Program Request: Precautionary Stand-by Arrangement

Armenia’s long-standing engagement with the Fund both under surveillance and successive economic programs has been instrumental to maintaining macroeconomic and financial stability. Drawing on the most recent Fund-supported programs, the Armenian authorities acknowledge that the blend three-year 2010–13 ECC/EFF program has helped to mitigate the impact of the global financial crisis on the domestic economy. The latest 2014–2017 EFF arrangement has anchored their stabilization efforts to stem the economic slowdown amid the 2014–2015 regional shocks.

Building on the progress achieved under the previous arrangements, and well-recognizing the remaining economic and structural challenges, the Armenian authorities request a new 3-year Stand-by Arrangement (SBA) in an amount equivalent to SDR 180 million (139.75 percent of quota). Given the adequate external financing and foreign exchange reserves, they intend to treat the arrangement as precautionary. The authorities believe that the arrangement will help push forward their comprehensive reform agenda while improving the country’s resilience against external shocks. They confirm their strong commitment to the economic policies, quantitative targets and structural benchmarks set under the program and stand ready to further adjust policies as necessary.

Macroeconomic Developments and Outlook

Sound macroeconomic policies ensured robust economic performance. Following the subdued growth in 2016, economic activity strengthened significantly in 2017 (7.5 percent), and while remaining strong, moderated to a more sustainable 5.2 percent in 2018. The 2018 growth was mainly driven by manufacturing, service and trade sectors while agricultural and mining sectors contracted. The economy maintained the growth momentum in early 2019 -the economic activity indicator increased by 6.5 percent in January-March.

Fiscal consolidation, supported by the upgraded fiscal rules and strong tax administration efforts, remained on track. As a result, the fiscal deficit was below the budget target, reflecting also the underperformance in current and capital spending. Government debt declined to 51.4 percent of GDP. The current account deficit, after narrowing to below 3.0% over 2015–2017, widened to 9.1 percent of GDP in 2018, on the back of strong imports, weaker primary income and remittances, and some one-off factors. Monetary policy ensured a low inflation environment with annual headline inflation reaching 2.2 percent in April 2019. Following the increased monetary stimulus in January 2019, the CBA kept monetary conditions expansionary in March 2019 leaving the policy rate unchanged at 5.75 percent. International reserves remained broadly adequate, with limited exchange rate pressures. The financial system remains well-capitalized; and weathered the political transition well.

Looking ahead, the authorities believe that the government’s 2019–2023 comprehensive reform agenda will deliver substantial economic benefits, raising the medium-term growth to 5.0–5.5 percent. However, under the scope of the IMF program, the authorities agreed on a more conservative 4.5 percent scenario. The inflation is expected to stay around the lower bound of the target range in 2019, gradually converging to the 4.0 percent target over the medium-term. The current account deficit is expected to improve in 2019 and gradually narrow over the medium-term.

Fiscal Policy and Reforms

The growth-friendly fiscal consolidation is underway. The authorities have prepared a corrective action plan, guided by the upgraded fiscal rules, to bring down the central government debt to below 50 percent of GDP by 2023. To achieve this objective, they are determined to maintain the fiscal deficit at around 2 percent of GDP supported by both strong revenue mobilization and spending constraint. That said, the authorities are committed to protecting the social spending envelope to promote sustainable and inclusive growth. The 2019 budget has been designed in line with this objective.

A tax reform package has been announced to promote export-oriented inclusive growth. The proposed tax package introduces a number of measures, including flattening of the personal income tax (PIT) structure; reducing the PIT and corporate income tax (CIT) rates; simplifying the special tax regimes; and cancelling the scheduled reduction of the VAT threshold. The Draft Law on «Making Amendments and Addenda to the Tax Code of the Republic of Armenia» has been submitted to the National Assembly (NA) in March 2019 for approval. The tax reform package is expected to become effective in 2020.

The authorities have adopted a package of tax policy measures to fully offset the potential revenue losses. These generally include the increase and indexation of certain excise taxes, the removal of selected tax exemptions, the increase in gambling and financial sector license fees, supported by strong tax administration efforts. The authorities are determined to take additional compensation measures if needed. Meanwhile, they are currently working with the World Bank on building a model to analyze the impact of the fiscal reform on equity and stand ready to take adequate mitigating measures if needed.

The authorities put the overhauling of the property taxation system high on their agenda. The Cadaster Committee has completed the work on the new evaluation zoning and has elaborated a new methodology based on market values and contractual prices. The draft law on “Establishing a Market Evaluation Procedure for Real Estate Taxation” has been submitted to the cabinet in March 2019 and it is currently in an active discussion process. The draft law is planned to be submitted to the NA for approval by June 2019. Going forward, the authorities are planning to review the tax rate structure and nontaxable threshold taking into consideration the IMF’s recommendations, and to enhance the electronic tax management system by December 2020.The new system will become operational in January 2021.

The authorities stress the importance of an enhanced tax administration and structural expenditure reforms. The draft document on the 2019–2022 tax administration strategy is well-tailored to this objective, and the significant overperformance of tax revenues during the first months of 2019 confirms the authorities’ strong commitment in this area. To this end, the authorities are determined to carefully consider all the recommendations and prior actions envisaged in the report, including the introduction of a tax return system by end-2021. On the expenditure reforms, the public-private partnership (PPP) law is planned to be submitted to the NA by June 2019 with a ceiling on government exposure from such partnerships.

Monetary Policy and Financial Stability

The CBA will continue to balance the dual mandate of price and financial stability. Inflation remained low in 2018 shaping below the lower end of the target range and rebounding to 2.2 percent in April 2019. In response to weaker-than-expected external demand and government spending, the CBA lowered the policy rate by 25 basis points to 5.75 percent in January for the first time since February 2017. The CBA considers the current monetary policy stance appropriate to stabilize the inflation around the 4.0 percent target over the medium-term. Meanwhile, the CBA closely monitors the macroeconomic developments and stands ready to adjust monetary conditions if needed, in line with the IT framework and MPCC clause under the program.

On the financial sector, the banking system remains well-capitalized; and financial soundness indicators, including dollarization, have continued to improve. On the back of declining lending and deposit rates, the credit growth picked up to 17.3% at end-2018. Supervisory and regulatory frameworks have been further strengthened; and the CBA has started implementing the 2018 FSAP recommendations.

Going forward, the CBA will continue to adhere to the two-way exchange rate flexibility under the IT framework while using limited interventions to smooth excessive fluctuations. The CBA is determined to explore policy actions to strengthen the liquidity management system, to deepen the interbank market, and enhance its communication strategies. Capital market development in coordination with the MOF is considered essential.

The CBA is determined to further strengthen the financial supervision framework in line with the 2018 FSAP recommendations. To this end, the efforts are focused on refining the risk-based differentiation in capital levels; the enforcement of large exposure limits; and the amendment of the definition of NPLs in line with international best practices. Most importantly, the CBA puts strong emphasis on creating a time-bound action plan and communication strategy to boost the foreign currency liquidity buffer as described in the 2018 FSAP recommendations. On the macroprudential side, the CBA stands ready to further strengthen the regulatory measures in line with staff’s recommendations, including the introduction of a capital conservation buffer and a surcharge for domestic systemically important banks.

Structural Reforms

The authorities put structural reforms high on their agenda to promote sustainable and inclusive growth. The 2019–2023 government program is well-tailored to reaching this objective. Fighting corruption and enhancing governance is a top priority. The authorities believe that digitalization will help anchor their efforts in all the reform areas.

The authorities put strong emphasis on human capital development and social protection. The reforms in this area focus on labor market, education, health and social protection. To this end, the authorities have started developing a comprehensive employment strategy for 2019–23 aimed at reducing the long-term unemployment and increasing participation of vulnerable groups in labor market. The government is determined to elaborate a set of policies to increase female labor force participation. The authorities are planning to further strengthen the existing social and family benefit schemes. The reforms in the education system focus on increasing equitable access to pre-school education, improving general education programs and physical conditions of secondary schools, and operationalizing tertiary education management system. The pension reform, fully implemented since July 1, 2018, has mobilized a growing supply of long-term capital that will play an important role in providing pensions to Armenian citizens. Creating a pipeline of projects and capital market instruments to channel pension savings into the economy is a high priority.

The authorities are determined to improve the business environment. The efforts toward achieving this objective mainly focus on developing SMEs, enhancing corporate governance and contract enforcement. To this end, the authorities will prepare an action plan for 2020 to address the issues identified in the 2019 WB Doing Business Report. To enhance transparency and improve access to finance, they plan to conduct an efficiency review of the existing SME support programs.

The new government has pledged to fight corruption and improve governance. To achieve this objective, the government has prepared an anti-corruption strategy for 2019–2022 with a strong emphasis on implementation. They plan to submit to the NA a draft law on a single autonomous anti-corruption entity with combined detection and investigation functions by September 2019. The legislation on establishing a registry of beneficial ownership information is planned to be adopted by June 2019. The implementation of the CPC (Commission for Prevention of Corruption) law on asset declarations is underway, and the revision of the Criminal Code is processing.

Conclusion

Notwithstanding the progress achieved over the recent years, some important challenges remain, including a high share of foreign currency debt, still-high dollarization, social inequality, high poverty and unemployment. The economy remains vulnerable to external shocks. On the structural front, poor business climate, corruption and weak governance constrain the economy’s capacity to achieve sustainable and inclusive economic growth. These call for immediate and well-articulated economic policies and structural reforms.

Against this background, the authorities have requested a new Fund-Supported program under the precautionary Stand-by Arrangement. They believe that the program will support their economic and financial reform agenda while providing an additional buffer to cope with adverse shocks. The authorities remain strongly committed to the full and timely implementation of the policies under the program. They reiterate their determination to maintain a close policy dialogue with the Fund. Meanwhile, they stand ready to consult in advance with the IMF on any revision to the policies under the program. The authorities acknowledge the crucial role that Fund technical assistance has played in building capacity and addressing macro-critical issues in the country. To this end, they look forward to further broaden the support to achieve their economic objectives.