TOPIC OF THE WEEK: Armenia: Key Macro Risk Materializes - A slide presentation
Armenia has been our cyclical favorite in the upcycle and it still enjoys double-digit GDP growth rates, having posted an estimated 10.4% YoY expansion of the economy over Jan to Aug. However, Yerevan’s fortunes have now changed given the outcome of the 3rd Karabakh war. In this week's report, which is a slide presentation, we investigate how the new geopolitical reality might affect the economic status quo in the country.
The formal loss of NK and measures undertaken by the government, including joining the International Criminal Court and refusing to participate in the regular events of the Russia-led Collective Security Treaty Organization, have created a dangerous security and geopolitical vacuum for Armenia that could inevitably weigh on the economy. Given the more tenuous nature of the existing security guarantees, there is a clear and present danger that Armenia may face fresh territorial demands on the southern part of the country should Azerbaijan (and Turkey) reach the conclusion that Yerevan is not willing to open up communications along the so-called "Zangezur Corridor". While we are of the view that this is not an immediate threat because Azerbaijan will now most likely focus on fully integrating NK into the country and further, because of possibly a harsher international reaction, this will nevertheless constitute a real medium-term risk with a non-negligent probability. As a consequence, while a peace deal between Armenia and Azerbaijan may now be easier to come by, which may give markets a reprieve, a permanently higher risk premium may need to be assigned to Armenia given the newly emerging geopolitical challenges.
The strong momentum accumulated so far in the year will carry the economy to our forecast 8.0% GDP growth for the year, but we now see more powerful headwinds to 2024 growth, which we project at 4.0% (vs our previous forecast of 5.0 percent and the 5.6% forecast of the central bank). While the economy may take some time to react to elevated uncertainty, the exchange rate has already fallen prey to the new backdrop, having lost about 10 percent against the US$ in the last 10 days or so. The Central Bank has had to intervene to prop up the currency. As a result, the dram’s fortunes have completely turned around from being the best-performing currency in the CCA (and the world, for that matter) last year to competing now with the Uzbekistan sum for the title of the worst performing currency in the region this year.
Inflation has been very well behaved in recent months, hovering around zero on an YoY basis and below the 4.0% CPI target, but higher energy prices and the dram’s depreciation will complicate inflation’s path in the months to come. The 3Q23 Inflation Report, released by the CB on Sep 26th, already looks outdated in assuming a benign trajectory for price growth and overall economic performance. We think there will still be room for rate cuts, but they will be more modest than previously anticipated. We now see the end-2023 and end-2024 refinancing rate at 9.25% and 8.0% (vs 9.0% and 7.50% before).
The external environment is also complicated. The temporary respite that the current account enjoyed last year on the back of excess monetary inflows from Russia will give way to the more standard environment, in which Armenia runs structural current account deficits. FX reserve cover is already the lowest in the region, giving little room to maneuver for policymakers. Should Russia decide to retaliate for Armenia’s unfriendly gestures, the CA position (and the broader economy) may take a further blow given that about 40% of Armenia’s external trade is with Russia (the highest in the CCA space). While we don’t judge this to be a high probability event, including because Yerevan plays an important role for Moscow as a hub for sourcing sanctioned goods, it nevertheless remains a risk that should not be underestimated.
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