Armenia: Risk Assessment
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Business Climate Rating
- Significant mineral resources (gold, copper, molybdenum, zinc)
- Comfortable foreign exchange reserves and relative flexibility of the dram exchange rate
- Significant financial support from international organizations, including the International Monetary Fund (IMF)
- Member of the Eurasian Economic Union (EAEU) and partnership agreement with the European Union (EU)
- Willingness to reform in terms of corruption, justice, and competition
- Dependence on minerals (50% of exports and 10% of GDP), despite the ongoing diversification effort
- Strong dependence on Russia in terms of security, trade (largest partner), expatriate remittances (63% of total), and FDI (37% of total)
- Banking system still heavily dollarized (42% of deposits and 48% of credits)
- About 75% of Armenia's public debt is denominated in foreign currencies, making it vulnerable to exchange rate fluctuations.
- High and persistent levels of poverty (30% of the population) and unemployment (17%)
- Geographic isolation compounded by a lack of infrastructure and the closure of two out of four borders.
- Armed conflict with Azerbaijan over the Nagorno-Karabakh enclave, which may lead to occasional clashes even after the 9 November 2020 cease-fire.
Inflation control at the heart of concerns
Faced with the double shock of the pandemic and the armed conflict in 2020, the economy witnessed the abrupt end of three years of robust growth. The moderate recovery of 2021 will continue in 2022, despite weakening the favorable base effect. Private consumption (80% of GDP) will remain the main driver, thanks to rising household incomes and remittances from Russia. The latter is likely to decline due to a lower forecast for Russian growth.
Most businesses, industries, and educational institutions have been allowed to reopen. This will help the recovery, as services contribute 60% of GDP. However, a low vaccination rate will prevent further expansion of the economy. As of January 9th, 2022,25 % of the population had been fully vaccinated. In addition, the global rise in oil prices will harm the trade position, as Armenia is an oil-importing country. The rebound in imports (40% of GDP) of capital goods and oil to meet rising domestic demand will be more significant than the increase in exports (30% of GDP, driven by the excellent performance of gold and copper ores). The investment will remain moderate (15% of GDP), as tensions with Azerbaijan discourage foreign investors.
Inflation exceeded the target of 4% due to the impact of dram depreciation in 2020 and rising commodity prices. By the end-2021, the Central Bank of Armenia (CBA) should have raised its policy rate by a cumulative 230 basis points to 7.75%. Further tightening may occur in 2022 as external inflationary pressures remain less so as global supply chains adjust. The high level of dollarization implies that the CBA is closely monitoring the impact of interest rates on the exchange rate, which will appreciate further.
Deficit management to stabilize the debt
The government will continue to implement its strategy (2022-26), which aims to stimulate growth through structural reforms (creation of an anti-corruption agency), promoting agricultural and manufacturing exports, and increasing FDI. On September 30th, 2021, the government presented its draft budget for 2022. Expenditures, in nominal terms, are expected to increase by 18% compared to 2021, with the bulk of the increase going to social security, the defense sector, and education. Nominal revenues will increase by 29%, thanks to introducing a progressive tax system and revising the taxation of interest earned on bank deposits and corporate bonds. In May 2019, the IMF approved a three-year Stand-By Arrangement (lending facility) for Armenia with an initial amount of SDR 180 million, which increased to SDR 308.8 million (USD 432 million) in May 2020. It aims to support the strengthening of economic fundamentals, policy frameworks, and structural reforms. In return, Armenia commits to a sustainable budget path. By the end of 2021, USD 72 million had been disbursed, bringing total disbursements to USD 396 million. Public debt (75% external, 25% domestic) mainly consists of external loans, foreign currency-denominated bonds, and treasury bills. Primarily denominated in foreign currencies and vulnerable to exchange rate fluctuations, it should remain under control, as the government is keen to abide by the fiscal rule introduced in 2022. Nevertheless, the debt-to-GDP ratio will tend to decline; GDP growth will be stronger than debt growth.
The current account deficit is due to the trade deficit (12% of GDP) and the primary income account deficit resulting from foreign investors' income repatriation. Thanks to expatriate transfers (8% of GDP), more than the surplus on the secondary income account will be needed to cover the negative balance.
The current account deficit is expected to widen slightly, in line with the rise in global oil prices. It is financed by external borrowing and unrecorded foreign exchange inflows.
Conflict with Azerbaijan weighing on the political scene
September 27th, 2020, marked the resurgence of the 30-year armed conflict between Armenia and Azerbaijan over Nagorno-Karabakh. This confrontation was the deadliest since the 1994 war, which led to the proclamation of independence of this enclave, which, although internationally recognized as Azerbaijani territory, was, at the end of the war, populated by Armenians and under the control of forces supported by Armenia. After several unsuccessful attempts, a ceasefire was signed on November 9th, 2020, under the auspices of Russia, ending hostilities and restoring Azerbaijan's control over a fraction of Nagorno-Karabakh and the majority of the territories adjacent to it. Tensions have been rekindled since May 2021, however, by Armenian allegations that the Azerbaijani army is crossing the border in violation of the agreement. Clashes, with casualties on both sides, were reported again in early January 2022. On the domestic front, the ceasefire led to protests organized by the opposition demanding the resignation of Prime Minister Nikol Pashinian, who has been in power since the Velvet Revolution of 2018. After resigning in April 2021, he called early parliamentary elections for June 20th. He and his "Civil Contract" party, supported by his former coalition, the "My Step" Alliance, won the election comfortably (54% of seats compared to 66% in 2018). The opposition grouped in the "Armenian Alliance," under the leadership of former president Robert Kocharian, will keep up the pressure by alleging weakness in the government in negotiations.