STRONG DRAM HOLDS ARMENIA’S INFLATION IN CHECK.

Annual inflation rates in many CIS economies, including Russia and Ukraine, are currently in the 20-50 percent range and rising. Not so in Armenia. Consumer price inflation there fell from 8.7 percent in 1998 to 0.8 percent in 1999, and continues to drop. In monthly terms, consumer prices dropped in March, April and May, and were down by 0.6 percent on an annual basis in May (Russian agencies, June 9). Falling prices for foodstuffs and services have driven the overall decline in consumer prices. During the twelve months to May 2000, food prices fell by some 4 percent, while prices for services fell 2 percent. In contrast, nonfood prices rose during this period, albeit by a modest 3 percent.

Armenia’s stable price level stems largely from the stability of the dram during the past sixteen months. After falling against the dollar during the first five months after the August 1998 Russian financial crisis, in February 1999 the dram began to strengthen. Since then the dram has been one of the strongest currencies in the CIS. Between February 1999 and May 2000, the dram fluctuated between 520-540 to the dollar. Such exchange rate stability contrasts with most other countries in the region–particularly Russia, Belarus and Moldova–where sharp drops in the currency triggered high inflation during 1998-1999.

During the first half of 1999, the Central Bank of Armenia (CBA) stabilized the dram by intervening heavily on the foreign exchange market. These interventions brought official reserves below the limit called for in Armenia’s stabilization agreement with the IMF. As part of a mid-1999 package of policy changes designed to pry loose frozen IMF and World Bank credits, the CBA stopped supporting the exchange rate during the second half of 1999, and has since refrained from further intervention. Instead of collapsing, however, the exchange rate appreciated to US$1=534 dram by May 2000, up 2 percent from June 1999. Much of the dram’s strength during this period results from improving trends in Armenia’s external accounts. Although still relatively large at US$277 million (15 percent of GDP), Armenia’s 1999 current account deficit narrowed substantially compared to 1998s US$390 million (21 percent of GDP) deficit. US$131 million in direct foreign investment in 1999 also helped offset downward pressures on the dram.

Encouragingly, exports are growing rapidly this year: Through the first four months they were up by 21 percent. Imports grew by 17 percent during this time, however, causing Armenia’s trade deficit to grow by some 15 percent. This has raised concerns about a possible resurgence in the current account deficit, which could trigger a sizeable depreciation in the dram and rapid inflation. Strong growth in retail trade in the first quarter of 2000 suggests that personal consumption is fueling this import growth. The government and CBA may choose to tighten monetary and fiscal policies later this year to prevent the trade deficit from widening further.

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