Armenia: Risk Assessment

Country Rating¹

Rating: C

Business Climate Rating¹

Rating: C

Risk Assessment²

GDP growth below pre-crisis levels
Armenia came out of recession with modest growth in 2010. The countercyclical policy pursued by the government with the international community support and improved world economic conditions enabled the strong economic rebound in the first half, particularly in industry. The farm sector was battered, however, by periods of drought and strong rains that ultimately triggered off a surge of inflation from summer and, as a result, a slowdown of economic growth, which is only expected to be moderately stronger in 2011. Metal and mineral prices will nonetheless be likely to remain high, which will benefit export-oriented sectors. Russia's economic dynamism will also benefit Armenia via remittances which will, however, remain below pre-crisis levels. Domestic demand could suffer from the reduction in public spending stipulated in the fiscal consolidation plan implemented under IMF conditions. The normalization of the situation in the farm sector would ease inflationary pressures.

Twin deficits
The conclusion in 2010 of a new IMF stand-by agreement - two concessional loans totaling $400 million - prompt the consolidation of public finances, which were severely undermined by the financial crisis and the dram devaluation early 2009 with over 80% of the debt denominated in foreign currencies. This consolidation effort is expected to facilitate shaving one point off the public debt in 2011 and keeping it at a steady level thereafter. This adjustment is also intended to reduce a current account deficit that will nonetheless remain very high. The cumulative impact of the main multilateral financial support (IMF, World Bank, European Union, Asian Development Bank), in conjunction with parsimonious use of foreign exchange reserves, will likely limit an additional debt to cover the economy's financing needs. A further sharp depreciation of the dram thus appears highly unlikely. The banking sector, meanwhile, seems to be stabilized with the decline of nonperforming loans and new prudential rules strengthening capitalization requirements.

A still risky geopolitical environment
The window of opportunity for rapprochement with Turkey that opened briefly in 2009 ultimately failed to work out with Armenia refusing to tie such a move on the dispute over Nagorno-Karabakh. The Turkish-Armenian border thus remains closed. Relations with Azerbaijan also remained tense in 2010 with military skirmishes - the most serious since the cease-fire in 2008 - resulting in the deaths of several soldiers. The negotiations on the status of the Nagorno-Karabakh region appear deadlocked. And the risk of conflict has thus remained high especially with the defense budgets increasing sharply in both countries. In governance terms, little progress has been made in recent years. Corruption and constraints on competition remain commonplace.

Strengths

• Support of the international financial community
• Consolidation of the country’s financial position thanks to measures implemented by the government
• Warming relations with Turkey
• Growth of currency reserves thanks to a return to a flexible exchange-rate regime

Weaknesses

• Structurally large current account deficits
• Growth of public foreign debt
• Very slow process of opening up the country, which remains very dependent on Russian investments
• Landlocked geographic position
• Risk of conflict with Azerbaijan