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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 loan: "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 people. 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 unrealistic. 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 Armenia. --------------------------------------------------------------------- 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.