February 17, Business New Europe, Germany

Armenia is close to signing a $500m stabilisation loan agreement with Russia. The government needs to raise more money if it is to carry out its 2009 budget plans, which were based on an optimistic forecast of 9.2% growth.

Since the budget was approved in November, the impact of the international crisis on Armenia has continued to deepen. Falling prices for its main exports - copper and molybdenum - and the collapse of a speculative bubble in the construction sector have caused a sharp increase in unemployment. The number of people seeking work rose from 90,500 in December to 95,000 on January 23. The situation is worst in the mining regions of Lori and Lyunik, according to the State Statistical Service. Job losses in the construction industry are also expected, as virtually no new projects are being commissioned.

Analysts argue that opportunities to diversify the economy and tackle corruption have been missed, and low levels of tax collection are contributing to the current plight of the country. As a result, Yerevan has no choice but to try to tap international lenders.

International lenders

A $500m stabilisation loan, already agreed with Moscow, is expected to be signed off on by early March, Finance Minister Tigran Davtian has said. Terms for the 15-year loan haven't been disclosed, but are expected to be granted on relatively soft conditions, and there is likely to be an initial grace period of four years to allow Armenia time to deal with the crisis.

Yerevan is hoping to raise additional funds from other international sources. The World Bank said in January it would more than double its lending to Armenia over the next four years. Armenia is due to receive at least $525m in low-interest loans from 2009 to 2012, as well as funding from the International Finance Corporation and the Multilateral Investment Guarantee Agency, which could increase the total to as much as $800m, the World Bank's vice-president for Europe and Central Asia, Shigeo Katsu, has said.

Armenia has only started to feel the full force of the crisis in recent months due to its being out of the mainstream of the world economy. It has, for example, been spared the banking sector problems that have affected Kazakhstan in particular. No significant losses have been recorded in the sector to date. However, its economic prosperity will depend to a large extent on international metals prices, and the flow of remittances from Armenians working abroad - many of whom are in countries that are now suffering.

"It has become clear by now that the ongoing financial crisis will have a deep and prolonged impact on a wide range of economies," says a recent report from Policy Forum Armenia. "This is also likely to be true for a peripheral economy like Armenia's, regardless of how isolated its relevant sectors are from the rest of the world."

Hovsep Khurshudyan, senior analyst at the Armenian Center for National and International Studies (ACNIS), considers that the impact of the crisis is not yet fully felt in Armenia. "It is on account of the government's gold and money reserves that it has so far been possible to secure stability in the country's financial market," he says. "In particular the dollar-dram ratio is the same as it was prior to the outset of the crisis in August 2008. This also is having a positive effect on the societal mood, as the increase of panic still is restrained."

However, further job losses in mining and construction could lead to social unrest, which has spurred on government efforts to raise cash. But critics of the government say that the Russian loan is unlikely to be used wisely, and hark back to the last time Russia forgave an Armenian debt of around $100m; soon after, Russian companies acquired strategic assets in the country.

Armenian officials are being open about their expectation of increased Russian influence once the deal is signed. Just before the loan was announced, the parliament's permanent economic commission chairman Vardan Aivazian was quoted by Interfax as saying that, "Russia and Armenia are strategic partners. The loan will help increase Russia's political influence in Armenia. Most likely, Russia will agree to grant us a loan."

Khurshudyan doubts the funds will benefit Armenia in the long term, forecasting that the money will merely be spent on maintaining the Armenian dram's high exchange rate, but without helping the economy to recover. "That is, they will serve Armenia's high negative foreign trade balance, in which the volume of import nearly quadruples that of export. The government will leave the burden of foreign debts on the shoulders of future generations, and momentarily put off the social distress that ultimately could destroy the foundations of the authority of the oligarchic elite."

Armenia's growth in the last decade was mainly driven by the metals and mining sector, which benefited from high copper and molybdenium prices. Real estate prices also soared, but the focus was on elite apartments, and - as the recent slump in prices has shown - wasn't sustainable. The government is currently trying to encourage development of small and medium-sized businesses with the aim of creating new jobs, but it failed to act during the years of rapid growth. Widespread corruption has made it difficult for legitimate businesses to compete, especially when they are burdened with high tax rates.

In recent years, Armenia has made efforts to move closer to Europe, but achieving financial stability has become a more immediate goal and - as the recent example of Kyrgyzstan demonstrates - could lead to a fundamental change of direction. "Should Armenia receive those loans from the West, and not from Russia or China, this means there still is hope that we ultimately won't deviate from the course of European integration and once again find ourselves in the East," says Khurshudyan.