Armenia Country Economic Update Summer 2018 An Opportunity to Unlock Armenia’s Potential Macroeconomics, Trade & Investment Global Practice ARMENIA: An Opportunity to Unlock Armenia’s Potential Country Economic Update Summer 2018 Government fiscal year: January 1 – December 31 Currency unit: Armenian dram (AMD) Currency equivalents: Exchange rate effective as of June 1, 2018 US$1 = 482.9 AMD Weights and measures: Metric system Abbreviations and acronyms AMD Armenian dram CBA Central Bank of Armenia RPA Republican Party of Armenia CEU Country Economic Update EAI Economic Activity Index EEU Eurasian Economic Union EU European Union IMF International Monetary Fund FDI Foreign direct investment GoA Government of Armenia LPI Logistics Performance Index GDP Gross Domestic Product MTEF Medium term Expenditure Framework NPL Nonperforming loan NSS National Statistics Service SCD Systematic Country Diagnostics VAT Value-added tax WBG World Bank Group ii| Table of Contents Foreword....................................................................................................................................................... v Key Messages ................................................................................................................................................ 1 A. Recent Developments ............................................................................................................................ 2 Political Developments .................................................................................................................... 2 Economic Growth and Inflation ....................................................................................................... 2 External Sector ................................................................................................................................. 5 Fiscal Policy and Public Debt ............................................................................................................ 8 Social Sector and Labor Markets ................................................................................................... 12 Monetary and Exchange Rate Policies ........................................................................................... 14 Financial Sector .............................................................................................................................. 16 B. Structural Reform Agenda .................................................................................................................... 17 C. Economic Outlook and Risks ................................................................................................................ 19 D. Special Topic: FDI Sector Scan, Agribusiness in Armenia ..................................................................... 22 Sector Scan Results ........................................................................................................................ 24 Conclusion...................................................................................................................................... 26 Annex 1: Tables ........................................................................................................................................... 28 Annex 2: What Makes A Good Fiscal Rule? ................................................................................................ 32 Figures Figure 1. Real GDP Growth ........................................................................................................................... 3 Figure 2. Quarterly Real GDP Growth ........................................................................................................... 3 Figure 3. GDP Growth by Sector ................................................................................................................... 4 Figure 4. GDP Growth by Source of Demand................................................................................................ 4 Figure 5. Inflation, by Component ................................................................................................................ 5 Figure 6. Headline and Core Inflation ........................................................................................................... 5 Figure 7. Current Account Balance ............................................................................................................... 6 Figure 8. Remittances ................................................................................................................................... 6 Figure 9. Exports of Copper Ore And World Price ........................................................................................ 6 Figure 10. Exports by Commodity Groups .................................................................................................... 7 Figure 11. Exports by Destination Economy ................................................................................................. 7 Figure 12. Tourist arrivals, by Economy ........................................................................................................ 7 Figure 13. Net Foreign Direct Investment..................................................................................................... 8 Figure 14. Gross International Reserves ....................................................................................................... 8 Figure 15. Fiscal Developments .................................................................................................................. 10 Figure 16. Public Debt Dynamics ................................................................................................................ 10 Figure 17. Tax Revenues ............................................................................................................................. 10 Figure 18. Unemployment and Labor Force Participation.......................................................................... 12 Figure 19. Poverty Rates in Europe and Central Asia ................................................................................. 13 Figure 20. Real GDP Growth and Per Capita Income .................................................................................. 13 |iii Figure 21. Real Policy Rate .......................................................................................................................... 15 Figure 22. Policy, Deposit, and Lending Rates ............................................................................................ 15 Figure 23. Exchange Rate ............................................................................................................................ 16 Figure 24. Real Effective Exchange Rate ..................................................................................................... 16 Figure 25. Commercial Banks’ Profitability ................................................................................................. 16 Figure 26. NPLs and Liquidity Ratio............................................................................................................. 17 Figure 27. Medium-Term Growth Projection, Baseline .............................................................................. 21 Figure 28. FDI in Agriculture in Armenia, 2008–15 ..................................................................................... 23 Figure 29. Fish Production in Armenia ........................................................................................................ 24 Figure 30. Prioritization of Target Sub-Sectors For Proactive FDI Promotion ............................................ 27 Tables Table 1. Contribution to Real GDP Growth ................................................................................................... 4 Table 2. State Budget .................................................................................................................................. 12 Table 3. Baseline Scenario: Selected Macro-Fiscal Indicators .................................................................... 22 Box Box 1: Fiscal Rules ......................................................................................................................................... 9 Annex Tables Table A 1. Selected Macroeconomic and Social Indicators, 2013-20 ......................................................... 28 Table A 2. Balance of Payments and Official Reserves, 2013–17 ............................................................... 30 Table A 3. Consolidated Fiscal Accounts, 2013–17 ..................................................................................... 31 iv| Foreword This edition of Armenia’s Country Economic Update (CEU) is part of a semi-annual series designed to monitor socio-economic developments in Armenia. It presents a concise analysis of political, economic, and social developments as well as of progress achieved in the implementation of structural reforms since the Winter 2018 edition of the CEU. This edition’s author is Armineh Manookian (Country Economist for Armenia), with a significant contribution by Evgenij Najdov (Senior Economist for South Caucasus) and support from Artsvi Khachatryan (Consultant). It also includes a special focus section highlighting the findings of the Foreign Direct Investment Sector Scan of the agribusiness sector in Armenia conducted by the World Bank Group. The authors are grateful for the support of, and inputs from, Mercy Miyang Tembon (Regional Director, ECCSC), Sylvie Bossoutrot (Country Manager for Armenia), Genevieve Boyreau (EFI Program Leader for South Caucasus), Jeff Chelsky (Lead Economist) and Moritz Meyer (Economist). Sarah Nankya Babirye (Program Assistant in Washington, D.C.) and Gayane Davtyan (Program Assistant in Yerevan) provided administrative support. Vigen Sargsyan (Senior Communications Officer, ECAEC) helped with the report dissemination. María González-Miranda Practice Manager Macroeconomics, Trade & Investment Global Practice |v Key Messages The political landscape Following 10 years as President and after recently being elected Prime underwent a massive Minister, Serzh Sargsyan resigned on April 23, 2018, following nationwide change in early 2018. protests. Nikol Pashinyan, the MP and opposition leader, was elected Prime Minister on May 8. The new administration has identified anti-corruption efforts, free and fair early parliamentary elections, and greater equity as its priorities. In 2017, the economy Supported by a recovery in the external environment and a strong rebound in grew at the fastest domestic demand, the economy grew by 7.5 percent in 2017 (following flat rate since the global growth in 2016). The positive trend continued in the first quarter of 2018, with financial crisis. high-frequency data suggesting that political developments in April and May did not significantly impact economic activity. Inflation was within the Central Bank of Armenia (CBA) inflation target range and low compared with the region. The fiscal position improved in 2017, although by less than planned, and government debt increased to 54 percent of GDP at end-2017, two percentage points of GDP above its 2016 level. Although the new government has signaled its commitment to lower the deficit while strengthening redistributive policies and fighting tax evasion, the details are yet to be articulated. Low employment The positive macroeconomic developments in 2017 had a relatively small levels and poverty impact on labor markets. The unemployment rate—which declined only remain Armenia’s two marginally, from 18 percent in 2016 to 17.8 percent in 2017—remains among biggest obstacles to the highest in the region. Strong GDP growth in 2017 pushed GDP per capita social progress. up by 10 percent, reaching its 2014 level. However, the benefits of economic growth were not widely shared. There is reason for Fresh political will to implement significant regulatory reforms governing optimism about competition and the business environment—together with efforts to Armenia’s economic strengthen human capital—can boost growth to above Armenia’s medium- outlook, but significant term baseline annual growth potential of 4 percent. However, in the short risks remain. term, economic activity may slow as the economy adjusts to the new realities and as the drivers of growth from 2017 dissipate. Adverse shocks—affecting, for instance, the economic recovery of the Russian Federation, metal prices, or global demand—would undermine prospects for Armenia’s external performance. Domestically, the capacity to design and push through reforms is yet to be tested. It will be important to preserve the gains achieved by recently- introduced reforms (in taxation and pensions, for example). Re-designing economic policies to address the population’s grievances while safeguarding fiscal and macroeconomic stability may prove challenging. |1 A. Recent Developments Political Developments Nationwide protests The political landscape underwent a massive change in recent months, resulted in a culminating in a peaceful transition of power. On April 17, 2018, Serzh leadership change. Sargsyan—who served two consecutive terms as President—was elected Prime Minister by parliament. With Armenia recently having completed a transition to a parliamentary system that shifted significant powers from the president to the prime minister, the move would have secured an additional term for Mr. Sargsyan. However, this was met with massive non-violent nationwide protests, building on growing dissatisfaction with the government's performance, particularly perceptions of systemic corruption and a lack of social and political reform. The protests resulted in the Prime Minister stepping down on April 23. Nikol Pashinyan, the leader of the protests, was subsequently elected Prime Minister on May 8 with the backing of 59 of 101 members of parliament, including some from Mr. Sargsyan’s Republican Party. The new government was sworn in on May 21. Its members include several senior officials from the previous government, experienced technocrats, and young associates and political appointees representing the three factions in the Armenian Parliament. The new government The new administration has identified its immediate priorities as anti- has identified anti- corruption efforts and putting in place the conditions for free and fair early corruption and free parliamentary elections. So far, several investigations have been launched and fair early elections against businesses for alleged tax evasion. At the same time, early as priorities - parliamentary elections are slated to take place within one year, following amendments to the Electoral Code and electoral system.1 … while supporting The new government has confirmed its commitment to Armenia’s major continuity in international engagements. In particular, Mr. Pashinyan has expressed his international relations. administration’s commitment to the implementation of the Comprehensive and Enhanced Partnership Agreement with the European Union (approved by the Armenian authorities on December 28, 2017), while maintaining close relationships with Russia and the Eurasian Economic Union. Importantly, the new administration has restated its openness to advancing negotiations on multiple issues with countries in the region. Economic Growth and Inflation In 2017 Armenia’s The favorable trends in economic activity in the first half of 2017 accelerated economy expanded at towards the end of the year, supported by a buoyant regional economy. the highest rate since Improving GDP growth rates was a global phenomenon in 2017. The region also experienced the fastest growth since the 2008 global financial crisis, mostly 1 The holding of early elections is specified in the Government Program approved by the National Assembly on June 7, 2018. 2| the global financial driven by rising private sector demand and a shift toward exports. Following a crisis. flat economic performance in 2016, Armenia’s real GDP growth rate is estimated to have reached 7.5 percent in 2017, the highest rate in a decade (Figure 1) More than one-half of GDP growth came from a strong expansion in services, notably from trade, financial and insurance activities, and arts, entertainment, and recreation. This performance reflects positive developments in the labor market and higher remittance inflows as well as robust tourism earnings. Manufacturing expanded by 6 percent, while agriculture was the only sector that posted a contraction in 2017, with output falling by 5 percent year on year due to unfavorable weather conditions. Importantly, value added from the construction sector rose by 3 percent year on year, the sector’s first positive contribution since 2008. On the expenditure side, economic growth was driven by a strong rebound in consumption and investment. At the same time, exports rose by about 20 percent in real terms; however, strong domestic demand resulted in a 26 percent increase in imports of goods and services. Consequently, net exports acted as a drag on growth, in contrast to recent years (Table 1). Figure 1. Real GDP Growth Figure 2. Quarterly Real GDP Growth (In percent, year-over-year) (In percent, quarter over same quarter previous year) 12 8 8 6 4 4 2 0 0 -4 2015-Q4 2016-Q1 2016-Q2 2016-Q3 2016-Q4 2017-Q1 2017-Q2 2017-Q3 2017-Q4 2018-Q1 2018f 2017p 2010 2011 2012 2013 2014 2015 2016 Source: NSS and World Bank staff calculations. Source: NSS and World Bank staff calculations. Favorable trends The expansion of the economy continued into the first quarter of 2018. Based continued into early on preliminary data, real GDP in the first quarter expanded by 9.6 percent 2018, with the compared with the first quarter 2017 (Figure 2). The recovery in the construction sector construction sector strengthened as value added rose by 13 percent year on registering the fastest year. However, years of contraction in the sector have significantly reduced its growth. share in the total economy; as a result, the construction contributed only 0.5 percentage points to overall economic growth. Most of the expansion (6.2 percentage points out of 9.6 percent growth) came from growth in trade and other services, particularly from services related to human health and social work and real estate activities. Industry expanded by 6.4 percent in the first quarter of 2018, building on strong growth in 2017, while the agriculture sector |3 continued to stagnate. High-frequency data for April showed a modest slowdown in the growth rate to 7.3 percent, possibly reflecting the impact of nationwide demonstrations and strikes during the month of April. So far, however, there is no conclusive evidence that recent political developments have had a significant negative impact on the overall economy. Figure 3. GDP Growth by Sector Figure 4. GDP Growth by Source of Demand (In percent) (In percent) 15 15 10 10 5 5 0 0 -5 -5 -10 2010 2011 2012 2013 2014 2015 2016 2017p 2010 2011 2012 2013 2014 2015 2016 2017p Agriculture Industry Construction Private consumption Gross investment Services Net taxes Public consumption Net exports Source: NSS and World Bank staff calculations. Source: NSS and World Bank staff calculations. Table 1. Contribution to Real GDP Growth (In percentage points) 2013 2014 2015 2016 2017p Real GDP growth 3.3 3.6 3.2 0.2 7.5 Domestic demand -0.7 0.0 -6.3 -2.9 11.1 Consumption 1.6 0.7 -6.1 -1.1 8.6 Gross capital formation -2.3 -0.7 -0.3 -1.8 2.5 Net exports 3.4 2.3 8.5 2.5 -4.9 Exports of goods and services 2.4 1.8 1.4 5.7 6.5 Imports of goods and services -1.0 -0.5 -7.1 3.2 11.5 Statistical discrepancy 0.6 1.3 1.0 0.6 1.3 Source: World Bank staff calculations based on data published by NSS. Note: Sums may not add due to rounding. Despite a slight uptick, Recovering domestic demand, weak agriculture yields, and higher global food inflation remains and fuel prices pushed inflation up, but it remained within the target range. below the CBA target. Annual inflation at the end of 2017 reached 2.6 percent compared with deflation in 2016. The main contributor to the acceleration in 2017 was food prices (including beverages and cigarettes), which rose by 5.3 percent year on year. Transport prices increased by 4.6 percent in 2017. The other groups registered either lower inflation or deflation. The utilities price index declined by 4 percent on a year-on-year basis, due in part to reduction in administered prices for gas and electricity at the start of the year by 5 and 3 percent, 4| respectively. Inflation accelerated to 3.7 percent in the first quarter of 2018, with the increase in food and beverage prices explaining half of the price increase. Meat prices (up by 14 percent year on year due mainly to higher international prices) made the largest contribution to the food price increase. Inflation was also pushed up by a significant (9 percent) increase in transport prices, particularly petrol and diesel (up 17 and 26 percent year on year, respectively), reflecting higher excise tax rates effective January 2018 and gradually recovering global oil prices. Core inflation edged up to 5.1 percent by the end of the first quarter of 2018, exceeding headline inflation, mainly owing to flat administered gas and electricity tariffs (Figure 5 and Figure 6). April data showed a deceleration in annual inflation, to 2.4 percent, suggesting that political developments did not have a major impact on product markets. Figure 5. Inflation, by Component Figure 6. Headline and Core Inflation (In percent, month over same month previous year) (In percent, month over same month previous year) 6 8 4 6 2 4 0 2 -2 0 -4 -2 Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar -4 Apr Apr Apr Oct Oct Oct Jul Jul Jul Jan Jan Jan Jan 2015 2016 2017 2018 Contribution from energy and utility prices 2015 2016 2017 2018 Contribution from food prices Contribution from others CPI inflation, 12-month Headline inflation Core inflation, 12-month Source: NSS and World Bank staff calculations. Source: NSS and World Bank staff calculations. External Sector Despite robust export The current account balance continued to improve in the first three quarters earnings, the current of 2017; however, a strong expansion in imports in the last quarter of the year account deficit resulted in the overall deficit widening to 3.5 percent of GDP, 1.2 percentage widened. points higher than in 2016 (Figure 7) The significant increase in goods imports in the fourth quarter, particularly in December, was partly related to an in-kind military loan from Russia. Excluding this transaction, the 2017 current account deficit was about 2 percent of GDP. Importantly, goods exports continued to perform well, increasing by 26 percent year on year in nominal US dollar terms.2 The services balance also registered an improvement, while remittance inflows increased by 12 percent, with 2017 being the first year since the 2014 Russian crisis when remittances increased (Figure 8). 2 Balance of payments data on free on board (FOB) basis. |5 Figure 7. Current Account Balance Figure 8. Remittances (US$ million) (In percent of GDP) (Annual percent change) 2,000 10 30 1,000 5 15 0 0 -1,000 -5 0 -2,000 -10 -15 -3,000 -15 2010 2011 2012 2013 2014 2015 2016 2017 -30 Trade balance Services balance 2010 2011 2012 2013 2014 2015 2016 2017 Primary income Secondary income Remittances (yoy change, %) CAB (RHS) Source: CBA, NSS and World Bank staff calculations. Source: CBA and World Bank staff calculations. Exports of goods The recovery in global metal Figure 9. Exports of Copper Ore And World Price benefited from the prices, particularly for (In US$ million) (‘000 US$ per metric ton) continued recovery in copper, and a resumption of commodity prices and growth in Russia pushed 200 8.2 growth in main trading export earnings up by about 150 7.0 partners. 25 percent in 2017.3 Copper exports rose by 64 percent in 100 5.8 nominal terms (20 percent in volume terms), benefiting 50 4.6 from higher demand as well 2014 2015 2016 2017 as rising prices (Figure 9). Exports of Armenian wine Export of copper ores and concentrates, (LHS) increased by 76 percent year Copper, (RHS) on year, with nearly 90 Source: CBA, NSS and World Bank staff calculations. percent of wine exports sold at the Russian market. In sync with declining agricultural output, exports of agriculture products also contracted, especially of tomatoes and stone fruit (apricots, cherries, plums, and peaches, in particular). Exports of gold and jewelry also contracted by 14 percent year on year (Figure 10) The data on exports by destination market show that the share of total exports to Russia increased from 20 percent in 2016 to 24 percent in 2017. Exports to EU economies increased by 32 percent, bringing the block’s total share of Armenian exports to 28 percent (Figure 11). Foreign trade Exports grew by 34 percent year on year in the first quarter of 2018, following continued to expand a similar trajectory to that recorded in 2017. Exports of textiles more than briskly in the first doubled year on year in the first quarter of 2018, boosting its share of total quarter of 2018. exports from 5 percent to 8.5 percent. At the same time, imports increased by 39 percent, driven mainly by rising capital goods imports (including imports of 3 Foreign trade data on cost, insurance, and freight (CIF) basis. 6| machines, equipment, and devices, and capital goods for land, air, and water transport). Figure 10. Exports by Commodity Groups Figure 11. Exports by Destination Economy (US$ million) (US$ million) 2,400 2,400 2,000 2,000 1,600 1,600 1,200 1,200 800 800 400 400 0 0 2014 2015 2016 2017 2014 2015 2016 2017 Metals and minerals Manufacturing Gold and jewelry Other EU Russia China Georgia Iraq Other countries Source: NSS, World Bank staff calculations. Source: NSS, World Bank staff calculations. Despite improving in Exports of services Figure 12. Tourist arrivals, by Economy 2017, net service rose by 18 percent, 10 (‘000 persons) (In percent change) exports remained percentage points of 1,800 26 negative. which was due to an 1,500 20 increase in tourism- 1,200 14 related services as the 900 number of tourists 8 600 visiting Armenia 300 2 reached 1.5 million 0 -4 (19 percent annual 2015 2016 2017 growth). One-fifth of Russia EU tourists came from USA Iran Other countries Yoy change, % (RHS) Russia, with a similar number coming from Source: NSS, World Bank staff calculations. the European Union. More than 200,000 tourists from the Islamic Republic of Iran visited Armenia in 2017, accounting for 14 percent of all visitors (a similar proportion as in 2016). Tourist arrivals from the United State increased by 70 percent year on year, totaling around 200,000. Tourists from other economies also increased, by around 40 percent, suggesting some of diversification in Armenia’s tourism base (Figure 12).4 Exports of other services, such as information and communication technology (ICT) and construction abroad, also positively contributed to the improvement of the services balance in 2017. 4 In 2018, Armenia will host three major events that are expected to attract more members of the Armenian diaspora and international tourists. These are: (i) the 100th anniversary of the First Republic (May); (ii) The 2,800-year anniversary of Yerevan (September); and (iii) the Francophonie Summit (October). |7 Foreign direct Capital and financial account inflows exceeded the current account deficit in investment flows 2017, allowing for some reserve accumulation although smaller than in 2016. remain subdued. Net FDI inflows fell to US$223 million in 2017, about 18 percent below the previous year. As a percentage of GDP, net FDI declined from 2.5 percent in 2016 to 1.9 percent in 2017 (Figure13), partly reflecting a high base of comparison (commercial banks increased capital levels in 2016 to meet higher capital requirements set by the CBA). Inflows of FDI in 2017 went mostly to the construction and mining sectors,5 suggesting that efficiency- seeking investment—that is, investment that enters an economy to benefit from factors that enable it to compete in international markets—continues to bypass Armenia. The portfolio account registered a deficit of around US$87 million, as Armenian entities increased holdings abroad and reduced their foreign liabilities. Net inflows from loan transactions were positive, mainly reflecting government borrowing (including the military loan received from International Russia in late 2017) as well as reduced short-term foreign claims of Armenian reserves increased in banks. As a result, international reserves continued to increase, reaching 2017; but came US$2.3 billion at end-2017, up by US$110 million compared to a year earlier, under pressures and providing 4.6 months of import cover (Figure 14) However, the political during the recent developments in April and May 2018 pushed up demand for foreign political exchange, triggering limited interventions by the CBA. Nonetheless, reserves developments. stood at more than US$2 billion by end-April, providing relatively comfortable cover. Figure 13. Net Foreign Direct Investment Figure 14. Gross International Reserves (In percent of GDP) (In US$ million) (In months of imports) 6 2,500 5.5 5 2,000 5.0 4 1,500 4.5 3 1,000 4.0 2 500 3.5 1 0 3.0 2010 2011 2012 2013 2014 2015 2016 2017 0 2010 2011 2012 2013 2014 2015 2016 2017 Gross interntional reserves (mln. USD) Goods and services import cover (RHS) Source: CBA, NSS, and World Bank staff calculations. Source: CBA, NSS, and World Bank staff calculations. Fiscal Policy and Public Debt The fiscal deficit was The fiscal position improved in 2017, although by significantly less than larger than planned in planned. After tightly controlling spending through November 2017, the 2017, resulting in rising government received an unbudgeted in-kind military loan from Russia in the government debt. last month of the year, resulting in the widening of the fiscal deficit to 4.8 5 The majority of FDI in Armenia’s mining sector in 2017 was related to the Amulsar Gold mine project, located in south-central Armenia. Owned 100 percent by Lydian International, the mine is expected to start operations in 2018. 8| percent of GDP, compared to a target of 2.8 percent. Excluding this transaction, the fiscal deficit would have been 3.3 percent of GDP. Still, the deficit was down from 5.5 percent in 2016 (Figure 15). In response, government debt increased to 54 percent of GDP by the end of 2017, up from 52 percent a year earlier. Public debt (including CBA debt) reached 59 percent of GDP, most of which (48 percent of GDP) was external debt (Figure 16). The fiscal rule was adjusted in 2017 to provide greater flexibility for countercyclical fiscal policy. With government debt above 50 percent of GDP at the end of 2016, the fiscal rule6 mandated a relatively rapid fiscal consolidation. However, in an environment of no growth, a rapid fiscal adjustment would have been procyclical. Furthermore, the fiscal rule was considered too restrictive as it did not provide an escape clause for unexpected events or developments. In response, the authorities, with technical assistance from the IMF, revised the fiscal rule at the end of 2017 by amending the Public Debt Law to remove the pro-cyclicality feature of the old rule, and the Budget System Law to define specific expenditure disciplinary rules which would become effective as public debt levels reach certain thresholds. To fully operationalize the new fiscal rule, the authorities still need to adopt a decision that will define certain technicalities, including the calculation of long-term GDP growth. (see Box 1 and Annex 2 for details of the new rule). Box 1: Fiscal Rules Fiscal rules have gained popularity in recent decades as countries have tried to improve fiscal discipline. A recent IMF blog “Fiscal Rules: Make them Easy to Love and Hard to Cheat”7 analyzed fiscal rules which became effective over the last three decades in over 90 economies. The blog noted three attributes of effective fiscal rules—they need to be simple, flexible, and enforceable in the face of changing economic circumstances. However, the authors found that rules were often too complex, overly rigid, and difficult to enforce. The analysis also proposed principles for fiscal rule design. Armenia’s recently revised its fiscal rule. In general terms, the revision brings Armenia’s fiscal rule closer to the good principles for fiscal rule design. For example, in line with proposed principles, the revised rule contains a debt rule (debt should not exceed 60 percent of GDP) but also introduces a number of operational rules that are supposed to guide annual budget decisions (for example, imposing limits on spending when certain thresholds are reached). Furthermore, the legislation envisages for a clear exemption from these rules in case of emergencies. On the other hand, the number of operational rules may be on the high end, while the incentives for better compliance may require strengthening. Experience over time will demonstrate if the revised rule strikes a better balance between effectiveness and simplicity. 6 The Fiscal Rule adopted in 2008 stated that if government debt exceeds 50 percent of previous year GDP, the fiscal deficit for the next year would be reduced to 3 percent of the average nominal GDP of the previous three years, and if it exceeds 60 percent of GDP, no further debt can be issued. Following to this rule, in 2016, when the debt level exceeded the 50 percent threshold, the government planned to reduce its deficit from 5.5 percent of GDP in 2016 to 2.8 percent of GDP in the 2017 State Budget Law. 7 https://blogs.imf.org/2018/04/13/fiscal-rules-make-them-easy-to-love-and-hard-to-cheat/ |9 Figure 15. Fiscal Developments Figure 16. Public Debt Dynamics (In percent of GDP) (In percent of GDP) 60 40 40 20 20 0 0 -20 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2010 2011 2012 2013 2014 2015 2016 2017 Total revenues Total expenditures External debt Domestic debt Fiscal balance CBA's external debt Source: MoF, NSS and World Bank staff calculations. Source: MoF, NSS, and World Bank staff calculations. Indirect taxes Tax revenue rose Figure 17. Tax Revenues accounted for the bulk by 7.3 percent year (In dram billion) (In percent) of the increase in tax on year in 2017 in 1,500 8 collection. nominal terms, driven by higher 1,000 collections of 4 excise, customs, 500 and environmental taxes. The share of 0 0 indirect taxes and 2015 2016 2017 customs duties in VAT Excise tax total taxes Customs duty Profit tax increased from 47 Income tax Other taxes to 49 percent Yoy change, % (RHS) (Figure 17). Source: MoF and World Bank staff calculations. Environmental taxes8 registered the highest year-on-year growth, rising by 47 percent. Profit tax collection was the only tax category which declined compared to the previous year. This decline was partly on account of the weak performance of the economy in 2016, which is the basis for profit tax payments in 2017. Social contributions collected from employees who are members of the fully-funded pension pillar9 increased by 18 percent year on year, to AMD 16 billion. This amount was matched with a similar amount from the state budget and transferred to the pension system asset managers. Overall, the tax-to-GDP 8 Environmental taxes include natural protection and natural resource use fees, such as royalties, fees for emission of harmful substances into the environment, and fees for the use of water, biological resources, or for exhausted deposits of solid mineral resources. 9 Since July 2014, the funded pillar has been mandatory for public sector employees and new labor market entrants born on or after January 1, 1974. For all other private sector employees, it will become mandatory in July 2018. 10| ratio in 2017 was 20.8 percent, half a percentage point of GDP lower than in 2016, led by the lower profit tax collections. Current spending Current expenditures were tightly controlled, making room for an increase in declined slightly, while capital spending, one-third of which was for military equipment purchased capital spending was from Russia. The only category of current spending which registered a boosted by a military substantial increase was interest payments, rising from 1.9 percent of GDP in equipment purchase. 2016 to 2.2 percent of GDP, mostly due to a higher domestic debt burden and a shift in the portfolio towards securities with longer maturities and higher interest rates10. The primary deficit declined to 2.6 percent of GDP in 2017, compared to 3.6 percent of GDP in 2016. Social benefits and the wage bill increased by 1.5 and 2 percent, respectively, compared with 2016. On the other hand, capital expenditures rose by 36 percent, mostly in the form of machinery and equipment (one-third of this was the military equipment purchased at the end of the year). The 2018 budget The budget projects a reduction in the fiscal deficit to 2.6 percent of GDP in envisages a significant 2018 (from 4.8 percent of GDP in 2017), with the financing of the deficit evenly fiscal consolidation. split between domestic and external sources (Table 2). As a percentage of GDP, current spending is projected to decline slightly, while a more significant reduction is envisaged for capital spending, given the elevated base associated with the 2017 Russian military equipment purchase. Excluding this, capital expenditures as a percentage of GDP are budgeted to remain on par with 2016 levels. Underspending in the So far in 2018, both revenues and expenditure appear to be below target, with first quarter of 2018 a higher underperformance on expenditures. Based on preliminary execution resulted in a smaller data for the first quarter of 2018, state budget revenues totaled AMD 256 deficit than expected. billion, 97 percent of the revenue target for the quarter.11 At the same time, expenditures reached AMD 282 billion, 15 percent below the budget allocation for the period. As a result, the fiscal deficit in the first three months of 2018 was less than one-third of the planned amount. 10 Medium and long-term domestic debt accounted for 95 percent of total domestic debt at the end of 2017, compared to 84 percent of domestic debt a year earlier. Yields on government securities with maturity of up to 1 year are around 6.5 percent, they increase to 8.5 percent on 5-year bonds and to above 10 percent on 10-year bonds. 11 A direct comparison of tax collections between 2018 and 2017 is not possible due to changes in the coverage of tax revenue in the 2018 budget that are consistent with international good practices. These changes include the exclusion of the VAT refund and registering only the net tax revenue. |11 Table 2. State Budget (In percent of GDP) 2016 2017 2018 Actual Actual Plan Total revenues and grants 23.1 22.2 22.1 Tax revenues and state duties /1 21.3 20.8 21.1 Official transfers / grants 0.6 0.3 0.6 Other revenues 1.2 1.2 0.4 Total expense 28.5 27.0 24.7 Current expenditures 25.2 22.7 22.1 Transactions with non-financial assets 3.3 4.2 2.7 Overall balance -5.5 -4.8 -2.6 Domestic financing 2.1 1.4 1.3 Foreign financing 3.4 3.4 1.3 Source: MoF. 1/ The coverage of tax revenue changed in the 2018 budget plan making the data incomparable with previous years. Social Sector and Labor Markets The economically Around 61 percent of the labor force was economically active in 2017, similar active population, on a to 2016 but still below the peak 2013 level of 63.4 percent. Despite strong downward trend since economic growth in 2017, the unemployment rate fell only marginally (from 18 2013, stabilized in percent in 2016 to 17.8 percent in 2017). Armenia’s unemployment rate 2017. remains among the highest in the region. The modest decline in the unemployment rate in 2017 was observed only among females and in urban areas; the unemployment rate in rural areas rose by 2 percentage points in 2017, reaching 7.7 percent. The lower unemployment rate in rural areas masks significant migration from villages to Yerevan, the capital city, or abroad— mainly due to a lack of job opportunities and profitable activities—but also reflects the vital role of subsistence farming in rural areas. Figure 18. Unemployment and Labor Force Participation (In percent) 22 64 20 62 18 60 16 58 14 56 2010 2011 2012 2013 2014 2015 2016 2017 Unemployment rate (% ) Economically active population (% of labor resources) (RHS) Source: NSS and World Bank staff calculations. 12| Armenia continues to Poverty continues to affect a significant proportion of Armenia’s population. In have relatively high 2016 (the last year for which poverty data are available), 14.1 percent of the poverty rates. population lived below the lower-middle-income economy poverty line of $3.2/day at 2011 purchasing power parity (PPP), calculated based on the World Bank methodology for international comparisons. Even though Ukraine and Moldova have a lower GDP per capita, their poverty rates were substantially lower than Armenia’s (Figure 19). At the same time, Georgia has a higher poverty rate even though GDP per capita exceeds that of Armenia. Figure 19. Poverty Rates in Europe and Central Asia 30 Poverty headcount at $3.2 PPP 2011 25 GEO (2015) KGZ (2015) 20 15 ARM (2015) 10 MKD (2015) 5 BGR (2014) MDA (2015) UKR (2015) MNE (2014) 0 0 5000 10000 15000 20000 GDP per capita, PPP (constant 2011 international) Source: World Development Indicators. Last Updated January 25, 2018. Note: The poverty headcount is estimated using lower-middle-income economy poverty line of $3.2/day PPP 2011. The impact of higher As a result of strong Figure 20. Real GDP Growth and Per Capita Income GDP per capita on economic growth, GDP (In US$) (In percent) poverty reduction may per capita increased in be limited. 2017, reaching US$3,800, 4,000 15 returning to its 2014 3,700 9 peak and approaching GDP per capita levels 3,400 3 recorded in Georgia in 3,100 -3 2016. However, available data suggest that the 2,800 -9 benefits of economic 2,500 -15 growth were not evenly 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 distributed. Between 2011 and 2016, annual consumption growth for Per capita GDP, USD Real GDP growth, % (RHS) the poorest 40 percent of Source: NSS. the population averaged 2.3 percent, well below the 4.6 percent consumption growth rate for the population overall. If the same pattern continued in 2017, then high economic |13 growth in 2017 is unlikely to have translated into a significant reduction in Armenia’s poverty rate. Persistently high High unemployment and poverty, which remain pressing concerns, fueled unemployment and recent political protests. Over one-third (36 percent) of respondents to the poverty remain 2017 Caucasus Barometer indicated that unemployment was the most Armenia’s two biggest important challenge facing Armenia. Just under two-fifths (17 percent) of challenges for social respondents indicated that poverty was the most important issue, reflecting progress slow progress towards better living standards. Both issues have topped public concerns since the global financial crisis and, along with widespread corruption and an unequal economic environment, were among the main drivers of the massive nationwide protests in early 2018. Monetary and Exchange Rate Policies The monetary stance With inflation increasing to the CBA’s target level and output growth remains unchanged. approaching potential, monetary policy remains unchanged. The CBA last made adjustments to its main policy rate in February 2017, reducing it by 25 basis points to 6 percent in response to low (and even negative) inflation and anemic economic growth. Since then, the authorities have continued to assess the monetary policy stance as adequate and not requiring a change in the policy rate. However, at its May 2018 meeting, the CBA hinted that maintaining the inflation rate around the target of 4 percent over the forecast period may require a gradual offsetting of expansionary monetary policy12 and an upward adjustment in the policy rate. With inflationary pressures intensifying, real interest rates continued to fall over the course of 2017 and into the first months of 2018 (Figure 21). Despite the unchanged policy rate, commercial banks’ deposit and lending interest rates continued to fall as they adjusted to the 2015–16 cycle of monetary loosening and to increased competition in the banking sector (Figure 22). The stock of credit and Credit from commercial banks expanded by 10 percent in 2017, moderating deposits grew by from the 15 percent growth rate in the previous year. Data on credit by about 10 percent each economic area show that the construction sector registered the highest growth in 2017 and the first in 2017 (40 percent year on year), while credit to the agriculture sector quarter of 2018. contracted. Credit continued to expand in the first quarter of 2018 at a similar pace (rising by 12 percent year on year) with almost equal growth in credit denominated in domestic and foreign currency (14 and 12 percent, respectively). The dollarization of the loan portfolio stood at 62 percent at end- March 2018, down by 1 percentage point compared with end-2016. Declining deposit interest rates also led to a moderation in deposits growth, to 9 percent in 2017. Dram deposits expanded faster due to relatively higher interest rates on dram deposits than on foreign currency deposits. A similar pattern continued into 2018, with deposits posting growth of 10 percent year on year at the end of first quarter. About one-half of the increase in total 12 See https://www.cba.am/EN/News/Pages/news_20-06-12.aspx 14| deposits relative to March 2017 was due to household dram time deposit growth. End-April 2018 data signaled a reduction in the outstanding net stock of deposits by 4 percent, mostly related to foreign currency deposits held by non-residents. However, this is expected to be only a temporary response to political developments; there is no indication that the pressure on deposits will continue. The deposit dollarization rate fell by 5 percentage points from 65 percent at end-2016 to 60 percent at end-March 2018 due to greater exchange rate stability and the large spread between dollar and dram interest rates for deposits. Figure 21. Real Policy Rate Figure 22. Policy, Deposit, and Lending Rates (In percent) (In percent) 12 20 9 15 6 10 3 5 Mar May Jul Mar Nov May Jul Mar May Jul Mar Nov Nov Jan Sep Jan Sep Jan Sep Jan 0 2015 2016 2017 2018 Mar Dec Mar Dec Mar Dec Mar Dec Mar Dec Mar Jun Sep Jun Sep Jun Sep Jun Sep Jun Sep Policy rate 2013 2014 2015 2016 2017 2018 Average deposit rate in AMD (over 1 year) Inflation adjusted policy rate (%) Average lending rate in AMD (over 1 year) Source: CBA and World Bank staff calculations. Source: CBA and World Bank staff calculations. The exchange rate The CBA has continued to implement a flexible exchange rate policy, with remained relatively interventions limited to smoothing out large fluctuations, including in response stable in 2017, to the events of April and May 2018. The CBA took advantage of strong inflows reflecting sound of remittances and tourism proceeds in 2017 to increase purchases of foreign current and financial exchange and prevent the excessive appreciation of the dram. Domestic inflows, but came political instability in April 2018 put some downward pressure on the exchange under pressure during rate; however, the quick resolution of the situation—together with prompt the events of April action by the CBA through open market operations—helped to stabilize the 2018. exchange rate. Although the dram depreciated by 1.4 percent during the protests (to AMD 487/US$1 on May 8), it has since recovered half of the lost value (Figure 23) Based CBA calculations, the real effective exchange rate depreciated by 4.5 percent in 2017, reflecting a 2 percent nominal effective exchange rate depreciation and relatively low inflation (1 percent on average during this period) compared with inflation in its trading partners (Figure 24). |15 Figure 23. Exchange Rate Figure 24. Real Effective Exchange Rate (Dram/US$) (Index, 1997=100) 488 150 May 8 486 140 484 130 482 120 480 478 110 Feb-18 Apr-18 Jan-18 Mar-18 May-18 2011-Q1 2011-Q3 2012-Q1 2012-Q3 2013-Q1 2013-Q3 2014-Q1 2014-Q3 2015-Q1 2015-Q3 2016-Q1 2016-Q3 2017-Q1 2017-Q3 Source: CBA. Source: CBA. Financial Sector The banking sector The banking sector Figure 25. Commercial Banks’ Profitability performed well in has continued its (In percent) 2017, raising recovery from the 10 profitability. effects of the 8 Russian Ruble 6 crisis of 2014, which had a severe 4 impact on 2 Armenia's banking 0 sector. Aggressive tightening by the CBA managed to Return on assets Return on equity control the situation, but Source: CBA. commercial banks continued to run losses throughout 2015. The banking system’s return on assets started to recover only in 2016, with the pace of recovery gradually strengthening. By March 2018, the return on assets reached 1.4 percent, close to pre-crisis levels. Attracting creditworthy clients and identifying bankable projects remain significant challenges for Armenian banks. 16| The sector remains The capital-to-risk-weighted-assets ratio for the overall banking sector stood at adequately capitalized. 18.6 percent at end-2017, slightly lower than at the beginning of the year, but still well above the 12 percent minimum Figure 26. NPLs and Liquidity Ratio threshold. The (In percent) nonperforming loan 10 35 (NPL) ratio declined 8 28 during 2017, returning to its pre- 6 21 crisis level of 5.5 4 14 percent, and 2 7 remained stable in early 2018. The 0 0 sector remains very liquid, with liquid assets accounting for NPLs to total gross loans around 30 percent in Liquid assets to total assets (RHS) early 2018, slightly below levels Source: CBA. registered in 2017 but above levels in 2014 (Figure 26) Encouragingly, developments in April-May 2018 did not have a significant impact in the banking sector, reflecting growing confidence in Armenia’s banks. B. Structural Reform Agenda The new The new administration published its program, which aims to lay the administration’s groundwork for free and fair early elections and to strengthen social inclusion. program—approved According to the announced schedule, parliamentary elections should take on June 7— envisages place within one year, following the amendment of the Electoral code and political reforms, adoption of changes to the electoral system. In the socio-economic sphere, the stronger equity, and program prioritizes support for socially vulnerable groups by improving the tackling vested targeting, fairness, and effectiveness of social benefits. The authorities agreed interests. to proceed with the ongoing reforms to the pension system on July 1, 2018, although with some modifications (see below). Importantly, the government’s program emphasizes strengthening competition and providing equal economic opportunities for all while targeting the elimination of political and economic favoritism. In the area of taxation, the government has initiated a review of the tax liabilities of some large businesses and has expressed its commitment to creating a stable and predictable tax environment, exploring opportunities to shift from income and capital taxation towards consumption taxation, and introducing a more equitable property tax system. These reforms, if properly implemented, have the potential to impact Armenia’s economic and investment outlook positively. Below is an update on progress achieved in the implementation of some important structural reforms which were undertaken by the previous administration and should be continued and strengthened by the current one. |17 The new tax code The new tax code extends Armenia's system for the return or offset of overpaid includes measures that VAT to any business operating in Armenia; previously this was only offered to are expected to exporters. This change will result in the release of a significant amount of strengthen the overpaid VAT, providing businesses with additional working capital. The new business environment. tax code also exempts the import of industrial machinery, equipment, and raw materials from VAT payment at the border. Similarly, to increase the attractiveness of Armenia as a transit economy, the new code removes the requirement for VAT payment at the border at the time of import when goods are imported for re-exporting purposes. The new Following the introduction of pension reforms in 2014 for public sector administration is employees,13 the extension of the mandatory fully-funded pension pillar to committed to private sector employees was planned for July 1, 2018. The new government continuing the pension agreed to move ahead as scheduled, but by shifting half of the burden of the reform process. employees’ contribution to the budget14. This is expected to cost the Budget around 0.13 percent of GDP in 2018 and going up to almost 0.3 of GDP in later years. The measure is expected to be in place until the planned reduction in the personal income tax rates. However, the public remains lukewarm to the proposal, suggesting a need for the authorities to increase public awareness efforts highlighting the need for the reforms and also that further revisions may take place (also due to renewed motions to examine the constitutionality of parts of the reform). While a healthy public debate on pension reform has the potential to strengthen its prospects for sustainability, this debate should consider two critical factors: (i) the existing social security system does not provide for old-age financial security and with current demographic trends the situation is likely to deteriorate; (ii) a funded pensions system has the potential to increase savings in the economy and provide better old-age returns, but it also requires a larger insurance pool, which can be achieved by making the system mandatory to offset the relatively high fixed costs of running the system. 13 Armenia introduced a funded pension pillar in 2014 to gradually replace its poorly performing pay-as-you-go system. The funded system, in which participants contribute 5 percent of their salaries which is matched 1:1 with contributions from the government (up to a ceiling of ARM 25,000), became mandatory for public sector staff and new private sector employees in July 2014. The extension to private sector employees born after January 1, 1974, was initially slated for 2017. However, it has proven unpopular with the general public and the implementation has been postponed twice; the new start date is July 1, 2018. 14 The amendments to the Pension Law were approved at the National Assembly’s extraordinary session on June 20, 2018. 18| The streamlining and Following these crucial reforms, the average number of inspections fell from reform of the 18 to 6. The legal framework for the change was approved in March 2018, inspection service was allowing for the restructuring of the inspection bodies, the removal of overlaps, recently completed, and ensuring better governance through institutional analysis and legal review. helping to improve the A perception survey of sole proprietors and companies on the inspection business and issue15 showed that respondents feel that most aspects of inspections have investment climate. improved during the past several years. The majority of respondents agreed that the duration of inspections has been reduced, inspections became easier, inspection decisions became fairer, and overlaps have been reduced. A new medical The new health insurance system for public sector employees is expected to insurance financing improve the quality of service and increase efficiency in service delivery for mechanism was around 100,000 beneficiaries (out of a total of 250,000 public sector introduced for public employees). The new system covers civil servants, public school teachers, and servants in 2017. some other categories of employees of public institutions. Under the new mechanism, the provision of medical services is organized through six private insurance companies licensed by the CBA to provide health insurance services in Armenia. Competition between private insurers will improve financial protection and access to care, and create incentives for efficiency and equity in service delivery. A new law on public Armenia’s new public procurement law is harmonized with the directives of the procurement took European Union and Eurasian Economic Union (EEU) regulations. With the effect in 2017. introduction of the new legislative framework, the State Procurement Agency (SPA) was disbanded and its functions16 were shifted to the Ministry of Finance. A three-member Complaints Resolution Body—comprised presidential appointees—was also created. The new government’s program emphasizes the use of e-procurement to improve the transparency and efficiency of public procurement. C. Economic Outlook and Risks The external Growth in the region is expected to strengthen in 2018, but moderate slightly environment remains over the medium-term. According to the World Bank’s Global Economic favorable but with Prospects, regional economic growth is projected at 3.2 percent in 2018 before growing downside moderating to 3 percent by 2020 as activity slows in commodity importers amid risks. increasing capacity constraints and less accommodative fiscal and monetary policies. However, the risks are weighted to the downside, including the possibility of a disorderly tightening of financing conditions, lower-than- 15 WBIFC “Armenia Investment Climate Reform Project. The survey was done with support from the WB “Armenia Investment Climate Reform Project” during July-September 2017 on a sample of 600 active private businesses. The compliance cost savings were reported in the amount of US$19 million, compared to a target of about US$5 million. 16 These functions include procurement training and certification, upgrade and maintenance of the e-procurement system through outsourced companies, support to business and procurement entities in using the e-procurement system (ARMEP) and maintaining a hotline for consultations. |19 The priorities projected oil prices, and heightened policy uncertainty.17 Armenia’s economic expressed by the new performance will benefit if the current favorable external conditions continue. government could help Recent developments in Armenia provide a new impetus to boost the country‘s tackle some of the efforts to reduce poverty and share prosperity. The new government has factors constraining signaled a willingness to tackle some of the key constraints to Armenia’s Armenia’s potential … growth more forcefully, including by strengthening competition and the rule of law and dealing with vested interests.18 Combined with a shift towards more effective social programs supported by prudent macroeconomic policies, this could signal change in the country’s economic and poverty prospects. … but, in the short run, In the short run, economic growth may slow to around 4 percent (the baseline GDP growth is likely to scenario) as the impact of some of the factors that drove growth in 2017 moderate. dissipate. Given that the structural issues constraining Armenia’s growth will take time to be addressed, growth will remain demand driven for a while and fragile. The policies of the incoming administration are gradually emerging, and some could face headwinds from a parliament where the new prime minister does not command a majority. At the same time, further gains in copper prices are not expected, and remittance inflows are expected to stabilize. Implementing some of the announced fiscal policies (higher wages and transfers, for example), could result in a higher fiscal deficit than currently envisaged and consequently increase the debt further. Under this scenario, fiscal adjustment is likely to be smaller. Armenia’s potential With current fundamentals (human, physical and institutional assets), and a growth rate is around moderate reform effort, Armenia’s potential growth rate is estimated at about 4 percent … 4 percent. The agribusiness, information and communication technology (ICT), and tourism sectors could deliver solid growth as efforts to boost competitiveness and connectivity start to deliver results. Inflationary pressures are likely to remain moderate, due in part to the continued commitment of the monetary authority to price stability and an increasingly more sophisticated monetary policy toolbox. Under the baseline scenario, the fiscal balance is expected to narrow to below 3 percent of GDP as the authorities comply with the revised fiscal rule, helping put public and government debt on a downward trajectory. The current account deficit will remain close to the average in recent years. As the economy continues to grow and incomes rise—and remittance inflows continue to support livelihoods—the absolute poverty rate is forecast to decline to single-digit levels by 2020. 17 World Bank. Global Economic Prospects, June 2018. 18 For a fuller account of the development challenges facing Armenia, please see the recently completed Armenia Systematic Country Diagnostic at http://documents.worldbank.org/curated/en/716961524493794871/pdf/Armenia-SCD-in-Eng-final-04192018.pdf. 20| Figure 27. Medium-Term Growth Projection, Baseline (In percent) 8 6 4 2 0 Source: NSS and World Bank staff projections. … however, bolder Bold reforms to enhance competition and improve the business environment, reforms could raise together with efforts to develop human capital, can raise potential growth potential growth. above the baseline scenario. Such reforms would open opportunities to attract more investment both from the Armenian diaspora and others and could slow down and eventually reverse out-migration. Stronger domestic demand could put upward pressure on prices compared to the baseline scenario; however, stronger competition in product and services markets could help offset some of this impact through gains in efficiency. Effective implementation of the tax code, plus additional measures to close loopholes and deal with tax evasion, combined with efforts to increase efficiency in spending (including effective enforcement of the new framework for public procurement and stronger public investment management) can help create fiscal space for new priorities while ensuring compliance with the fiscal rule. The external balance could also widen as higher domestic demand translates into higher imports; however, this could be financed by a stronger recovery in FDI. The banking sector is Building on the relatively favorable outlook, greater competition among banks, expected to remain and a generally sound banking system, the baseline scenario envisages a stable. positive trend for banking system stability. However, this will also depend on the evolving policies of the new government. For example, the authorities have announced plans to introduce measures to lower the debt service burden of indebted farmers and other groups. Such proposals should be carefully analyzed to ensure that the banks’ financial health is not negatively affected and that financial discipline is not undermined. Significant risks Risks to the outlook are tilted towards the downside. Externally, growth remain. recovery may have already peaked in 2017 and that growth will decelerate in 2018 and beyond. While the deceleration of growth is expected to be moderate, a more severe slowdown cannot be ruled out if combined with greater trade and political tensions. Adverse shocks linked to the Russian recovery or metal export prices would undermine prospects for Armenia’s exports of goods and services and FDI and remittances inflows. Domestically, so far, the implications of recent events have been limited to small pressure on the exchange rate and a contained run on deposits. However, prolonged |21 tensions in parliament and uncertainty in upcoming parliamentary elections could affect economic activity. Re-designing economic policies to address the population’s grievances and promises by the incoming administration while also safeguarding fiscal and macroeconomic stability will be challenging. Under the previous administration, Armenia recently made a number of important reforms, including in the area of taxation and pension reforms and a reversal could undermine gains. Table 3. Baseline Scenario: Selected Macro-Fiscal Indicators (In percent, unless otherwise indicated) 2014 2015 2016 2017 2018 2019 2020 Real GDP growth 3.6 3.2 0.2 7.5 4.1 4.0 4.0 Agriculture 6.1 13.2 -5.0 -5.3 2.5 2.7 2.4 Industry -2.3 2.8 -0.3 5.4 5.4 5.2 5.1 Services 6.7 1.6 3.2 12.4 3.9 3.8 3.9 Consumer price inflation, period average 3.0 3.7 -1.4 1.0 3.5 3.8 4.0 Current account balance (percent of GDP) -7.6 -2.6 -2.3 -3.5 -2.9 -3.5 -3.8 Overall/primary fiscal deficit (percent of GDP) -1.9 -4.8 -5.5 -4.7 -2.6 -2.5 -2.3 Public debt (percent of GDP)* 43.7 48.7 56.6 58.8 58.6 58.3 57.5 Government debt (percent of GDP) 39.4 44.1 51.9 53.7 53.3 52.9 52.0 Source: World Bank staff calculations based on data published by NSS, CBA and GEP. Note: Sums may not add exactly due to rounding. */ Includes government and CBA debt D. Special Topic: FDI Sector Scan, Agribusiness in Armenia The recent World Bank Group Systematic Country Diagnostic identified agriculture, along with IT and tourism, as potential sources for stronger and more inclusive growth in Armenia. Both the previous and the new administrations considered agriculture as a priority sector. To better explore the opportunities and obstacles to realizing the potential of the agricultural sector, this edition of the Armenia Economic Update is devoted to the agribusiness sector. The section summarizes the results of a review of agribusiness sub-sector competitiveness for FDI (known also as a “FDI sector scan”) undertaken by the World Bank Group in 2017.19 The review attempted to identify agricultural subsectors that are sufficiently competitive to attract FDI and that are likely to have development impact. FDI in agriculture in Armenia’s track record in attracting FDI is modest, especially in the agriculture Armenia is sector. Being a landlocked developing country with a small domestic market, an negligible and unfinished structural reforms agenda, and notable weaknesses in governance and constitutes a small competition, Armenia has been largely bypassed by FDI. Between independence in share of an already 1991 and 2005, Armenia received very modest amounts of FDI. FDI inflows low level of FDI. increased in the second half of the 2000’s, peaking at 8 percent of GDP in 2008. However, the global financial crisis of 2008–09 interrupted this trend and FDI 19 The authors of the report are Robert Hejzak (Investment Promotion Consultant), Jana Krajcovicova (Private Sector Specialist), and Arsen Nazaryan (Senior Private Sector Specialist). 22| inflows have not Figure 28. FDI in Agriculture in Armenia, 2008–15 recovered, falling 40 to 2 percent of GDP 35 in 2017 (with the 30 exception of a 25 positive FDI 20 15 rebound in 2016). 10 FDI in agriculture 5 has been negligible 0 ((Figure 28), with 2008 2009 2010 2011 2012 2013 2014 2015 most financing in US$ million in percent of total FDI going to viticulture Source: NSS, 2016. and winemaking. Agriculture accounted for 2 percent of total FDI on average in 2008–15.20 A small share of FDI in agriculture is, however, not unusual. In most economies, investment in agriculture tends to be dominated by local investors as these are usually better positioned to access land, interface with local farmers, understand the local climate, consumer tastes, and so on. Unresolved Armenia benefits from intense solar radiation, but access to land and the structural issues availability and quality of supplies are obstacles. Access to consolidated arable and policy and land is limited given the existing land ownership structure and supply-side regulatory barriers constraints for food processing industries. Other challenges—including poor constrain the transport links, low farming intensity, fluctuating seasonal supply of agricultural sector. raw commodities, and inconsistent volume and quality of supplies—mean that contract farming is currently an unattractive value proposition for foreign investors. Although some non-equity investment21 has taken place, the scope of the investment is small and difficult to scale up (non-alcoholic beverages are produced for the domestic market only; processed vegetable production is constrained by limited volume of locally produced raw materials). Agriculture sector Addressing these issues can open the door to greater FDI. Increasing FDI in development and agribusiness will help to diversify the economy, increase value-added and support attraction of FDI to job creation, particularly among women. Armenia needs substantial investment in this sector remains primary agriculture and necessary downstream activities, as well as in public goods a priority. like roads, electrification, and irrigation, but it also needs appropriate investor targeting for promoting FDI. The priority sectors should be selected based on a careful analysis of the benefits they offer to Armenia and to the investors. The analysis looked at the following agricultural sub-sectors: (i) aquaculture,22 (ii) dairy sector (in particular cheese production), (iii) floriculture (flower production), and (iv) fruit and vegetable production. 20 The exceptionally high share of FDI in agriculture as a percentage of total FDI in 2015 is due to low total FDI inflows rather than an increase in FDI in agriculture. 21 French Bonduelle, for example, has been sourcing part of its canned vegetables production for the Russian market in Armenia; Coca Cola Hellenic Bottling Company Armenia is a franchised bottler of The Coca Cola Company. 22 Includes caught and/or captive bred fish, crustaceans, and products derived from them. |23 Sector Scan Results Aquaculture Aquaculture has The aquaculture sub-sector has expanded strongly over the past decade (Figure grown rapidly, but 29), with production rising by an annual average of 40 percent. The vast majority prospects for (92.6 percent) of the sector's exports go to Russia, yet Armenian exports of fish future growth are products make up only 0.2 percent of total Russian consumption. Most Armenian uncertain. fish product is exported by air (passenger airplane) and by refrigerated truck. Currently, Armenia’s fish products supply chain lacks cold storage facilities and warehouses; the country mainly markets and exports fresh and chilled fish products on ice. Access to water is the most critical factor for future sector development and investment. Also, ongoing discussions about changes in aquaculture farming land reclassification could lead to further significant increases in land prices, land lease payments, and land tax. Figure 29. Fish Production in Armenia (In tons) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: NSS and Ministry of Agriculture. FDI opportunities in With limited access to water resources, potential investors would need to acquire aquaculture are existing aquaculture operations to obtain a water use permit. Given the small size currently scarce. of existing operations, the initial investment in modern intensive fish breeding technologies would not generate a high return on investment as the economies of scale would not be sufficient. According to information collected, a growing number of existing aquaculture producers are willing to sell their operations as growing costs—associated with tighter environmental regulations which require use of new water and environment saving technologies—bring down profit margins. Dairy Products (Cheese) A traditional Cheese production capacities more than doubled over the past five years. Russia economic sector, and the United States (mainly Armenians in the diaspora) are the leading export cheese is Armenia's markets for Armenian cheese. At present, Armenian exporters benefit from the main dairy product. opportunities provided by Eurasian Economic Union (EEU) membership; however, competition in the Russian market is very intense. More than 70 percent of total 24| domestic cheese production is in the informal sector. Formal and informal sectors compete for milk. Milk production in Armenia is still mainly a low-input, subsistence-based system, although a few intensive stall-fed operations exist in the country. There are around 180,000 dairy farms in Armenia and 95 percent of fresh cow milk is produced by farms that have fewer than seven cows. Armenia is still not self-sufficient in milk production; most milk or milk powder imports occur in the winter months when local production volumes decline. Several binding The most critical impediment to expanding cheese production is the insufficient constraints limit quantity and quality of milk as well as large seasonal fluctuations in milk supply. further expansion These issues are compounded by poor infrastructure (difficulties in setting up of the sub-sector. electricity, water, and gas supply lines for cheese production facilities) and lack of knowledge and skills in the dairy sector. Under current conditions, FDI in the Armenian dairy sector is unlikely. A lack of large domestic processing operations open to acquisition precludes FDI. Although investment opportunities could be promoted in some of the upstream value chain sub-sectors, such as fodder and intensive dairy cattle farming, interest is most likely to come from firms already operating in Armenia that are looking into the vertical integration of their operations rather than from large international companies. The Armenian diaspora may be interested in some small-scale dairy processing operations or in equity funding of some of the existing dairy operations. To stimulate future FDI in the dairy sector the government should resolve some of the export-related regulatory barriers and weak quality infrastructure. Floriculture Greenhouse flower Most greenhouses in Armenia are small and do not use advanced technologies production is a resulting in high costs and low productivity. However, there are notable exceptions. relatively new and Ecotomato Company,23 for example, is one of the top companies in the rose- dynamic sector in growing market worldwide by production volume. Greenhouses can be an Armenia. important source of new employment, particularly for women. Existing domestic companies operating in the floriculture sector have experienced considerable growth. The bulk of flowers grown are exported to emerging markets including Belarus, Georgia, Kazakhstan, and Russia. 23 Ecotomato was founded in 2011 and is engaged in growing Dutch roses. It has built greenhouses jointly with Dutch Dalsem, a world leader in this business. |25 The flower growing With rising global exports—in particular to emerging markets (including Russia)— industry could offer a shift from traditional growers (in the Netherlands, for example) to new value-added to producers, and strong regional trade links, Armenia's floriculture sub-sector can investors. present a robust value proposition to potential foreign investors. The current strong export performance of the domestic sector, availability of land, and supportive government policies could promote this sub-sector for potential FDI. Fruit and vegetable production Fruits and Although both vegetable-sown areas and fruit orchards have been expanding vegetables are over the last decade, infrastructure bottlenecks and climate uncertainties lower traditional the attractiveness of open-field cultivation for FDI. For low-value fruits and Armenian products. vegetables produced during the main production season (for example tomato, cucumber, apricot, and peach crops), the high initial costs to establish the plantation (land purchase given limited availability of larger plots and irrigation systems) together with limited cold storage facilities, climatic risks, international competition, and high transportation costs, make FDI in primary production unlikely. FDI in primary or secondary processing is also unlikely given the limited output of existing Armenian agricultural production. Most of the domestic processing companies are unable to fully utilize their existing production facilities or expand their operations due to the limited supply of raw agricultural material. Niche investment Higher-value fruits and vegetables—berries and nuts, in particular—have seen opportunities may growth in investment interest from the Armenian diaspora. Investment exist in higher- opportunities may also exist in greenhouse crop production, both for low- and high- value fruits and value crops. Greenhouse crop production has been expanding rapidly, particularly vegetables and in during the last four years, when the total area of greenhouse farms increased by greenhouse crop nearly 2.5 times, from 510 ha in 2011 to 1,220 ha in 2016. At the same time, the technological sophistication of greenhouse farms has also improved. Employment production. generation opportunities are, however, likely to be modest due to the growing use of advanced intensive farming technologies, which minimize human work but are necessary to increase efficiency. Conclusion Greenhouse-grown The sector scan identified flower production and greenhouse farming as flowers and fruits potentially viable investment propositions for foreign investors (figure 30). and vegetables However, none of the reviewed sub-sectors currently demonstrates robust enough have the most features that could motivate FDI into a large-scale greenfield production in the investment short run. Greenfield investment is likely to be on the small-scale side. Diaspora potential. seed capital is expected to continue to be attracted to projects in some niche sub- sectors (for example, berry or nuts cultivation), yet the economic benefits to the Armenian economy will not be substantial and will be mostly limited to capital inflow. Supply-side There are significant general investment climate and sector-linked impediments obstacles reduce which hamper investment and require action. On top of general investment 26| the attractiveness climate obstacles—such as policy and regulatory uncertainty, access to export of the sector and markets, and a shortage of skills and knowledge—investments in agriculture also need to be face sector-specific impediments which make the sector less attractive for foreign addressed. investors. These impediments include access to land and irrigation, complex import procedures for agriculture sector inputs, cadastral classification of greenhouse structures, and energy efficiency issues. As an important sector, which has been identified as a priority sector for Armenian economic growth, the government should work to effectively regulate and invest in this sector to make it attractive for foreign investment. Figure 30. Prioritization of Target Sub-Sectors For Proactive FDI Promotion 24 Flowers cultivation 22 Milk collection & Greenhouse farming treatment 20 Secondary fish Agrochemical processing production Fruit & vegetable Value for Armenia1 18 processing Dairy products Animal feed process. 16 Seed production Dairy cattle farming Fruits & vegetables Fish farming 14 storage Open field farming Animal meds & vet services 12 Fresh fish process. Flowers packaging 10 8 10 11 12 13 14 15 16 17 18 19 20 Value for FDI investor2 Source: World Bank staff calculations, based on interviews with policy-makers, investors and other stakeholders as well as existing studies of the value-chain needs and opportunities. 1/ The score is based on the sum of rankings (on a scale of 1 (lowest) to 5 (highest)) given for each of the following criteria: 1) Will new investors add value that is not already provided by local farmers / producers & existing investors? 2) Will new investors create additional jobs? Will investment contribute to job generation among women? 3) Will new investors increase opportunities for domestic firms to supply their goods/services to foreign investors? 4) Will new investors create increased export revenues or reduce imports? 5) Will new investors improve the performance of the value chain as a whole? 2/ The score is based on the sum of rankings (on a scale of 1 (lowest) to 5 (highest)) given for each of the following criteria: 1) Is the local and regional market attractive? 2) Is the global market attractive? 3) Does Armenia have competitive natural endowments (land, climate, location, etc.)? 4) Does Armenia have competitive infrastructure? 5) Does Armenia have competitive skills and supportive services? 6) Does Armenia offer a conducive business (regulatory/institutional) environment? |27 Annex 1: Tables Table A 1. Selected Macroeconomic and Social Indicators, 2013-20 2013 2014 2015 2016 2017 2018 2019 2020 Projections (Percent, unless otherwise indicated) National Income and Prices Nominal GDP (LCU bn) 4,556 4,829 5,044 5,067 5,569 5,925 6,272 6,635 Nominal GDP per capita (US$) 3,686 3,856 3,519 3,532 3,881 4,026 4,151 4,331 Real GDP growth 3.3 3.6 3.2 0.2 7.5 4.1 4.0 4.0 Private consumption growth 0.9 1.0 -7.8 -1.1 8.8 5.0 4.7 4.5 Gross investment growth -9.1 -3.0 -1.2 -8.7 13.9 4.5 4.2 4.1 Exports of G&S growth 8.6 6.4 4.9 19.1 19.7 10.1 9.8 9.5 Imports of G&S growth -2.1 -1.0 -15.1 7.6 26.8 10.3 9.5 8.9 Gross investment (percent of GDP) 22.3 20.9 20.7 18.4 19.4 18.6 18.8 19.1 Consumer price inflation, year-end 5.6 4.6 -0.1 -1.1 2.6 3.0 3.3 3.5 Consumer price inflation, pa 5.8 3.0 3.7 -1.4 1.0 3.5 3.8 4.0 GDP deflator 3.4 2.3 1.2 0.5 2.2 2.0 1.8 1.7 Real exchange rate change 1.5 7.1 6.5 -0.7 -4.6 … … … (Current US$ millions, unless otherwise indicated) External Accounts Merchandise exports, of which: 1,479 1,547 1,485 1,792 2,150 2,390 2,561 2,755 Key commodity exports 1,215 1,257 1,224 1,447 1,725 2,016 … … Metals and minerals 716 688 705 693 945 958 … … Products of prepared food 310 338 325 417 524 588 … … Precious stones and metals 188 230 194 337 257 469 … … Merchandise imports 4,386 4,424 3,239 3,274 3,993 4,380 4,601 4,849 Current-account balance -813 -883 -272 -238 -400 -348 -434 -486 as percent of GDP -7.3 -7.6 -2.6 -2.3 -3.5 -2.9 -3.5 -3.8 Foreign direct investment, net 320 388 162 272 224 525 556 606 Total official international reserves 2,252 1,489 1,775 2,204 2,314 2,464 2,604 2,754 Public external debt, total 3,899 3,785 4,316 4,806 5,495 5,793 5,927 6,184 as percent of GDP 35.1 32.6 40.9 45.5 47.5 48.4 48.0 48.0 (Percent of GDP, unless otherwise indicated) Consolidated Fiscal Accounts Revenues 24.2 24.4 23.8 23.7 22.9 22.7 23.2 23.4 Expenditures 25.7 26.3 28.6 29.2 27.6 25.3 25.7 25.7 Overall fiscal balance -1.5 -1.9 -4.8 -5.5 -4.7 -2.6 -2.5 -2.3 Primary fiscal balance -0.5 -0.6 -3.3 -3.6 -2.6 -0.5 -0.3 0.0 Non-commodity fiscal deficit -1.5 -1.9 -4.8 -5.5 -4.7 -2.6 -2.5 -2.3 Public debt and fiscal savings, net 40.9 43.7 48.7 56.6 58.8 58.6 58.3 57.5 (Percent, unless otherwise indicated) Monetary Accounts Base money growth 6.9 -8.9 4.6 18.0 20.3 … … … 28| 2013 2014 2015 2016 2017 2018 2019 2020 Projections Real growth of credit to the private 6.1 16.3 -3.0 16.2 7.4 … … … sector Policy rate (eop) 7.75 8.50 8.75 6.25 6.00 … … … Social Indicators Population, total (millions) 3.017 3.011 2.999 2.986 2.973 2.973 2.974 2.975 Population growth (percent) -0.32 -0.22 -0.40 -0.42 -0.44 0.02 0.02 0.02 Unemployment rate (percent of labor 16.2 17.6 18.5 18.0 17.8 … … … force) Poverty rate, national (percent of 32.0 30.0 29.8 29.4 … … … … population) International poverty rate 2.2 2.3 1.9 1.8 1.4 1.3 1.0 0.8 (US$1.9/day 2011 PPP, percent of population) Lower middle-income poverty rate 16.2 16.4 13.5 14.1 11.6 10.1 9.1 8.1 (US$3.2 /day 2011 PPP, percent of population) Inequality – Gini coefficient 0.372 0.373 0.374 0.375 … … … … Life expectancy (years) 74.8 75.0 75.0 75.0 … … … … Sources: World Bank staff calculations and estimates based on official data published and provided by the authorities. |29 Table A 2. Balance of Payments and Official Reserves, 2013–17 (US$ millions) 2013 2014 2015 2016 2017 Current account balance -813.0 -882.9 -272.4 -238.1 -399.9 Merchandise trade -2,196.2 -2,055.4 -1,186.4 -944.4 -1,482.1 Exports f.o.b. 1,635.9 1,698.1 1,623.9 1,890.7 2,378.3 Metals and minerals 716.2 688.3 704.8 693.4 944.5 Products of prepared food 310.2 338.1 325.3 416.6 523.5 Precious stones and metals 188.1 230.3 194.0 336.9 256.7 Imports f.o.b. 3,832.0 3,753.6 2,810.3 2,835.1 3,860.4 Services -125.0 -113.5 -95.4 -71.4 -62.5 Primary income 682.5 541.1 442.9 224.2 497.7 Secondary income 825.6 744.9 566.5 553.4 647.1 Capital and financial account balance 1,582.8 259.7 754.7 921.1 607.7 Foreign direct investment 319.5 387.9 161.5 271.9 223.5 Portfolio investment 689.4 - 38.4 235.0 33.9 86.8 Other investment 489.5 - 160.2 292.9 580.4 424.7 Capital transfers 84.4 70.4 65.3 34.9 46.3 Errors and omissions -299.2 -36.5 -149.3 -232.1 -112.0 Overall external balance 470.6 -659.6 332.9 450.8 95.8 Change in FX reserves at Central Bank -470.6 659.6 -332.9 -450.8 -95.8 Memorandum items: Official reserves, eop 2,251.6 1,489.3 1,775.3 2,204.1 2,313.9 SDR holdings 1.9 6.2 2.9 3.5 7.2 Foreign Exchange 2,249.7 1,483.2 1,772.4 2,200.6 2,306.6 GDP 11,121 11,610 10,553 10,546 11,537 Consumption 11,022 11,335 9,624 9,571 10,557 Gross capital formation 2,476 2,423 2,188 1,900 2,195 Exports of goods and services 3,154 3,316 3,137 3,496 4,390 Imports of goods and services 5,360 5,462 4,418 4,511 5,814 Source: World Bank staff calculations based on data published by CBA and NSS. Note: Sums may not add exactly due to rounding. 30| Table A 3. Consolidated Fiscal Accounts, 2013–17 (Percent of GDP) 2013 2014 2015 2016 2017 Revenue and grants 24.2 24.4 23.9 23.7 22.9 Tax revenue, of which 22.4 22.5 21.7 21.7 21.3 VAT 8.8 9.1 8.4 7.7 7.3 Profit tax 2.7 2.1 2.1 2.5 2.0 Income tax 5.6 6.0 6.2 6.5 6.1 Excise tax 1.1 1.0 1.0 1.2 1.5 Non-tax revenue 1.5 1.5 1.6 1.4 1.4 Capital revenue Grants 0.3 0.4 0.6 0.6 0.3 Expenditure and net lending 25.7 26.3 28.7 29.2 27.6 General government expenditures 25.7 26.3 28.7 29.2 27.6 Current expenses 22.7 23.4 25.4 26.1 23.3 Capital expenses and net lending 3.0 2.9 3.3 3.1 4.3 Overall fiscal deficit -1.5 -1.9 -4.8 -5.5 -4.7 Primary fiscal deficit -0.5 -0.6 -3.3 -3.6 -2.6 Deficit financing 1.5 1.9 4.8 5.5 4.7 Domestic borrowing, net -0.3 1.5 0.2 2.1 1.3 Foreign borrowing, net 1.8 0.4 4.6 3.4 3.4 Privatization Source: World Bank staff calculations based on data published NSS and MoF. Note: Sums may not add exactly due to rounding. |31 Annex 2: What Makes A Good Fiscal Rule? A recent IMF blog “Fiscal Rules: Make them Easy to Love and Hard to Cheat”24 analyzed fiscal rules which became effective over the last three decades in over 90 economies. The blog noted three attributes of effective fiscal rules—they need to be simple, flexible, and enforceable in the face of changing economic circumstances. However, the authors found that rules were often too complex, overly rigid, and difficult to enforce. The analysis proposed three principles for fiscal rule design:  Rules should be internally consistent, parsimonious, and guarantee debt sustainability. Fiscal rules should include both a debt rule to set the course of medium-term fiscal policy, and a small number of operational rules that guide annual budget decisions, such as an expenditure rule or a budget balance rule.  They should contain incentives for compliance. Financial sanctions and costs are often not credible. There appears to be more success with efforts that increase the political and reputational costs of non-compliance. In this case, Fiscal Councils could play an important role, by monitoring and publicizing mismanagement of public funds.  They should allow for adequate flexibility in the face of shocks without sacrificing simplicity. Below is a summary of the changes in the current fiscal rule as defined in Armenia’s current Public Debt Law and the Budget System Law. Few details, such as method of calculations of the long-term GDP growth, are yet to be defined by a government decree to fully operationalize the rule. In general terms, the changes are consistent with the above principles. For example, the revised rule contains a debt rule as well as a number of operational rules and a clear exemption from these rules in case of emergencies. On the other hand, the number of operational rules may be on the high end while the incentives for better compliance may require strengthening. Experience over time will demonstrate if the revised rule strikes a better balance between effectiveness and simplicity. OLD NEW (Amended December 20, 2017) Article 5, Section 6: Article 5, Section 6: State debt as at December 31 of As of December 31, of each year, the upper threshold for the ratio the year in question shall not between the government debt and GDP of the Republic of Armenia exceed 60 percent of previous is 60 percent. year GDP. Article 5, Section 7: Article 5, Section 7: Where state debt as at If the government debt as at December 31 of the previous year December 31 of the year in exceeded 40, 50, and 60 percent of GDP, the following rules shall question exceeds 50 percent of apply. GDP of the previous year, the state budget deficit of the next If >40 percent of GDP => year shall not exceed 3 percent • capital expenditure shall be not less than the deficit; midpoint of the annual average If >50 percent of GDP => 24 https://blogs.imf.org/2018/04/13/fiscal-rules-make-them-easy-to-love-and-hard-to-cheat/ 32| GDP for the previous three 1. same as above (1) years. 2. the maximum year-on-year growth rate for aggregate current expenditure (excluding government debt service costs) should be equal to long-term growth of GDP in previous years*. 3. within a range of 50-60 percent of previous year GDP, the government shall present an action plan in the state Medium-Term Expenditure Framework (MTEF) prepared in the following year for gradually bringing the projected path of the level of government debt below 50 percent of GDP. If > 60 percent of GDP => 1. Same as above (1) 2. Same as above (2) 3. Total current expenditure-to-tax revenue ratio shall be established by the government based on the long-term growth in the GDP of previous years*. 4. Together with presenting to the NA the MTEF in the following year, the government shall submit an action plan for consideration by the Standing Committees on Financial, Credit and Budget and Economic Issues bringing the projected path of the level of the government debt below 60 percent. The requirements set forth in section 8.2 of this Article shall not apply in exceptional cases defined by the government decree when negative economic developments arise due to large-scale natural and man-made disasters, military operations, economy’s transition from peace to war and driven by economic shocks. Article 5, section 8: DELETED Any instrument originating state debt, which is inconsistent with paragraphs 6 and 7 of this Law, shall be deemed void. * Pending to be defined by Government in a government decree. |33 Armenia Country Economic Update | Summer 2018