REVENUES AND EXPENDITURES UP IN DRAFT 2006 BUDGET

UNCLAS SECTION 01 OF 02 YEREVAN 001960

SIPDIS

SENSITIVE

E.O. 12958: N/A
TAGS: ECON EFIN EAID AM
SUBJECT: REVENUES AND EXPENDITURES UP IN DRAFT 2006 BUDGET

REF: A) 04 YEREVAN 1651 B) YEREVAN 1705

Sensitive but unclassified. Please protect accordingly.

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SUMMARY:
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1. (SBU) The GOAM draft budget for 2006, currently under
debate in the National Assembly, envisages significant
increases in health and social security expenditures paid for
by increased tax revenue and deficit spending. The budget is
based on an exchange rate of AMD 420 to the dollar, a dram
appreciation of approximately 8 percent from the current
rate. The IMF Country Representative describes the 2006
draft budget as consistent with program targets and in line
with Armenia's Poverty Reduction Strategy. End Summary.

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DRAFT BUDGET: HEALTH AND SOCIAL SECURITY EXPENDITURES UP
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2. (SBU) The GOAM recently submitted its draft 2006 budget to
the National Assembly. The draft is currently under debate
and will likely be approved by the end of November. Under
the draft proposal, total expenditures for 2006 will increase
by almost 15 percent compared to 2005 (from AMD 394.6 billion
to AMD 451.9 billion -- approximately USD 1 billion at the
projected exchange rate of AMD 420 to the dollar). The
projected total expenditures in the 2006 budget are the
largest since Armenian independence, with significant
increases in health care and social security spending.
Health care expenditures are projected to be AMD 39.1 billion
(approximately USD 93 million at the projected exchange rate
of AMD 420 to the dollar) an increase of AMD 6.8 billion
compared to 2005. Social security spending is projected to
reach AMD 55.4 billion (approximately USD 132 million at a
rate of AMD 420 to the dollar) up by AMD 8.8 billion from
2005 levels. The proposed 2006 budget also envisages
increases in public sector wages and defense spending.

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"AMBITIOUS" TAX COLLECTION TARGET
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3. (SBU) The 2006 draft budget proposes a significant (15.5
percent) increase in tax revenue. The International Monetary
Fund (IMF) Country Representative described this target as
"ambitious." According to statistics provided by the IMF,
tax revenue collection for the first nine months of 2005 was
approximately 18.4 percent higher than for the same period in
2004, but still slightly below the IMF target. The GOAM also
plans to increase deficit spending to cover 2006
expenditures. Deficit spending is projected to increase by
AMD 17.9 billion, from AMD 52 billion in 2005 to AMD 69.9
billion (approximately USD 166 million at a rate of AMD 420
to the dollar) in 2006. The IMF Country Representative told
us the draft 2006 budget was consistent with program targets
and in line with Armenia's Poverty Reduction Strategy.

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CBA PROJECTS 8 PERCENT DRAM APPRECIATION
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4. (SBU) The proposed 2006 budget is based on an exchange
rate of 420 AMD to the dollar. This estimate, which was
agreed upon by both the Central Bank of Armenia (CBA) and the
Ministry of Finance and Economy, indicates that the GOAM
expects the dram to appreciate against the dollar by about 8
percent in 2006. The current exchange rate is approximately
450 AMD to the dollar, but it has been fluctuating on a
near-daily basis. According to Head of the Financial
Monitoring Center and former Advisor to the Chairman of the
CBA Nerses Yeristyan, the CBA set the target exchange rate in
anticipation of an increase of dollar flows into Armenia due,
in part, to a possible Millennium Challenge Corporation grant
and a confirmed USD 60 million grant from the Lincy
Foundation. Yeristyan said the CBA planned to sterilize a
portion of the in-flows, but expected that there will be some
appreciation of the dram. According to Yeristyan, the higher
priority for the CBA is not to exceed the IMF-sanctioned 3
percent inflation rate. In previous years, the CBA has been
accused of manipulating the exchange rate in order to mask
greater than anticipated increases in inflation (ref A).


5. (SBU) The estimated appreciation of the dram was greater
in last year's 2005 budget than it is in the 2006 budget.
The average exchange rate in 2004 was 533, but the rate set
in the 2005 budget was 468 (13 percent lower than the 2004
average). This year the margin between the average exchange
rate and the rate used for the 2006 budget is 9 percent. The
average rate to-date for 2005 is 459 and the 2006 budget
target is 420.

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COMMENT: ARMENIA ON TRACK WITH POVERTY REDUCTION STRATEGY
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6. (SBU) Steady growth (ref B) and increased tax revenue have
allowed the GOAM to propose additional health and social
security spending for 2006. While there is an on-going need
for reform within the tax sector, this draft budget shows
that the GOAM is making progress towards improving its
economic position and meeting the requirements of its Poverty
Reduction Strategy. The projected appreciation of the dram,
should it materialize, may pose a threat to Armenian exports.
Current growth rates, however, suggest that the impact on
exports to date has been limited.
EVANS