ArmInfo.On Aug. 25, 2023, S&P Global Ratings raised its long-term foreign and local currency sovereign credit ratings on Armenia to 'BB-' from 'B+' and affirmed its short-term foreign and local currency sovereign credit ratings at 'B'. The outlook is stable.
S&P also agency revised Armenia's transfer & convertibility assessment to 'BB' from 'BB-'. S&P Global Ratings reports, indicating that the stable outlook balances Armenia's strong economic growth prospects and improved fiscal balance sheet against its moderately weak external position and elevated geopolitical risks. Rationale for Upgrading Armenia's Sovereign Rating
The Agency also notes that the stable outlook balances Armenia's strong economic growth prospects and improved fiscal balance sheet against its moderately weak external position and elevated geopolitical risks. S&P analysts noted that th The upgrade reflects the improvements in Armenia's GDP per capita and fiscal performance. The country's close geographic, economic, and cultural ties with Russia have positioned it as one of the preferred destinations for Russian individuals and businesses seeking refuge from their home country's economic and political stresses. As a result, migrant and capital inflows have propelled economic growth, with real GDP in Armenia increasing by 12.6% in 2022, and have narrowed Armenia's persistent fiscal and current account deficits. Financial inflows also resulted in a 22% appreciation of the Armenian dram against the U.S. dollar in 2022. This substantial currency appreciation has helped to shrink the government debt stock in U.S. dollar terms. Tensions between Armenia and Azerbaijan over the disputed region of Nagorno-Karabakh have also reduced, with a shaky peace deal so far holding up.
"A sharp reversal in financial and labor inflows into Armenia from Russia within the next few years appears unlikely. Firstly, the ongoing Russia-Ukraine war seems protracted and, even if a settlement is achieved, sanctions and stresses on the Russian economy are likely to linger. Secondly, anecdotal evidence from Russian emigrants suggests they have no immediate plans to return home from Armenia, and alternative destinations for them are limited. Barring extreme scenarios--such as a new direct military conflict with Azerbaijan--we expect Armenia's economic growth prospects in the coming years to remain robust, with projected real-term growth of approximately 7.5% in 2023 and averaging 4.0% in 2024-2026. Moreover, we anticipate that the country's external and government balance sheets will remain stronger than pre-war levels.
Our ratings on Armenia are constrained by weak, albeit improving, institutional settings, moderately low income levels, weak external and fiscal positions, and its exposure to geopolitical and external security risks. The ratings are supported by Armenia's strong growth outlook, continued availability of external official funding, and a prudent macroeconomic policy framework that has helped preserve economic and financial stability in recent years despite multiple external shocks. Institutional and economic profile: Economic growth is set to slow in 2023 on base effects but will otherwise remain robust until 2026
-We anticipate that moderating financial and migrant flows will result in real GDP growth decelerating to 7.5% in 2023 from 12.6% in 2022.
-Inflows of capital and labor could significantly boost Armenia's medium-term economic growth rate to approximately 4%-5% per year in real terms.
-External security threats stemming from the Nagorno-Karabakh region conflict continue to pose a risk. However, the recent increase in momentum in peace talks is positive in addressing and mitigating the potential threat of conflict.
After a stellar year for Armenia's economic output in 2022, we expect growth will slow but remain at a robust 7.5% in 2023. This mild slowdown can be attributed to weaker external demand, more restrictive financial conditions, and moderating financial and migrant inflows.
Last year, spillovers from the Russia-Ukraine conflict helped Armenia's economy to expand significantly by 12.6%. This surge is primarily attributed to inward migration from Russia, which boosted the economy through various channels. A substantial portion of migrants from Russia are skilled and young IT professionals. As such, the influx of skilled labor, coupled with the establishment of over 1,000 foreign-owned companies, has contributed significantly to the growth of sectors such as IT, which expanded by 51% in 2022 (the country's most productive sector). Significant financial inflows, particularly through money transfers from Russia, have also benefited Armenia's economy. Gross inflows of money transfers from Russia equated to 18.4% of Armenia's GDP in 2022, up from 6.2% in 2021. However, these transfers have begun to stabilize in recent months, which we expect to continue given that immigration flows have dissipated. Migration from Russia has also boosted Armenia's catering, real estate, and transportation sectors. In 2022, Armenia received 1.67 million tourists, though this is still 14% below 2019 levels. That said, tourism remains strong, with a 79% increase in arrivals in the first quarter of 2023, compared with the same period last year. Despite the recent appreciation of the Armenian dram against the U.S. dollar reducing tourists' purchasing power, we expect tourism levels to remain robust.
Russia remains a key trader partner for Armenia. In 2021, 28% of the country's total exports went to Russia, surging to 45% in 2022, largely due to the Russia-Ukraine conflict and Russia's diminished trading opportunities. However, distinguishing between Armenian-origin exports and re-exports via Armenia is challenging due to limited data. Exports to Russia have begun to stabilize and we anticipate this will continue due to Russia's weaker economic prospects and the implementation of stricter Armenian export controls on certain product categories such as semiconductors.
From 2024, Armenia's growth outlook could face several possible challenges. Firstly, labor and capital inflows from Russia could reverse. However, this seems unlikely in the near-term as recent domestic political and economic stresses in Russia are reducing the incentives for its citizens to return. Secondly, a sharp slowdown in economic growth in Russia and the EU, which are key trading partners for Armenia, could weigh on Armenia's own economic growth prospects. Lastly, persistent external security risks along the Armenian/Azerbaijan border could spill over into Armenia and affect economic performance. Nevertheless, we note that the recent increase in human and financial capital could strengthen Armenia's potential growth rate. In our base-line scenario, we anticipate an average annual real GDP growth rate of around 4% until 2026.
Tensions between Armenia and Azerbaijan have persisted over the disputed Nagorno-Karabakh region since fighting reignited in November 2020, leading to some territorial gains for Azerbaijan. Since then, besides the occasional flareup--including a bout of fighting in late 2022--the situation has largely been contained. The U.S. and the EU, and separately Russia, have been encouraging both countries to pursue a peace agreement. Armenia recently stated it is ready to recognize Nagorno-Karabakh as a part of Azerbaijani territory with certain conditions. Given this development, recent months have shown some momentum in peace talks, raising the possibility of an agreement in the medium term. However, given Nagorno-Karabakh's historical significance, any peace deal will likely face public opposition in Armenia; previous peace negotiations with Azerbaijan sparked protests against the government. Such political tensions could escalate and influence the government's policy direction.
Flexibility and performance profile: The budget deficit is set to widen this year, but will narrow thereafter as the authorities prioritize fiscal prudence
-In our view, the budget deficit will increase to 2.8% of GDP in 2023 and then narrow gradually in the subsequent periods.
-We therefore expect net general government debt is estabilize at a moderate 42% of GDP through 2026.
-Armenia's current account deficit will widen to 2.0% of GDP in 2023, from a modest surplus of 0.8% in 2022, but then shrink in 2024-2026.
The government targets a budget deficit of 3.1% of GDP in 2023, widening from an estimated 2.4% in 2022. The 2023 budget target encompasses an economic growth forecast of 7% in real terms. We estimate a significantly smaller budget deficit of 2.8% of GDP given strong growth this year. Beyond 2023, we expect gradual consolidation on the back of the government's efforts to improve revenue collection and increase compliance with fiscal rules, resulting in average annual general government deficits of 2%-3% of GDP through 2026. We expect the three-year stand-by arrangement (SBA) program with the IMF will underpin the fiscal path.
Armenia's net government debt-to-GDP ratio declined to 42% in 2022 from 54% in 2021. This was driven by a lower-than-planned budget deficit, a 22% appreciation of the dram against the U.S. dollar, and high nominal GDP growth of 22%. We expect net general government debt levels to remain relatively stable given our fiscal projections, averaging 42% of GDP in 2023-2026.
Armenia is somewhat insulated from the effect of high energy prices. The country's economy relies heavily on natural gas (61%) as its primary energy source, with a smaller dependence on oil (12%). Russia supplies most of Armenia's natural gas (85%) through long-term contracts, which helps protect Armenia from the effect of the elevated spot prices experienced in 2022.
Despite recent improvements, Armenia's balance of payments position currently remains pressured. The country has run current account deficits consecutively in recent years, translating into a sizable net external liability position of some 87% of current account receipts (CAR). Owing to lower external demand (for both goods and services) and lower inward remittances, we expect the current deficit to widen to 2.0% of GDP in 2023, from a surplus of 0.8% in 2022. We project the current account deficits will be financed through a combination of government external borrowing (mostly concessional), net foreign direct investment inflows. As a result of this funding mix, Armenia's external debt net of liquid external assets (narrow net external debt--our preferred measure of external leverage) is set to gradually increase in the medium term to 52% of CAR, but to stay below 100% of CAR.
In December 2022, the IMF approved a $171 million 36-month SBA for Armenia as a precautionary measure to protect against balance-of-payments shocks. The first review of the program was completed recently, granting Armenian authorities access to an additional round of funds. The authorities continue to treat the program as precautionary (and have made no withdrawals to date).
Armenia's official reserves reached $4.1 billion in June, up 16% compared with the same period last year. Reserves have generally increased on the back of the Central Bank of Armenia's (CBA)'s net purchases of foreign currency (FX) last year to absorb excessive FX inflows, stemming from higher tourist arrivals and significant capital and remittances transfers. We expect the dram to begin to depreciate as the current account deficit widens and transfers slow. That said, we expect the exchange rate to act as a key shock absorber and the FX reserve buffer to remain broadly stable.
Inflation peaked at approximately 10% in mid-2022 but has since transitioned into deflation, decreasing to -0.5% in June. Among other factors, the decrease can be attributed to base effects, the appreciation of the dram, and the CBA's tight monetary policy stance. From 2024, robust consumer demand fueled by tourist arrivals and a tight labor market may cause inflation to rise. However, we anticipate these risks will be contained by the CBA's restrictive monetary policy stance and the lagged impact of the dram's appreciation on prices. Therefore, we project inflation to average 2.5% this year, below the CBA's inflation target (of 4%). Our inflation outlook leads us to expect the CBA will continue to gradually reduce its benchmark policy rate.
We classify the banking sector of Armenia in group '8' under our Banking Industry Country Risk Assessment, with an economic risk score of '8' ('1' denotes the lowest risk and '10' the highest) and an industry risk score of '8'. Armenia's banking sector appears well capitalized, profitable, and liquid. Its direct exposure to Russia and Ukraine is relatively moderate, and nonperforming loans remain low at 2.6% as of May 2023. Risks remain around the mortgage market, which has grown by roughly 30% over the last year, alongside rising house prices. In response to potential pain points, the authorities increased the countercyclical capital buffer and introduced loan-to-value ratios. Another macroprudential tool set to be used is a draft law restricting U.S. dollar mortgage lending. Overall, the risk to the government of contingent liabilities from the banking sector remains limited."