Financial system ready for sustainable development, economy financing, quality service: Central Bank Deputy Chairman

Economy 5 February, 2024 11:25

The Armenian banks concluded the last year with high capital and liquidity reserves, which are prerequisites for guaranteeing the resilience of the financial system against possible future shocks. Currently, the financial system has all the prerequisites for further sustainable development, financing the economy, and providing quality service, Hovhannes Khachatryan, Deputy Chairman of the Armenian Central Bank, told Armenpress.

In the interview, Khachatryan addressed the problems of the financial system in the past year, discussing indicators of inflation and economic growth, loans and deposits, the effects on the dram exchange rate, forecasts for the current year and other topics.

- Mr. Khachatryan, what factors primarily influenced the financial system of Armenia in 2023, both positively and negatively? To what extent were the challenges addressed? Which problems do you rule out from the financial system this year?"

- Despite all the difficulties, we can consider the previous year a period of stable development for the financial system. The main challenge was related to geopolitical and regional events. We should note that the Armenian banks concluded the last year with high capital and liquidity reserves, which are prerequisites for guaranteeing the resilience of the financial system against possible future shocks. In addition, the banking sector recorded sufficient profitability, providing an additional impetus for both the expansion of capital stock and regular lending to the economy. As for 2024, the financial system has all the prerequisites for further sustainable development, financing the economy and ensuring quality service.

-What was the recorded inflation in the Republic last year, and what is the reason for this indicator? How does it compare with the previous year, and what are your predictions for this year?

-According to official statistics, in December 2023, deflation of 0.6 percent per year was recorded in the Republic of Armenia. In its discussions, the Board of the Central Bank has repeatedly noted that deflationary effects transferred from the external sector have been significant in recent inflation developments.

They are manifested mainly in terms of imported food products as well as non-food products. For example, as of December 2023, the prices of imported food decreased by 7.9 percent, while non-food items experienced an inflation rate of 0.1 percent. This also reflects a gradual decline from the very high price levels of previous years. In the post-pandemic period, we had a situation where international commodity markets encountered a sharp rise in prices due to disruptions in global value chains, which were further exacerbated by increased geopolitical tensions. As a result of the gradual restoration of value chains and the implementation of restraining monetary policy in the main partner countries, prices in the international markets gradually decreased, which was also reflected in the Armenian inflation indicators of 2023.

It is also important to note that high demand has played a significant role in the development of Armenian inflation in recent years. Starting from 2022, this was mainly due to the high foreign demand generated by a large inflow of international visitors, which somewhat weakened in 2023. Additionally, in 2023, the acceleration of domestic demand in the construction and services sectors became essential. Throughout this period, the actions of the Central Bank were aimed at regulating excess demand and preventing the manifestation of potential unmooring of inflationary expectations. According to the Central Bank's estimates, inflation will gradually increase starting in 2024 and approach the target level of 4 percent in the 3-year horizon.

The published monetary policy program also presents various scenarios for the development of the macroeconomic situation in the Republic of Armenia, which may result in the formation of either a higher inflationary or lower inflationary environment. However, in any scenario, one thing is clear: the Central Bank, regardless of developments, will be ready and consistent in implementing the inflation target and ensuring price stability in the country over the medium term.

- Mr. Khachatryan, what were the exchange rates of the dram last year, and what factors influenced them?

- During 2023, although at a milder pace, the trends observed since 2022 continued due to the significant inflow of international visitors and tourists, as well as financial and capital. These influences were also reflected in the trends of the dram exchange rate. In September-October 2023, against the backdrop of Artsakh events, a certain increase in uncertainty and concerns was recorded in the market, which was further reflected by a specific rise in volatility in the currency market. The latter, in fact, settled when the background of uncertainties somewhat eased, leading to the stabilization of the dram exchange rate.

- In general, what significant changes did 2023 have in terms of financial stability and risks? To what extent was it possible to overcome the existing problems in that regard and end the year with positive results? What to expect this year? What are the steps taken by the Central Bank towards financial stability and what are the predictions for the new year?

-In addressing the risks threatening financial stability, it is necessary to underscore the factor of geopolitical uncertainties. Another risk, the Central Bank referred to in its publications for many times, pertains to potential overheating trends in the real estate market in recent years. To mitigate these risks, the Central Bank has incrementally raised the capital requirements for the banking system throughout the year, establishing the countercyclical capital buffer rate at 1.5 percent starting from August 2023. To mitigate mortgage credit risks, maximum limits for the loan-to-collateral ratio (set at 90 percent for dram loans) were introduced in 2022.

It is significant to note the amendments made in 2023 to the Law 'On Currency Regulation and Currency Control,' of the Republic of Armenia which prohibited the provision of foreign currency mortgage loans to residents. Additionally, minimum requirements were implemented for the balances of special development accounts. In 2024, the Central Bank's actions aimed at ensuring the stability of the financial system will be guided by macro-financial conditions, uncertainties and systemic risks.

- What changes and indicators were observed in terms of loans and deposits in 2023 compared to 2022 and what do these indicators signify?

- As of the end of December 2023, the credit portfolio of the banking system amounted to about 4.7 trillion drams, increasing by about 797 billion drams or 20.4 percent compared to the previous year. Deposits (demand and term) amounted to about 5.1 trillion drams, increasing by about 429.3 billion drams or 9.2 Deposits (demand and term) percent compared to the previous year. These indicators affirm that the banking system is evolving at a dynamic pace, contributing significantly to both the accumulation of savings and the financing of the Armenian economy through lending.

- What was the economic growth index concluding 2023, and how does it compare with the previous year? Additionally, what is the forecast for this year?

- In 2023, according to the estimates from the Central Bank, annual economic growth is anticipated to be at a level higher than 8 percent, and in 2024, high growth is also expected within the framework of 6 percent. It is crucial to consider the factors influencing economic growth. In 2022, as mentioned, the primary driver of growth was high external demand, while in the last year, growth fueled by domestic demand in the construction and services sector became significant. The latter is also estimated to gradually weaken, and in 2024, we are expected to approach our long-term potential growth level of 5 percent. It is essential to emphasize that the entire toolkit of the Armenian Government, from the implementation of capital investments to various initiatives and measures aimed at improving the private investment environment, will be directed towards increasing potential growth in the coming years, with the goal of achieving the 7 percent indicator targeted by the Government.

- Mr. Khachatryan, do you anticipate the possibility of sudden sharp fluctuations in the foreign exchange market this year? What are the prospects for sustainability in that regard?

- Firstly, it is important to note that the exchange rate in Armenia is free-floating, determined by a combination of market factors, and the Central Bank does not consider it as a goal. It is noteworthy that various scenarios of economic development, encompassing factors such as tourism, money transfer, other financial flows, as well as potential changes in exports and domestic demand, could lead to scenarios involving both appreciation and depreciation of the exchange rate. It should also be noted that in certain situations, characterized by large-scale financial flows and rapid changes in market expectations, an increase in volatility might occur in the currency market. The Central Bank adheres to the principles of a floating exchange rate and is prepared to intervene to ensure the normal functioning of the market only in the event of risks that could disrupt the regular operation of the financial markets.

- Considering the processes and developments of the past year, what will be the priorities of the Central Bank's activities this year?

- Among other priorities, it is worth noting that on January 12, the Central Bank officially presented its new and improved Monetary Policy Development and Decision-Making System (FPAS MARK II). Starting this year, the Central Bank of RA will structure monetary policy decision-making under multiple scenarios and enhance risk management. The latter also signifies significant changes in the areas of transparency and communication of monetary decisions. Regarding the development of the financial system, the priorities of the Central Bank of the Republic of Armenia are outlined in its strategy. Our focus will be on the digital transformation of the financial system, the development of payment systems, the creation and enhancement of modern infrastructure, reducing the sensitivity of the financial system to climate risks, combating money laundering and terrorist financing (AML/CFT), and improving the compliance function, along with the continuous adoption of modern regulatory standards. In addition, we have initiated an institutional transformation program at the Central Bank. As a result, we will be reviewing the bank's management, decision-making, project implementation, budgeting, procurement, personnel management, IT infrastructure, and systems modernization, among other processes. This is important, as the effectiveness of our operations is fundamental to fulfilling the Central Bank's mission.