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Armenia - Economy

Economic and financial conditions worsened rapidly in Armenia in 2008, due to a drop in international metals prices and a downturn in the Russian economy following the collapse of oil prices in late 2008. The end of a remittance-fueled construction boom that had driven growth in recent years resulted in a 14.4% drop of real GDP for 2009 (compared to 6.8% GDP growth in 2008), with about 80% of this decline due to a plunge in the construction sector. Since 2008, Armenia has experienced a significant drop in investment, exports, and real incomes primarily caused by the global financial crisis. The Government of Armenia’s (GOAM) anti-crisis measures, additional loans and budgetary support from international donors helped to avoid further economic decline in 2010.

Economic indicators, while on the rebound, still fall short of the pre-crisis growth trend for the two decades following independence. Gradual recovery of remittance flows in comparison to 2010 also contributed to the slight upturn. Nevertheless, poverty and prices remain high, and the sustainability of growth remains a concern. Some of the major impediments for potential investors remain the lack of transparency in the tax and customs administration, the unpredictability of doing business in Armenia, and unequal competition between domestic and foreign firms.

Armenia is beset by severe economic problems as a result of both the isolation imposed by Turkey and Azerbaijan and the instability in Georgia. Except for the European Union-sponsored TRACECA project, aimed at coordinating the development of transit routes between East and West, Armenia remained on the sidelines of most of the region's major economic projects. Armenia is in the midst of economic and social transition. More than 55% of the population languishes in poverty, nearly double the percentage of just a few years ago. After several years of double-digit economic growth, Armenia is facing a severe economic recession with GDP declining at least 15% in 2009, despite large loans from multilateral institutions. Sharp declines in the construction sector and workers' remittances, particularly from Russia, were the main reasons for the downturn.

Armenia is particulary dependent on Russian commercial and governmental support and most key Armenian infrastructure is Russian-owned and/or managed, especially in the energy sector. The electricity distribution system was privatized in 2002 and bought by Russia's RAO-UES in 2005. Construction of a pipeline to deliver natural gas from Iran to Armenia was completed in December 2008 but though it is unlikely significant quantities of gas will flow through it until the Yerevan Thermal Power Plant renovation is completed in 2010.

The government made some improvements in tax and customs administration in recent years, but anti-corruption measures have been ineffective and the current economic downturn has led to a sharp drop in tax revenue and forced the government to accept large loan packages from Russia, the IMF, and other international financial institutions. Armenia will need to pursue additional economic reforms in order to regain economic growth and improve economic competitiveness and employment opportunities, especially given its economic isolation from two of its nearest neighbors, Turkey and Azerbaijan.

Armenia is the second most densely populated of the former Soviet republics. It is a landlocked country between the Black and the Caspian Seas, bordered on the north by Georgia, to the east by Azerbaijan, on the south by Iran, and to the west by Turkey. Up until independence, Armenia's economy was based largely on industry--chemicals, electronic products, machinery, processed food, synthetic rubber, and textiles--and highly dependent on outside resources. Agriculture accounted for only 20% of net material product and 10% of employment before the breakup of the Soviet Union in 1991. In recent years, the construction sector has taken off, fueled by an ambitious government-backed construction project in the capital, and remittances to relatives by ethnic Armenians living in Russia and the United States.

Like other New Independent States of the former Soviet Union, Armenia's economy suffers from the legacy of a centrally planned economy and the breakdown of former Soviet trading networks. While investment from these states in support of Armenian industry has virtually disappeared, and few major enterprises are still able to function, Russian entities have nevertheless increased their exposure in the mining, energy, telecommunications, and transportation sectors. In addition, the effects of the 1988 earthquake, which killed more than 25,000 people and made 500,000 homeless, are still being felt, though international donors and diaspora Armenian groups continue to fund reconstruction efforts in the earthquake zone.

Although a cease-fire has held since 1994, the 20-year-old conflict with Azerbaijan over Nagorno-Karabakh has not been resolved, in spite of intensive efforts by the OSCE Minsk group to reach a settlement. The consequent closure of both the Azerbaijani and Turkish borders resulting from the war has prevented Armenia from realizing its economic potential, because of Armenia's dependence on outside supplies of energy and most raw materials.

Land routes through Azerbaijan and Turkey are closed, though air connections to Turkey exist; land routes through Georgia and Iran are inadequate or unreliable. In 1992-93, GDP fell nearly 60% from its 1989 level. The national currency, the dram, suffered hyperinflation for the first few years after its introduction in 1993. Since 2005, however, the dram has continued to appreciate versus the dollar, going from an annual average of 458 drams in 2005, to 342 in 2007, and 300 for most of 2008. The currency's appreciation stems largely from growing remittances by diaspora Armenians in Russia and the United States, a weakening dollar, and gradual increase in the productivity of Armenian industry.

In spite of the Nagorno-Karabakh conflict, the Government of Armenia has been able to carry out wide-ranging economic reforms that have paid off in dramatically lower inflation and steady growth. Armenia has registered strong economic growth since 1995, with double-digit GDP growth rates every year from 2002 to 2007.

The structure of Armenia's economy has changed substantially since 1991, with sectors such as construction and services replacing agriculture and industry as the main contributors to the economic growth. The diamond processing industry, which was one of the leading export sectors in 2000-2004 and also a major recipient of foreign investment, faced a dramatic decrease in output since 2005 due to raw material supply problems with Russia and overall decline in international diamond markets. Other industrial sectors driving industrial growth include energy, metallurgy, and food processing.

Armenia maintains a floating exchange rate regime with no explicit exchange rate target. The nominal exchange rate of the Armenian dram with major currencies was fairly stable between 1998 and 2003; however, it strengthened sharply starting in 2004, recording around 46% nominal appreciation against the U.S. dollar compared to January 2004. The main causes of the appreciation of the dram are the global weakening of the U.S. dollar, a large inflow of foreign currency to Armenia from remittances, as well as increases in domestic productivity and incomes. The sharp appreciation of the dram has already affected negatively the external competitiveness of Armenian products as well as the value of remittances from abroad, most of which are dollar-denominated.

Armenia is highly dependent on import of energy fuel, mainly from Russia. The Armenia Nuclear Power Plant (ANPP) provides around 40% of electricity generation for the country, and hydro and thermal plants provide roughly 30% each. Armenia imports all of its natural gas from Russia at a significant discount from world market rates, though a new contract signed with GazProm in late 2008 calls for significant price increases in 2009 and 2010, and in succeeding years the price is expected to converge with the market price. A gas pipeline from Iran to Armenia will help to diversity Armenia's gas supply, and is expected to become fully operational during 2009. Armenia imports nearly all of its refined petroleum products through Georgia. The recent conflict between Russia and Georgia resulted in periodic disruptions of fuel and food imports, and highlighted Armenia's vulnerability to this single transit corridor.

Steady economic progress has earned Armenia increasing support from international institutions. The International Monetary Fund (IMF), World Bank, European Bank for Reconstruction and Development (EBRD), as well as other international financial institutions (IFIs) and foreign countries are extending considerable grants and loans. These loans are targeted at reducing the budget deficit, stabilizing the local currency; developing private businesses; energy; the agriculture, food processing, transportation, and health and education sectors. In December 2005, the U.S. Millennium Challenge Corporation approved a 5-year $235 million Compact with the Government of Armenia, which was to focus on rehabilitation of irrigation networks and upgrading of rural transport infrastructure.

Continued progress will depend on the ability of the government to strengthen its macroeconomic management, including increasing revenue collection, improving the investment climate, and making strides against corruption. A liberal foreign investment law was approved in June 1994, and a Law on Privatization was adopted in 1997, as well as a program on state property privatization. Armenia joined the World Trade Organization on February 5, 2003.

Armenian President Serzh Sargsyan said on 01 January 2014 that his country would complete all procedures to join the Russian-led Customs Union this year. "I’m sure that this year we will become a full-fledged member of the Customs Union. Armenia will create a new environment, in which it will be better protected and more competitive, Sargsyan said in his televised New Year speech.

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Page last modified: 05-01-2014 18:59:57 ZULU