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Republic of Armenia and the IMF

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Public Information Notice (PIN) No. 02/118
October 9, 2002
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2002 Article IV Consultation with the Republic of Armenia

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On September 25, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Armenia.1

Background

Armenia has experienced rapid growth with low inflation in recent years. Since 1999, real GDP has grown at an average rate of 8 percent per year and inflation has remained below 4 percent. Economic growth has been primarily export-led, fueled by continued expansion in agriculture, manufacturing, construction, and tourism industries. The official unemployment rate declined from 11.7 percent at end-2000 to 9.5 percent by mid-2002. According to the 2001 household survey, the incidence of poverty, while still high, declined significantly between 1998 and 2001.

The external current account deficit has more than halved since 1998, reflecting strong export growth and continued subdued import demand. This adjustment has been supported by a 19 percent real effective depreciation of the dram. Gross international reserves have remained at a comfortable level, surpassing 3.5 months of imports of goods and services during the last three years. There has also been an improvement in external-debt indicators. At end-2001, the net present value of debt was equivalent to 129 percent of exports of goods and services, down from 154 percent in 1999.

Fiscal performance, however, has been mixed. The central government deficit on a commitment basis narrowed from 7.2 percent of GDP in 1999 to 3.9 percent of GDP in 2001, but it remains high. Tax revenues at 14.4 percent of GDP in 2001 have remained low, reflecting insufficient improvements in tax and customs administration. Tax revenue collections, however, began to increase in the first half of 2002 as a result of important tax and customs administration reforms implemented earlier in the year.

There has been progress in implementing structural reforms. Key measures implemented in 2001 include the passing of a financial disclosure law for senior public officials and a treasury law, setting up an automated VAT audit system, and introducing legislation aimed at strengthening the central bank's ability to deal with problem banks. In addition, the authorities approved a new civil service law, established an internal audit unit at customs, and developed an anti-corruption strategy in collaboration with donors.

The objectives of the authorities' program for the period July 2002-June 2003 are to maintain a growth rate of real GDP of at least 6 percent and to keep inflation at 3 percent or less. Tax revenues are projected to increase by 0.5 percent of GDP per year in 2002-03, the fiscal deficit on a commitment basis is expected to decline to 2-2.5 percent of GDP in 2002-03, and expenditure arrears will be eliminated. The program incorporates increases in government wages, social sector spending, and public investment. The central bank will continue to guide its monetary policy by adherence to a reserve money corridor and will maintain a flexible exchange-rate policy.

Structural reforms under the program focus on (i) improving tax and customs administration, (ii) resolving the situation of the banks under interim administration and promoting confidence in the banking system, and (iii) enhancing transparency and governance. The authorities are expected to finalize a financial rehabilitation plan for the energy, water, and irrigation sectors, and focus on privatization, selecting competent operators, and bringing tariff rates to cost-recovery levels. Over the medium term, the expenditure framework and the Poverty Reduction Strategy Paper (PRSP) contemplate higher social and infrastructure spending.

Prospects for the Armenian economy remain favorable, but several challenges remain. To sustain the high rates of growth experienced in recent years and to further reduce poverty, inequality, and unemployment, Armenia needs to increase revenue collection and spending on basic infrastructure and on the social sectors, strengthen the banking system, and reduce corruption and red tape. Property rights need to be strengthened, as well as the enforcement of bankruptcies and contracts. Private sector growth will hinge on enhanced financial intermediation, further bank consolidation, and increased ability of banks to collect collateral. Corruption needs to be reduced to ensure that the fruits of rapid growth are distributed more evenly among the population; the recently drafted anti-corruption strategy is an important step in that direction.

Executive Board Assessment

Executive Directors welcomed the authorities' success in keeping inflation low and the exchange rate stable, improving the external current account balance, and creating an environment conducive to an increase in real incomes and rapid output growth. However, while macroeconomic performance has been strong, policy performance in 2001 was mixed. Directors expressed particular concern that there had been slippages in the implementation of key structural policies; that tax revenue collection had fallen short of expectations—in part a result of inadequate auditing of enterprises and persistent tax evasion; that budgetary arrears had not been cleared; and that the banking system remained fragile.

Directors welcomed recent fiscal and energy sector measures as important steps that have begun to yield positive results. They emphasized, however, that the authorities would need to forcefully pursue structural reforms. Directors attached particular priority to progress in tax administration; reform in the energy, water, and irrigation sectors; and the clearance of budgetary arrears. They called for efforts to establish a stronger, more equitable and transparent regulatory and judicial infrastructure, and stressed the importance of continuing steps to fight corruption, which would strengthen the credibility of state institutions and contribute to private sector growth. Directors urged the authorities to strengthen program ownership and fully adhere to targets under the second annual program under the Poverty Reduction and Growth Facility (PRGF) arrangement.

Directors welcomed the targeted reduction in the budget deficit in 2002. They called for ambitious—and in the view of some Directors, more ambitious—revenue efforts and a strong focus on non-grant receipts. In this connection, Directors encouraged the authorities to strengthen tax and customs administration, fight tax evasion, and ensure that all taxpayers are treated in accordance with the law. They considered that the revenue impact of the airport free-trade zone should be monitored vigilantly. Directors emphasized that prioritization of expenditures and clearance of arrears are essential to enhance the government's ability to finance poverty reduction programs. They agreed that the further reforms anticipated in the area of expenditure control and budget management would lay the groundwork for an improved composition of public spending, including an increase in social spending as a share of GDP.

Directors welcomed the steps taken in 2002 to improve the performance of the energy, water, and irrigation sectors. They stressed the need to finalize the financial rehabilitation plan for these sectors, bring tariff rates in line with cost recovery levels, and to eliminate their quasi-fiscal deficits. Directors noted the importance of ensuring that the recent sale of the electricity distribution company results in improved efficiency and a more reliable supply of electricity. Energy sector developments should continue to be subject to close monitoring and review under the program, to ensure that these do not negatively impact macroeconomic performance. Some Directors would have preferred to retain a performance criterion on the energy sector balance and encouraged reconsideration of this in the future.

Directors considered the current floating exchange rate system appropriate. They agreed that monetary policy should remain focused on maintaining price stability through, inter alia, keeping reserve money within a target corridor. At the same time, in light of the uncertainties of gauging money demand in Armenia at the current juncture, the central bank should also continue to monitor inflation developments directly. They noted the importance of a supportive fiscal policy to achieve the authorities' monetary goals.

Directors welcomed the measures being taken to strengthen banking supervision and resolve the situation of banks under interim central bank administration, which were steps in the direction of enhancing the health and efficiency of the banking system. However, financial intermediation remains shallow, and weaknesses in the legal system hamper the collection of collateral and the enforcement of bankruptcy procedures. Directors emphasized the need for a prompt restructuring of the financial sector, a reinforcement of banking supervision, and an appropriate legal framework to deal with problem banks and the collection of collateral. They commended the authorities' adoption of a resolution on anti-money laundering and establishment of a committee to work on this issue, and looked forward to the prompt implementation of measures in this area.

Directors were encouraged by the recent increase in real incomes of households, the reduction in unemployment, and the improvement in poverty indicators. However, poverty remains high, and further progress in this area will depend on improving public finances, targeting social expenditures better, and adopting measures to enhance governance and the business environment. Regarding the PRSP Preparation Status Report and the associated Joint Staff Assessment, Directors highlighted the importance of linking the medium-term expenditure framework effectively with the PRSP; they encouraged the authorities to assume full ownership of the PRSP and finalize a high quality poverty reduction strategy by the end of this year. Directors encouraged the authorities to follow up on the recommendations of the recent anti-corruption report and intensify efforts to apply laws and regulations in a consistent manner.

Lastly, directors commended Armenia for maintaining a liberal trade regime and applying for accession to the World Trade Organization. They welcomed the recent decline in external debt ratios and the authorities' efforts to reduce the stock of nonconcessional debt, all of which will provide debt service savings that can be used to finance higher social expenditures. They also welcomed the regularization of external arrears.



Republic of Armenia: Selected Economic Indicators, 1999-2003


 

1999

2000

2001

2002

2003

     

Prog.

Proj.


National income and prices

         

Real GDP growth

3.3

6.0

9.6

7.5

6.0

Gross domestic product (in billions of drams)

988

1,031

1,175

1,301

1,421

Gross domestic product (in millions of U.S. dollars)

1,847

1,912

2,119

2,300

2,515

Gross National Income per capita (in U.S. dollars)

655

664

763

814

875

Inflation (end of period)

2.1

0.4

3.0

3.0

3.0

           

Investment and saving (in percent of GDP)

         

Investment

17.9

19.7

19.2

21.4

23.2

National savings

1.3

5.1

9.8

12.7

14.5

           

Money and credit (end of period)

         

Broad money

13.6

25.8

15.0

14.3

12.5

Commercial banks' 3-month lending rate (in percent) 1/

34.5

28.6

27.7

24.6

...

           

Central government operations (in percent of GDP)

         

Revenue and grants

19.3

16.5

17.1

19.5

19.8

of which: tax revenue

16.1

14.7

14.4

15.0

15.5

Expenditure and net lending

26.5

22.8

21.0

21.5

22.2

Overall balance (commitment basis)

-7.2

-6.4

-3.9

-2.1

-2.5

Overall balance (cash basis)

-5.5

-4.6

-4.0

-3.3

-3.5

           

Primary balance of the energy sector

-0.8

-1.3

-2.5

-0.5

0.0

           

External sector

         

Current account (in percent of GDP)

-16.6

-14.6

-9.5

-8.7

-8.7

NPV of external debt to exports ratio 2/

154

135

129

123

96

Debt service ratio 3/

14.3

10.6

9.7

10.5

13.3


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

1/ End of period. For 2002, the column displays the actual for June.

2/ In percent of the three-year moving average of exports of goods and services centered on the previous year.

3/ In percent of exports of goods and services.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the September 25, 2002 Executive Board discussion based on the staff report.


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