CENTRAL BANK, MINISTRIES SCRAMBLE TO KEEP THE

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

--------------
SUMMARY
--------------


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.

--------------
DRAM CHANGES COURSE IN 2004
--------------


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.

-------------- --------------
THE CENTRAL BANK: "WE HAVE A FREE FLOATING CURRENCY"
-------------- --------------

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.

-------------- --------------
USING DRAM APPRECIATION TO MEET INFLATION TARGETS?
-------------- --------------


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.

--------------
DRAMATIC IRONY
--------------


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.

--------------
SPECULATION?
--------------


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.
--------------
COMMENT: FINANCIAL MARKETS STILL VULNERABLE
--------------


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