Inflation in Armenia:What is happening to Armenian prices?

Nienke OomesInternational Monetary FundResident Representative in Armeniawww.imf.org/yerevan

Outline1. What is inflation targeting?2. How is CPI inflation measured in Armenia?3. Recent inflation developments4. Why did food prices increase in 2007?5. How does Armenia compare?6. Policy recommendations

1. What is inflation targeting?A monetary policy first introduced in New Zealand in 1990Central bank commits to a numerical inflation target, for example:

Target range: 1-3% in New ZealandPoint target: 2% in UK, 2.5% in NorwayPoint target plus range: 2+1% in Canada and Sweden

Central bank should not have targets for other variables (e.g., exchange rate, monetary aggregates)Central bank’s inflation forecast should approach the inflation target, and is central to monetary policyCentral banks need to be independent, transparent, and accountable (no secrecy)Fiscal policy should also support the inflation target

As of 2007, IT had been adopted by 27 countriesIT appears to be more successful than other monetary policy regimes (money targeting, exchange rate targeting) in stabilizing inflation and GDP growth

Inflation targeting in ArmeniaInitial phase of IT was introduced in Armenia in 2006Primary objective: ensure price stabilityInflation indicator: growth in consumer price index (CPI)Target band: 4% +1.5%Nominal anchor: inflation forecastTime horizon: 12 monthsOperational target: short-term interest rateMain instrument: repo (refinancing) operationAccountability and transparency: quarterly inflation report, quarterly minutes on interest rates, monthly press releases, minutes on interest rates after board meeting, CBA'smonthly Bulletin, biannual monetary program submitted to National Assembly, etc.

Inflation targets in Armenia

2006Target: 3%, later revised to 5+1.5 %Actual: 5.2%

2007Target: 3+1.5 %, later revised to 4+1.5 %Actual: 6.6 %

2008Target: 3+1.5 %, later revised to 4+1.5 %Actual: ?

2. How is inflation measured in Armenia?

Inflation = growth rate of Consumer Price Index (CPI)CPI = price of a “basket” of 470 goods and servicesThis price is an average price, averaged over:

470 goods and services11 regions (Yerevan plus 10 marzes), weighted by population9-12 different shops for each good for each region3 monthly observations (around the 1st, 10th, and 20nd)

The weight of each item in the CPI basket is based on the structure of average household expenditure, based on the Living Standards Households Survey dataThese weights are updated every 3-5 years (the last revision was in 2006, based on the survey for 2004-05)

CPI weights of goods and servicesFOOD 53.9% SERVICES 29.9%Bread and cereals 14.9% Electricity 4.9%Meat 9.5% Hospital surgery services 4.3%Alcohol and tobacco 5.9% University education 2.5%Vegetables 4.7% Air transport 1.4%Milk 4.3% Gas 1.3%Oils and fats 4.1% Taxi rides 0.9%Fruit 2.6% Diagnostic care 0.9%Other 8.0% Other 13.6%

OTHER GOODS 16.2%Petrol 2.6%Washing powder 0.6%Liquid Gas 0.5%Color television 0.5%Water-soluble tablets, Aspirin UPSA 0.3%Trousers 0.3%Pills for heart disease 0.3%Other 11.1%

3. Recent inflation developments

-4

-2

0

2

4

6

8

10

Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Services inflationFood inflationOther goods inflationStatistical discrepancy

Inflation contributions(December 2007 / December 2006)

Weight Inflation Contribution

Food 53.9% 9.7% 5.2%Services 29.9% 3.2% 0.9%Other goods 16.2% 2.5% 0.4%

Total 100.0% 6.6% 6.6%

Composition of food inflation

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-5

0

5

10

15

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Meat Fruit VegetablesBread and cereals Oils and fats Other

Food price contributions(December 2007 / December 2006)

Weight Inflation Contribution

Bread and cereals 14.9% 23.9% 3.6%Oils and fats 4.1% 29.2% 1.2%Fruit 2.6% 15.9% 0.4%Meat 9.5% 2.7% 0.3%Vegetables 4.7% -5.3% -0.3%Other food 18.2% 0.5% 0.1%

Total 53.9% 9.7% 5.2%

4. Why did food prices increase in 2007?

Higher world demand for foodHigh GDP growth (China, India)High energy prices → higher demand for corn (ethanol)

Lower world supply of foodBad weather (global warming?)High energy prices → using farmland for biofuels

Armenian food prices largely followed world pricesFood prices also increased in other countries

Higher world demand for food

High GDP growth, especially in China and India (40% of the world’s population)As people in India and China get richer, they want to eat more meat and dairy productsHigher demand for meat → higher demand for grain (it takes 7 kilos of grain to produce 1 kilo of beef)Higher grain prices → farmers switch to using corn for animals → higher corn pricesHigher oil prices → higher demand for biofuels (e.g., use corn to make ethanol) → higher corn prices (world corn prices roughly doubled in the last 2 years)

Lower world supply of foodBad wheat harvests in Ukraine, Russia, Egypt, AustraliaDrought in Australia → shortfall in Australian milk outputDroughts in northern and western China (27 million acres dried up)Floods in southern China (21.5 million acres drowned)Industrialization in China (Between 2000 and 2005, China lost over 3 million acres of farmland per year)Rapid decline of the EU share in the global dairy marketsHigher demand for biofuels → less land available for growing food → higher food prices

Armenian bread prices increased in line with Russian wheat export prices

Russian Wheat Export Prices and Armenian Bread Prices in USD (Index: December 2001 = 100)

Armenian bread prices

Russian wheat export prices

50

100

150

200

250

300

350

Dec-01

Jun-02

Dec-02

Jun-03

Dec-03

Jun-04

Dec-04

Jun-05

Dec-05

Jun-06

Dec-06

Jun-07

Dec-07

Armenian sunflower oil prices increased in line with U.S. prices

Sunflower oil prices in USD(Index: September 2002 = 100)

U.S. price of sunflower oil

Armenian price of sunflower oil

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50

100

150

200

250

300

350

Dec-02

Jun-03

Dec-03

Jun-04

Dec-04

Jun-05

Dec-05

Jun-06

Dec-06

Jun-07

Dec-07

Armenian butter prices increased in line with (but less than) Oceania and the EU

Butter prices in USD(Index: December 2000 = 100)

Oceania butter price

Armenian butter price

EU butter price

0

50

100

150

200

250

300

350

400

450

500

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jul-06

Jan-07

Jul-07

Jan-08

Armenian sugar prices followed world sugar price increases, but did not fall

Refined Sugar Price in USD(Index: December 2004 = 100)

World refined sugar price

Armenian refined sugar

price

60

80

100

120

140

160

180

200

220

Dec-04 May-05 Oct-05 Mar-06 Aug-06 Jan-07 Jun-07 Nov-07

Rising inflation is a regional phenomenon

2

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6

8

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12

14

16

18

Dec-04

Mar-05

Jun-05

Sep-05

Dec-05

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

Dec-07

Average CIS inflation

Average CIS inflation excluding food

(Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan, and Uzbekistan)

5. How does Armenia compare?

Armenian inflation is relatively low compared to other CIS countriesArmenian prices are relatively low compared to prices in advanced countriesHowever, Armenian import prices are relatively high compared to other CIS countries

Armenian inflation is low compared to other CIS countries

7%

21%

11%

19%20% 20%

12%

Armen

ia

Azerba

ijan

Georgi

aKaza

khsta

n

Kyrgyst

an

Tajikis

tan

Uzbek

istan

02468

101214161820222426

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Azerbaijan

0

2

4

6

8

10

12

14

16

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Georgia

0

2

4

6

8

10

12

14

16

18

20

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Kazakhstan

02468

1012141618202224

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Kyrgyz Republic

02468

10121416182022

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Tajikistan

-4

-2

0

2

4

6

8

10

Jan-05

Mar-05

May-05

Jul-05

Sep-05

Nov-05

Jan-06

Mar-06

May-06

Jul-06

Sep-06

Nov-06

Jan-07

Mar-07

May-07

Jul-07

Sep-07

Nov-07

Total CPI inflation

Non-food inflation

Armenia

Why is inflation lower in Armenia?

Inflation targeting regimeRelatively little exchange rate interventionIncrease in interest rates

Tight fiscal policyLower gas import prices

Armenian prices are still low (but rising) in percent of U.S. prices

0

10

20

30

40

50

199319941995199619971998199920002001200220032004200520062007

Armenian price level in % of U.S. price level

Source: IMF, World Economic Outlook

Armenian bread prices are relatively highBread Prices in Capitals of Selected CIS Countries, October 2007(AMD per kilo)

0

100

200

300

400

500

600

Moldov

aAzer

baija

nTaji

kistan

Ukraine

Kyrgyz

Rep.

Belarus

Russia

Armen

iaKaza

khsta

n

Source: Inter-State Statistical Committee of the CIS

Armenian butter prices are relatively highButter Prices in Capitals of Selected CIS Countries, October 2007

(AMD per kilo)

0

500

1000

1500

2000

2500

3000

Belarus

Tajikis

tanKaza

khsta

nAzer

baija

nUkra

ineMold

ova

Armen

iaKyrg

yz Rep

.

Russia

Source: Inter-State Statistical Committee of the CIS

Armenian vegetable oil prices are very highVegetable Oil Prices in Capitals of Selected CIS Countries, October 2007

(AMD per liter)

0

200

400

600

800

1000

1200

Tajikis

tanMold

ova

Ukraine

Azerba

ijan

Kyrgyz

Rep.

Belarus

Russia

Kazakh

stan

Armen

ia

Source: Inter-State Statistical Committee of the CIS

Armenian sugar prices are relatively lowSugar Prices in Capitals of Selected CIS Countries, October 2007

(AMD per kilo)

0

100

200

300

400

500

600

700

800

Tajikis

tanUkra

ineArm

enia

Belarus

Kyrgyz

Rep.

Moldov

aKaza

khsta

n

Russia

Azerba

ijan

Source: Inter-State Statistical Committee of the CIS

Armenian egg prices are very highEgg Prices in Capitals of Selected CIS Countries, October 2007(AMD per dozen)

0

100

200

300

400

500

600

700

Belarus

Tajikista

n

Kyrgyz Rep.

Ukraine

Russia

Kazakhsta

n

Azerbaija

n

Moldova

Armenia

Source: Inter-State Statistical Committee of the CIS

What explains Armenia’s relatively high import prices?

Transportation costsSmall country size (no economies of scale in packaging, distribution, marketing, etc)Imperfect information and high search costs for buyersLimited competition between sellersHigh exchange rate appreciation, combined with low pass-through

Inflationary risks in 2008

Large foreign exchange inflows (remittances, FDI, real estate, foreign aid)High GDP growth60% increase in pensionsFurther increases in food pricesFurther increases in energy prices

5. Policy recommendationsMake inflation targeting more effective

Increase competition between banksReduce dollarizationFurther develop financial marketsNot change targets in response to external shocksExtend IT horizon to several years

Facilitate reduction in Armenian import pricesImprove infrastructure → reduce transportation costsIncrease competition between importersStrengthen the Committee for the Protection of Economic Competition

Tighten fiscal policyLimit government expenditureRaise tax revenues

Increase the public’s knowledge of inflation targetingExplain how inflation is measuredExplain why inflation targets were missed