Naubet Bisenov in Almaty -

Armenia's economy is slipping towards an abyss, as a combination of a brain drain, economic mismanagement, poor policymaking, corruption and too much power concentrated in the hands of elites all take their toll.

The contracting economy has led its youth to flee in search of better opportunities, removing the most productive members from an already small population of just 3m people.

And the country's situation will only get worse if Yerevan goes through with its commitment to join the Russia-led political and economic alliance with Moscow. The country's membership of the Customs Union, which will be transformed into the Eurasian Economic Union in 2015, will only make it easier for people to leave and find employment in the more prosperous Kazakhstan and Russia.

Although migration has slowed in recent years, 32,800 people still left in the first quarter of 2014, due to stiflingly high unemployment of 16.8% in 2013. According to Russian Federal Migration Service figures, nearly 600,000 Armenians moved to Russia in 2013. The only silver lining in the migration story is that these transient workers in Russia sent $1.7bn back home in remittances, which accounted for 16.3% of the country's GDP last year.

The country's economic growth prospects have already been hurt by the ongoing Ukrainian crisis and western sanctions imposed on Moscow, which have slowed the Russian economy and produced a double-whammy of reducing both remittances as well Russia's ability to buy Armenian imports.

And Armenia wasn’t doing well before. In April the International Monetary Fund (IMF) cut the country's economic growth forecast for 2014 by about half a percentage point to 4.3% and the World Bank was similarly gloomy. "The continuing Ukrainian crisis and the weakening of the Russian ruble can have a negative impact on Armenia's economy," the World Bank's report, "Armenia: Looking for More Dynamism", indicated.

As a result, the country is rapidly losing its appeal for foreign investment. Foreign direct investments (FDI) last year fell by more than a third – a greater fall than even suffered during the crisis-low of 2009. Even Armenia's ever-loyal diaspora are having second thoughts about investing in the country, say experts.

Despite its billing as a free economic zone, membership of the Customs Union is expected to entrench the oligarchic system and stymie the kind of deep and painful structural reforms that association with the West would've helped drive. "What is most significant is the composition of the newly installed Armenian cabinet actually raises new concerns over the course of reform in Armenia," Richard Giragosian, director of the Yerevan-based Regional Studies Centre think-tank, tells bne. "Much of the previous pro-western, pro-European element led by the former prime minister has now left the government and we see the return of the older generation of ministers from the 1990s."

Currently the main reform hurdle is the government's attempt to put a new pension law in place – something that has already caused one administration to fall. Armenian President Serzh Sargsyan finished appointing a new government on May 3 led by Prime Minister Hovik Abrahamyan following Tigran Sargsyan's resignation as PM on April 3, after his government's controversial pension reform was defeated in the Constitutional Court.

The new law, which came into force on January 1, led to widespread protests and has been challenged by the leading four opposition parties in the court. Sargsyan tried to resign once over the issue, but was talked out of it by the president due to Armenia's ongoing accession talks with the Customs Union. However, his resignation was also linked to his pro-western stance.

Abrahamyan has taken a new tack and turned, like many countries in Central Asia, in the other direction – away from the West and towards Armenia's main trading partner Russia.

Cronyism

Despite lacking direct overland links to any of the Customs Union's existing member states – Russia, Belarus and Kazakhstan - the Armenian economy, its proponents argue, will benefit from membership, and especially from Russian investment and cheaper supplies of Russian gas. However, experts question how much benefit Armenia will really gain from Customs Union membership.

Giragosian believes that the turn east will only concentrate even more decision-making in the president's office and hand more power to the oligarchs that already dominate the economy. "[Prime Minister] Hovik Abrahamyan is not a representative or advocate of an oligarchic group; he himself is one of the most influential oligarchs in Armenia, the leader of a group of people pursuing their own parochial interests," political analyst Vigen Hakobyan said in April following Abrahamyan's appointment in remarks carried by the ARKA news agency.

"The prime minister and several ministers are already amongst the wealthiest businessmen in the country," says Giragosian. "Secondly, many of these so-called oligarchs have entered parliament and they exercise not only economic but also political power through dominant market shares in key imports of commodities."

Abrahamyan is believed to be closely linked to former president Robert Kocharyan, and his appointment as prime minister is all part of a power play for political control of the country. "The new prime minister may become a convenient scapegoat or a public face for anything that goes wrong," Giragosian says. "Unlike the past when the prime ministerial post was a platform to a higher office like the presidency, in this case it's more Central Asian-style – it's the appointment of a manager who may actually be blamed for mistakes."

Another problem with the Customs Union is that Armenia joins as a junior member, dwarfed by not only Russia but also Kazakhstan. "Once Armenia is in the straightjacket of the Customs Union and then the Eurasian [Economic] Union, Russia will have enhanced its power and influence further, limiting Armenia's options, especially with its neighbours Iran and Georgia," Giragosian said.

The benefits of membership of the Customs Union remain "vague and undefined" he notes. Currently, Armenia has a fairly liberal trade regime, but when it joins the Customs Union it will have to adopt higher customs tariffs and this will make it less competitive and reduce its appeal to foreign investors, which is to the benefit of Russian investors. With Georgia moving increasingly closer to the EU and expected to sign an Association Agreement in June, the real threat to Armenia is "insignificance and isolation," Giragosian tells bne.

Armenia has already sold its last 20% stake in the Armenian gas distribution company to Gazprom for $157m in January. In December Gazprom agreed to supply natural gas to Armenia at the knockdown price of $189 per 1,000 cubic metres (cm) for the next five years (less than half what Ukraine pays), with the Kremlin agreeing to abolish export duties on Armenian supplies.

President Sargsyan hailed the deal as an incentive for foreign investors to set up energy-intensive production in Armenia. However, Giragosian believes that by giving away its energy sector to Russia, Yerevan is "mortgaging its future": despite the discounted gas price, the country's energy security is in danger because Armenia cannot now buy gas from Iran because Russia controls all the infrastructure.

Where's the money?

Even the promised Russian investment is in doubt if the West follows through on its threats to impose real and painful economic sanctions on Russia, as well as killing off any western investment projects. "Heightened tensions and economic difficulties in Ukraine are likely to be associated with intensified capital flight from Russia, leading to a sharp drop in investment. Lower demand from Russia will impact negatively countries that have close trade and financial links with it," the European Bank for Reconstruction and Development (EBRD) said in a recent report.

Further investment by Russian firms is unlikely anyway, as during the fire sale of Armenian assets, Russian companies have already invested into many of the country's most attractive assets, such as energy, telecommunications, railways and mining. There isn't much left to buy.

With little hope for Russian investment, Prime Minister Abrahamyan has ordered the country's embassies abroad to turn into marketing and investment shops to attract investment, or face closure. He is expected to tour the Armenian diaspora this summer to ask for the badly needed money. To pressure the diaspora, his government might stop paying pensions for a couple of months, the LraTVAKAN online newspaper suggests. "Will the diaspora help Armenia and Armenian oligarchs to survive?" the paper asks. "The diaspora has always helped Armenia, but it has long refused to feed the oligarchic government which is incapable of investing the diaspora's [financial] assistance in developing the country and is simply stealing it."

Loans issued by Russia are another bone of contention. In 2009, in order to support the economy during the global economic crisis Yerevan obtained a 15-year $500m loan at an interest of Libor plus 3% with a four-year grace period. In late 2013 it paid off this loan with $700m of Eurobonds issued at 6% for seven years.

During hearings in parliament, the opposition questioned the use of the loan and the logic behind its repayment with money raised at a higher rate. Secretary of the Prosperous Armenia party, MP Naira Zahrobyan, said that the loan was covered with "the veil of secrecy" and charged that "the loan had been given to entrepreneurs close" to the ruling elite. She clarified that former PM Tigran Sargsyan's government had given "significant sums" from this loan to "ethnic Armenian entrepreneurs from Russia". "This means a certain part of the money received from Russia has again been given to Russia," Zahrobyan suggested, according to the Hetq online newspaper.

But the biggest challenge the country faces is rampant corruption. Transparency International ranks Armenia in 94th place out of 177 countries in its latest Corruption Perception Index for 2013, below Georgia at 55 but above Azerbaijan in 127th place. "The real problem is entrenched corruption within the system. In other words, the problem is no longer personalities and politics, the problems is the system, the lack of checks and balances and relationship between business and politics where so-called oligarchs control 92-95% of all imports of major commodities," Giragosian says. "This is not a failed state, it is the opposite. The state still has unchallenged monopoly on power and on the instruments of power from the army to security services."

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