Statement at the Conclusion of an IMF Staff Mission to Armenia

Press Release No. 10/365
September 29, 2010

An International Monetary Fund (IMF) mission headed by Ms. Ratna Sahay, Deputy Director of the IMF’s Middle East and Central Asia Department, visited Yerevan from September 9−24, 2010. The team completed the 2010 Article IV Consultation discussions and reached a staff-level agreement with the authorities on their economic reform program under the First Review of the Extended Fund Facility (EFF)/Extended Credit Facility (ECF) Arrangements with the Republic of Armenia. The total financial commitment under this IMF-supported program amounts to SDR 266.8 million (about US$410 million). The IMF’s Executive Board is expected to consider Armenia’s request for the completion of the first review and conclude the Article IV consultation in November 2010. Upon approval, a disbursement of SDR 36.2 million (about US$56 million) would be made available to Armenia.

The Armenian economy is slowly recovering from a sharp downturn of over 14 percent last year. While rebounding trade and remittances are reviving industry and services, agriculture has been hit hard by adverse weather conditions. As a consequence, overall economic activity is expected to grow by about 4 percent in 2010 and 4½ percent in 2011. Reflecting the pick-up in activity, credit has also begun to flow to the private sector.

The contraction of agricultural output, together with the spike in imported wheat prices, has translated into higher food prices. With nearly half the weight in the consumer price index, higher food prices have pushed annual inflation to 9.6 percent in August. Looking ahead, inflation is expected to moderate and decline to about 7 percent by the end of this year.

During the 2009 crisis, the authorities successfully mitigated the negative impact on the population by appropriately pursuing countercyclical fiscal policy. These policies inevitably lead to a widening of the deficit, an increase in public debt, and contributed to the deterioration in the current account balance. With the onset of the global crisis and a postponement of the exchange rate adjustment in 2009, dollarization increased rapidly.

As a consequence of domestic and external developments in 2009 and this year, important medium term challenges have emerged. There is a need to consolidate public finances to ensure fiscal and debt sustainability. Given the fragile economic outlook of its key economic partners—Russia and the European Union—there is greater urgency to step up broad-based structural reforms to boost competitiveness and diversify exports so as to raise growth rates and reduce poverty further. Maintaining macroeconomic and financial stability and deepening financial markets in local currency will be critical in helping to dedollarize the economy and raise the effectiveness of monetary policy.

Policies to secure fiscal and debt sustainability.

The mission supports the authorities’ fiscal stance for 2010, which envisages substantial consolidation given the need to anchor the fiscal policy framework around debt sustainability. With the pick-up in revenue performance in the first eight months of this year, the overall deficit is expected to narrow by more than 3 percent of GDP relative to 2009, reaching about 4¾ percent of Gross Domestic Product (GDP) in 2010.

The main focus of fiscal consolidation should continue to be to strengthen revenue collection in the short and medium term, rather than expenditure compression that could hurt spending on important sectors—education and health—as well as the poor. The authorities’ recent revenue and expenditure reform initiatives are steps in the right direction. These include: setting up an Appeals Council under the government to deal with tax disputes; establishing greater transparency in interpreting the law; extending e-filing coverage of tax returns; and improving the quality of taxpayer services. The IMF mission calls for further steps to modernize tax administration and reduce tax evasion and corruption, including a revamping of the value added tax (VAT) refund system, stepping up the monitoring of large taxpayers, streamlining the reporting system, and introducing a risk-based system for tax audits. On the expenditure side, the authorities aim to reverse the recent increase in poverty and improve access to social services, including in education and health sectors.

With the right policies, the fiscal deficit is projected to fall to about 2 percent of GDP in the medium term, which will ensure that public debt remains sustainable. The mission welcomes the re-introduction of the medium-term expenditure framework, suspended during the crisis, and the adoption of the new debt management strategy which intends to lower the debt over the medium term.

Policies to strengthen competitiveness of and competition in the economy

Armenia is lagging behind many comparator countries in the area of business environment. Recent initiatives to improve regulations regarding standardization, competition rules, and public procurement, aim at bringing these in line with international best practices. But bolder and deeper reforms are needed to enhance competition, diminish monopolistic behavior, diversify exports, and more generally modernize the economy. The tourism industry remains largely untapped—it could serve as an important engine for raising growth and employment, as well as fiscal revenues and foreign exchange earnings. The mission looks forward to additional steps by the authorities in these areas, in consultation with its multilateral partners, including the World Bank.

Policies to control inflation and raise the effectiveness of monetary policy

While monetary policy will continue to focus on price stability, a small open economy like Armenia will inevitably face temporary shocks that are out of the authorities’ control. The mission shares the authorities’ views that the recent increase in consumer prices is mostly attributed to higher imported wheat prices and domestic food prices following the unfavorable weather conditions earlier in the year. A key goal of monetary policy should be to ensure that such temporary increases in prices do not translate to permanently higher inflation through second-round effects.

The Central Bank of Armenia’s (CBA) policy rate remains appropriate as a signal of the monetary policy stance. To strengthen the interest rate channel of monetary transmission, the CBA should continue to actively manage liquidity by using all available monetary policy instruments to ensure that market rates are close to the policy rate. Measures to strengthen the market for dram instruments and increase the use of dram transactions in the economy are welcome, as these would help fight high dollarization, deepen financial intermediation, and raise the effectiveness of monetary policy. The mission also welcomes the authorities’ commitment to maintaining a flexible exchange rate policy which should continue to aim at smoothing sharp fluctuations in the market, guarding foreign exchange reserves, and ensuring that the economy remains competitive. At the same time, it is important that competition and labor policies are supportive of the CBA’s initiatives to prevent temporary price increases of imported and domestic goods from becoming permanent.

The banking sector proved resilient to the crisis. The authorities’ measures to ensure the stability of the financial system by enhancing the capital base of banks, strengthening risk management and the supervisory framework have helped at limiting financial sector vulnerabilities. Measures to enhance crisis preparedness and contingency planning are also welcome. Further measures to strengthen and develop the financial sector will be considered under the forthcoming update of the Financial Sector Assessment Program in 2011.

During their visit, the IMF mission consulted with a wide section of the Armenian society—government officials, parliamentarians, central bank officials, representatives of the international community, banking and business sectors, and civil society. The mission would like to thank the authorities and the Armenian people for their kind hospitality, fruitful collaboration, and open discussions. The IMF team looks forward to continuing their close cooperation with the authorities under the current program.



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