STORM CLOUDS GATHERING FOR ARMENIA'S ECONOMY?

C O N F I D E N T I A L SECTION 01 OF 04 YEREVAN 000100 SIPDIS E.O. 12958: DECL: 01/30/2019 TAGS: ECON EFIN EINV ETRD AM SUBJECT: STORM CLOUDS GATHERING FOR ARMENIA'S ECONOMY? REF: A) 2008 YEREVAN 983 B) YEREVAN 004 YEREVAN 00000100 001.2 OF 004 Classified By: Ambassador Marie L. Yovanovitch. Reasons 1.4 (b/d) SUMMARY -------------- ¶1. (C) Armenia's economy continues to worsen as the effects of the global financial crisis take root. While the banking system remains stable, Armenia is highly vulnerable to external events, particularly in Russia. The real economy is already hurting, with indicators pointing to further pain ahead. GDP growth is projected to decline significantly in the wake of crises in several key sectors. Remittances are likely to decline as many Armenians begin to lose jobs in Russia's economic crisis. The GOAM is reportedly to receive over USD 1 billion in stabilization loans from the World Bank, IMF and Russia. Against widespread advice, the GOAM continues to support the Armenian Dram in an effort to maintain financial stability and forestall panic among depositors. The GOAM may also face serious social and political problems if workers are unable to find employment either domestically or abroad. End Summary. MACROECONOMIC INDICATORS FALLING -------------- ¶2. (C) The Ministry of Finance projects that Armenia's GDP will increase just 1.5 percent in 2009, and does not rule out the possibility of negative growth. This is based on estimates that the construction and industrial sectors--two major drivers of GDP growth in recent years--will decline by 3.5 percent and three percent, respectively. Both imports and exports are expected to decline in 2009, by 13.9 and 32.5 percent respectively, and the current account deficit is projected to be 12.7 percent of GDP. The official unemployment rate was 6.3 percent in 2008, although household surveys usually put the figure at closer to 25 percent, excluding persons who have gone to work abroad. REMITTANCES UP IN 2008, EXPECTED TO DECLINE IN 2009 -------------- -------------- ¶3. (C) Armenia's leading vulnerability remains Russia, where up to a million Armenians have been working in recent years, and from where they sent home over USD one billion in 2008. These transfers accounted for 85 percent of Armenia's remittances, which in turn comprised 15 percent of Armenia's GDP. According to the Central Bank of Armenia (CBA), remittances for 2008 were up last year 50 percent over 2007 (less than the 61 percent increase of 2007). January 2009 remittances also increased over those of January 2008. However, despite the January increase, the CBA estimates that 2009 remittances may decline up to 25 percent from 2008 levels. RETURN OF ARMENIAN WORKERS FROM ABROAD MAGNIFIES HARM -------------- -------------- ¶4. (C) While reliable statistics are not yet available, anecdotal evidence suggests that significant numbers of Armenians working in Russia have returned to Armenia for the "off season" and are unlikely to return to Russia in the spring. According to Khachatur Kokobelian, CEO of Artik Tuf (a major provider of a type of stone used in many Armenian buildings),800-900 persons from his native village typically go to Russia each year for seasonal work, but he expects this year that figure to be less than 100. Kokobelian also noted that the majority of seasonal workers returned unpaid from Russia this year, with only promises that their back wages will be paid to them in the upcoming months. DECLINES IN KEY SECTORS -------------- ¶5. (C) The key sectors of mining and construction continue to experience difficulty, due to a combination of declining world prices and falling demand. In November the GOAM bought a brief respite with Deno Gold in Kapan by refunding the firm USD 2.5 million in VAT refunds it had long been owed, in exchange for a 90-day moratorium on layoffs. That stay will expire on February 18 and there is no sign that the mining sector is about to revive and save those jobs. ¶6. (C) Several persons in the construction industry told Econoff that it has almost entirely shut down due to economic conditions, with sales of building materials down 80 percent over normal levels from this time of year. Despite the proliferation of construction cranes in downtown Yerevan, construction work is reportedly occurring at just two buildings. Gagik Tsarukian, Armenia's richest man and owner of dozens of companies employing 22,000 persons (he said), told the Ambassador that sales volume across his businesses is down significantly--mentioning specifically his firms that YEREVAN 00000100 002.2 OF 004 produce concrete, brandy, and pharmaceuticals, and his car import business. He claimed that he is covering losses himself, unwilling to lay off employees who depend on him for economic survival. ¶7. (C) Two very recent reports suggest that falling demand has also affected the airline and advertising industries. The local director of Austrian Airlines told us that traffic is lower than normal this year on the Yerevan-Vienna route and that Lufthansa is about to terminate its Yereven-Munich service due to low demand. The Embassy has also learned that USG-funded billboards advertising Radio Liberty/Radio Free Europe (RFE/RL),for which the Embassy had purchased a six-month contract, will receive a free three-month extension, evidently because the provider has nothing with which to replace them. PRICES ODDLY STABLE IN REAL ESTATE AND CONSTRUCTION -------------- -------------- ¶8. (C) Despite the slowdown in the construction and real estate sectors, prices for real estate have remained fairly level. Khachatur Kokobelian told Econoff that in downtown Yerevan, land is selling for USD 1,000 per square meter, very high by international standards (by comparison, it is reportedly selling for USD 750/square meter in downtown Warsaw). ¶9. (C) While there is little construction activity occurring at present, prices of cement have not dropped and warehouses are full of cement. He suggested that producers are stockpiling inventory in anticipation of the known April 1 increase in natural gas prices that will increase production costs, and also suggested that many cement producers are hoping to supply cement for Olympics-related construction in Sochi, Russia--presumed to be a recession-proof project. At the same time, prices for imported building materials (including steel) and equipment have fallen due to reduced worldwide demand and the continued strength of the Dram. BANKING SECTOR STABLE, BUT SOME MOVEMENT OUT OF DRAM -------------- -------------- ¶10. (C) Armenia's banking indicators remain stable. CBA Deputy Chairman Vache Gabrielian told EconOff that the banks are well-capitalized, have high levels of liquidity and are still lending. There is little vulnerability to bad loans, and Gabrielian said that stress tests done by the CBA show that absent major shocks, the banking system should be able to withstand the strains of the economic crisis. Gabrielian also said that the CBA would welcome some bank mergers, but only to reduce the number of banks in this relatively small country, not because any of them are in poor condition. ¶11. (C) Despite the CBA's efforts to sustain the Dram, deposits continue to flow out of AMD and into foreign currencies: During the month of December AMD deposits declined by AMD 32 billion (USD 105 million) or 12 percent, and foreign exchange deposits increased by AMD 35 billion (USD 115 million) or 17 percent. Outstanding loans remained essentially unchanged; many banks have found it more profitable--and less risky--to invest in government securities rather than to make new loans. FEW TOOLS FOR GOAM TO ADDRESS THE CRISIS -------------- ¶12. (C) According to new IMF Regional Director Mark Lewis, the crisis could still have a much greater impact on Armenia, and the GOAM has few tools at its disposal to address the situation. So far the GOAM has sought loans frominternational financial institutions for SME lending and budget support payments; supported troubled businesses, especially in the IT sector; and perhaps most controversially, continued to support the Armenian Dram (AMD),which due to intervention in the foreign exchange markets has held steady against the dollar even when most major currencies have experienced significant declines. The GOAM also hopes that the economy will benefit from some major infrastructure projects funded by donors including, they hope, reinstated MCC funding for road construction. CONTINUED SUPPORT OF THE DRAM -------------- ¶13. (C) Over the past year the AMD has held steady at about 305 per USD, due to intervention in the forex markets by the CBA. Between October and the end of January, the CBA has spent over USD 250 million--about one-sixth of its foreign reserves--supporting the Dram. Independent estimates are that it may be overvalued by 25 percent or more at present. According to CBA Deputy Chairman Vache Gabrielian, while the CBA still officially adheres to a policy of a managed float, YEREVAN 00000100 003.2 OF 004 it is trying to maintain financial stability through its forex intervention. ¶14. (C) Gabrielian acknowledged that the CBA cannot continue propping up the AMD indefinitely. Gabrielian refused to confirm the state of Armenia's forex reserves; however, based on published statistics and other information, we believe that the CBA had about USD 1.5 billion worth of hard currency reserves as of last fall, and has expended approximately USD 250 million dollars since October on its forex interventions. CBA policy calls for maintaining the value of three months of imports (about USD 1 billion) as a minimum reserve. ¶15. (C) Gabrielian said that while there has been internal discussion about a gradual devaluation, the CBA has made no decision about changing its policy on supporting the Dram. Vachram Nercissiantz, Presidential Economic Advisor, told EconOff his preference would be for the CBA to manage a gradual devaluation of the AMD. He also expressed hope that the credits from the World Bank, IMF and Russia, by increasing liquidity in the banking system, would bolster confidence in the AMD and prevent a panic-driven devaluation. TWO LOAN PACKAGES DOWN...ONE TO GO -------------- ¶16. (C) In the past three weeks, the World Bank and the Russian Government have reportedly each committed at least USD 500 million in stabilization loans to Armenia -- although the World Bank funds will be disbursed over four years, diluting somewhat the stimulus effect, and few details are known of the announced Russian loan package. (Comment: Russian financial aid packages in the past have sometimes featured a big headline number, which later turns out to be inflated with smoke-and-mirrors accounting and amount to much less new money than appeared at first. We have no information about this case. End Comment) Much of this World Bank and Russian money would be reportedly used for SME lending. ¶17. (C) The GOAM hopes to receive the same amount from the IMF, whose delegation was in Yerevan until February 17 negotiating a loan package. Discussions with IMF delegation members thus far suggest that the GOAM probably will not receive as large a credit--via the IMF's "standby" credit facility--as from the World Bank or Russia. ¶18. (C) Both the World Bank and IMF have told us in recent weeks that any aid packages would be conditioned on the CBA abandoning its forex interventions. However, Gabrielian told Econoff that although the World Bank and IMF have expressed their concerns about this issue, they understand the rationale behind Armenia's currency policy. IMF officials have been tightlipped with us, but the World Bank Resident Representative told us that arm-twisting the Armenian CBA to stop trying to prop up the Dram was the major policy goal of the IMF delegation visit the week of February 9--a message, if true, that the CBA appears not to have taken on board. There have also been suggestions--including from the World Bank's resident representative--that the GOAM would use the Russian money to continue supporting the Dram. Deputy Finance Minister Vardan Aramian denied to EconOff that the money would be used this way. PRIME MINISTER OUTLINES SEVERAL MEASURES -------------- ¶19. (C) In a meeting with the Ambassador in January, Prime Minister Tigran Sargsian outlined a strategy to revive the economy that would include SME lending and a range of infrastructure projects including roads and replacement of the Armenian Nuclear Power Plant (ANPP). He expressed great confidence that the ANPP project*estimated to cost USD 5-6 billion*would get funding. Taking the Ambassador aside afterward, the Prime Minister also suggested that as a last resort for funding projects, the GOAM would simply print more money if necessary, in spite of its inflationary effect. COMMENT -------------- ¶20. (C) Armenia is in a difficult position given that it is largely feeling the effects of economic problems in other countries--notably the collapse of world oil and mineral prices*-so cannot easily turn things around on its own. This leaves the GOAM with few viable strategies to address the crisis, and many of those it is considering may be of questionable effectiveness: adding liquidity to the financial system may be of little use if the banking system has few liquidity problems or if banks find it more profitable to buy government securities; SME lending may achieve little if the businesses receiving financing lack customers. While Armenia YEREVAN 00000100 004.2 OF 004 will surely benefit in the long run from infrastructure improvements, some of the envisioned road projects can probably be completed this year but the ANPP is several years from construction and unlikely to provide any meaningful short-term fiscal stimulus. The CBA's support of the Dram threatens an excessive drawdown of its foreign currency reserves, and may merely postpone an inevitable and precipitous devaluation. ¶21. (C) Even in good times, Armenia has its economic challenges, with a per capita GDP of just USD 3,000 even after six years of double-digit growth, and with many towns and rural areas having few employment prospects. The longtime solution has been for workers to go abroad in search of employment. That option is now disappearing as well. An economic problem could eventually become a political problem for the GOAM if thousands of workers return to Armenia with no employment prospects either domestically or abroad. END COMMENT. PENNINGTON