Moody`s: Downgrade of Armenia`s government bond rating to B1 caused by increasing external vulnerabilities

 

Head of the Department of Public Debt Management of Armenia's Ministry of Finance Arshaluys Margaryan commented in a talk with ArmInfo's correspondent the possibilities for improvement of the rating this year, "The chances mainly depend on the key external factors, such as softening or lifting sanctions from Russia and growth of oil prices. Improvement of external environment will have a favorable influence on Armenia's economic situation". 

 

Moody's in its Global Credit Research published on 18 Mar 2016 mentions the following key drivers for the downgrade to B1. The first driver for downgrading Armenia's issuer and government bond ratings to B1 (from Ba3) is the country's increasing external vulnerabilities 

stemming from (a) declining remittances from Russia that have not yet bottomed out, (b) an uncertain outlook for foreign direct investment (FDI) inflows that collapsed in 2015, as well as (c) an elevated susceptibility to renewed pressures on the local currency and the country's foreign exchange reserves. The second driver captures Armenia's worsening fiscal and government debt metrics in the recent past and the likely upward debt trend trajectory over the coming two years. The rating agency expects the upward debt trajectory to continue, with the debt-to-GDP to rise above 50% in 2017.

 

Moody's experts mention that Russia remains Armenia's largest single export market destination as well as the major originator of gross money transfers (remittances) and FDI inflows into the country. Russia's ongoing economic crisis has not only weighed on Armenia's 

export sector, but also, and more importantly, depressed domestic private consumption through a drastic decline in remittances from Russia. Remittances from Russia, which had already contracted by 10% in US$ terms or 8.6% in local-currency (Armenian Dram; AMD) terms in 2014, declined by a further 35.6% in 2015 US$ terms (or 26% in AMD terms). Increased remittances from other countries, including the US, were not able to compensate for the deep fall in remittances from Russia. As a result, total gross remittances into Armenia decreased by 23.5% in 2015 in US$ terms (or 12.1% in AMD terms), addition to the contraction of 7.8% (or 6.3%) that had already occurred in 2014.  Despite recent declines, remittances from Russia still account for more than 60% of Armenia's total remittances (or 9.5% of Armenia's GDP). Given Russia's ongoing economic problems, Armenia's remittances 

will likely decline further this year and continue to depress private consumption. The collapse in FDI inflows also means that Armenia's gross capital formation will remain weak, weighing on the economy in the near term and constraining Armenia's medium-term growth potential. 

 

While Armenia's gross capital formation continued to contract for the third consecutive year in 2015 (latest number is as of Q3 2015: -13.2% Y-o-Y), annualized FDI inflows (as measured by the 4 quarter moving sum) decreased by almost 80% Y-o-Y in US$ terms in the third quarter of last year. Meanwhile, Armenia's gross external debt level has remained high both relative to Armenia's GDP as well as current account receipts, leaving the country vulnerable to a further worsening of external conditions. While Armenia's gross-external-debt-to-GDP ratio increased to more than 80% in 2015 (according to latest available data for Q3 2015) from 73.3% in 2014, the country's ratio of gross external debt to current account receipts rose further to an estimated 168% from roughly 153% in 2014.  Moody's forecasts Armenia's upward debt trend trajectory over the coming two years.  After remaining broadly stable between 2010 and 

2014, Armenia's government debt resumed its upward trajectory in 2015, primarily as a result of fiscal easing to support the domestic economy amid severe external headwinds and alsobecause of the debt-raising effects stemming from the currency depreciation on thegovernment's large share of foreign-currency debt. Specifically, the government-debt-to-GDP ratio increased to 48.7% in 2015 from 43.5% in 2014. At the same time, the government-debt-to-revenue ratio rose to around 208% (from roughly 180%). Debt affordability as captured by the ratio of interest payments to government revenues also deteriorated, increasing to 6.5% in 2015, up from 5.2% in 2014. Going forward, Moody's forecasts the ratio of interest payments to government revenues to increase further to around 8.5% in 2016, more than double the level of 2013 (4.2%). 

 

Moody's specialists forecast that the government will face significant headwinds this year and beyond in its efforts to gradually narrow the fiscal deficit as a result of weakening economic 

conditions. After benefiting from one-time boosting effects in the agriculture and mining sectors, Moody's expect real GDP growth to decelerate to 2.2% in 2016 (from an estimated 3.0% in 2015) given the ongoing adverse external environment. Beyond this year, economic 

growth is unlikely to pick up rapidly given the latent and weak recovery expected in its main trading partner, Russia. As a result, the rating agency expects the upward debt trajectory to continue, with the debt-to-GDP to rise above 50% in 2017.  Moody's baseline scenario does not foresee a reversal of this unfavorable trend in the coming years. Therefore, the strength of the government's balance sheet will remain much weaker than in the past, leaving the country more vulnerable to the adverse impact of potential renewed economic shocks in the future.

 

Downside risks mainly relate to worsening economic situation in Russia, which would adversely hit Armenia's economy more sharply than expected, mainly through the remittances, trade and investment channels, and which could prompt significant downward pressures on the local currency and the country's foreign exchange reserves.  Moreover, further major downside risks stem from lower prices for Armenia's major commodity export items (such as copper or metals), which would further affect the country's terms of trade. Under this adverse macro-economic scenario, the budgetary and debt trajectory would likely worsen significantly and further erode the country's fiscal strength. Major upside risks stem from a faster-than-expected improvement in the external environment and the related positive 

spill-over to the Armenian economy as well as rising prices for Armenia's major commodity export items (such as copper or metals), which would lead to an improvement in the country's terms of trade and would make foreign direct investment into Armenia's commodity sector more attractive. Stronger- than-expected growth could pave the way for more favorable budgetary outcomes and general government debt trends.