ARMENIAN INFLATION: CENTRAL BANK IN A CORNER

UNCLAS YEREVAN 001781

SIPDIS

SENSITIVE

DEPT FOR EUR/CACEN-ESIDEREAS, EUR/ACE-MLONGI, EB/CBA

E.O. 12958: N/A
TAGS: ECON EFIN AM
SUBJECT: ARMENIAN INFLATION: CENTRAL BANK IN A CORNER

Ref: Yerevan 1651


1. (U) Sensitive but unclassified. Please protect
accordingly.


2. (SBU) Summary. A rising tide of dollars in the
economy is forcing Armenia's Central Bank to choose
between an appreciated local currency or increased
inflation. Although it is choosing to let the Dram
rise, inflation nevertheless exceeds the 3 percent
target. End Summary.

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EXTRA DOLLARS DRIVE DRAM APPRECIATION
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3. (U) Extra dollars are coming from both outside and
inside the country, raising the value of the Dram
against the dollar. From inside, a significant
increase in dollar-denominated commercial and consumer
lending by banks has taken dollars from bank vaults and
put them on the street. Recent economic growth and
better business expectations have attracted non-bank
dollar savings from houses into investments. From
outside, foreign investments, remittances and private
transfers, as well as tourism income have contributed
to the expansion of the dollar supply. The Dram's rapid
appreciation against the dollar, which makes exports
uncompetitive and causes instability in the heavily
dollarized economy, makes matters difficult for the
CBA. There is political pressure on the CBA to
intervene to stabilize the Dram but it cannot put Drams
on the market without further fueling inflation or
raising interest rates, both undesirable.

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CENTRAL BANK UNLIKELY TO MEET INFLATION TARGET
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4. (SBU) Although the CBA decreased the real (Dram)
money supply by 3 percent for the first half of 2004,
the economy posted 7.6 percent year-on-year inflation,
due to an expanding economy and increases in the price
of imported staple goods. Nerses Yeristyan, Advisor to
the Chairman of the CBA, told us recently that meeting
the inflation target of 3 percent is going to be "a
very difficult task." The CBA claims that 50 percent
of the money transactions in the economy are in
currency other than the Dram, and are thus outside the
CBA's control. Whether or not political pressure
forces the CBA to intervene to keep the Dram from
appreciating, if will be difficult to meet the 3
percent inflation target.
GODFREY