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

Armenia’s growth has picked up in 2011, led by manufacturing, mining, and services, while agriculture has rebounded from the collapse. Credit continues to grow rapidly, particularly in foreign currency and based on strong inflows to banks. Inflation has come down sharply, reflecting policy rate hikes, spending restraint, the agriculture recovery, and favorable global price developments. Challenges include safeguarding financial system stability, strengthening tax revenues to ensure sustainability and support pro-growth and pro-poor spending, improving the business environment to enhance growth and reduce poverty and unemployment, and reducing external imbalances.

Abstract

Armenia’s growth has picked up in 2011, led by manufacturing, mining, and services, while agriculture has rebounded from the collapse. Credit continues to grow rapidly, particularly in foreign currency and based on strong inflows to banks. Inflation has come down sharply, reflecting policy rate hikes, spending restraint, the agriculture recovery, and favorable global price developments. Challenges include safeguarding financial system stability, strengthening tax revenues to ensure sustainability and support pro-growth and pro-poor spending, improving the business environment to enhance growth and reduce poverty and unemployment, and reducing external imbalances.

I. Economic Context

A. Background and Program Implementation

1. Armenia’s post-crisis recovery is continuing, although challenges remain. Growth has strengthened in 2011, and inflation has declined rapidly. Challenges include safeguarding financial system stability, strengthening tax revenues to ensure sustainability and support pro-growth and pro-poor spending, improving the business environment to enhance growth and reduce poverty and unemployment, reducing external imbalances.

2. Program performance has been sound. All but one of the quantitative PCs was met. PCs on the fiscal deficit and NIR were met with large margins. The end-June PC on NDA of the CBA was missed by a small amount due to brief delays in budget support loans. A waiver is being requested, and an adjustor will be incorporated into the program. All but one of the structural benchmarks were met, one with a delay.1

3. The election cycle is gaining speed. Parliamentary and presidential elections are due in 2012 and 2013, respectively, and there may be changes in coalition arrangements or a return to politics by two-term former President Robert Kocharian, which may affect electoral dynamics. The 2008 presidential elections were followed by demonstrations that turned violent, and opposition protests have taken place throughout 2011.

B. Recent Developments and the Outlook for 2011

4. With strong performance in mining, manufacturing and services, growth is expected to reach 4.6 percent in 2011. While construction remains subdued, agriculture is rebounding from last year’s collapse with better weather, a recovery of remittances (a key financing source), and targeted policy interventions.2 Along with policy rate hikes, spending restraint, and favorable global price developments, the agriculture recovery helped bring headline inflation down sharply from a peak of 11.5 percent in March.3 The CBA reduced its policy rate in September, the first time since September 2009.

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Contributions to Growth

(In percent, production side)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities.
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CPI Inflation

(Year-on-year growth, in percent)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities.

5. While credit has grown at a fast pace, the banking sector remains sound. Credit grew by 37 percent year-on-year through September, with demand spread evenly across sectors and consumers. The credit-to-GDP ratio remains relatively low at around 30 percent, while strong financial flows have continued from parent banks and international financial institutions. Deposit and credit dollarization remain high. Rapid growth of foreign currency (FX) lending—by 47 percent through September—has increased vulnerabilities to exchange rate changes, and with higher risk weights, has contributed to declining capital adequacy ratios (CAR). The ratio of non-performing loans to total loans has remained low, but edged up recently, mainly in respect of FX lending, suggesting that rapid credit growth and competition may have lowered lending standards. Still, the system-wide CAR remains around 20 percent, with no bank below the required 12 percent.

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12-Month Credit Growth

(In percent)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities.

6. With the nominal exchange rate roughly at its end-2010 level, the dram likely remains overvalued. Modest depreciation in the first part of 2011 was offset by appreciation over the summer. Staff estimates suggest that that the real effective exchange rate is overvalued by 10–15 percent. The authorities have continued to intervene to smooth volatility, although with concerns about inflation, sales have exceeded purchases.

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FX Intervention and Exchange Rate

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities.

7. Consolidation of the external current account deficit is continuing, although at a slow pace. Driven by strong growth in remittances and exports (particularly metals and minerals), the current account deficit fell in percent of GDP in the first half of 2011. The deficit for 2011 is projected at just over 12 percent, down from 14.7 percent in 2010.

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Remittances and Mining Exports 1/

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities; and Fund staff estimates.1/ Remittances are defined as noncommercial money transfers of individuals from abroad through commercial banks.

8. Fiscal consolidation has also continued. The end-June deficit target was met by a wide margin, as the authorities restrained both current and capital expenditures. Spending is expected to pick up in the second half of the year, but better targeting of pension and social allowances is expected to lead to savings. Combined with higher-than-projected grants, the deficit is projected to reach 3½ percent of GDP, well below the 3.9 percent target, and possibly lower, if first half underspending is not unwound.

uA01fig06

Cumulative Spending, 2011 (bln AMD)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenia authorities; and Fund staff estimates.

9. Business environment reforms are proceeding. Risk-based approaches are being adopted by inspection agencies, with a focus on simplification and transparency. Greater use is being made of electronic services and one-stop shops, and processes for obtaining permits are being streamlined. Legal changes have given greater power and tools to the competition committee, which initiated cases in telecommunications, energy, and food marketing. Two free economic zones were inaugurated in Yerevan: one focused on agricultural exports at the airport and a second aiming to spur high-tech activities. Neither has commenced operations, however, as the authorities are ensuring that proper tax and customs controls are in place.

C. Short-and Medium-Term Outlook and Risks

10. Growth is expected to moderate in 2012. In the absence of shocks, growth should remain close to potential, estimated by staff at 4 percent, from 2012 onwards. Mining, manufacturing, and services are likely to outperform other sectors, notably agriculture and construction, where significant structural challenges remain (Box 1). Headline inflation is expected to return to the CBA’s target band (4 ± 1.5 percent) later this year and remain there through end-2012, based on current interest rate levels and barring supply-side shocks. Credit growth is projected to be lower next year, as economic activity moderates and banks react to lower capital adequacy ratios.

Armenia: Recent Developments and Prospects for the Construction Sector1

Armenia experienced major real estate and housing-price booms prior to the crisis, as construction increased from 10 to 25 percent of GDP during 2000–08. The booms were fueled by the large diaspora and remittances and were concentrated in residential real estate in Yerevan. Construction activity in Yerevan reached nearly 90 percent of nationwide building in 2007–08. House prices increased by 2.5 times during 2004–08, larger than in advanced countries but less than in Russia, Latvia, and Georgia.

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Armenia: Construction activity indexes

(in real term)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

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Share of construction in GDP

(in percent)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Notably, construction was undertaken by households and financed by pre-payment, rather than bank credit. Mortgages peaked at just 2.3 percent of GDP in Armenia, compared with 40 percent of GDP in Latvia. The sector was also characterized by informality; official statistics on tax revenues and employment do not show a rise commensurate with the sector’s growing contribution to GDP.

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House prices

(SA, 2002 Q1=100)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

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Number of transactions ins Yerevan

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Construction activity fell sharply with the crisis. Also, transaction volumes declined by 30 percent, and prices fell by 15 percent. Prices recovered somewhat in 2010, possibly linked to the government’s stimulus, which included creation of a mortgage fund and guarantees for construction companies. However, unsold inventories remain large, and prices have again fallen. Even with the recovery of remittances, household-financed construction has continued to decline.

The outlook for construction is uncertain. As housing projects initiated during the boom are finished, the inventory of unsold units continues to grow. While limited use of bank credit mitigated financial sector impacts, some buyers who pre-financed construction took losses and depressed prices are likely to weigh on activity for some time.

1 Prepared by G. Tolosa and A. Manookian.

11. Further fiscal consolidation is planned. The 2012 budget targets a deficit of 3.1 percent of GDP, and deficits of 2.3 percent of GDP in 2013 and 2 percent of GDP from 2014 would keep debt on a declining path (Appendix I).4 Higher tax revenues are needed to safeguard priority social and capital spending, and the authorities will implement comprehensive tax measures in 2012 and complete a tax strategy paper to lay out reforms for 2013–15. In the absence of significant additional tax revenues, spending restraint will be needed in 2013 and beyond.

12. Business environment reforms should continue. “Doing Business” and investment climate reform action plans are being implemented, while a new streamlining (“guillotine”) initiative aims to significantly reduce the regulatory burden. Preparations for a free trade agreement with the EU should provide a further push.

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Fiscal Revenue and Expenditure

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities; and Fund staff estimates.

13. The external current account deficit is projected to decline to below 11 percent of GDP in 2012 and below 10 percent in 2013. This will be driven by further fiscal tightening, a continued recovery of remittances, and business environment improvements, which should spur domestic competition (including to imports), FDI, and export growth. Export growth is expected to moderate in 2012 (along with import growth), mainly reflecting slower growth of minerals and metals prices. Greater flexibility of the dram should also facilitate external adjustment.

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Current Account and Key Components

(In percent of GDP)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities; and Fund staff estimates.

14. The key risk facing Armenia is a significant global slowdown, which would have consequences for remittances, exports, and capital flows (Box 2). Other risks include election-related policy slippages and renewed conflict over Nagorno-Karabakh.

Armenia: Is Armenia Prepared for a Global Downturn?1

Armenia was among the countries most affected by the 2008–09 crisis, with growth declining from over 13 percent in 2006–07 to 6.9 percent in 2008, and output contracting by 14.2 percent in 2009. Armenia has recovered well from the crisis, with strong export growth and a recovery of remittances, foreign direct investment, bank flows, and reserves. However, many of these flows (remittances, FDI, non-mining exports, banks inflows) are concentrated on Russia, which is vulnerable to lower oil prices and adverse trade and financial spillovers from the euro area. In the event of a second global downturn, Armenia’s financing options may be more constrained compared with 2008–09, due to debt sustainability concerns, and possibly, availability of funding. Import compression may need to play a larger role, and if fiscal revenues are affected, spending may come under pressure.

Possible Vulnerabilities

  • Remittances. Gross private transfers and compensation of employees were 17 percent of GDP in 2010, 80 percent from Russia (services and construction), 5 percent from the U.S., and the remainder from the EU. During the previous crisis, remittances fell by 30 percent.

  • Exports. Exports consist largely of raw materials; minerals and metals constituted 60 percent of exports last year. In 2009, these exports fell 30 percent in dollar terms, driven largely by prices. The net effect may be mitigated, if a fall in metals prices is accompanied by lower prices of oil and other imports.

  • FDI. With telecoms and energy projects winding down, the major FDI destination is mining. While business environment reforms aim to make Armenia more attractive for mining FDI, a fall in the price of copper, molybdenum, and iron may have an impact, possibly with a lag.

  • Other capital flows and banking sector resilience. Bank funding is relatively stable, relying largely on retail deposits and FX credit lines of parent banks and IFIs. Financial turbulence could lead to a reduction or reversal of these flows. Direct losses from exchange rate (ER) movements are expected to be limited as the net FX open position is small. ER changes could affect unhedged borrowers, but relatively large capital buffers would help weather possible losses.

  • Fiscal risks. Revenues could fall in the event of a downturn; in 2009 revenues fell by 14 percent in real terms. The recent increase in public debt and the legislative debt ceiling (50 percent of GDP) may necessitate spending cuts (to reach a deficit of 3 percent of GDP), although the political cycle and recent expenditure compression could make cuts challenging.

Buffers and Policy Responses

  • Reserves. Gross reserves stand at just under $2 billion, or nearly five months of imports. While this buffer is large, in late-2008 and early-2009, sizable reserves were used to support the dram, while in 2012, fairly large repayments of crisis-related support are due. ER flexibility will be critical in the event of another global downturn.

  • Debt ratios. At end-2008 Armenia’s public debt ratio stood at 16 percent of GDP, compared with 42 percent at present. Some space remains, and debt is sustainable under the baseline scenario. However, an ER shock or fall in GDP could push the debt-to-GDP ratio towards the 50 percent of GDP debt threshold. Larger fiscal deficits may be difficult in the event of a second slowdown, in light of higher debt ratios and limited availability of financing. Efforts would be needed to protect priority social spending and the poor.

1 Prepared by J. Thornton, K. Fujita, and T. Komatsuzaki.

II. Policy Discussions

15. Key objectives for 2011–12 are to support the recovery and alleviate poverty, while ensuring that inflation remains low. This will require: (i) prudent monetary policy; (ii) exchange rate flexibility; (iii) continuing fiscal adjustment (securing an increase in tax revenues, while maintaining priority investment and social spending); and (iv) further structural reforms.

A. Monetary and Exchange Policy and the Financial Sector

16. The CBA will continue to focus on price stability. Inflation is projected to decline below the mid-point of the target band in the first half of 2012, reflecting the current policy stance, base effects, the favorable outcome in agriculture, and the easing of international food price inflation. The authorities expressed concern with undershooting their inflation target; however, given the temporary nature of the decline and the projection of inflation returning to the upper end of the band by end 2012, staff argued and the CBA agreed that further policy rate cuts are not needed. However, the CBA should stand ready to cut the policy rate, if downside risks materialize.

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Inflation and Central Bank Targets

(Year-on-year, percent change, eop)

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

Sources: Armenian authorities; and Fund staff estimates.

17. The CBA has used its instruments more actively in 2011 to target dram liquidity and strengthen the interest rate channel (Box 3). However, interbank rates remain volatile, and the authorities acknowledged the need to further improve liquidity management to more effectively guide interbank rates. Following a regional IMF-CBA-EBRD inflation targeting workshop in Armenia last April, the CBA is enhancing its modeling and forecasting capacity in collaboration with the IMF’s Research Department.

18. The CBA agreed that it should further enhance tools for monitoring FX lending risks. The authorities noted that high credit growth rates are not surprising, given the recovery from the crisis and Armenia’s low credit-to-GDP ratio. However, they agreed that FX lending poses vulnerabilities and have taken steps to manage risks (net open position limits and higher risk weights and provisioning for FX loans). They are improving stress-testing methodology by developing a credit risk model and using loan-by-loan information. Staff urged consideration of liquidity coverage ratios by major currencies, and the CBA agreed to assess potential impacts on bank portfolios, profitability, and the government securities market. The forthcoming FSAP Update will assess financial sector stability in the context of rapid credit growth and dollarization and a possible global downturn. In particular, the assessment will examine crisis preparedness and the sufficiency of the prudential policy framework.

19. The CBA reaffirmed its commitment to stronger reserves and exchange rate flexibility. Higher reserves were viewed by both staff and the CBA as crucial to smoothing BOP pressures, particularly as crisis support unwinds and the external environment becomes more risky. The end-December NIR target was increased by $16 million, and ambitious 2012 targets were agreed. With inflationary pressures having moderated, staff stressed the need for greater exchange rate flexibility. The authorities agreed, but underscored that stability of the dram has reflected market forces and argued that developments in 2011 had reduced or eliminated overvaluation.

Armenia: Recent Developments in Monetary Operations1

Since April, the CBA has stopped allowing large excess dram liquidity on a daily basis, and overnight interbank rates, which had stayed close to the deposit facility rate (300 bps below the policy rate), have come to move around the policy rate. Volatility of interbank rates has increased, however, weakening the interest rate channel of monetary policy and suggesting room for improvement in these operations.

Staff analysis suggests that there is a statistically-significant relationship between daily changes in aggregate excess dram liquidity and overnight interbank rates. The relationship is not rock-solid (right chart), however, and the interbank market at times fails to redistribute liquidity due to segmentation.

The CBA could take actions to lessen the volatility of interbank rates. Reducing the daily deviation of dram liquidity from the amount of required reserves would help stabilize overnight interbank rates. This would require more accurate liquidity forecasting by the CBA and more frequent open market operations. Second, efforts should be continued to facilitate market transactions. Planned measures such as publication of liquidity forecasts by the CBA and introduction of new term interbank transaction tools are welcome. If these steps fail to lessen volatility, the CBA may need to consider intervening more forcefully in the market, including by narrowing the interest rate corridor.

uA01fig14

Interest Rates and Excess Liquidity 1/

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

1/ Adjusted excess liquidity = dram reserves + use of deposit facility - use of Lombard repo-daily average of required reserves.
uA01fig15

Interest Rates and Adjusted Excess Liquidity 1/

Citation: IMF Staff Country Reports 2011, 366; 10.5089/9781463929879.002.A001

1/ Adjusted excess liquidity = dram reserves + use of deposit facility - use of Lombard repo-daily average of remaining required reserves
1 Prepared by K. Fujita.

B. Fiscal Policy

20. Staff and the authorities agreed to maintain the 2012 deficit target of 3.1 percent of GDP, which continues the consolidation aimed at ensuring debt sustainability. Discussions focused on the availability of financing. The timing of possible new funding from official partners is not yet clear, and the authorities expressed concern that domestic sources could not make up the difference.1 They requested continuing Fund support for external budgetary payments of 0.4 percent of GDP for 2012, a reduction from 2011 (0.6 percent of GDP). Additional World Bank and domestic funding was also identified.

Deficit Financing

(In percent of GDP)

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21. The authorities will implement a wide-ranging tax package in 2012. The package aims to raise Armenia’s relatively low revenue-to-GDP ratio by 0.6 percent and improve efficiency and equity. Key measures include a new mining royalty, increased income and payroll taxes on high-income earners, higher excise and presumptive taxes across a range of goods, transfer pricing and thin capitalization provisions, and gains from ongoing tax administration improvements (Box 4). Staff welcomed these measures and looks forward to the tax strategy paper, due in December, which will lay out further reform plans. Both sides noted risks that the envisaged gains may not materialize, however, given the complexity of administering the new measures and uncertainty about yields and growth.

22. Additional revenues will allow the authorities to protect priority spending, while continuing the post-crisis consolidation. The authorities will safeguard pension and family benefits and improve medical and other benefits for the core civil service. Funding will also be directed to organizing elections and higher debt service. Capital spending will be reduced next year, partly reflecting a significant decline in grants.2 Spending on wages and goods and services will also be restrained in 2012. The authorities pledged to again manage budgetary expenditures cautiously.

Armenia: Tax Measures in 20121

The authorities are committed to wide-ranging tax measures in 2012 to increase the tax-to-GDP ratio by 0.6 percent. They reviewed recommendations of two IMF TA missions and identified measures based on yield, administrative feasibility and readiness, and inflationary impacts. Measures include:

  • Personal income tax. An increase in the personal income tax rate and higher social security contributions for high-income tax payers.

  • Mining. A redesign (profit-based) of the royalty for metallic minerals, complemented by a strict limit on the length and coverage of the fiscal stability clause and a transfer pricing rule. Introduction of an extraction-based royalty for non-metallic minerals. A broad transfer pricing rule to be implemented for other sectors from 2013.

  • Excises. An increase of excise rates for domestically-produced (by 20–58 percent) and most imported (20–35 percent) alcoholic beverages, domestic (14 percent) and imported (7 percent) filtered cigarettes, and luxury vehicles, and SUVs. Introduce a new excise tax on engine oil. For most items, the excise rate increase is far higher than what would be implied by inflation indexation. The authorities will reiterate their objective of increasing excise yields over the next few years to recoup erosion since 2002 in a tax strategy document due in December

  • Presumptive taxes. An increase of the presumptive tax rate on casinos and other gambling activities by 50 percent. An increase of the presumptive tax rate on restaurants by 30 percent.

  • Customs duty. Introduction of the new customs duty on car parts.

A tax strategy paper to be issued by December will lay out further reforms for 2013–15.

1 Prepared by T. Komatsuzaki.

23. The authorities are considering concessional external borrowing for Nairit, a privatized chemical company and Armenia’s largest industrial enterprise. They are exploring financing from the EurAsEC Anti-Crisis Fund of $400 million (4 percent of GDP), and involvement of a new strategic investor. Staff cautioned that the considerable operational and financial difficulties encountered by Nairit in the past increase the risks of the borrowing, notwithstanding the concessional terms. In addition, with elevated public debt after the crisis, the borrowing would utilize a large share of Armenia’s remaining fiscal space, and staff urged that the project be clarified and strengthened and other options assessed, including a private-sector solution. The authorities contended that with new ownership, management, and modernization, Nairit could attain profitability and export markets in Russia, the CIS, Europe and North America. They pledged to enhance project plans and consider the full range of options prior to securing concrete financial commitments and funding.

C. Structural Reforms

24. Continuing structural reforms are vital for sustainable growth, reducing poverty and unemployment, and addressing imbalances. The authorities highlighted actions taken to increase transparency and reduce the cost of inspections, registration, tax filing and compliance, customs declaration, legal proceedings, and contract enforcement.3 A follow-up set of “Doing Business” reforms was recently approved, and the authorities have initiated a major initiative to streamline Armenia’s numerous, complex, and cumbersome regulations over the next 18 months. Staff welcomed recent legal changes and enforcement actions aimed at creating more competitive domestic markets. Further enforcement actions and greater public information on market concentration would help. Staff and the authorities agreed that progress on the EU FTA would also be beneficial.

III. Program Issues

25. Program design and monitoring remain broadly unchanged. The authorities are requesting a waiver for non-observance of the end-June PC on CBA NDA, modification of end-December PCs for NIR and NDA, and revision of the NDA PC to include a symmetrical adjustor on external financing. Structural benchmarks focus on tax policy and revenue administration. The authorities’ capacity to repay remains strong and is supported by an agreement between the CBA and the Ministry of Finance. Staff estimates indicate a financing gap of 1.4 percent of GDP in the balance of payments (BOP) and the fiscal accounts in 2013. Staff expects this gap to be filled by additional official support. Preliminary discussions are underway with partners who have provided significant budgetary and BOP support in the recent past, including the EU.

IV. Staff Appraisal

26. Policies continue to deliver on program objectives. The recovery has picked up and broadened, and inflation, a significant concern earlier this year, has moderated. Private inflows and credit growth have continued, and banking sector indicators remain sound. The fiscal adjustment is continuing, helping reestablish sustainability. Business environment reforms are progressing, although important structural challenges remain. External vulnerabilities continue to be significant, and buffers are still being rebuilt. The global outlook is uncertain, which adds to the downside risk.

27. Continuing fiscal consolidation will help maintain stability and reduce vulnerability. With the output gap closing next year and limited external funding, further adjustment is needed to ensure debt sustainability. The authorities should be commended for undertaking an ambitious tax reform package. While there are risks that revenue gains may not materialize in full, the authorities have demonstrated a strong commitment to manage budget execution tightly to meet program fiscal targets. Staff looks forward to further tax measures in the authorities’ upcoming tax strategy paper. Without these, continued spending restraint will be needed in 2013 and beyond. In light of uncertainty about other financing, staff supports the authorities’ request for further Fund support for external budgetary payments in 2012. This financing supports the authorities’ fiscal consolidation, and the 2012 tax package and lower amount relative to 2011 are consistent with exit. The Fund staff has voiced concern, together with the World Bank staff, about possible large-scale borrowing or guarantees for the troubled Nairit chemical company, and welcomes efforts to strengthen preparations and consider options that limit state involvement and risk.

28. External pressures may reemerge if the global economic environment deteriorates. In this case, the authorities will need to be prepared to allow sufficient exchange rate flexibility to support the necessary external adjustment and safeguard an appropriate level of reserves. While the external consolidation has so far been supported by fiscal adjustment, strong commodity prices, and remittance inflows, over the medium term, a broadening of the export base, supported by further structural reforms, will be essential.

29. The monetary policy framework remains appropriate, supported by efforts to improve transmission. The CBA should continue to improve communications and enhance transparency, particularly with regard to inflation projections and policy responses. With enhanced commitment to inflation targeting, the CBA should become more responsive to interest rate volatility and less concerned with exchange rate movements. To this end, the change of the liquidity management strategy since April is welcome, but greater effort will be needed to reduce interest rate volatility and strengthen this monetary policy channel.

30. The banking sector remains sound, but the CBA should be vigilant to vulnerabilities arising from high credit growth. The currently high CARs will likely continue to fall, as credit portfolios expand, albeit at a slower pace. The central bank will need to carefully balance the objectives of encouraging greater financial deepening and safeguarding financial stability, given the dollarized environment. Staff welcomes the CBA’s efforts to enhance its stress-testing and also looks forward to the results of the upcoming FSAP Update.

31. While growth has accelerated, broad-based business environment should be further advanced. These include the reduction of excessive regulation, improved transparency to reduce arbitrary application of rules, and strong control of corruption. Fairer internal market competition should be promoted. These actions would help make headway in an economy widely viewed as dominated by a handful of “oligarchs.”

32. Staff recommends completion of the Third Review, along with approval of the request for a waiver of the missed PC on NDA of the CBA at end-June, modification of end-December 2011 PCs, and establishment of new PCs for end-June 2012.

Table 1.

Armenia: Selected Economic and Financial Indicators, 2006–13

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

From 2008, the poverty rate is computed using a different methodology based on the new household survey.

Including the gas subsidy in 2006–08.

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 holdings.

A positive sign denotes appreciation.

Table 2.

Armenia: Balance of Payments, 2008–16

(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 holdings.

Debt relief from the United Kingdom.

Table 3.

Armenia: Monetary Accounts, 2008–12

(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).

Discrepancy between the fiscal and monetary accounts in 2009Q3-Q4, 2010, and 2011 is exp lained by government lending to the economy through commercial banks.

Table 4.

Armenia: Financial Soundness Indicators for the Banking Sector, 2008–11

(In percent, unless otherwise indicated)

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Source: Central Bank of Armenia.
Table 5.

Armenia: Central Government Operations, 2009–13

(In billions of drams)

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

Discrepancy between the fiscal and monetary accounts in 2009Q3-Q4, 2010, and 2011 is explained by government lending to the economy through commercial banks.

Includes IMF budget support.

The program balance is measured as below-the-line overall balance minus net lending, except from 2010 to 2011Q1, where project financing is also subtracted.