Luys Foundation analysts urge government to reconsider 2022 budget  spending priorities

ArmInfo.The Armenian economy in 2022 may record regression, despite the indicator set in the y-o-y budget at the level of 7%. This is stated in the report of the  analytical group of the Luys Foundation entitled "On the verge of a  new crisis. Possible impact of sanctions against Russia on the  economy of Armenia."

Analysts of the Luys Foundation analyzed in detail the economic ties  between Russia and Armenia in the document, the ways of transmitting  shocks, assessed the possible consequences for the Republic of  Armenia of the economic sanctions imposed by Western countries  against the Russian Federation in connection with the Ukrainian  events in 2014, as well as new sanctions in 2022. As noted by  coordinator of the group, a member of the Foundation's Board of  Trustees, an international consultant on public finance, former  Minister of Finance of Armenia Vardan Aramyan, the estimates obtained  are comparable to those obtained by the Central Bank of the Republic  of Armenia (with a 5% decline in the Russian economy, the growth of  the Armenian economy will be 1.6%), as well as the IMF and WB. Three  scenarios for the development of the Russian economy were considered:  optimistic -7%, basic -11% and pessimistic -15% (there are negative  dynamics in all cases). In this case, the possibility of a recession  in the Armenian economy is estimated at 1.3% growth and 3% decline.  And in the medium term, as a result of the shock of the Russian  economy, the Armenian economy will lose the pre-crisis potential of  real GDP. At the same time, one of the main factors determining the  slowdown in Armenia's economic growth - exports, remittances from  Russia - foreign direct investment will suffer significant losses.

As stated in the analysis, economic ties with Russia have always  played a significant role in the economic development of the Republic  of Armenia, being reflected in such areas of the economic life of the  RA, as foreign trade, remittances, foreign investment and tourism.  Russia is Armenia's largest trading partner. As of 2021, exports to  Russia accounted for 28% of total exports, while imports from Russia  accounted for 33% of total imports. In the net inflow of remittances  from individuals, transfers from Russia account for about half, due  to the large influx of seasonal workers to Russia and the presence of  a large Armenian community in Russia. About 40% of foreign  investments in Armenia are from Russia. In addition, Armenia receives  a large number of Russian tourists, as a result of which 40% of  tourism revenues in 2021 came from services provided to Russian  tourists.

Nevertheless, as the Foundation's experts noted, the overall economic  dependence on Russia has weakened over the years. Having considered  such indicators as exports to the Russian Federation, net inflow of  remittances from Russia, net inflow of foreign investments from  Russia, as well as funds generated by the tourism sector, it was  revealed that in 2014-2021 (and especially during the years of  upheaval), dependence on Russia showed a downward trend, and if in  2014 Armenia received about $1.9 billion from Russia through these  channels, then in 2021 this figure decreased by about $200 million -  to 1.7 billion dollars.  Moreover, if earlier the lion's share of  these funds was remittances, now dependence on Russia has  diversified, exports have begun to play an especially large role. In  particular, the share of the above- mentioned complex indicator  (exports + remittances + foreign investment + tourism) in GDP 2021  decreased from 17% in 2014 to 12%.

At the same time, in 2014-2021, Armenia has become more dependent on  the import of some strategically important products (wheat, barley,  corn, imported mainly from Russia, poultry, imported mainly from  Ukraine). In these conditions, with the worst-case scenario, the  Armenian economy will be able to withstand those shocks only during  this year. At the same time, compared to 2014, in 2021  self-sufficiency in wheat, barley and corn decreased significantly  from 48.7% to 24.4%, from 95.1% to 74.4% and from 27.9% to 8%,  respectively.

"According to the three scenarios considered, the deterioration of  macroeconomic indicators leads to a significant loss of tax revenues  to the state budget. In 2022, the loss of tax revenues in the case of  the main (baseline) scenario will be about 93 billion drams, in the  case of an optimistic scenario - about 72 billion drams, and in the  case of the pessimistic scenario - about 127 billion drams. And in  the medium term, the loss of state treasury tax revenues will  gradually increase. Three scenarios show a significant deterioration  in the fiscal situation: a significant increase in the debt burden of  the Government of the Republic of Armenia and an increase in  instability risks, since the debt/GDP ratio may remain higher 60% of  the threshold set by the fiscal rules of the Republic of Armenia and  even exceed the accepted 70% risk threshold for debt stability. As a  result, the Armenian government faces a serious limitation of "fiscal  space," the report says.

The Foundation's analysts identified the following key areas of  economic policy. Thus, taking into account the nature of the shock,  the fiscal policy (as the main shock absorber) should play a key role  in counteracting this shock, the prompt and targeted reaction of  which will be necessary to mitigate the negative economic impacts  from the outside on the activity of the RA economy. At the same time,  they urge to take into account that, unlike the period of the  epidemic shock, this time Armenia is significantly limited by the  already high debt burden of the RA government, as well as the fact  that we will have additional pressure on supply inflation, as a  result of which the Central Bank, seeking anchor future inflationary  expectations, raise interest rates. However, on the other hand, high  interest rates constrain lending to the economy, which leads to a  slowdown in economic growth in the medium term.

 Therefore, in this situation, there is a risk of stagflation (high  inflation + economic recession), in order to neutralize it, the need  for coordination of monetary and fiscal policy increases  significantly, and the government must be more aggressive, excluding  price abuses in certain areas in consumer markets, thereby will help  the Central Bank to effectively deal with growing inflationary  expectations. Otherwise, the Central Bank will be forced to raise  interest rates (or maintain the current level longer), which will  also hit economic activity.

In the short term, the Government of the Republic of Armenia should  focus on preserving the economic potential and easing social  tensions. In particular, targeted instruments should be used  primarily to support exporters (especially those with a relatively  large role in exports to Russia), seasonal workers and socially  vulnerable groups. Moreover, given the limited fiscal capacity, it is  necessary to reconsider the spending priorities of the 2022 budget  very quickly, the authors of the report noted.

In the medium term, after overcoming the shock, it will be possible  to focus on strengthening fiscal stability, the Foundation's experts  noted. In particular, it will be necessary to carry out fiscal  consolidation at a faster pace than planned, as well as to discuss  the issue of revising the goals of the RA Government program,  focusing mainly on measures to strengthen the potential of the  economy. At the same time, special attention should be paid to  measures to increase the stability of the economy, which will allow  (new export markets conquered, increasing the role of high  value-added industries, growing the tourism sector, geographical  diversification, diversification of FDI), reducing dependence on  energy carriers in all directions, increasing self-sufficiency  strategic commodities, increasing the share of AMD debt, etc., in  order to accumulate sufficient resources to better deal with future  shocks.

It should be noted that the government of Armenia, represented by  Finance Minister Tigran Khachatryan, has repeatedly stated that even  in the face of a reduction in tax revenues, the state treasuries do  not plan to reduce state budget expenditures and they will be fully  implemented by attracting new loans.