IMPLICATIONS OF THE FINANCIAL CRISIS ON ARMENIA’S ECONOMY

INTRODUCTION /MOTIVATION

It has become clear by now that the ongoing financial crisis will have a deep and prolonged impact on a wide range of economies. Despite originating in the advanced economies, the crisis is unlikely to let many countries stay on the sidelines and remain unaffected. 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. While in-depth research on the causes and consequences of the crisis is still in the pipeline and will become available as more facts are uncovered, economists around the world agree that there is ample evidence of a serious crisis in the making. And perhaps the loudest indicator of the expected slowdown in global economic activity is the drop in the price of crude oil to below $40 per barrel in early- December from its all-time high of $140 in July. It all started when a broad spectrum of rather difficult-to-price and illiquid assets—mostly asset-backed securities and complex structured instruments—took large losses against the background of falling US housing prices. Given the extent of the leverage in the global financial system, the capital level was not sufficient to cover losses, rising counterparty risks and leading to a flight to quality. A high degree of cross-border financial integration ensured that the shock spread simultaneously across most major economies advanced and emerging economies. World-wide deleveraging and increased risk aversion resulted in large and persistent capital outflows from emerging markets, posing significant external financing difficulties and putting emerging markets' currencies under pressure. Forced and in some countries disorderly external adjustments, sharply falling commodity prices, and the worldwide credit crunch are taking a significant toll on the world economic growth, pushing the world economy into a prolonged and deep recession. There are strong signs of the crisis spreading and putting strain on countries as well as international financial institutions. In recent weeks alone, seemingly solid and diversified countries/economies such as Hungary, Iceland, Ukraine, Serbia, and Pakistan have turned to the International Monetary Fund (IMF) for support of their worsening external balance-of- payments positions. A few others are presently in the process of negotiating arrangements with the IMF (IMF Survey, 2008) and the number is likely to grow. Interestingly, the IMF itself has secured a deal with the government of Japan whereby it will be given access to additional funds totaling $100 billion to strengthen the IMF's crisis prevention capabilities in these turbulent times (Financial Times web). In this context, Armenia and all other low income and emerging economies alike are likely to be significantly affected. Moreover, recent developments in emerging markets suggest that the crisis-related deterioration of the economic outlook is likely to occur abruptly with little (if any) signs of early warning. This puts a high premium on the pre-emptive policy response and crisis preparedness efforts. Against this background, this note discusses the main channels through which Armenia's economy is likely to be affected as a result of the adverse global conditions. Along the way, it discusses the peculiarities of Armenia's economy and policies (past and present) that are likely to exacerbate the impact of the crisis and make early prevention efforts more pertinent. To conclude, the note offers some policy recommendations that may help mitigate the impact of the ongoing global crisis on Armenia's economy.download