Martin Galstyan: Economic activity in Armenia is weakening and labor  market development prospects are too uncertain

ArmInfo.Economic activity in Armenia continues to weaken, approaching the estimated level of  long-term sustainable growth, and there remains high uncertainty regarding the development of the labor market.

This was stated on February 4 at a press conference called to announce the next  reduction of the refinancing rate by 0.25 percentage points - to  6.75%, by Chairman of the Central Bank of Armenia Martin Galstyan,  presenting the rationale for this decision of the Central Bank Board.

He noted that the growth of economic activity in the fourth quarter  of 2024 was largely driven by services, construction and trade  sectors. These dynamics continued to be impacted by certain  short-term factors posing significant uncertainty with respect to the  sustainability of economic growth and its long-term outlook, as well  as the future trajectory of domestic demand conditions. Uncertainty  has increased regarding the direction and magnitude of the potential  impact of the fiscal policy on demand. Labor market conditions  continue to cool amid these conditions, as reflected in stabilizing  wage growth, non-traded sticky price inflation, and  inflation  expectations.

In Q1 2025, risks of slowing economic growth globally and in the key  trading partner countries of Armenia remain. Inflation in partner  countries has moderately expanded, while the prices of goods and  services characterized by sticky prices in key trading partner  economies continue to remain significantly above target levels.   Growing tensions in international  trade relations continue to create  risks for future growth in global commodity prices and potential  disruptions in global supply chains. At the same time, labor market  conditions in key trading partner countries, particularly in the  United States, remain tight. In these context, advanced economy  central banks would be expected  to continue to gradually ease policy  rates at a slower pace, while maintaining a relatively tight stance.  Consequently, the external environment  would be expected  to  transmit weak  inflationary pressures on the Armenian economy.

Summary of Economic Conditions

Global Economy 

In Q4 2024, economic activity among Armenia's main trading partners  has been mixed. High economic activity persists in the US and Russia,  driven largely by robust growth in domestic consumption, particularly  in the services sector. In China, while economic growth has somewhat  accelerated, approaching target levels, the environment of weakening  domestic demand persists due to structural challenges. In the Euro  Area, economic growth has markedly decelerated following the fading  impact of certain short-term factors. Risks of slower economic  activity globally remain latent.  

Uncertainty regarding economic fundamentals in the United States  persists. Despite elevated interest rates in recent quarters, the US  continues to experience strong growth, spurred by consistently robust  consumption. Thus, in Q4 2024, economic growth has moderated  somewhat, forming around 2.3%, but the contribution of private  consumption growth was about 2.8 percentage points, indicating the  persistence of high domestic demand. Simultaneously financial asset  prices remain at high levels, creating risks for further expansion of  demand. In this context, headline inflation has somewhat increased,  sticky prices and wage growth remain significantly above their target  levels. A further escalation of the inflationary environment may also  be anticipated as a result of the tightening of external trade   policies.  

Risks have remained, particularly in the medium term, regarding the  potential shift towards a more stimulative fiscal policy stance. This  poses an additional challenge for monetary policy, not only due to  the short-term inflationary effects but also in the context of its  potential impact on the neutral interest rate, especially if a higher  debt burden trajectory materializes. These highlight the challenges  that monetary authorities face in the "last mile" of bringing  inflation back to target and maintaining long-term price stability.  

On the other hand, continued tightening of financial conditions and  the lending environment poses risks of further, undesirable weakening  in the labor market. However, it is important to note that these  risks have somewhat eased in recent times. In this context, the  Federal Reserve decided to leave the policy rate unchanged. It should  also be noted that financial market expectations regarding the future  trajectory of the Federal Reserve's policy rate have significantly  increased in recent times. At the same time, uncertainties regarding  the long-term neutral interest rate persist, which would have  implications on both the future stance of Fed policy and capital  flows to emerging markets.  

In the Euro Area, the European Central Bank (ECB) cut interest rates  by an additional 25 basis points to 2.9% in February 2025.In the Euro  Area, both short-term and, particularly, medium-term growth prospects  and structure, especially in the industrial sector, continue to  remain concerning. Headline inflation has slightly expanded, yet it  remains near the target level, primarily due to the modest inflation  of manufacturing goods, while services inflation remains elevated,  highlighting a growing divergence between these two sectors of the  economy. This poses significant challenges for the pace of policy  adjustments and the pursuit of long-term price stability.  

Risks associated with persistently weak domestic demand in the Euro  Area and China, continue to remain key sources of uncertainty driving  a weaker global economic outlook.  

Meanwhile, Russia has maintained robust growth and strong domestic  demand, supported by expansionary fiscal policies and notable  increases in private expenditures. Labor market tension remains  persistent. In this context, despite the significant tightening of  policy conditions by the Central Bank of Russia, no significant  progress has yet been observed in controlling inflation.  Additionally, the sustained imposition of stricter and more targeted  Western sanctions, particularly the targeting of Russian "shadow  trade vessels" by the United States, continue to pose risks to the  medium-term Russian economic outlook, especially under conditions of  prolonged strict monetary policy.  

In the global commodity markets, food prices have stabilized in  recent months. Nevertheless, significant uncertainty persists  regarding the medium-term developments in commodity markets,  particularly in the oil market. In the case of effective targeting of  "shadow trading vessels" transporting Russian oil at prices above the  cap set by Western countries, global oil supply could be somewhat  reduced, leading to inflationary pressures. Conversely, further  weakening in global demand may lead to deflationary pressures in  commodities.  

Domestic Demand Conditions 

In Q4 2024, economic growth in Armenia continued to slow, approaching  the estimated level of long-term sustainable growth. The sectors of  services, construction, and trade continue to remain the major growth  drivers. It is worth noting that the weakening of economic activity  is largely driven by the reduction in external trade flows.  Nevertheless, the structure of growth continues to pose high  uncertainty regarding the relative position of aggregate demand  versus aggregate supply.  An uptick in economic activity is observed  in certain "traditional" sectors of the manufacturing industry, such  as food and tobacco production.  Nevertheless, risks remain regarding  the growth prospects of these sectors, driven by slow growth in  capacity (including construction in these sectors, the import of   investment goods, and employment growth).  

The robust external demand observed since 2022 has been gradually  weakening, as reflected in the stabilization of both real expenses  per tourist and tourist arrivals. Non-commercial money transfers from  Russia to Armenia are also somewhat decreasing. This may be due to  the recent narrowing of the wage gap between Armenia and Russia,  heightened uncertainty regarding Russia's medium-term economic  outlook, and a decline in labor migration to Russia amid stricter  migration policies.  Meanwhile, considerable uncertainty continues to  surround current domestic demand conditions. The strong growth in  retail trade, consumer credit, domestic tourism, and other services  suggest robust domestic demand. In this context, consumer credit  rates remain high, reflecting strong demand. On the other hand,  recent economic growth has been fairly concentrated in certain  sectors, remittances have continued to decline, and labor market  conditions have eased somewhat. These factors, coupled with the  overall weak inflationary environment for several successive  quarters, could point to weaker demand conditions in the economy.  

Uncertainties also surround the outlook and future trajectory of  domestic demand conditions. Key uncertainties relate to the reduced  debt burden (given higher incomes); the future utilization of  accumulated savings in the private sector. For example, depending on  how and in which direction savings are spent (consumption vs.  investment), this could have different implications on the  relationship between aggregate demand and aggregate supply in the  economy.  

Additionally, uncertainty regarding the impact of fiscal policy on  aggregate demand has increased. This is driven by concerns over  revenue underperformance and high current expenditures necessitated  by various social support programs. Significant risks remain  regarding the underperformance of expenditures, particularly capital  expenditures, as well as their structural characteristics, which may  result in a restrictive impact on demand.  

Labor Market & Inflation 

Labor market data has offered mixed signals in recent months. The  household survey-based unemployment rate in Q2 2024 stands at 13.8%,  representing increase of approximately 2 percentage points relative  to the same quarter of last year. Considering the uncertainty  surrounding the level of unemployment, it is crucial to monitor  potential development scenarios and their implications.  

On the one hand, this trend could signal weakening demand conditions  across the economy. The increase in the unemployment rate has not  been driven by a significant rise in labor supply compared to the  previous year, but rather by a decrease in the number of employed  persons. This aligns with the observed outflow of foreign workers and  the slowdown in wage growth rates over the course of this year.  

On the other hand, data from the State Revenue Committee indicates  that the total number of registered employees has continued to rise,  with about 41,200 more individuals employed compared to the same  period of last year. This could suggest that labor conditions are  tighter than the household survey indicates.  As an alternative  interpretation, the growth in registered employees might reflect a  gradual decline in the shadow labor market in favor of formal  employment.  

In recent months, some acceleration has been observed in private  sector wage growth, largely reflecting the high wage increases in the  financial sector. However, excluding the financial sector, private  sector wage growth remains around 5%, which remains below levels that  are consistent with productivity growth and the inflation target. In  the medium and long term, a potential increase in labor supply could  contribute to further easing of labor market conditions and labor  market-driven inflationary pressures. The main uncertainty is tied to  the high unpredictability surrounding Russia's economic growth  prospects and the potential decline in the flow of Armenian labor  migrants to Russia, as well as the challenges of integrating them  into the domestic labor market.  

The weak inflationary environment persisted in Q4 2024, primarily  driven by moderate deflationary pressures from the external  environment, as well as a decline in prices of imported non-food  products and domestically produced food items. The deflation of  imported non-food products persists, primarily driven by the ongoing  decline in producer prices in China's economy. In this context,  overall CPI inflation has remained below target since April 2023,  standing at 1.5% Y-o-Y in December 2024. Non-Traded Sticky Price  Inflation, which captures domestically driven demand dynamics,  continued to stabilize, standing at 2.4% Y-o-Y in December 2024.  The  latter continues to be negatively affected by the inflation of  services highly exposed to external demand, including the gradual  decrease in hotel service prices and residential rental rates. In  this context, households' inflation expectations have moderately  decreased approaching target levels. This is supported by both the  consistently low inflationary environment in Armenia as well as the  results of household surveys.  

Monetary Policy 

Market expectations regarding the Central Bank of Armenia (CBA)  policy rate path have adjusted slightly downward since the latest  decision and continue to reflect expectations of a gradual reduction  in the policy rate over the next eight decisions. Following the CBA's  recent policy rate announcements, the short- and medium-term segments  of the yield curve have shifted downward. At the same time, according  to CBA estimates, the yield curve likely incorporates not only market  expectations about the future policy rate but also various other risk  factors.  

Armenia's country risk premium has moderately declined in recent  months mainly driven by positive developments surrounding the Middle  East conflict and remains significantly below the long-term stable  level determined by the country's fundamentals. However, it still  reflects uncertainties related to debt sustainability, geopolitical  tensions (including border issues), and regional developments. In  this context, a upward reappraisal of the country risk premium could  pose risks regarding the reassessment of neutral interest rates,  which, all else being equal, would primarily carry inflationary risks  in a more accommodative monetary policy environment. At the same  time, macroeconomic stability in Armenia and strong economic growth  can serve as important preconditions for a potential reassessment of  the country's risk profile with impacts on the neutral rate.  

Considering the persistence of numerous types of uncertainty, the CBA  builds and evaluates several different scenarios for future economic  developments in order to manage possible risks stemming from these  key areas of uncertainty. On one hand, the Board has discussed  scenarios in which developments necessitate a tighter policy response  relative to market expectations to stabilize inflation around the  target in the medium term. These scenarios primarily encompass the  following risks and uncertainties:  

    Risk associated with the U.S. neutral interest rate being higher  than market expectations.      A rapid adjustment in Armenia's  country risk premium, as well as an increase in its fundamental  level.      Excessive demand formation in the domestic economy and  its sustained persistence.      In the global economy, the  intensification of regional conflicts and the imposition of tangible  tariffs by major economies on each other and the external world give  rise to risks of an expanded inflationary environment, driven by  disruptions in supply chains.  

On the other hand, the Board has considered scenarios in which  potential economic developments suggest a faster downward trajectory  for the policy interest rate compared to market expectations. These  scenarios encompass the following risks and uncertainties:       Risks of a sharp slowdown in global economic growth, largely driven  by deep structural challenges in the Chinese and Eurozone economies.       Risks associated with a gradual slowdown in economic growth,  weakening demand, and the prolonged maintenance of a low inflationary  environment in the RA.      Declining seasonal migration from  Armenia to Russia, driven by the further narrowing of the wage gap  between the two countries and heightened uncertainty regarding  Russia's growth outlook.      Tightening of trade policies among  major economies over the medium-term horizon, potentially leading to  excess supply of goods and services in international markets and a  deflationary environment, along with other risks and uncertainties.