Dangerous Numbers: The Dark Side of Armenia's Economic 'Miracle'

Armenia’s fiscal challenges and their impact on the country’s future

Numbers Do Not Lie

Trends in public finance are of exceptional importance for the sustainable development of the state. When the planned revenues of any organization, especially a state, are chronically underperformed, it indicates systemic management problems.

These trends require special attention and comprehensive analysis. Over the past 15 years, Armenia has not recorded 3 consecutive quarters where tax collections were continuously below 7 percent, as shown in the first chart.

Chart 1

Tax revenues, being the main source of state budget collection, are of key importance. When the state receives less revenue than planned, the likelihood of crisis phenomena significantly increases. The situation in 2024 is particularly concerning, as a significant under-collection of taxes is recorded. This phenomenon is not due to the shortcomings of the State Revenue Committee (SRC), but is the result of an ineffective fiscal policy. It was as a result of this situation that significant changes took place within the government on October 18, including the resignation of the SRC chairman. It should be noted that since 2018, the growth of tax collection has become the main indicator of the current government’s performance, which in the current economic situation has become an end in itself. Between 2018 and 2023, tax revenues grew by an average of 15.6 percent each year. However, there is currently a clearly expressed problem of underperformance in tax revenues.

It is important to emphasize that this situation is not due to SRC shortcomings. Moreover, since tax collection is one of the key indicators of government efficiency, it directly determines the volume of bonuses. To solve the problem of under-collection of tax revenues, the government has recently taken a number of measures, such as tightening tax collection, introducing new types of taxes and duties, eliminating existing tax privileges, and raising the rates of certain types of taxes. Among these measures are, for example, discussions on the double taxation of income tax returns generated from mortgage loans and doubling the turnover tax rate from 5 percent to 10 percent starting from the beginning of 2025. It is also planned to terminate the tax privileges provided to the IT sector from the beginning of 2025. The government’s rhetoric has also been formed within the framework of this policy, according to which the tax collector is a “hero” to whom a toast should be raised. It is indisputable that tax collection is the cornerstone of state operations, without which the normal functioning of the state is impossible. Tax revenues, being the main source of the state budget, ensure the financing of education, healthcare, defense, and social services. However, as already mentioned, the existing problems are not due to shortcomings in the SRC’s operations, but rather the ineffective implementation of fiscal policy. Currently, there are a number of fundamental problems in the economy that have been analyzed in detail in our publications on tvyal.com. These include the decline in real export volumes, the dependence of economic growth on gold re-exports from Russia, the reduction in the number of registered organizations, significant capital outflow, the decline of the tourism sector, and the negative trends observed in the IT sector. Among these systemic problems, the reduction in tax collection volumes is particularly noteworthy, which is mainly expressed by a decrease in VAT and profit tax. This directly testifies to a decline in the number of transactions in the real economy and the profitability of organizations. In other words, a significant reduction in trade turnover volumes is being recorded. Under such conditions, it is unrealistic to expect additional tax revenues from citizens and economic entities. Such a policy can lead to the opposite result. In conditions of real economy contraction and an increased tax burden, economic entities may resort to various solutions, like moving to other countries (especially in the IT sector), finding themselves on the verge of bankruptcy, or moving into the shadow economy. The under-collection of tax revenues is a serious economic indicator, not just a simple statistical deviation. During the first nine months of the current year, the underperformance of planned tax revenues amounted to about 8 percent or 150 billion AMD. It is noteworthy that this underperformance was recorded under conditions of around 6 percent economic growth. The 12.6 percent growth recorded in Armenia’s economy in 2022 was mainly an indirect consequence of the sanctions imposed against Russia. As a result of this situation, a significant volume of capital and human resources moved to Armenia from Russia, especially from the IT sector. In 2022, the net profitability of the banking system recorded almost a threefold increase, thanks to which the IT and banking sectors together provided approximately half of the annual 12.6 percent economic growth. However, this phenomenon was temporary in nature and already began to fade away significantly from the middle of 2023. Moreover, capital began to move in the opposite direction, flowing out of the country, which is a serious challenge for our economy that heavily depends on external financing. From November 2023, however, another short-term economic phenomenon emerged: the re-export of significant volumes of gold and diamonds from Russia to Greater China and the UAE. This process contributed to the 8.3 percent economic growth in 2023, providing about 2 percentage points of it. In our previous studies, we already noted that in the first half of 2024, the re-export of precious stones and metals accounted for an unprecedented 72 percent of the structure of RA exports. This figure has actually masked the decline in exports of all other commodity groups and the downward trends in the real economy. During the given period, the main driving forces of Armenia’s economic growth were gold re-export processes and trade operations. However, this phenomenon too, being of a short-term nature driven by external factors, has already begun to show fading trends since May 2024. In the current situation, the economy lacks a stable source of internal growth that can guarantee the coveted annual 7 percent economic growth targeted by the government. Under such conditions, the unrealistically high economic growth forecasts underlying the budget contain significant risks and can lead to crisis phenomena in the form of a decrease in tax revenues and an increase in state debt, the signs of which are already noticeable. It is noteworthy that the government has already begun to realize the seriousness of these problems, which we have been vocalizing for more than two years, and has envisaged a more moderate 5.4 percent growth figure in the 2025 budget. However, even this relatively restrained forecast is overly optimistic in the current situation.

The long-term average growth rate of Armenia’s economy is 4.5 percent. Any system, without significant qualitative changes, tends to return to its long-term average indicators. Currently, the growth of the RA economy is overwhelmingly driven by short-term external factors emanating from Russia, which, however, cannot serve as a basis for long-term sustainable internal economic growth. The situation is also complicated chronologically. Armenia’s economic growth figures, especially the 12.6 percent in 2022, have generated overly optimistic assessments, up to claims of an “economic miracle”. However, as in-depth analysis shows, behind this apparent success is a significantly more complex and disturbing reality.

Publications related to this material 🚨📉🕵 Hidden Decline: What Does Armenia’s Economy Live On? 💸🔚🏦 From Capital Influx to Outflow 🧮⏳🎲 Armenia is Taxing Time: Playing with Economic Growth 💰🚧⚖️ The Pendulum of State Debt: For the first time, internal debt exceeds external debt 🆘🇦🇲🧑🏼‍💻 SOS RA IT: From Strategic Priority to Potential Decline The complete list of analyses is here

Chart 2

The second chart presents the performance of Armenia’s state budget revenues and expenditures against the planned indicators. As the data shows, the expenditure part of the budget shows a trend of underperformance until the end of the year, when the main part of expenditures is carried out. In this context, those years when a significant underperformance was recorded in year-end tax revenues have been particularly problematic. In order to give a clear assessment of the effectiveness of the implementation of government programs, it is necessary to wait for the final expenditure indicators at the end of the year. However, some concerning trends are already noticeable, especially in the IT sector, which will be discussed in detail in the next section. In the context of the first 9 months, the underperformance of total state budget expenditures amounted to approximately 13 percent or 290 billion AMD. The underperformance of 30 percent or 124 billion AMD in capital expenditures (school building, reservoir building, road building, etc.) is most concerning. The underperformance of economic support programs by the RA Ministry of Economy amounted to 26 percent, which was mainly due to the low performance of programs in the investment, export promotion, and agriculture sectors. It is noteworthy that after a long decline in the agricultural sector, a slight growth was recorded during the first nine months of the current year. At the same time, without accounting for Russian gold re-export operations, almost zero growth was also recorded in the industrial sector. The 8.5 percent decline recorded in the information and communication sector, as well as the 13 percent decline recorded in the information technology sector, are more concerning. Under such conditions, the risk of an increase in state debt significantly grows. According to current fiscal rules, when the Government’s debt exceeds 60 percent of GDP, the executive body is obliged to limit current expenditures and present a clear plan to reduce the debt level. The RA Ministry of Finance, within the framework of its medium-term policy, has set a goal to keep the state debt/GDP ratio within the limits of 50 percent. However, given budget underperformance, a slowdown in economic growth, and the possible depreciation of the AMD, there is a serious risk that the state debt/GDP ratio could exceed the 60 percent threshold. If the current trends persist, the probability of the mentioned scenario occurring is sensitive.

The underperformance of the IT sector

Table 1

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Perhaps nowhere else among the economy are the problems so obvious at this moment as in Armenia’s technology sector. This sector has been declared a strategic branch for the country’s sustainable growth. At this moment, the IT sector is showing concerning signs. The Ministry of High-Tech Industry has been able to implement only 58.4% of its planned budget, drastically underperforming, which also raises concerns regarding the health of this sector by echoing it. The problems of this sector have also been deciphered in our recent research 🆘🇦🇲🧑🏼‍💻 SSOS RA IT: From Strategic Priority to Potential Decline. The numbers tell a not-so-positive story. According to official data, the total expenditures of the RA Ministry of High-Tech Industry amounted to only 7.8 billion AMD, half compared to the planned expenditures. For a sector that is supposed to be the driving force of Armenia’s economic future, this is quite a telling indicator, rather than just budget statistics. This also testifies to a strategic setback in the sector.

Recent data show that the IT sector has recorded negative growth over the last three quarters, which may indicate a crisis in this strategic sector. The boom that started in 2022, mainly driven by an influx of specialists from Russia, has started to fade. Although the number of IT companies registered in Armenia has decreased sharply, the number of IT companies registered abroad but operating in Armenia has recorded an interesting growth. However, this shift does not match the number of employees, which suggests data inaccuracy or a massive closure of small businesses. There are a number of factors behind this decline, including the appreciation of the Armenian dram, changes in tax policy, and the high cost of living in Yerevan, as well as an ineffective fiscal policy. The strengthening of the dram has had a particularly negative impact on export-oriented sectors, such as the IT sector. Additionally, the termination of tax privileges for IT companies and the possible doubling of the turnover tax for small and medium-sized enterprises make neighboring countries like Georgia more attractive for IT businesses. The situation is further complicated by capital outflows and reduced inflows. As Armenia’s IT sector approaches a crucial stage, revising development strategies, rethinking tax policy, and exploring opportunities for establishing new IT centers outside of Yerevan become urgent in order to maintain the sector’s competitiveness and growth. In summary, we can state that Armenia’s economy is facing complex and multi-layered challenges. The under-collection of tax revenues, underperformance of budget expenditures, the decline of the IT sector, and dependence on external factors create serious risks for long-term sustainable development. Without systemic reforms and a revision of economic policy, talks of an “economic miracle” could turn into a real threat of an economic crisis. It is especially important to revise fiscal policy, develop a new strategy for IT sector development, and diversify the economy, reducing dependence on temporary external factors. Solving these problems requires not only a quick response but also a long-term, consistent, and balanced approach.

You can familiarize yourself with the budget performance reports provided by the Ministry of Finance by visiting this official link. To dive deeper into this topic, you can also read the official analysis of the execution of the RA state budget for the first 9 months of 2024.

problems, also in the expenditure section of the state budget. The authorities say they will somehow ensure the 7% economic growth so that our economy records a 50% growth over 6 years. This is welcome, but if there is no real production in the economy that can ensure long-term economic growth, then this is problematic.

• Our economy lives not on production, but on money coming from outside, ensuring economic growth based on the banking system, but it also means that our economy is dependent not on internal impulses, but on external changes.
• Currently, about 70% of our exports, a huge number, we are talking about billions, is the re-export of gold. Which distorted the picture. That gold came to Armenia, got registered as production through some channels, and ensured our economic growth.
• In the first quarter of 2024, they wrote that our economic growth was 9.2%, which was a quite significant figure and at first glance it created the impression that our economy is recovering, but this was an illusion, deception and irony, because 4 percentage points of the 9.2% economic growth, almost half, was provided by industry, or rather, the re-export of gold. Because of that, the number was revised, reduced, and became 6.6%; according to the latest figures it is 6.4% and by the third quarter, it can be assumed that they will drop further, since according to the latest figures the economy is recording a decline across all sectors.
• Our exports are falling in almost all directions: comparing the first half of this year with the first half of last year, our exports to the EAEU, our main partner, have fallen by almost 20%. To the EU, by 25%, and at this moment our exports to the EU make up 3.6%. That is, where are we going.
• The real economy is experiencing a decline, and under these conditions, the government already understands that there are problems and has lowered the bar for next year from 7% to 5.6% this year and 5.4% next year. Knowing the government, this is an optimistic picture.
• The government has taken quite good steps in the sense that more than 50% of our state debt is in AMD; it has hedged that risk, but it is there. Taking into account that the Armenian dram is the most appreciated among all convertible currencies, the risk of depreciation is there. The full interview is in the attached video.

Watch the interview given to 1in.am, which discusses the budget execution as well as the diseases of Armenia’s economy

📺 Armenia’s economy is highly dependent on Russia; this affects our foreign policy 📺