Armenia: Economic Report and Interim Operational Strategy (ERIOS)
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Economic Report and Interim Operational Strategy Armenia (2006–2009) August 2006 CURRENCY EQUIVALENTS (as of 30 March 2006) Currency Unit – dram (AMD) AMD1.00 = $0.0022 $1.00 = AMD451.08 ABBREVIATIONS ACS – Anti-Corruption Strategy ADB – Asian Development Bank ADF – Asian Development Fund BSTDB – Black Sea Trade and Development Bank CBA – Central Bank of Armenia CIS – Commonwealth of Independent States DFID – Department for International Development of the United Kingdom EBRD – European Bank for Reconstruction and Development EU – European Union FDI – foreign direct investment FSU – former Soviet Union GDP – gross domestic product GTZ – German Agency for Technical Cooperation IFAD – International Fund for Agricultural Development IFC – International Finance Corporation IMF – International Monetary Fund IOS – interim operational strategy JBIC – Japan Bank for International Cooperation JFPR – Japan Fund for Poverty Reduction KfW – Kreditanstalt für Wiederaufbau MCC – Millennium Challenge Corporation MDG – Millennium Development Goal MEFP – Memorandum of Economic and Financial Policies MLSA – Ministry of Labor and Social Affairs MTEF – Medium-Term Expenditure Framework MW – megawatt NBF – nonbank financial NPP – nuclear power plant NSS – National Statistical Service OCR – ordinary capital resources ODA – official development assistance PRGF – Poverty Reduction and Growth Facility PRSP – Poverty Reduction Strategy Paper SDR – special drawing rights SME – small and medium-sized enterprise TA – technical assistance TACIS – Technical Assistance to the Commonwealth of Independent States TPP – thermal power plant UN – United Nations UNDP – United Nations Development Programme USAID – United States Agency for International Development WSS – water supply and sanitation WTO – World Trade Organization NOTES (i) The fiscal year (FY) of the Government and its agencies ends on 31 December. (ii) In this report, "$" refers to US dollars. Vice President L. Jin, Operations 1 Director General J. Miranda, Central and West Asia Department (CWRD)* Director R. Siy, Country Coordination and Regional Cooperation Division, CWRD* Contributors Team leader S. Jha, Economist/Country Programs Specialist, CWRD* Team members D. Ellingson, Project Economist, EARD* R. Mamatkulov, Project Specialist, CWRD* H. Masood, Senior Transport Specialist, EARD* A. Maxwell, Environment Specialist, EARD* M. Perlas, Senior Project Economist, CWRD* S. Shrestha, Financial Economist, CWRD* S.F. Wong, Senior Financial Specialist, EARD* M. Barrow, Principal Structured Finance Specialist, Private Sector Operations Department (PSOD) V. John, Principal Structured Finance Specialist, PSOD J. Klein, Structured Finance Specialist, PSOD Y. Elhan-Kayalar, Senior Poverty Reduction Specialist, Regional and Sustainable Development Department *Reflects new Department after the realignment in May 2006. This version has been revised in line with the guidance received during the meeting of the Board of Directors on 1 August 2006. CONTENTS Page EXECUTIVE SUMMARY i I. COUNTRY BACKGROUND 1 A. Geography and Population 1 B. Administration and Political Environment 1 II. INSTITUTIONAL REFORMS AND ECONOMIC GROWTH 2 A. Economic Management 2 B. Banking and Finance 6 C. Business Environment and Enterprise Development 7 D. Trade and External Sector Development 8 E. Governance 9 III. SOCIALLY INCLUSIVE ECONOMIC DEVELOPMENT 12 A. Poverty Reduction 12 B. Human Development and Millennium Development Goals 13 C. Environmental Management 15 IV. THE GOVERNMENT’S DEVELOPMENT STRATEGY 15 A. Development Goals and Main Features of the Poverty Reduction Strategy 15 B. Assessment of the Government’s Development Strategy 18 C. Resource Mobilization and Investment 19 D. Relations with International Organizations and External Assistance 21 V. ADB’S INTERIM OPERATIONAL STRATEGY 24 A. Strategy Formulation 24 B. Key Challenges and Strategic Priorities 24 C. Determination of Assistance Modalities and Duration of the Strategy 27 VI. RISKS AND PERFORMANCE MONITORING AND EVALUATION 29 A. Risks 29 B. Monitoring Process and Plan 29 APPENDIX 1: COUNTRY INDICATORS AND THE RESULTS FRAMEWORK 30 Table A1.1: Country Economic Indicators 30 Table A1.2: Country Poverty and Social Indicators 31 Table A1.3: Progress Toward the Millennium Development Goals and Targets 32 Table A1.4: Country Environment Indicators 35 Table A1.5: Development Coordination Matrix 36 Table A1.6: The Results Framework 45 APPENDIX 2: SECTOR AND THEMATIC ASSESSMENTS 48 A. Agriculture and Rural Development 48 B. Finance 53 C. Private Sector 58 D. Transport and Communications 62 E. Trade 68 F. Energy 70 G. Poverty and Millennium Development Goals 73 H. Social Development 83 I. Environment 89 EXECUTIVE SUMMARY Armenia is a mountainous country in the Lesser Caucasus area, bordering Turkey, Georgia, Azerbaijan, and Iran. It has a population of about 3 million, abundant water resources, and some metal and mineral resources. The country became independent in 1991 and adopted a unicameral parliamentary system. The Government is run by a three-party coalition and political stability is slowly improving. Constitutional amendments following the 27 November 2005 referendum on constitutional reforms transferred significant powers from the President to parliament. Armenia has a two-tiered administrative structure, namely, central government and local communal self- administration, and is divided into 11 regions (marzes) including the capital, Yerevan. Armenia has set an example as a leader among the countries of the former Soviet Union, accelerating growth and reducing poverty through a series of well-sequenced economic reforms. Armenia’s economic performance has continued to exceed expectations despite lack of natural resources, turmoil after its independence in 1991, disputes with neighbors, high inflation, falling living standards, rising unemployment, poverty, and migration. Crucial factors in this achievement include (i) commitment to reform, (ii) prudent fiscal and monetary policies, (iii) liberal trade and foreign exchange regimes, (iv) improvement in the business regulatory environment, and (v) significant support from the Armenian diaspora. Growth and trade have been boosted by a well-educated low-cost labor force, diaspora investment through remittances, and noninterventionist trade policies. The last 5 years have been the turning point in the economy. With a new wave of second generation reforms from 2001, implementation of a poverty reduction strategy in 2002, and accession to World Trade Organization (WTO) in 2003, fast-growing exports and investment in construction and industry have become the main drivers of growth. These factors culminated in real gross domestic product (GDP) recovering its 1990 level in 2004. Economic growth averaged about 12% over 2001–2004 and recorded almost 14% in 2005. The share of nonconcessional to total loans was reduced systematically from almost 50% in 1997 to 3% in 2004. From 1999 to 2004, the external debt-to-GDP ratio fell from 47% to 33% and debt service-to-exports ratio from 15.9% to 9.7%. The private sector environment has improved significantly in recent years through a number of reforms implemented by the Government. However, despite the Government’s high performance in many measures of regulation, the unfavorable domestic environment for the entry and exit of firms, persisting corruption, lack of a fully developed legal system, and limited capacity of firms to recover due payments remain key binding constraints to fair competition and inflow of wider international investment. Part of the foreign direct investment (FDI) (30% in 2005) has been from the diaspora. The banking system has been strengthened through regulation, privatization, and consolidation. However, it suffers from inefficiencies, weak risk management, and high lending risk. The nonbank financial services market remains underdeveloped. Despite its exemplary economic performance, Armenia is a small country with high levels of poverty and pockets of extreme poverty. Although poverty has declined significantly, it remains high at 39% in 2004. Income inequality and unemployment are also high. Poverty reduction has mostly benefited the capital city and peripheral urban areas, so regional inequality is evident. The Millennium Development Goal (MDG) indicators for education are encouraging; those for gender equality, health, and environmental sustainability require closer attention. Following independence, air and water pollution declined dramatically because of the widespread closure of industrial facilities. Air emissions also reduced as a result of increased reliance on nuclear energy, and switching from heavy oil to natural gas for power generation. However, poverty related environmental impacts such as deforestation for fuelwood, land degradation, and mismanagement of water resources increased. The basic infrastructure is ii deficient. The private sector does not yet enjoy a level-playing field. Armenia is a landlocked country. The structural and institutional reform program remains to be completed. The Government detailed Armenia’s development strategy until 2015 in its 2002 Poverty Reduction Strategy Paper (PRSP). The main goal is to reduce poverty—including extreme poverty, income inequality, and human poverty—through human development. In particular, it has increased social sector spending significantly but further expansion is required to achieve the sector goals. Several large donors operate in Armenia with an extensive array of resources to address the