Tuesday, 15 September 2015

Armenia's economic woes

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By Natalia Konarzewska 

September 15th, 2015, The CACI Analyst

Armenia’s economy is currently experiencing a significant decline, which is primarily caused by spillover from Russia’s recession. At the end of 2014, Armenia’s national currency, the dram, saw rapid depreciation, which boosted inflation. Falling remittances from Russia are putting additional pressure on the dram, negatively affecting the livelihood of many ordinary citizens. Additionally, export volumes to Russia, which is Armenia’s top export destination, have decreased significantly. Armenia currently has few options to boost its faltering economy due to a falling number of foreign direct investments, high national debt and a shortfall of budget revenue. Economic forecasts for Armenia remain grim and since June the country has seen a wave of protests over the price hike on electricity.

BACKGROUND: The World Bank and International Monetary Fund forecast that in 2015, economic growth in Armenia will be weak or even negative. Armenian authorities paint a much rosier picture and predict that the economy will grow by 4.1 percent this year versus 3.4 percent in 2014. However, the most recent shocks to the economy suggest that the former prediction is closer to reality. The depreciation of the dram accelerated in November and December 2014. In November, one US$ was worth 416 drams, whereas the currency hit a record low in December, with exchange rates of 550 drams to one US$. Since then, Armenia’s national currency has strengthened slightly, although the Eurasian Economic Commission calculated that the dram dropped by 16.11 percent to the US$ in the first quarter of 2015. The dram’s exchange rate to other convertible currencies (except for the ruble) still remains relatively low and amounts to around 484 drams per US$ and 539 drams per Euro, as per September 8.

The decrease in financial transfers from Russia puts additional pressure on Armenia’s economy, as 21 percent of the country’s GDP derives from remittances. Remittances from Russia diminished by 56 percent last year, and are expected to decrease further due to ruble depreciation and a slowdown in the Russian market. Slumping remittances and devaluation of the national currency have an adverse effect on salaries and tax revenue, and boost the price of essential foodstuffs, which increases economic hardship for ordinary people.

The government currently has few options to boost the faltering economy and mitigate the wave of public discontent. Mounting national debt, which is expected to reach 44.5 percent of GDP in 2015, and significant shortfalls in budget revenues severely limit expenditures on social welfare needed to abate the risk of social protests. Moreover, Armenia is experiencing a decrease in foreign direct investments, which could otherwise help boost the tumbling economy. In June and July, key international companies such as Etihad Airways, Samsung and France Telecom-Orange announced that they will soon stop business operations in Armenia.

Economic hardship and a failure to realize anticipated economic benefits from joining the Eurasian Economic Union (EEU) have led many in Armenia to second-guess its capacity to boost the growth of Armenia’s economy. Armenia joined the EEU at a very unfortunate moment, when the Russian economy, the Union’s largest, is contracting sharply, which significantly undermines the feasibility of the whole organization. The EEU technical requirements leave Armenia with few possibilities to diversify its trade or attract foreign direct investment from outside the EEU, due to increased customs duties and tariff rates for non-EEU trade partners. Furthermore, the free trade arrangement has not proven to be as beneficial as anticipated. In 2015, Armenia is experiencing a severe downturn in foreign trade, the worst since the 2008 crisis. In particular trade turnover with Russia, which is Armenia’s largest trade partner, has declined significantly this year and fell by 41.2 percent in the first quarter of 2015 compared to the same period last year. Its EEU membership makes Armenia even more economically dependent on Russia, and thereby less capable of independently managing the domestic economic fallout and more vulnerable to fluctuations on the Russian market.

IMPLICATIONS: The failure of anticipated benefits from joining the EEU to materialize and the economic turmoil on the domestic market has forced Armenia to rebalance its foreign policy and seek to diversify its trade and investment options. In particular, Armenian officials hope to receive financial assistance and attract foreign investments to counter the adverse effects of the economic slump. In the past few months, the Armenian government has actively sought a new framework for relations with the European Union, which will not breach Armenia’s commitments under other international formats. Yerevan has proposed to sign an Association Agreement (AA) excluding the trade component, which is technically incompatible with requirements for EEU members.

Nonetheless, Brussels decided not to proceed with any form of AA with Armenia, due to Yerevan’s support for Crimea’s annexation referendum in 2014. Instead, during the last Eastern Partnership summit in Riga in May 2015, the EU proposed a new format for bilateral cooperation with Armenia, which includes measures to promote democratization, improvement of governance and human rights, justice reforms and support for investment and the development of small and medium businesses. While negotiations on the new flexible legal format for cooperation between Yerevan and Brussels are underway, the European Investment Bank decided in June to allocate €212 million for developing the key areas of the Armenian economy. Funds will be designated for supporting transportation, energy and water sector infrastructure, as well as development of small and medium enterprises.

On May 7, Armenia concluded the Trade and Investment Framework Agreement with the U.S., which aims to improve the trade and investment climate between the two countries. However, the economic impact of the agreement is questionable, because the U.S. is not among Armenia’s most important trade partners – bilateral trade amounts to only 4.6 percent of Armenia’s overall foreign trade and this number is steadily dropping. Moreover, the U.S. still is reluctant to restore Millennium Challenge Account funding for Armenia. This aid program, which allocated US$ 67 million for road construction, was cut in 2009.

Pending the end of international sanctions against Iran, Armenia anticipates possible trade and investment benefits from non-restricted cooperation with its southern neighbor. A proposed railway connecting Iran and Armenia with one of Georgia’s Black Sea ports remains a most important project for Yerevan. Government officials present the project as a top priority infrastructural initiative, connecting EEU member states with Iran, and hope to receive additional Russian funding to cover the construction costs. Nonetheless, Russia has not yet specified the amount of financial support and apparently questions the commercial viability of the project. In June, the President of Russian Railways Vladimir Yakunin termed the Iran-Armenia railway link inefficient: “It is like opening a window to nowhere, to the wall of a neighboring building.” From Moscow’s point of view, the project’s geopolitical significance and profitability are undermined by the lack of a direct connection to Russia. Until the conflicting interests between the South Caucasian states are reconciled, extending the railway through Abkhazia is highly unlikely.

Protests over a price hike on electricity, which has taken place in Armenia since July this year, reflect a growing public disillusionment with the government’s economic policy. Armenia’s energy monopoly Electric Networks of Armenia (ENA), a subsidiary company of Russia’s RAO UES International, has justified the increase in electricity fees for retail customers with a low profitability. Armenian authorities could do little to avoid the price hike, because ENA warned that if the demands for a fee increase were not fully met, the country would experience energy shortages or even a shutdown. Despite the fact that the electricity price hike reflects Armenia’s deepening overdependence on Russia in strategic sectors of the economy, protesters avoid voicing an anti-Russian narrative. Nonetheless, Russian media have linked the protests to the U.S. geopolitical agenda. Moscow is apparently concerned that the protests could spiral into an anti-Russian outcry and has made several conciliatory moves towards Armenia. After months of difficult negotiations, Russia agreed to cut the gas price and provided Armenia with a loan of US$ 200 million for purchases of military equipment.

CONCLUSIONS: Rebalancing Armenia’s foreign policy and undertaking efforts aimed to diversify its trade and investment options are the best options for countering the current economic crisis. The small and isolated Armenian economy can  benefit immensely from regional trade and investment cooperation with economically stronger trade partners. However, several factors can hinder the effectiveness of this strategy. Under EEU obligations, Armenia cannot pursue free trade relations with non-EEU partners, such as the EU. On the other hand, the extreme overreliance on Russia makes the Armenian economy more vulnerable to economic shocks on the Russian market and limits Armenia’s capability to independently counter the crisis. Furthermore, the oligarchic structure of Armenia’s economy and the low quality of governance will hinder any efforts to modernize and boost the economy. 

AUTHOR’S BIO: Natalia Konarzewska is a graduate of University of Warsaw and a freelance expert and analyst with a focus on political and economic developments in the post-Soviet space.

Image Attribution: www.armenianow.org, accessed on Sept 18th, 2015

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