EDB analysts: Significant volumes of remittances to Armenia may  provoke "Dutch disease"

ArmInfo.The Armenian dram has shown a steady appreciation against the currencies of the trading partner countries since the beginning of Q2 2022. In July of this year, compared to the  beginning of 2022, the Armenian dram appreciated against a basket of  currencies: - by 19.8% y/y against the dollar, by 21.7% y/y against  the euro, by 32.4% y/y against the Russian ruble. In terms of the  real effective exchange rate, the Armenian dram appreciated by 33.6%  in 2022 and by 40% in June 2023 compared to the beginning of 2022. 

This is stated in EDB's analytical Macroeconomic Review regarding the  unprecedented appreciation of the Armenian dram, the state and  prospects of the Armenian money market.

It is noted that the appreciation of the dram is mainly due to the  large-scale inflow of financial resources into the country. This is  due to the movement of individuals, the inflow of remittances and  capital to Armenia. Net inflow of cross-border transfers through the  banking system in 2022 totaled $2.6 billion, or 13.2% of GDP, 4-fold  higher than the average for the last five years ($665 million, or  5.2% of GDP) . In Jan-June of this year, the indicator increased by  another $897 million, or by 90% y/y. Growth in export revenue from  the supply of goods (+80% in 2022 and +72.8% y/y in H1 2023) and  services (+2.4-fold in 2022 and +2.2-fold y/y  in Q1 2023), as well  as net FDI inflows of $998 million (+2.7 times yoy in 2022) also  contributed to an increase in the supply of foreign currency in the  country.

The Review states that, according to the estimates of the Central  Bank of the Republic of Armenia, as of the end of 2022, there were 99  thousand non-residents in the Republic of Armenia, 51 thousand of  which are immigrants employed mainly in the IT sector. The number of  tourists visiting the country in 2022 increased by 90% y/y, and in H1  2023 - by 70.3% y/y. Tourist activity and a generally large number of  foreign visitors have created an increased demand for the national  currency - in addition to the already increased demand for the  Armenian dram after the expansion of consumption due to the influx of  remittances.

At the same time, according to EDB analysts, significant volumes of  remittances strengthen the national currency, which can adversely  affect the competitiveness of exports and, according to studies  (Anwar, Mang, 2022), provoke the "Dutch disease". A sharp increase in  consumer income creates demand in non- exportable sectors of the  economy (such as construction and a significant part of services and  trade) and stimulates an increase in wages by a significant margin  from other industries.

Analysts also note that over time, the role of the export-oriented  industrial sector of the economy may decrease due to the transfer of  production resources to non-exportable industries.

Such a scenario implies a fundamental strengthening of the national  currency rather than a short-term overvaluation, which (Magud, Sosa,  2010), as a rule, is the cause of economic growth losses. However,  shocks that can cause "Dutch disease", in the case of Armenia, it is  a large influx of capital and remittances, usually associated with  periods of economic boom. These are the consequences of an abundance  of foreign exchange, which also has important beneficial effects,  such as an overall increase in income, the availability of imports of  capital and investment goods.

According to the base scenario of the EDB forecast, the nominal  exchange rate at the end of the year will be close to 397 drams per  dollar.This is somewhat weaker than the current level, but still  significantly lower compared to the beginning of 2022 (482 drams per  dollar). The dram will depreciate by gradual adjustment of external  demand (partial outflow of immigrants, completion of the peak of  tourist activity, stabilization of export volumes, growth of imports  against the backdrop of appreciation of the dram, as well as an  increase in demand for minerals [gas] (in the cold season) and lower  rates in the RA money market.

According to EDB analysts, in the medium term, the dram will  depreciate against the dollar in nominal terms, but the exchange rate  will fall to the level of the end of 2021 to the beginning of 2022.  This is due to the effect of the permanent component, the increase in  the productivity of the Armenian economy, due to the fact that a  significant part of the resettlers, from all appearances, intends to  continue to stay in Armenia.