Global Insight Perspective | |
Significance | In the Joint Staff Advisory Note (JSAN) of the Poverty Reduction Strategy Paper (PRSP) Annual Progress Report, the World Bank's International Development Association (IDA) and the International Monetary Fund (IMF) have assessed Armenia's progress in the implementation of its Poverty Reduction Strategy (PRS), which aims at achieving equitable economic growth and sustainable poverty reduction in the former Soviet Union country. |
Implications | Generally, Armenia has made good progress in poverty reduction, but still faces several considerable tasks on its reform path. |
Outlook | A notable remaining challenge is to further strengthen tax administration, while also financial deepening needs to progress. |
The PRSP Implementation Action Plan was first approved in January 2004, and the Armenian authorities presented the first progress report to the World Bank's International Development Association (IDA) and the International Monetary Fund (IMF) in April 2005. The second progress report was presented to the international financial institutions in June, and examines reform implementation over 2004-05.
The IDA and IMF state that generally, the second PRSP Progress Report provides further evidence of rapid Armenian GDP growth and considerable reduction in poverty, as well as testifying to improved implementation of fiscal policy and social service delivery. Moreover, the authorities have made progress in improving their monitoring and evaluation of reforms, as well as in aligning the budget progress with the PRSP, as recommended in the previous Joint Staff Advisory Note (JSAN).
The IDA and IMF state that Armenia's economic performance remains strong, with annual GDP growth having reached double-digits in recent years, driven by agricultural production and construction. Meanwhile, inflation has remained low. The international lenders also note that Armenia's external debt indicators have improved, with the foreign debt to GDP ratio having fallen from 28.4% in 2002 to only 14.3% in 2005.
The staff of the IDA and IMF see that continued reform efforts are needed, especially in three fields.
- Reform of Tax and Customs Administration
While the Progress Report highlights continued progress in improving the conduct of fiscal policy, the IDA and IMF staff note that tax collection urgently needs to be strengthened further, as the tax-to-GDP ratio still remains relatively low compared to several regional peers. The international lenders urge Armenia to push on with continued reform in tax and customs administration, in order to secure sustainability of fiscal reforms and to enable efficient and transparent revenue mobilisation and improvements in business environment. In addition, while substantial progress has already been made in improving administration of public expenditures, further steps are needed in order to ensure transparent public resource management and stronger budget management systems.
- Deeper Competition in Key Services and Financial Intermediation
The international institutions note that the Armenian authorities have recently taken forward steps in improving the financial environment by strengthening banking supervision, supporting creditor rights, clarifying procedures for registering loan collateral, and for enforcing contracts. However, the Progress Report only includes limited discussion on further financial sector development, and the IDA and IMF urge the Armenian authorities to continue pursuing the financial reform agenda with determination, in order to achieve financial deepening and increased financial intermediation, to strengthen corporate governance in banks and to facilitate the introduction of new financial products such as housing finance.
The staff expressed their concern about Armenian plans to extend subsidised credits to targeted firms in the framework of a loan guarantee programme for small and medium sized enterprises (SMEs). As noted in the Progress Report, most of the SMEs enjoy relatively large returns, and thus do not seem to need subsidised credits, and giving these to profitable firms distorts incentives in the financial sector, thus also distorting resource allocation.
In addition, the international financial institutions recognise Armenia's progress in improving service supply and accountability in the important energy and water sectors. However, the staff urge further reduction in efficiency losses. As water tariffs are increased toward cost recovery levels, the most vulnerable consumers should be protected through targeted transfers rather than by providing general subsidies to producers. In addition, service quality and transparency should be ensured by regulatory measures. Rural development necessitates adequate and timely implementation of reform plans related to roads, water, energy and telecom sectors.
- Education, Health and Pension Reforms
Social sector expenditures have increased from 7.8% as a percentage of GDP in 2002 to 8.3% in 2004, which still is below the targeted ratio of 9.3% specified in the PRSP. Growth in social expenditures is necessary in order to meet poverty reduction targets. However, increased budget allocations to the social sector need to be combined with efforts to improve the efficiency and equity of social spending. In particular, the staffs recommend conducting costing exercises in the health and education sector in order to ensure that the services reflect costs, and building capacity for utilising and monitoring the use of funding. Finally, they note that the government has achieved satisfactory progress in introducing individual accounts in pension systems, improving collection of social insurance contributions and increasing pensions. The staffs encourage the authorities to keep increasing the real level of pensions, given their crucial role in reducing poverty. Consequently, it is of crucial importance that further pension reform is conducted so as to ensure sustainability and reliability, and in a way that encourages savings.
Outlook and Implications
The PRSP Progress Report provides donors with a significant amount of information to assess the advancement of poverty reduction, and the JSAN concludes that Armenia has achieved significant progress with reforms over the past years. However, it still needs to improve its business environment, increase competition in the service sector, deepen financial intermediation, continue implementing tax and customs reforms, and continue reforms in the sector of social service order to raise their quality.
Deepening financial intermediation would be of vital importance, as especially the important agricultural sector has reported difficulty in finding investment financing. Moreover, higher financial deepening is a crucial part of the general transition process.
As noted in the report by the IDA and IMF, Armenia's strong economic growth has recently been combined with very modest inflation rates. However, inflation pressures have shown signs of intensifying recently, as world market energy prices remain high and remittance inflows from abroad to Armenia remain strong (see Armenia: 11 August 2006:Strong Foreign Remittance Inflows to Armenia Signal Dependency and Boost Inflation). The Central Bank of Armenia (CBA) has curbed inflation by letting the dram appreciate. While this has not yet proved harmful to external competitiveness, given the dram's undervaluation and concurrent general productivity gains in the economy, macroeconomic policy conduct may become more challenging in the longer term.