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Revaluation Of Armenian Dram Lowers Inflationary Expectations, Poten

REVALUATION OF ARMENIAN DRAM LOWERS INFLATIONARY EXPECTATIONS, POTENTIAL

ARKA News Agency
Feb 4 2008
Armenia

ARKA: Mr. Sargsyan, what preliminary estimates of the country’s key
macroeconomic indicators for 2007 can you make?

Sargsyan: 13.6% macroeconomic growth was recorded in Armenia in
January-November 2007, which growth was mainly facilitated by such
sectors as construction, services and agriculture. In January-November,
a 2.7% increase was recorded in the industrial sector, and a 9.1%
increase without the diamond-cutting industry.

The increase was mainly due to the food industry, particularly due to
the confectionary industry, the production of alcoholic beverages,
tinned food and natural juices. The increase was also facilitated
by the nonferrous industry, namely, the production of aluminum and
ferromolybdenum, and that of building materials, particularly cement
and lime.

The agricultural sector recorded a 9.6% increase, mainly due to a 10.6%
increase in plant cultivation. Bumper fruit and vegetable harvest
was gathered thanks to favorable weather conditions in Armenia last
year. The cattle-breeding industry recorded an increase as well,
mainly due to an increase in the output of meat and eggs.

In January-November 2007, the construction sector recorded a
19% increase, mainly due to capital investments in transport and
communication, particularly due to large investments made by mobile
operators, as well as due to road construction carried out on the funds
allocated by the Lincy Foundation. The increase was also facilitated
by intensified energy construction, particularly the construction of
small hydro-power plants, as well as the construction of the second
section of the Iran-Armenia gas main.

A 13% increase in the service sphere was mainly facilitated by a
considerable increase in the amount of transport and communication
services, as well as in the volume of trade (primarily wholesale and
the trade in cars). The amount of services rendered by all types
of transport increased, and the primary reason for the increase
in communication services is the increase in mobile communication
services.

Moreover, an approximate 20% rise in wages was recorded on the labor
market along with reduction of unemployment and higher rates of
increase in labor productivity – by about 13% against 12.5% in 2006.

ARKA: How well have the principal provisions of the monetary
management program been implemented? What were the major obstacles
to the accomplishment of the tasks set?

Sargsyan: The major obstacle we encountered in implementing our
monetary management policy involves the world commodity markets,
which not only sprang a surprise on us, but also exerted serious
influence on all the processes of global economy. First of all, this
is a rise in prices for food products, bread, baked goods and butter.

Also, the prices for oil and oil products have risen since the
beginning of the year. This all seriously influenced prices worldwide,
with special damaged caused to transitional economies, as the share
of the aforementioned products in the basket of goods there is rather
large compared with developed countries. So the inflation exceeded
the planned level in all the countries in transition. I would like to
note that inflation exceeded the planned level by about 4% in all the
countries of the Commonwealth of Independent States (CIS). Inflation
is to reach about 12% in Russia, and rather high inflation is expected
in Georgia. In Azerbaijan inflation may be twice as high as in Armenia.

Armenia is expected to end this year with inflation about 7%. With
monetary factors alone considered, inflation would not exceed 3%
(about 2.6%), the cause of the rest 4% being the rise in prices on
the world markets.

As regards the principal provisions of the monetary management policy
of the year, most of them have been implemented. The increase in
the monetary base and money supply exceeded the planned level, the
primary reason being the fact that the economic growth rates exceeded
the planned level, which made the Central Bank serve the real sector
by means of emission, which was actually done.

A special feature of the year is also the huge amount of foreign
exchange the Central Bank has purchased from the market. By our
preliminary estimates, this index will exceed last year’s index by
about 40% and reach $350mln.

Despite this, further AMD revaluation against the USD has been
observed and is to make about 17%. However, this process facilitated
the reduction of inflationary pressures and potential.

By and large, the major obstacles we have encountered this year are:
first, the world prices, second low-level price elasticity, which
testifies to the need for measures to step up competition on the
domestic market for the AMD revaluation to be accompanied by control
over import prices.

ARKA: The Central Bank has been managing all the market segments for
the second year. What are the results?

Sargsyan: First of all, the Central Bank is trying to smooth away
the existing serious differences between individual segments of the
country’s financial market. It is no secret for anybody that Armenia’s
banking system has made considerable progress and meets international
standards now, which cannot be said about the insurance market, the
securities market and the pension system. So it is obvious that more
rapid reforms are necessary to smooth away the existing differences.

It should be noted that the largest resources were directed to the
nonbank part of the financial sector. First of all, this is the
securities sector, for which we drafted a special bill later adopted
by the Parliament. Moreover, the Central Bank approved a large number
of statutory acts.

The second segment is the insurance market, where we are cleaning the
insurance field. At the initial stage, 23 insurance companies were
operating in Armenia, whereas only nine are working now. The process
of clearing the segment is accompanied by the improvement of insurance
laws. In 2007, the RA Parliament adopted a bill on insurance companies
in conformity with European standards. The new law will allow reforms
to be implemented at higher rates.

And finally, an important achievement of 2007 is the entry of the
OMX operator to Armenia’s market, which will promote the development
of Armenia’s financial market in general and the formation of a real
capital market in particular.

ARKA: What is your general assessment of Armenia’s financial system?

What are the financial results of the year?

Sargsyan: In general, Armenia’s financial system can be characterized
as rather stable. The share of banks and credit institutions that
recorded a considerable increase is 97% now.

First of all we are happy over the banking sector, which recorded
a 70% increase in crediting of the country’s economy. High-rate
increase in assets was recorded. As a result, a 3-point increase in
the assets/GDP ratio was recorded during one year – up to about 23%,
which is a rather serious result. In general, Armenia’s banking system
can be said to be solidly based. The rates of the banking sector’s
development are expected to exceed those of economic growth during
the next few years. It should also be noted the bank capitalization
level is rather high in Armenia in the context of financial stability –
29% against the CBA-set 12%.

Credit institutions have recorded progress as well. The banking
sector recorded a 70% increase in crediting, while credit institutions
doubled their crediting volume. The interest in credit institutions
has increased, and their number has reached 22, as many as commercial
banks. In general, credit organizations are developing at higher
rates than banks.

Nonresident entities have shown interest in the local insurance market,
and we hope that new serious players will come to Armenia next year,
and new insurance companies will launch their activities here. First
of all, the matter concerns the HSBC Group, which plans to open its
insurance company in Armenia. We have been negotiating with it for
a long time. Besides, we hope for another European insurance company
to come to Armenia. One Russian and one Ukrainian insurance company
are expected to launch their activities in Armenia as well.

ARKA: What is your view of 2007 in the context of the entry of new
banking brands to Armenia’s market?

Sargsyan: The Central Bank is welcoming this process. We are vitally
interested in first-rate participants entering Armenia’s banking
sector, which, on the one hand, promotes competition in the sector,
and on the other hand, will contribute to the development of financial
intermediation in Armenia.

Thus, we can state that the emergence of the German ProCreditBank
will promote competition in the retail sector. The Russian Troyka
Dialog Company will introduce new technologies and products on the
securities market. The Lebanese Byblos Bank will introduce corporate
management culture and private banking, which is well-developed
in Lebanon. Finally, the Russian Gasprombank will promote banks’
competition for large enterprises.

All this is rather promising for Armenia’s financial sector, if we
consider the fact that it is due to new players that the Armenian
banking system’s capital increased by about 40% in 2007.

ARKA: Since the banking system remains the largest player on the
financial market, what is your assessment of the current stage of
development of Armenia’s banks. What are the forecasts for 2007
and 2008?

Sargsyan: First of all, noteworthy is a considerable decrease in net
external assets of the banking system in 2007 – by approximately 82bln
AMD. As a result, the system’s net external assets for the first time
proved to be negative – minus 71.6bln AMD (over $200mln).

This means that our banks started attracting more funds from
nonresidents and investing them in Armenia, primarily in the country’s
economy. Another important feature is a lower dollarization level in
the country. First, AMD credits doubled.

Secondly, a decrease in the share foreign-exchange deposits was
accompanied by an increase in the share of AMD deposits – up to 53%.

Assets increased by 41% and amounted to 741bln AMD, the share of
AMD assets being 65% – a 7% increase. The share of assets in the GDP
increased from 19.8% in 2006 to 23% in 2007.

The banking system’s liabilities increased by 43% during one year
and amounted to 580bln AMD, and individual deposits increased by 34%
and amounted to 191.6bln AMD. The number of banks’ clients increased
by 150,000 or 20% and reached 913,000, and the number of accounts
reached 1,000,000 – a 15% increase.

The capital increased by 34% or by 41bln AMD and reached 161.6bln
AMD. Nine banks replenished their authorized capital with 27mln AMD.

The banking system’s net profit is to total 23.5bln AMD – a 40%
increase compared with 2006.

As regards forecasts for 2008, we hope that the development of the
banking system will doubly exceed that of the real sector. The raising
of the financial intermediation level requires the development of the
banking system at higher rates. Also, we expect the Dutch Postbank
in Armenia next year.

ARKA: Early this year you mentioned three "problematic" banks in
Armenia, which received low marks by the CAMELS system. Have the
problems of the banks been resolved, and are all the banks operating
without any problems?

Sargsyan: All the three banks have improved their financial situation
this year. At present we have no banks that would not meet economic
requirements and have any supervision-related problems with the
Central Bank. In this aspect, all the problems have been resolved. Of
course, competition will encourage banks to pay more attention to
the management level. It is no secret that it is primarily a bank’s
management that accounts for its success or failure. So next year we
will pay more attention to raising the management level at banks.

ARKA: Early this year you stated the intention to introduce principles
of protecting consumers’ interests in the banking system.

At what stage is the process, and what progress in the accomplishment
of the tasks has been made?

Sargsyan: The Parliament has adopted a number of normative documents.

We have started putting into practice the requirements for banks’
activities to become more transparent. Clients must be ware of the
services rendered by banks, of the interest rates and of the prices.

The Central Bank’s web-site contains full information on the services
rendered by all the local banks.

We also plan the introduction of a system of universal interest rates
with due regard for clients’ other expenses. This will help banks’
clients to be aware of the real cost of credits.

New bills have been drafted, which take into account the best
international experience and are aimed at the protection of clients.

The laws are supposed to regulate crediting process, ensure the
protection of clients’ rights and make the services rendered by banks
opener. Specifically, we have drafted bills "On financial ombudsman",
"On consumer crediting", "On order of attracting deposits".

The Central Bank has also prepared a new concept of financial
arbitration. All the aforementioned procedures and concepts will be
submitted to the Government and Parliament in 2008.

ARKA: What other new legislative amendments concerning Armenia’s
financial system, particularly banks, credit institutions, insurance
market and stock market , were adopted in 2007?

Sargsyan: In 2007, the Central Bank seriously mitigated the bank
management and banking supervision requirements, which allowed banks
to manage operational risks using market mechanisms. The bank liquidity
requirements were mitigated as well. The first step toward Basel-2 was
made. Specifically, a standard approach to credit risk calculation was
introduced. For financial services to be more available in Armenia’s
regions and rural communities, banks were allowed to carry out field
crediting.

As I have already noted the newly adopted laws allowed of radical
changes in the management of securities and insurance markets. The
relevant legislation was brought to conformity with European
standards. The new law on insurance prohibits life and nonlife
insurance of only one legal entity. New requirements for and standards
of corporate and risk management were set for insurance companies.

In conformity with the new law on the regulation of securities, the
Armenian Stock Exchange and the Central Depository were transformed
to open corporations and later sold to the Swedish OMX stock exchange
operator. Minimal requirements to capital were set for professional
market participants. The new law allows banks to be immediate
securities market participants.

ARKA: What is your assessment of Armenia’s insurance market? What
is the Central Bank’s current policy and forecasts? What are your
expectations of the sphere in 2008?

Sargsyan: The first result we achieved is to clear the sector of
weak insurance companies that are unable to function in conformity
with insurance standards. If we fail to clear the insurance market,
we cannot speak of solid foundations for the development of insurance
in Armenia.

Our goal is to clear the sector with further introduction of the best
standards. We have adopted a law our German colleagues assessed as
one of the best laws on insurance. All the changes are supposed to
create favorable conditions for the development of insurance business
in Armenia.

Our next step is the introduction of compulsory insurance in Armenia.

We hope that the Government will approve the concept of compulsory
third-party insurance against traffic accidents, which will promote
the development of the insurance sector. The next field is medical
insurance. The Government has included measures to develop medical
insurance in its program of action. Among the requirements for the
development of insurance business is also the development of the
institute of actuaries and the creation of a database.

ARKA: How much will the OMX’s entry intensify the activities on
Armenia’s stock market. Can any results be expected this year? In your
opinion, how many enterprises will be working on the stock exchange
in 2008?

Sargsyan: A priority task for 2008 is the formation of
infrastructure. We have quite a long list of measures we must implement
in cooperation with the OMX. Specifically, the matter concerns
legislative and statutory acts, formation of market institutes,
which are necessary for normal operation of the stock exchange and
depository. In other words, in 2008 we will direct all our resources
to the formation of infrastructure.

In 2007, several entities showed interest in the securities market,
and we encourage this process in every possible way, practicing the
rating of enterprises. Some of the enterprises have issued their own
bonds. In fact, we have entities on the market which will intensify
their activities after the OMX enters the market, and, naturally,
the interest in the securities market will increase.

ARKA: What inflation level is expected in Armenia in the context of
the global economic processes? How well is the bank accomplishing its
major task, namely, maintaining stable prices in the country? What
is your general opinion of inflation?

Sargsyan: Serious inflationary potential was accumulated in 2007,
which is a rather serious problem for global economy creating serious
turbulence on all the financial markets. Of course, the behavior of
China and India exerts serious influence on prices, world markets. In
this context, we have fears that the inflationary pressure from the
world markets will be rather strong in 2008.

Our goal is 5.5% highest inflation. We hope that this goal will
be attainable by the end of 2008. As regards the year 2007, I have
already noted that 7% inflation is expected in Armenia.

ARKA: Will anything be changed in your inflation targeting policy in
2008? Are our exporters now able to oppose inflation?

Sargsyan: In 2008, the Central Bank will continue implementing all
the necessary measures to switch over to full inflation targeting in
the medium-term prospect. Among the measures are the enhancement of
confidence in the Central Bank’s policy, further development of the
financial system, improvement of the macroeconomic forecast system,
instruments of monetary policy, etc..

As regards the second part of the question, it is important that the
financial market participants are already offering new services to
their clients, particularly derivatives, which will allow them to have
forecast exchange rates at their disposal for a small price. Of course,
it is primarily transparent enterprises able to sign relevant contracts
with commercial banks that will be allowed to use these services. On
its part, the Central Bank will encourage the introduction of a new
culture of financial market, and the market participants must learn
to manage their currency risks.

ARKA: Do Armenian citizens trust the Armenian dram now, and how much
did the dollarization level reduce?

Sargsyan: Our citizens obviously give their preference to the Armenian
dram. Specifically, last year (2006) we reached 50% level in assets,
and this year (2007) we reached this level in liabilities.

Over 50% are funds attracted in terms of drams, and this trend will
be continued. This process is facilitated by the revaluation of the
Armenian national currency on the one hand, and by the reduction of
shadow economy on the other hand, which, in turn, stimulates reduction
of the dollarization level.

I think that approximate 10% reduction of dollarization level can
be expected in 2007 if it is estimated in the context of the share
of drams assets in our banks’ gross assets as well as that of USD
deposits in the total amount of deposits.

ARKA: Does the sovereign rating assigned to Armenia produce any
results?

Sargsyan: There is increasing interest in Armenia, especially in the
context of the forecasts on the ratings being made. In their turn,
our commercial banks started paying more attention to their ratings,
which facilitates the establishment of contacts with foreign partners
and attraction of new financial resources. The ratings assigned to
Armenia are of paramount importance for the country’s further economic
development, especially in the context of the region.

ARKA: What is Armenia’s real and specific potential to become a
regional financial center in the context of present-day geopolitical
situation?

Sargsyan: First, our banking system is more advanced from the
viewpoint of management, organization, knowledge and skills compared
with the other countries of the Commonwealth of Independent States
(CIS). International experts point out a rather high level of
management and supervision in Armenia. The experience and knowledge
of employees of Armenia’s banking sector play an important role as
well. Besides, we plan to direct considerable resources to sharply
increase the potential necessary for the country’s financial market
to be able to render world-class services.

ARKA: At what stage is the KfW Bank’s mortgage crediting program
in Armenia?

Sargsyan: At present, nine commercial banks and two credit institutions
are involved in the program. It is being implemented according to
the schedule agreed on with the German side. By mid-2007, under the
program financial institutes had issued 286 credits amounting 1.6bln
AMD. By our estimates, during the first quarter of 2008 the first
tranche of the program, ~@6mln, will have been utilized. The second
~@6mln tranche is expected in April-May 2008.

In 2008, more attention will be paid to the development of the
secondary mortgage market, which is most important for us. In tote,
mortgage crediting doubled in Armenia in 2007 and amounted to 55bln
AMD – a 110% increase.

ARKA: What is the expected amount of private transfers in 2007? What
are the expected trends for 2008?

Sargsyan: I would like to note that the amount of transfers
is increasing. This is reality accounted for by our nation’s
peculiarities. Two thirds of Armenians are residing abroad, and
when their economic and financial situation gets better, they are
more active in investing in Armenia. Naturally, this is a generally
positive trend for our nation.

It is no secret for anybody that Armenia is a center of economic
interests of not only our country’s citizens, but also all Armenians,
and the creation of a favorable investment environment in Armenia
promotes inflow of capital, development of tourism and use of
services. This is reality which shows a long-term trend, and, if no
cataclysms occur in the world, particularly in Russia and in the USA,
the countries that are principal providers of transfers and have the
largest Armenian communities, this trend will continue.

This year our forecasts of private transfers have been exceeded. They
were expected to increase by 20-25 per cent, while the actual
increase was 40%. That is the volume of private transfers is to exceed
$1bln.

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