From revolution to reform: Armenia sets sights on next economic level

Despite the political upheaval following its 2018 political revolution, Armenia has launched an aggressive and wide-ranging series of reforms that, if carried through successfully, should propel the economy to a new level

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A political revolution can often throw a small and developing economy like Armenia’s into disarray, but after the Velvet Revolution of May 2018, Armenia and its new regime have enjoyed GDP growth of 5.2%, in spite of a period of difficult political transition.

The nation’s partnership with international financing institutions like the IMF and the World Bank has helped smooth over the bumpy period and is now shepherding the country through a challenging programme of institutional reforms.

Among the biggest challenges facing the new regime was Armenia’s history of endemic corruption.  Former prime minister Tigran Sargsyan said in 2008 that corruption was Armenia’s number one problem obstructing reforms. Armenia still ranks 105th in Transparency International’s Corruption Perceptions Index, although it has steadily crept up the rankings from 113th in 2016.

Previous efforts at tackling the problem have had little success. An anti-corruption council was established in 2004 but was widely regarded to have achieved little of value. In 2015, a second attempt was made, and the anti-corruption council was relaunched. If anything, the results were even worse. The council was quickly beset by accusations of lavish spending, and an unwillingness to pursue investigations into senior politicians robbed the initiative of credibility.

“Previous governments failed to tackle the problem effectively, largely because they were corrupt themselves,” says Tigran Jrbashyan, head of management advisory services at Ameria CJSC, one of Armenia’s top consultancy and advisory companies. “It’s different this time. The new government is quite radical on fighting corruption within the public sector.”

Part of this is achieved through reforms to the judicial system, making the judiciary more independent, but the enforcement aspect is perhaps more important. “The new government has taken the fight against corruption to a completely new level,” says Jrbashyan. “Now they are quite radical on fighting corruption and shadow economy. There’s a clear message to public officials that things have to be done above board. However, fight against corruption should be accompanied with building effective institutions.”

New prime minister Nikol Pashinyan announced in September that there would be two new bodies set up to tackle corruption, and that they are moving towards establishing an independent judiciary. 

Armenia has also set up a register of beneficial ownership that will provide public information on the real owners of businesses operating in Armenia. The bill has been signed and the register should be fully operational by December 2020.

The focus on corruption should help to improve investors’ confidence in doing business in Armenia.

“Transparency, rule of law and consistency should create a new level of trust, both in Armenia and abroad,” says Jrbashyan. “That is also an important prerequisite for foreign direct investment. In the mid-term, FDI should improve.”

Attracting foreign investment

Low FDI has plagued Armenia for many years. It remains static at around 2.3% of GDP, much of which is concentrated in Armenia’s mining and commodity export businesses.

The history of corruption has deterred international investors, but there are other factors that are less easily tackled. “It’s a small country in a rather challenging location, which is nevertheless full of opportunities,” says Artashes Shaboyan, chief researcher at Ameria CJSC. “Large investors focus on the region and don’t delve into the particular features of each country. The government has to invest resources to get international international investors to recognise it as an opportunity.”

That often means missing out on Armenia’s unique strengths. Unlike the rest of the region, Armenia’s currency has enjoyed remarkable stability over the past few years. Its inflation too has remained in check and its banks have been subject to some of the most stringent regulation in the region and, as such, have had fewer non-performing loans than most of the regional peers.

The Armenian dram has appreciated around 20% over the past 10 years, compared to 50% for most of its peers in the CIS region.

“From a macro stability point of view, Armenia has been very impressive,” says Shaboyan. “After the global financial crunch, growth has been remarkably stable, and we do expect further positive developments in this regards. Armenia has proved to be outstanding in the region with an average inflation of 3%-4% for the last 10 years, only 1%-2% fluctuation of exchange rate over the last five years and much better diversified economy, where the largest sector of economy has less than 14% share”

The government’s new tax code, which it will implement between 2020 and 2023, will lessen the tax burden for smaller businesses and entrepreneurs in an effort to create a better environment for business.

But despite cutting and simplifying taxes, government tax receipts climbed hugely this year and are expected to continue rising. “Armenia is pursuing an e-governance concept that would give a leap to transparency and reporting, as well as enable many online services both by the public and private sectors,” says Jrbashyan.

Christian Fang, senior analyst for Armenia at Moody’s, agrees. “Expanding digitisation to include invoicing as well as revenue collection has really helped cut down on tax avoidance. Over the next year or so, the filing of income taxes will become automated, which should improve things even more.”

But beyond the government’s attempt to reform itself, it is working on structural changes to the Armenian economy.  Fang says: “These reforms, if effectively implemented, will increase Armenia’s economic competitiveness and its attractiveness as a business destination.”

Armenia is working hard on developing various sectors of its economy. It has never been a manufacturing powerhouse, although the manufacturing sector output increased by 10% in 2018, but the jewel of Armenia’s economy and the sector that will likely drive the bulk of its economic growth in years to come is technology.

Armenia has become a hub for software development, industrial computing and general information technology services.


Resilience against external shocks

Armenia has experience in riding out periods of domestic and regional turmoil, but with the world facing a slowdown in growth, Armenia will have to adapt to survive.

Where many economies around the world will suffer from the slowdown in economic growth and the spillover of reduced demand thanks to the trade war between the US and China, Armenia will only be indirectly exposed to the conflict.

“Armenia has a pretty limited exposure to US and China trade tensions,” says Fang. “Its main trading partners are the EU, Switzerland and Russia, not the US or China.”

But should the decline in global growth result in a fall in commodity prices, it is likely that Armenia would suffer as a result. Mining, particularly of copper, is still an important part of the Armenian economy.

However, as the importance of the technology sector grows, Armenia’s reliance of mineral production will fall. The World Bank has been pursuing a programme of trade promotion in Armenia, seeking to address the country’s reliance on low value-added commodity products.

“The technology sector of its economy is growing strongly, and we expect it to prove resilient in the face of slowing growth,” says Fang. “Armenia services a wide region as a provider of technology solutions, and they’ll likely be needed even in times of slow growth.”


Challenges facing Armenia

Most agree that if Armenia successfully accomplishes its programme of reforms, it will reap the rewards — a stable, diverse economy with dynamic growth. However, that it is successful in its reforms is not a foregone conclusion.

“The government is currently working on the transformation strategy of the country. We are proud to have developed innovation-led industrial strategy, yet implementation of all those great ideas is still a big challenge. It will require detailed and consistent implementation,” says Jrbashyan.

The government was elected with a 70% majority in December 2018 and appears to still enjoy much of the goodwill that carried it to victory. That goodwill will go a long way towards facilitating reform.

But that goodwill will not last forever. Unless the government is able to produce results in line with the public’s expectations, it could begin to evaporate quickly.

“Apart from quality of decision making, there is a huge time pressure and I expect that more public sector operations should be outsourced to the private sector to enable swift and efficient implementation of good intentions of the government,” says Jrbashyan.

Some of Armenia’s structural challenges are less amenable to improvement through reform. It is a landlocked nation, and two of its four borders are closed. Poor diplomatic relations with Turkey and Azerbaijan mean that those countries are barred as routes for trade.

Its borders with Georgia and Iran are open, but the economic sanctions on Iran make it a difficult option for trade opportunities. There is little that can be done to address this, but Armenia’s membership of the Eurasian Economic Union provides a valuable outlet for trade.

Although Armenia’s GDP is growing at an impressive rate, and projected to continue to do so, its current account deficit and trade balance are both substantial. The World Bank projects that these deficits will fall, thanks to structural reforms calculated to boost exports and tourism.

Armenia’s new government, although it was born out of a revolution, has proved an ambitious but credible body. Its reform programme, though daunting, has the advantage of public support and the backing and confidence of the international investment community.