IHS Global Insight
January 2, 2014
Armenian central bank opts for further rate cut despite inflation rate
remaining above target
by: Lilit Gevorgyan
Despite inflation rate remaining significantly above the government’s
target range, the Central Bank of Armenia cut its refinancing rate to
7.75% from 8.0% last week.
During its latest board meeting on 24 December the Central Bank of
Armenia (CBA) introduced a 25-percentage-point reduction to its key
refinancing rate, bringing it down to 7.75%. The latest rate cut was
only just over a month ago, on 12 November 2013, when the CBA brought
down the 8.0% rate by 0.5%. In a statement published on the CBA’s
website the Board explained that three factors had contributed to the
decision.
Firstly, consumer price inflation continues on its downward trend,
although it is still outside the upper threshold of the 2.5-5%
inflation target set up by the CBA. According to Armenia’s Statistics
Office, consumer price inflation rose to 6.6% in November 2013,
slowing down from 7.1% reported in the previous month. The breakdown
of November consumer price index showed that the rise in food prices
and alcoholic beverages and tobacco were the main drivers of
inflation, rising 5.2% and 6.8% year on year (y/y) respectively. Cost
of services posted a double-digit y/y rise, standing at 10.1%, and
growing nearly at the same rate as in October 2013, when prices for
services increased by 10.3% y/y. The overall contribution of this
sub-component to the overall CPI is relatively small, but the CBA also
noted that consumer prices, including food prices, are likely to trend
down in the coming month.
Secondly, another contributor to the latest CBA decision is the weak
real GDP performance in the third quarter of 2013. The real economic
activity expanded by 2.6% y/y during January-September 2013, slowing
down from a 3.5% y/y gain in the first half of the year. Meanwhile, in
annual terms the real GDP has posted 3.1% growth during
January-November, which was mainly a result of sluggish private
consumption, as well as decline in fixed investments. CBA also noted
that it expects the year-end private consumption growth to rise only
by 2.3% y/y, while fixed investment is expected to decline by 7.6%
y/y. The slowdown is expected to increase disinflationary pressures in
the coming months.
Thirdly, the central bank also assessed that there are not external
pressures contributing to inflation in the coming months. Thus,
according to the CBA’s press statement average Brent dated crude oil
prices have declined 1.9% y/y in the fourth quarter of 2013 compared
to the previous three months. Meanwhile, copper trading in London’s
Metal Exchange declined 9.5% y/y in prices in the fourth quarter.
Finally, world prices for coarse wheat and raw sugar prices posted
double-digit y/y drops in the last three months of 2013.
In addition, the CBA noted that during January-November 2013,
Armenia’s current-account gap has been narrowing, due to increase in
real exports and also rise in remittances. Thus, exports on a customs
basis (FOB), expanded 8.4% y/y during the first 11 months of 2013,
while imports, customs basis (CIF), expanded by 4.2% y/y. More
importantly, remittances, one of the largest contributor to Armenia’s
foreign currency inflows, increased by 9.5% y/y. Meanwhile, the
Armenian national currency, the dram, maintained a relatively stable
exchange rate against a basket of foreign currencies. Thus dram’s
average monthly exchange rate against the US dollar in October
strengthened only by 0.2% (AMD405.3/USD1), while the dram’s value
against euro declined 0.1% in the same period (AMD554.4/EUR1).
Outlook and implications
We expect that the Armenian monetary authorities are likely to cut the
refinancing rate further in the coming months, while inflation rate is
expected to fall within next two quarters under the upper threshold of
the target range, meaning just under 5%. This is due to expected
further weakening of consumer spending, in the view of slow real
disposable income growth. Furthermore, the main inflationary pressure
in 2013 came from nearly 60% increase in natural gas prices, initiated
by the Russian-controlled energy importer and distributor,
ArmRusGazArd. However, with Armenia’s decision to join the Russian-led
Customs Union, the country has received a 30% price discount as a
result of cancelling the export duties on Russian energy supplies.
While the Armenian government has been proven prudent in its public
spending policies in 2013, at the same time even the IMF has
recommending Yerevan to increase its government expenditure, and
address some of the social issues, while trying to offset these
expenses through improved taxation. Under the 2014 budget
infrastructure and housing spending is likely to increase, but the
provisions for welfare spending are too small and unlikely to stoke
consumer confidence.
Other sectors of the economy – particularly private investment – are
likely to remain a drag on overall economic performance, which will
continue to have a negative impact on the overall employment rate and
further curtail household spending intentions.