MACRO ADVISOR: Can Armenia break free of Russia’s economic grip?

By bne IntelliNews June 2, 2015

Chris Weafer of Macro Advisory -


Armenia’s economic performance will be poor this year mainly because of the contagion from Russia’s recession. But the economy is more vulnerable to negative contagion because efforts to reform the business and investment climate have been moving far too slowly as successive governments were distracted by a sequence of domestic political squabbles and unresolved disputes with the country’s biggest neighbours. Recently there has, however, been more encouraging progress in developing new sectors of the economy, in particular technology, and this year’s slowdown could yet act as a spur to sustain and add to those efforts.

Armenia’s real GDP growth, which exceeded 7% in 2012, is expected to be only 1% (see table) for this year. It could be worse even than that, eg. the International Monetary Fund (IMF) forecasts a full-year contraction, depending on the performance of the Russian and other regional economies. The specific problems include the big drop in worker remittances from Russia and the loss of competitiveness due to the ruble collapse in late 2014.

In 2013, worker remittances contributed over 21% of GDP. For this year that contribution is expected to fall to 15%, or less, as Russian industry cuts workers and wages, and because the devalued ruble means smaller receipts when converted into the local currency. The Central Bank of Armenia (CBA) did adopt the same strategy as other counties impacted by the Russia crisis and pushed the value of the dram lower. The dram weakened by 16% in 2014 and is forecast to drop by another 10% this year, albeit that will mostly be determined by what happens to the ruble.

While allowing the dram to weaken to try to protect the value of remittances and minimize the loss of competitiveness, the CBA also tried to prevent inflation from spiking too high by boosting its benchmark interest rate from 6.75% in mid-December to 10.5%, where it currently is. The high interest rate, coupled with the other negative macro and confidence trends, is adding pressure to such sensitive sectors as retail and construction.

Reflecting the tough spot in which the economy is now stuck, the two rating agencies that have assigned ratings to Armenia’s sovereign credit risk – Moody’s Investors Service and Fitch Ratings – cut their ratings in January, citing concerns about the impact of the Russia crisis and the lack of progress in expanding external trade deals.

Glacial change

But while the external contagion has pulled the macroeconomic indicators lower this year, the main problem is the slow pace of change in the country and lack of job creation. Unemployment, which has been in double digits for years, is expected to exceed 18% later this year. Armenia does actually rank more favourably than the other former Soviet states, except for Georgia, in such surveys as the World Bank’s “Doing Business”, but has not managed to capitalize on that to attract any meaningful volume of inward investment.

Is that starting to change?  In January Armenia formally joined the Eurasian Economic Union (EEU) and while that is not expected to make any meaningful difference over the medium term – ie. because Armenia already has extensive bilateral trade deals in place with Russia and Kazakhstan – it may create an opportunity to attract international companies looking to establish a base inside the EEU. Nervousness about Russia’s poor legal protections and perception of corruption and bureaucracy, may work in Armenia’s favour, especially in technology-based industries.

This is one area where the economy has been making progress in recent years. It is also one of the similarities the country shares with Ireland: it is a small economy on the edge of a larger economic block with a poor resource base and a large diaspora. Ireland also had a very poor economic base until it started to focus on producing, and retaining, skilled graduates in such areas as IT, biotechnology and other knowledge based industries. Armenia is starting down the same route, albeit it is early days yet.

The country’s IT sector has been growing at an average of 22% between 2003 and 2014, according to the Enterprise Incubator Foundation (EIF). It says that the 400 IT companies in the country registered in 2014 generated revenues for $475mn, about 4.3% of total GDP and 10% of total exports. Last year the sector created 17 new start-ups and 1,100 new jobs. In 2008 the government adopted a 10-year industry development strategy, focusing on building infrastructure, improving the quality of IT graduates, and creating venture capital and other financial mechanisms to support start-ups, like tax breaks and simplified bureaucratic procedures.

Armenia’s economy may also benefit from being a link in China’s so-called 21st Century Maritime Silk Road. This project envisages multiple road and rail routes carrying Chinese goods to ports on the Arabian, Mediterranean and Black Seas, as well as through Russia and into Europe. Armenia and Iran are planning an improved rail link across their shared border and, with Georgia, Armenia is building new transit bridges. Armenia is, theoretically, well positioned to benefit from the opening up of Iran’s economy once sanctions are eased.

Politics intrude

Political concerns could still prevent Armenia from taking advantage of its potential as a high-tech hub and as a trading partner with re-emergent Iran. Just recently the leader of the country’s second-largest party, also reputed to be the country’s third richest individual, was forced out of the party because of various government investigations, which many believe are linked to his criticism of the president-sponsored constitutional referendum set for 2016. The lead-up to that referendum is expected to see frequent and potentially more intense protests by opposition groups.

The unresolved conflict with Azerbaijan over the ethnic Armenian enclave of Nagorno-Karabakh that its troops are still occupying after fighting a bloody war over it in 1988-94 is also part of the risk equation for investors. The number of reported incidents and threats are expected to increase this year ahead of the November parliamentary elections in Azerbaijan. One encouraging trend, however, is what appears to be an effort by Armenia not to escalate the conflict with Azerbaijan and, for this reason, it has not officially recognized the outcome of the recent elections in Nagorno-Karabakh. The president is quoted in media reports as saying: “The recognition of the Republic of Nagorno-Karabakh will mean giving up the negotiations process. Then there will be nothing to talk about.”

For portfolio investors Armenia is a frontier market with few real access opportunities. The country placed its first Eurobond in 2013, raising $700mn, and added a second issue worth $500mn in late March this year. There are no Armenian depositary receipts traded on international bourses as yet. But if the government sticks to its plan to start privatizing state-controlled enterprises, then this may start to change in the coming years. One factor that should help and encourage this process is the mandatory pension contribution system which, starting in January 2014, requires all employees born after 1974 to set aside 5% of their total yearly salary into private pension funds. That at least creates the required local investor base.

Armenia as a country and an economy clearly has potential for business and investors. To realise that requires political will and a longer period of stability than has been possible previously.

Chris Weafer is Senior Partner at Macro Advisory, which offers bespoke Russia-CIS consulting


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