Statement by Age Bakker, Executive Director for Republic of Armenia and Grigor Sargsyan, Advisor to Executive Director

In this study, Armenia’s financial challenges observed in the global crisis are discussed, and also the development processes initiated by Armenia are analyzed. Short- and medium-term outlooks, and risks are also outlined. Fiscal, monetary, and banking sector policies play important roles in the development of the financial system. Structural reforms are accelerated for addressing imbalances, sustainable growth, and poverty reduction. Sound macroeconomic policies and structural reforms will help to ensure rise in productivity, exports, and inflation pickup and reduce the foreign exchange risk.

Abstract

In this study, Armenia’s financial challenges observed in the global crisis are discussed, and also the development processes initiated by Armenia are analyzed. Short- and medium-term outlooks, and risks are also outlined. Fiscal, monetary, and banking sector policies play important roles in the development of the financial system. Structural reforms are accelerated for addressing imbalances, sustainable growth, and poverty reduction. Sound macroeconomic policies and structural reforms will help to ensure rise in productivity, exports, and inflation pickup and reduce the foreign exchange risk.

Armenia continues to recover gradually from the deep global downturn and economic recession. The ECF/EFF blend arrangement approved by the Board in June 2010 has been instrumental for the authorities to restore growth, address the challenges of the surge of global inflation, set the basis for a smooth and orderly adjustment of the balance of payments, and strengthen the implementation of structural reforms. The authorities would like to thank Executive Directors, Management, and staff for their continued support and constructive dialogue.

The authorities concur with staff’s appraisal on the necessity of further fiscal consolidation, reforms in tax administration, and external adjustment. Performance under the program has been strong, with many performance criteria met with a substantial margin. The authorities remain committed to advancing structural reforms to help underpin the nascent recovery by enhanced competitiveness, an improved business environment, and strong export growth. Macroeconomic policies will be geared to striking a balance between fostering growth and containing inflationary pressures, as well as preserving fiscal and debt sustainability.

Macroeconomic situation

During the past year, growth has been very uneven. While mining, industry, trade and transportation have performed strongly, overall output growth was dragged down by the agricultural sector, due to poor climatic conditions and structural weaknesses in the sector. The authorities are expecting a faster growth in 2011, supported by improved agricultural production, and staying above 4 percent for the next several years.

Inflationary pressures from shortages in domestic agricultural production were exacerbated by the increase in global food prices, pushing inflation to 11.5 percent in March 2011, a record-high level in the past 10 years. The monetary authorities, fearing that these pressures might spill over into second-round effect, acted by increasing interest rates by 125 bps. Recent data show that twelve-month inflation decreased to 9 percent in May.

With the post-crisis recovery underway, fiscal policy continues to be contractionary. After reaching 8 percent of GDP in 2009, the fiscal deficit was cut to 4.6 percent last year. The authorities plan further fiscal consolidation and intend to reach a target deficit of 2.4 percent of GDP by 2013. At the same time, the revenue-to-GDP remains relatively low. Based on recent technical assistance from the Fund, the Armenian authorities are planning a set of measures in tax policy and revenue administration that could add significantly—up to 4 percentage points of GDP—to overall revenue collections.

The financial system remains sound. However, while the banking sector is well capitalized and NPLs have decreased to 4 percent, the system on the whole remains highly dollarized, which impedes the effectiveness of monetary policy. The Central Bank of Armenia (CBA) has taken anti-dollarization measures, including requiring banks to maintain a higher portion of dram reserve requirements against foreign exchange deposits, as well as strengthening enforcement of foreign exchange regulations, which require the use of drams in certain transactions and for listing the prices of goods and services.

The authorities recognize the necessity of improving the business environment. A number of measures have been implemented during the past several months in this regard. With support from international partners, the business registry is now fully functional, allowing the registration of a new business on-line in just fifteen minutes. Also, the procedure for certifying exports has been streamlined. Seventy percent of exports need certification of origin, and recently-passed regulations have streamlined what were cumbersome and bureaucratic procedures for obtaining certification.

Future policies and measures

The CBA will continue its close monitoring of developments in consumer prices. Committed to inflation targeting, the CBA stands ready to increase interest rates further to curb inflation, especially if evidence reemerges of a pass through of food and fuel prices to core inflation. The authorities project inflation to moderate towards the end of the year and reach the target band of around 4 percent. The CBA is also aiming to increase the effectiveness of monetary policy by increasing the responsiveness of market interest rates to open market operations. Accordingly, several term-rate instruments are being developed for trading on the NASDAQ OMX Armenia exchange platform.

On the fiscal side, the authorities are planning to cut the deficit by another 0.7 percent of GDP in 2011. As in the past, the authorities are committed to saving at least half of any higher-than-expected revenues to create a buffer should risks materialize. This will also help maintain debt sustainability on a firm footing.

The authorities are committed to changing several laws and codes to support growth and increase fiscal revenue collection. Last week, Parliament began discussions on amendments to the mining code. The new code is aimed at improving taxation of the industry, while boosting investment in the sector. Non-ferrous metals, such as copper and molybdenum, as well as metal ore concentrates, are currently Armenia’s largest export items.

Last week, the President of Armenia signed a new law on free economic zones. The aim of the law is to establish a favorable economic environment for export-oriented companies. The first two zones will be set up this year, one at the international airport in Yerevan, with operations including packaging of high-value fresh fruits and vegetables for export via air. The second one will be a high-tech industrial facility. The authorities are strongly committed to preventing any leakages from the zones to the rest of the economy.

Republic of Armenia: Second Reviews Under the Extended Fund Facility and Extended Credit Facility, and Request for Modification of Performance Criteria: Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Armenia.
Author: International Monetary Fund