ENP Newswire
December 31, 2014 Wednesday
-IMF Executive Board Completes First Review under the Extended
Arrangement, Approves US$ 17 Million Disbursement, and Concludes 2014
Article IV Consultation with Armenia
LENGTH: 3423 words
ENP Newswire – 31 December 2014
Release date- 30122014 – On December 22, 2014, the Executive Board of
the International Monetary Fund (IMF) completed the first review of
Armenia’s economic performance under a three-year program supported by
the extended arrangement under the Extended Fund Facility (EFF).
The completion of the first review enables the release of SDR 11.74
million (about US$ 17 million), bringing total disbursements under the
arrangement to SDR 23.48 million (about US$ 34 million). The extended
arrangement for SDR 82.21 million (about US$ 119.1 million was
approved on March 7, 2014 (see Press Release No. 14/88) In addition,
the Executive Board concluded the 2014 Article IV consultation1 with
Armenia and endorsed the staff appraisal without a meeting on a
lapse-of-time basis.2
After a steady recovery during 2010-12 from the deep 2009 recession,
Armenia’s growth softened in 2013 and has remained subdued in 2014.
The softening of economic activity has been broad based, as growth of
exports and remittances slowed, and government spending was lower than
budgeted. Construction, which had declined since the 2009 crisis, was
relatively flat. Growth is projected at 2.6 percent in 2014 and is
expected to increase only gradually in 2015 and over the medium term
in light of expectations of slow growth in key trading partners. In
line with the subdued economic activity, inflation fell during the
year below the Central Bank of Armenia’s (CBA) target range (4+/-1.5
percent) but is expected to return to that range, as the recent
depreciation of the dram pushes the price of imported goods up.
In the context of regional developments, pressures in the foreign
exchange (FX) market emerged in early 2014 and reemerged in late
November due to further depreciation of the Russian ruble. The CBA
moved to stem these pressures by allowing some depreciation of the
dram in line with changes in economic fundamentals, but also
increasing its FX supply to the market. On December 8th the CBA
activated pre-announced daily FX auctions to help ensure smooth
functioning of the FX market. The CBA also tightened dram liquidity
conditions by increasing the Lombard rate for repo transactions to 21
percent in early December. As a result, interest rates on the
overnight market jumped to over 20 percent from December 1-5.
International reserve levels are adequate based on standard import and
debt metrics. Reserves also continue to compare well with peer
countries.
The banking sector remains sound, but performance has been weakening
amid challenging economic conditions. In particular, bank
profitability has declined as weaker economic growth has been
accompanied by an increase in non-performing loans (NPLs), which
reached 6.5 percent in September, and as credit and deposits growth
have slowed. The recent tightening of domestic liquidity conditions
and FX developments may also put pressure on bank profits going
forward. The CBA has continued to monitor financial sector
developments closely, and the robust capitalization of the banking
sector constitutes an important cushion.
The fiscal deficit is expected to reach 1.5 percent of GDP in 2014,
well below the budget (2.3 percent of GDP). This reflects capital
under-spending (especially in the multi-donor North-South Highway),
lower-than-budgeted matching pension contributions (due to pension
reform changes), and less spending on goods and services. Despite
lower growth, revenues have been close to budget targets so far this
year, and even amid regional uncertainties, Eurobond spreads have
remained stable.
The authorities’ policies remain geared toward maintaining
macroeconomic stability and fostering sustainable and inclusive
growth. The CBA continues to conduct monetary policy under an
inflation targeting framework, accompanied by exchange rate
flexibility, and to implement policies aimed at maintaining and
strengthening financial sector stability. Fiscal policy remains
focused on keeping the deficit and debt at manageable levels, while
augmenting growth-enhancing expenditures and strengthening social
protection. In addition, the authorities are pursuing a structural
reform agenda to foster growth. On October 10, the presidents of
Armenia, Belarus, Kazakhstan, and Russia signed an agreement on
Armenia’s membership in the Eurasian Economic Union (EEU). Armenia is
expected to formally join the Union in January, once the treaty is
ratified by the four national parliaments.
Executive Board Assessment
In concluding the 2014 Article IV consultation with Armenia, Executive
Directors endorsed the staff appraisal in the staff report as follows:
Armenia faces a period of slower growth unless decisive actions are
taken. Sound macroeconomic policies since the crisis have helped
sustain domestic and external stability in a highly uncertain context.
However, going forward, projected growth rates will not be sufficient
to generate sufficient jobs and stem emigration. Sluggish investment
in recent years, a still-weak
business climate, and the absence of strong growth drivers constrain
the capacity of the economy to generate sufficient jobs to stem
emigration and reduce poverty. EEU membership could help increase
exports to the large EEU market, but medium-term growth prospects for
Russia are modest as well. Therefore, more decisive implementation of
reforms, as anchored in the Fund-supported program, is needed to
reduce vulnerabilities and boost potential growth.
Performance has moderated due to both domestic and regional factors. Growth is
expected to slow to 2.6 percent of GDP in 2014 from 3.5 percent in
2013, while inflation has fallen below the CBA’s target range. Growth
of exports and remittances has weakened, but slower growth of imports
meant that the FX market remained relatively stable through much of
2014, although pressures emerged in November-December. The banking
sector remains well capitalized and liquid, but weakening conditions
have been associated with an increase in non-performing loans (NPLs).
On a brighter note, while the slowdown has been broadly based,
agriculture and tourism are benefitting from investment and structural
reforms and are growing at a healthy pace.
Vulnerabilities remain high. While international reserves are
adequate, the consolidation of the external current account deficit
has slowed in 2014 due to lower-than-expected exports and remittances.
Staff estimates that an adjustment of the real exchange rate over the
medium term would help facilitate further external adjustment and
improve competitiveness. However, the banking system is still highly
dollarized, which could imply pressures on bank balance sheets if a
disorderly external adjustment occurs.
Armenia faces a high degree of risk. Growth is projected to pick up to
3.3 percent of GDP in 2015, in the context of supportive macroeconomic
policies-notably, monetary policy easing in 2013-14 and stronger
capital budget execution. However, the short-term outlook is subject
to a high degree of uncertainty, especially given regional
geopolitical developments and tensions. An intensification of these
would lead to further negative spillovers to Armenia’s economy.
The authorities should create fiscal space to boost social and
investment spending over the medium term. Efforts should focus on
revenues, as underexecution of capital spending has had a negative
impact on growth, although staff commends the authorities for not
diverting spending into low pay-off areas and welcomes efforts to
assess and address reasons for underspending. With lower growth,
available financing, and few risks to inflation or sustainability,
staff sees merit in a higher deficit in the 2015 budget, with
increased spending going to capital outlays. Staff has long pressed
for higher tax revenues to support higher social spending and
growth-enhancing infrastructure projects. Tax measures should also aim
to improve the tax system by eliminating gaps and ensuring greater
equity. The upcoming formulation of a comprehensive tax code is an
opportunity to broaden the tax base and rationalize exemptions and tax
expenditures. EEU common customs pool revenues could provide a further
opportunity to build fiscal buffers through savings. However, the
revenues must be secured and in any event are transitory, as EEU
tariffs are expected to decline over the medium-term. Staff commends
the authorities’ cautious approach in evaluating the sustainability of
these additional revenues, prior to incorporating them in the budget
framework.
Further strengthening of monetary and financial sector policies should
remain a priority, building on recent progress. The CBA’s
Inflation-Forecast Targeting (IFT) framework has served Armenia well
and remains an appropriate anchor for monetary policy. Nonetheless,
the effectiveness of the IFT framework should be further strengthened
by reducing dollarization, improving monetary policy instruments, and
enhancing the CBA’s communication and modeling capabilities.
Similarly, the CBA has made noteworthy progress in implementing
recommendations of the Financial Sector Assessment Program (FSAP) and
Basel III guidance, while strengthening financial sector regulation
and resilience. However, further work is needed to incorporate new
guidance on large exposures and liquidity requirements, as well as to
revisit the dedollarization strategy, and to foster better financial
intermediation via improved legislation on registration and execution
of collateral.
Exchange rate policy should support external adjustment. The current
situation poses challenges to exchange rate policy, notably the recent
depreciation of the Russian ruble, uncertainty surrounding regional
geopolitical events, and pressures to calm what are perceived as
disorderly conditions in a thin market. While limited interventions to
mitigate disorderly conditions are warranted, pressures that reflect
economic fundamentals should be accommodated. Enhanced central bank
communications will be important to provide clarity and guidance.
Maintaining robust buffers, together with flexibility of the dram,
should support further reduction of the external current account
deficit to its sustainable level.
The authorities should implement ambitious reforms to bolster
potential growth and promote inclusion. The successful implementation
of ‘open skies’ in civil aviation is a good example of how bold policy
decisions can have positive results in a relatively short period of
time. Recent delays in implementation of reforms in the competition
and regulatory areas, while relatively minor, should be reversed. The
reform agenda should be implemented decisively to improve Armenia’s
capacity to grow, create jobs, and reduce poverty. Business
environment reforms should overcome long-standing concerns about
uneven competition, unnecessary regulation, high costs, and skills
shortages and mismatches. The authorities should move quickly to
bolster the pension reform and ensure its long-run success. Reforms in
the energy sector should be compatible with long-term fiscal
sustainability, involve the private sector, and be transparent and
cost-effective, while mitigating the impact on the poor. Finally, the
authorities should leverage EEU membership to increase exports,
improve standards, enhance domestic competition, and invest in
infrastructure. They should also pursue deeper integration beyond the
EEU to enhance growth prospects and reduce vulnerabilities.
Policies under the program remain on track. All performance criteria
and most indicative targets were met. Competition and regulatory
reforms have advanced at a slower-than-expected pace, causing delays
in meeting structural benchmarks, mainly due to the government change
in mid-2014 rather than a change in policy direction. Going forward,
the program will accommodate a modest fiscal stimulus in 2015, while
maintaining macroeconomic stability and fiscal sustainability. The Net
International Reserves (NIR) targets will help maintain strong
buffers. Structural benchmarks for the remainder of 2014 and first
half of 2015 are focused on core areas, including tax administration,
Public Financial Management (PFM), financial sector development, and
central bank operations.
Risks to the program are significant, but manageable, and Armenia’s
repayment capacity remains robust. While the short-term outlook is
subject to a high degree of uncertainty, and Armenia is vulnerable to
geopolitical developments, the authorities have a strong track record
of sound macroeconomic policies and program implementation. A low
fiscal deficit, moderate public debt, broadly adequate reserves, and
growth-supporting reforms embedded in the program reinforce this
assessment. Staff supports the authorities’ request for the equivalent
of SDR 11.74 million to become available with the completion of the
first review.
In addition, the Executive Board endorsed the staff appraisal of the
staff supplement as follows:
Staff welcomes the authorities’ move to put in place a clear,
transparent, and sustainable FX framework in the face of market
pressures. These pressures emanate in large part from external
developments that are expected to be more than temporary, calling for
ER adjustment. The changes were well communicated, and the authorities
have demonstrated their commitment to limiting FX auctions to the
daily maximum, in order to establish credibility of the new approach.
This has provided a clear cap on CBA intervention, helping the market
find a new equilibrium ER, and fostering sales of FX by banks,
exporters, and others. The new ER should facilitate external
adjustment and improve competitiveness.
Staff welcomes the authorities’ commitments to limit FX sales in 2015,
rebuild buffers, and further adjust policies as needed. The
authorities are to be commended for limiting intervention and
strengthening communications and guidance to market participants. The
steps to tighten liquidity should be reversed when pressures have
abated. The recently activated auction system provides a framework for
managing exchange rate pressures and preventing ad hoc interventions.
The auction could also be used to rebuild buffers in 2015, for
example, by providing a mechanism for daily FX purchases. As the dram
adjustment and the increase of interest rates-combined with slowing
growth-could have implications for the banking sector, the authorities
should continue to monitor the situation closely, with frequent stress
testing and contingency plans in place. If pressures continue, a
tightening of monetary and fiscal policies may be needed.
Challenges are likely to continue. The authorities have rightly noted
that the period ahead is expected to be characterized by continued
uncertainty and volatility, including in the oil markets and the
regional geopolitical context. The policy framework of a low fiscal
deficit, reinforced exchange rate flexibility, sound buffers, and
growth enhancing reforms is appropriate, although as indicated in the
staff appraisal, more ER flexibility and decisive structural reform
implementation would be desirable.
Staff continues to support the conclusion of the First Review.
From: Baghdasarian