VZCZCXRO5965
RR RUEHDBU RUEHLN RUEHVK RUEHYG
DE RUEHYE #1093/01 2431255
ZNR UUUUU ZZH
R 311255Z AUG 07
FM AMEMBASSY YEREVAN
TO RUEHC/SECSTATE WASHDC 6241
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC 0509
RUCNCIS/CIS COLLECTIVE
RUEHAK/AMEMBASSY ANKARA 1305
RUEHIT/AMCONSUL ISTANBUL 0576
RUEHLMC/MILLENNIUM CHALLENGE CORP

UNCLAS SECTION 01 OF 04 YEREVAN 001093 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EAID
SUBJECT: MACROECONOMIC OVERVIEW FOR THE FIRST HALF OF 2007 
 
REF: A) 06 YEREVAN 269 
 
YEREVAN 00001093  001.2 OF 004 
 
 
------- 
SUMMARY 
------- 
 
¶1. (SBU) Double-digit expansion of Armenia's economy continued in 
the first half of 2007, with GDP growth equal to 11.2 percent 
year-on-year.  As in the previous year, the growth was driven mostly 
by construction and services. The inflation rate in June was 4.8 
percent year-on-year, due to rising food and fuel prices, as well as 
growth in government spending and large inflows of cash remittances. 
 The budget posted a surplus of USD 9.6 million, with revenues and 
expenditures (foreign-financed programs included) increasing by 26.7 
percent and 18.2 percent respectively.  The trade deficit expanded 
by 64 percent, with import and export revenues increasing by 44 
percent and 20.5 percent respectively.  The Armenian Dram 
appreciated by nearly 18 percent against the dollar between June 
2006 and June 2007.  Foreign direct investment (FDI) almost doubled 
year-on-year in the first quarter of 2007, most of that investment 
being made in the telecommunications sector. 
 
--------------------- 
GROWTH REMAINS STRONG 
--------------------- 
 
¶2. (SBU) During the first six months of 2007, Armenia's GDP grew 
11.2 percent (compared to the same period of 2006) to approximately 
USD 2.7 billion (AMD 944,845.7 million), according to the National 
Statistical Service.  GDP per capita in January-June 2007 was equal 
to USD 822.  Construction, trade and services were the main driving 
forces of the growth.  The construction sector expanded by 20.1 
percent year-on-year, and accounted for 17 percent of overall GDP, 
contributing 3.1 percentage points to the overall GDP growth rate. 
(NOTE: The rate of growth in the construction sector slowed down 
considerably, compared to 37.7 percent growth in the first six 
months of 2006. END NOTE).  The rapid construction growth was led by 
a surge in roadbuilding, as well as construction of high-end, 
mid-rise residential and office towers in the center of Yerevan. 
The construction industry will also receive additional boost from 
new projects in the energy and transport sectors.  The services 
sector, which accounted for 4.7 percentage point contribution to the 
GDP growth, rose by 13.4 percent.  Transport and communications, 
trade and catering collectively increased by 13.7 percent and 
financial services grew by 24.6 percent. 
 
¶3. Industrial output (energy sector included) increased by 2.3 
percent year-on-year to around USD 920 million, against a 1.4 
percent decline in same period of 2006.   The industry share in 
overall GDP was equal to 21.8 percent, compared to 25 percent in the 
first half of 2006.  The poor performance of the industry is mainly 
explained by a continued downturn in the diamond sector since 2004. 
In the first half of 2007, the diamond industry declined by 48 
percent, to USD 75 million (approximately AMD 25 billion) mainly 
attributed to global diamond industry crisis, as well as 
appreciation of the Armenian Dram.  (Septel will report on the 
Armenian diamond sector in detail) Overall, manufacturing output 
contracted by 0.1 percent, despite considerable growth registered in 
the metallurgy (up by 7.3 percent) and food production (up by 12.2 
percent).  Industrial output without diamonds grew by 8.2 percent 
totaling USD 911.5 million. 
 
¶4. The agricultural sector contracted by 1.8 percent year-on-year 
and accounted for 13.3 percent of GDP at approximately USD 356 
million.  The decline was mainly due to unfavorable weather 
conditions, which particularly hurt the fruit and vegetable 
sub-sectors. 
 
-------------------------------------- 
NEW GOVERNMENT HAS AN ABITIOUS PROGRAM 
-------------------------------------- 
 
¶5.  In June, the Armenian Parliament approved a new economic program 
that aims for at least eight percent annual economic growth and 
reduction of the poverty rate from 30 percent currently to 12 
percent by 2012.  One goal of the program will be to increase the 
ratio of tax collections to GDP - at 14.4 percent in 2006 the lowest 
among CIS countries - by increments of at least .3 percentage points 
annually.  The program also aims for investment to grow by at least 
10 percent annually, and envisages further strengthening of regional 
self-governance bodies and improvement of their financing. 
 
---------------- 
PRICES INCREASE 
---------------- 
 
¶6. In June 2007, inflation was equal to 4.8 percent year-on-year (up 
 
YEREVAN 00001093  002.2 OF 004 
 
 
by 2.1 percentage points in the June 2006 figure).  Prices of 
foodstuffs (including alcohol and cigarettes) were up by 6.2 percent 
compared to January-June 2006, prices of services grew by 5.3 
percent, and the prices of non-food products decreased by 0.9 
percent.  The increase in food prices came largely from increased 
fruit and vegetable prices (18.2 percent and 30.7 percent increases 
compared to June 2006, respectively).  Between May and June 2007, 
bread and bakery product prices increased 10.3 percent, wheat 13.3 
percent and flour 7.5 percent due to increased world wheat prices, 
and particularly in the Russian market.  Average inflation for 
January-June 2007 was equal to 4.5 percent compared to the same 
period of the last year.  If these trends continue, the year-end 
inflation may exceed the Government's four percent target for 2007. 
 
 
¶7.  Prices in the first half of 2007 rose 5.1 percent for 
construction materials and 5.8 percent for agricultural products. 
Freight shipping prices rose 24.3 percent, due primarily to a 
61-percent increase in pipeline transportation costs in the 
beginning of the year. 
 
---------------------------- 
DRAM CONTINUES TO APPRECIATE 
---------------------------- 
 
¶8.  The value of the Dram increased 5.4 percent against the dollar 
during the first half of 2007, and in June 2007 was 18 percent 
higher against the dollar compared to June 2006.  While the process 
slowed considerably in the first quarter of 2007, the appreciation 
trend picked up in the second quarter.  The average exchange rate in 
June was at AMD 344.8/USD, 41 percent lower than in June 2003.  The 
main causes of Dram appreciation remain the global weakening of the 
U.S. dollar, a large inflow of foreign currency to Armenia from 
remittances (especially dollar remittances from Armenian workers in 
Russia), as well as increases in domestic productivity and incomes. 
 
 
----------------------------------- 
HOUSEHOLD INCOMES AND REVENUES RISE 
----------------------------------- 
 
¶9.  In the first half of 2007, household incomes rose 26 percent 
compared to the same period of 2006, and totaled AMD 853 billion 
(around USD 2.4 billion), a growth supported by higher monthly wages 
and remittances.  Average monthly wages for the period of 
January-May 2007 were AMD 71,000 (approximately USD 200), a nominal 
increase of 17.4 percent compared to the same period in 2006.  The 
highest wages were paid in the financial services sector (USD 600), 
followed by the mining (USD 420) and energy sectors (USD 300). 
Average monthly wages in the public sector were equal to USD 200, up 
by 20 percent year-on-year. Taking into consideration the relatively 
low inflation rate, real wages rose by around 10 percent 
year-on-year in May 2007. 
 
¶10.  According to the Central Bank of Armenia (CBA), individual net 
cash inflows through commercial banks were equal to USD 378 million 
in January-June 2007, up by 36 percent year-on-year.  According CBA 
estimates, the amount of remittances in 2007 will reach 
approximately USD 1.3 billion, as similar amounts of remittances 
enter the country through non-bank transfers, and the majority of 
remittances are transferred in the second half of the year. 
 
------------------------------ 
UNEMPLOYMENT REMAINS UNCHANGED 
------------------------------ 
 
¶11.  According to the National Statistical Service, unemployment was 
7.2 percent in the first half of 2007, compared to 7.6 percent the 
same period of 2006.  Seventy-two percent of officially registered 
unemployed were women. 
 
--------------------------------------------- - 
HIGHER REVENUES RESULT IN SMALL BUDGET SURPLUS 
--------------------------------------------- - 
 
¶12.  According to preliminary data from the Ministry of Finance and 
Economy, budget revenues in the first half of 2007 were 
approximately USD 686 million, up by 26.7 percent compared to the 
same period in 2006 (calculated in terms of local currency). Taxes, 
which accounted for 82.2 percent of total budget revenues, rose by 
27 percent year-on-year to approximately USD 564 million, equivalent 
to 21.3 percent of GDP. (NOTE: The Tax/GDP ratio is typically 
significantly higher in the first half of the year, as many large 
tax collections occur in the first part of the year, while GDP tends 
to be higher in the second part of the year. END NOTE)  The increase 
in tax revenues was due primarily to growth in VAT collections (an 
increase of 39.3 percent compared to the same period of 2006), which 
 
YEREVAN 00001093  003.2 OF 004 
 
 
provided for 48 percent of total tax revenues.  Corporate profit tax 
collections increased by 14.4 percent and comprised 18.6 percent of 
total tax revenues.  Budget expenditures increased by 17.5 percent 
to approximately USD 640 million (USD 676.8 million, foreign 
financed programs included). A small budget surplus of USD 9.2 
million (foreign-financed programs included) was posted in the first 
half of 2007, compared to deficit of approximately USD 25 million 
during the same period of 2006.  In July 2007 the Armenian National 
Assembly adopted a decision to increase budget revenue and 
expenditure targets for 2007 by AMD 25 billion (around USD 70 
million), which will be raised from land privatization and 
additional tax revenues. 
 
¶13.  Expenditures on education and science increased considerably, 
to USD 109 million, up by 16.9 percent compared to the same period 
of 2006, comprising 4.1 percent of GDP.  Despite 12.7 percent growth 
in health expenditures to USD 48.3 million, its share of GDP 
remained just 1.8 percent. 
 
¶14.  In May 2007, the Government of Armenia adopted a three-year 
Strategic Development Program for the tax system of Armenia, aimed 
at increasing tax collections through a number of structural, 
legislative and technological changes within the State Tax Service. 
As a part of the reform, the amended law on Simplified Tax, which 
was adopted by the parliament in July 2007, will considerably 
decrease the number of taxpayers that were allowed to pay the 
"simplified tax" instead of other, higher taxes. (NOTE: The 
"simplified tax" is a tax on gross receipts (currently 3.5 percent 
of sales turnover) and was intended for smaller companies. The GOAM 
moved to curb its use when larger enterprises found it advantageous 
to pay it in place of the VAT or profit tax. END NOTE). 
 
------------------------------ 
FOREIGN TRADE DEFICIT EXPANDS 
------------------------------ 
 
¶15. Armenia's trade deficit increased by 64 percent year-on-year in 
the first half of 2007 to USD 838 million, owing to a surge in 
imports.  Total trade turnover grew by 36.5 percent, reaching USD 
1,892 million, with exports equal to USD 527 million (up by 20.5 
percent) and imports equal to USD 1,365 million (up by 43.9 
percent).  Rising costs of mineral products were one of the driving 
factors behind import growth, while exports suffered mainly from the 
poor performance of the diamond processing industry.  Excluding 
diamonds, exports grew by 37.1 percent and imports rose by 53.9 
percent.  Continuing growth in the metallurgy sector resulted in 
base metals becoming the largest export commodity group.  In the 
first six months of 2007, exports of base metals, which comprise 
34.3 percent of total exports, were equal to USD 181 million, 
recording 36.4 percent growth compared to the same period of the 
last year.  Export volumes of precious stones and metals slumped by 
23.9 percent. 
 
¶16.  The share of the Commonwealth of Independent States (CIS) in 
overall trade increased considerably, accounting for approximately 
32 percent of the total.  Russia remained Armenia's largest trading 
partner (14.6 percent of total trade turnover), with overall trade 
between the countries increasing by 54.5 percent year-on-year.  The 
second-largest trading partner was Germany (9.2 percent), followed 
by Kazakhstan (6.8 percent), and Ukraine (6.6 percent). The U.S. 
share remained at 5.4 percent of overall trade turnover. 
 
---------------------------------- 
FOREIGN DIRECT INVESTMENT DOUBLES 
---------------------------------- 
 
¶17.  Foreign investment reached USD 136.63 million in January-March 
2007, up by 45 percent compared to the same period in 2006.  Foreign 
direct investment almost doubled year-on-year in the first quarter 
of 2007 to USD 88.9 million.  During this period the leading 
investor was Lebanon (USD 34.7 million), accounting for about 40 
percent of total FDI in this period through Lebanese firm K-Telecom, 
which operates Vivacell, a two-year-old firm that is now the largest 
mobile phone operator in Armenia.  The second-largest investor was 
Russia (USD 23.5 million), which accounted for 26 percent of total 
FDI, 15.5 times more compared to the same period of 2006.  The major 
part of Russian investment was in the telecom sector, through 
Armentel Telecommunications Company (now owned by the Russian 
company Vimpelcom).  Thus, the telecommunications sector was the 
largest recipient of FDI in the January-March 2007 period, 
attracting 63.2 percent of total FDI.  Shares of the next-largest 
FDI recipients - Civil Aviation and Food Processing - were 6.6 
percent and 6.5 percent, respectively. 
 
-------- 
COMMENT 
-------- 
 
YEREVAN 00001093  004.2 OF 004 
 
 
 
¶18. Despite the fact that construction remains the main driving 
force for growth, the growth base is gradually expanding, with 
trade, communication and transport making considerable contributions 
to growth.  This is a positive trend, as the construction sector 
almost certainly cannot sustain its torrid pace indefinitely.  Some 
worry, in fact, that Yerevan may be headed for a real estate glut, 
given the explosion of downtown construction projects all nearing 
completion this year or next.  However, the Millennium Challenge 
program is expected to inject tens of millions of dollars into 
roadbuilding over the next four years, which will tend to prop up 
the construction sector.  The appreciation of the Armenian Dram 
continues to remain a major concern for Armenian exporters, as it 
harms their competitiveness.  The European Bank for Reconstruction 
and Development has warned that if the productivity of local 
manufacturers does not increase, the continuing Dram appreciation 
will eventually restrict economic growth. 
 
PERINA