Concerns over Armenian Economy Rise as GDP Shrinks, Trade Gap Widens in Q1

Intensifying Downward Trend

The latest reports on Armenia's national accounts and trade data serve as a further, ever-stronger indication of the current sharp turn for the worse in the country's economic fortunes. Indeed, quoting figures from the Armenian National Statistical Service, ARKA News reports that the Caucasian economy suffered a contraction of 6.1% in annual terms in the first quarter of the year. These data signal intensifying downward momentum in March; contraction of the GDP over January-February had previously been reported at 3.7%, while GDP had decreased by a more modest rate of 07% year-on-year (y/y) in January. The deep downward trend becomes ever clearer when the first-quarter GDP is contrasted with the strong growth rate of 9% y/y seen in the same period in 2008.

No detailed data were reported, but one key factor contributing to the very weak overall economic performance over January-March is likely to have been the industrial sector, where contraction may even have reached double-digit rates. This probably also drove down electricity output. In addition, the remarkable construction boom of recent years has now come to a halt, and this downturn is seen as a major drag on overall growth this year.

Rapid Widening of Trade Gap

Industrial production in the country is suffering from very weak export demand. Indeed, according to ARMINFO News, further preliminary figures from the National Statistical Service show that exports plummeted by 47.3% over the first quarter, bringing their total value to 40.4 billion dram (US$123.4 million). Over March alone, exports fell by 1.1% from February. Meanwhile, imports decreased by 21.2% during January-March amounting to 213.4 billion dram for the three-month period, while they increased by 11.2% month-on-month (m/m) in March. The resulting trade deficit for the first quarter of 2009 thus came in at US$531 million. As the GDP data put the first-quarter total value added to 465.5 billion dram (some US$1.4 billion), this trade gap corresponds to around 37% of the estimated GDP for the period. Moreover, using the current exchange rate rather than the average for the first three months of the year, the trade deficit to GDP ratio stands at an even higher rate of 54.5% of the GDP. Thus, the imbalance in trade deepened further over March, as the trade gap for the January-February period had earlier been put at 38% of the two-month GDP.

Outlook and Implications

The Armenian economic reality has endured a complete turnaround over the past quarters. While this is true for several countries in the world amid the current global downturn, the deterioration Armenia is among the most drastic. Indeed, last year saw the economy expand by 6.8%, with deceleration in growth becoming clearer towards the end of the year, following double-digit annual growth rates over the past six years prior to this (see Armenia: 23 January 2009: Armenian Growth Finally Cools as Construction Activity Brakes). Specifically, growth in 2007 measured a very high 13.8%.

Whereas the economy seemed to be relatively isolated from the current international financial crisis at its outset, due to the undeveloped nature of its financial sector and correspondingly low exposure to the fall in demand for high-risk assets, it now is ever more clearly feeling the indirect negative impact from it, as the financial turmoil has led to deep recession in several parts of the world economy. The economy remains very dependent on inflows of foreign investment and remittances for growth and for covering its wide current-account deficit without having to extensively increase its borrowing. In our ongoing second-quarter forecasting round, we are likely to downgrade our GDP projection for Armenia to show a contraction of around 4% this year, with only modest recovery to around flat growth foreseen for 2010. Even these forecasts are subject to downward risks, especially given the country's external vulnerability. The economic crisis in Russia, in particular, has sharply harmed inflows of workers' remittances from there, and this is a key factor in weakening Armenia's external position.

On the bright side, with domestic demand easing, imports should moderate again in the coming months, although the impact from the dram devaluation resulted in a rising value for them in March.

The recent economic boom had included persistent widening of Armenia's external deficit as surging domestic demand has fed imports at the same time as export potential remains weak. Some slowing down of growth would thus have been a welcome development, in that weaker domestic demand helps in safeguarding macroeconomic stability. Then again, remembering the Armenian economy's dependence on foreign investment and remittance inflows, the current downturn comes with added risks, given its timing and the sharply deteriorated external environment. Given the tightness of global liquidity, finding external financing for covering the still-deep current-account gap currently present a significance source of risks and external vulnerability.

Armenia's financial sector is still developing and does not display high direct vulnerabilities to the international financial crisis. However, while still rising from a relatively low base, credit growth has recently been strong, and this has led to increased financial risks in Armenia. Thus, external exposure could in the future feature as a greater source of external risks in the country, via exchange rate vulnerability and risks related to refinancing costs. In addition, banks' vulnerability to developments in the real estate sector has also clearly increased recently; the current economic downturn and the sharp deterioration in construction activity, which is also dependent on external investment inflows, indicate a clearly increased risk of a real estate market collapse. The probability of this is particularly high in the capital Yerevan.

However, the economy is expected to continue receiving some support from investment and some large investment projects in infrastructure and the energy sector should continue. Then again, risks also exist relating to the investment outlook, as financing of the projects partly relies on private funding. However, if Armenia's economic reforms continue to progress, its access to concessional credits from international financial institutions should remain unproblematic (see Armenia: 4 March 2009: Exchange Rate Flotation Earns Extra IMF Support for Crisis-Hit Armenian Economy). However, the related reform programmes include considerable challenges related to restructuring and stabilisation, as demonstrated with the recent adjustment of the dram exchange rate, needed in order to support competitiveness.