Another open question concerns the impact of the current events around Nagorno-Karabakh: accommodating and integrating roughly 100,000 refugees from the region poses a significant challenge for the government.
Strong growth gradually cools down
The Armenian economy grew by a strong 12.6% in 2022. This was mainly due to special factors directly related to the situation in Russia. Among other things, migration from Russia significantly strengthened consumption and service exports; the increase in re-exports to Russia significantly boosted external trade. These effects persist in 2023, although the positive impact of the shocks is gradually fading. Nevertheless, the economic situation remains very solid. The IMF, which recently revised its forecast significantly upwards, expects real GDP growth of 7% in 2023. Assuming that economic growth returns to its long-term potential in the coming year, real GDP growth of 5% is forecast for 2024.
At the sectoral level, the positive shocks are mainly reflected in the strong growth of the services sector (8M2023: +14.8% yoy) and trade (+23.1%). The construction sector is also developing very dynamically: the imminent phase-out of subsidies for construction loans and the influx of Russian migrants are boosting short-term activity. In contrast, the manufacturing and agriculture sectors show a weak performance. The situation in the mining sector also remains problematic (-5.1%). The sector, however, is expected to recover once the necessary modernisation works have been completed.
Inflation dynamics have weakened significantly
The special factors from last year also had an impact on inflation, which accelerated in 2022. However, the Central Bank of Armenia (CBA) reacted quickly and tightened the monetary policy stance by raising the key interest rate several times. This, combined with a strong Armenian dram, led to a decline in inflation. As a result, the CBA expects inflation to reach 0.4% by the end of 2023. The monetary policy stance remains tight in order to stabilise demand, which remains high, and to anchor inflation expectations. For 2024, a return to the inflation target of 4% is expected; the CBA projects an inflation rate of 3.5%.
Dram remained stable against the US dollar
A significant effect of the influx of migrants from Russia was also felt with regard to the exchange rate: the Armenian dram appreciated significantly against the US dollar. This caused problems for some export-oriented sectors, as their products became less competitive. In 2023, the exchange rate stabilised, but remained at the high level of the previous year.
One benefit of the appreciation was that the CBA was able to further accumulate its international reserves during 2023, which amounted to USD 4.2 bn in August 2023. This is equivalent to 4.3 months of import cover.
In terms of the budget balance, the deficit is expected to increase slightly to 2.7% of GDP in 2023. For 2024, a similar level is expected. Higher expenditures budgeted for investments and infrastructure development are the primary reason for the increase in the deficit. So far, however, execution remains behind the investment plan.. Another factor is expenses for fiscal support for the approximately 100,000 refugees from Nagorno-Karabakh. However, according to preliminary GET estimates, the immediate impact on the budget will remain manageable at less than 1.5% of total expenditures in 2023.
Public debt is expected to reach 48.0% of GDP in 2023 and to slightly increase to 48.7% in 2024. Thus, debt remains below the fiscal rule threshold of 50% of GDP.
Good external position
The external position was also strongly influenced by the special effects. In 2022, trade in goods grew mainly due to re-exports to Russia. In 2023, this remains an important factor driving the strong increase in exports (8M2023: +51.8% yoy) and imports (+53.8%). However, it is becoming clear that this trend is gradually slowing down – due to base effects, but also because of new regulations and sanctions that make re-export business more difficult. The situation is similar for services exports. These show a strong (H1 2023: +82.5% yoy), but declining momentum. The recovery of tourism (+94.9%) and the significant ICT service exports (+103.1%) by Russian IT specialists in Armenia are the main positive drivers here.
Summary and outlook
The special factors from the previous year remain a positive economic driver in 2023 but are starting to fade out slowly. Against this background, the question arises whether some of these factors – such as the influx of Russian IT specialists – will also have an effect on the long-term potential of the Armenian economy. In addition, there is another important challenge: the accommodation and integration of roughly 100,000 refugees from Nagorno-Karabakh into the Armenian economy. From a purely economic perspective, this shock comes at a time when the economy is in good shape and the fiscal situation is stable. This leaves enough room to develop targeted policy measures for the medium term.
This newsletter is partly based on the 10th issue of the Economic Monitor Armenia