Structural reforms more urgent amid significant uncertainty – IMF

ArmInfo.The Executive Board of the International Monetary Fund (IMF) approved SDR 128.8 million (about US$171.1 million) 36-Month Stand-By Arrangement (SBA) for Armenia to help maintain macroeconomic stability, provide insurance against downside risks, and support structural reform agenda. On this occasion, Mr Mehdi Raissi, IMF Resident Representative in Armenia, kindly agreed to answer a number of questions in an interview with ArmInfo.

- Please tell us about the key areas of the new 2023-2025 three-year precautionary Stand-By Arrangement for Armenia. How different is it from the main items in the previous program? The actual amount of the support under the new arrangement has been decreased from 180 to 171.1 million. What is the reason for it? After all, risks of instability - primarily risks of high inflation and fiscal imbalances - are increasing globally.

- In May 2022,Armeniasuccessfully completed an IMF-supported program that helped mitigate the adverse effects of the Covid-19 pandemic and the war in the Nagorno Karabakh (NK) conflict zone, and paved the way for further structural reforms. The economy has experienced robust growth for two years now, and the outlook for 2023 and the medium-term is generally positive. Nonetheless, uncertainty is very high and structural reform needs are there.

In this context, the new Stand By Arrangementaims tosupport the authorities in their efforts to:

1. Preserve macroeconomic stability. Specific policies include:

A 2023 government budget that is supportive of Armenia’s development needs and a medium-term spending paththat will keep public debt moderate. Raisingadditional revenueswill allow for spending on health, education, infrastructure, and social protection.

A monetary policy stance that brings inflation down to the CBA target of 4 percent over time, supported by exchange rate policy thatpreserves the existing two-way flexibility of AMD andmaintains healthy international reserve buffers.

Financial sector measures to reduce risks from rising housing prices and fast mortgage lending, preserve banks’ capital buffers, and strengthen the regulatory and supervisory framework.

2. Invest in the future and pursue higher, more inclusive economic growth. A package of structural reforms that aims to facilitate trade and investment; develop infrastructure and improve connectivity; make it easier for the private sector to do business in Armenia; create jobs and enhance social protection; advance digitalization; and build resilience against climate change. Reforms in these areas will also complement efforts supported by other development partners.

3. Provide insurance against downside risks. The Armenian authorities intend to treat the Stand By Arrangement as precautionary, given that the economy is currently doing well, and financing is available. The IMF-supported program aims to provide a positive market signal, catalyze support from other International Financial Institutions, and serve as insurance against potential external financing needs. The size of the arrangement is tailored to achieve these objectives.

- How do you evaluate performance under the previous program considering the force majeure circumstances related to the pandemic and the war in Nagorno Karabakh? Isn’t the IMF concerned about the Government’s under-execution of the budget items in respect of capital investment?

- Performance under the 2019-22 IMF- supported program was strong. The shocks that hit the economy in 2020 required greater financial support than originally envisaged. This allowed the authorities to provide targeted health and social protection to the vulnerable while preserving fiscal sustainability. Reforms of revenue administration and public financial management helped increase resources for priority spending. The CBA’s efforts to enhance communication and develop financial markets helped strengthen the inflation targeting framework. The CBA also refined its supervisory toolkit. The CBA’s international reserves gradually increased to comfortable levels by May 2022. Structural reforms began to strengthen governance and support the business environment.

Nonetheless, progress with execution of foreign financed projects has remained slow. This is a long-standing issue that needs to be carefully analyzed and addressed. Under the new IMF-supported program, the Armenian authorities have committed to identify and address the bottlenecks to an effective cycle of planning, budgeting, implementing, and monitoring of large capital projects. The IMF stands ready to provide Technical Assistance to advance these efforts.

- In officially disseminated messages the IMF recommends that tight monetary policies are maintained. You probably know that the tight monetary policies focusing on curbing inflation lead to contained inflation on the one hand, and strengthened dram exchange and rate reduced public debt on the other; however, at the same time they significantly reduce the competitiveness of export-oriented businesses. In the meantime, export support remains one of the critical tasks of the government. How can the golden mean be found? After all, the government is avoiding the provision of direct assistance to exporters. 

- Let me explain each one of these important issues:

1. High inflation is a key concern, and the CBA’s efforts to address inflationary pressures have been timely and proactive. The CBA’s policy priority is to steer inflation toward the target of 4 percent over time. This is critical to preserve macroeconomic stability and support medium-term growth. High inflation is particularly harmful for the most vulnerable, adding to the urgency of tackling it head on.

2. The drivers of dram appreciation need to be understood well. The massive influx of income, capital, labor, and business to Armenia following the war in Ukraine increased the supply of foreign currencies and raised the demand for dram, causing significant appreciation pressures.

3. Public debt is expected to drop from 60.3 percent of GDP in 2021to 51 percent of GDP by end-2022, which is an achievement. Our assessment shows that GDP growth in 2022 has had the largest contribution to this decline. Indeed, dram appreciation has also contributed very significantly, given the large share of foreign currency denominated debt in total public debt. This also underscores the need to build buffers against future shocks that could affect growth and the exchange rate.

4. Competitiveness of export-oriented sectors is multi-faceted and depends on both price and non-price factors. As a result of the large inflows since the onset of the war in Ukraine, the dram has appreciated by20 percent in nominal terms against a basket of currencies of Armenia’s trading partners, but has notably depreciated against the ruble, contributing to the increase of Russia’s share in Armenia’s exports. Nonetheless, exports to most key trading partners have increased significantly in 2022. Preserving competitiveness and broadening Armenia’s export destinations depends on factors such as quality, sophistication, and flexibility of exports. In this regard, the authorities’ plans to conduct a comprehensive assessment of Armenia’s competitiveness are welcome.

The new Stand-By-Arrangement will support the authorities’ objective to pursue export-led growth. Specific reforms will be guided by the 2021–26 Government Program. For example, expanding the existing infrastructure system is critical to support exports and attract foreign direct investment. Easing customs procedures and reducing processing times could contribute to higher trade volumes.

- Excess liquidity in Armenia’s banking sector and serious slowdown in credit to the economy could over time increase the risks of loss in profitability over time with inflows from abroad coming to a halt and reduced non-interest income. And how do you think can investment activity of the country’s banking sector be increased?

- Thanks to CBA’s prudent risk management and strong supervision, the banking system is well capitalized and liquid (enabling it to withstand shocks, absorb losses, and pay its short-term liabilities). Banks’ capital adequacy ratios remain well above the current minimum requirement of 12 percent, liquidity is ample (as protection for depositors), and Non-Performing Loans are low at around 3 percent of total. Albeit due to transitory factors, profitability of the banking sector has improved. The recent pick-up in credit growth has been driven by a32-percent increase in dram mortgages (compared with December 2021). Loans to companies have also risen, but their overall stock in banks’ balance sheets has declined due to the dram appreciation. Growth in consumer loans, which accounted for less than one-fourth of total loans as of October 2022, has been minor due to limited demand and ample liquidity of households’ balance sheets.

A key priority for the CBA is to continue monitoring financial sector risks and enhancing the macro prudential tools (i.e., policies aimed at ensuring the stability of the financial system as a whole). This would help stem risks associated with the rapid rise in housing prices and mortgage lending. Preserving the stability of the financial system is critical to ensure that banks can continue to support the economy and contribute to investment activity.