Macroeconomic performance

The post-crisis recovery has slowed. In the past year, Armenia has been unable to sustain the rapid pace of economic growth seen before 2008. After expanding 7.2 per cent in 2012, growth decelerated to 3.5 per cent in 2013 and remained in the low-growth territory in the first half of 2014. The slow-down was driven mainly by a contraction in investment activity, in part due to delays in implementing infrastructure projects. Weak household consumption – partly as a result of a slow-down in remittances, which represent approximately 18 per cent of GDP – was another drag on growth. Unemployment and poverty levels remained elevated. By mid-2014, inflation decelerated to below the target range of 4 ± 1.5 per cent. In response, the central bank loosened its monetary policy.

External imbalances remained wide but under control. The current account deficit on a 12-month rolling basis widened slightly to 8.8 per cent as of the end of June 2014, partly due to a decelerating Russian economy. On balance, the currency has been stable over the past two years, fluctuating in the narrow range of 405 to 415 drams against the US dollar. Official reserves covered approximately five months of imports. In March 2014 the International Monetary Fund (IMF) reached an agreement with the Armenian government on a 38-month arrangement under the Extended Fund Facility (EFF), in the amount of US$ 128 million. The EFF will provide buffers in times of significant market volatility, thereby supporting investor sentiment. The fiscal position has been sustainable, with public deficit and debt at 1.7 per cent and 44 per cent of GDP, respectively, in 2013.

The short-term economic outlook is subject to uncertainty. While growth in 2014 and 2015 is likely to continue at roughly similar rates to 2013, the tense geopolitical situation in the region, Armenia’s significant trade and financial exposure to Russia, and the potential impact of international sanctions on Russia, may trigger direct and indirect implications for the country. At the same time, Armenia could benefit from increased food exports to Russia, replacing exports from sanctioned countries and countries affected by the ban on food imports, and gain from lower energy prices, closer trade, as well as financial and investment linkages in the context of the EEU. Deeper integration in the global economy and further efforts to promote openness are crucial for Armenia’s long-term development, given the country’s small size, scarce resources, landlocked status and geopolitical constraints. Armenia therefore needs to pursue policies, which focus on improving the investment climate and public sector governance. Bearing in mind debt affordability constraints and limited fiscal space, Armenia also needs to develop cross-border infrastructure and promote interconnectivity within the country.

Major structural reform developments

The new government has expressed its intent to continue institutional reforms. Following the resignation of the previous government in April 2014, a new cabinet was formed in May 2014. The new government stated its commitment to reforms, which include creating a level playing field in the private sector, tackling corruption and reducing tax evasion. Progress in these areas has been limited so far.

Armenia joined the Eurasian Economic Union. In October 2014 Armenia’s President signed the accession treaty to the EEU with the presidents of Belarus, Kazakhstan and Russia at the Commonwealth of Independent States summit in Minsk. The EEU comes into force on 1 January 2015. With the EEU membership, there is a strong likelihood that Armenia will adopt more protectionist trade policies pursued by other EEU member states. At the same time, the treaty will allow Armenia to exempt more than 800 types of imported goods from much higher customs duties set by the EEU. Armenia is expected to adopt the EEU’s tariffs by 2022. In the short to medium term, the country will likely benefit from lower energy import prices, higher customs revenues (Armenia will receive 1.13 per cent of the amount of customs duties derived from imports of goods into the EEU territory) and possibly increased investments from Russia. Longer-term implications on the structure of the economy and trade, as well as foreign investments and reforms momentum, remain unclear.

Armenia’s decision to participate in the EEU has paved the way for energy deals. Russia waived its 30 per cent export duties on natural gas, thereby setting a new gas price for Armenia at US$ 189 per thousand cubic meters, effective from 2014. In turn, Armenia transferred its remaining 20 per cent government stake in the gas monopoly, ArmRosGazprom, to Russia’s Gazprom (increasing Gazprom’s stake to 100 per cent). In addition, the authorities agreed to a 30-year immunity clause on changes to laws, regulations, decrees and corporate income tax rates that could negatively affect the company’s finances. In January 2014 the US firm ContourGlobal signed an agreement with the Armenian government to acquire Vorotan Hydro Cascade, a series of three hydroelectric power plants totalling 405 MW on the Vorotan River in southern Armenia, for US$ 180 million. Under the terms of the agreement, ContourGlobal will invest US$ 70 million in the facility’s modernisation over the next six years. The Cascade is one of the largest power-generating facilities in Armenia, accounting for approximately 15 per cent of Armenia’s power generation capacity. The deal, if successfully finalised, is expected to diversify investor presence in the country’s energy sector.

Pension reform has been substantially revised and postponed. In January 2014 the Constitutional Court suspended the mandatory pillar of the new funded pension system, which was supposed to become effective in 2014. In April the court ruled that a number of provisions in the pension reform legislation were unconstitutional, namely those related to mandatory employee contributions, future pension guarantees and fines for violation of the pension law. The ruling gave the government and parliament until 30 September to make legal amendments. In June 2014 parliament adopted a new version of the pension law, whereby public sector employees must pay “social payments” to the state budget equivalent to 5 per cent of their monthly salary instead of making pension contributions. The payments were made mandatory for public sector employees as of early July and will be optional for private sector employees until July 2017.

Important steps have been taken towards air traffic liberalisation. In October 2013, following consultations with various local and international stakeholders, the authorities announced that all local and foreign airlines meeting safety standards would be allowed to fly to and from Armenia without special authorisations or restrictions. This is a significant turnaround compared with earlier piecemeal liberalisation plans, which only envisaged replacing the previously bankrupt national carrier, Armavia, with up to three Armenian airlines that would each enjoy a five-year exclusive monopoly over several main routes. Air traffic is of particular importance to Armenia given its landlocked status. The new “open skies” policy will promote competition in the sector and foster Armenia’s regional and global integration. There are some early indications that the policies are effective, with lower prices for air travel and an increased flow of passengers.

Capital market development and access to international capital markets have advanced. The International Finance Corporation and the EBRD issued dram bonds in December 2013 and January 2014, respectively, thus becoming the first non-resident (and international financial institution) issuers in Armenia’s capital markets. The placements amounted to 4 billion drams (approximately US$ 10 million) in total. While the amount is relatively small, this is an important step in strengthening Armenia’s capital market. In addition, in September 2013 Armenia issued its debut 7-year Eurobond, raising US$ 700 million at a 6.25 per cent yield from some 190 institutional investors. The transaction helped to establish Armenia’s sovereign benchmark in international capital markets.