Program Performance: Request for Completion of the First Review

Armenia’s program performance remains broadly on track. All end-June 2019 quantitative performance criteria (QPCs) and structural benchmarks (SBs) were met, some by a large margin. Most importantly, the tax reform package and the draft public-private partnership (PPP) law were adopted by the National Assembly (NA). Furthermore, the 2020–2024 Tax Administration Strategy was developed, the draft law on establishing a market evaluation procedure for real estate taxation was approved by the NA, the legislation requiring the establishment of a registry of beneficial ownership was adopted by the NA, a time-bound action plan and a communication strategy was prepared to reform the FX reserve requirement regime, and the macro-prudential toolkit had been further strengthened. All indicative targets (ITs) were observed except the IT on social spending was missed by a very small margin.

Progress has been made in preparing a draft capital market development program. The draft 2019–2023 comprehensive anti-corruption strategy has been approved by the government on October 3, 2019. That said, the authorities need more time for technical consultations both internally and with the IMF, and request to reset the end-September 2019 SBs on capital market development program and on a single autonomous anti-corruption entity to December 2019 and March 2020, respectively. Also, on the back of lower than expected demand factors and improved social targeting, the authorities are requesting to adjust the end-December IT on social spending.

Against this background, and with strong determination to push forward the reforms and policies under the program, the Armenian authorities request for the completion of the first review of the SBA. They continue to treat the arrangement as precautionary due to the country’s continued access to external financing and adequate foreign exchange reserves. The authorities reiterate their strong commitment to the economic policies, quantitative targets and structural benchmarks set under the program and stand ready to further adjust these policies in accordance with the program objectives.

Macroeconomic Developments and Outlook

Macroeconomic performance remains strong supported by sound economic and financial policies. After stronger-than-expected economic growth in the first half of 2019 (7.1 percent), Armenia’s economy maintained its growth momentum in the second half, posting 7.9 percent growth in 2019 Q3, driven by manufacturing and services sectors, and high consumption growth. Inflation, albeit remaining low, rebounded moderately to 1.0 percent in November 2019, after falling to 0.5 percent in end-September. In response, the Central Bank of Armenia (CBA) cut its policy rate by 25 basis points to 5.5 percent in September, its second reduction this year. On December 6, 2019, the CBA Board decided to leave the policy rate unchanged, at 5.5 percent.

The financial system remains well-capitalized and liquid; profitability has somewhat increased, and financial soundness indicators, including dollarization, have continued to improve. Credit growth remained strong at 16.5 percent in end-October, and NPLs remained low at 5.2 percent. International reserves continued to increase, remaining adequate. The current account deficit is narrowing, after a sharp increase in 2018, on the back of decelerating import growth rates and higher exports.

The fiscal deficit is expected to be around 1.5 percent of GDP, below the 2019 budget target of 2.2 percent of GDP. This reflects the overperformance of tax revenues, supported by the upgraded fiscal rules and strong tax administration efforts, and lower than budgeted spending due to some delays in the execution of capital expenditures. To this end, the central government debt is expected to fall to around 50 percent in 2019. In the light of these developments, the authorities successfully placed a $500 million 10-year Eurobond in September with oversubscribed issuance.

Against this background, international credit rating agencies upgraded Armenia’s sovereign rating in 2019. In August, Moody’s Investors Service upgraded the country’s credit rating to ‘Ba3’ from ‘B1’ with a stable outlook. Later on, in November, Fitch Ratings upgraded Armenia’s sovereign rating to ‘BB-’ from ‘B+’ again with a stable outlook. In their report, Fitch emphasized the government’s commitment towards stable macroeconomic policies and the implementation of structural reforms, including the fight against corruption and monopolies.

Looking ahead, economic growth is expected at somewhat above 6.5 percent in 2019. While the robust growth is likely to continue in the near-term, under the scope of the IMF program, the authorities assume a more conservative scenario for 2020 at around 4.5–5.0 percent. That said, the authorities believe that their comprehensive reform agenda will deliver substantial economic benefits, raising the medium-term growth to 5.0–5.5 percent. Inflation is expected to run below the 4.0 percent target in 2019 and gradually converge towards the target over the medium-term. The external position is expected to strengthen in 2019, with the current account deficit gradually converging to its 6.0 percent of GDP norm over the medium-term.

Fiscal Policy and Reforms

The authorities remain strongly committed to preserving medium-term debt sustainability while protecting investment and social spending. On December 6, the Parliament adopted the 2020 state budget targeting a fiscal deficit of 2.3 percent of GDP. The 2020 budget has been designed with the fiscal objective of bringing down public debt below 50 percent of GDP by 2023. To this end, the authorities are determined to further enhance their tax administration and compliance efforts and take measures to address the bottlenecks in the implementation of capital spending. The 2020 budget puts particular emphasis on protecting the social spending envelope to promote sustainable and inclusive growth. The authorities fully recognize the importance of safeguarding the credibility of fiscal rules and are determined to take actions to further strengthen the budgetary process and address shortcomings.

Structural fiscal reforms have been advancing. In June 2019, the Parliament adopted the planned growth-friendly tax reform package, which will become effective in January 2020. The adopted tax package introduces a number of measures to promote export-oriented inclusive growth, including flattening of the personal income tax (PIT) structure, reducing the PIT and corporate income tax (CIT) rates, and simplifying the special tax regimes. Meanwhile, the package includes a range of measures to fully offset the potential revenue losses by introducing new taxes on tobacco and gambling, indexing excise tax rates to inflation, removing selected tax exemptions, and increasing gambling and financial sector license fees. The authorities are determined to take additional compensation measures in case of any revenue shortfalls.

The authorities have made notable progress on property taxation reform. In November 2019, the Parliament approved the law on Establishing Market Evaluation Procedure for Real Estate Taxation. The authorities remain committed to starting tax collections under the new regime in 2021 and are working on developing mechanisms to mitigate the impact on the low-income population and enhancing the electronic tax management system.

Notable progress has been made in enhancing tax administration and structural expenditure reforms. On December 12, 2019, the cabinet approved the comprehensive tax administration strategy for 2020–2024 aimed at enhancing taxpayer compliance and combating tax evasion. The strategy includes an action plan to implement the key recommendations from the recent IMF TA, including developing a compliance strategy and establishing procedures for cleaning and updating the taxpayer register. The authorities are currently finalizing their tax reform strategy for 2019–2023 aimed at removing tax arbitrage opportunities and rationalizing tax expenditures in line with the program commitments. To this end, the authorities are looking forward to the upcoming IMF TA on microdata-based tax gap analysis to help design an action plan to improve tax compliance and raise tax-to GDP ratio in the medium term. They remain committed to the introduction of an individual tax return system by end-2021 including an action plan on the required steps.

On the expenditure reforms, in June 2019 the Parliament adopted the PPP law, in line with best international practice. The authorities are now working on drafting the secondary legislation and creating a database for all PPPs. They are determined to improve the implementation of foreign-financed capital spending projects and to develop a sound public investment management (PIM) process. The recent IMF follow-up TA on PIMA, which took place in early December, was well-tailored to this objective.

Monetary Policy and Financial Stability

The CBA will continue to balance the dual mandate of price and financial stability. The CBA considers the current monetary policy stance appropriate to stabilize the inflation around the 4.0 percent target over the medium-term. At the same time, the CBA closely monitors the macroeconomic developments and stands ready to adjust its policy actions to ensure price and financial stability, in line with the IT framework and MPCC clause under the program. Going forward, the CBA will continue to adhere to the two-way exchange rate flexibility under the IT framework while enhancing international reserves buffers.

The CBA remains committed to further strengthening the IT framework. The monetary authorities continue to explore policy actions to enhance the liquidity management system and improve the monetary policy transmission mechanism, in coordination with the MOF. In this context, capital market development remains a key priority and a draft capital market development program has been prepared and shared with staff. That said, more time is needed to comprehensively review all necessary elements of the program and consolidate the views of responsible entities. To this end, the authorities are requesting to postpone the SB on capital market development to March 2020.

Significant progress has been made in strengthening financial resilience in line with FSAP recommendations. The CBA has prepared a time-bound action plan and communication strategy to reform the FX reserve requirement regime. The conversion of 6 percent of FX reserve requirements has already been completed and the remaining re-denomination is expected to be completed by mid-2024. Liquidity buffers have been further strengthened. These include introducing regulations on the recovery plans for banks, introducing capital conservation and countercyclical capital buffers, and a surcharge for domestic systemically-important banks. Moreover, the draft regulations on introducing LCR and NSFR for all currencies are being finalized and expected to come in force by March 2020. Going forward, the monetary authorities are determined to further strengthen their macro-prudential toolkit, including working towards adopting a stressed LTV ratio.

Structural Reforms

The authorities continue to put structural reforms high on their agenda to promote sustainable and inclusive growth. The 2019–2023 government program and the National Plan, expected to be put in place by end-2019, are well-tailored to this objective.

Efforts to tackle the weaknesses in the business environment are ongoing. The authorities are working diligently on creating an Investment Support Office within the Ministry of Economy (MOE) to facilitate investments in an efficient and streamlined manner. The efficiency review of the existing SME support programs and the development of a framework for strengthening SME financial reporting and auditing are underway. Also, the authorities are preparing an action plan to address the core issues identified in the 2019 WB Doing Business Report.

The authorities adhere to pursuing their social and human capital development reforms. The focus is on the labor market, education, health, and social protection. To promote female labor force participation and to overcome gender discrimination in various socio-economic fields, the gender strategy for 2019–23 has been adopted, while the employment strategy is expected to be finalized and approved by the government by end-2019. The reforms in the education system focus on operationalizing the tertiary education management system and establishing the organizational and financial autonomy of higher education institutions. To this end, a draft law on Higher Education and Science has been prepared which is expected to be submitted to the NA by end-2019. On social policies, the government remains strongly determined to further strengthen existing social and family benefit schemes in cooperation with the WB and is working on developing a concept note to introduce a universal health coverage financing system.

Fighting corruption and enhancing governance remain top priorities. Notable progress has been made in strengthening the anti-corruption framework. Most importantly, in June 2019, the NA adopted a law to establish a registry of beneficial ownership information, prioritizing the extractive sector. The implementation of the CPC law on asset declarations is underway, and the revision of the Criminal Code is in the process. All five members of the CPC were appointed in November, and the seamless continuity of the currently existing asset declaration system had been ensured in the course of the year. Also, in October 2019, the cabinet approved the comprehensive anti-corruption strategy for 2019–23. However, since the strategy is set to guide the overall institutional anti-corruption framework, including the role of a single autonomous anti-corruption body, the draft law on a single autonomous anti-corruption entity will be submitted to the NA with a slight delay by end-December 2019.

Against this background, Armenia’s composite WB governance indicator improved substantially in 2018 to 46% ranking, from 42.2% in 2017, reflecting a marked improvement in the control of corruption, political stability, government effectiveness, and voice and accountability sub-indicators.

Conclusion

Armenia’s economic program is off to a good start. Macroeconomic performance remains strong, monetary and financial conditions are stable. All PCs and SBs for end-June 2019 have been met, and most policy objectives for 2019 are broadly on track. Notable progress has been made in many areas and the new government remains determined to push forward its comprehensive reform agenda.

Against this background, the Armenian authorities request the completion of the first review of the program and intend to treat the arrangement as precautionary. The authorities remain strongly committed to the full and timely implementation of the policies set under the program and stand ready to consult with the Fund in advance of any revisions. They acknowledge the crucial role that the Fund has played in the country through its continuous support in addressing macro-critical issues and enhancing capacity building. The authorities restate their strong determination to maintain the well-established cooperation and close policy dialogue with the IMF. They look forward to further broadening the support from the Fund to achieve their economic objectives.