Armenia: Economy

Armenia is the second most densely populated of the former Soviet republics. It is a landlocked country between the Black and the Caspian Seas, bordered on the north by Georgia, to the east by Azerbaijan, on the south by Iran, and to the west by Turkey. Up until independence [1991], Armenia's economy was based largely on industry--chemicals, electronic products, machinery, processed food, synthetic rubber, and textiles--and highly dependent on outside resources. Agriculture accounted for only 20% of net material product and 10% of employment before the breakup of the Soviet Union. Construction, which was the leading sector of the economy for the past eight years, constituting 27% of the country's GDP in 2008, declined by 34.6% in 2009. In 2010, the sector continued to shrink, with a decrease of three percent compared to the same period in 2009. The beginning of the slowdown in construction coincided with the tense political situation connected to the presidential election campaign and the post-election civil unrest in 2008. Market saturation, a drop in demand related to the global economic crisis, and a steep decline in foreign remittances contributed to the further slowdown.

Like other New Independent States of the former Soviet Union, Armenia's economy still suffers from the legacy of a centrally planned economy and the breakdown of former Soviet trading networks. While investment from these states in support of Armenian industry has virtually disappeared, and few major enterprises are still able to function, Russian entities have nevertheless increased their ownership in the mining, energy, telecommunications, and transportation sectors. In addition, the effects of the 1988 earthquake, which killed more than 25,000 people and made 500,000 homeless, are still being felt, though international donors and diaspora Armenian groups continue to fund reconstruction efforts in the earthquake zone.

Although a cease-fire has held since 1994, the 20-year-old conflict with Azerbaijan over Nagorno-Karabakh has not been resolved. While intensive efforts by the OSCE Minsk Group is ongoing in pursuit of a settlement, for the time being, the closure of both the Azerbaijani and Turkish borders has prevented Armenia from realizing its economic potential. Armenia's economy depends heavily on outside supplies of energy and most raw materials. While land routes to Turkey are closed, regular and charter air connections operate between Yerevan and Istanbul and Antalya; land routes through Georgia and Iran raise the risk and cost of transport.

The structure of Armenia's economy has changed substantially since independence in 1991, with sectors such as construction and services replacing agriculture and industry as the main contributors to economic growth. The diamond processing industry, which was one of the leading export sectors in 2000-2004 and a major recipient of foreign investment, faced a dramatic decrease in output since 2005 due to raw material supply problems with Russia and an overall decline in international diamond markets. Other industrial sectors driving industrial growth include energy, metallurgy, and food processing.

Despite the Nagorno-Karabakh conflict, the Government of Armenia has been able to carry out wide-ranging economic reforms that have paid off in dramatically lower inflation and relatively steady growth. Armenia registered strong economic growth after 1995, with double-digit GDP growth rates every year from 2002 to 2007.

After rapid expansion in 2001-2007, economic and financial conditions worsened rapidly in Armenia in 2008, due to a drop in international metals prices and a downturn in the Russian economy following the collapse of oil prices in late 2008. The end of a remittance-fueled construction boom that had driven growth in recent years resulted in a 14.4% drop of real GDP for 2009 (compared to 6.8% GDP growth in 2008), with about 80% of this decline due to a plunge in the construction sector. Since 2008, Armenia has experienced a significant drop in investment, exports, and in real incomes primarily caused by the global financial crisis. The Government of Armenia’s (GOAM) anti-crisis measures, additional loans and budgetary support from international donors helped to avoid further economic decline in 2010. However, economic indicators, while on the rebound, still fall short of the pre-crisis growth trend for the two decades following independence. Gradual recovery of remittance flows in comparison to 2009 also contributed to the slight upturn. Nevertheless, poverty and prices remain high, and the sustainability of growth remains a concern. Some of the major impediments for potential investors remain the lack of transparency in the tax and customs administration, the unpredictability of doing business in Armenia, and unequal competition between domestic and foreign firms.

Armenia maintains a floating exchange rate regime with no explicit exchange rate target. The nominal exchange rate of the Armenian dram with major currencies was fairly stable between 1998 and 2003. During 2003-2007, the Armenian Dram appreciated sharply against the US dollar by around 45%, mainly due to significant growth in remittances, growth of exports in absolute terms, the de-dollarization of the economy and weakening of the dollar in international markets. The appreciation of the dram affected negatively the traditional export industries, including information technologies, diamond cutting, the wine industry, and textiles. Exporters responded to the increased costs by either reducing their capacities of production or by reducing their number of employees in order to stay afloat. During 2008, the exchange rate was mainly stable at around 300 drams per dollar, until March 2009, when the Central Bank stopped its heavy intervention in the foreign exchange market and announced that it would adopt a floating currency regime. As a result, the Dram devalued by around 25%, and has remained roughly stable at this rate of exchange.

Armenia is highly dependent on import of energy fuel, mainly from Russia. The Armenia Nuclear Power Plant (ANPP) at Metsamor provides around 40% of electricity generation for the country, and hydro and thermal plants provide roughly 30% each. Armenia imports most of its natural gas from Russia, which provided significant discounts to Armenia until 2009. Russian import gas prices rose from $110 to $154 per thousand cubic meters in April 2009, and increased further to $180 in April 2010. The gas price was set to further rise in April 2011 to approach the international market price, but this has been temporarily averted as a result of extensive negotiations between the Russian and Armenian governments. However, the current price is still below the international average of over $300, and in the coming years the price is expected to converge with market prices.

Since May 2006 Armenia has also received natural gas from Iran through a direct pipeline between the two countries, in addition to tanker trucks. As a result of a Gazprom-brokered deal, Armenia and Iran participate in a program of direct exchange of natural gas for electric power, which has diversified Armenia’s supply of gas products.

Armenia imports nearly all of its refined petroleum products through Georgia. The August 2008 conflict between Russia and Georgia resulted in periodic disruptions of fuel and food imports, and highlighted Armenia's vulnerability to this primary transit corridor.

Armenia has received significant support from international institutions. The International Monetary Fund (IMF), World Bank, European Bank for Reconstruction and Development (EBRD), as well as other international financial institutions (IFIs) and foreign countries, particularly Russia, are extending considerable grants and loans. These loans are targeted at reducing the budget deficit, stabilizing the local currency; developing private businesses; energy; and the agriculture, food processing, transportation, and health and education sectors. In 2009 Armenia received more than $ 1.5 billion in donor financing for budget support and different government-led anti-crisis programs. In 2011, the Eurasian Economic Community (EurAsEC), an economic organization in which Russia is a principal participant, provided a loan of $500 million to finance Armenia’s external debt and restructure a number of branches in the Armenian economy, in return for the transfer of major assets. Further, Russian energy conglomerates have pledged to invest $71 million in natural gas and electricity distribution networks in Armenia in 2011.

Continued economic growth will depend on the ability of the government to strengthen its macroeconomic management, including increasing revenue collection, improving the investment climate, and combating significant corruption. A liberal foreign investment law was approved in June 1994, and a Law on Privatization was adopted in 1997, as well as a program on state property privatization. Armenia joined the World Trade Organization on February 5, 2003. Armenia recently acceded to the WTO’s Agreement on Government Procurement which imposes an obligation to improve its existing procurement practices.

Environmental Issues
Armenia is trying to address its environmental problems. The Ministry of Nature Protection has introduced a pollution fee system by which taxes are levied on air and water emissions and solid waste disposal, with the resulting revenues used for environmental protection activities. Deforestation by mining concerns in certain parts of the country, especially the Teghut Forest in the Lori marz (region), have resulted in periodic protests by environmental non-governmental organizations (NGOs), and stirred controversy over government policies to support investment in the mining sector. Armenia is interested in cooperating with other members of the Commonwealth of Independent States (CIS--a group of 11 former Soviet republics) and with members of the international community on environmental issues. Armenia has been under strong pressure from the international community to close its thirty-five year old nuclear power plant (ANPP) at Metsamor by 2016. This pressure has only increased in the aftermath of the Fukushima nuclear disaster in Japan in March 2011. Given that Armenia depends on the ANPP for over 40% of its electricity, the Armenian Government sees no alternative to construction of a new nuclear plant. A U.S. Agency for International Development (USAID)-funded initial planning study was completed in 2009, and concluded that a new nuclear plant is the least-cost option to replace the existing facility: however, construction of a new plant will still be expensive, costing between $5 billion and $7.2 billion to complete, and will likely require significant foreign investment capital. The Armenian Government is continuing with the planning process for a new plant. Beginning in 2010, USAID is providing technical assistance to the Government of Armenia to ensure that the new nuclear plant meets proper safety and environmental standards.

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