Armenia Economics - Withstanding a Double Shock

Last year, the Armenian economy was hit hard by the double shock of Covid and a flare-up in the Nagorno-Karabakh conflict, but it proved to be in sufficiently strong fundamental shape to withstand the pressure. The country suffered one of the highest levels of Covid infections per capita in the region, while Nagorno-Karabakh saw by far the worst escalation since the war 30 years ago. These factors combined to cause the economy to contract 7.2% last year, with the budget deficit reaching 7% of GDP, we estimate.> Improvement in fundamentals in 2018-19 helped to cushion the blow. We expect the economy to recover 3.5% this year, while fiscal consolidation should commence in 2022. We forecast that the budget deficit will stay fairly elevated this year at 5% of GDP, but we believe the government has sufficient funding available to cover its needs for the year.> External sector took a hit last year but should start to improve this year. Covid dealt a blow to exports, tourism revenues, remittances, FDI and capital inflows. Coupled with increased debt servicing requirements in 3Q20, these factors pressured the dram and forced the regulator to spend an estimated $300 mln of its reserves to smooth the volatility. We expect both exports and remittances to improve this year, supported by the global economic recovery and higher commodity prices.> Slow vaccinations and political uncertainty are major risks. The economic recovery will be dictated by the speed of vaccinations both inside the country and abroad, as any delays could result in further lockdowns and a decline in economic activity. The widespread discontent with the outcome to the conflict in Nagorno-Karabakh, coupled with rising social tension due to a rise in unemployment and decline in real incomes, could limit the government's ability to conduct fiscal consolidation, as required by the IMF. The lingering political and geopolitical uncertainty could also hamper FDI.