Armenia Economic Update - Improved Fundamentals Will Help Withstand the Storm

The Armenian economy rose 7.6% last year, demonstrating the highest GDP growth rate in the CIS region. While strong growth continued during 2m20, economic activity likely sharply decelerated in March. The decline in external demand will dampen both exports and remittances from abroad. Moreover, the quarantine measures will hurt domestic consumption and will lead to a contraction of lending, an important growth driver in recent years. Despite all of this, Armenia will be less affected by the current turmoil than other countries in the region, which depend more on tourism or on oil and gas revenues. Overall, we still expect the Armenian economy to contract by 2% this year. > Armenian GDP could shrink by 2% this year. GDP climbed 7.6% last year, up from 5.2% growth in 2018. The positive trend continued early this year: the indicator of monthly economic activity rose 8.7% y-o-y in 2m20. However, the spread of the coronavirus and associated quarantine measures will likely usher in an economic contraction. Still, given Armenia's less significant reliance on external demand, we expect the economy to be less affected than other countries in the region. We estimate that the quarantine measures could subtract around 5.5 pp from GDP growth, while slower consumer lending due to tighter financial conditions will chop an additional 2 pp off GDP growth. This gives us a forecast of a 2% GDP contraction this year, down from our previous forecast of 5.5% growth.> Budget deficit will widen, while external debt could jump to 100% of GDP this year. The budget deficit came at 0.8% of GDP last year, the best result since 2008 and below the budgeted 2.2% of GDP. This year, a drop in revenues due to economic contraction and higher expenditures to fight the effects of the coronavirus will likely result in a budget deficit above 4% of GDP. This, coupled with weaker dram, will likely push public debt to 62% of GDP from 53.6% of GDP last year. External debt will increase to 100% as a share of GDP. Armenia's large current account deficit and high external debt make it sensitive to capital outflows. However, the country will be able to rely on support from the IMF and other international organizations. > Monetary policy eased due to weak inflation. Inflation slowed to 0.7% last year (from 1.8% in 2018), the lowest level since 2016. Prices declining by 0.5% y-o-y in February. While inflation will likely pick up in the following months due to the weaker currency, it should remain below the official target of 4%. Due to weak price dynamics and looming drop in domestic demand, the CBA cut the key rate by 25 bps to 5.25% at its monetary policy meeting on March 17. The dram was down 4% YTD, although it is still quite strong relative to the currencies of Armenia's main trading partners, which have seen steeper drops, meaning that a further 5-10% decline is possible.