US embassy cable - 04YEREVAN349

UNCLAS SECTION 01 OF 03 YEREVAN 000349 
 
SIPDIS 
 
SENSITIVE BUT UNCLASSIFIED 
 
DEPT FOR EUR/CACEN-MPAWLICK, EUR/ACE-MLONGI, EB/CBA 
PASS TDA-DSTEIN, OPIC, EXIM-TUMMINIA, USTR-CKLEIN 
COMMERCE FOR 4231/MAC/EUR/OEERIS/RISD/MLONDON 
COMMERCE FOR 4201/ITA/IEP/OEERIS/BISNIS/MWALTERS 
MOSCOW, KIEV, TBILISI, BAKU, ANKARA AND ISTANBUL - PASS 
FCS 
ANKARA ALSO FOR CFC/SNIDER/BALLINGER 
 
E.O. 12958: N/A 
TAGS: ECON, ENRG, EFIN, EAID, EAIR, AM, RU 
SUBJECT: ARMENIA: DOUBLE DIGIT GROWTH 
 
 
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SUMMARY 
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1.  Armenia's 2003 economic performance exceeded all 
predictions; despite the rounds of elections and 
political tremors during the year, the real Gross 
Domestic Product (GDP) grew by 13.9 percent, a record 
high since 1991 independence.  Construction (mostly 
donor financed) and industry contributed to the growth 
by about 6 and 4.5 percentage points respectively.  The 
external sector expanded by more than 30 percent, with 
exports growing faster than imports.  The economy 
posted positive trends in labor and financial markets 
as well.  The major price indices, however, show sharp 
increases:  the Consumer Price Index (CPI) grew by 8.6 
percent, while the Producer Price Index (PPI) jumped by 
21.1 percent, the highest annual inflation rate since 
1998.  End Summary. 
 
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MACROECONOMIC OVERVIEW: CONSTRUCTION DRIVES GROWTH 
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2.  Although the annualized economic growth rate 
declined by the end of December compared to November, 
the annual growth rate finished the year at 13.9 
percent, the highest since independence.  The growth 
pattern, however, was volatile in the first half of 
2003, fluctuating from 7.5 percent in February to 14.9 
percent in June.  In the second half of 2003 the growth 
rate was relatively stable hovering around 15 percent. 
3.  As in 2002, industry and construction continue to 
drive growth.  Year-on-year construction growth was 
roughly 40 percent from January to December 2003 (with 
residential construction growing by nearly 80 percent). 
Diaspora-based Lincy Foundation financing supported 
most of the growth in construction.  Private 
construction almost doubled, however, responding to 
demand and sustained price increases in the real estate 
market.  (Note:  Construction as a share of GDP is 
estimated at 14.4 percent.  End Note.) 
4.  Production of industrial goods increased by 14.9 
percent with the level of electricity production was 
unchanged.  Within the manufacturing sector, tobacco 
output was up 37 percent in volume terms, rubber and 
plastic by 125 percent, metal processing by 46 percent 
and machinery by almost 26 percent.  These high rates 
are partly attributable to a depressed base-period, but 
also reflect considerable new investment in these 
sectors.  Industry has by far the largest share of GDP, 
24.1 percent.  Agriculture, constituting about 21 
percent of GDP, grew at 4.3 percent, despite 
pessimistic forecasts due to an unusually cold winter 
in 2002-2003.   Retail trade and services also grew 
strongly (about 13 percent), indicating a consolidation 
of domestic demand. 
 
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INFLATION: BREAD PRICES HIT THE CONSUMER BASKET 
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5.  Monthly price trends followed seasonal patterns in 
deflationary summer.  In September, however, when the 
trend is also usually deflationary, prices rose by 2.5 
percent, owing to a sharp jump in prices for bread and 
related products.  This brought year-on-year inflation 
in September to more than 7 percent.  Although in 
September international financial institutions as well 
as the Central Bank of Armenia (CBA) gave various 
forecasts of up to 7 percent inflation for the year, 
inflation for the rest of the year continued its trend 
with the highest monthly price increase of 5.3 percent 
in December.  That brought the annual cumulative 
inflation to 8.6 percent, the highest since 1998. 
6.  An estimated 5 percentage points of the inflation 
is explained by an increase in wheat prices in Russia, 
the main trade partner in this category.  Wheat 
products represent nearly 20 percent of the CPI basket, 
and aggregate prices for this group increased by more 
than 25 percent in 2003.  In early September the 
governor of the CBA, Tigran Sarkissian, said that there 
was no need to adjust monetary policy for 2003, 
implying only "moderate" growth in the money supply to 
neutralize inflationary pressures.  He referred to the 
price increase as a "temporary external shock," without 
which the CPI would be in line with the targeted level 
of 3 percent.  (Note:  According to the Monetary Policy 
Program, the CBA forecasts 7 percent inflation in 2004, 
mostly due to anticipated increases in gas and water 
tariffs.  End Note.) 
7.  The GDP deflator, the indicator of price changes on 
all products, increased in December by 0.2 percentage 
points, bringing annualized growth in the deflator for 
January-December to 4.7 percent, the highest since 
1998.  The Producer Price Index, an indicator of cost- 
driven inflation, also trended upward by the end of the 
year, increasing by 21.1 percent, the highest level 
since 1998. 
 
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EMPLOYMENT: NUMBERS MIXED, BUT GENERALLY HIGHER 
--------------------------------------------- -- 
8.  According to the National Statistics Services 
(NSS), 10.1 percent of the active population, or 124.8 
thousand people, is currently unemployed, compared to 
9.4 percent in 2002.  Although this may appear 
paradoxical in a period of high growth, the NSS finally 
incorporated the 2001 Census results into the 
unemployment calculus, according to which the 
denominator used, active population, decreased from 
about 1.4 million in 2002 calculations to 1.24 million 
in 2003.  Applying the new numbers back to the 2002 
estimate, the unemployment rate would come to 10.8 
percent.  Thus, over the course of 2003, real 
unemployment decreased by 0.7 percent.  (Note: Official 
unemployment counts only those who receive unemployment 
insurance, not all those who are looking for jobs.  End 
Note.) 
 
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EXTERNAL SECTOR: RUSSIA LOSES MARKET SHARE 
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9.  Armenia's trade turnover expanded rapidly in year- 
on-year terms, with growth driven mainly by a 
substantial increase in trade in precious stones and 
metals.  According to official data, export revenue was 
up by 34.2 percent at USD 678.1 million, well above the 
USD 590 million projected by the CBA.  Import 
expenditures grew at about 28.6 percent to USD 1.3 
billion.  Precious metals and stones continue to 
dominate Armenia's trade structure:  about 52 percent 
of export growth and 41 percent of import growth is 
attributed to precious stones and metals.  The sector 
has benefited from stable supplies of stones from its 
main sources:  Israel, Belgium and Russia. 
 
10.  Russia, although it remains Armenia's largest 
trade partner, lost market share for the second year in 
a row.  Russia's total trade share decreased from 19.2 
percent in 2001 to 17.3 in 2002 and 15.5 (or USD 302.3 
million) in 2003.  Imports from Russia, although they 
increased in dollar terms, decreased as a share of 
total imports from 19.5 percent in 2002 to 16.4 percent 
(or USD 207.7 million) in 2003.  Israel became the 
largest export partner for Armenia, with total exports 
of USD 142.3 million, up by about 84 percent.  Belgium 
and the USA remain the third and fourth trade partners 
in terms of exports. 
 
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FINANCIAL SECTOR: DECREASING INTEREST RATES AND STABLE 
ARMENIAN DRAM (AMD) HERALD LOWER COUNTRY RISK 
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11.  During 2003, the CBA twice revised its refinancing 
rate, eventually cutting it from 13.5 percent to 9 
percent in August.  The policy was designed to 
stimulate the demand for money in the economy, 
increasing money supply (M2) by 28 percent.  (Note: 
This provided yet another reason for increased 
inflation.  End Note.)  In 2003 most interest rates 
declined, including deposit and money market rates. 
Nevertheless, high credit risks and the poor quality of 
financial management between banks and enterprises kept 
lending rates high, thus increasing profits in the 
banking sector. 
 
12.  The Armenian national currency, the Dram (AMD), 
fluctuated within a narrow band against the USD during 
the year.  In August a nominal depreciation of 4.2 
percent year-on-year was recorded, partly reflecting 
inflationary expectations.  By the end of September, 
however, the rate stood at AMD 570/USD 1, an 
appreciation of almost 2 percent, mostly due to USD 
inflow to the country via transfers and tourist 
spending.  (Note:  According to the NSS, the number of 
tourists in 2003 increased by about 27 percent to 
205,000.  End Note.)  The AMD lost value during the 
usual Christmas and New Year shopping frenzy, sliding 
back to normal rates immediately after the holidays. 
ORDWAY