Twin deficits in Armenia

The reduction of private and public income in the light of declining economic growth in Armenia facilitates fiscal and external sector imbalances. Twin deficits prevailing in the Armenian economy - budget deficit and current account deficit are expected to remain in the medium and long-term.

Budget deficit. The sharp economic contraction in the second quarter of this year (13.7%), pandemics, and the escalation in the Nagorno-Karabakh conflict have negatively affected the fiscal balance of the country and have put general government debt on a high trajectory.

Budget revenues significantly deviated from the planned indicators. It was mostly driven by lower customs duty and profit taxes in January-August 2020 that declined by 6% compared to the last year. The revised official forecasts show a 6.8 % reduction in GDP and tax revenues, while military and healthcare spending rises.

Armenia has an exceptionally high infection per capita rate; thus, the country's fiscal balance is strongly affected by the pandemics. In line with the region countries, a budget envelope was implemented in 2020 around 4% of GDP. Although they were projected to be 10 percent of overall public spending in 2020 before the onset of the COVID-19 pandemic, the health expenditures are expected to be higher.

Meanwhile, military spending is increased in the 2020 budget. As reported by the U.S. Central Intelligence Agency, the country spends about 5% of its GDP annually on military (10%, according to Global Fire Power). Conditioned with Armenia's current military situation, these expenses with little fiscal multiplier effect may rise and further tighten the fiscal space for infrastructure investments and social expenditures in Armenia.

Despite the pension reforms, the pension system remains ineffective and creates an additional budget deficit burden. Low productivity, aging population, and high emigration rate deepen this problem. According to the UN, Armenia is expected to have an old-age dependency ratio of around 17.5 % and 34.3 % in 2020 and 2050, accordingly. The EU estimates the pension systems' financial sustainability to deteriorate on average by 4.6% of GDP between 2020 and 2050. The youth emigration from Armenia adds more to this issue. The average net migration rate for 1990-2015 was -11.8

The national debt in Armenia has increased by 8.8% in January-August, exceeding $ 7.97 billion. The domestic debt jumped by 24.3% to $ 1.9 billion by September 2020. Fitch considers substantial uncertainty regarding the potential to implement a fiscal consolidation program as additional fiscal measures would be needed to support weakening GDP. The ongoing war and worsening situation with pandemic put downside risk to fiscal projections of Armenia.

To supplement the under-execution of revenues and the budget deficit more than doubling in July, the government revised the budget deficit. According to the official forecasts, Armenia's budget deficit is projected to reach 7.4% of the GDP by the end of 2020. It will be covered by attracting debt, increasing the ratio of debt to GDP to 67% in 2020. Fitch forecasts the government debt to remain elevated over the medium term.

Current account deficit. Armenia's external vulnerabilities, including net external debt, large structural current account deficit, weak FDI inflows, and high dependency on remittances, prevailed in 2020. The trade is challenged, and the country's attractiveness for foreign investment is halted due to cross-border integration and transportation problems, restrictions of access to markets, underdeveloped infrastructure, and prevailing corruption despite the measures taken against it. Borders with neighboring countries are either closed due to political reasons or offer limited opportunities, and the Nagorno-Karabakh war has escalated with Azerbaijan. In October 2020, Fitch Ratings has downgraded Armenia's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B+' from 'BB-.' The country's debt service costs are expected to increase.

Armenia's current account deficit to GDP ratio is 8.2%. This deficit prevailing since 1991 is chronic.