Monday, September 5 2022 16:55
Karine Melikyan

Fitch Affirms Armenia`s Sovereign Rating at B+, Upgrades GDP Growth  Outlook to 6.4%

Fitch Affirms Armenia`s Sovereign Rating at B+, Upgrades GDP Growth  Outlook to 6.4%

ArmInfo. Fitch Ratings has affirmed Armenia's Long-Term Foreign- Currency Issuer Default Rating (IDR) at 'B+' with a Stable Outlook.  A full list of rating actions  is at the end of this rating action commentary. This was reported on  the Fitch Ratings website.

KEY RATING DRIVERS

Credit Fundamentals: Armenia's 'B+' IDRs reflect strong per-capita  income, governance and business environment indicators relative to  peers, as well as a robust macroeconomic and fiscal policy framework  and credible commitment to reform, underpinned by IMF support. Set  against these strengths are a high share of foreign-currency  denominated public debt, relatively weak external finances, and  geopolitical risks.

Positive Economic Spillovers from Ukraine Conflict: The Ukraine  conflict and sanctions on Russia have triggered a substantial  migration of Russian, Ukrainian and Belarusian citizens to Armenia  since March, with visitor numbers rising 515% yoy in 1H22. This is  further supported by a 200% yoy increase in money transfers from  Russia to Armenia in 1H22.  A large proportion of the migrants are  believed to be highly educated professionals, particularly from the  information and communications technology sector. These trends helped  boost growth 13% yoy in 2Q22 (1Q22: 8.7% yoy) and should provide  momentum in 2H22. Fitch has upped its real GDP growth projections for  2022 to 6.4% as remittances boost personal consumption, and export  performance (particularly to Russia) holds up. Fitch expects growth  will average 4.7% in 2023-24.

Geopolitical Risks: Armenia maintains a cautious approach to managing  relations with the US, UK and EU with regards to sanctions on Russia.  While authorities are committed to de-risking the banking sector to  avoid sanction violations, trade relations with Russia remain  sizeable. As of June 2022, Russia accounted for 31% of Armenia's  exports and 36% of imports, and an estimated 40% of FDI. Russia was  the source of 32% of money transfers (including remittances) before  the Ukraine conflict started. Armenia is also exceptionally dependent  on Russia for its energy supply, and since the start of the Ukraine  conflict, has started making payments for Russian natural gas imports  in roubles. There is little sign that diversification of export  markets is likely to occur in the short to medium term.

Relations with Azerbaijan have worsened in recent months, with  military engagement between the two countries in Nagorno-Karabakh in  August resulting in casualties on both sides, and further reported  territorial gains by Azerbaijan.  Tensions are expected to remain  high in the short term as Azerbaijan has begun resettling formerly  expelled residents of Nagorno Karabakh in the region, although Fitch  does not presently expect this will have broader macroeconomic  implications.

Overheating Risks: The large influx of migrants and resultant boost  to demand added to inflationary pressures, with consumer price growth  reaching an 11-year high of 10.3% in June, well outside the Central  Bank of Armenia's (CBA) 4% (+/- 1.5pp) target. Property rentals,  driven by rising demand from expatriates, rose by 23.4% yoy in June  and will pose upside risks to inflation. The strength of the dram,  which appreciated 16% against the US dollar in February-July, acts as  a restraint on price growth to some extent, given the very high  dependence on food imports. Retail energy price pressures are more  limited, given that Armenia has locked in natural gas supplies from  Russia at 2021 prices. The CBA has raised rates by a cumulative 175bp  in 2022 to 9.5% as of August, and is expected to reduce rates only  gradually, to 8.5% by end-2023. While the inflation targeting regime  is broadly credible, the high level of dollarisation (42% of banking  sector deposits and 39% of loans to residents as of July 2022)  impedes the transmission mechanism of monetary policy to some extent.

Reduced External Liquidity Risks: The large increase in money  transfers and other remittances, and the drawdown of the final USD35  million tranche of a USD415 million IMF Stand-By Agreement Facility  in 1H22 boosted FX reserves to a 20-year high of USD3.5 billion as of  July (representing an 11.4% increase since February 2022). However,  Fitch expects the trend to level off in the context of historically  large current account deficits (CAD; annual average of 5.3% of GDP in  2012-21). Fitch projects the CAD to reach 4.8% of GDP in 2022 and  average 6.2% in 2022-23 (current 'B' median: 4.1%).  The net external  debt levels of Armenia, at a projected average of 46.4% in 2022-24,  will remain well above the current 'B' median of 25.5%.

Solid External Creditor Support: Armenia benefits from strong support  and technical assistance from a range of multilateral and bilateral  creditors. As of end-1H22, 48% of general government debt was owed to  official lenders.  Authorities intend to rely on a pipeline of  concessional borrowing to build up cash buffers in 2022-24. These  include the World Bank, Asian Development Bank, and the French  Development Agency, which will keep borrowing costs low and reduce  liquidity risks.

Fiscal Overperformance Likely in 2022: Tax revenue overperformance  owing to strong nominal growth in 1H22, as well as capex  under-execution will help reduce the fiscal deficit from 4.6% of GDP  in 2021 to 3.1% in 2022 (below the pre- pandemic five-year average of  3.5%). A strong dram reduces debt servicing costs and is net positive  for the budget. Fitch forecasts the fiscal deficit to further fall to  2.6% in 2023 and 2.3% in 2024, outperforming the 'B' median of 4.4%.  We anticipate that authorities will remain committed to returning to  adherence to fiscal rules in 2022, following the activation of the  escape clause for 2020 and 2021.

High FX Debt: Exposure to exchange rate volatility is the key risk to  debt dynamics in the medium term, given that 64.7% of gross general  government debt (GGGD) was foreign-currency denominated at end-June  (current 'B' median: 63.4%).  Fitch projects the substantial  appreciation of the dram vs the US dollar in 2022 and strong nominal  GDP growth will reduce GGGD/GDP by nearly 10pp to 50.5%, but that  subsequent depreciation could lift it back to around 54% in 2023- 24.

ESG - Governance: Armenia has an ESG Relevance Score (RS) of '5'  Political Stability and Rights, and '5[+]' for the Rule of Law,  Institutional and Regulatory Quality and Control of Corruption. These  scores reflect the high weight that the World Bank Governance  Indicators (WBGI) have in our proprietary Sovereign Rating Model.  Armenia has a medium WBGI ranking at the 49th percentile reflecting a  recent record of peaceful political transitions, a moderate level of  rights for participation in the political process, moderate  institutional capacity, established rule of law and a moderate level  of corruption.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative  rating action/downgrade:

- External Finances: A worsening of external imbalances or emergence  of external financing pressures leading to a sharp fall in reserves  and/or a rise in the external interest burden.  - Public Finances: Fiscal deterioration that results in financing  difficulties and/or a  sustained increase in general government debt/GDP over the medium term.  - Macro: A severe macroeconomic shock, related to spillovers from Russia or renewed hostilities in Nagorno- Karabakh, which greatly  undermines growth and financial stability.

Factors that could, individually or collectively, lead to positive  rating action/upgrade:  

- Public Finances: Improved confidence in  general government debt/GDP returning to a firm downward path over  the medium term.   - External Finances: A sustained improvement in external indicators;  for example, a fall in net external debt levels  to closer to the 'BB' median, supported by improved current account  balance and FDI inflows.   - Structural: A marked and durable reduction in geopolitical risks.

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