RAEX-Europe confirmed Armenia`s ratings at `BB-` with outlook  "Positive"

ArmInfo. Rating-Agentur Expert RA confirmed the  sovereign government credit rating (SGC) of Armenia at 'BB-'  (Sufficient level of creditworthiness of the government) in national  currency and at 'BB-' (Sufficient level of creditworthiness of the  government) in foreign currency.

As noted in the official press release of the agency, received by ArmInfo the confirmation of sovereign government credit ratings of Armenia at 'BB-' with positive  outlook reflects the continued high economic growth supported by  stabilization of the fiscal balance and drop of public debt levels.  Furthermore, the quality of the monetary and fiscal policies remains  efficient and adequate.

"Nevertheless, government debt levels continue to be elevated and  exposed to currency risks. In addition, the economy is highly  dependent on imports, remittances inflow and main trading partners.  Final, the current account remains negative, making the weak external  position one of the key factors constraining the rating" clarified  Olena Kolokolova, Rating Analyst of RAEX-Europe.

Economy shows remarkable growth in 2019. The economic activity  remained strong during 3Q 2019, driven by solid private consumption  and investment, mainly in the construction sector. On the production  side, the largest growth belongs to the mining industry with a 45,2%  increase since the beginning of the year. However, the energy sector,  which is considered an important industry for economic  diversification, decreased by 3,5% within the same time frame. 

Estimated real GDP growth for 2019 is 6-7%, the highest in the  Caucasus region. The large Amulsar gold project run by the foreign  company Lydian International is currently facing environmental  concerns from Armenian authorities; despite this, the opening of the  new gold mine operation will have a positive impact on economy  growth.

The banking sector remains stable. Commercial banks are well  capitalized and have sufficient liquidity. According to the Central  Bank of Armenia (CBA), regulatory capital to risk-weighted assets  indicator is stable at 17,5% as of October 2019. The NPLs to total  loans ratio remained stable at 5,2%, however, the real asset quality  improvement might be lower due to the overall loans growth.  Profitability remained subbed and volatile, ROA stood at 1,7% and ROE  11,1% in October 2019, despite an annual improvement of 0,1 p.p. and  1,7 p.p. respectively.

Domestic credit provided by financial sector to GDP is expected to  rise by 4% in 2019 up to 67% as total loans grew by 13% since the  beginning of the year; it is mostly related to the household sector  (increase of 27%) and not to the corporate sector, which contributes  to production and growth of the real economy. In order to control  rapid consumer lending growth, the CBA tightened the capital adequacy  ratio from January 2020 by introducing tree Basel III standards:  buffer for systemically important banks, capital conservation buffer  and a counter-cyclical buffer. Another aim of the requirements is to  create additional reserves to protect the banking system from  external shocks and financial instabilities. 

"Despite the positive trend, financial dollarization continues to be  high, as 50% of total loans and 47,3% of total deposits of the  residents were denominated in the foreign currencies as of November  2019. Moreover, more than 42% of total banking system assets are  concentrated in the hands of the top-3 banks", RAEX Europe reports  reads.

Government debt continues in a downward trend. In 2019, Armenia came  very close to the target of 50% debt to GDP set by the fiscal rule  introduced in 2018, as according to preliminary data government debt  will be close to 51% of GDP and 212 % of budget revenues. 

The structure of the public debt continues to be stable. As of  November 2019, short-term debt accounted for 4,6% of total debt, 15%  had floating interest rate and FX-denominated debt remained elevated  at 78,6%; nevertheless, this type of debt remains mostly  concessional. 

The 10-year USD-denominated Eurobond issued by the government in  September 2019 has a yield spread of around 2,3 p.p. with US bonds  with the same maturity, reflecting relatively low risk.

The CBA continues with its expansionary monetary policy. The low  inflation environment allowed the CBA to take action and cut the  refinancing rate twice in 2019 by 0,25p.p. each time down to 5,5%.  Nevertheless, the inflation rate in 3Q 2019 was 1%, which is lower  than originally expected and well below the CBA initial target of 4% . 

RAEX Europe expects further monetary policy stimulus of CBA in order  to bring inflation closer to the target in 2020. The effect of the  monetary policy transmission mechanism together with the stable local  currency was reflected in declining dollarization trend.

The fiscal environment continues to improve. Contractionary fiscal  policy allowed to narrow budget deficit further in 2019 with the  final estimation for the year 1,5% of GDP, lower by 0,7p.p. than  initially targeted in the State Budget law and 0,3 p.p. narrower than  previous year result due to the higher VAT revenues and capital  underspending.

In the mid-term, RAEX Europe continues to expect the fiscal policy to  remain prudent and as government introduced in 2020 a new tax policy  to decrease a tax burden, fight shadow economy and improve tax  administration. The corporate income tax was reduced by 2p.p. to  18,0% and the tax on dividends for non-resident organizations by  5p.p. to 5,0%, while Personal Income Tax (PIT) was changed to a fixed  level of 23%. Higher taxes on special activities and removing several  tax exemption should offset the rates cuts, however, the Agency will  observe carefully the effects of the new tax system, in terms of  budget tax revenues generation and a change of income disproportion  within the population. 

According to the Medium Term Expenditure Framework for 2020-2022  there will be a change in the budget expense structure with higher  capital expenditure prioritization and the budget deficit to GDP  ratio around 2,2%.

External position continues to deteriorate. The estimated current  account deficit of Armenia is 7,3% of GDP in 2019. The country is  heavily dependent on imports and the trade deficit is expected to  expand further in 2019 until up to 18% of GDP, 3p.p. higher than in  2018 due to unfavorable prices on the main export commodity - cooper  ore. The wider trade deficit was partly offset by stronger transfers  from abroad, 6% y-o-y increase in 3Q 2019. 

Starting from January 2020, Armenia will be affected by new import  customs duties from the countries that are not members of the  Eurasian Economic Union (EAEU), such as USA, Brazil and Ukraine,  potentially increasing overall imports. Additionally, the results of  the import substitution policy in Russia regarding the food industry  had a negative effect on neighboring countries' exports. 

At the end of 2019, Gazprom Export LLC signed a new one-year contract  with Gazprom Armenia CJSC to supply gas to Armenia in 2020 on the  same terms as in 2019 (with a discount of 30%). However, there is a  risk of gas prices to rise in 2021 significantly impacting the trade  balance.

In 2019, the government adopted a five-year program, which outlines  the main foreign relationship development directions and  anti-corruption policies in order to improve the investment climate.  Despite all the potential, FDI inflows to GDP will remain at 2% in  2019, an average rate for the last five years. 

In conclusion the authors of the report note that the conflict with  Azerbaijan for the Nagorno-Karabakh remains unresolved and has a  potential to escalate. Moreover, rising global trade and political  tensions could cause a slowdown in Armenia's main trading partners.

Read the full report on the RAEX-Europe sovereign rating of Armenia  at:   https://raexpert.eu/reports/Research_report_Armenia_10.01.2020.pdf  (English version).

Agency Information: Rating-Agentur Expert RA GmbH (RAEX-Europe) is an  independent European rating agency affiliated with the international  group of rating agencies RAEX. The Agency is registered by ESMA  (European Securities and Markets Authority) and received ECAI status  (External Credit Assessment Institution) in 2015. The Agency's office  is located in Frankfurt (Germany). The purpose of the Agency is to  assign ratings in accordance with the strictest regulation and code  of ethics to non-financial companies, financial institutions,  insurance companies, regions and countries. AmRating National Rating  Agency is a partner of RAEX-Europe in the Republic of Armenia.