## 1. Fiscal Rules

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---

### A. Purpose, scope and medium-term perspective
- Purpose of a robust fiscal framework:
  - Promote macroeconomic stability, enhance resource allocation efficiency, and build public confidence in government financial management.
  - Provide structured constraints on government spending and borrowing to align fiscal policies with long-term fiscal sustainability.
  - Enhance fiscal transparency and accountability by outlining government intentions, targets, and performance (Wang et al., 2015).
- Medium-term perspective:
  - Extends decision-making horizon beyond the annual budget cycle to improve prioritization and integration of policy objectives with available resources (Curristine et al., 2024).
- Role of fiscal rules:
  - Establish specific, measurable constraints on fiscal aggregates (debt, deficit, expenditure).
  - Act as commitment devices to signal fiscal responsibility and bolster credibility.
  - Require balance between clarity for monitoring and flexibility (escape clauses); poorly designed escape clauses can make rules procyclical (Davoodi et al., 2022; Ulloa-Suárez, 2024).
- Scope of this SIP:
  - Evaluates Armenia’s fiscal framework focusing on design and implementation of fiscal rules, countercyclical effectiveness, operational flexibility, credibility, and transparency.
  - Notes the 2026–28 MTEF envisages an ambitious fiscal consolidation path while current rules have been largely non-binding due to recent high economic growth.

### B. Structure and legal framework of Armenia’s fiscal rules
- Legal framework:
  - Three key laws: the Budgetary System Law (BSL); the Public Debt Law; and the annual Budget Law.
- Medium-Term Expenditure Framework (MTEF):
  - Provides indicative spending ceilings and projections over a three-year period.
  - Not binding; government approves annually by mid-year and submits to Parliament for information.
- Annual Budget:
  - Binding document; approved before year end by Parliament.
  - Annual budget law (and the MTEF) can include a general reserve fund of up to 5 percent of total expenditures.
  - Government flexibility within limits:
    - Increase spending up to 10 percent of approved budget expenditure in specific cases when additional revenues materialize.
    - Cut spending up to 10 percent if risk of revenue under-execution up to 10 percent.
    - Redistribute allocations among programs for up to 3 percent of approved budget expenditures.
- Historical evolution of rules:
  - 1997: budget balance rule with deficit ceiling of 10 percent of GDP; reduced to 5 percent of GDP in 2003; increased to 7.5 percent of GDP in 2009.
  - 2008: debt rule added with debt limit of 60 percent of GDP.
  - 2018 reforms: introduction of an expenditure rule for multiple debt thresholds and a capital expenditure sub-rule under the balanced budget rule.
- Current central government rules (summarized):
  - Balanced budget in T+1:
    - Budget deficit < 7.5 percent of GDP.
    - Capital expenditures should not be below the level of the budget deficit if government debt exceeds 40 percent of GDP.
  - Expenditure ceiling in T+1:
    - If debt in T-1 < 60 percent of GDP, but >50 percent: Average current primary expenditure growth < average nominal GDP growth in previous 7 years.
    - If debt in T-1 > 60 percent of GDP:
      - Average current primary expenditure growth < average nominal GDP growth in previous 7 years – 0.5 percentage points.
      - Current expenditures < tax revenues + state duties.
    - The expenditure rule was introduced in 2018 and applies for ex-ante planning purposes only.
    - The expenditure rule does not apply to capital expenditures.
  - Debt in T+1:
    - Upper threshold: 60 percent of GDP.
    - If debt in T-1 > 60 %: Submit an action plan to parliament to bring debt below 60 percent of GDP.
    - If debt in T-1 < 60 %: Present an action plan in MTEF to lower debt to 50 percent of GDP in 5 years.
- Escape clause:
  - Can be triggered in “exceptional cases” (large-scale natural disasters, wars, and economic shocks) based on government interpretation of negative impact.
  - Formally activated once Parliament has approved deviations with an amendment to the budget law; legislation does not require a formal declaration on activating the escape clauses.

### C. Recent performance, compliance and deviations
- Recent improvements:
  - Strengthened macroeconomic projections, simplified procedures, improved transparency and reporting, better alignment of MTEF with the budget, and improved public investment management (PIM).
  - 2026-28 MTEF approved with new procedures focusing on medium-term macroeconomic projections and expenditure ceilings.
  - Amendments submitted to Parliament to restrict new PPP liabilities and budgetary guarantees if sum of central government debt, PPP liabilities and budgetary guarantees exceed 70 percent of GDP; restrict new PPP liabilities if central government debt exceeds 60 percent of GDP.
- Deviations and breaches:
  - Breaches mostly in 2020-21 when escape clause activated due to COVID-19 and war; government submitted amendments to budget law without publishing formal justification.
  - Balanced budget rule (BBR):
    - Breached in 2009 following the global financial crisis. Since then, no breaches to this rule.
    - Balanced budget sub-rule on capital expenditures was breached in 2020-21 when the deficit exceeded capital expenditure.
- Adherence data (selected figures preserved exactly):
  - Table 1. Armenia: Adherence to the Capital Expenditure Rule (columns: 2018 2019 2020 2021 2022 2023 2024)
    - Debt in t-2 (in percent of GDP ): 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Budget Deficit Projection: -2.7 -2.2 -2.3 -5.3 -3.0 -3.1 -4.6
    - Capital Expenditures Projection: 3.0 3.3 4.1 3.4 4.5 6.0 6.8
    - Budget Deficit Actual: -1.8 -1.0 -5.4 -4.6 -2.5 -2.0 -3.7
    - Capital expenditures Actual: 2.5 2.9 3.7 3.1 4.6 5.2 5.5
    - Deviation from rule/Escape clause - COVID, Martial Law
  - Table 2. Armenia: Adherence to the Primary Current Expenditure Rule (columns: 2018 2019 2020 2021 2022 2023 2024)
    - Debt in t-2 (in percent of GDP)     : 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Nominal GDP growth (average of 7 years): 6.1 6.1 5.9 6.4 4.1 5.1 8.0
    - Primary current expenditures growth: -0.7 5.4 10.4 6.3 4.1 5.1 13.0
    - Primary current expenditures growth: -1.0 5.9 14.8 12.8 6.5 6.7 10.5
    - Deviation from Rule/Escape Clause - COVID, Martial Law
    - Ex post breach
  - Table 3. Armenia: Adherence to the Current Expenditure Rule Condition on Tax Revenues (columns: 2018 2019 2020 2021 2022 2023 2024)
    - Debt in t-2 (in percent of GDP)   : 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Current Expenditure Projection: 22.4 21.1 22.1 25.6 23.4 21.9 23.9
    - Tax Revenue Projection: 21.3 20.7 22.6 22.5 23.4 23.7 24.9
    - Current Expenditure Actual: 21.6 22.0 27.0 25.6 22.3 21.9 23.7
    - Tax Revenue Actual: 20.9 22.4 22.4 22.7 22.7 23.4 23.5
    - No breach of the rule observed.

### D. Assessment: countercyclicality, design limitations and measured biases
- Countercyclicality — key findings:
  - 2018 reforms intended to strengthen countercyclicality, but gains limited.
  - Pre-2018 (2010-17): fiscal policy consistently procyclical in good times.
  - Post-2018:
    - Countercyclical during crises period of 2020-21 when escape clause triggered.
    - Remained procyclical ex-ante and ex-post as growth rebounded and peaked during 2022-24.
    - Expenditure rule breached twice; expenditure outturn consistently exceeded authorities’ projections due to over-execution of current expenditures and under-execution of capital spending.
  - Measured biases:
    - During 2018-2024, the actual share of current expenditures in total expenditures was on average 1.8 percentage points of GDP higher than envisaged in annual budgets.
    - This average increased to 2.8 percentage points of GDP in 2023-24.
- Identified design and implementation limitations:
  - Rules are inherently procyclical:
    - Backward-looking rules enable additional spending during high growth and can constrain spending during extended low growth.
    - Expenditure rule binding only when debt exceeds 50 percent of GDP; does not mandate countercyclical policy below that threshold.
  - Incentives for unrealistic planning:
    - Expenditure rule applies to primary current expenditures, incentivizing higher projections for interest payments to create room for discretionary spending ex-ante; can lead to ex-post breaches.
    - Capital expenditure exclusion from expenditure rule removes constraints on public investment but encourages optimistic planning for capital spending and lower current expenditure ex-ante, with ex-post deviations.
  - Enforcement weaknesses:
    - Expenditure rule legally applies for ex-ante planning purposes only, limiting ex-post monitoring incentives.

### E. Institutional, transparency and coverage issues
- Escape clause shortcomings:
  - Lacks clarity and specificity about activation triggers and potential trigger events.
  - Missing procedural details, transparency and communication to the public.
  - Absent measurable monitoring indicators and guidelines on the path back to application of fiscal rules.
  - No independent ex-ante and ex-post scrutiny; application remains ambiguous and discretionary.
- Reserve fund weaknesses:
  - Reserve fund rules not binding in practice; funds can be redistributed from other allocations (e.g., capital expenditures to current expenses).
  - Use of reserve fund can result in deviation from planned spending, over-execution of current spending, and ex-post breaches of the expenditure rule.
  - Reserve fund is effectively used as a tool for discretionary spending rather than risk management.
- Complexity:
  - Fiscal rules consist of several “if-then” statements with different rules depending on debt thresholds.
  - Expenditure rule is not a typical expenditure rule and exempts capital expenditure.
  - Complex design creates incentives for inconsistent projections and reclassifications of expenditures.
- Coverage gaps:
  - Rules limited to central government.
  - Rules do not cover subnational governments, SOEs, PPPs and contingent liabilities.
  - Separate, more lax government decrees cap stock and flow of guarantees, creating preferences for off-balance sheet transactions and increasing monitoring complexity.
- Monitoring and enforcement weaknesses:
  - Independent monitoring, compliance, and enforcement are lacking.
  - MOF’s macroeconomic department prepares the MTEF required to be ex-ante compliant with fiscal rules; government approves and publishes it without independent scrutiny.
  - Ex-post compliance assessments are not legally binding; MOF conducts and publishes an assessment of ex-post deviation in the MTEF.
  - The Parliamentary Budget Office (PBO) occasionally conducts assessments for internal purposes only and lacks mandate and adequate resources to assess fiscal forecasts or ensure ex-ante compliance.
  - The Audit Chamber focuses on ex-post financial audits and is not mandated to systematically review fiscal rule implementation.
- Transparency and reporting:
  - MTEF and annual budget are prepared, approved and published in a timely manner and include detailed macroeconomic and fiscal projections, scenario analysis, priorities and objectives of fiscal policy, assessment of compliance with fiscal rules in the medium-term, and assessment of macro and specific fiscal risks.
  - Annual execution reports include sub-sections on fiscal rules and MOF’s assessment of ex-post compliance.
  - General government financial statistics published in line with international standards.
  - The 2019 IMF Fiscal Transparency Evaluation: Armenia met good or advanced practices on 16 out of 36 principles and basic practice on 14 others; major gaps remain including limited institutional coverage.

### F. International comparisons and empirical indicators
- Fiscal Rule Strength Index:
  - Armenia’s de jure fiscal framework quality exceeded the peer group average after 2018 reforms.
  - Armenia ranked 19th out of 45 countries in its income group and 58th out of 106 countries for which the index was available in 2021.
  - The Fiscal Rule Strength Index (Davoodi et al., 2022) is standardized with scores ranging from -0.7 to 3.6.
- Rule deviations:
  - Deviations from the debt rule limit have been in line with peer group trends; most countries breached limits during the pandemic and regained space afterwards.
  - For the balanced budget rule, Armenia experienced smaller deviations relative to peers.
- Countercyclicality metric:
  - Armenia’s coefficient of countercyclicality is 0.13 (structural primary deficit moves procyclically by 0.13 percent for every one percent change in GDP on average).
  - The sample average coefficient of countercyclicality is 0.15.
  - Armenia ranks 31st out of 62 countries for which estimates are available.

### G. Policy options and recommendations
- Improve countercyclicality and escape clauses:
  - Upgrade the expenditure rule by:
    - (i) Regular adjustment for past forecast errors to limit shocks that make rules too lax in upturns or too constraining in downturns.
    - (ii) Adding a forward-looking feature based on conservative, independent and credible forecasts of potential output (example: Chile).
  - Apply the expenditure rule to total expenditures including capital expenditures and interest payments to avoid incentives for forecast bias, procyclicality and ex-post breaches.
  - Introduce stricter regulations and formal procedures on discretionary use of the reserve fund and on flexibility to increase current spending to limit high-spending bias, reduce procyclical spending and avoid ex-post breaches.
  - Consider redesigning the balanced budget rule as a more dynamic tool with countercyclical deficit targets or structural balance targets across economic cycles (examples: Serbia, Croatia).
- Strengthen escape clauses through clarity, transparency and correction mechanisms:
  - Codify clearly defined and measurable conditions and triggers for activation (e.g., a specific threshold for GDP contraction or a certain size of fiscal impact from natural disasters or wars).
  - Embed such conditions in the Budget System Law and publicly communicate them through budget documentation.
  - Clarify the required details of the corrective plan to return to the rules; current law requires a plan to return to rules within 5 years of invoking the escape clause but details could be expanded.
  - Mandate an independent fiscal institution (e.g., the PBO) to evaluate compliance with escape-clause conditions and corrective plans.
- Simplify and broaden coverage:
  - Consolidate separate rules for current expenditures, current primary expenditures and capital expenditures into an “all inclusive” or a more streamlined expenditure rule.
  - Consider making such a rule apply even for safe levels of debt, with more restrictive provisions for higher debt thresholds.
  - Broaden public sector coverage of fiscal rules to include non-financial SOEs, PPPs and contingent liabilities.
  - Consolidate all fiscal rules in a single primary legislation instead of multiple laws and decrees.
- Strengthen oversight and enforcement:
  - Introduce an accountability mechanism (e.g., legal requirement to publish the reasons and corrective measures for ex-post breach of the rule) for the expenditure rule.
  - Implement an independent mechanism for ex-ante as well as ex-post scrutiny of fiscal projections and compliance with fiscal rules.
  - Possible institutional arrangements:
    - Vest scrutiny roles in an independent fiscal council, or
    - Use the Parliamentary Budget Office (PBO) for ex-ante and the Audit Chamber for ex-post evaluation.
  - Enhance the mandate and resources of the PBO; expand Audit Chamber remit to systematically review fiscal rule implementation.
- Comparative best-practice elements for escape clauses (selected):
  - Peru:
    - Escape clause can suspend fiscal rule application for up to three years under two conditions:
      - When real GDP is declining: the ceiling on the deficit can be raised to 2.5 percent of GDP, accompanied by a minimum annual reduction of 0.5 percent of GDP until the deficit ceiling of 1 percent is restored.
      - In emergencies declared by Congress: specific ceilings for deficit and expenditure rules must be specified, with the same minimum annual reduction of 0.5 percent of GDP applying.
  - Jamaica:
    - Escape clause can be triggered only under specific conditions: natural disasters, public health or other emergencies, or a quarterly GDP contraction of at least 2and the projected fiscal impact must exceed 1.5% of GDP.
    - Activation requires a formal report to Parliament, Ministry of Finance documentation, approval by both houses of Parliament, and independent verification by the constitutionally autonomous auditor general.

### H. Conclusion
- Armenia’s fiscal framework has served the country well, but further improvements could align it with international best practices and facilitate the fiscal consolidation envisaged in the 2026-28 MTEF.
- Priority reforms:
  - Improve countercyclicality features of fiscal rules (adjustments for forecast errors, forward-looking elements, broadened expenditure base).
  - Simplify and strengthen the design of fiscal rules; codify clear escape clauses and correction mechanisms.
  - Improve transparency and legal consolidation of rules.
  - Broaden coverage to include off-budget entities, extra-budgetary funds, and contingent liabilities.
  - Enhance oversight and enforcement via statutory codification and an empowered independent fiscal institution or strengthened mandates for PBO and Audit Chamber.

*Source: sipea2025155 — Selected Issues paper excerpt on Armenia’s fiscal rules and fiscal framework improvements.*

### 1. Fiscal Rules ___________________________________________________________________________ 4

### 1. Fiscal Rules

### A. Introduction
- Purpose of a robust fiscal framework:
  - Promote macroeconomic stability, enhance resource allocation efficiency, and build public confidence in government financial management.
  - Provide structured constraints on government spending and borrowing to align fiscal policies with long-term fiscal sustainability.
  - Enhance fiscal transparency and accountability by outlining government intentions, targets, and performance (Wang et al., 2015).
- Medium-term perspective:
  - Extends decision-making horizon beyond the annual budget cycle to improve prioritization and integration of policy objectives with available resources (Curristine et al., 2024).
- Role of fiscal rules:
  - Establish specific, measurable constraints on fiscal aggregates (debt, deficit, expenditure).
  - Act as commitment devices to signal fiscal responsibility and bolster credibility.
  - Require balance between clarity for monitoring and flexibility (escape clauses) to accommodate cycles and emergencies; poorly designed escape clauses can make rules procyclical (Davoodi et al., 2022; Ulloa-Suárez, 2024).
- Evolution of frameworks:
  - Emphasis on integrating medium-term planning, robust forecasting, and coordination across government for practical budgetary decision-making (Caselli et al., 2022).
- Scope of this SIP:
  - Evaluates Armenia’s fiscal framework with a focus on design and implementation of fiscal rules, including countercyclical effectiveness, operational flexibility, credibility, and transparency.
  - Notes the 2026–28 MTEF envisages an ambitious fiscal consolidation path while current rules have been largely non-binding due to recent high economic growth.

### B. Armenia’s Fiscal Framework Performance — Overview
- Legal framework:
  - Three key laws: the Budgetary System Law (BSL); the Public Debt Law; and the annual Budget Law.
- The Medium-Term Expenditure Framework (MTEF):
  - Provides indicative spending ceilings and projections for revenues and key macroeconomic indicators over a three-year period.
  - Not binding; government approves annually by mid-year and submits to Parliament for information.
- The Annual Budget:
  - Detailed assessment of macroeconomic and fiscal developments; sets expenditure envelopes, revenue objectives and fiscal balance targets for the year.
  - Binding document; approved before year end by Parliament.
  - Annual budget law (and the MTEF) can include a general reserve fund of up to 5 percent of total expenditures.
  - Government flexibility within limits:
    - Increase spending up to 10 percent of approved budget expenditure in specific cases when additional revenues materialize.
    - Cut spending up to 10 percent if risk of revenue under-execution up to 10 percent.
    - Redistribute allocations among programs for up to 3 percent of approved budget expenditures.
- Fiscal rules — historical evolution and current structure:
  - First rule (1997): budget balance rule with a deficit ceiling of 10 percent of GDP; reduced to 5 percent of GDP in 2003; increased to 7.5 percent of GDP in 2009.
  - Debt rule added in 2008 with a debt limit of 60 percent of GDP.
  - 2018 reforms: introduction of an expenditure rule for multiple debt thresholds and a capital expenditure sub-rule under the balanced budget rule to improve countercyclicality and flexibility.
  - Current central government rules (Box 1):
    - Balanced budget in T+1:
      - Budget deficit < 7.5 percent of GDP.
      - Capital expenditures should not be below the level of the budget deficit if government debt exceeds 40 percent of GDP.
    - Expenditure ceiling in T+1:
      - If debt in T-1 < 60 percent of GDP, but >50 percent: Average current primary expenditure growth < average nominal GDP growth in previous 7 years.
      - If debt in T-1 > 60 percent of GDP:
        - Average current primary expenditure growth < average nominal GDP growth in previous 7 years – 0.5 percentage points.
        - Current expenditures < tax revenues + state duties.
      - The expenditure rule was introduced in 2018 and applies for ex-ante planning purposes only.
      - The expenditure rule does not apply to capital expenditures.
    - Debt in T+1:
      - Upper threshold: 60 percent of GDP.
      - If debt in T-1 > 60 %: Submit an action plan to parliament to bring debt below 60 percent of GDP.
      - If debt in T-1 < 60 %: Present an action plan in MTEF to lower debt to 50 percent of GDP in 5 years.
  - Escape clause:
    - Can be triggered in “exceptional cases” (large-scale natural disasters, wars, and economic shocks) based on government interpretation of negative impact.
    - Formally activated once Parliament has approved deviations with an amendment to the budget law; legislation does not require a formal declaration on activating the escape clauses.

### C. Compliance with Fiscal Rules — Recent Reforms and Adherence
- Recent improvements:
  - Strengthened macroeconomic projections, simplified procedures, improved transparency and reporting, better alignment of MTEF with the budget, and improved public investment management (PIM).
  - 2026-28 MTEF approved with new procedures focusing on medium-term macroeconomic projections and expenditure ceilings.
  - Amendments submitted to Parliament to restrict new PPP liabilities and budgetary guarantees if sum of central government debt, PPP liabilities and budgetary guarantees exceed 70 percent of GDP; restrict new PPP liabilities if central government debt exceeds 60 percent of GDP.
- Deviations and breaches:
  - Breaches mostly in 2020-21 when escape clause activated due to COVID-19 and war; government submitted amendments to budget law without publishing formal justification.
  - Balanced budget rule (BBR):
    - Breached in 2009 following the global financial crisis. Since then, no breaches to this rule.
    - Balanced budget sub-rule on capital expenditures was breached in 2020-21 when the deficit exceeded capital expenditure.
- Adherence data (Tables reproduced as presented):
  - Table 1. Armenia: Adherence to the Capital Expenditure Rule
    - Columns: 2018 2019 2020 2021 2022 2023 2024
    - Debt in t-2 (in percent of GDP ) : 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Budget Deficit Projection: -2.7 -2.2 -2.3 -5.3 -3.0 -3.1 -4.6
    - Capital Expenditures Projection: 3.0 3.3 4.1 3.4 4.5 6.0 6.8
    - Budget Deficit Actual: -1.8 -1.0 -5.4 -4.6 -2.5 -2.0 -3.7
    - Capital expenditures Actual: 2.5 2.9 3.7 3.1 4.6 5.2 5.5
    - Deviation from rule/Escape clause - COVID, Martial Law
  - Table 2. Armenia: Adherence to the Primary Current Expenditure Rule
    - Columns: 2018 2019 2020 2021 2022 2023 2024
    - Debt in t-2 (in percent of GDP)     : 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Nominal GDP growth (average of 7 years): 6.1 6.1 5.9 6.4 4.1 5.1 8.0
    - Primary current expenditures growth: -0.7 5.4 10.4 6.3 4.1 5.1 13.0
    - Primary current expenditures growth: -1.0 5.9 14.8 12.8 6.5 6.7 10.5
    - Deviation from Rule/Escape Clause - COVID, Martial Law
    - Ex post breach
  - Table 3. Armenia: Adherence to the Current Expenditure Rule Condition on Tax Revenues
    - Columns: 2018 2019 2020 2021 2022 2023 2024
    - Debt in t-2 (in percent of GDP)   : 51.9 53.7 51.2 50.1 63.5 60.2 46.7
    - Current Expenditure Projection: 22.4 21.1 22.1 25.6 23.4 21.9 23.9
    - Tax Revenue Projection: 21.3 20.7 22.6 22.5 23.4 23.7 24.9
    - Current Expenditure Actual: 21.6 22.0 27.0 25.6 22.3 21.9 23.7
    - Tax Revenue Actual: 20.9 22.4 22.4 22.7 22.7 23.4 23.5
    - No breach of the rule observed.

### D. Assessment of Armenia’s Fiscal Rules
- Countercyclicality — summary of findings:
  - 2018 reforms intended to strengthen countercyclicality, but gains limited.
  - Pre-2018 (2010-17): fiscal policy consistently procyclical in good times.
  - Post-2018:
    - Countercyclical during crises period of 2020-21 when escape clause triggered.
    - Remained procyclical ex-ante and ex-post as growth rebounded and peaked during 2022-24.
    - Expenditure rule breached twice; expenditure outturn consistently exceeded authorities’ projections due to over-execution of current expenditures and under-execution of capital spending.
  - Measured biases:
    - During 2018-2024, the actual share of current expenditures in total expenditures was on average 1.8 percentage points of GDP higher than envisaged in annual budgets.
    - This average increased to 2.8 percentage points of GDP in 2023-24.
- Identified limitations of existing fiscal framework:
  - Rules are inherently procyclical:
    - Backward-looking rules enable additional spending during high growth and can constrain spending during extended low growth.
    - Expenditure rule binding only when debt exceeds 50 percent of GDP; does not mandate countercyclical policy below that threshold.
  - Incentives for unrealistic planning:
    - Expenditure rule applies to primary current expenditures, incentivizing higher projections for interest payments to create room for discretionary spending ex-ante; can lead to ex-post breaches.
    - Capital expenditure exclusion from expenditure rule removes constraints on public investment but encourages optimistic planning for capital spending and lower current expenditure ex-ante, with ex-post deviations.
  - Enforcement weaknesses:
    - Expenditure rule legally applies for ex-ante planning purposes only, limiting ex-post monitoring incentives.

*Source: sipea2025155 - 1. Fiscal Rules*

### 11.      Armenia’s fiscal rules provide sufficient flexibility to maintain an agile fiscal

### 11.      Armenia’s fiscal rules provide sufficient flexibility to maintain an agile fiscal framework, but there are key limitations

### Key limitations of the current fiscal rule framework
- Escape clause shortcomings:
  - Served to provide flexibility for countercyclical policy during severe downturns.
  - Lacks clarity and specificity about activation triggers and potential trigger events.
  - Missing procedural details, transparency and communication to the public.
  - Absent measurable monitoring indicators and guidelines on the path back to application of fiscal rules.
  - No independent ex-ante and ex-post scrutiny; application remains ambiguous and discretionary.
- Reserve fund weaknesses:
  - In practice, reserve fund rules are not binding; funds can be redistributed from other allocations (e.g., capital expenditures to current expenses).
  - Use of reserve fund can result in deviation from planned spending, over-execution of current spending, and ex-post breaches of the expenditure rule.
  - Reserve fund is effectively used as a tool for discretionary spending rather than risk management.

### Complexity
- Complexity reduces effectiveness and ease of communication.
- Armenian fiscal rules consist of several “if-then” statements with different rules depending on debt thresholds.
- The expenditure rule:
  - Is not a typical expenditure rule that predetermines limits for safe debt levels.
  - Has different rules for current and current primary expenditures relative to the deficit, revenues and moving average nominal GDP growth.
  - Exempts capital expenditure from the expenditure rule.
- Complex design creates incentives for inconsistent projections and reclassifications of expenditures.

### Coverage
- Fiscal rules coverage is limited to central government.
- Rules do not cover subnational governments, SOEs, PPPs and contingent liabilities.
- Separate, more lax government decrees cap stock and flow of guarantees, creating preferences for off-balance sheet transactions and increasing monitoring complexity.

### Monitoring and enforcement
- Independent monitoring, compliance, and enforcement are lacking.
- MOF’s macroeconomic department prepares the medium-term macro-fiscal framework (MTEF) required to be ex-ante compliant with fiscal rules; the government approves and publishes it without independent scrutiny.
- Ex-post compliance assessments are not legally binding; MOF conducts and publishes an assessment of ex-post deviation in the MTEF.
- The Parliamentary Budget Office (PBO):
  - Occasionally conducts assessments of compliance with fiscal rules for internal purposes only.
  - Lacks the mandate and adequate resources to assess fiscal forecasts or ensure ex-ante compliance with fiscal rules.
- The Audit Chamber focuses on ex-post financial audits and is not mandated to systematically review fiscal rule implementation.

### Transparency and reporting
- Progress made in enhancing transparency and reporting of the fiscal framework and fiscal rules.
- MTEF and annual budget are prepared, approved and published in a timely manner and include:
  - Detailed macroeconomic and fiscal projections.
  - Scenario analysis, priorities and objectives of fiscal policy.
  - Assessment of compliance with fiscal rules in the medium-term.
  - Assessment of macro and specific (SOEs, PPP, other) fiscal risks.
- Annual execution reports include sub-sections on fiscal rules and MOF’s assessment of ex-post compliance.
- General government financial statistics published in line with international standards.
- The 2019 IMF Fiscal Transparency Evaluation found Armenia met good or advanced practices on 16 out of 36 principles and basic practice on 14 others, but major gaps remain including limited institutional coverage.

### International comparison and empirical indicators
- Fiscal Rule Strength Index:
  - Armenia’s de jure fiscal framework quality exceeded the peer group average after 2018 reforms.
  - Armenia ranked 19th out of 45 countries in its income group and 58th out of 106 countries for which the index was available in 2021.
  - The Fiscal Rule Strength Index (Davoodi et al., 2022) is standardized with scores ranging from -0.7 to 3.6.
- Rule deviations:
  - Deviations from the debt rule limit have been in line with peer group trends; most countries breached limits during the pandemic and regained space afterwards.
  - For the balanced budget rule, Armenia experienced smaller deviations relative to peers.
- Countercyclicality:
  - Armenia’s coefficient of countercyclicality is 0.13 (structural primary deficit moves procyclically by 0.13 percent for every one percent change in GDP on average).
  - The sample average coefficient of countercyclicality is 0.15.
  - Armenia ranks 31st out of 62 countries for which estimates are available.

### Policy options and recommendations
- Improving countercyclicality and escape clauses:
  - Upgrade the expenditure rule by:
    - (i) Regular adjustment for past forecast errors to limit shocks that make rules too lax in upturns or too constraining in downturns.
    - (ii) Adding a forward-looking feature based on conservative, independent and credible forecasts of potential output (example: Chile).
  - Apply the expenditure rule to total expenditures including capital expenditures and interest payments to avoid incentives for forecast bias, procyclicality and ex-post breaches.
  - Introduce stricter regulations and formal procedures on discretionary use of the reserve fund and on flexibility to increase current spending to limit high-spending bias, reduce procyclical spending and avoid ex-post breaches.
  - Consider redesigning the balanced budget rule as a more dynamic tool with countercyclical deficit targets or structural balance targets across economic cycles (examples: Serbia, Croatia).
- Strengthening escape clauses through clarity, transparency and correction mechanisms:
  - Codify clearly defined and measurable conditions and triggers for activation (e.g., a specific threshold for GDP contraction or a certain size of fiscal impact from natural disasters or wars).
  - Embed such conditions in the Budget System Law and publicly communicate them through budget documentation.
  - Clarify the required details of the corrective plan to return to the rules; current law requires a plan to return to rules within 5 years of invoking the escape clause but details could be expanded.
  - Mandate an independent fiscal institution (e.g., the PBO) to evaluate compliance with escape-clause conditions and corrective plans.
- Comparative best practices for escape clauses:
  - Peru:
    - Escape clause can suspend fiscal rule application for up to three years under two conditions:
      - When real GDP is declining: the ceiling on the deficit can be raised to 2.5 percent of GDP, accompanied by a minimum annual reduction of 0.5 percent of GDP until the deficit ceiling of 1 percent is restored.
      - In emergencies declared by Congress: specific ceilings for deficit and expenditure rules must be specified, with the same minimum annual reduction of 0.5 percent of GDP applying.
  - Jamaica:
    - Escape clause can be triggered only under specific conditions: natural disasters, public health or other emergencies, or a quarterly GDP contraction of at least 2and the projected fiscal impact must exceed 1.5% of GDP.
    - Activation requires a formal report to Parliament, Ministry of Finance documentation, approval by both houses of Parliament, and independent verification by the constitutionally autonomous auditor general.
    - Legal provisions ensure transparency and public communication; rated well above the regional average across six clarity dimensions.

*Source: sipea2025155 (IMF).*

### 21.      Armenia‘s fiscal rules could benefit from simplification. Armenia’s fiscal rules could be

### 21. Armenia‘s fiscal rules could benefit from simplification.

### Simplification of fiscal rules
- Armenia’s fiscal rules could be simplified by consolidating separate rules for current expenditures, current primary expenditures and capital expenditures into an “all inclusive” or a more streamlined expenditure rule.
- Such a rule could be specified to apply even for safe levels of debt, with more restrictive provisions for higher debt thresholds.
- Tradeoffs noted: simplicity versus countercyclicality.
- International examples cited:
  - Costa Rica: simple expenditure rule where total expenditure cannot grow faster, on average, than revenue.
  - Peru: Responsibility Law caps nominal annual growth of non-financial expenditure at 4% (IMF, 2023b).

### Enhancing transparency and broadening coverage
- Fiscal transparency progress in Armenia is notable, but communication could be improved.
- Suggested transparency improvements:
  - Adequately report compliance with fiscal rules, as mandated by law, in a timely, transparent, independent, and simplified manner.
  - Enhance standardization and provide concrete revenue mobilization and expenditure rationalization measures in debt reduction plans mandated after the escape clause is triggered.
  - Consolidate all fiscal rules in a single primary legislation instead of multiple laws and decrees.
- Example of good practice: New Zealand promotes fiscal transparency through an open budget process, mandates clear long-term fiscal strategies and regular performance reporting, and ensures credible analyses and projections (Căpraru et al., 2024).
- Broaden public sector coverage of fiscal rules to include:
  - Non-financial SOEs, PPPs and contingent liabilities to avoid separate rules and limits for each.
  - Flexibility for discretionary spending and usage of the reserve fund should be covered and have clearly defined enforceable rules.
- Ongoing legal reform:
  - Authorities are revising the 2008 Debt Law to expand coverage of public debt to include state-owned and municipal entities, but the draft legislation excludes public guarantees.
  - Expanding the legal definition and coverage of public debt and reforms related to restricting PPPs when debt is high (see ¶8) would address a key limitation of current rules, which apply narrowly to central government debt.
- Examples of broader coverage:
  - Ecuador: debt rule limits non-financial public sector debt to 40 percent of GDP; Article 125 of the Código Orgánico de Planificación y Finanzas Públicas limits decentralized entities’ debt to 200 percent and debt service to 25 percent of their annual revenue.
  - Panama: limits non-financial public debt to 40 percent of GDP.
  - Peru: limits non-financial public debt to 30 percent of GDP.

### Strengthening oversight and enforcement
- Reforms to strengthen enforcement and oversight could include:
  - Introduce an accountability mechanism (e.g., legal requirement to publish the reasons and corrective measures for ex-post breach of the rule) for the expenditure rule (e.g., as part of the MTEF or the budget).
  - Implement an independent mechanism for ex-ante as well as ex-post scrutiny of fiscal projections and compliance with fiscal rules, as recommended by IMF TA (IMF, 2019).
- Possible institutional arrangements:
  - Vest scrutiny roles in an independent fiscal council created to assess compliance, or
  - Use the Parliamentary Budget Office (PBO) for ex-ante and the Audit Chamber for ex-post evaluation.
- Current institutional gaps:
  - The PBO, formally independent since 2016, currently lacks the mandate and resources to assess fiscal forecasts or ensure ex ante compliance with fiscal rules.
  - The Audit Chamber focuses on ex-post financial audits but is not systematically mandated to review fiscal rule implementation.
- Example of oversight practices:
  - Aruba: Board of Financial Supervision (CAft) oversees compliance with fiscal rules (IMF, 2025).
  - Canada, Croatia, Serbia, and Sweden cited as examples of good country practices on independent fiscal oversight (see Box 5).
- Box 5 highlights:
  - Canada: Federal Accountability Act (FAA) 2006 created the Parliamentary Budget Office (PBO). Reforms via Bill C-44 in 2017 made the PBO an independent Officer of Parliament with fixed-term appointments, direct reporting to Parliament, expanded mandate, improved access to government data, and public tabling requirements.
  - Sweden: Swedish Fiscal Policy Council (FPC) established in 2007, composed of six academic economists and two former politicians, operates as a government agency with a small staff and external consultants; mandate includes evaluating fiscal policy, economic trends, budget clarity, and forecast quality. The FPC lacks legal authority for ex-ante forecasting or costings but plays a key role in promoting transparency and accountability.

### Conclusion and policy recommendations
- Armenia’s fiscal framework has served the country well, but further improvements could be considered to align with international best practices and facilitate the fiscal consolidation envisaged in the 2026-28 MTEF.
- Recommended policies:
  - Improve the countercyclicality features of fiscal rules:
    - Upgrade the expenditure rule to incorporate adjustments for past forecast errors and forward-looking elements based on credible estimates of potential output.
    - Redesign the balanced budget rule to include countercyclical or structural deficit targets.
    - Enforce stricter procedures governing the use of reserve funds and current spending flexibility.
  - Simplify and strengthen the design of fiscal rules:
    - Move to a simplified set of rules to improve clarity and facilitate monitoring.
    - Establish transparent, well-defined escape clauses linked to well-specified economic or emergency conditions (Lledo et al., 2018).
  - Improve transparency of fiscal rules:
    - Legally mandate clearer reporting of compliance with fiscal rules.
    - Require standardized and detailed debt reduction plans as part of the escape clause.
    - Consolidate fiscal rules in a unified primary legislation.
  - Broaden coverage of fiscal rules:
    - Include off-budget entities, extra-budgetary funds, and contingent liabilities to improve comprehensiveness and coverage of fiscal risks.
  - Enhance oversight and enforcement:
    - Statutory codification of rules and ex-post enforcement mechanisms.
    - Establish an independent fiscal council or enhance the mandate of existing oversight bodies such as the PBO and Audit Chamber to improve transparency, support rule-based fiscal policy, and foster public accountability.

*Source: sipea2025155 — Selected Issues paper excerpt on Armenia’s fiscal rules and fiscal framework improvements.*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025155.pdf_