Armenia: Caucasian Tiger or Expensive Dream?

The Illusion of Armenia’s Economic Growth

Armenia’s economy stands before a turning point. Recent revisions to GDP growth have revealed a concerning reality: the country’s economic boom, which was so highly praised recently, was primarily built on unsustainable factors. Upon closely examining the data, it becomes clear that the growth of the economy is illusory; the reality consists of serious challenges.

GDP Growth: The Story of Revision

The Illusion of Prosperity

Following the latest revision, GDP growth indicators have been reduced by 2.6 percentage points. These reductions caused a shock in Armenia’s economic landscape, compelling a reassessment of the country’s economic health.

Chart 1.

The first chart shows the volatility of Armenia’s economic trajectory. While the long-term average growth is around 4.5%, significant fluctuations have been observed in recent years. The latest revisions bring these figures closer to the historical average, putting into question the sustainability of the recent growth.

Uncovering the Illusion of Growth

The story of the revision is dramatic and has far-reaching consequences:

1. Growth for the first quarter of 2024 has been revised downwards from 9.2% to 6.6%, a significant drop of 2.6 percentage points.
2. Growth for the fourth quarter of 2023 has been adjusted from 7.7% to 6.4%, a decrease of 1.3 percentage points.

These are not minor adjustments but a fundamental reassessment of Armenia’s economic reality. As depicted in the chart, while the economy seemed to have an upward trend before this revision, it now has a certain trend towards stagnation post-revision.

Chart 2.

The second chart depicts the significant “before and after” difference of the GDP growth revision. The industrial sector (C), once considered the engine of growth, providing 4.0 percentage points to the GDP growth in the first quarter of 2024, now provides only 1.2 points. This shocking adjustment reveals the vulnerability of Armenia’s recent growth.

It is worth noting that these numbers were revised after we published a report stating that the 4% of value added from gold re-exports, which controversially found its way into the state budget, provided 4 percentage points of the 9.2% growth in the first quarter of 2024. It is concerning that the gold re-export “industry” had a 4% contribution, trade 3%, financial services 1.1%, while the rest of the economy registered a -0.1% decline.

After this post:

1. The GDP growth for the first quarter of 2024 was revised from 9.2% down to 6.6%.
2. Industry’s contribution to GDP dropped sharply, going from 4 percentage points to 1.2.
3. The reason: the revision of the indicators of the gold re-export “industry”.

The Precious Effect: The Illusion of Gold Re-export

At the center of this statistical drama is the phenomenon of gold re-export, which gained momentum from November 2023 and continued until May 2024. This sector imparted a seeming vitality to Armenia’s growth figures. However, recent revisions effectively zeroed its contribution to GDP growth. It is worth noting that the annual economic growth figure for 2023 is still stated at the 8.7% level and has not yet been revised. We had predicted at the end of 2023 that economic growth would be around 7%. However, the significant increase in gold re-exports since November inflated economic growth to 8.7% against the backdrop of an overall economic downturn, causing a “precious effect”. It can be expected that the 2023 annual economic growth of 8.7% may also be revised down to 7.5%.

Economic Sectors and Their Contribution

Overview of Sector Performance

Chart 3.

The third chart shows significant differences in growth rates across various sectors, indicating that economic growth is not evenly distributed and is not sustainable. Key observations:

1. The IT sector (J), which since early 2022 was one of the providers of the growth engine, recording a 62.6% annual growth in the second quarter of 2023, has now experienced a significant decline. In the second quarter of 2024, it showed a 14.1% annual decline.
2. Other sectors, including public catering (I) and transport (H), are also experiencing a decline.
3. The growth of the main drivers of the economy, construction (F) and trade (G), is slowing down.

The Decline of the IT Sector and Its Consequences

The decline of the IT sector is particularly concerning. After registering a decline for three consecutive quarters, this strategic sector is no longer positively contributing to GDP growth. This trend questions the sustainability of Armenia’s technology-driven growth strategy and the reasons for this regression. This is evidence of a crisis in this sector. Read more in our IT analysis: 🆘🇦🇲🧑🏼‍💻 SOS IT RA: Armenia’s IT sector, from strategic priority to possible decline

Current Drivers of Growth

Chart 4.

The 4th chart shows the factors contributing to GDP growth in the second quarter of 2024:

1. Wholesale and retail trade (G) provides 3.1 percentage points of the 6.4% GDP growth, almost half.
2. Real estate transactions (L) provide 2.3 percentage points, about a third of the growth. This is a significant increase compared to its previously recorded average contribution of 0.5 percentage points.
3. The financial sector (K) provides 1.9 percentage points.

The significant contribution of real estate operations is noteworthy. It includes “Imputed rent for owner-occupied dwellings”, essentially estimating the potential rent of all apartments in Armenia, regardless of whether they are owner-occupied or rented. This means that about a third of the 6.4% growth is attributed to the rise in the market value of real estate, which may not be sustainable.

The Sustainability of Economic Growth

Recent GDP revisions and sectoral analysis raise serious questions about the sustainability of Armenia’s economic growth.

Analysis of Growth Drivers

Chart 5.

Chart 5 shows the factors contributing to Armenia’s economic growth by quarter. Several important points emerge:

1. Long-term average growth: Armenia’s long-term average economic growth rate is about 4.5%. Any system tends to return to its long-term average unless there are qualitative changes in the given system that can ensure stable, long-term creation of value added.
2. Post-pandemic recovery: After the 2020 COVID-19 pandemic and the 44-day war, the economy showed signs of recovery. The main sectors of the economy provided about 4.5% of economic growth.
3. IT sector contribution: The IT sector (J) provided about 1-2.5 percentage points of growth, mainly due to the relocation of IT professionals resettled from Russia. However, this sector has been declining over the last three quarters.
4. Financial services and trade: From the beginning of 2022, the main GDP increase has been provided by financial services (K) and trade (G). It is worth noting that as a result of a massive capital influx from Russia, the net profit of the banking system tripled in 2022 (Read more: 💸🔚🏦 Capital Outflow).
5. Recent trends: From the beginning of 2022 to mid-2023, the main sectors of the economy were showing a steady contribution to economic growth. However, since then almost all economic activity classifiers have been registering a decline in their contribution to overall economic growth.

Dependence on Temporary and Artificial Factors

The data show that Armenia’s economic growth has been heavily driven by external factors:

1. In 2022, there was a significant capital inflow from Russia.
2. The large-scale gold re-exports that started in November 2023 boosted the growth figures (more: 🇷🇺💰🇦🇲 Armenia: a haven for Russian gold).
3. Growth is mainly driven by trade, real estate, and financial services, which depend on external factors (more: 🌅🏖🌄 Beyond the Border: Armenia’s Tourism Growth and Potential Decline).

These factors, while acting as short-term stimuli, do not represent drivers of sustainable, long-term economic growth. Under these conditions, economic growth will tend towards its long-term average figure.

Fiscal Implications

Issues related to the sustainability of economic growth have a direct impact on Armenia’s fiscal situation.

Tax Revenue Collection Issues

There is currently a significant 9% shortfall in tax revenues. This deficit leads to discussions about possible cuts in budget expenditures (Read more: 🧮⏳🎲 Armenia Taxes Time: Playing with Economic Growth).

Budget Expenditure Considerations

Plans are being discussed to use about 150 billion drams from the reserve fund to cover expenditures amidst the revenue shortfall. This situation increases the likelihood of public debt growth.

Potential Growth of Public Debt

Several factors contribute to the risk of public debt growth:

1. If the 7% economic growth envisioned by the budget law is not secured, and the long-term average of 4.5% materializes instead, the government may be forced to allocate about half of the reserve fund to cover the difference.
2. Under conditions of 2.5% or lower economic growth, we might be forced to increase the public debt.
3. Current positive long-term GDP growth forecasts lack a solid foundation for sustainable, long-term value-added growth.

Conclusion

The recent GDP revisions and sectoral analyses present a troubling picture for Armenia’s economic future. Armenia’s heavy reliance on external factors and temporary stimuli from activities such as gold re-exports show that without substantial structural changes, sustaining high growth rates will be difficult. The decline in the IT sector, the unstable nature of real estate’s contribution to GDP, and potential fiscal challenges all point to an economy at a crossroads. The risk of rising public debt and potential fiscal instability in the coming years cannot be ignored. 💰🚧⚖️ The Public Debt Pendulum: For the First Time, Internal Debt Exceeds External

As things stand, our long-term forecasts for GDP growth are not positive at this moment. Without a solid foundation of sustainable, long-term value-added growth, Armenia may find itself pursuing economic illusions instead of building sustainable prosperity (more: 🌿🤨💎 The Precious Effect: Reasons for Economic Growth in 2024). The coming months and years will be crucial in determining whether the country can change direction toward more sustainable economic strategies or will continue to rely on unsustainable and temporary growth factors.