ArmInfo.Fitch forecasts that the Armenian economy will contract by 6.2% this year, with 3.2% growth in 2021. This is noted in the report published yesterday by Fitch, which indicated that the agency now expects a weaker recovery in external demand, including in the tourism sector, along with a moderate slowdown from the curtailment of fiscal measures.
According to Fitch forecast GDP growth to improve modestly to 4.0% in 2022 helped by firmer consumer and investor confidence and stronger tourism, and reflecting a negative output gap. In line with our global macro-economic forecasts, the pace of recovery will be highly dependent on the path of the health crisis, and a further spike in infections and potential re-introduction of lockdown measures represents a key risk to Armenia's economic outlook and our forecasts, the report reads.
Government deficit to widen
Fitch forecasts the general government deficit to widen to 7.6% of GDP this year, from 0.8% last year, driven by higher expenditure. The on-budget fiscal package amounts to close to 4% of GDP in 2020, and focusses on labour subsidies, direct social transfers, corporate income tax deferrals, and higher health spending. In addition, 1.4% of GDP is available for on-lending, the largest component of which is private sector projects through the Investment Fund, which we anticipate will not be fully spent this year.
Fitch forecasts the deficit to narrow to 4.9% of GDP in 2021, with only limited new support measures extended under the "economic recovery" phase of the government's plan, followed by 3.8% in 2022. The government has activated the escape clause in its Fiscal Rule, which falls away on dissipation of the economic shock, and is planning compliance with the requirement to bring debt/GDP below 60% of GDP within five years. However, Fitch considers there is sizeable uncertainty around the capacity for implementation of a fiscal consolidation programme, and the potential for additional fiscal measures to support weaker than expected GDP outturns represents a key downside risk to our revised fiscal forecasts.
The current account deficit will narrow
Fitch forecasts the current account deficit to narrow by 1.4pp in 2020 to 5.8% of GDP as sharp import compression more than offsets the fall in export demand, including from the collapse in tourism and weaker remittances. A statistical change to how the current account is calculated also lowered the end-2019 deficit by 2.2pp to 7.2% of GDP, mainly due to revisions to autos and tourism figures. We project that the recovery in domestic demand will drive a moderate widening of the current account deficit to average 6.4% in 2021-2022, which compares unfavourably with the 'B' median of 4.1%. Less than one- third of the deficit is covered by non-debt creating capital inflows, and net external debt is forecast to increase to 57.6% of GDP at end-2022 from 47.3% at end-2019, well above the peer group median of 29.9% of GDP.
Government debt is forecast to rise in 2020-2021
General government debt is forecast to rise from 53.5% of GDP at end-2019 to 63.9% at end-2020, above the 'B' median of 58.1%. We forecast that government debt will continue to rise to 65.6% of GDP in 2021 (9.6pp above our previous forecast) and to remain elevated over the medium term, reflecting a combination of weaker growth impacted by economic damage from the health crisis and further spending pressures from fiscal measures to support the economy. 76% of government debt is foreign-currency-denominated, compared to the 'B' median of 61%, giving rise to exchange rate vulnerability.
Armenia's institutions have facilitated an orderly political transition, and GDP per capita, governance and ease of doing business indicators are above the peer group medians. There is a robust macroeconomic policy framework, and credible commitment to reform and medium-term fiscal targets, underpinned by the IMF Stand-By Arrangement (SBA). Set against these factors are Armenia's weaker external finances, a high, albeit declining, reliance on the Russian economy (for remittances, trade and FDI), borders are closed with two neighbours, and the long-standing conflict with Azerbaijan over Nagorno-Karabakh has the potential to further escalate. Moreover, the large-scale hostilities that began recently (from 07:30am on September 27 and are currently ongoing - Ed. note) along the line of contact in the Nagorno-Karabakh conflict zone have spread to a wider territory and were somewhat more intense than the last major confrontation in 2016. Increased Turkish support for Azerbaijan heightens uncertainty and increases the risk that this time the conflict will be more protracted.
Armenia's external vulnerabilities remain in place
Armenia's external vulnerabilities, including high and growing net external debt, a relatively large structural current account deficit, a reliance on remittances and relatively weak FDI inflows, remain in place. However, the balance of payments has been relatively stable since the initial phase of the coronavirus shock. Having depreciated 5% against the US dollar in March, the dram has returned to close to the pre-pandemic level since end-April. The Central Bank has not intervened since USD94 million of net FX sales in March and April to support the normal functioning of the FX market, and net interventions for the year as a whole are lower, at USD36 million. In 2Q20 there was a moderate narrowing of the current account deficit, and net remittances, which were 9.0% of GDP in 2019, fell 22% in 1H20 yoy.
Factors mitigating short-term risks of balance of payments
The availability of IFI financing, and an increase in foreign exchange buffers coming into the crisis mitigate near-term balance of payments risks. FX reserves were USD2.7 billion in August, similar to the end-2019 level of USD2.8 billion having fallen to USD2.5 billion in April. Fitch forecasts that FX reserves will remain stable through 2022 at near 4.0 months of current external payments, higher than the end-2018 level of 3.5 months and in line with the 'B' median. In addition to the IMF budget support and EU grant funding the Armenian authorities have drawn on this year, there is USD1.3 billion of undisbursed IFI project financing in place. The government has already met the majority of 2020 financing needs, with domestic issuance of bonds amounting to close to 50% of the full-year total, and more than four-fifths of external financing from IMF budget support.
Fitch anticipates broad continuity in macroeconomic policy, including steady reforms to reduce corruption and strengthen institutions and public financial management. Fitch does not expect significant problems in completion of the next IMF SBA review, which is likely to focus on the budget plans and the fiscal trajectory beyond this year as well as improving fiscal risk management, including from PPPs and this year's off-budget on-lending measures, alongside ongoing measures to enhance tax reporting and efficiency.
To note, according to the forecast of the Central Bank of Armenia, updated in September, in 2020, the decline in Armenia's GDP will amount to 6.2%, against the previously expected decline of 4%, and the actual 7.6% growth in 2019. The Central Bank of Armenia also downgraded the forecast for exports and imports for 2020 to a uniformly significant decline of 29-32%, against the previously expected decline in imports by 15-17%, and exports by 12-15%, and their actual growth in 2019 by 9.1% and 10.3% respectively. In terms of the current account deficit to GDP ratio, the Central Bank in the updated forecast improved its expectations for 2020 to a range of 5-6% (against the previously expected 6-7%), and the forecasts for the medium term have not changed - the current account deficit / GDP ratio will approach balanced level in the range of 3-5%. The Central Bank of Armenia slightly improved the forecast for 2020 on the decline in private transfers to 19-22% (from the previously expected 22-25%), drawing attention to the change in the country structure of private transfers: the reduced volume of transfers from Russia is being made up by remittances from the USA and other countries, presumably , due to the growing transfers of an "altruistic" nature.
In the updated forecast for 2020, the Central Bank of Armenia expects a higher budget deficit - 5.7% of GDP (against the previously projected 5%), with an annual growth of 4.8 percentage points. In terms of taxes / GDP ratio, the Central Bank forecasts a level of 22.1% for 2020 (against the previously expected 22.4%), with an annual decline of 0.2 percentage points. In terms of the expenditure / GDP ratio, the Central Bank predicts a level of 29.4% for 2020 (against the previously expected 29%), with an annual growth of 4.7 percentage points, noting that 150 billion drams of the economic assistance package are included in government spending. The Central Bank, taking into account these estimates, predicts that in 2020 the impact of fiscal policy on aggregate demand will be expanding (5.7%). The Central Bank's assessment of the medium-term impact of fiscal policy is as follows: in 2021 it will be moderately expanding, and in 2022-2023 it will be neutral based on the baseline scenario of the preliminary version of the medium-term spending program for 2021-2023.
