Some Thoughts on Developments in Europe and Their Implications for Fiscal Outlook in Armenia

Developments with sovereign debt markets in Europe are quite intriguing these days. Western European government bonds just turned riskier than emerging-market debt for the first time ever. While very few economists expect a full-blown crisis in Europe, this will have direct implications for the cash strapped Yerevan. The bilateral funding from Western European countries, one of the key sources of grants and fiscal financing for Armenia, will dry out as a result of impending fiscal austerity measures in those countries.

The ongoing European mess will also force the IMF, Armenia’s second largest creditor and the Central Bank of the world, to limit the size of its assistance to poor performers like Armenia, if it were to prepare itself adequately for bailouts of large European economies (e.g., Spain). These resources are typically/mostly used to prop up central bank reserves against potential shocks (and in Armenia’s case allow the Central Bank of Armenia to sell reserves to maintain an overvalued currency!) but also for fiscal/budgetary purposes.

This puts Armenia’s budget financing for 2011 under strain and may provide a good opportunity for a fresh look at the overall fiscal stance. Doing so becomes especially pertinent given that the assumptions behind the government revenue for 2011 are based on optimistic GDP growth rates, which are unlikely to materialize given the outcome in the second half of 2010 and all leading indicators of growth (such as, foreign investment, remittances, population dynamics, etc.). This will eventually cause the revenue collection to remain below target and will put additional pressures on the deficit. A business-as-usual attitude in Yerevan is likely to lead to expenditure arrears (e.g., on wages and social payments) at some point during the year and put Armenia in breach of IMF conditionality with potential freeze of funding. But then there is always Russia, with its helping hand…

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