US embassy cable - 04YEREVAN1651

UNCLAS SECTION 01 OF 02 YEREVAN 001651 
 
SIPDIS 
 
SENSITIVE 
 
DEPT FOR EUR/CACEN 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, AM, RU 
SUBJECT: CENTRAL BANK, MINISTRIES SCRAMBLE TO KEEP THE 
DRAM STABLE AGAINST THE DOLLAR 
 
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SUMMARY 
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1. (SBU) As the Central Bank of Armenia's (CBA) 
Chairman Tigran Sargsyan left for his summer holiday 
July 19, a sharp and unexpected appreciation of the 
Armenian Dram (AMD) against the dollar and euro caused 
uncertainty and suspicion in Armenia's currency 
markets.  With rare volatility, the dram rose 10 
percent against the dollar (to AMD 495) in the 
beginning of the week of July 19, its highest level 
since 1998, only to fall back by 6 percent later in the 
week.  The press and the banking community blamed the 
CBA for reacting too slowly, hinting that the market 
had been manipulated with the tacit acquiescence of the 
bank.  The CBA appeared to intervene only after a 
political meeting with the President and Ministry of 
Finance and Economy (MFE), despite the bank's 
ostensible autonomy.  Although it is too early to say 
what caused the sudden volatility, the bumpy ride 
exposed the lack of confidence the banking community 
has in the ability of Armenia's currency markets to 
resist speculative manipulation, and of the CBA to 
guarantee the stability of the Dram.  End Summary. 
 
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DRAM CHANGES COURSE IN 2004 
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2. (SBU) Since it was introduced in 1993 and until the 
end of 2003, the Dram continued on a slow depreciation 
against the dollar of about 3 percent annually.  This 
year, due only in part to the dollar's fall against all 
currencies, the Dram has steadily climbed from its all- 
time low (AMD 590/1 USD) in December 2003.  By the end 
of the first quarter it gained value to 560 and reached 
540 by the end of the second quarter.  In contrast to 
the dram's steady rise all year, last week's 
appreciation to AMD 495 USD was widely viewed as too 
high, triggering banks and businesses to quickly buy 
dollars aiming to turn a quick profit.  The MFE tried 
to intervene at this point and purchase USD 10 million 
in dollars, but the CBA prevented the sale and instead 
intervened by lowering the overnight Dram lending rate 
by a point. 
 
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THE CENTRAL BANK: "WE HAVE A FREE FLOATING CURRENCY" 
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3. (SBU) In a recent conversation with the Ambassador, 
the Chairman of the CBA, Tigran Sargsyan, commented 
that the sharp appreciation of AMD was caused by 
seasonal factors, such as foreign remittances, 
increased investment flows and tourism.  Sargsyan 
insisted that the CBA is following the free-float 
pricing policy for its currency and does not interfere 
in the foreign exchange market.  He predicted that the 
recent volatility would be stabilized by October, when 
seasonal effects are weaker. 
4. (SBU) Local bankers note that there has no 
significant increase in the inflow of tourism dollars 
or remittances that could explain the Dram's rise.  The 
stability of the Dram during last year's inflow of USD 
80 million from the Lincy foundation suggests that 
small increases in foreign trade or remittances are 
unlikely to be the sole cause of such volatility.  The 
Central Bank and two private bankers noted that there 
was no significant difference in transfers of dollars 
from abroad, suggesting that Armenia's economy is 
sufficiently dollarized that significant amounts of 
dollars can enter the market without the necessity for 
international transfers. 
 
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USING DRAM APPRECIATION TO MEET INFLATION TARGETS? 
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5. (SBU) The press and bankers alike have accused the 
CBA of allowing (or even orchestrating) the 
appreciation in order to meet their increasingly 
unrealistic inflation target of 3 percent.  For its 
part the bank denies managing a controlled currency 
float, although the bank of course periodically buys 
and sells the dollars and euros it keeps as reserve 
currency.  In a conversation before the sudden peak, 
CBA board member Vache Gabrielyan commented that the 
Central Bank had substantial foreign currency reserves, 
so he didn't expect that the bank would purchase 
dollars to offset the rising Dram as it has done in the 
past. 
 
6. (SBU) Note:  Consumer price inflation was 8.6 
percent last year, due to a rise in the world price of 
food commodities, especially wheat.  A 3 percent target 
next year seems unrealistic, as fuel and water tariffs 
will likely rise.  Because Armenia relies heavily on 
imports for its basic consumables, a rise in the Dram 
should have downward pressure on inflation.  But 
despite the steady appreciation of the Dram this year, 
inflation remains high at 4.5 percent because basic 
foodstuffs are not sold in competitive markets, but 
rather, by de facto import monopolies which translate 
lower costs into higher profits.  End Note. 
 
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DRAMATIC IRONY 
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7. (SBU) The impetus to intervene to stabilize the Dram 
appeared to come from outside the CBA, which is charged 
with maintaining its stability.  According to Deputy 
Minister of Finance David Avetissian, the President 
convened an urgent meeting July 21 with the CBA 
Chairman and the Minister of Finance and Economy to 
discuss the rapid rise of the Dram.  Minister of 
Finance Vardan Khachatryan told the press that he had 
outlined the danger of a strong Dram to the state 
budget, which is financed in part in foreign currency 
by international donor organizations.  To counteract 
the threat, Khachatryan proposed that the Ministry 
intervene on the currency market to buy USD 10 million 
in dollars, which the budget could use to service loans 
to foreign lenders.  The CBA objected, claiming 
(rightly) that such interventions were the exclusive 
domain of the Central Bank.  The CBA then proposed to 
lower the overnight Dram lending rate, which should 
have encouraged some banks to switch short-term assets 
into dollars.  Deputy Minister Avetissian said that the 
Dram depreciated by 6 percent shortly after the 
meeting, as speculators became confident that the Dram 
increase would be controlled. 
 
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SPECULATION? 
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7. (SBU) A prominent banker, along with the media, 
suggested that speculators drove the Dram up under the 
assumption that currency traders would overreact, 
allowing the speculators to purchase back dollars at an 
even lower price.  The banker added that one local 
commercial bank was actively selling dollars when the 
Dram was very high, raising suspicions that they were 
somehow trying to manipulate the market.  Although 
Chairman Sargsyan insisted that any speculation in the 
foreign exchange market would be noticed by the Central 
Bank, the recent rapid appreciation and fallback of the 
dram has sparked speculation that someone is 
manipulating the currency markets to his financial 
benefit.  Minister Khachatryan noted in a press 
conference that President Kocharian had ordered an 
investigation of transactions during last week to 
ascertain the cause of the Dram's fleeting spike. 
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COMMENT: FINANCIAL MARKETS STILL VULNERABLE 
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9. (SBU) Recent events highlight the fact that Armenia 
is a small economy that lacks developed financial 
markets, and is vulnerable to even medium-scale 
currency flows.  Currency traders don't appear to know 
what to expect from the monetary authorities at the 
Central Bank.  The fact that it apparently took a 
political meeting to enforce a monetary solution casts 
doubt on the Central Bank's nominal autonomy.  Whatever 
the cause of the sharp fluctuation in the currency 
market, the press and the banking community alike were 
quick to note their lack of confidence in the CBA's 
ability to ensure a stable and predictable monetary 
policy. 
ORDWAY