EDB expects fiscal policy to stimulate Armenian economy in 2024 

ArmInfo.The baseline scenario projects Armenian GDP growth at 5.7% in 2024 and 5.3% in 2025. Inflation could accelerate to  3.6% in  2024 amid continued elevated domestic demand, a moderate weakening of the national currency, and the ongoing cycle of refinancing rate reductions, according to the Macroerconomic Outlook by the Eurasian Development Bank (EDB). 

"We expect fiscal policy to stimulate the Armenian economy in 2024,"  EDB experts state.  

Current situation

Armenia's economic growth rate has weakened since last year's spike  in activity, but remains high. Growth was 9.2% YoY in January-October  2023. The services sector was the key driver behind these economic  trends amid expanding output in the IT, air transport, and  food  service industries. The financial and manufacturing sectors2 saw a   decline in January-October after last year's surges. Construction,  however, is keeping up pace (up 16.4% YoY in January-October),  bolstered by high mortgage lending3. The economy will continue to  enjoy support from significant revenues. For example, cross-border  remittances of individuals increased by 17.8% YoY to $4.8 billion in  January-October this year, remaining at historical highs for the  country first recorded last year (revenue totalled $5.1 billion in  2022 vs. the yearly average of $1.9 billion in 2018-2021). The first  ten months of 2023 also saw continued high levels of tourism: visits  from other countries increased by 48.8% YoY after +90% in 2022.  Domestic demand has strengthened as more individuals take out loans  (up 22.5% YoY in October), while consumer prices are falling.

Armenia's economy will keep growing strongly till the end of 2023, at  a rate faster than previously expected, i.e., 8.3% YoY for the year.  We have raised our projections because of the strong economic  performance in January-September, the recovering Russian economy,  increased consumer demand as the Karabakh population relocates to  Armenia, and a potential increase in budget expenditures in 4Q.  January- October saw the foreign trade deficit increase to $3.8  billion after a $2.6 billion deficit in the same period last year.  Exports rose by 38.5% YoY. Precious stones and metals, machinery and  equipment, and transport made a major contribution to growth in goods  exports. Imports increased (+42.9% YoY) for all product groups in  January-October. Import growth began to  outpace exports due to  the  continued high domestic consumption and investment, as well as the  increasing purchasing power of the Armenian dram against the  currencies of major trading partners.

Inflationary pressures have remained muted throughout the year,  driven by both food and non-food prices, in particular, a reduction  in the cost of imported food and vehicle fuel. Last year's surge in  food costs driven by higher international prices and prices of  services amid strong demand5 also held back inflation.  As the  Armenian dram strengthened, and external prices no longer exerted as  much pressure, this limited price increases over January-October  2023. Tight monetary conditions also contributed to the fall in  inflation. Inflation will somewhat accelerate from its current weak  level (-0,5% YoY in November) by the end of the year but will remain  well below the target range of the Central Bank of Armenia (4ñ1.5%).  We estimate it to reach 0.3% YoY.

The Central Bank of Armenia held a meeting on 12 December, where it  decided to reduce the refinancing rate for the fifth time in a row,  this time by 0.25 p.p. to 9.25%, a decision brought about by slowing  inflation and easing external price pressures. All in all, the Bank  has decreased the refinancing rate by 1.5 p.p. in the second half of  the year. Monetary policy did not see much more easing due to  pro-inflationary risks which emerged in late September and  early  October amid devaluation expectations and  increasing domestic  consumer demand.

The state budget posted a surplus of 0.8% of GDP in January-September  2023 (vs. 0.6% of GDP in 2022), thanks to a 13.8% YoY increase in  revenues in January-September in the context of growing business  activity and a more restrained 12.7% YoY rise in expenditures. At the  same time, the 2023 budget anticipated higher expenditures over the  nine months (a deficit of 2.5% of GDP for 2023 was planned), which  paves the way for quicker funds allocation in 4Q and stronger  economic stimulus at the end of the year.

Forecasts Economic activity and inflation 

The baseline scenario projects Armenian GDP to increase by 5.7% in  2024. As demand stabilises after peaking in  2022-2023, economic  growth will reach a  balanced pace. Monetary conditions will have a  neutral impact on demand in  2024; we expect the impact of fiscal  policy to be stimulative. Construction work at the Amulsar field and  investment inflow and revenues from its further development will  contribute to GDP and economic growth6. Economic growth will be near  the long-term rates in 2025 and 2026, at 5.3% and 5.0%, respectively.

External demand will continue to  have both positive and  negative  effects on the Armenian economy. A slowdown in  global business  activity in  2024 will have a  more negative impact, translating into  weak external demand for exported goods and a decline in remittances,  including from the U.S. This will be offset by the switch of exports  to Russia and rising remittances from Russia amid changes to the  country breakdowns of exports and remittances in 2022-2023.

Under the baseline scenario, we project inflation at 3.6% YoY at the  end of 2024. Several factors will have a pro-inflationary effect in   2024, namely the easing of monetary conditions by the Central Bank of  Armenia, stimulative fiscal policy, strengthening domestic demand,  additional consumer demand from immigrants from Nagorno-Karabakh, and  some depreciation of the exchange rate of the dram from its 2023  level. That said, the disinflationary effect from international goods  and commodity prices together with lower inflation expectations will  curb prices. Inflation will meet the Central Bank's target range in  2025- 2026.

Under the baseline scenario, we project inflation at 3.6% YoY at the  end of 2024. Several factors will have a pro-inflationary effect in   2024, namely the easing of monetary conditions by the Central Bank of  Armenia, stimulative fiscal policy, strengthening domestic demand,  additional consumer demand from immigrants from Nagorno-Karabakh, and  some depreciation of the exchange rate of the dram from its 2023  level. That said, the disinflationary effect from international goods  and commodity prices together with lower inflation expectations will  curb prices. Inflation will meet the Central Bank's target range in  2025- 2026.

Monetary policy and the Armenian dram exchange rate 

Under the baseline scenario, the IBL rate will gradually decline to  an average of 8.6% for 2024, following the refinancing rate (Figure  10.A). With price growth decelerating steadily, consumer demand  stabilising gradually after peaks in 2023, and inflation falling  within the CB RA's target range (4ñ1.5%), we assume a continued  reduction in the refinancing rate in 2024. Nevertheless, we project  monetary policy to have a neutral effect on demand over the year. The  IBL rate will fall to 8.0% in 2025, which will be on a par with the  CB RA's stable inflation target range.

The average annual exchange rate of the Armenian dram against the  U.S. dollar is projected at 414 in 2024 (Figure 10.B). 2024 will see  gradual depreciation of the dram from the current year, driven by  several factors. These include a slowdown in the growth rate of  exports of goods and services in 2024 after a strong performance in  2022-2023, higher import growth than export growth amid continued  strong domestic consumer and investment demand, depreciation  expectations caused by the geopolitical situation, a rate cut in the  money market, and slower economic growth. The inflow of remittances  and foreign capital will, however, bolster the national currency  along with a high tourism level, the overall effect being slight  depreciation in 2024. 

Stimulative fiscal policy in the medium term. Fiscal policy will  stimulate demand in 2024 according to our estimates, given the  government's plans to increase the budget deficit to 3.2% of GDP vs.  2.5% in 2023 in the context of expenditures rising by 1.1 p.p., to  28.7% of GDP. The government is looking to increase capital spending  by 0.6 p.p. to 6.6% of GDP in 2024 and keep it at that level until  2026. This will help boost productivity and expand the  economy's  growth potential in the medium term. Under the government's  Medium-Term Expenditure Programme for 2024-2026, expenditure rates  will stabilise around 28% of GDP, and tax revenues will grow by 0.6  p.p. per annum.

Risks

Deteriorating geopolitical environment in the region. This expands  uncertainty around the forecasts of key macroeconomic indicators. If  unfavourable scenarios materialize then this will increase  pro-inflationary risks and risks that external demand for services  will weaken, as well as raising the country risk premium.

The external sector faces a risk of a deeper and more protracted  recession in the world's major economies.  If an unfavourable  external conditions scenario materializes then this will lead to  slower economic growth in Armenia in 2024. With weak external demand,  exports and remittance inflows will slow down.

Armenia's economic growth driver for 2022-2023 could pose a risk to  the economy. The likelihood of capital and labour outflows is a  significant threat to the economy and to the stability of the  national currency. A reversal of the net inflow of cross-border  remittances would lead in the first place to sharp depreciation of  the national currency and a surge in prices. 

The EDB Macroeconomic Outlook 2024-2026 is available here:

https://eabr.org/upload/iblock/abe/EDB-Macroeconomic-Outlook-2024_2026_eng.pdf