Statement by Mr. Yakusha and Mr. Sargsyan on Republic of Armenia Executive Board Meeting

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.

The Armenian authorities would like to thank staff for their continued and valuable advice on macroeconomic policies. The Fund’s long-lasting engagement with Armenia has always been highly appreciated and its support has been crucial for getting the country’s economy back on the path of stabilization. The current ECF/EFF arrangement will continue helping Armenia in restoring stability, fostering growth and rebuilding its macroeconomic buffers.

The performance under the program has been good, and all performance criteria except one were met with wide margins. The end-June performance criterion on net domestic assets was missed by a small margin for a few days due to delays in donor budgetary support.

Macroeconomic situation

Economic growth has been strong throughout the year, albeit a little uneven. The agricultural sector, which underperformed last year due in part to bad climatic conditions, has strongly rebounded. The economy, however, remains confronted with challenges. While private remittances from abroad, which were fueling the real estate boom prior to the crisis, have picked up strongly, the construction sector remains weak. On the other hand, mining and services contributed to growth, with the former picking up amid higher global prices on metals in the first half of the year.

The current account deficit continues its downward trend and is projected to reach levels below 8 percent of GDP in the medium term. The Armenian authorities believe that the current account deficit will shrink faster than envisaged by the program. Recently, the government has presented a set of policy initiatives with long-term diversification of exports in various sectors as compared to the current highly concentrated exports. The authorities have also reiterated their commitments to accelerate reforms to start negotiations on Free Trade Agreement (DCFTA) with the European Union.

The Central Bank’s recent analysis shows that it is premature to conclude that the exchange rate is under- or overvalued in real and nominal effective terms. A further depreciation in real terms may not necessarily close the current account gap, because of the structural issues in the balance of payments, such as high concentration of imports that hinders imports substitution. The authorities are well aware of these bottlenecks and so far have been successfully addressing these issues through enhanced monitoring and enforcement action of the anti-monopoly commission, as well as through other measures encouraging investments and removing entry barriers.

Monetary policy

Maintaining a low rate of inflation will remain the Central Bank’s main priority. As predicted by the authorities, inflation has returned to its target band of 4+/- 1.5 percent and currently stands at 4.8 percent, after peaking at 11.5 percent in March 2011. This would have not been possible without timely intervention of the Central Bank and structural policy measures taken by the government, including targeted support for interest payments on commercial loans borrowed by farmers and government import and distribution of high-quality seeds.

Increased global uncertainties may create challenges for the Central Bank in conducting monetary policy in the future. In its most recent policy meeting in early December, the CBA opted to leave the policy rate at 8 percent, as its projections show that inflation will comfortably stay in the target band in the forecasted period.

While the authorities remain committed to the flexible exchange rate policy, the stability of the dram has been beneficial in anchoring expectations and reducing the output volatility. Foreign exchange interventions have so far been conducted to smooth out unexpected spikes in the exchange rate and have been in small amounts. To improve the transmission mechanism and to lower volatility in the foreign exchange markets, the Central Bank has started to make available to commercial banks its liquidity forecasts in order to facilitate the effectiveness of policy implementation.

The financial sector remains sound. Banks are well-capitalized, while the system overall remains resilient to external shocks due to high reliance on local deposit financing. The authorities look forward to the forthcoming World Bank-IMF FSAP Update.

Fiscal Policy

Committed to ensuring debt sustainability, the authorities have further reduced the fiscal deficit, and currently target a deficit of 3.1 percent of GDP in 2012. However, the revenue performance has lagged behind, and the deficit reduction came mostly at the expense of cuts in expenditures. Therefore, for 2012, the authorities have set a target to increase tax revenues by 0.6 percents in GDP. This increase will come not only from continued progress in tax administration, but also as a result of tax reforms. These tax reforms draw on recommendations by the IMF technical assistance provided in February and June. One of the important tax policy changes is the amendment to the tax code on mining royalties. Other tax policy measures include changes in the personal and corporate income tax, and in excise and presumptive tax rates. A comprehensive Tax Strategy paper that outlines the implementation plan and future measures will be approved by end-December 2011.

The authorities have been considering concessional external borrowing to revive Armenia’s chemical industry. The sector once was one of the main drivers of the economy. The Nairit chemical plant, which produces synthetic rubber, has been the engine behind the chemical industry, providing around 3,000 workplaces and jobs in suppliers and other companies in the sector. Reviving this chemical giant remains crucial to the sector in general. A preliminary assessment shows that there is a business case and with proper management and technological modernization the plant can be turned into a profitable venture. However, recognizing the complexity and risks of this operation, the authorities are moving cautiously to find a private-sector led solution that will minimize exposure of the government and use of public funds. The authorities are committed not to assume any liability without consultations with the IMF and the World Bank.

ECF/EFF arrangement

The ECF/EFF arrangement has helped Armenia restore buffers and prepare for macroeconomic shocks from a possible global downturn. However, the most recent household survey revealed a further elevation of the poverty level in Armenia, reaching 35 percent of population as a result of the recent crisis. While the ECF/EFF arrangement continues to provide a strong framework for sustainable growth and poverty reduction, an abrupt decline in exports, remittances and FDI would place substantial pressures on Armenia, and additional resources may well be needed to avert a further deepening of social vulnerabilities.

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.
Author: International Monetary Fund