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Pilleler » News » Armenia: Acquired investment deficit syndrome

Armenia: Acquired investment deficit syndrome

The war that began on September 27, 2020 in Nagorno-Karabakh, the internationally recognized territory of Azerbaijan, will inevitably lead to devastating consequences for the economy of Armenia, which is already weak and has an unstable resource base. Over the past 10 days, the war has had a negative impact on the short-term and long-term expectations of the development of the Armenian economy, intensified and deepened the current recession caused by the pandemic.
Pre-war indicators show that the economy of this country was completely collapsed. Compared to the corresponding indicators of the previous year, in the 2nd quarter of 2020, the economic decline was 13.7%, and the unemployment rate was about 20%. Also, the deficit in the state budget was financed by external borrowing, as well as balance of payments and the current account experienced shortage.
The war deepens this entire crisis and will crush all prospects of the Armenian economy in all time frames. International credit rating agency Fitch Ratings has downgraded Armenia's long-term credit rating to B+. This indicator suggests that the country's credit rating is significantly lower than a satisfactory level, and the financial situation is significantly volatile. This fact proves that international organizations are re-evaluating the economic prospects of Armenia.
The main factor to be immediately affected by the war and to become the engine of a deep crisis will be investments, which are the most crisis-sensitive component of aggregate demand. The sharp reduction and withdrawal of investments during the war will result in macroeconomic instability, rise of unemployment, capital depreciation, and decrease of productivity, and thereby will completely undermine potential growth prospects, leading to economic instability.
The minimum level of national savings and the limited ability of the state to attract external debt (weak fiscal space) limit opportunities for domestic investment. Even in stable times, the country failed to attract significant foreign direct investment (FDI). According to the World Investment Report 2020, over the past 6 years, the volume of FDI invested in Armenia amounted to 1.6 billion US dollars (for comparison, in Azerbaijan this figure was 19 billion US dollars). Until 2019, the volume of FDI in the country was equal to 5.9 billion US dollars (in Azerbaijan this figure was 32 billion US dollars).
The harsh negative expectations emerged because of the war will not only prevent FDI from participating in the country's economy, but will also trigger their rapid one-way flow from Armenia.
The rapid withdrawal of FDI from the Armenian economy means a disastrous scenario for economic activity. Besides, the growing balance of payments deficit in the financial account will further increase the pressure that already exists in the foreign exchange market. If we add the panic effect arising in connection with the war, a sharp drop in the Armenian dram (national currency) will be inevitable. In its turn, such situation will lead to inflation and cause further serious damage to the social welfare of the country. In addition, depreciation of capital, lack of knowledge and technology transfer to the country's economy will lead to a one-time loss of development prospects for the country's economy. 
The above-mentioned allows saying that there are practically no factors determining the involvement of FDI in the Armenian economy:
  • Against the background of political instability and war, the safety of investors is not ensured.
  • There are expectations that the current macroeconomic stability will be aggravated by the depreciation of the currency, rapid inflation, volatility of external debt, and a deep crisis in the banking and financial sector.
  • Due to the small and poor internal market compared to neighboring countries, unfavorable geographic location and conditions of the blockade, the country's external market practically has no potential. 
  • Due to the poor condition of power supply, transportation and other physical infrastructure, production and transportation costs are high.
  • The current banking and credit system, interest rates on loans, financing terms, and conditions of collateral indicate unfavorable financial availability.
  • There are serious cases of corruption and intervention at the level of state bodies.
  • In addition to the shortage of a competent workforce, the country's labor market suffers from increased emigration.
  • There is a high likelihood that weak business and investment climate will collapse in the face of war. 
Thus, the above-mentioned provides a basis for asserting that against the background of a decrease in domestic investments in the Armenian economy, in the short and long term, the one-way flow of foreign investments from the country will continue. As a result of the continued economic downturn in the country and the growth of poverty in the long term, Armenia will turn into an enclave of poverty in a developing region.

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