Global Insight
October 5, 2007
Poverty-Reduction Programme Remains on Track in Armenia, IMF
Concludes
by Venla Sipila
The latest International Monetary Fund (IMF) assessment of the
Armenian economy restates that the economy is performing well and has
achieved sound progress with restructuring, but sizeable reform
challenges still remain.
Reforms on Course
The IMF in September conducted a mission to Armenia, to discuss
near-term policy framework for the fifth review under the country’s
Poverty Reduction and Growth Facility (PRGF) arrangement. The mission
held meetings with government and Central Bank of Armenia (CBA)
officials and representatives of the business sector and the
international donor community. In particular, the Fund hoped to reach
an understanding of appropriate macro-economic policies in the light
of the need to manage strong foreign-exchange inflows, and to find
the best way to deal with intensifying expenditure pressures
connected with the planned pension increases and the further rise in
the price of gas, potentially to be tackled in 2009.
Global Insight Perspective
Significance After concluding its latest mission to Armenia in
September, the IMF commended the country’s strong economic
performance and pointed out that prudent fiscal policy has supported
high growth, low inflation, and modest public debt levels.
Implications Armenia’s relationship with the IMF and other
international lenders remains good, and its access to concessionary
financing should thus prove unproblematic. This is important, as the
country still faces considerable challenges on its reform path.
Outlook As highlighted by the IMF, one of the most pressing areas
calling for further reform effort is continued strengthening of tax
administration; additionally, improving financial intermediation and
increasing domestic competition are key tasks.
After concluding the mission, the IMF issued a statement outlining
its views of Armenia’s reform progress and the remaining challenges.
The Fund concluded that the economic outlook for next year and beyond
remains positive, while the PRGF-supported reform programme remains
on track.
It has been reported that the IMF will consider approving the fifth
tranche under the current PRGF arrangement in the near future.
According to ARMINFO, the executive council of the IMF may extend a
further sum of over US$5 million in assistance under the programme in
November. The fourth tranche under the current assistance programme
was approved in May (seeArmenia: 25 May 2007:).
Tasks Ahead
The Fund-supported development programme will continue to focus on
maintaining macro-economic stability and on implementing structural
reforms necessary to improve tax administration and to support
increased financial intermediation. The IMF stressed that keeping to
responsible fiscal policy is essential in order to achieve this and
to maintain external competitiveness, and also to support foreign
investment. In addition, increasing the ratio of tax revenue to GDP
further and enhancing the transparency and fairness of tax collection
will be of crucial importance in order to finance important
infrastructure projects, reduce poverty, and to strengthen the
business environment.
The IMF also stated that while import growth continued to exceed the
rate of export growth, the extent to which the widening trade deficit
is translated into a weakening current account is mitigated through
strong remittance inflows, as these dampen the impact of an
appreciating dram exchange rate on the overall external balance.
However, the expected continued strength of foreign currency inflows
further underlines the crucial need to support external
competitiveness by adhering to suitably tight monetary and fiscal
policies as well as to make further progress with structural reform
in order to enhance growth potential.
Further, the Fund noted that while inflation remains within the
authorities target band of 4% +/- 1.5%, the CBA should be willing to
step in and tighten monetary policy if inflationary pressure
increases. The IMF also stated that while the recent acceleration in
credit growth is positive in that it supports the goal of increasing
financial intermediation, it also poses risks and needs to be
combined with appropriate regulation and risk management. Among other
things, this calls for implementing high prudential standards and
seeking to improve corporate governance.
Outlook and Implications
The newest IMF assessment reiterates the persistent, key challenges
on the Armenian reform path; it is vital to strive and improve tax
administration further, while it is also imperative to keep
macro-economic policies compatible with sustainable management of the
strong foreign currency inflows.
One key problem with Armenian public finances is that revenue
collection is still suppressed by the vast shadow economy. The budget
proposal put forward by the government targets fiscal revenue at some
21.2% of GDP (see Armenia: 4 October 2007:). According to ARKA News,
the government hopes to boost revenue next year by suppressing the
black economy. A more transparent tax administration would also help
in supporting productivity and competitiveness. Increasing general
competitiveness of the industrial sector also has a connection to the
tax policy in that reforms in the system of tax rebates and fixed
payments would be needed in order to create an even playing field for
producers, and to support efficient allocation of resources. This,
further, is necessary in order to increase Armenia’s long-term growth
potential and export earnings capacity.
The Armenian monetary authorities have let the dram appreciate
strongly in response to sizeable foreign currency inflows in the form
of workers’ remittances from the Armenian diaspora and FDI. A
flexible exchange rate has been a prerequisite for implementing an
inflation targeting policy, where the Central Bank of Armenia has
been relatively successful. There should still be some strengthening
capacity for the dram without the threat of overvaluation. However,
in the longer term, further continued appreciation may start to harm
the competitiveness of Armenian domestic industries. Given the
importance of foreign currency remittances in the economy, continued
dram appreciation may also become politically more difficult in the
long term, as dram appreciation reduces the domestic currency value
of US$-nominated revenue. This scenario also would risk making the
task of lowering dollarisation in the economy more difficult. This,
further, would make monetary control in the economy in general more
challenging. Consequently, increased financial-sector development is
of crucial importance in order to increase the means available for
monetary authorities for sterilising currency market interventions.
In addition, more developed financial markets would allow exporters
increased opportunities to hedge exchange rate risk.