Mission Concluding Statement 

Armenia: Concluding Statement of the IMF Mission (September 2008)

September 19, 2008

Armenia — Concluding Statement of the IMF Mission
September 16, 2008

An IMF staff team, led by Ms. Marta Castello-Branco, IMF Mission Chief for Armenia, visited Yerevan during September 3-16, 2008 to meet with representatives of the government, the Central Bank of Armenia (CBA), the international donor community, and the private sector. Mr. Lorenzo Pérez, Deputy Director of the IMF, also participated in the concluding policy discussions. The goal of the mission was to review recent economic developments, reach agreement on the 2009 budget, and conduct negotiations on a new IMF-supported program for Armenia.

Macroeconomic Performance and Outlook

GDP growth continues to be strong, but inflationary pressures are still high. Thus far, the conflict between Georgia and Russia does not seem to have significantly affected the growth outlook and, unless tensions persist, a 10 percent real growth rate is within reach this year. Annual inflation surged to 11.5 percent in August, mostly due to external shocks, but also as a result of higher domestic demand-driven by rising incomes, rapid credit growth, and large foreign exchange inflows.

Tightened monetary and fiscal policies and the recent fall in international food and fuel prices are expected to bring inflation back to around 7.5 percent by the end of this year. In the next few years, growth should remain robust, and inflation should stabilize around the central bank's target rate of 4 percent.

Under the current macroeconomic conditions, fiscal policy could play a more active stabilization role, notably with a tighter fiscal stance this year. Budget execution in 2008 has been prudent thus far, due to strong revenue performance and under-execution of expenditure, despite the increase in average pensions by 60 percent. On this basis, we expect the 2008 fiscal deficit to be significantly lower than budgeted. Fiscal policy will need to remain tight in 2009 in order to help keep inflation low.

To limit the effect of higher food and energy prices on other price increases, the CBA has raised its policy interest rate gradually from 4.5 percent in June 2007 to 7.75 percent in September 2008. Nevertheless, private sector credit and monetary aggregates continue to grow at a rapid pace, reflecting strong domestic demand and the still limited impact of monetary policy on bank lending rates.

The widening current account deficit is a growing concern. Although private transfers have remained strong, the current account has continued to deteriorate. Imports have surged on the back of high international food and energy prices and strong import demand, while exports have been sluggish. With appreciation pressures diminished by rising import demand, the dram/dollar exchange rate has remained broadly stable thus far in 2008.

Structural Reforms

The new government has given clear priority to tax and customs reform. It approved a comprehensive and ambitious plan to make the tax administration more efficient, and create more equal conditions for businesses. To make tax compliance simpler for small businesses, a VAT threshold of AMD 58.3 million will be introduced in January 2009. Starting in 2010, trade fairs will be moved from the presumptive to the general VAT and income tax regime. However, there are still delays in processing VAT refunds, which negatively affect exporters. The authorities are planning to reform the VAT refund process following best international practices, clear the stock of late VAT refund claims, and process all VAT refund claims within the legal time limit. In the financial sector, the authorities have introduced legislation to improve consumer protection, market transparency, and financial intermediation. Finally, preparations for the introduction of a funded pension pillar are underway.

New IMF Program

Under the previous three-year IMF program, which ended in May 2008, Armenia achieved double digit growth, single digit inflation, and a significant reduction in poverty. Nevertheless, more progress needs to be made with structural reforms in several areas, particularly in tax policy and tax and customs administration. The government has requested a new IMF program to support this unfinished reform agenda. Given the progress made so far, this new IMF program would provide less financing than its predecessors. Its main purpose is to signal the IMF's support for Armenia's macroeconomic policies and structural reform agenda in the country's transition from low-income to emerging market economy status, thus facilitating Armenia's integration into the world economy.

Structural conditionality under the new program will focus mainly on tax administration and tax policy reforms, given their positive impact on the business environment, financial intermediation, economic growth, and poverty reduction. In addition, the program aims at making fiscal policy a more effective demand management tool, improving the fiscal framework, and strenghtening coordination between the monetary and fiscal authorities.