IMF says Armenia's banking sector remains sound

The Executive Board of the International Monetary Fund (IMF) today 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.

In addition, the Executive Board concluded the 2014 Article IV consultation with Armenia and endorsed the staff appraisal without a meeting on a lapse-of-time basis. 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), lowerthan-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 growthenhancing 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 member- ship 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.

In concluding the 2014 Article IV consultation with Armenia, Executive Directors said 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.