The Armenia Alliance Presents Analysis on the State Budget Draft

The Armenia Alliance has presented an analysis of the draft state budget for Armenia for 2022, which is outlined below.

For 2022, the Armenian government has forecasted a 7% economic growth rate, and 9% in the case of a "favorable external environment." The anticipated economic growth, among other measures, is expected to be achieved through the implementation of programs aimed at enhancing economic potential, specifically:

• State investments in infrastructure and human capital development sectors,
• Improvement of the business environment,
• Ensuring technological advancement,
• Implementation of policies aimed at boosting the exportable sector of the economy and exports.

The government also states that "as a result of improvements in the business environment, both domestic and foreign-funded private investments will increase." However, the government's calculations are questionable; the unfounded optimistic forecasts appear to be purely political, aimed at quelling the anger of our citizens who are living in increasingly deteriorating socio-economic conditions through false promises and reflect an unsuccessful attempt to present the situation created after the defeat in the 44-day war in Artsakh as a "new era of opportunities."

Before moving on to forecasts for next year, let’s briefly comment on the economic results of 2021:

1. According to preliminary data, the economic growth in Armenia for the third quarter of 2021 compared to the same period last year was only 2.66%.
2. Year-on-year, the growth rate of economic activity indicators (EAI) for the third quarter (January-September 2021 compared to January-September 2020) was recorded at 4.4%. Notably, the volume of industrial production increased by only 0.7%, while agricultural output decreased by 1.5%. Growth was secured mainly by construction, trade, and services, specifically in sectors that are primarily non-exportable. The agricultural decline was mitigated by a 3.3% increase in fishing.
3. For ten months, the EAI growth rate slowed down to only 4.3%. Notably, agricultural output is not included in the EAI calculation (only included in quarterly reports).
4. Considering the above and the low level of public and private capital expenditures, we do not consider the declared expected economic growth of 6.5% as realistic. Neither the government nor the central bank believes in that figure.
5. From 2017 to 2021, Armenia's real GDP growth averaged 3.88%. This figure was significantly affected by the 7.4% economic decline in 2020. Expert assessments indicate our long-term growth potential is in the range of 3.5% to 4.5%. According to estimates from the central bank, our long-term growth potential is at 3.5%. This raises the question of how a higher economic growth rate was recorded in previous years (excluding 2020). It is worth noting that the 7.6% growth in 2019 was mainly due to the growth of trade and services (5.4%). It is evident that this "growth" stemmed from the reduction of shadow in retail trade, which is indeed a positive phenomenon but not a real increase.

It is clear that the economy has not yet returned to the levels of 2019. A year-on-year economic growth significantly above the long-term potential (55-75% above) is unrealistic, especially considering that the loss of economic potential during the war has not yet been restored and geopolitical, security, and domestic political risks have not only not decreased but have intensified. Moreover, uncertainty about copper prices persists. As of Friday, contract prices for copper on the London Metals Exchange show a downward trend.

Meanwhile, let’s summarize this year’s outlook with a brief note on inflation. In the consumer market of Armenia, the year-on-year inflation rate for the third quarter was 8.9% (November 2021 against November 2020 was 9.6%).

Now let us examine some aspects of the state budget for 2022:

7. In October 2021, the International Monetary Fund revised its forecast for global economic growth in 2021 from 6.0% down to 5.9%, with 2022’s growth forecast being 4.9%. This indicates that global economic growth is expected to slow down next year.
8. According to the budget draft, the probability distribution of real GDP forecasts is skewed towards values below 7%.
9. Despite forecasts from the Ministry of Finance that the most probable scenario is a 5-7% economic growth, it cannot be conclusively stated that the upper boundary of this range is the most likely scenario. A trivial analysis of graphs and tables suggests that the most likely figure should be around 5.5-6%.
10. The central bank's forecasts are much more modest. The third-quarter report on inflation includes the following economic growth forecasts.
11. Furthermore, the growth forecasts from the IMF and the World Bank for Armenia in 2022 are more modest than government projections, at 4.5% and 4.3% respectively.
12. The government expects to ensure high economic growth by increasing state capital expenditures mainly on road and reservoir construction. For 2022, the government has budgeted 346.5 billion AMD for capital investments (4.4% of GDP), approximately 120 billion AMD more than the revised plan for 2021.
13. The government's ability to execute capital investments is highly questionable; it chronically underperforms in carrying out capital expenditures. Between 2017-2021, capital expenditure projections averaged 207.6 billion AMD. The average performance over five years has been 78% (with the performance for the first nine months of 2021 at 68.3%). Thus, in essence, it has executed an annual average of 163 billion AMD in capital expenditure.

In fact, the government plans to spend 346.5 billion AMD in capital investment, which is more than double the five-year average value.

The primary reason cited for the underperformance in capital expenditures is the mismanagement of the procurement process. However, there is no assessment of whether the existing human resources (including professional) and material resources (equipment and raw materials) in the country are sufficient to carry out such a volume of construction.

The performance of capital expenditures for 2021 has been the lowest for the following ministries: [Tables and data omitted]. Furthermore, current public expenditure performance is higher than that of capital spending, at 92.8%. For example, the budget performance for payroll for nine months has been 96.2%, and the budget for international official missions was completed at 99.9%. In contrast, expenditures for "Resolving Urgent Issues in Regions" amounted to 545.7 million AMD, or 44% of the planned figure, which is due to the fact that the funds were utilized "as needed." This raises the question: "Why allocate almost 1.5 times more budget if it wasn't that necessary?" The answer is evident: to trumpet how much money is being directed to regional development. As a result, there was no funding left for expenditures in other areas, such as defense. Or perhaps regional development required exactly that amount or even more, but the authorities have proven incapable of implementing the necessary programs.

In addition to addressing the government’s capacity for capital expenditure, it is essential to also consider the effectiveness of those investments. The government plans to attract 229.1 billion AMD in loans as external assistance. These loans are intended for capital construction with the expectation that they will increase the potential for economic growth. However, no calculation of the economic efficiency of these investments has been presented. It is unclear whether the investments will justify themselves or simply add to the external debt without creating means to service that debt. There are significant risks that Armenia may find itself in a "sub-infrastructure debt trap."

Despite the government declaring the improvement of the business environment as a priority and linking it with high rates of economic growth, the budget draft does not clearly outline what steps will be taken in that direction and what economic results are expected. The reality is that investment volumes have significantly decreased due to the activities of successive governments formed by the ruling political force.

Particularly, by the second quarter of 2021, foreign direct investments amounted to only 42.8 million USD. The net international investment position by the second quarter of 2021 was -10.9 billion USD. For comparison, by the second quarter of 2018, when Mr. Pashinyan took office as Prime Minister, it was -9.05 billion, and in the same period of 2020, it was -10.2 billion USD. Total foreign direct investments by the second quarter of 2021 reached 518 million USD, whereas in the respective periods in 2020 and 2018, they were 547.7 and 677.7 million USD.

Moreover, investments in fixed assets have also significantly decreased since 2018. It is expected that the real increase in private company investments in fixed assets will be only 0.6% in 2021. The government’s forecast that investments by private companies will sharply grow and reach 15.6% in 2022 appears utterly unbelievable. Likewise, the rate of expected real growth of public investments in fixed assets at 46.2% is not credible either.

The low influx of investments and businesses avoiding capital expenditures suggest another critical aspect. As of October 31, 2021, cash demand deposits (including accounts) of resident private enterprises increased by 40%, while term deposits rose by 32%. By the end of October, they amounted to 316.45 billion and 115.73 billion AMD, respectively. Foreign currency demand deposits grew by 34%, while term deposits decreased by 1%, reaching 224.15 and 63.9 billion AMD, respectively. In other words, private enterprises prefer to keep more than 720 billion AMD in banks, of which 432 billion is on non-interest-generating accounts, rather than invest in the Armenian economy.

Though the government has declared export promotion as a priority and a driver of economic growth in 2022, the external trade sector shows signs of deterioration. According to the government’s assessment, the current account deficit and the goods and services balance deficit for 2022 will increase by 88% and 24%, respectively, amounting to -455.6 million and -1.657 billion AMD. The growth rate of exports is expected to decline from 20.2% to 16.6%, while the volume of imports will increase from 16.7% to 18.3%. The growth rate of money transfers is expected to slow significantly from 34.5% to 5%.

Thus, the government that has declared export a priority admits that the situation in the external trade sector will worsen in 2022. Therefore, the optimism of the government is again inexplicable.

Regarding public debt, according to forecasts based on the 2022 state budget, by December 31, 2021, the public debt will amount to 4.509 trillion AMD or 64.1% of GDP, while by the end of 2022, it will rise to 5.029 trillion AMD or 63.9% of GDP. The external debt is expected to constitute 3.3 trillion and 3.56 trillion AMD, respectively. As of the third quarter of 2021, Armenia’s public debt stood at 4.3698 trillion AMD (9.0381 billion USD).

In the envisaged state budget for 2020, it was planned to incur additional debt from domestic resources. However, on February 2, the Republic of Armenia issued currency-denominated bonds worth 750 million USD with a 10-year maturity and a yield of 3.875%. Furthermore, according to the revised state budget for 2021, financing the state's budget deficit was meant through currency-denominated bonds for the amount equivalent to 500 million USD (241.9 billion AMD). The issuance of an additional 250 million USD in currency-denominated bonds was a result of the favorable conditions formed in the international capital market, high demand for the issued bonds, and low yields, aimed at improving the manageability of risks associated with financing state budget deficits and also stabilizing the external sector of the balance of payments. The excess funds obtained from the placement of currency-denominated bonds (136.8 billion AMD) were directed towards filling the stabilization deposit account.

It is also noted that the performance of external targeted loans is below planned levels. It is worth mentioning that the interest rates on loans are lower than those on bonds. Unlike bonds, external loans are targeted and can only be allocated for the implementation of specified programs.

In the initial plans, the government intended to cover the budget deficit largely from domestic resources. However, on February 2, currency-denominated bonds were issued for 750 million USD. In reality, instead of targeted loans, the state decided to finance the deficit with "free" bonds, issuing more bonds than planned. The surplus was exchanged for AMD and allocated to filling the stabilization deposit account. This is nothing more than an attempt to stabilize the exchange rate of the currency. The additional funds have not been directed towards economic development.

Finally, it should be emphasized that the government is increasing the debt burden, collecting money from people and businesses but is unable to use it for economic development.

Let’s turn to the expected revenues and planned expenditures for the state budget of 2022. According to forecasts, the government expects state budget revenues to amount to approximately 1.95 trillion AMD (of which tax revenues and state duties are 1.84 trillion AMD), compared to an expected 1.65 trillion AMD for 2021 (of which tax revenues and state duties were 1.58 trillion AMD). The expected growth in revenues for 2022 compared to the previous year is 17.5%, equivalent to about 290 billion AMD (the increase in tax revenues and state duties is expected to be 16.6% or 263 billion AMD). Over the last five years, the average annual growth rate of tax revenues has been 9.68%, and that of tax revenues and state duties has been 10.08%. Therefore, the government not only anticipates an unprecedented volume of state income but also record growth in revenues.

It should be noted that the government expects that this year the tax revenues to GDP ratio will reach its historical maximum of 23.4%. The overall revenues ratio to GDP is expected to be 24.7%.

The high revenue forecast, among other factors, is largely due to unrealistic economic growth forecasts and therefore cannot be regarded as realistic.

The government expects to increase budget expenditures in 2022 by 18.3% (338.35 billion AMD) compared to the approved expenditures for 2021. Capital expenditures will account for 16% of total expenditures. The budget allocated to the Ministry of Territorial Administration and Infrastructure is expected to increase by 66.9 billion AMD (32%) compared to 2021, during which the ministry failed to execute capital expenditures. The budget for the Ministry of Economy will increase by 27% (8.7 billion AMD). It is noteworthy that this ministry also failed in capital budget execution in 2021. In contrast, the budget for the Ministry of Defense is planned to be increased by only 11% (33.7 billion AMD). Presumably, the Armenian government is preparing for a peacetime era and is guided by the principle of the Heritage (HZ) party's slogan that "our defense is in our defenselessness." Notably, there is also a 54% reduction in the budget for the Armenia-Diaspora program.

In conclusion, the Armenian government predicts a 7-9% economic growth for 2022. To achieve the described economic growth, the government's proposed measures include:

• State investments in infrastructure and human capital development sectors,
• Improvement of the business environment,
• Ensuring technological advancement,
• Implementation of policies aimed at boosting the exportable sector of the economy and exports.

However, the policies pursued by the government, the modest results recorded so far, and significant failures do not provide grounds to believe that the government will be able to achieve its promised economic growth. The unrealistic economic growth forecast renders the target value of budget revenues unrealistic as well. In the face of security threats and social hardships, the government prefers to allocate funds to superficial programs that do not address security and economic challenges.