## Supporting Sustainable Financing and Access to Finance in Armenia ## Source details **Canonical URL:** [Supporting Sustainable Financing and Access to Finance in Armenia](https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023004-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2023/english/wpiea2023004-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2023/english/wpiea2023004-print-pdf.pdf.json) --- ### I. Introduction - Armenia achieved robust growth with real GDP growth averaging 6½ percent during 2000–2019. - Historically inward foreign direct investment (FDI) was key, reaching 6.4 percent of GDP on average during 2003–2007. - Over the past decade the share of inward FDI in private external financing declined significantly; reliance on debt-related inflows (loans and deposits) increased. - Access of the private sector to finance is moderate regionally but with important disparities: substantial gender gap and urban-rural gap in financial inclusion; SMEs face difficulties due to limited transparency, informality, and low financial management. - Three main messages: - Panel regressions confirm governance-related structural factors significantly affect Armenia’s attractiveness to inward FDI. Improving core governance and business environment to top 5–25 percent of peer CCA and EMDE countries could increase inward FDI flows by as much as ¾ percentage points of GDP. - Financial depth and inclusion: informality, poor accounting practices, and low financial management limit firm access to finance; lack of sufficient funds, gender gap, financial literacy, and urban-rural differences constrain household inclusion. - Policy measures to reinvigorate inward FDI and expand domestic finance (including strengthening financial reporting and reducing informality) could support recovery and private/export sector development; developing high-value-added exports could raise domestic saving (reference to Karapetyan et al., 2021). ### II. Context: External and Domestic Financing in Armenia - Saving-Investment balance: - Gross investment rate has declined steadily over the past 15 years; gross saving relatively stable since the GFC. - Prior to COVID-19, the saving-investment balance worsened due to rising investment and declining saving ratios. - Foreign saving (net income and transfers) declined steadily over the past 10 years. - Relative to peers, Armenia’s gross saving rate has been lower than CCA and EMDE since around 2010. - Implications: - Declining gross saving limits potential domestic financing for investment, placing greater emphasis on external financing (current account deficit). - Changing nature of private external financing: - Net FDI accounted for majority of net private capital inflows before the GFC; after the GFC net FDI declined to about one-third of pre-GFC levels relative to GDP. - Loans and deposits became more important since the GFC; nonresident deposits particularly influential since early 2010s. - Between 2010 and 2020 the share of non-FDI liabilities in total external liabilities increased by 10 percentage points to 60 percent. - The diminished role of inward FDI coincides with a trend decline in domestically-financed private investment (gross private capital formation minus net FDI). - Correlations and vulnerabilities: - Net inflow of deposits by residents and nonresidents positively correlated with global growth. - Exchange rate has been correlated with overall net capital inflows but less with FDI in recent years; exchange rate is highly correlated with nonresident deposits and loans to private sector. - Shift from FDI to non-FDI liabilities raises financial stability risks given Armenia’s relatively large external net liabilities. ### III. Access to Domestic Financing H3 subsections for households and firms are summarized below. - A. Financial Inclusion of Households - Financial system dominated by banks with total assets about 110 percent of GDP. - Account ownership at a financial institution: 48 percent of population ages 15+. - ATMs and commercial bank branches per capita increased, reaching an average for Central Europe and the Baltics. - Total deposits with commercial banks nearly doubled to 40 percent of GDP over the last ten years. - Gender gap: - In 2017 about 40 percent of women had a bank account compared with about 60 percent of men; improved since 2014 but still below world average (65 percent) and Eastern Europe and Central Asia (66 percent). - The 2014 National Strategy of Financial Education included separate targets for women. - Financial literacy: - OECD survey: average literacy score in Armenia is 11.4 (out of 21); 27 percent of adults achieved minimum target score of at least 4 out of 7 on financial knowledge (compared with ~60 percent in South East Europe and ~70 percent in OECD). - Low literacy associated with negative attitudes towards saving. - Urban-rural divide: - Rural areas face limited infrastructure, higher informality, lower financial literacy, lower income, and lack of trust in financial system; fewer bank branches and ATMs. - B. Financial Inclusion in Firms - Access to finance is main challenge for doing business: 30 percent of respondents in 2020 World Bank Enterprise Survey identified access to finance as main obstacle; informal sector practices were second at 15 percent. - SMEs: - About 42 percent of all firms and about 35 percent of small firms had a bank loan or line of credit (2020 Business Environment and Enterprise Performance Survey). - Main source of finance for SMEs is owner’s funds/internal resources; start-up financing often from informal sources. - Major barriers: lack of transparency, high informality; result: high collateral requirements and high risk premiums. - Payments and e-commerce: - Payments mainly in cash; less than 20 percent of total value of payments are cashless. - Corporate transparency and insolvency: - Informality and poor financial reporting generate information asymmetries increasing due diligence costs and loan premia. - Collateral requirements: value of collateral needed for a loan in Armenia is second highest in CCA and much higher than EMDE average (120 percent), though decreased since 2013. - Insolvency regime weaknesses and inefficient debt enforcement do not sufficiently protect secured creditors; 2016 amendments need further improvements to maximize returns to creditors and prioritize reorganization over individual creditor collection. ### IV. Determinants of Inward FDI and Implications of Declining Inward FDI - A. Empirical Analysis - Method: Fixed effects (FE) panel model using nonadvanced economy data over 1996–2020; dependent variable net inward FDI by nonresidents (percent of GDP); macroeconomic controls lagged one year (real GDP growth, log GNI per capita, inflation, general government fiscal balance, current account balance); structural variables from Worldwide Governance Indicators (control of corruption, government effectiveness, regulatory quality, rule of law, voice and accountability). - Key regression findings: - Real GDP growth has a significant positive impact on inward FDI; coefficient ~0.05 with statistical significance. - Log GNI per capita estimated negative but not consistently significant. - Inflation positive and significant in some specifications but coefficient close to zero. - Among structural variables, rule of law and voice and accountability are statistically significant when included individually; rule of law remains significant in horse race regression with all five structural variables. - Housman test favored FE over random effects at 1 percent level. - Magnitude: - Improving Armenia’s core governance and business environment characteristics to levels seen in top 5–25 percent of peer CCA and EMDE countries and maintaining them could lastingly increase inward FDI flows by up to ¾ percentage points of GDP. - Armenia’s performance: - Over 2017–2020 Armenia’s inward FDI averaged 1.1 percent of GDP (GNI per capita US$4,220 in 2020), below peer averages (countries with GNI per capita between US$4,000–6,000: average 2.8 percent). - Decline: net inward FDI fell from 4 percent of GDP (2011–2015 average) to 1¾ percent of GDP (2016–2020) — a decline of about 2 percentage points; larger than most peers. - Predicted vs actual: in 2020 actual inward FDI was 3½ percentage points lower than predicted using cross-country panel coefficients. - Sectoral drivers: - Decline in inflows associated with fading FDI in utility and telecommunication sectors after initial post-Soviet openings; stimulating new investment opportunities (e.g., manufacturing, high-value-added exports) may attract FDI. - B. Implications of Declining Inward FDI - Loss of benefits: - FDI contributes to production function via capital (K) and positive spillovers to total factor productivity (A) through knowledge and skill transfers; can increase employment if A and K raise optimal labor input (L). - FDI is relatively sticky and supports financial and external stability by contributing to foreign reserves. - Increased financial vulnerabilities: - Shift to debt-based external financing (loans, deposits) is more procyclical and volatile, raising financial stability risks. - Quarterly regressions suggest a positive association from one-quarter lag of loans by non-residents (net inflows, % of quarterly GDP) to dram appreciation against US$ (coefficient 0.35* in a specification), implying rapid reversal could trigger exchange rate depreciation. ### V. Policy Implications - Reinvigorate inward FDI and expand domestic financing; main recommendations: - Improve the business environment: - Continue progress on governance improvements, including anti-corruption measures (establishment of single anti-corruption entity highlighted). - Reduce informality and facilitate human capital development. - Maintain prudent macroeconomic policies to mitigate uncertainty and support higher stable growth that can stimulate FDI. - Prioritize efficient development of high-quality infrastructure via fiscal policy. - Expand and facilitate domestic financing to compensate for lower inward FDI and limit financial stability risks from reliance on less stable non-FDI external financing. - Develop a high-value-added export sector by reducing nontariff barriers, improving infrastructure quality, and strengthening education to expand domestic saving and attract FDI. - Increase financial inclusion of households and SMEs: - Reduce informality by providing incentives for formalization to broaden financial inclusion. - Improve financial literacy targeting gender and urban-rural disparities. - Reforms to facilitate corporate finance: - Improve financial reporting to simplify bank due diligence and lower collateral requirements. - Strengthen insolvency regime to better protect creditor rights and enhance rehabilitation and creditor recovery. ### VI. Conclusions - Sound macroeconomic policies and strengthening the business environment are central to reversing the decline in Armenia’s inward FDI. - Over past decade inward FDI declined more sharply and persistently in Armenia than in other emerging and developing economies. - Empirical estimates suggest improving core governance and business environment to top 5–25 percent among peers could increase inward FDI by up to ¾ percentage points of GDP. - Key constraints to improve access to finance: lack of sufficient funds, gender gap, financial literacy, urban-rural differences for households; informality, poor accounting, and weak financial management for firms. - Recommended priorities: reduce informality, develop capital markets, improve business environment, strengthen financial reporting and insolvency framework, and promote high-value-added exports. - COVID-19 and recent geopolitical developments heighten the importance of stable financing sources such as FDI and domestic financing for investment-led growth under the new government program. *Supporting Sustainable Financing and Access to Finance in Armenia Working Paper No. WP/2023/4* ### References ............................................................................................................. ### Supporting Sustainable Financing and Access to Finance in Armenia ### I. Introduction - Armenia achieved robust growth with real GDP growth averaging 6½ percent during 2000–2019. - Historically inward foreign direct investment (FDI) was key, reaching 6.4 percent of GDP on average during 2003–2007. - Over the past decade the share of inward FDI in private external financing declined significantly; reliance on debt-related inflows (loans and deposits) increased. - Access of the private sector to finance is moderate regionally but with important disparities: substantial gender gap and urban-rural gap in financial inclusion; SMEs face difficulties due to limited transparency, informality, and low financial management. - Three main messages: - Panel regressions confirm governance-related structural factors significantly affect Armenia’s attractiveness to inward FDI. Improving core governance and business environment to top 5–25 percent of peer CCA and EMDE countries could increase inward FDI flows by as much as ¾ percentage points of GDP. - Financial depth and inclusion: informality, poor accounting practices, and low financial management limit firm access to finance; lack of sufficient funds, gender gap, financial literacy, and urban-rural differences constrain household inclusion. - Policy measures to reinvigorate inward FDI and expand domestic finance (including strengthening financial reporting and reducing informality) could support recovery and private/export sector development; developing high-value-added exports could raise domestic saving (reference to Karapetyan et al., 2021). ### II. Context: External and Domestic Financing in Armenia - Saving-Investment balance: - Gross investment rate has declined steadily over the past 15 years; gross saving relatively stable since the GFC. - Prior to COVID-19, the saving-investment balance worsened due to rising investment and declining saving ratios. - Foreign saving (net income and transfers) declined steadily over the past 10 years. - Relative to peers, Armenia’s gross saving rate has been lower than CCA and EMDE since around 2010. - Implications: - Declining gross saving limits potential domestic financing for investment, placing greater emphasis on external financing (current account deficit). - Changing nature of private external financing: - Net FDI accounted for majority of net private capital inflows before the GFC; after the GFC net FDI declined to about one-third of pre-GFC levels relative to GDP. - Loans and deposits became more important since the GFC; nonresident deposits particularly influential since early 2010s. - Between 2010 and 2020 the share of non-FDI liabilities in total external liabilities increased by 10 percentage points to 60 percent. - The diminished role of inward FDI coincides with a trend decline in domestically-financed private investment (gross private capital formation minus net FDI). - Correlations and vulnerabilities: - Net inflow of deposits by residents and nonresidents positively correlated with global growth (Table 2 correlations reported). - Exchange rate has been correlated with overall net capital inflows but less with FDI in recent years; exchange rate is highly correlated with nonresident deposits and loans to private sector (Table 3). - Shift from FDI to non-FDI liabilities raises financial stability risks given Armenia’s relatively large external net liabilities (Figure 2). ### Access to Domestic Financing A. Financial Inclusion of Households - Financial system dominated by banks with total assets about 110 percent of GDP. - Account ownership at a financial institution: 48 percent of population ages 15+ (better than CCA average). - ATMs and commercial bank branches per capita increased, reaching an average for Central Europe and the Baltics. - Total deposits with commercial banks nearly doubled to 40 percent of GDP over the last ten years (exceeding CCA average). - Gender gap: - In 2017 about 40 percent of women had a bank account compared with about 60 percent of men; improved since 2014 but still below world average (65 percent) and Eastern Europe and Central Asia (66 percent). - The 2014 National Strategy of Financial Education included separate targets for women. - Financial literacy: - OECD survey: average literacy score in Armenia is 11.4 (out of 21); 27 percent of adults achieved minimum target score of at least 4 out of 7 on financial knowledge (compared with ~60 percent in South East Europe and ~70 percent in OECD). - Low literacy associated with negative attitudes towards saving. - Urban-rural divide: - Rural areas face limited infrastructure, higher informality, lower financial literacy, lower income, and lack of trust in financial system; fewer bank branches and ATMs. B. Financial Inclusion in Firms - Access to finance is main challenge for doing business: 30 percent of respondents in 2020 World Bank Enterprise Survey identified access to finance as main obstacle; informal sector practices were second at 15 percent. - SMEs: - About 42 percent of all firms and about 35 percent of small firms had a bank loan or line of credit (2020 Business Environment and Enterprise Performance Survey). - Main source of finance for SMEs is owner’s funds/internal resources; start-up financing often from informal sources. - Major barriers: lack of transparency, high informality; result: high collateral requirements and high risk premiums. - Payments and e-commerce: - Payments mainly in cash; less than 20 percent of total value of payments are cashless. - Corporate transparency and insolvency: - Informality and poor financial reporting generate information asymmetries increasing due diligence costs and loan premia. - Collateral requirements: value of collateral needed for a loan in Armenia is second highest in CCA and much higher than EMDE average (120 percent), though decreased since 2013. - Insolvency regime weaknesses and inefficient debt enforcement do not sufficiently protect secured creditors; 2016 amendments need further improvements to maximize returns to creditors and prioritize reorganization over individual creditor collection. ### III. Determinants of Inward FDI and Implications of Declining Inward FDI A. Empirical Analysis - Method: Fixed effects (FE) panel model using nonadvanced economy data over 1996–2020; dependent variable net inward FDI by nonresidents (percent of GDP); macroeconomic controls lagged one year (real GDP growth, log GNI per capita, inflation, general government fiscal balance, current account balance); structural variables from Worldwide Governance Indicators (control of corruption, government effectiveness, regulatory quality, rule of law, voice and accountability). - Key regression findings (Table 5 summaries): - Real GDP growth has a significant positive impact on inward FDI; coefficient ~0.05 with statistical significance (various specifications). - Log GNI per capita estimated negative but not consistently significant. - Inflation positive and significant in some specifications but coefficient close to zero. - Among structural variables, rule of law and voice and accountability are statistically significant when included individually; rule of law remains significant in horse race regression with all five structural variables. - Housman test favored FE over random effects at 1 percent level. - Magnitude: - Improving Armenia’s core governance and business environment characteristics to levels seen in top 5–25 percent of peer CCA and EMDE countries and maintaining them could lastingly increase inward FDI flows by up to ¾ percentage points of GDP (estimates interpreted with caution due to perceptions-based WGI). - Armenia’s performance: - Over 2017–2020 Armenia’s inward FDI averaged 1.1 percent of GDP (GNI per capita US$4,220 in 2020), below peer averages (countries with GNI per capita between US$4,000–6,000: average 2.8 percent). - Decline: net inward FDI fell from 4 percent of GDP (2011–2015 average) to 1¾ percent of GDP (2016–2020) — a decline of about 2 percentage points; larger than most peers. - Predicted vs actual: in 2020 actual inward FDI was 3½ percentage points lower than predicted using cross-country panel coefficients. - Sectoral drivers: - Decline in inflows associated with fading FDI in utility and telecommunication sectors after initial post-Soviet openings; stimulating new investment opportunities (e.g., manufacturing, high-value-added exports) may attract FDI. B. Implications of Declining Inward FDI - Loss of benefits: - FDI contributes to production function via capital (K) and positive spillovers to total factor productivity (A) through knowledge and skill transfers; can increase employment if A and K raise optimal labor input (L). - FDI is relatively sticky and supports financial and external stability by contributing to foreign reserves. - Increased financial vulnerabilities: - Shift to debt-based external financing (loans, deposits) is more procyclical and volatile, raising financial stability risks. - Quarterly regressions (Table 7) suggest a positive association from one-quarter lag of loans by non-residents (net inflows, % of quarterly GDP) to dram appreciation against US$ (coefficient 0.35* in a specification), implying rapid reversal could trigger exchange rate depreciation; results interpreted with caution due to potential reverse causality. ### IV. Policy Implications - Reinvigorate inward FDI and expand domestic financing; main recommendations: - Improve the business environment: - Continue progress on governance improvements, including anti-corruption measures (establishment of single anti-corruption entity highlighted). - Reduce informality and facilitate human capital development. - Maintain prudent macroeconomic policies to mitigate uncertainty and support higher stable growth that can stimulate FDI. - Prioritize efficient development of high-quality infrastructure via fiscal policy. - Expand and facilitate domestic financing to compensate for lower inward FDI and limit financial stability risks from reliance on less stable non-FDI external financing. - Develop a high-value-added export sector by reducing nontariff barriers, improving infrastructure quality, and strengthening education to expand domestic saving and attract FDI. - Increase financial inclusion of households and SMEs: - Reduce informality by providing incentives for formalization to broaden financial inclusion. - Improve financial literacy targeting gender and urban-rural disparities. - Reforms to facilitate corporate finance: - Improve financial reporting to simplify bank due diligence and lower collateral requirements. - Strengthen insolvency regime to better protect creditor rights and enhance rehabilitation and creditor recovery. ### V. Conclusions - Sound macroeconomic policies and strengthening the business environment are central to reversing the decline in Armenia’s inward FDI. - Over past decade inward FDI declined more sharply and persistently in Armenia than in other emerging and developing economies. - Empirical estimates suggest improving core governance and business environment to top 5–25 percent among peers could increase inward FDI by up to ¾ percentage points of GDP. - Key constraints to improve access to finance: lack of sufficient funds, gender gap, financial literacy, urban-rural differences for households; informality, poor accounting, and weak financial management for firms. - Recommended priorities: reduce informality, develop capital markets, improve business environment, strengthen financial reporting and insolvency framework, and promote high-value-added exports. - COVID-19 and recent geopolitical developments heighten the importance of stable financing sources such as FDI and domestic financing for investment-led growth under the new government program. *Italic: IMF Working Paper — Supporting Sustainable Financing and Access to Finance in Armenia* ### References ### References ### Determinants of Foreign Direct Investment and Capital Flows - Albuquerque, Rui, Norman Loayza, and Luis Servén (2005) “World Market Integration through the Lens of Foreign Direct Investors,” Journal of International Economics, 66(2): 267–295. - Bénassy‐Quéré, Agnès, Maylis Coupet, and Thierry Mayer (2007) “Institutional Determinants of Foreign Direct Investment,” The World Economy, 30(5): 764–782. - Borensztein, E, J De Gregorio, and J-W Lee (1998) “How Does Foreign Direct Investment Affect Economic Growth?” Journal of International Economics, 45(1): 115–135. - Dellis, Konstantinos, David Sondermann, and Isabel Vansteenkiste (2017) “Determinants of FDI inflows in Advanced Economies: Does the Quality of Economic Structures Matter?" Working Paper Series 2066, European Central Bank. - Hannan, Swarnali A (2018) “Revisiting the Determinants of Capital Flows to Emerging Markets—A Survey of the Evolving Literature,” IMF Working Paper No. 18/214. - Mistura, Fernando and Caroline Roulet (2019) “The Determinants of Foreign Direct Investment: Do Statutory Restrictions Matter?” OECD Working Papers on International Investment 2019/01: OECD Publishing. - Walsh, James P and Jiangyan Yu (2010) “Determinants of Foreign Direct Investment: A Sectoral and Institutional Approach,” IMF Working Paper No. 10/187. - Cheung, Calista, Davide Furceri, and Elena Rusticelli (2010) “Structural and Cyclical Factors behind Current-Account Balances,” OECD Economics Department Working Papers No. 775. - Borensztein, E, J De Gregorio, and J-W Lee (1998) “How Does Foreign Direct Investment Affect Economic Growth?” Journal of International Economics, 45(1): 115–135. ### Financial Inclusion, Financial Literacy, and Regulation - Alliance for Financial Inclusion (2017) “Integrating Gender and Women’s Financial Inclusion into National Strategies: A Guideline Note Developed by Members of the Financial Inclusion Strategy Peer Learning Group,” Guideline Note No. 27, February 2017. - Atkinson, Adele and Flore-Anne Messy (2012) “Measuring Financial Literacy: Results of the OECD/ International Network on Financial Education (INFE) Pilot Study,” OECD Working Papers on Finance, Insurance and Private Pensions, No. 15. Paris: OECD Publishing. - Nurbekyan, Armen and Naneh Hovanessian (2018) “Financial Inclusion, Regulation, Financial Literacy, and Financial Education in Armenia,” Asian Development Bank Institute, Working Paper, No. 843. - Organisation for Economic Co-operation and Development (2018) “Financial education in Armenia.” - International Monetary Fund (2019) “Financial Inclusion of Small and Medium-Sized Enterprises in the Middle East and Central Asia,” IMF Middle East and Central Asia Departmental Paper 19/02. - World Bank (2020) “Enterprise Surveys. Armenia 2020”, January 2020. ### IMF, Country Assessments, and Armenia-specific Analyses - French, Alice, Sebastiaan Pompe, Vahram Janvelyan, and Yulia Ustyugova (2019) “Anti-corruption Enforcement Priorities,” IMF Selected Issues Paper (Republic of Armenia), IMF Country Report No. 19/155. - International Monetary Fund (2020) “Republic of Armenia : Second Review under the Stand-by Arrangement,” Staff Report, IMF Country Report No. 20/176. - International Monetary Fund (2018) “Armenia Financial Sector Assessment Program” Country Report No. 18/361. - Karapetyan, Lili, Klakow Akepanidtaworn, Yulia Ustyugova, and Nathalie Reyes (2021) “Rebalancing Armenia’s Growth Model,” IMF Selected Issues Paper (Republic of Armenia), IMF Country Report No. 2021/274. - International Monetary Fund (2016) “Understanding the Slowdown in Capital Flows in Emerging Markets,” World Economic Outlook, Chapter 2, April 2016. - Kaufmann, Daniel, Aart Kraay and Massimo Mastruzzi (2010) “The Worldwide Governance Indicators: Methodology and Analytical Issues,” World Bank Policy Research Working Paper No. 5430. - Mistura, Fernando and Caroline Roulet (2019) “The Determinants of Foreign Direct Investment: Do Statutory Restrictions Matter?” OECD Working Papers on International Investment 2019/01: OECD Publishing. *Supporting Sustainable Financing and Access to Finance in Armenia Working Paper No. WP/2023/4* --- _Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023004-print-pdf.pdf_