ARMENIA'S STEADY GROWTH, STABLE ECONOMY CONTINUES

UNCLAS SECTION 01 OF 02 YEREVAN 001007

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN EAID AM
SUBJECT: ARMENIA'S STEADY GROWTH, STABLE ECONOMY CONTINUES
IN 2005



1. (U) THIS CABLE IS SENSITIVE BUT UNCLASSIFIED. PLEASE
PROTECT ACCORDINGLY.

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SUMMARY
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2. (SBU) Armenia's steady economic performance continues
during 2005. First quarter data supports the International
Monetary Fund's (IMF) forecast of 8 percent GDP growth in
2005, and there are encouraging signs that growth is more
broad-based than in the past. The government appears to be
succeeding in its effort to raise tax revenues to support
increased state-sector wages as well as social spending, key
components of its poverty reduction strategy. Sharp
increases in foreign investment and remittances from abroad
have pushed the dram up against the dollar and Euro,
worrying foreign investors and forcing the Central Bank into
an awkward trade-off between controlling inflation and
controlling sharp exchange rate increases. The dram's
appreciation notwithstanding, indicators suggest a stable
macroeconomic environment and steady but slow progress
reducing poverty. End Summary.

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MACROECONOMIC OVERVIEW: GROWTH REMAINS STRONG
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3. (SBU) In the first quarter of 2005, Armenia's GDP growth
remained strong (and in-line with forecasts) at 7.8 percent
against the same period of 2004. As in the past three
years, growth in construction (22.3 percent) drove the
overall economic expansion. Construction spending totaled
USD 43.6 million during the first quarter, of which 82
percent was privately financed. The World Bank financed
only 9.3 percent of construction and the GOAM 6.3 percent,
refuting the common but spurious assertion that donors alone
drive Armenia's construction boom. In addition to
construction, there are encouraging signs of a broad-based
economic expansion. Industry showed strong growth (5.1
percent on average) in several sectors; the strongest growth
was in electricity generation, bottled water production and
distribution, tobacco production as well as mining and
metallurgy.

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EXCHANGE RATES FLUCTUATE
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4. (SBU) Inflows of investment and a rapid growth in
remittances caused the dram to appreciate sharply over the
past 18 months, creating a complicated situation for
Armenia's Central Bank. The dram rose 16 percent against
the dollar (13 percent against the euro) during 2004 and an
additional 10 percent (6 percent against the euro) since the
beginning of 2005. Although the appreciation has not yet
significantly hurt exports (see below),the Central Bank has
intervened timorously in recent months to contain upward
pressure on the exchange rate. The Central Bank has not,
however, intervened strongly enough to reverse or stall the
dram's rise for fear that large purchases of foreign
exchange could cause an inflationary increase in the money
supply. (Note: The IMF has come out publicly in support of
the Central Bank's decision to allow the dram to appreciate
rather than risk increased inflation. End Note.)

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INFLATION CYCLICAL BUT STABLE
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5. (SBU) Armenia's 4.4 percent inflation rate for the first
quarter of 2005 illustrates the cyclical nature of Armenia's
inflation. High consumer price inflation in January (a 5.4
percent increase on previous month) was followed by 0.7
percent and 0.9 percent deflation in February and March
respectively. Because food makes up the greatest part of
the consumer basket, higher prices for fish and meat brought
inflation in January, and lower prices for vegetables in
February and March drove the deflationary trend that
typically continues through fall. The Central Bank
(reasonably) projects that it will meet its 3 percent
inflation target, relying on Armenia's deflationary summer
months and the appreciation of the Armenian Dram (which
presumably makes imported food cheaper).


6. (SBU) The outlook for the producer price index was more
ominous. Producer price indices in construction, sales, and
agricultural sectors rose noticeably in the first quarter,
by 15.2 percent, 7.9 percent and 7.3 percent, respectively,
due largely to a significant price increase for non-ferrous
metals (up by 62.7 percent). Increases in the producer
price indices will likely have only a muted effect on the
consumer price index, which comprises (largely imported)
food and services.

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FOREIGN TRADE EXPANDS
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7. (SBU) Despite the appreciation of local currency,
Armenia's exports and imports increased by 28 percent during
the year's first quarter. The increase was due to
substantial growth in exports to Germany (copper),Holland
(diamonds),Israel (diamonds) and Switzerland and in imports
from Russia, Belgium, and Israel (all diamonds). Although
the diamond trade kept up its share of the growth in trade,
non-diamond exports and imports also grew by 29.4 percent
and 22.4 percent, respectively, albeit from a low base, to
USD 134 million and USD 293 million.

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WAGES UP, UNEMPLOYMENT DECREASING
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8. (SBU) Average nominal monthly wages/salaries increased by
23.7 percent to AMD 47,564 (approximately USD 107) compared
to the first quarter of 2004. In part this increase was
driven by a 31.3 percent increase in public sector wages,
but private sector wages rose 19 percent as well, despite
the fall in nominal wages for the many employees whose
paychecks are dollar-denominated. Also suggesting stronger
demand for labor, the official unemployment rate fell from
9.4 percent to 8.9 percent the first quarter 2005. While
the official unemployment rate grossly understates real
unemployment (which was estimated to be 30 percent in 2001),
when combined with the positive trend in wages it suggests
that total unemployment is falling.

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BUDGET REVENUES AND EXPENDITURES ARE UP
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9. (SBU) According to first quarter data from the National
Statistics Service, the government has succeeded in
increasing tax revenues to support increases in social
expenditures. Budget revenues for January-March 2005 were
AMD 77,445 million (approximately USD 172 million),36.6
percent higher than the same period last year and tax
revenues increased to 15 percent of GDP. Government
expenditures also rose 31.5 percent. While defense still
claimed the largest share of expenditures at 17.7 percent
(up 2 percent from 2004),education and science received
15.4 percent (also up 2 percent from 2004) and social
insurance 15.9 percent (up 4 percent).

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COMMENT: ARMENIA FULFILLING POVERTY REDUCTION STRATEGY
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10. (SBU) As Armenia's economy continues its steady growth,
the government of Armenia has taken steps to implement its
Poverty Reduction Strategy Paper, the government's de facto
economic development strategy. The GOAM maintains
macroeconomic stability by keeping a prudent monetary policy
and a free-floating exchange rate. Although the dram's
appreciation affects many in Armenia who have dollar-
denominated contracts, it has not yet hindered the growth of
Armenia's exports, which often have dollar-denominated
inputs. While both foreign investment and domestic growth
continue, the State Tax Service has been able to increase
tax collection which has translated into increased spending
on public wages (such as teachers and hospital workers, many
of whose salaries are below the poverty level) and social
welfare.
EVANS