Abstract
On behalf of the Armenian authorities, we would like to extend our deep gratitude to Mrs. Petrova, her team, and the Resident Representative Office headed by Mr. Raissi for the constructive engagement on the authorities’ request for Fund support. This positive collaboration is fully in line with the Fund’s strong support to Armenia in recent years, notably the 2019–22 SBA and numerous capacity development activities, including through the recently established CCAMTAC.
On behalf of the Armenian authorities, we would like to extend our deep gratitude to Mrs. Petrova, her team, and the Resident Representative Office headed by Mr. Raissi for the constructive engagement on the authorities’ request for Fund support. This positive collaboration is fully in line with the Fund’s strong support to Armenia in recent years, notably the 2019–22 SBA and numerous capacity development activities, including through the recently established CCAMTAC.
The authorities have requested a 36-month Stand-By Arrangement with access at 100% of quota, which they intend to use on a precautionary basis. This would provide insurance against external shocks and thus complement the authorities’ structural reform agenda aimed at building an export-led, investment-driven, and knowledge-based economic growth model. The request builds on the positive experience and solid track record of the 2019–22 SBA, during which the authorities have strengthened fiscal, monetary, structural, and institutional resilience despite a very challenging external environment. Yet, challenges remain, and the authorities are determined to maintain this reform momentum, continue the close policy dialogue with the IMF and take any measures needed to achieve the program objectives.
Macroeconomic developments & outlook
Supported by sound macroeconomic policies, Armenia’s economy has rebounded strongly in 2022 due to robust domestic consumption and a large inflow of external income, capital, and labor. Despite double-digit growth, inflation has increased less quickly (also in comparison to regional peers) thanks to the early and steadfast actions by the Central Bank of Armenia – though inflation remains above target. Meanwhile, Armenia’s external position was broadly in line with the level implied by fundamentals, and unemployment has dropped markedly since the COVID-19 pandemic.
Though the economic outlook remains generally positive on the back of Armenia’s macroeconomic stability, uncertainty is extremely high amid downside risks from the external environment. In addition to Armenia being particularly exposed to the repercussions of the war in Ukraine and the general deterioration of economic performance in its main trading partners (Russia, EU, USA), regional instability further deepens uncertainty. At the same time, continued implementation of the authorities’ comprehensive reform agenda should durably raise potential growth to 7% over the medium-term.
Fiscal policy
Consistent with the strong economic recovery, the fiscal outturn has been much better than anticipated in both 2021 and 2022. Importantly, this performance is driven by both buoyant tax revenues (notably corporate income taxes, VAT, and mining sector taxation) and current expenditure restraint. At the same time, capital spending is projected to further increase by 1.6pp of GDP in line with the government’s ambitions for infrastructure investment.
For 2023, the authorities plan a neutral fiscal stance to help ease inflation and reduce public debt levels, while further improving the quality of public finances. The government maintains its strong commitment to keeping public debt on a downward trajectory to ensure stability in the face of tightening global financial conditions and developed an ambitious reform agenda to simultaneously create fiscal space for growth-friendly expenditure. Importantly, the authorities aim to reach a tax-to-GDP ratio of 25% by 2026.
To that end, and as reflected in the MEFP, the authorities are progressing on several workstreams to raise domestic revenue mobilization and improve spending efficiency. On the revenue side, a major policy objective is to reduce the tax policy gap – including by rationalizing tax expenditures and broadening the tax base. Moreover, there is scope to further strengthen the revenue administration, notably by introducing a universal income tax declaration system. On the expenditure side, significant reforms are underway to bolster the efficiency and effectiveness of spending on public sector wages, the healthcare system, pensions, and social safety nets.
Building on IMF technical assistance, the authorities plan to further improve public financial management. This strategy rests on further upgrading the Ministry of Finance’s administrative capacity to cost new fiscal policy initiatives, conduct regular program evaluations, and identify fiscal risks. Moreover, continued improvements to data production and sharing will facilitate better liquidity management and coordination between institutions. Finally, to support the economy’s growth potential, the authorities will conduct a review to close the execution gap on foreign-funded infrastructure projects.
Monetary policy
While inflation has remained high in 2022 due to strong demand and high global commodity prices, decisive monetary policy action will ensure a return to the inflation target of 4% over the medium term. Early tightening since end-2020 was showing signs of success before the repercussions of the war in Ukraine once again raised inflationary pressures. The CBA is ready to pursue further tightening if economic data warrants such action and is committed to keeping inflation expectations anchored through clear communication. To that end, the authorities reiterate their attachment to the CBA’s independence.
Moreover, the authorities maintain their strong commitment to exchange rate flexibility on both sides, also in support of inflation targeting. As in early 2022, the CBA’s foreign exchange interventions will be strictly limited to avoiding disorderly market developments.
Financial sector policies
The banking sector has remained resilient throughout the COVID-19 pandemic and the repercussions of the war in Ukraine, thanks to prudent risk management and strong supervision. Already high capital levels are further bolstered by the authorities’ requirement to maintain a capital conservation buffer of 1.5/2.5%. Meanwhile, the ratio of liquid assets to total short-term liabilities remains comfortably above 100%. NPLs are also very low at 2.8% of gross loans.
At the same time, the authorities are committed to further strengthening risk-based supervision. Following the implementation of Basel III standards and macroprudential measures, the authorities will introduce Pillar 2 capital buffers. To mitigate foreign exchange risks in the meantime, higher risk weights and loss provisions for foreign exchange loans will remain in place. Moreover, in line with the MEFP, the authorities will develop a draft law for an enhanced bank resolution framework. Finally, capital market development remains a key priority, with immediate action focused on introducing an over-the-counter commercial trading platform for the overnight repo market.
Structural policies
As noted above, the authorities’ request for a precautionary SBA will underpin the development of an export-led, investment-driven, and knowledge-based growth model for Armenia. To that end, the authorities designed a set of complementary reforms to (i) improve the business environment; (ii) enhance labor market outcomes; (iii) foster the economy’s digitalization, and (iv) address structural obstacles in the agriculture sector.
To enhance the business environment, the authorities will focus on improving access to finance for domestic firms and facilitating foreign investment. In this context, notable actions include (i) progress on the reform of the insolvency regime; (ii) further reinforcements of the resources, capacity, and independence of the judiciary; and (iii) continued improvements to the AML/CFT framework in compliance with international standards.
To improve labor market outcomes, the authorities concluded a comprehensive reform of the education sector. Together with immediate actions to expand access to early childcare, this will address skills mismatches and raise labor force participation. Looking ahead, the focus will be on the development and costing of an employment strategy based on active labor market policies.
Furthermore, the authorities are steadfastly pursuing their efforts toward a digital transformation of society, the economy, and the government. The development of a national digital ID will be the cornerstone on which further developments can be built, notably as regards e-government, also benefitting from a vibrant IT sector.
As shown in Annex VII, modernizing the agriculture sector can have numerous positive effects, including in terms of revenue mobilization and climate change mitigation. To harness these positive effects, the authorities will introduce a modern land registration system to address fragmented land ownership and informality. Moreover, they will enhance climate change resilience through expanding the agricultural insurance scheme and improving water management.
Finally, as noted in the MEFP, the authorities will design a comprehensive strategy to fight climate change, based on national mitigation and adaptation targets. In this context, due consideration will be given to the introduction of carbon pricing, while using revenues to protect the most vulnerable.
Program objectives and safeguards
The authorities welcome the close alignment of the program objectives with their reform agenda. While this will ensure a high degree of ownership, it will also lend the IMF’s credibility to the authorities’ agenda, thus increasing the program’s catalytical role. Indeed, firm financing commitments from other donors are already in place for the first 12 months of the program and there are good prospects for financing for the full period given the authorities’ strong track record. Meanwhile, reserve levels are at comfortable levels and are projected to remain above 110% of the ARA metric over the entire forecast horizon.
Staff’s debt sustainability analysis projects a decline in both public debt and gross financing needs over the medium-term. Indeed, even under a very adverse scenario, government debt is not expected to exceed 70% in 2027 – compared to a level of 63.4% in 2021.
Finally, the authorities reiterate their strong commitment to adequate safeguards. The CBA will undergo a new safeguards assessment by the time of the first review and the ex-post audit of the COVID-19 on-lending business support scheme will be finalized.
Concluding remarks
While the authorities are convinced that their reform agenda will steer the country and economy to a successful and stable growth model in the medium-term, they believe that a precautionary Fund program can serve as a positive signal on the appropriateness of their reform agenda and be a useful insurance against external downside risks.