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Republic of Armenia and the IMF
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IMF Executive Board Concludes Article IV Consultation with the Republic of Armenia
On December 1, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Armenia.1
Armenia's economy has performed well during the last three years. Annual real GDP growth averaged 12 percent between 2001 and 2003. Fiscal and quasi-fiscal deficits were significantly reduced and inflation remained in single digits. The external current account deficit fell rapidly in response to strong export growth stemming from increased competitiveness as well as import substitution. Poverty, while still high, fell about 8 percentage points to an estimated 43 percent of the population.
Armenia's strong economic performance has been continuing in 2004. In the period January-September, the year-on-year rate of GDP growth was 10 percent, fueled by increases in agricultural production, housing construction, and services. GDP growth for the year as a whole is projected to be 9 percent. The 12-month rate of inflation fell from 8.6 percent in December 2003 to 6.1 percent in September. The central bank's inflation objective of 3 percent for 2004 is within reach, but may be exceeded slightly because of recent increases in fuel prices.
On fiscal policy, tax revenues through September 2004 increased by 21 percent over the same period last year. The fiscal deficit in 2004 is projected at 1.1 percent of GDP because of under-execution of expenditures mainly due to capacity constraints. The 2005 budget is expected to target a fiscal deficit of about 2 percent of GDP and will accommodate higher social and infrastructure spending in line with Poverty Reduction Strategy Paper priorities, while rationalizing nonpriority current expenditures. The projected deficit is consistent with macroeconomic stability.
Regarding monetary policy, broad money and private sector credit grew by 20 percent and 43 percent in the year through September respectively. In 2004, reserve money and broad money are projected to grow at about 4 percent and 15 percent, respectively.
Since mid-2003, banking sector performance has improved and there has been a gradual return of confidence toward banks following the resolution of eight intervened banks. While interest rates have continued their gradual declining trend, dollarization remains at over 70 percent.
After a slight deterioration in 2003, the external current account deficit is expected to narrow to 5.6 percent of GDP in 2004 because of higher workers' remittances. Despite lower capital grants, the capital and financial account remain well supported by continued increases in foreign investment. Gross international reserves are expected to remain slightly below four months of imports. External debt ratios are projected to decline further in 2004-05. The recent real exchange rate appreciation has helped to mitigate the effect of recent hikes in the prices of imported fuels on inflation and on real incomes. The appreciation only partially compensates for a more than 25 percent real depreciation between 2000 and 2003.
The structural reform agenda has progressed during the last two years, although there have been a number of delays. There was good progress in strengthening expenditure control, reducing red tape, and improving efficiency in the energy and water sectors. Notwithstanding these achievements, there is a need for further deepening of structural reforms to revamp tax and customs administration, strengthen the financial system and the judiciary, improve expenditure management, and increase efficiency in the water and irrigations sectors. To tackle corruption in the public sector, the implementation of the recently prepared anti-corruption strategy needs to be stepped up, especially regarding the development of an independent judicial system.
Executive Board Assessment
Executive Directors commended the Armenian authorities for remarkable progress made, particularly in recent years, to consolidate macroeconomic stability and build the foundations for a modern market economy. Prudent economic policies and structural reforms have contributed to double-digit growth, poverty reduction, low inflation, and a sustainable debt burden. Notwithstanding these achievements, Directors noted that some structural reforms had suffered from delays or incomplete implementation, and that important challenges remain to sustain high rates of economic growth and reduce poverty further.
Directors endorsed the current stance of monetary policy aimed at lowering annual inflation to 3 percent. They agreed that the planned deepening of the government debt market would facilitate monetary management and private debt issues. While welcoming the recent increase in credit to the private sector, Directors underscored the importance of monitoring closely the quality of loan portfolios and potential foreign exchange risks as part of the steps to strengthen banking supervision. Directors also noted that further efforts are needed to increase financial intermediation, including enhancing corporate governance in banks, streamlining collateral recovery procedures, and improving court processes. They looked forward to the recommendations of the forthcoming Financial Sector Assessment Program mission. Approval by parliament of the anti-money laundering and financing of terrorism legislation, and its implementation would also be important.
Directors considered that the flexible exchange rate regime has served Armenia well, facilitating the conduct of monetary policy and helping the economy to adjust to external shocks. They noted that the recent appreciation of the dram has helped offset the impact of higher import prices on inflation, while competitiveness has been safeguarded by productivity gains since 2001.
Directors welcomed the progress made in reducing fiscal imbalances in recent years. They looked forward to a cautious fiscal stance in 2005 and an expenditure envelope in line with PRSP priorities on social and infrastructure spending. Directors also welcomed the planned increases in social spending in the 2005 budget, but emphasized the importance of capacity building and transparency in state-owned noncommercial organizations to ensure the efficient provision of social services. At the same time, a balanced mix of current and capital expenditures will be critical to sustain the high trajectory of growth. This will require higher allocations to capital expenditures in the transport, agriculture, and water sectors. In this regard, Directors encouraged the authorities to formulate a medium-term public investment program to define and prioritize public investment and poverty reduction needs as well as guide future external assistance.
On the revenue side, Directors generally expressed disappointment that, despite high growth in nominal tax revenues in recent years, the tax effort has not increased. In this regard, Directors noted that remaining deficiencies and discretion in tax and customs administration are one of the key barriers to higher tax collection, and urged the authorities to make wide use of improved systems for collection, VAT refunds, and customs clearance. This would yield the higher tax revenues that are needed to maintain fiscal sustainability and finance rising levels of pro-poor spending. Directors also endorsed the staff's proposals to revamp the organizational structure of the tax and customs agencies and bring them under the umbrella of the Ministry of Finance.
The authorities should be commended for the progress made in the energy sector in recent years. Notwithstanding these achievements, Directors underscored the importance of completing reforms in this sector and advancing the reform agenda in the water and irrigation sectors, including through bringing tariffs toward cost-recovery levels.
Directors noted that governance and the business environment have improved in recent years, but that more remains to be done to reduce red tape, increase accountability in the public sector, and combat corruption. To this end, they urged the authorities to avoid complacency and press ahead with the implementation of the anti-corruption strategy in consultation with civil society. Regarding the PRSP, Directors welcomed the recent establishment of monitoring indicators and looked forward to the forthcoming progress report on its implementation.
Directors welcomed the opportunity to review the ex post assessment of Armenia's long-term program engagement. They agreed that Fund involvement has been effective in promoting sound economic policies and reforms. While recognizing that much has been achieved during the last 10 years, Directors noted that a stronger political commitment would be needed to address remaining problems in tax and customs administration, the banking system, and to improve governance. In the context of such a demonstrated commitment, Directors considered that a new arrangement with the Fund could play a valuable role in facilitating consensus on appropriate policies and providing confidence to donors and investors.
IMF EXTERNAL RELATIONS DEPARTMENT