AMBASSADOR'S INTRODUCTORY MEETING WITH CENTRAL

C O N F I D E N T I A L SECTION 01 OF 03 YEREVAN 001014

SIPDIS

E.O. 12958: DECL: 12/09/2018
TAGS: PROV PREL ECON EFIN EINV AM RU
SUBJECT: AMBASSADOR'S INTRODUCTORY MEETING WITH CENTRAL
BANK CHAIRMAN

Classified By: Ambassador Marie L. Yovanovitch. Reasons 1.4 (b/d)

SUMMARY
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1. (C) In their introductory meeting December 8, Central Bank
of Armenia (CBA) Chairman Arthur Javadyan stressed to the
Ambassador the high priority the CBA places on maintaining
monetary stability and preventing panic among Armenian
depositors. He insisted that Armenia's banking system is in
sound condition, due to conservative banking practices and
low levels of debt in the Armenian economy. Javadyan
defended the CBA's revocation of Western Union's license over
its withdrawal from Nagarno-Karabakh, which is reported
septel. End Summary.

MONETARY STABILITY IS KEY
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2. (C) During their introductory meeting December 9, CBA
Chairman Arthur Javadyan told Ambassador that he is not
concerned about the Armenian banking sector, as it is stable,
liquid and well-capitalized, with liquidity and
capital-adequacy ratios well within normal ranges and higher
than in many western banks. While this is not necessarily
good for generating financial returns, most banks are in a
good position to meet cash demands of their depositors, if
necessary.


3. (C) Asked about CBA intervention in the foreign exchange
markets to support the Dram--the CBA spent USD 100 million in
October and November doing so--Javadyan confirmed the CBA's
support for floating exchange rates, but said the CBA is
trying to smoothe fluctuations. The CBA's target is not a
particular exchange rate but accumulated foreign-currency
reserves equal to the value of three months of imports; the
reserve balance is now equal to 3.2 months of imports. He
noted that while the CBA has spent USD 170 million supporting
the Dram during 2008, just two weeks ago the CBA purchased
USD to maintain stability. Javadyan acknowledged that there
is not necessarily an economic rationale for tying financial
stability to the exchange rate, but that a volatile exchange
rate will likely generate panic among the public and provoke
a run on deposits.

DEPOSITS AND LOANS ARE UP
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4. (C) Javadyan noted that in the first part of December,
bank deposits, especially from households (as opposed to
businesses with seasonally-based transactions) have been
increasing, suggesting favorable trends for household
savings and confidence in the banking system. While deposits
fell slightly in November, that was largely the result of
some depositors needing to meet cash needs rather than a
reflection of panic. Lending in October and November also
increased, though terms are becoming more stringent,
especially for real estate transactions, where banks have in
the past generally assumed prices would only increase.
Personal loans and those for SMEs are on the increase, as
well, and for the first ten months of 2008, year-to-year
lending increased 58 percent over 2007, comparable to the
increase during the same period in the prior year.


5. (C) Decreased activity is coming largely from the real
sector rather than the financial sector, with the mining and
chemical industries particularly affected. (NOTE: In a
separate conversation December 9, the British CEO of HSBC
Bank Armenia commented that the stock of bank deposits in the
Armenian banking sector had declined three percent in
October-November, in a seeming show of no-confidence. He
also said that HSBC's lending portfolio had reached record
highs during the period, because most other banks in Armenian
had dramatically curtailed lending, leaving the field to
HSBC. However, as a result, HSBC will soon run short of
available capital to lend, with flat deposits lagging well
behind the spike in loan applications. END NOTE)

CONCERN ABOUT RUSSIA
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6. (C) Javadyan confirmed that Armenia remains highly
vulnerable to developments in the Russian economy. In
addition to concern about declines in employment leading to a
major reduction in remittances, Russian consumers carry much
higher debt loads than Armenians, so a high level of credit
defaults could further devastate the banking system, which
already faced closure of hundreds of institutions.
(According to Javadyan, in late November the Vice Governor of
Russia's Central Bank announced plans to close 400 banks, and
subsequently increased the figure to 900. Also, Russian
Prime Minister Putin met recently with bankers and
businesspersons, and said that 200 banks should be enough for

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Russia). The CBA is concerned that while Armenian banks are
in good condition, failure of Russian banks could create a
panic among Armenians that could imperil healthy Armenian
institutions. Many Armenia workers in Russia also have
accounts in Russian banks.


7. (C) While the CBA has been projecting zero growth of
remittances in 2009, Javadyan indicated that it is still
difficult to make a realistic projection. One factor is that
the Russian government is considering potential stimulus
programs, with one possibility a proposal to subsidize
completion of buildings or roads already more than 50 percent
finished. Given the number of Armenians working in the
Russian construction sector, such an initiative could blunt
the job loss for Armenians and help keep remittances flowing.

DRAM-DENOMINATED MORTGAGES
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8. (C) Javadyan said that the CBA is still considering the
possibility of amending regulations under the Law on
Currencies to require that all mortgage lending be done in
AMD, as is already required for other types of loans. While
some financial institutions that receive funds from abroad
are concerned about the impact of such a regulation on their
business, Javadyan indicated that having a significant part
of the economy denominated in other currencies can lead to
problems with monetary policy and undermine the CBA's goal of
ensuring monetary stability. He noted that when Moody's and
Fitch rated Armenia last year, both cited concerns about
creeping dollarization or currency substitution. (Note: Our
contacts at Fitch told EconOff that they do not identify
specific policy actions as ratings triggers. However, they
confirm that a high level of dollarization can be problematic
for sovereign credit, as it exposes the economy to sharp
exchange-rate movements. End Note).


9. Javadyan noted that only last year did AMD-denominated
deposits exceed USD-denominated deposits (as of October 31,
foreign currencies comprised 43 percent of bank deposits and
39 percent of outstanding loans). He stressed the importance
of protecting consumers from long-term foreign exchange risks
if they borrow in currencies other than AMD, particularly
over a 15-year mortgage term. He insisted, however, that the
proposal is only being circulated at present, with a decision
still several months away. With inflation not a serious
concern at present, the CBA just this week reduced the "repo"
(overnight lending) rate by 50 basis points, to 7.25 percent.
Javadyan hopes that the rate will soon be reduced to 6.5
percent, if the threat of inflation remains low. This rate
remains the lowest in the CIS region.

LOSSES FROM RUSSIA-GEORGIA CONFLICT
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10. (C) Javadyan reiterated the GOAM's estimates that losses
to the Armenian economy--both direct and indirect--from the
August conflict between Russia and Georgia were close to USD
700 million. He noted that the estimate--first undertaken by
the Ministry of Finance and later reviewed and modified
slightly by the CBA--employed the same methodology as the
Georgian government had used its own estimates. Javadyan
noted that the global financial crisis began to take effect
only in late September--when global commodity prices began to
fall--and there is little likelihood that the GOAM is
conflating the effects of the two crises in estimating its
economic losses. (Comment: We are less certain that USD 700
million is an accurate figure and IMF calculations do not
support this amount of losses in Armenia. End Comment).

ARMENIA'S FISCAL STIMULUS
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11. (SBU) Javadyan outlined a number of projects the GOAM
plans to undertake in order to spur economic activity. These
include completion of a long-discussed (since 2000)
north-south railroad linking Russia to Iran (through Georgia
and Armenia); replacement of the Armenian Nuclear Power Plant
(ANPP) and construction of over 4,000 housing units in the
areas most severely damaged by the 1988 earthquake, including
Gyumri, Spitak and some villages. If there is no increase in
commodity prices in the next 6-7 months, the GOAM will look
to undertake other projects, as well. (Comment: All of these
are long-term projects that are unlikely--particularly in the
case of the nuclear power plant--to be initiated within the
next several months. While they will also doubtless be of
considerable economic benefit to Armenia in the future, they
seem to be of little value in the short run. End Comment).

MONEY-LAUNDERING PROSECUTIONS
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12. (C) Ambassador praised the cooperation of the Financial

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Monitoring Center (FMC) with Embassy staff, though expressed
regret that there have not yet been any money-laundering
prosecutions initiated. Javadyan said a recent case had in
fact been launched, which we are still attempting to verify.

COMMENT
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13. (C) Javadyan's assessment of the economic situation seems
largely on-target and the CBA has to-date engaged in prudent
management of the economy and of the financial institutions
under its jurisdiction. The CBA--under both Javadyan and his
predecessor, now-PM Tigran Sargsian--has a reputation as a
competent, serious body. We nevertheless believe that the
CBA is painting a more positive picture of the road ahead
than is likely warranted. End Comment.
YOVANOVITCH