US embassy cable - 05YEREVAN1007

UNCLAS SECTION 01 OF 02 YEREVAN 001007 
 
SIPDIS 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EAID, AM 
SUBJECT:  ARMENIA'S STEADY GROWTH, STABLE ECONOMY CONTINUES 
IN 2005 
 
 
1. (U) THIS CABLE IS SENSITIVE BUT UNCLASSIFIED.  PLEASE 
PROTECT ACCORDINGLY. 
 
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SUMMARY 
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2. (SBU) Armenia's steady economic performance continues 
during 2005.  First quarter data supports the International 
Monetary Fund's (IMF) forecast of 8 percent GDP growth in 
2005, and there are encouraging signs that growth is more 
broad-based than in the past.  The government appears to be 
succeeding in its effort to raise tax revenues to support 
increased state-sector wages as well as social spending, key 
components of its poverty reduction strategy.  Sharp 
increases in foreign investment and remittances from abroad 
have pushed the dram up against the dollar and Euro, 
worrying foreign investors and forcing the Central Bank into 
an awkward trade-off between controlling inflation and 
controlling sharp exchange rate increases.  The dram's 
appreciation notwithstanding, indicators suggest a stable 
macroeconomic environment and steady but slow progress 
reducing poverty.  End Summary. 
 
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MACROECONOMIC OVERVIEW: GROWTH REMAINS STRONG 
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3. (SBU) In the first quarter of 2005, Armenia's GDP growth 
remained strong (and in-line with forecasts) at 7.8 percent 
against the same period of 2004.  As in the past three 
years, growth in construction (22.3 percent) drove the 
overall economic expansion.  Construction spending totaled 
USD 43.6 million during the first quarter, of which 82 
percent was privately financed.  The World Bank financed 
only 9.3 percent of construction and the GOAM 6.3 percent, 
refuting the common but spurious assertion that donors alone 
drive Armenia's construction boom.  In addition to 
construction, there are encouraging signs of a broad-based 
economic expansion.  Industry showed strong growth (5.1 
percent on average) in several sectors; the strongest growth 
was in electricity generation, bottled water production and 
distribution, tobacco production as well as mining and 
metallurgy. 
 
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EXCHANGE RATES FLUCTUATE 
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4. (SBU) Inflows of investment and a rapid growth in 
remittances caused the dram to appreciate sharply over the 
past 18 months, creating a complicated situation for 
Armenia's Central Bank.  The dram rose 16 percent against 
the dollar (13 percent against the euro) during 2004 and an 
additional 10 percent (6 percent against the euro) since the 
beginning of 2005.  Although the appreciation has not yet 
significantly hurt exports (see below), the Central Bank has 
intervened timorously in recent months to contain upward 
pressure on the exchange rate.  The Central Bank has not, 
however, intervened strongly enough to reverse or stall the 
dram's rise for fear that large purchases of foreign 
exchange could cause an inflationary increase in the money 
supply.  (Note:  The IMF has come out publicly in support of 
the Central Bank's decision to allow the dram to appreciate 
rather than risk increased inflation.  End Note.) 
 
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INFLATION CYCLICAL BUT STABLE 
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5. (SBU) Armenia's 4.4 percent inflation rate for the first 
quarter of 2005 illustrates the cyclical nature of Armenia's 
inflation.  High consumer price inflation in January (a 5.4 
percent increase on previous month) was followed by 0.7 
percent and 0.9 percent deflation in February and March 
respectively.  Because food makes up the greatest part of 
the consumer basket, higher prices for fish and meat brought 
inflation in January, and lower prices for vegetables in 
February and March drove the deflationary trend that 
typically continues through fall.  The Central Bank 
(reasonably) projects that it will meet its 3 percent 
inflation target, relying on Armenia's deflationary summer 
months and the appreciation of the Armenian Dram (which 
presumably makes imported food cheaper). 
 
6. (SBU) The outlook for the producer price index was more 
ominous.  Producer price indices in construction, sales, and 
agricultural sectors rose noticeably in the first quarter, 
by 15.2 percent, 7.9 percent and 7.3 percent, respectively, 
due largely to a significant price increase for non-ferrous 
metals (up by 62.7 percent).  Increases in the producer 
price indices will likely have only a muted effect on the 
consumer price index, which comprises (largely imported) 
food and services. 
 
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FOREIGN TRADE EXPANDS 
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7. (SBU) Despite the appreciation of local currency, 
Armenia's exports and imports increased by 28 percent during 
the year's first quarter.  The increase was due to 
substantial growth in exports to Germany (copper), Holland 
(diamonds), Israel (diamonds) and Switzerland and in imports 
from Russia, Belgium, and Israel (all diamonds).  Although 
the diamond trade kept up its share of the growth in trade, 
non-diamond exports and imports also grew by 29.4 percent 
and 22.4 percent, respectively, albeit from a low base, to 
USD 134 million and USD 293 million. 
 
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WAGES UP, UNEMPLOYMENT DECREASING 
--------------------------------- 
 
8. (SBU) Average nominal monthly wages/salaries increased by 
23.7 percent to AMD 47,564 (approximately USD 107) compared 
to the first quarter of 2004.  In part this increase was 
driven by a 31.3 percent increase in public sector wages, 
but private sector wages rose 19 percent as well, despite 
the fall in nominal wages for the many employees whose 
paychecks are dollar-denominated.  Also suggesting stronger 
demand for labor, the official unemployment rate fell from 
9.4 percent to 8.9 percent the first quarter 2005.  While 
the official unemployment rate grossly understates real 
unemployment (which was estimated to be 30 percent in 2001), 
when combined with the positive trend in wages it suggests 
that total unemployment is falling. 
 
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BUDGET REVENUES AND EXPENDITURES ARE UP 
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9. (SBU) According to first quarter data from the National 
Statistics Service, the government has succeeded in 
increasing tax revenues to support increases in social 
expenditures.  Budget revenues for January-March 2005 were 
AMD 77,445 million (approximately USD 172 million), 36.6 
percent higher than the same period last year and tax 
revenues increased to 15 percent of GDP.  Government 
expenditures also rose 31.5 percent.  While defense still 
claimed the largest share of expenditures at 17.7 percent 
(up 2 percent from 2004), education and science received 
15.4 percent (also up 2 percent from 2004) and social 
insurance 15.9 percent (up 4 percent). 
 
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COMMENT: ARMENIA FULFILLING POVERTY REDUCTION STRATEGY 
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10. (SBU) As Armenia's economy continues its steady growth, 
the government of Armenia has taken steps to implement its 
Poverty Reduction Strategy Paper, the government's de facto 
economic development strategy.  The GOAM maintains 
macroeconomic stability by keeping a prudent monetary policy 
and a free-floating exchange rate.  Although the dram's 
appreciation affects many in Armenia who have dollar- 
denominated contracts, it has not yet hindered the growth of 
Armenia's exports, which often have dollar-denominated 
inputs.  While both foreign investment and domestic growth 
continue, the State Tax Service has been able to increase 
tax collection which has translated into increased spending 
on public wages (such as teachers and hospital workers, many 
of whose salaries are below the poverty level) and social 
welfare. 
EVANS