Republic of Armenia: 2019 Article IV Consultation and Request for a Stand-by Arrangement—Press Releases; Staff Report; and Statement by the Executive Director for the Republic of Armenia

2019 Article IV Consultation and Request for a Stand-By Arrangement-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia

Abstract

2019 Article IV Consultation and Request for a Stand-By Arrangement-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Armenia

Context

1. Since the previous Article IV consultation and the completion of the 2014–17 EFF, macroeconomic stability has been maintained and macroeconomic policy implementation has been sound. The 2014–15 external shocks generated significant challenges and created serious obstacles to policy implementation. Since then, the authorities’ efforts, supported by close engagement with the Fund, have helped mitigate the macroeconomic impact of the shocks. Economic activity has strengthened, and the fiscal deficit and debt have started to decline. Inflation is under control, the financial system remains stable, and international reserves are assessed to be adequate, while pressures on the exchange rate have been limited.

Implementation of Main Recommendations of the 2017 Article IV Consultation

The 2017 Article IV consultation called for: (i) maintaining a prudent fiscal path to reverse the increase in debt while creating room for higher capital expenditure; (ii) improving expenditure management, especially for foreign-financed projects; (iii) upgrading the fiscal rule to align it with international best practices; (iv) further improving inflation targeting framework; and (iv) accelerating implementation of reforms to promote growth. In addition, the 2018 FSAP made specific recommendations to improve supervision and financial intermediation, and bolster FX buffers. The authorities have made progress in several areas.

Fiscal performance in 2017–18 was broadly satisfactory. Following zero growth in 2016, a higher-than-budgeted fiscal deficit in 2017 helped jumpstart growth. By contrast, better-than-budgeted fiscal outturn in 2018 in part reflected lower capital expenditure, necessitating further efforts to improve expenditure management. A declining deficit stemmed the rise in public debt-to-GDP, which had significantly risen in 2014–15 (in large part reflecting dram’s depreciation).

Monetary policy has focused on price stability and maintaining exchange rate flexibility. Monetary conditions have been accommodating, with lending rates falling in response to earlier monetary easing. With inflation getting close to the Central Bank of Armenia’s (CBA’s) medium-term 4 percent target, the CBA paused monetary easing for two years from February 2017 to January 2019.

The CBA has started implementing the 2018 FSAP recommendations. Banking supervision has been strengthened by implementing a risk-based approach. However, further work is needed to enhance banks’ foreign exchange liquidity buffers and to foster better financial intermediation by developing capital markets and strengthening financial literacy.

Some progress has been made in implementing structural reforms. The fiscal rule was amended in December 2017 with IMF technical assistance (Annex I: Armenia’s Revised Fiscal Rule). The new rule, in line with the new generation of fiscal rules, reduces the bias toward pro-cyclical fiscal policy and avoids large abrupt fiscal adjustments. To effectively manage foreign-financed capital spending, the authorities have been restructuring project implementation units. A full-fledged pension reform came into effect in July 2018. The new government has pledged to promote inclusive growth and tackle corruption head-on, although competition in the domestic market remains limited.

2. Looking ahead, Armenia continues to face significant challenges, requiring an acceleration in the implementation of structural reform (Table 1). The still-weak business climate, corruption, and the absence of key growth drivers constrain the economy’s capacity to grow solidly. Private consumption and investment are still relatively dependent on remittances, leaving the economy vulnerable to external shocks. Public debt, while declining, is relatively elevated and improving revenue mobilization remain critical to unlocking the potential for much needed growth-enhancing investment spending. Despite gradual improvements, poverty, income inequality, and unemployment remain relatively high, causing migration and a shrinking labor force.

Table 1.

Armenia: Inclusive Growth Indicators

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Sources: IMF World Economic Outlook, World Bank, World Economic Forum, International Labour Organization, Transparency International, UNDP, Oxfam International.

Indicators use official sources and surveys to summarize perceptions of the quality of governance and business environments, but note that uncertainties around Armenia’s point for governance indicators.

3. The 2018 peaceful political transition has generated a new momentum for reforms. Widespread but peaceful protests led to the appointment of opposition leader Pashinyan as the new prime minister in April 2018. The National Assembly (NA) was dissolved in October and a snap parliamentary election in December 2018 resulted in a landslide victory for the alliance led by the new PM. A new government took office in January 2019 and launched its five-year program in February 2019. The new government has set fighting corruption and improving the business environment as its main priority.

4. Against this background, the government has requested a new Fund-supported program to support its economic plans. The 2010–13 and 2014–17 Fund-supported programs helped mitigate the adverse macroeconomic effects of the global financial crisis and the 2014 external shock (Annex II: Ex-Post Peer Review Assessment). However, the shocks hampered effective implementation of structural reforms, particularly relating to governance and the business climate.

Recent Developments

5. Economic activity remains robust, while inflation is below expectations (Figure 1 and Table 2). Following unusually strong growth in 2017 (7.5 percent) and 2018H1 (8.5 percent), real GDP growth decelerated to 3 percent in 2018H2 reflecting weak public sector spending and a slowdown in trading partners. As a result, the economy grew by a more sustainable 5.2 percent in 2018 as a whole. On the production side, manufacturing and services sectors more than offset the contraction in agricultural and mining production. More recently, high-frequency indicators through March point to a continuation of the 2018 growth momentum. The output gap is estimated to be still negative but closing. Annual CPI inflation fell to 1.9 percent in March (reflecting both supply and demand conditions), below the lower end of CBA’s medium-term target band of 4±1.5 percent.

Figure 1.
Figure 1.

Armenia: Real Sector Developments

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Table 2.

Armenia: Selected Economic and Financial Indicators, 2016–23

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

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

uA01fig01

Contributions to Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: National authorities; and IMF databases.
uA01fig02

Consumer Price Inflation

(In percent change, year-on-year)

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: National authorities; and IMF data bases.

6. The current account deficit widened significantly in 2018, on the back of strong imports and weaker primary income while some transitory factors also played a role (Figure 2 and Table 3). The current account deficit, which had narrowed to below 3 percent over 2015–17 due to adjustment to the 2014 regional shocks, widened to 9.1 percent in 2018. This reflects are bound in imports on the back of recovery in domestic demand and some transitory factors. Two copper mines were temporarily shutdown in 2018 on environmental concerns, resulting in some loss of export revenue. Some exports have been underreported, especially re-exports of certain import items such as cars within the Eurasian Economic Union (EEU). On the income accounts, a larger-than-normal repatriation of profits lowered primary income. Remittance inflows continued to recover, although net remittances remained broadly similar to 2017 in nominal terms.

Figure 2.
Figure 2.

Armenia: External Developments

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: National authorities and IMF staff calculations.
Table 3.

Armenia: Balance of Payments, 2016–23

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

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Sources: Armenian authorities; and Fund staff estimates and projections.
uA01fig03

Current Account and Key Components

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: National authorities; and IMF databases.

7. Fiscal consolidation remains on track but spending has been well below plans (Figure 3 and Table 41 and 42). The ambitious nominal revenue target for 2018 was achieved, supported by strengthened efforts in tax administration. Spending, however, was lower than budgeted, owing to delays in both current and foreign-financed capital expenditure. As a result, the 2018 fiscal deficit was 1.8 percent of GDP, significantly lower than the budget target of 2.7 percent of GDP.

Figure 3.
Figure 3.

Armenia: Fiscal Developments

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: National authorities and IMF staff calculations.
Table 4a.

Armenia: Central Government Operations, 2016–23

(In billions of Armenian drams)

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

In 2016, an additional subsidy of AMD 2 billion is assumed to cover the electricity tariff differential for households and SMEs.

Changes in expense on goods and services relative to the Third Review reflect classification issues. In particular, spending on education which was previously reflected in “other expenditure” is now classified under “goods and services.”

Includes acquisition of military equipment.

EFSD financing ($100 million in 2015–17).

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

Sum of overall balance (above the line), interest expense, and domestic and external net lending.

Table 4b.

Armenia: Central Government Operations, 2016–23

(In percent of GDP, unless otherwise specified)

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

In 2016, an additional subsidy of AMD 2 billion is assumed to cover the electricity tariff differential for households and SMEs.

Changes in expense on goods and services relative to the Third Review reflect classification issues. In particular, spending on education which was previously reflected in “other expenditure” is now classified under “goods and services.”

Includes acquisition of military equipment.

EFSD financing ($100 million in 2015–17).

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

Sum of overall balance (above the line), interest expense, and domestic and external net lending.

8. Monetary and FX market conditions remain stable (Figure 4 and Table 5). The CBA lowered its policy rate by 25 basis points to 5.75 percent in January for the first time since February 2017 in response to downward pressure on inflation. Conditions in the FX market have remained stable while interventions have been limited, on account of higher capital inflows. The CBA continues to provide short-term liquidity to banks, reflecting inadequate activity in the interbank market. Credit growth was 17.2 percent (y-o-y) at end-2018. The credit-to-GDP gap1 is estimated by staff to be marginally negative.

Figure 4.
Figure 4.

Armenia: Monetary Developments

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: Central Bank of Armenia and IMF staff calculations.
Figure 5.
Figure 5.

Armenia: Financial Developments

Citation: IMF Staff Country Reports 2019, 154; 10.5089/9781498318563.002.A001

Sources: Central Bank of Armenia and IMF staff calculations.
Table 5.

Armenia: Monetary Accounts, 2016–20

(In billions of drams, unless otherwise indicated)

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

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).