Monday, July 31 2023 15:25

ArmInfo.Fitch Ratings has upgraded Armenia's Long-Term Foreign-Currency Issuer Default Rating  (IDR) to 'BB-' from 'B+'. The Outlook is Stable. This is stated in the message of the agency.

According to the source, the upgrade of the IDR reflects the  following key rating drivers and their relative weights: 

High

Solid Economic Growth: Armenia has had a strong rebound from  successive shocks in recent years since its downgrade in 2020, and  Fitch expects this dynamism to continue in light of an extraordinary  inflow of migrants. Since the start of the Ukraine conflict in 2022,  an estimated 50,000-65,000 immigrants (equivalent to 2.2% of  Armenia's pre-conflict population) from Russia, Ukraine and Belarus  have settled in the country. This supported strong growth of 12.6% in  2022, and Fitch expects the economy to grow by 7.2% in 2023, 5.9% in  2024 and 4.5% in 2025.

Consumption will remain solid while the outlook for  goods-and-services exports is also positive despite a strong  appreciation of the Armenian dram, mainly due to a resurgence in  tourism and re-exports to Russia. If current economic trends  continue, Armenia's already favourable medium-term potential growth  (estimated at 4.5%) could receive a further boost from expansion of  the labour force and improvements in productivity. Fitch expects  income per capita (at market exchange rates) to nearly double from  2021 levels by 2025.

Debt Stabilising at Low Level: Government debt/GDP fell sharply to  46.7% in 2022 from 60.2% in 2021 due mainly to currency appreciation,  but also the strong nominal GDP rebound and fiscal consolidation.  Fitch expects stabilisation at around 44.6% in 2023-25, below its  pre-pandemic 2019 level of 53.7% and the current 'BB' median of  54.1%. The share of FX-denominated debt of 60.5% as of 1Q23 is above  the 'BB' median of 55%, although this has declined from 71.2% at  end-2021 due to sharp dram appreciation as well a shift to greater  local borrowing.

Risks to debt dynamics are mitigated by the relatively large share of  concessional debt, and the high proportion of fixed rate debt (84.1%  as of May).

Medium

Stable Fiscal Performance: Fitch expects that robust nominal economic  growth and higher spending will result in a moderate increase in the  general government deficit (cash basis) to 2.5% of GDP, from 2.2% in  2022. Fitch's forecast is more optimistic than the government's  expectation of a deficit of 2.9%, given the agency's higher growth  projection, and slightly more conservative view of capex execution.  Fitch expects the deficit to widen to an average of 3% of GDP in  2024- 25.

Improving External Balance Sheet: The current account posted a  surplus of 0.8% of GDP in 2022 (2021: deficit of 3.7%) as a result of  solid demand for services and goods exports and money transfers  (including remittances). We expect the current account to fall back  into a deficit of 1.1% of GDP on average in 2023-2025 on strong  domestic demand, but remain below historical averages in light of  these positive factors. The stronger external position reduced net  external debt to 24.6% of GDP in 2022 from 44.5% in 2021, and we  expect a further decline to 16.1% of GDP by 2025, in line with peer  medians. The external liquidity ratio is expected to peak at about  150% in 2024.

There are some inherent risks from high reliance on the Russian  market (49% of exports and 25% of imports in January-May 2023),  although in the short term, Armenia will benefit from the sharp  increase in re-exports to the country that is occurring as a result  of closure of other trade routes to Russia due to sanctions.   Armenia's 'BB-' IDRs also reflect the following key rating drivers:   Rating Fundamentals: Armenia's 'BB-' ratings are supported by a  robust macroeconomic and fiscal policy framework, and credible  commitment to structural reforms, and favourable per capita GDP.  These factors are balanced against a high share of  foreign-currency-denominated public debt, and relatively high (albeit  reducing) financial dollarisation. Governance scores are slightly  below the 'BB' median, and capture heightened geopolitical risks  emanating from tensions with Azerbaijan.

Rising Geopolitical Risks: Fitch considers geopolitical risks from  Azerbaijan to have increased since the start of the year. As of July,  a seven-month long Azerbaijani blockade of the Lachin Corridor in the  disputed Nagorno-Karabakh region is ongoing, and there have been  multiple deadly military clashes on the border. Peace talks between  the two countries continue, but in our view, are unlikely to yield a  lasting peace agreement in the absence of territorial adjustments  that may be politically difficult for Armenia to accept.

Fitch believes that in the event of a military conflict with  Azerbaijan over Nagorno- Karabakh, fighting will largely be limited  to the disputed region, and broader macroeconomic implications for  Armenia will be limited.

Lower Inflation, Strong Currency: Sharp increases in money transfers  and movement of migrants from Russia have contributed to a sustained  strengthening of the dram since mid-2022. The strong dram and the  easing of global commodity prices caused inflation to fall into  negative territory in June (-0.5% yoy) from a peak of 8.1% in  January-February. Core inflation is also declining, from an average  of 8% in 1Q23 to 1.5% yoy in June, notwithstanding strong wage growth  (18% yoy as of May 2023), reducing concerns over economic  overheating. Fitch expects the dram to moderately depreciate in  2023-24, albeit still to levels stronger than before the start of the  Ukraine conflict.

Solid External Creditor Support: Armenia benefits from strong support  and technical assistance from a range of multilateral and bilateral  creditors. As of May 2023, an estimated 78% of external public debt  was owed to official lenders, offering favourable financing  conditions. Armenia is also the beneficiary of a 36- month USD172  million stand-by arrangement with the IMF, although authorities are  currently treating this as precautionary.

Stable, Dollarised Banking Sector: The Armenian banking sector has  favourable profitability (return on equity of 18%), asset quality  (non-performing loan ratio of 2.6%) and capitalisation (Tier 1  capital ratio of 18.7% as of May).  Deposit dollarisation levels have  been stable, at 52.3% as of May 2023, while loan dollarisation  declined slightly to 34.8% as of May.

There are signs of overheating in the property market, with  residential property prices rising by an average of 10% yoy in 1H23,  owing mainly to the heightened demand from the population surge.  However, Fitch sees risks of a disorderly correction as relatively  low, and any spill over on the broader economy will likely be  limited, given strong household and corporate balance sheets. Banks  have adequate dram and US dollar liquidity, and a destabilising  outflow of deposits is not seen as likely.

ESG - Governance: Armenia has an ESG Relevance Score (RS) of '5' &  '5[+]' respectively for both Political Stability and Rights and for  the Rule of Law, Institutional and Regulatory Quality and Control of  Corruption. Theses 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 47th percentile,  reflecting a moderate level of rights for participation in the  political process, moderate institutional capacity and level of  corruption, and established rule of law. Armenia scores poorly on  Political Stability and Absence of Violence, reflecting high  geopolitical risks arising from a territorial dispute with  Azerbaijan, the source notes.

Fitch believes that the factors that could, individually or  collectively, lead to negative rating action/downgrade are:

- Structural/Macro: Materialisation of geopolitical risks that could  undermine growth and financial stability.

- External Finances: External shocks that result in a sizeable  decline in international reserves or increase in current account  deficits.

- Public Finances: A substantial increase of general government  debt/GDP, particularly due to a slowdown in growth or sharp fiscal  loosening.

Avd factors that could, individually or collectively, lead to  positive rating action/upgrade are:

- Macro: Increased confidence in durability of high growth rates  relative to rating peers that results in a sustained increase in GDP  per capita.

- Public Finances: Fiscal consolidation that supports a decline in  general government debt/GDP, and deepening of local-currency funding  sources that reduces the FX proportion of government debt.

-Structural: A marked and durable reduction in geopolitical risks.

Fitch's proprietary SRM assigns Armenia a score equivalent to a  rating of 'BB' on the Long-Term Foreign-Currency (LT FC) IDR scale.   Fitch's sovereign rating committee adjusted the output from the SRM  to arrive at the final LT FC IDR by applying its QO, relative to SRM  data and output, as follows:

- Macro: -1 notch to offset the large improvement in several SRM  variables resulting from the appreciation of the dram in 2022-2023,  which renders them sensitive to a potential reversal of this trend,  as well as lingering uncertainties about the longer-term  macroeconomic benefits emanating from capital and migration flows  into Armenia.

Fitch's SRM is the agency's proprietary multiple regression rating  model that employs 18 variables based on three-year centred averages,  including one year of forecasts, to produce a score equivalent to a  LT FC IDR. Fitch's QO is a forward-looking qualitative framework  designed to allow for adjustment to the SRM output to assign the  final rating, reflecting factors within our criteria that are not  fully quantifiable and/or not fully reflected in the SRM.

According to the source, the Country Ceiling for Armenia is 'BB-', 1  notch above the LT FC IDR. This reflects moderate constraints and  incentives, relative to the IDR, against capital or exchange controls  being imposed that would prevent or significantly impede the private  sector from converting local currency into foreign currency and  transferring the proceeds to non-resident creditors to service debt  payments.

Fitch's Country Ceiling Model produced a starting point uplift of +1  notch above the IDR. Fitch's rating committee did not apply a  qualitative adjustment to the model result.

As for the  bestworst case rating scenario they note:

"International scale credit ratings of Sovereigns, Public Finance and  Infrastructure issuers have a best-case rating upgrade scenario  (defined as the 99th percentile of rating transitions, measured in a  positive direction) of three notches over a three-year rating  horizon; and a worst-case rating downgrade scenario (defined as the  99th percentile of rating transitions, measured in a negative  direction) of three notches over three years. The complete span of  best- and worst-case scenario credit ratings for all rating  categories ranges from 'AAA' to 'D'. Best- and worst-case scenario  credit ratings are based on historical performance."

They also noted, that "references for substantially material source  cited as key driving of rating, the principal sources of information  used in the analysis are described in the Applicable Criteria."

As for the ESG considerations,  they note, that:  "Armenia has an ESG  Relevance Score of '5' for Political Stability and Rights as World  Bank Governance Indicators have the highest weight in Fitch's SRM and  are therefore highly relevant to the rating and a key rating driver  with a high weight. As Armenia has a percentile rank below 50 for the  respective Governance Indicators, this has a negative impact on the  credit profile.

Armenia has an ESG Relevance Score of '5[+]' for Rule of Law,  Institutional & Regulatory Quality and Control of Corruption as World  Bank Governance Indicators have the highest weight in Fitch's SRM and  are therefore highly relevant to the rating and a key rating driver  with a high weight. As Armenia has a percentile rank below 50 for the  respective Governance Indicators, this has a negative impact on the  credit profile.

Armenia has an ESG Relevance Score of '4' for Human Rights and  Political Freedoms as the Voice and Accountability pillar of the  World Bank Governance Indicators is relevant to the rating and a  rating driver. As Armenia has a percentile rank below 50 for the  respective Governance Indicator, this has a negative impact on the  credit profile.

Armenia has an ESG Relevance Score of '4[+]' for Creditor Rights as  willingness to service and repay debt is relevant to the rating and  is a rating driver for Armenia, as for all sovereigns. As Armenia has  a track record of 20+ years without a restructuring of public debt  and captured in our SRM variable, this has a positive impact on the  credit profile.

Except for the matters discussed above, the highest level of ESG  credit relevance, if present, is a score of '3'. This means ESG  issues are credit-neutral or have only a minimal credit impact on the  entity, either due to their nature or to the way in which they are  being managed by the entity. For more information on Fitch's ESG  Relevance Scores, visit www.fitchratings.com/esg."