Armenia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Significant mineral resources (gold, copper, molybdenum, zinc)
- Comfortable foreign exchange reserves and relative flexibility of the dram exchange rate
- Strong 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)
- Will to reform in terms of corruption, justice, and competition
- Dependence on minerals (50% of exports and 10% of GDP), despite ongoing diversification efforts
- Strong dependence on Russia in terms of security, trade (first partner), expatriate remittances (63% of total), and FDI (37% of total)
- Banking system still heavily dollarized (42% of deposits and 48% of credits)
- About 80% 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 (24%)
- Geographic isolation compounded by a lack of infrastructure and the closure of two 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
Military defeat and continuing clashes weaken the government
27 September 2020 marked the resurgence of the 30-year-old armed conflict between Armenia and Azerbaijan in Nagorno-Karabakh. The six-week 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 Armenian-backed forces. After several unsuccessful attempts, a ceasefire was signed on 9 November 2020, under the auspices of Russia, ending hostilities and giving back Azerbaijan control of the majority of the territories of Nagorno-Karabakh. Tensions between the two countries have nevertheless been rekindled since May 2021 by Armenian allegations that the Azerbaijani army crossed the border in violation of the agreement. Clashes, with victims on both sides, were reported during summer 2021.
Domestically, the cease-fire was not well received by a part of public opinion, leading to demonstrations by opposition parties and calls for the resignation of Prime Minister Nikol Pashinyan and his government. After resigning in April 2021, he called early parliamentary elections on 20 June. Despite a setback compared to 2018, he and his "Civil Contract" party comfortably won the election (54% of seats compared to 66% in 2018). Appointed in May 2018 after the Velvet Revolution that pushed the Republican Party of Armenia (HHK, in power for 20 years) and Serge Sarkissian out of power, Mr. Pashinyan had benefited, until then, from the support of his coalition, the "My Step" Alliance.
A recovery gaining momentum
Faced with the double shock of the crisis linked to the COVID-19 pandemic and the armed conflict in 2020, the economy ended three years of robust growth. In 2021, the economy is expected to rebound, driven by private consumption (about 80% of GDP), thanks to growth in household income and remittances. Public consumption is also expected to increase due to higher spending on social services. Trade will contribute negatively to growth (-11.5% of GDP), despite a shrinking trade deficit. The rebound in imports (54% of GDP) of capital goods and oil to meet the increase in domestic demand will be more important than that of the level of exports (notably driven by the good performance of gold and copper ores). The contribution of investment (18% of GDP) will remain moderate, due to the decline in public investment spending and the sluggishness of private investment in an unfavorable business climate. Moreover, the latter could be curbed by the tightening of a monetary policy initiated by the Central Bank of Armenia (CBA) to combat inflation.
The latter has been rising rapidly since December 2020 and now exceeds its target of 4%, due to the impact of the depreciation of the dram in 2020 and the rise in commodity prices. Consequently, the CBA's key interest rate reached 7.25% in September 2021 (the highest level since August 2016), an increase of 300 basis points since December 2020. Inflation is expected to begin moderating in the second half of 2021 as the temporary impact of imported food inflation and dram depreciation dissipate, but also as recent monetary policy measures take effect.
The policy rate hike slows down private sector credit growth; it reached USD 10 billion in June 2021, a 9.5% year-on-year increase from 20.1 percent in January of the same year. In addition, the nonperforming loan ratio is increasing; it stood at 7.5% in February 2021, an increase of one point from December 2020.
Public consolidation on track
Despite the recovery in domestic activity, robust exports and remittances are expected to reduce the current account deficit slightly in 2021, and international reserves are expected to increase from 2020 levels (covering 5 months of imports). The February 2021 Eurobond and borrowing from international financial institutions will finance most of the deficit. As a result, external debt is expected to increase to 105 % of GDP.
After the activation of the safeguard clause of the fiscal rule for 2020, the government deficit is expected to decline in 2021. Expenditures will decline faster than revenues, due to the government's fiscal consolidation efforts (program-based budgeting, improved financial risk management). Nevertheless, the issuance of Eurobonds and additional borrowing during the year will lead to an increase in the debt level. The debt is mainly denominated in foreign currencies and is vulnerable to exchange rate fluctuations, but it should remain under control as the government should support measures to broaden the tax base, including bringing the debt-to-GDP ratio below 60% in the short term.