G lobal structural changes took place in the world in 2022, disrupting the economic progress and normal development of the countries in the world. Specifically, Russian-Ukrainian conflict had its impact on both the conflicting countries, global economy, international commodity markets and on the Armenian economy as well. 

Taking into account Armenia’s significant vulnerability to external shocks, particularly to the current developments in Russia, the development and implementation of an effective currency policy is even more important. Thus, both Armenia and every country tries to prevent or at least reduce the occurrence of negative consequences, creating a favorable environment for a long-term maintenance of positive developments. 

Currency crises, sharp exchange rate fluctuations, high inflation rates, continuous increase in refinancing interest rate: these are the monetary policy issues which almost all the countries in world face today. 

What are the current issues of monetary policy?

M onetary policy is a constituent part of the country’s economic policy. The necessary precondition for the development of any country is the development and implementation of a modern and justified monetary policy. The monetary policy is of a great importance in ensuring the connection between the domestic market and the outside world. 

In recent years, the adoption of an inflation targeting strategy has become widespread in both developed and developing countries. As of 2009, 26 countries implemented full inflation targeting, 11 of which were developed and 15 were developing countries. As of 2021, the number of countries applying this strategy is 55, 45 of which are member countries of the International Monetary Fund (IMF). 

Those countries, that have adopted a floating exchange rate regime and an inflation targeting strategy as an additional monetary policy tool often use interventions to achieve inflation targets. Interventions often have a positive impact on managing capital outflows and inflows. Thanks to them it is possible to achieve both macroeconomic and financial stability goals, while it would be impossible using only interest rate.

The international experience study shows that a universal strategy of a monetary policy that will be effective to apply in any country of the world has not yet been developed. That is why, when implementing a monetary policy each Central Bank should choose its own strategy, which will be consistent with the development needs of the given country and will include the experience accumulated by other countries in this field. 

Effective management of capital flows is considered a current issue of a monetary policy in both developed and developing countries. Capital flows bring significant benefits, but can often cause shocks. During the 2008-2009 crisis years, significant inflow of capital was observed in developed economies (e.g. Switzerland) due to high confidence in currency (Swiss franc). In this case, the significant inflow of capital has further appreciated the Swiss franc and hit the economy. However, the Swiss bank was able to achieve a financial stability in a short period of time due to the efficient monetary policy.  

The volatility of gross capital flows in developing countries has increased dramatically since the global financial and economic crisis, which further aggravated as a result of the 2011 Eurozone crisis.  

Different countries react differently to capital flows: some countries have adopted a “one tool, one target” approach, which limits the implementation of interventions, others use multiple tools to achieve goals and often use interventions as a monetary policy tool. 

Currently, countries implement an integrated policy, aimed at effective management of capital flows and establishment of macroeconomic and financial stability. Experience shows that monetary policy does not always cope effectively with external shocks, while the systematic use of integrated policy tools can be very effective in global crises (e.g. Covid-19). 

IMF data show, that the use of macroprudential policy tools has steadily increased in both the developed and developing countries in the last 30 years. 

In current conditions, the countries also face the issue of sharp currency fluctuation in the context of the implementation of monetary policy, which has its impact on macroeconomic indicators. In October 2022, the U.S. dollar reached its highest level since 2000: it has appreciated 22% against the yen, 13% against the Euro and 6% against emerging market currencies since the start of the year. [1]

The sharp strengthening of the dollar during a few months has had significant macroeconomic implications for almost all the countries given the dominance of the dollar in international trade and finance. Currently, 88% of the transactions carried out in foreign exchange market are in US dollars, due to which it continues to be the most traded currency in the world [2]. In 2022, most of the developing countries resorted to foreign exchange interventions, as a result of which total foreign reserves of those countries fell by more than 6% in the first 7 months of this year. 

During the implementation of the currency policy under the current conditions, the continuous increase of refinancing rate is also singled out as a problem. In particular, the US Federal Reserve System has raised the policy interest rates since the start of 2022, setting it 4.5-4.75% on March 15, 2023 compared to 0.25-0.5% of the same period of last year, which is the highest interest rate set since 2008. Meanwhile, low inflation in Japan and China has allowed their central banks to buck the global tightening trend of the interest rates. 

By monetary tightening conditions, the countries aim to reduce inflation rates and approach the target index. Dramatic changes in interest rates occurred mainly in crisis years, global financial and economic crisis in 2008, Covid-19 pandemic in 2019, Russian-Ukrainian conflict in 2021.



Summing up, it should be noted that most of the developing countries that have adopted a floating exchange rate regime (Armenia, Brazil, Columbia, Peru, Chili) also implements an inflation targeting strategy. At certain stages of the development, developing countries faced various monetary issues: 

• currency crises,
• sharp exchange rate fluctuations, ensuring currency stability,
• capital flow management,
• debt reduction,
• ensuring financial and economic stability 

To solve the current problems of monetary policy, interventions have been often carried out in both the developed and developing economies, which have had both positive and negative consequences. In different countries, in different stages of economic development, the implementation of interventions pursues various goals, but the primary goal is to ensure financial and economic stability. Some developing economies were able to solve the problems that arose during the implementation of the monetary policy through interventions: currency crises, sharp exchange rate fluctuations and so on. It is also noted that the efficiency of interventions in curbing exchange rate fluctuations was short-term in nature. 

Peculiarities of currency policy implementation in Armenia

H aving a small, open and developing economy, Armenia faced certain problems in the context of implementation of monetary policy at various times. The role of the Armenian dram exchange rate is large in the process of ensuring macroeconomic balance of the RA economy, therefore the implementation of the optimal monetary policy is a key issue. The RA Central Bank (CB) conducts a freely floating exchange rate policy, which is consistent with the principles of liberalized capital account transactions and the implementation of independent monetary policy. However, as in other developing countries, the RA Central Bank intervenes in the currency market at certain stages based on the main objectives of monetary policy, which is ensuring price and financial stability. 

In 2022, the dram-ruble exchange rate reached its lowest level in March, making 4.83 due to the sharp increase in the demand for dram by the flows of people visiting Armenia against the backdrop of the Russian-Ukrainian conflict, or in other words, the increase in the supply of foreign currency. Certain dram appreciation trends were also observed in September-October, which is mainly due to the increase in flows to Armenia as a result of the partial military mobilization announced in the Russian Federation. It should be noted that between the start of 2022 and the end of the year, the dram appreciated by more than 20%. 

Currently, due to the Russian-Ukrainian conflict and the sanctions imposed on Russia as a result, there is still great geopolitical uncertainty around the world, including the region. 

Armenia’s vulnerability to external shocks and particularly to the current developments in Russia, is due to its dependence on private transfers from the Russian Federation. In particular, the transfers received by individuals from abroad through the RA banking system in 2022 amounted to more than 5 billion 190 million US dollars, which is the highest since 2004. During the observed period, the volume of transfers received from Russia to Armenia amounted to more than 3 billion 598 million US dollars, the specific weight of which is 69% in the entire volume. 

Studying the volumes of the transfers coming from Russia to Armenia in the last 15 years, we note that, generally, they had a growth trend. The only exception was 2009, conditioned by the global economic crisis. A decrease was recorded from the middle of 2014 due to the devaluation of the ruble. And the decline recorded in 2020 was caused by the emergence of negative consequences of the pandemic.

Due to the recent events, the inflow of transfers from the Russian Federation has increased in Armenia, as well as the number of international visitors, which has had an impact on the currency market of Armenia. In particular, due to the inflow of international visitors, the demand for dram or the supply of dollars has increased, causing the dram to appreciate. 

It should be noted that the RA Central Bank resorted to the use of interventions at certain stages in order to mitigate sharp fluctuations in the exchange rate. We note that the largest sales volume was recorded in 2009, and the largest purchase volume in 2022, mainly due to dram appreciation. 

As for ensuring price stability, which has always been the final goal of the RA monetary policy, we should note that since January 1, 2006, it officially decided to switch to the inflation targeting strategy, setting the allowable range of variation of 4․0%+/-1.5 as a target indicator. 

From 2021 until today, the rate of inflation in the RA is continuously accelerating, which is due to the global changes taking in the world, when inflation has become a global phenomenon. Throughout 2022, the Central Bank of Armenia increased the refinancing rate 6 times, setting it at 10.75%, in order to bring inflation to the target index. It should be noted, that compared to the previous year, prices in the RA consumer market increased by 8.6% in 2022. 

Summing up the study of the currency and monetary policy in Armenia, we can confidently state, that the currency exchange rate is one of the backbones of monetary policy, affecting the interests of the entire society. Inflation is of great importance from the viewpoint of macroeconomic stability, and it has an impact on the fundamental indicators of the real sector: GDP level, population incomes, unemployment rate and so on. 

Despite the peculiarities of economies and differences in the level of development, low, stable inflation and a stable currency exchange rate are important prerequisites for ensuring economic growth in the market economy, which are influenced directly by the implemented monetary policy. At the same time, it should be noted that due to the current developments, we are getting signals from the RA Central Bank that the world should gradually transition from the inflation targeting strategy to the risk management policy, which helps to prevent or at least neutralize the negative impulses from the outside world in the short term. 

[1] IMF, How Countries Should Respond to the Strong Dollar.
[2] BIS, OTC foreign exchange turnover in April 2022.

 

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