Armenia Cbank To Pursue Stringent Monpol In Face of Inflation
YEREVAN, Armenia
By David Barwick

The Main Wire
February 29, 2008 Friday 11:08 AM GMT

The Central Bank of Armenia expects to face high inflationary pressures
at least through 2008 and will pursue "more stringent" monetary policy
to ward off second-round effects and return CPI to its definition of
price stability, Chairman Tigran Sargsyan said Tuesday.

Speaking to Market News International in an interview, Sargsyan
asserted that the recent increase from 3% to 4% of the midpoint of the
bank’s inflation target has not affected expectations. He defended
hiking the target, but suggested that returning to a target of 3%
would be possible as of 2011.

Despite wage growth averaging 20% annually in recent years, compared
with price increases of 3-4%, second-round effects have not posed a
problem thus far, thanks in large part to the inflation- dampening
effect of productivity gains, according to Sargsyan.

"Whether such a spiral is looming somewhere in the future is something
we have to be very cautious about, which is why I say up front that
we’re going to pursue ever-more-stringent monetary policies to preclude
second-round inflation effects," he said.

The bank missed its inflation target last year due to exogenous shocks
that propelled consumer price growth to 5% on commodities, notably
wheat, he explained. "We are attempting to raise interest rates to
keep the target within reach, and by the end of the year that should
get us back to the same corridor," he said, implying CPI for 2008 of
"5.5% at most."

At the same time, "it goes without saying that we cannot withstand
serious price shocks and would not even aspire to. What we would do
is try to explain them to the market participants so that our policies
enjoy their trust," he said.

"I have looked at today’s global market data, and they do not appease
our concerns in any way," he continued, citing wheat futures and fuel
prices. "We will be pursued by inflationary pressures throughout the
year. We haven’t received any hopeful signals yet."

The domestic agricultural sector could yet post a substantial gain in
production, which would mitigate inflation a bit, Sargsyan said. "But
at this point in time, the mood within the Armenian monetary authority
is that we intend to carry on stringent policies."

Sargsyan ruled out any further near-term change in the bank’s inflation
target, the last hike of which met with international criticism. "If,
hypothetically, there are exogenous shocks that result in higher
inflation, what we will do is come up with explanations for market
participants," he said. "We are responsible for inflation caused by
monetary factors."

He dismissed the complaints about the hike in the target, saying the
bank is "never short of criticism," be it for high inflation, the
appreciation of the country’s currency, the dram, or low financial
intermediation.

The combined impact of currently high inflationary pressures, rapid
wage growth and an expected "drastic" increase in national social
expenditures suggest it would be "more reasonable to aim for 4%
inflation the next three years and thereafter to aim for 3% again,"
he said.

The increase in the target had no effect on market expectations,
Sargsyan maintained. The bank’s surveys continue to show that, as in
Europe, Armenian consumers perceive inflation to be well in excess
of actual CPI, with banks and other companies exhibiting views more
in line with those of monetary authorities.

The appreciation of the dram over recent years "has restrained
inflation substantially in this country," Sargsyan said. "Because
we have stayed faithful to the floating exchange, as opposed to our
neighbors, who have been playing with both inflation and exchange
and failed at both," he explained.

Asked if he expected the dram to continue dampening inflation, he
replied, "We are not going to modify the foundation of our policies.

We only intervene in the forex market to mitigate significant
fluctuations that may agitate the market."

The last such occasion was to stem a "surge of panic" on the last
weekend of November 2007. The fears at the time were "absolutely
groundless," Sargsyan said, and mainly reflected the still-immature
nature of a market with very few institutional investors.

Sargsyan rejected what he called "the spearhead of criticism we’re
under" for the dram’s strength. Taking into account its real,
trade-weighted exchange rate rather than simply considering nominal
exchange rates reveals a far better-looking situation in which "export
growth rates have not suffered; on the contrary, they have increased,"
he stressed.

Asked if the dram reflects Armenian economic fundamentals, Sargsyan
merely noted that half of the currency’s appreciation since 2003
reflects private remittances from Armenians abroad, with another third
due to foreign direct investment and the balance caused by improving
terms of trade and productivity gains.

Remittance flows will shrink as Armenia’s standard of living increases,
he continued, observing that some repatriation of jobs, notably in
the construction sector, has already occurred.

"At the end of the day the dram’s rate is determined by the market,"
he added.

After averaging some 13% over the last five years, Armenian growth
should remain broad-based but cool to 10-11% this year and next,
he said.

"I don’t think growth of 10% will be undermined," Sargsyan affirmed,
noting that three to four percentage points of volatility are already
built into the forecasts. "It may fall short of 13%, but we will
still have at least 10%."

Downside risks to growth include the possibility that the current
global crisis could eventually affect private remittances; interfere
with large-scale projects currently envisioned in transportation,
mining, energy and agriculture; or dissuade Russian, European and
American private investors if those economies suffer, Sargsyan said.

The indirect impact of U.S. sub-prime woes depends on subsequent
developments in global capital markets

The direct impact of the sub-prime crisis on Armenia "will be
negligible if anything," he said, given that Armenian commercial banks
only have 0.1% of their holdings in anything other than government
paper of one kind or another, essentially rendering them "immune"
to the crisis. "So there will be no direct impact," he said.

Although the current weakness of the U.S. dollar is worrisome for
the central bank from the perspectives of the domestic macroeconomy,
forex reserve policy and international commodity prices, Sargsyan
expressed confidence in the dollar and the U.S. economy.

"For the next 15 years, the U.S. economy will not be seriously
challenged and will emerge stronger from the current tribulations,"
he predicted. "The dollar will maintain its dominance, backed by the
dominance of the U.S. economy."

China and India will become major producers of machinery and finished
goods, Russia will seek a niche between Europe and China, the U.S.

economy will be increasingly based on knowledge and technology, while
"Europe will attempt to catch up with the States, never really making
it," he said.

European Monetary Union is a "quite remarkable experiment" that has so
far had "significant successes," he allowed, but it is also fraught
with risks related to the lack of a corresponding governance system
and cultural or philosophical differences.

Although Armenia is well-positioned to attain levels of productivity
similar to those of Europe in a decade or so, Sargsyan said,
introducing the euro here "is a much more far-away issue; it’s not
even an objective yet.

Armenia is currently trying hard to pattern its economic structures
on European legislation, he noted, and to this end it "carefully
looks at all the European directives."

"I think that in the next five years the environment here will be
dramatically qualitatively changed and far less divergent from Europe
than it is now," he predicted