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The Resurgence of Inflation in Armenia?
King Banaian

Less than a year ago, Armenia's stabilization was being lauded from
all sides as a great triumph. GDP expanded for two years straight;
inflation fell to a western standard of 5.7% in 1996, and real incomes
were beginning to grow again. Its growth rate was faster than any
other CIS country, and that inflation figure for 1996 beat even the
well-cheered performance of the Baltic states.

The international arbiters of macroeconomic excellence, the
International Monetary Fund, however, sounded a worried note while
releasing the second tranche of Armenia's $47 million-a-year ESAF

"Performance under the first year of the ESAF-supported program was
uneven. Led by expansion in the services and construction sectors,
real GDP grew by 5.8 percent in 1996, inflation declined sharply to
under 6 percent during the year, and the current account position
improved noticeably. At the same time however, fiscal and monetary
policies were considerably relaxed in the run up to the presidential
elections in September. As a result of shortfalls in total revenues
and grants and higher-than-expected expenditures, the overall cash
fiscal deficit, amounted to 9.3 percent of GDP."  (Press release, 24
June, 1997.)

In other words, the Fund recognized that the government had engaged in
the usual game of making the economy look as rosy as possible before
the election, and damn the consequences afterward. It nonetheless
handed over half the loan in early July.

That game is known in the West as a "political business cycle". In an
experienced economy, the game seldom works: Investors know the date of
the election as well as anyone else, can guess what the government
will do, and will sniff out the damaging evidence that the game is on.
Once it's exposed, the extra spending by the government falls
predominantly on higher prices, to the detriment of its electoral
chances. But in immature economies, it is still possible to fool the

Even then, the inflation comes, but only later. And the chickens now
appear to have come to roost. The facts bear witness:

 o GDP growth has slowed considerably. According to Economics and
Finance Minister Armen Darbinian, GDP growth will slow to 3.5%, well
below the program target of 5.8% set in the ESAF program. In order to
hold down the deficit to meet the program target, expenditures are
being paid out on a cash basis only. The recent cut in external
funding from the European Union has meant a 6-9% cut in budget
expenditures, depending on the results of the new profits tax. (Noyan
Tapan, 3 Oct. 1997.)

 o Even 3.5% may seem optimistic. Much of the expenditures to be cut
come in the form of falling further in arrears on wages. Increased
taxes are also to be expected to reduce growth. The tax increases have
been demanded by the IMF to compensate for poor tax collections in the
past. There was a turnaround in September, but it is too soon to say
if that is a permanent change.

 o For the first eight months, inflation was 13.6%, compared with the
target of 9.5% for the entire year. Most of the inflation came, of
course, after the election. Since the election, inflation has been
around 17% per year. It seems impossible now to hit the target for
1997, and the 1998 target of 8% is also looking increasingly

 o The trade deficit continues to grow and is approaching crushing
proportions. The share of trade with the rest of the CIS has now
fallen below 45% (it was near 90% at the time of the breakup), while
export growth to the rest of the world is growing only at single-digit
rates. Meanwhile Armenia continues to suck in imports, largely of
consumer goods. While this is not terrible -- the alternative might be
that Armenians forgo any consumption -- it cannot persist forever.
The imports are not funding foreign investment, which has stalled
around $20 million. All this places pressure on the d'ram. A sharp
depreciation of the currency would undo the gains made on inflation.

Since the government has already played the game of the political
business cycle in 1996, it can do little more than watch. The tax
increases are the dark side of the cycle -- a fiscal and monetary
expansion before an election usually is offset by a contraction later.
These policies reach the economy with a lag, usually around three to
six months. Thus one would expect another long, cold winter in

King Banaian is associate professor of economics at St. Cloud State
State University in Minessota. He writes often on issues of money
and central banking, and was an advisor to the Ukrainian central
bank in 1996. His 1986 dissertation was on political business cycles.

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