Armenia: Country outlook

COUNTRY VIEW

ECONOMIST INTELLIGENCE UNIT
PUBLICATION DATE: August 01, 2005

OVERVIEW: Tension in Armenia’s political scene is likely to ease. Real
GDP growth will be relatively strong, at an annual average of about 7.5%
in 2005-06. We forecast an average annual inflation rate of 2.4% this
year, followed by a rate of 2.5% in 2006. Strong current transfers
credits will contain the current-account deficit at an annual average of
around 5% of GDP in 2005-06, despite a growing trade deficit.

DOMESTIC POLITICS: Tension in Armenia’s political scene is likely to
ease, following the approval by the Council of Europe’s Venice
Commission of a package of constitutional amendments intended to ensure
a more balanced distribution of power. The next challenge for the
authorities will be to persuade the public to support the changes in a
referendum. A positive outcome in the referendum will depend on the
opposition’s response to the proposed changes. Prior to the Venice
Commission’s assessment, several of Armenia’s opposition parties had
indicated that they would end their 18-month long boycott of the
National Assembly (parliament) and resume co-operation with the
government, assuming that the changes were sufficiently far-reaching in
terms of reducing the powers of the presidency. Their return to
parliament would accord a greater sense of legitimacy to the legislature.

INTERNATIONAL RELATIONS: Armenia will continue to pursue a
“complementary” foreign policy, whereby it seeks to balance relations
with the US, the EU, Russia and Iran. The government is also likely to
accord a high priority to an easing of relations with Turkey, and to
talks with Azerbaijan over the disputed region of Nagorny Karabakh.
Negotiations over Nagorny Karabakh have gained momentum over the past
few months, with several rounds of high-level talks held. Although
Armenian officials have sought to downplay expectations that a
breakthrough in the conflict is imminent, it appears that considerable
progress has been made towards reaching a settlement acceptable to both
sides.

POLICY TRENDS: A poverty reduction strategy paper, a medium-term
expenditure programme (for 2005-08) and an anti-corruption strategy will
determine the government’s economic policy. The main policy priorities
will include further reforms of the tax and customs administration,
enhancing fiscal transparency (in particular, by improving expenditure
management), and strengthening the financial sector and the judiciary,
along with the completion of reforms in the energy and water sectors.
More effective mobilisation of tax revenue will also be a priority, with
a view to reducing dependence on foreign grants.

ECONOMIC GROWTH: We expect real GDP growth to slow from 10.1% in 2004 to
an annual average of just over 7% in 2005-06. The strong base period is
the main factor behind the anticipated slowdown, as the outlook for
domestic demand is relatively favourable. Government consumption and
investment will rise strongly, as the authorities increase both social
and capital spending, and private consumption will be supported by
strong inflows of workers’ remittances. In addition, credit from banks
to private enterprises is expected to increase.

INFLATION: Price stability will remain the main objective of monetary
policy, and to this end the central bank will refrain from intervening
in the currency markets, instead allowing the dram to appreciate in
order to reduce inflationary pressure. External pressure on domestic
prices is expected to weaken in 2005-06, in view of our forecast for
easing world food prices. We forecast an average annual inflation rate
of 2.4% this year, followed by a rate of 2.5% in 2006.

EXCHANGE RATES: Foreign-currency inflows, in the form of workers’
remittances and other private transfers, will remain high in 2005-06,
ensuring that the dram stays strong against the US dollar. The Central
Bank has projected an annual average rate of Dram485:US$1 for 2005, but
on current trends an average rate of Dram445:US$1 appears more
realistic. After strengthening briefly in mid-2005, the US dollar is
once again expected to weaken, a trend that will continue throughout
2006, resulting in an annual average rate of about Dram430:US$1.

EXTERNAL ACCOUNT: A fall in donor-financed investment could lead to a
reduction in spending on capital goods such as construction materials,
machinery and equipment. However, strong inflows of private transfers
will support private consumption, keeping expenditure on consumer goods
imports high. The growing trade deficit will be only partly offset by
the surplus on current transfers, resulting in a widening
current-account deficit. Relatively robust economic growth will
nevertheless contain the annual average deficit at about 5% of GDP in
2005-06.

SOURCE: Country outlook