including foreign exchange swaps. Without undermining its overarching objective to stimulate economic activity, and market conditions permitting, the Ministry of Finance will increase its net T-bill issuance in coordination with the CBA. This will help absorb some of the excess liquidity, while allowing the government to refinance its debt at attractive interest rates. Proceeds from the issuance would be placed at the central bank at market interest rates.

10. We remain committed to the floating exchange rate regime and strive to promote increased exchange rate flexibility. In this context, the CBA will adhere to its internal guideline on foreign exchange intervention strategy introduced in June 2009. The strategy is designed to allow the exchange rate to move freely, with interventions limited to smoothing excessive exchange rate volatility and rebuilding reserves. The CBA will take particular care to avoid giving the market any perception, verbally or otherwise, of targeting a particular exchange rate level or band. In addition, to enhance transparency, the CBA will refrain from conducting foreign exchange intervention with counterparties other than foreign exchange market operators and government entities.

11. We continue to closely monitor the health of the financial sector and are ready to promptly take necessary actions to preserve financial stability. The latest stress tests show that the banking system remains sound with high capital and liquidity ratios, and is now less exposed to exchange rate risk. While non-performing loans have increased due to the economic crisis, banks are taking appropriate action by provisioning fully and by working with borrowers to restructure troubled but viable loans.

12. We will reduce banking sector vulnerabilities by imposing additional prudential measures, as appropriate. We intend to restrict banks’ reliance on a single source of funding, and reinstate limits on net open foreign exchange positions to ensure proper exchange rate risk management. We are in close consultation with market participants to ensure proper design of these measures and maximize their effectiveness.

13. We have made good progress on strengthening financial safety net and crisis preparedness. The government has approved the changes proposed by the Deposit Guarantee Fund (DGF) to enhance its effectiveness (structural benchmark, end-June 2009) and submitted the relevant law amendments to parliament in September. The changes include doubling the coverage on both domestic and foreign currency deposits, reviewing the appropriate level of coverage every 5 years, and increasing the financial resources of the DGF with government back-up funding. The proposed doubling of coverage would bring the coverage level to approximately 2.5 times per capita GDP. To further enhance our crisis management capability, we will participate in a regional crisis simulation exercise as part of the crisis preparedness programs organized by the Toronto Centre, which will provide an opportunity to test the effectiveness of our existing policy tools and coordination and decision-making mechanism framework. We also expect to receive Fund technical assistance in this area starting in October.

14. The draft legislation on the recapitalization of the CBA with marketable interest-bearing securities was submitted to parliament (structural benchmark for end-September 2009). The MOF will gradually issue government bonds to recapitalize the CBA, and bond issuance would follow a clear schedule to enhance the credibility of this operation and support the financial strength and independence of the central bank. The issuance of these securities would also help the development of the local debt market.

III. Fiscal Policy

15. A counter-cyclical fiscal policy remains appropriate for Armenia to minimize the impact of the global downturn on our economy. The government is implementing an expansionary strategy based on an increase in nominal spending compared to last year, despite the collapse in tax revenues under the impact of the crisis. This fiscal impulse goes beyond the effect of automatic stabilizers, as we are increasing capital expenditures and lending to SMEs and key enterprises compared to last year, while ringfencing social expenditures. In line with this stance, we will allow the fiscal deficit to rise up to 7.5 percent of GDP. Financing relies heavily on generous external financing from bilateral and multilateral partners, including the Fund.

16. However, we remain committed to a sustainable medium-term fiscal position. Because of the large external borrowing secured in 2009, the public-debt-to-GDP ratio is projected to more than double this year and to continue to rise in the coming years. While the public debt remains manageable, its rapid accumulation calls for undertaking strong fiscal consolidation as soon as possible. In addition, we intend to work with our development partners to obtain more favorable terms for new borrowing.

17. We will accordingly tighten fiscal policy starting next year. The 2010 budget that we will submit to parliament envisages a fiscal tightening of about 1½ percent of GDP as the economy is expected to rebound under the effect of this year’s expansionary policies. The fiscal adjustment will hinge on increasing tax collection in line with the economic recovery and on containing expenditures, mainly capital spending, compared to this year’s levels. We plan to finance the fiscal deficit from external sources—albeit to a lesser degree than in 2009—and a moderate increase in domestic debt. Should the economic crisis persist longer than anticipated, we stand ready to loosen our fiscal stance, provided that adequate domestic or external financing is available.

IV. Fiscal Structural Reforms

18. We remain committed to our tax administration reform program based on a self-assessment model to enhance the business environment and ensure a sustainable revenue base. To this end, we have submitted to parliament draft legislation to strengthen penalties for false VAT refund claims and to pay interest on all late legitimate VAT refund claims (structural benchmark for end September 2009), and we have further decreased the stock of tax credits (indicative target). We have made progress in implementing reforms in other areas, including the introduction of e-filing of tax returns by December 2009 for large taxpayers, and over 2010-2011 for all other taxpayers; the improvement of analytical capacity of the tax services; and development of a plan for further strengthening the large taxpayer inspectorate. In the remainder of 2009 and in 2010, we will continue to focus on addressing the systemic problems underlying tax credits, and ensuring the functionality of the risk-based audit system. We will also proceed with implementing a fully functional risk-based approach to VAT refund processing, a necessary condition for which is a change in legislation so to allow only high-risk VAT refunds to be subject to review (structural benchmark for end-March 2010). Finally, we will consider strengthening penalty regimes for all taxes by introducing graduated penalty rates, based upon the severity of the offence. Fund TA is helping us in all these efforts.

19. In the tax policy area, we are committed to abolishing presumptive taxation for fuel and tobacco products. To this effect, legislation will be submitted to parliament to bring all tobacco and petroleum products within the regular tax regimes (excise tax, customs duties, profit tax, and VAT), effective January 2011 (structural benchmark for end December 2009). To improve the effectiveness of social spending, the government is working with the World Bank to further strengthen the targeting of social safety nets (structural benchmark for end December 2009).

20. We also intend to strengthen our debt monitoring and planning capacity, notably regarding data on receipts and projections of foreign grants and loans. To this end, we will approve by end-March 2010 a time-bound action plan to strengthen our public debt management with the aim of developing a comprehensive medium-term debt strategy, preconditions for which are (a) the implementation of a public debt management information system; (b) the restructuring of the Public Debt Management Department (PDMD) of the Ministry of Finance along functional lines; and (c) the consolidation of public debt management within the PDMD. Timely delivery of technical assistance will be crucial to the successful implementation of this reform.

V. Other Structural Reforms

21. We believe that deepening structural reforms will boost the productive capacity of the economy, help support the economic recovery, and promote long-term economic growth. These reforms include substantial investments in transportation infrastructure, information technology, and telecommunications, and a continued push to strengthen education services. Likewise, we are committed to maintaining an open trade regime. We are carrying out a number of initiatives to improve Armenia’s business environment, with a focus on improving the capacity of regulatory bodies and the ease of doing business. We also intend to continue our anti-corruption efforts, notably by enforcing the constitutional provisions restricting public officials from engaging in commercial activities.

VI. Conclusion

22. We request the completion of the Second Review under the Stand-By Arrangement in light of the strong performance under the program and our continued commitment to strong policies. In addition, we request a waiver of nonobservance for the end-September performance criterion on the program fiscal balance, a target which we expect to have missed by a small margin. Since this review combines what were the second and third reviews under the original schedule, we request that the amounts previously scheduled to be available following the second and third reviews become available upon completion of this review, and we intend to purchase the SDR37.72 million that will be available to us upon completion of this review. We will maintain the usual close policy dialogue with the Fund and stand ready to take additional measures, as appropriate, to ensure the achievement of the government’s social and economic objectives under the Stand-By Arrangement. We will continue to consult with the Fund on the adoption of measures, and in advance of revisions to the policies contained in the LOI, in accordance with the Fund’s policies on such consultation. We will also provide the Fund with the information it requests for monitoring progress during program implementation.

23. The program will continue to be monitored via quarterly performance criteria, indicative targets, and structural benchmarks. We request the modification of the performance criteria for end December 2009, the establishment of performance criteria for end March 2010, and indicative targets for the remainder of 2010 as specified in the attached Table 1. Given the expected deterioration in our debt outlook, we also request that the program include an indicative target on contracting or guaranteeing new nonconcessional debt by the public sector, which would help inform our policy decisions. We expect to complete the third review of the program on or after February 15, 2010, and the fourth review on or after May 14, 2010. The attached Technical Memorandum of Understanding updates definitions for the adjusters related to external financing to the public sector Structural benchmarks under the program are described in Table 2.

24. We authorize the IMF to publish this Letter of Intent and its attachments as well as the accompanying staff report.

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Attachment II. Armenia: Technical Memorandum of Understanding

This memorandum sets out the definitions for quantitative performance criteria, indicative targets, benchmarks, adjusters, as well as the reporting modalities referred to in the Letter of Intent, under which Armenia’s performance under the program supported by the Stand-by Arrangement (SBA) will be assessed.

I. Quantitative Targets

1. The program targets a minimum level of net official international reserves (NIR) of the Central Bank of Armenia (CBA; performance criterion). The stock of such reserves will be calculated as the difference between total official gross international reserves (excluding reserve money denominated in foreign currencies) and official gross reserve liabilities. Total gross official international reserves are defined as the CBA’s holdings of monetary gold (excluding amounts pledged as collateral or in swaps), holdings of Special Drawing Rights (SDRs), including the August 28, 2009 General allocation and the September 9, 2009 Special allocation, any reserve position in the IMF, and holdings of convertible currencies in cash or in nonresident financial institutions (deposits, securities, or other financial instruments). Gross reserves held in the form of securities and other financial instruments are marked to market. Gross reserves are reported separate from the balance on the government’s Special Privatization Account (SPA) and the Millennium Challenge Account (MCA) and exclude capital subscriptions in foreign financial institutions and illiquid foreign assets. Official reserve liabilities shall be defined as the total outstanding liabilities of the government and the CBA to the IMF and convertible currency liabilities of the CBA to nonresidents with an original maturity of up to and including one year. NIR is monitored in U.S. dollars, and, for program monitoring purposes, assets and liabilities in currencies other than the U.S. dollar shall be converted into dollar-equivalent values using the exchange rates as specified in Table 1.

Table 1.

Armenia: (Program) Exchange Rates of the CBA

(As of December 31, 2008 for dollars per currency rates)

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2. The program targets a maximum level of net domestic assets (NDA) of the CBA (performance criterion). For program purposes, NDA is defined as reserve money minus NIR, minus reserve money denominated in foreign currencies, plus medium- and long-term liabilities (i.e. liabilities with a maturity of one year or more) of the CBA, plus the balance of outstanding Fund purchases credited to the government account at the CBA. To evaluate program targets, the dram-equivalent values of NIR, medium- and long-term liabilities, and reserve money in U.S. dollar are calculated at the program exchange rate of dram 385 per U.S. dollar. The dram-equivalent value of reserve money in euro is calculated at the program exchange rate specified in Table 1. NDA is composed of net CBA credit to the general government; outstanding credit to domestic banks by the CBA (including overdrafts) minus liabilities not included in reserve money (exclusive of accrued interest), and other items net. Reserve money is defined as the sum of currency issued, required and excess reserves, and current and time deposit accounts of certain resident agents.1

3. The program targets a maximum level of net banking system credit to the government (performance criterion), defined as the sum of net credit from the CBA and net credit from commercial banks to the central government.

  • The stock of net credit from the CBA to the government, which includes the CBA’s holdings of treasury bills and treasury bonds less all types of government deposits with the CBA (including the deposits in the Treasury Single Account, deposits of donor-financed project implementation units, the Lincy foundation, and balances of proceeds from the sale of humanitarian assistance). Treasury bonds are valued at the purchase price and excluding accrued interest, and treasury bills are valued at the purchase price plus the implicit accrued interest.

  • Net credit from commercial banks to the government includes: (1) gross commercial bank credit to the central government less government deposits with commercial banks (including the counterpart funds of certain government on lending to the economy financed by the Lincy Foundation and the World Bank); and (2) bank holdings of treasury bonds (valued at the purchase price and excluding accrued interest) and treasury bills (valued at the purchase price plus the implicit accrued interest).

4. The program imposes a zero ceiling on external payment arrears (continuous performance criterion) defined as all unpaid debt-service obligations (i.e., payments of principal and interest) arising in respect of public sector loans contracted or guaranteed including unpaid penalties or interest charges associated with these obligations that are overdue beyond 30 days after the due date.2

5. The program targets a minimum level of the program fiscal balance (performance criterion). The fiscal balance is measured as the negative of the sum of net domestic banking system credit to the government, domestic nonbank net financing, and external net financing to the government. Should a general subsidy be introduced off-budget, the overall balance will be measured including the subsidy as part of government spending.

  • Net banking system credit to the government equals the change during the period of net credit to the government.

  • Nonbank net financing equals the sum of: (1) the change during the period of outstanding treasury bills and bonds to nonbanks (including accrued interest for treasury bills and excluding accrued interest for treasury bonds);3 (2) any other disbursement or transaction that increases nonbanks’ claims on the central government plus withdrawals from the special privatization account or the treasury sub-account containing privatization proceeds in dram, less amortizations made by the central government to private resident nonbank agents.

  • External net financing equals total debt-increasing disbursements from non-residents to the central government (including Fund net purchases credited directly to the government accounts at the CBA) less total amortizations from the central government to non-residents. All foreign-currency denominated transactions are recorded in drams using the prevailing exchange rate at the time of the transaction.

6. The project implementation units, which carry out projects financed by the US-based Lincy Foundation, maintain accounts at the CBA. These grants are recorded in the fiscal accounts as external grants on the revenue side and as foreign-financed capital expenditure on the expenditure side. In addition, any loans extended by the U.S.-based Lincy foundation to finance investments and that are intermediated through the banking system are recorded in the financial accounts as a financing item below the line and are thus excluded from net lending.

7. Foreign currency proceeds from selling enterprises are deposited into the Special Privatization Account (SPA). The account is held at the CBA and the proceeds are invested abroad together with the CBA’s international reserves. These proceeds are included in the definition of the monetary accounts of the CBA as part of net foreign assets with a counter entry in other items net. Any budgeted withdrawal from the SPA will be accounted for as privatization proceeds used to finance the budget and will be recorded below the line. Any unanticipated withdrawal from the SPA will be recorded below the line as privatization receipts; these withdrawals, however, will be replenished during the same fiscal year. Domestic currency proceeds from selling enterprises to residents are deposited in a sub-account of the treasury single account.

8. The program targets a maximum level of stock of tax credits (indicative target) defined as the sum of outstanding accumulated credit by the State Revenue Committee (SRC) of all types of tax revenues (VAT, profit tax, excises, income tax, presumptive payments, and others) resulting from advanced tax payments to be offset against future tax liabilities.

9. The program sets a maximum on contracting or guaranteeing of new nonconcessional external debt by the public sector (indicative target). The definition of debt, for the purposes of the program, is set out in Executive Board Decision No. 12274, Point 9, as revised on August 24, 2000. For program purposes, nonconcessional external loans are defined as loans from lenders other than the IMF with a grant element of less than 35 percent of the value of the loan. The grant element is to be calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt. The NPV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt. The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the Organization for Economic Cooperation Development (OECD). For debt with a maturity of at least 15 years, the ten-year-average CIRR will be used to calculate the NPV of debt and, hence, its grant element. For debt with a maturity of less than 15 years, the six month average CIRR will be used. To both the ten-year and six-month averages, the same margins for differing repayment periods as those used by the OECD would continue to be added (0.75 percent for repayment periods of less than 15 years, 1 percent for 15 to 19 years, 1.15 percent for 20 to 29 years, and 1.25 percent for 30 years or more). Loans provided by a private entity will not be considered concessional unless accompanied by a grant or grant element provided by a foreign official entity, such as both components constitute an integrated financing package with a combined grant element equal to at least 35 percent. Previously contracted nonconcessional external debt that has been rescheduled will be excluded from the definition of “new debt” for the purposes of this performance criterion.

II. Adjusters

10. The quantitative performance criteria and indicative targets under the program are subject to the following adjusters, calculated, where relevant, using program exchange rates:

  • Changes in reserve requirements: The ceiling on the NDA of the CBA will be adjusted downward (upward) by the amount of banks’ reserves freed (seized) by any reduction (increase) of the reserve requirement ratio on both domestic currency and foreign currency deposits relative to the baseline assumption as per the following formula: ΔNDA = ΔrB, where B denotes the level of the reservable deposits in the initial definition and Δr is the change in the reserve requirement ratio.

  • KfW and World Bank loan disbursements: the ceiling on the NDA of the CBA will be adjusted upward (downward) by the full amount of any excess (shortfall) of disbursements from the KfW and World Bank loans directed at SME financing compared to programmed amounts (Table 2). The floor on NIR will be adjusted upward (downward) by the cumulative amount of any excess (shortfall) of these disbursements compared to program amounts.

  • External financing to the public sector, defined as disbursements of loans from bilateral and multilateral agencies for budget, project support, and the $500 million Russian loan disbursed in 2009 (including Fund purchases credited directly to the government accounts at the CBA), with the exception of the KfW and World Bank disbursements mentioned above:

    • The floor on NIR will be adjusted upward (downward) by the cumulative amount of any excess (shortfall) of external financing in the form of budget support (excluding Fund disbursements to the government) compared to program amounts (Table 3).

    • The ceiling on NDA will be adjusted upward by the amount of any shortfall of external financing in the form of budget support compared to program amounts.

    • The ceiling on net banking sector credit to government will be adjusted upward by the cumulative amount of any shortfall of total external financing compared to programmed amounts (Table 3).

    • The floor on the program fiscal balance on a cash basis will be adjusted downward by the cumulative amount of any excess of total external financing compared to programmed amounts (Table 3).

  • Recapitalization of the CBA: the ceiling on net credit of the banking system to the government will be adjusted upward by the full amount of the recapitalization of the CBA.

Table 2.

Armenia: KfW and IBRD SME Loan Disbursements, 2009–10 1/

(in millions of USD)

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Cumulative from the end of the previous year.

Table 3.

Armenia: External Financing to the Public Sector, 2009-10 (program) 1/

(in billions of drams)

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Cumulative from the end of the previous year, at program exchange rates, excluding grants.

III. Data Reporting

The government will provide the IMF the information specified in the following table.

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IV. Guidelines on the Indicative Benchmark with Respect to Foreign Debt

Excerpt from Executive Board Decision No. 12274, as revised on August 24, 2000.

9. (a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

  • (i) loans, that is, advances of money to obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans, and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

  • (ii) suppliers’ credits, that is, contracts where the supplier permits the obligor to defer payments until some time after the date on which the goods are delivered or services are provided; and

  • (iii) leases, that is, arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

(b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (for example, payment on delivery) will not give rise to debt.
1

In addition, domestic net lending will increase by 2.4 percent of GDP this year.

2

See Appendix II of the Middle East and Central Asia Regional Economic Outlook for an overview of the fiscal stance in Armenia and the region.

3

The revenue projection for 2010 also includes an additional 0.2 percent of GDP in revenue from taxation of donor-funded projects; this is neutral on the fiscal balance, as the government provides equal counterpart spending to donor-funded projects subject to taxation.

4

Quasi-fiscal risks from these operations appear limited. Under the successful framework pioneered by KfW, banks have to show that the borrower meets strict minimum standards set by the CBA before funds are released to the bank, and banks assume all credit risk. Applying a ratio of loss loans to the total loan portfolio of 10 percent—well above the actual ratio of 2½ percent—defaults on these externally refinanced loans would be limited to around 0.1 percent of GDP.

5

The government has agreed to gradually issue marketable interest-bearing government bonds to compensate for the CBA’s accumulated losses, which amounted to approximately AMD 85.7 billion as of end-2008.

1

Liquidity absorbing transactions under reverse repurchase agreements, the CBA’s deposit facility, foreign currency swaps, and securities issued by the CBA are excluded from the reserve money definition.

2

The public sector is defined following the Government Financial Statistics Manual (GFS 2001) and System of National Accounts (1993 SNA). It includes the general government and nonfinancial public enterprises.

3

Domestic nonbank holdings of treasury bills and treasury bonds are defined as total outstanding treasury bills and bonds less holdings by the banking system and the State Fund for Social Insurance.

4

As defined in CBA resolution No. 201 (December 6, 1999).

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Cover IMF Staff Country Reports
Republic of Armenia: Second Review Under the Stand-By Arrangement, Request for Waiver of Nonobservance of Performance Criterion, Modification of Performance Criteria, and Rephasing of Purchases: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director and Advisor for the Republic of Armenia.
Author:
International Monetary Fund
Volume/Issue:
Volume 2009: Issue 316
Publisher:
International Monetary Fund
ISBN:
9781451801767
ISSN:
1934-7685
Pages:
72
DOI:
https://doi.org/10.5089/9781451801767.002

Contributions to Growth

(In percent, production side)

CPI Inflation

(year-on-year growth, in percent)

Key Balance of Payments Components

(In percent of GDP)

Construction Sector Contribution to Real GDP Growth

(In percent)

Remittances and Construction Output

(In billions of drams)

Remittances and Real Estate Prices

Exports

(In billions of U.S. dollars)

Remittances 1/

(In billions of U.S. dollars)

Tax Revenues and Expenditure

(In percent of GDP)

Overall Balance

(In percent of GDP)

Public Sector Debt

(In percent of GDP)
Figure 1.

Armenia: Recent Exchange Rate and Monetary Sector Developments
Figure 2.

Armenia: External Debt Sustainability: Bound Tests 1/

(External debt in percent of GDP)

Interest Rates

(In percent)

12-Month Credit Growth

(In percent)

Banks’ Liquidity Conditions

(in percent)

Banking System Leverage Ratios

(in multiple of capital)

Nonperforming Loans in Percent of Total Loans 1/
Figure 3.

Armenia: Public Debt Sustainability: Bound Tests 1/

(Public debt in percent of GDP)