Tuesday, April 28 2009

EVENT: Real GDP will contract by 5% this year, the IMF's April World Economic Outlook predicts.

SIGNIFICANCE: Economic activity is falling to a record low as the economy undergoes an abrupt decline in activity, reflected among other things in lower government budget income.

ANALYSIS: According to preliminary data from the National Statistical Service, in the first quarter of 2009, real GDP contracted by 6.1% year-on-year. This is the worst performance since 1993. All the main branches of the economy plunged, compared with the year-earlier period:

industrial output (in volume terms) -- by 9.5%;
gross agricultural output -- by 5.1%; and
gross construction -- by 21.9%.
The service sector was the only one to show a slight increase, mainly thanks to a 3.9% increase in retail trade.

The contraction is an obvious consequence of the global economic crisis, which has resulted in a decline in investment in construction, the main engine of GDP growth in the past five years, and restricted demand for Armenian exports, mainly metals. Foreign trade has shrunk drastically, with exports at a mere 52.7% of the level of a year ago, and imports 77.8%. Imports now exceed exports more than fivefold, in dollar terms (659 million and 123 million, respectively).

Budget crisis. State budget revenues have also fallen. In January-February (the latest period for which data are available), they came to 84.6 billion drams (277 million dollars at the then-exchange rate). This is 15% less year-on-year and about 28% less than 2009 budget plan which, adopted last November, envisaged some 20% growth in revenues compared with 2008. In addition, it has become known that the 500 million dollar loan from Russia, initially expected in April, will not arrive before end-June.

In these conditions, the government decided to reallocate budget expenditure on a quarterly basis. On March 26, the cabinet restructured the budget by moving expenditures totalling some 131 billion drams (354 million dollars) into the fourth quarter of 2009 from earlier periods. This concerns mainly purchases for state bodies, which may for the first three quarters buy no cars, furniture or real estate. The government does not see any need as yet to adopt a reduced budget, counting on borrowing (the IMF approved in March a 28-month stand-by arrangement for 540 million dollars, of which 240 million is available now) or an upturn in revenues.

Remittances. Another difficulty is the decline in the level of private transfers from abroad (mainly from Russia). According to estimates, in January-February, they decreased by 30% year-on-year. However, this factor has not yet had a very significant influence on the market. As mentioned above, retail market sales increased in January-March; moreover, after the Central Bank (CBA) ceased intervening in the currency market on March 3, which resulted in the immediate depreciation of the dram from 305 to 370 to the dollar, pressure on the currency market has been low. In particular, the population's sale of dollars (near 40 million a week) has exceeded its purchases by more than 5% from March 10-April 15.

Forecasts. In an amended monetary policy document released in late March, the CBA expected real GDP to fall by about 3.0% year-on-year by end-2009, and estimated inflation at 5.9% in December. Moreover, in March, inflation was fairly low: 1.0% year-on-year, 0.7% since December 2008 and 2.0% over the first quarter compared with the year-earlier period. This enabled the CBA to lower the refinancing rate on April 7 by 0.25 percentage points to 7.5%. It also decided to increase its purchases of government bonds to inject more liquidity into the market.

The World Bank has warned that the economic crisis may result in an increase in the poverty level, from 22.7% in 2008 to 27.9% in 2010, above the level in 2006 (26.5%). Both the Bank and the IMF have urged the government to maintain a high level of social payments to limit impoverishment as far as possible. In particular, the IMF insists that the government increases social payments by 0.3% of GDP, as envisaged in the programme approved by the Fund. The government said it would protect social security expenditures in the state budget. Among the measures aimed at protecting the poor is a government programme of public works worth 700 million drams. So far, allowances, pensions and other social payments have been paid without delay.

Anti-crisis measures. The government has prepared the following anti-crisis measures to boost business activity and create jobs:

Under a bill adopted on March 19, value-added tax payments due on imported investment equipment are postponed for three years.

The process of simplifying the taxation, accounting and reporting rules for small and medium-sized enterprises (SMEs) has started under a legislative package adopted last year, but its implementation is controversial.

Five mining companies producing copper and molybdenum, one of which stopped work altogether late last year, have resumed operations, at least for the time being, and are to be working full-time by end-April. This has saved 6,000 jobs, which are important especially for Syunik province in the south. Thanks to a partial recovery in metals prices, their operations are nearly profitable, and the government is providing assistance. In particular, the Kajaran plant, which is the biggest in this sector, has obtained a short-term 10 million dollar credit for modernising its equipment.

The government is subsidising businesses. So far, 18 companies have received some 25 billion drams in different forms of assistance, ranging from loans and credit guarantees to the government's purchase of shares. These companies' activities include food processing, textiles, software and machine-tool production.

One of the principal steps aimed at reviving construction is the provision of loan guarantees for developers finishing off buildings that are 50% or more complete. The total sum of guarantees declared as of April 13 is 20 billion drams.

On April 2, the SME credit programme began, with a 50 million dollar World Bank loan.

The results of these measures are not yet evident. In particular, interest rates are still too high, at 15-20% per year. The government is looking for other sources of credit. Besides such international financial institutions as the European Bank for Reconstruction and Development and the Asian Development Bank, hopes are pinned on a domestic mortgage agency and a new bank, which are to be created later this year. However, the CBA is cautious about reducing interest rates further, out of concern for inflation.

CONCLUSION: The government's anti-crisis measures are unlikely to bring any quick improvement. Those taken so far are small, with the only actions likely to stimulate investments totalling less than 70 million dollars. Planned infrastructure projects have not yet started, other actions are only just getting under way and their impact will not be seen rapidly.

Keywords: EE, RUCIS, Armenia, IMF-World Bank, International, Russia, economy, industry, politics, social, debt, exchange rate, fiscal, government, growth, monetary, poverty, prices, agriculture, balance of payments, capital flows, construction, corporate, foreign trade, investment, manufacturing, metals, mining, public sector, retail, services, welfare