Fitch: Armenia s Geopolitical Environment is a Constraint on the Rating

ArmInfo. Fitch Ratings has affirmed Armenia's long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B+' with a Stable Outlook.  According to Fitch's July 27 statement, it has also affirmed the issue ratings on Armenia's senior unsecured foreign and local currency bonds at 'B+'.  The Country Ceiling has been affirmed at 'BB-' and the Short-term foreign currency IDR at 'B'.

According to Fitch experts, Armenia's geopolitical environment is a constraint on the rating. The latent conflict with Azerbaijan over the disputed Nagorno-Karabakh region entails the tail risk of escalating into a full-scale conflict. No resolution is expected in the short term.

Armenia's close relations with Russia have been strengthened further by Armenia's accession to the Eurasian Economic Union (EEU). After a hiatus in relations with the EU following Armenia's abrupt decision to join the EEU, the EU adopted a mandate in May for new negotiations with Armenia on improving the relationship.  Economic policy is supported by strong relations with the IMF, which act as a policy anchor.  Armenia is in a 38-month Extended Fund Facility with the IMF approved in March 2014.

Key Rating Drivers:

Armenia's ratings are currently supported by its relatively stable fiscal position and indicators of governance better than its 'B' rating peers. However, the country remains heavily exposed to the severe economic downturn in Russia (BBB-/Negative).

Latest national indicators on economic activity (Jan-May 2015 - 2.7% yoy growth - editor's note) suggest Armenia's economic growth is better than Fitch previously anticipated. As a result, we have revised upwards our real GDP forecast for 2015 to +1.5% from -0.5%, followed by growth of 2.5% and 2.9% in 2016 and 2017, respectively.  Growth will be mainly constrained by weak private consumption against a lower trend in net remittance receipts.

Armenia's large exposure to Russia increases risks to its growth prospects and balance of payments and weighs on the rating as a result. Russia is an important source of Armenia's net receipts of workers' remittances (80%, 2014) and export revenues (20%, 2014).  Remittances, which accounted for 13% of Armenia's GDP in 2014 and are a key driver of private consumption, fell 40% year-on-year in the first five months of 2015.

Armenia's external finances are weaker than the median of its 'B' range rating peers. Net external debt to GDP is high (42.6% vs 'B' median of 14.4%, 2014) and the current account deficit plus net FDI is large (-4.6% vs 'B' median of -2.7%, 2014). Pressures on the external finances have subsided in recent months. Foreign reserves up to June 2015 picked up 22.6% from February levels, helped by the issuance of a USD 500m Eurobond back in March. The dram has stabilised against the dollar following a17% depreciation between October 2014 and February 2015.

A degree of support for Armenia's rating is provided by the sovereign's public finances.  Armenia's fiscal deficit (2% of GDP, 2014) is less than half the 'B' median deficit (4.5% of GDP, 2014), and gross public debt-to-GDP (46.6%, 2014) is slightly below the 'B' median (47.8%). In addition, Armenia's debt profile benefits from a lower interest-to-revenue ratio than its peers. However, these positive characteristics are offset by the sovereign's large share of foreign currency debt.

The government deficit for 2015 is likely to come in at 3.5% of GDP, compared with the objective of 2.3% of GDP in the original budget, reflecting the weakening of the economy. A major objective is to increase government revenues, which are currently low, and an increase in excise duties is currently before parliament. However, tax increases and similar measures will likely face strong social and political challenges, as the recent protests against higher consumer electricity charges demonstrates.

The main factors that, individually or collectively, could trigger rating actions are:

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced.

The positive rating action factors are: a further easing of external pressures, for example an increase in foreign reserves and/or an improvement in the Russian economy, a decline in the debt-to-GDP ratio consistent with credible fiscal policies and robust GDP growth.

The negative rating action factors are:  a renewed worsening of economic conditions in Russia or a more severe spillover than expected; a renewed deterioration of foreign exchange reserves, fiscal slippage leading to a significant rise in the debt-to-GDP ratio. 

Key Assumptions:

Fitch assumes that Armenia will continue to enjoy broad social and political stability and there will be no significant worsening in tensions with Azerbaijan surrounding Nagorno- Karabakh. Fitch also assumes that the global economy performs broadly in line with Fitch's global Economic Outlook and that the US Federal Reserve interest rate hike expected for later in 2015 will not lead to disorderly market conditions that disrupt access to financial markets for emerging economies like Armenia.