Ben Aris in Yerevan -

Armenia's bankers used to curse the Central Bank of Armenia. Business was booming and entrepreneurs wanted the bank to loosen the fiscal reigns a bit so they could grow faster, but the CBA stuck to its conservative regime based on the Dutch model of prudent growth and caution. Then the world's financial system fell to pieces last autumn and as the dust settles, Armenia's bankers and businesses find they are amongst the few left standing in the region. The CBA's policies have been vindicated and the country's banking sector is amongst the world's healthiest.

That's not to say the country wasn't affected. "Starting from Ocober 2008, Armenia was seriously affected by the global crisis, which first hit the balance of payments position and afterwards the leading branches of the economy. For example, construction declined by 56% in January-May 2009, the retail turnover and brandy production also contracted on the back of falling demand, the latter affected largely by the weakened demand in Russia," Arthur Javadyan, governor of the CBA, tells bne in an exclusive interview.

As the situation deteriorated in the first quarter, the CBA took the dramatic decision to devalue the dram by about 22% at the start of March, falling from 306 to the dollar to about 380. Since then, it has recovered to 360, which the CBA considers to be its fair value. "The steep drop in private transfers and capital inflows put significant pressure on the exchange rate, which was adjusted in the beginning of March. Currently, there are no pressures in the currency market and the CBA ceased intervening in the market during the last free months," says Javadyan.

Expecting the economy to contract by some 7-8% at the start of this year, the actual contraction of 15.7% in the second quarter came as a shock. But since then, deals have been cut with both the International Monetary Fund (IMF) and Russia to raise over a billion dollars in loans and the economy had begun to stabilise by June. "International financial institutions stepped up to the plate as spring arrived and in coordination with the government and the central bank designed a growth promotion package for construction in the earthquake zone, road construction, as well as extension of credit lines to small and medium-sized enterprises to lay the basis for strong growth recovery in the medium term. We expect a 6-7% decline, some other public institutions up to a 9% output decline in the economy as a whole for 2009, with growth of 1-1.5% returning in 2010," says Javadyan.

Bounce back

On the face of it, those numbers look awful, but Armenia remains in a good position to bounce back relatively quickly thanks to the prudence of the CBA and the relatively underdeveloped state of the economy. The collapse of the construction sector was a severe blow, as it was one of the most important engines of growth. Most of the banking sector's non-performing loans are overdue mortgages, but credits by banks to the construction sector account for only 0.5% of their total loans, says Javadyan. "The owners of construction companies are mostly tycoons and they can simply wait until times get better again," says Javadyan.

Still, the CBA is working to put in place the institutions to support the market, irrespective of how rich the company owners are, and recently established a state mortgage agency together with the World Bank's International Finance Corporation to refinance mortgage loans, which is designed to support the secondary market as well as the construction industry.

The multilateral loans will be key in restarting economic growth and Javadyan sees the crisis as a cathartic pause more than real disaster. "The World Bank will extend more than $600m of credit to support building infrastructure and promote growth afterwards. In addition, under the stand-by arrangement, more than $700m of IMF credit will be used for balance of payment stabilization purposes and for promoting economic recovery," he says.

Most of the aid has been aimed at the banking sector. After running a tight monetary policy until the devaluation, the CBA has since significantly loosened its control and pumped liquidity into the sector. Amongst other things, the banks were given access to longer-term money after the repurchase agreement terms were extended from one week to three months. And the CBA also pumped in more liquidity by buying back treasury bills on the domestic exchange - the most developed part of the domestic capital market - to return cash to banks to the tune of AMD20bn ($55m) since April 1. More liquidity was provided through dram forex swaps. In addition, the central bank intends to create some new lending instruments, says Javadyan, using part of the Russian money to further bolster the position of banks with loans targeted at the agricultural and small business sectors by pre-financing loans - the bank offer credits and once these have been approved, they can apply to the CBA for refinancing.

Like elsewhere, NPLs are a growing problem, but as retail lending had only just started in earnest, neither the banks nor the consumers had enough time to run up big debts. "NPLs in the sector are about 6.5% now, which is good compared our neighbours and even the EU. But consider that the capital adequacy ratio for the sector is over 27% - well above the mandatory level of 12% - and the sector is in a pretty comfortable position," says Javadyan.

The CBA does regular stress tests and has been anticipating any problems. And it's the CBA's prudence that is largely responsible for the lack of problems the sector enjoys today. "Still, the bank sector is small, not very transparent and we still have problems with corporate governance. More than 65% of the bank sector assets are controlled by seven entities - mostly banks with foreign investments, while our oligarchs control only a few banks," says Javadyan. "So we should continue to be very tough with the regulation of the bank sector and I was at a recent meeting of the central bankers club where everyone now seems to be going in this direction."

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