ArmInfo. S&P Global Ratings affirmed its 'BB-/B' long- and short-term foreign- and local-currency sovereign credit ratings on Armenia. The outlook on the long-term ratings is stable.
This is noted in the message from S&P Global Ratings, which states, in particular:
Overview
We project Armenia's real GDP growth will moderate to 6.2% in 2024, from an annual average of 11.0% in 2022-2023, as migrant and financial inflows from Russia ease.
The budget deficit will likely rise to 4.3% of GDP in 2024 on increased expenditure related to refugees from the Nagorno-Karabakh region, leading us to anticipate a slight uptick in Armenia's moderate government debt levels over the coming three years.
We see persisting security and geopolitical risks stemming from the pending peace deal with Azerbaijan and gradually deteriorating relations with Russia that could affect the substantial economic ties between the two countries.
We affirmed our 'BB-/B' long- and short-term sovereign credit ratings on Armenia. The outlook is stable. Rating Action
On Feb. 23, 2024, S&P Global Ratings affirmed its 'BB-/B' long- and short-term foreign- and local- currency sovereign credit ratings on Armenia. The outlook on the long-term ratings is stable. Outlook
The stable outlook reflects a balance between Armenia's favorable economic growth prospects over the next year and comparatively modest net general government debt, against existing balance of payments vulnerabilities and elevated geopolitical risks.
Upside scenario
We could take a positive rating action should Armenia's fiscal or external balance sheets are stronger than our current expectations while geopolitical risk remain contained.
Downside scenario
We could lower the ratings if a pronounced reversal in accumulated financial and labor inflows from Russia slows growth, causes exchange rate depreciation, and weakens fiscal and external balance sheets. Additionally, although it is not our base-case scenario, repercussions from escalating geopolitical tensions with either Azerbaijan or Russia could constrain the ratings.
Rationale
Armenia faces a complex economic and political landscape, characterized by the recent influx of immigrants from Russia and Nagorno-Karabakh amid geopolitical uncertainty. Recent developments include:
Tensions with Azerbaijan over the delimitation of borders and the establishment of a transit corridor, following the transfer of control of the previously disputed Nagorno-Karabakh region to Azerbaijan in September 2023.
Armenia has started to reassess its security alliances, including with Russia, and strategies by exploring closer ties with Western partners and reevaluating military collaborations to adapt to evolving regional dynamics.
Fiscal pressures are intensifying as the authorities increase spending to accommodate the recent influx of refugees from Nagorno-Karabakh. Nevertheless, Armenia's prudent fiscal management, in our view, keeps net general government debt at modest levels.
Absent the significant escalation of geopolitical tensions, Armenia's economic prospects remain strong, reflecting higher productive capacity on the back of capital and labor inflows into the domestic information and communication technology (ICT) sector.
Our ratings on Armenia are constrained by weak, albeit improving, institutional settings, moderate per capita income levels, as well as balance of payments and fiscal vulnerabilities. Armenia's exposure to geopolitical and external security risks also constrains the ratings.
The ratings are supported by Armenia's strong growth outlook, its continued availability of external official funding, and a prudent policy framework that has helped preserve economic and financial stability in recent years despite multiple external shocks.
Institutional and economic profile: The economy will likely decelerate in 2024 compared with the high average real growth rate of 10.7% over 2022-2023
We project real GDP growth will slow to 6.2% in 2024, from 8.7% in 2023, because of weaker external demand and a decrease in migrant and financial inflows.
Despite the cessation of conflict in Nagorno-Karabakh, tensions between Azerbaijan and Armenia remain.
Emerging tensions between Armenia and Russia could introduce an additional layer of uncertainty, given the country's substantial economic and energy dependence on Russia.
We expect Armenia's real GDP growth to ease to 6.2% this year from a high 10.7% on average in 2022-2023; this was the third highest growth rate among the 137 sovereigns we rate. This slowdown is primarily due to reduced demand from major external trading partners, base effects, and the ebbing of Russian migrant and capital inflows. We project domestic consumption will support growth on the back of a buoyant tourism sector, positive real wage growth, and government fiscal stimulus. We also expect investment to underpin growth, spurred by an increase in government capital expenditure and construction activities aimed at accommodating the recent influx of migrants from the Nagorno-Karabakh region and those fleeing the conflict between Russia and Ukraine. However, we anticipate a negative impact on growth from net exports from weakening demand from main trading partners, especially countries in the Commonwealth of Independent States, such as Russia, which saw a surge in Armenian exports last year.
Although Russian labor and capital inflows to Armenia have decelerated from their peaks in 2022 and early 2023, the risk of a sharp reversal has diminished, in our view. This is due to prevailing domestic political and economic uncertainties in Russia that are reducing the incentives for its citizens who left to return. Moreover, a considerable number of migrants from Russia who now reside in Armenia are employed in the ICT sector, continuing to serve global clients. Their return to Russia could disrupt their business activities.
As a result, we project Armenia's economy will expand by a high annual rate of about 5% on average through to 2027, partly reflecting higher productive capacity on the back of capital and labor inflows into the domestic ICT sector. This growth rate is higher than in the decade preceding the pandemic.
That said, uncertainty persists around Armenia's growth prospects in the next few years. Downside risks stem from the global macroeconomic developments and, more importantly, persistent regional geopolitical volatility.
Tensions between Armenia and Azerbaijan over the previously disputed Nagorno-Karabakh region date back to the early 20th century and intensified following the dissolution of the Soviet Union. A full war lasted six weeks in September-November 2020. More recently, in September 2023, Azerbaijan undertook a military offensive against Nagorno-Karabakh with a ceasefire agreement brokered just one day after the conflict's onset, effectively transferring Nagorno- Karabakh to Azerbaijani control. A mass exodus ensued, with over 100,000 residents seeking refuge in Armenia.
Despite the cessation of military conflict, geopolitical tensions persist between Armenia and Azerbaijan, notably over the delimitation of borders and the establishment of a transit corridor. Although Azerbaijan has control over the region, neither Azerbaijan nor Armenia have fully agreed on the bilateral borders, and ongoing discussions have yet to yield a definitive peace deal. Key among the unresolved issues is Azerbaijan's pursuit to create a corridor through Armenia's Syunik Province to link with its exclave, Nakhichevan, despite proposals for an alternative route through Iran, known as the Aras corridor. There are additional initiatives underway, including "Crossroads of Peace."
Further complicating the regional security settings are emerging tensions between Armenia and Russia. Issues are partly related to Russia's reluctance to intervene in the Nagorno-Karabakh conflict, despite having peacekeepers in the region. This situation has led Armenia to express dissatisfaction with the effectiveness of Russian peace-keeping efforts in Nagorno-Karabakh, particularly after Azerbaijan imposed a blockade on the sole land corridor between the disputed region and Armenia in December 2022. Since then, Armenia has been reconsidering its previous security strategy, cancelling military drills with the Russia-led Collective Security Treaty Organization (CSTO), and exploring closer ties with the West, including holding joint military exercises with the U.S. These developments could reflect Armenia's strategic shift toward enhancing its international alliances and strengthening defense capabilities and diplomatic ties amid changing regional dynamics.
In our opinion, these developments would underpin a level of geopolitical uncertainty for Armenia given its significant economic and energy reliance on Russia. In 2023, approximately 40.0% of Armenia's total exports were directed to Russia, while about 31.5% of imports originated from Russia. Additionally, almost 70% of remittances came from Russia, underscoring the financial interconnections between the two countries. This dependency extends into the energy sector as well, with Russia supplying almost 90% of Armenia's natural gas through pipelines (which constituted 60% of the country's total energy needs in 2022).
Flexibility and performance profile: The budget deficit will likely widen this year before narrowing as refugee-related spending decreases
We expect the budget deficit to increase to 4.3% of GDP in 2024, from an estimated 2.2% in 2023, primarily due to increased spending on refugees from the Nagorno-Karabakh region.
Net general government debt will increase to a still-moderate 44% of GDP through 2027, from an estimate of 40% in 2023.
After peaking in August 2023, the Central Bank of Armenia's (CBA's) foreign reserves have gradually declined due to government external debt repayments.
The government has set a budget deficit target of 4.6% of GDP for 2024, an increase from the previous year's estimated level of 2.2% of GDP. This expansion in the fiscal deficit is primarily attributed to elevated capital expenditure and increased defense spending. Additionally, a notable allocation within the budget is the approximately 1.5% of GDP to cover housing, utilities, and one- time stipends, among other expenses, for refugees from the Nagorno-Karabakh region. The authorities plan to finance these expenditures by repurposing about 1.5% of GDP from the funds Armenia previously provided to the Nagorno-Karabakh government in the form of budget loans. We anticipate a general government fiscal deficit of 4.3% of GDP which is slightly below the government's projection. This expectation is based on the government's record of underusing funds allocated for capital expenditure.
In late 2023, following the ceasefire in the Nagorno-Karabakh region, the Armenian government opted to directly assume 70% of the debts owed by the authorities, entities, and individuals in Nagorno-Karabakh to Armenia's financial institutions, totaling AMD 315 billion (about 2.4% of GDP).
Over the medium term, we anticipate the authorities will adhere to a fiscal consolidation strategy. As a result, we expect the budget deficit to decrease, averaging 3.4% of GDP in 2024-2027. Consequently, we project general government debt net of liquid assets will average a moderate 44% over the same period. Approximately 54% of the government's debt is denominated in foreign currency (FX), making Armenia's debt stock susceptible to exchange rate fluctuations. However, a considerable portion of the FX-denominated debt is from bilateral lenders and International Financial Institutions (IFIs), granted at concessional and fixed interest rates.
Despite recent improvements, Armenia's balance of payments position remains vulnerable. The country has recorded consecutive current account deficits in recent years (except for 2022), leading to a net external liability position of approximately 90% of current account receipts (CAR). With external demand moderating, imports rising, and inward remittances falling, we anticipate the current account deficit will expand to 3%-4% of GDP in the coming years, up from a small deficit of 0.3% in 2023. We forecast that the current account deficits will be financed through a combination of government external borrowing and net foreign direct investment inflows. We expect this financing mix will result in Armenia's narrow net external debt as a percentage of CAR remaining near 50%.
In late 2022, the IMF approved a $171 million Stand-By Arrangement (SBA) for Armenia. This 36- month-long program was established to safeguard Armenia against potential balance-of- payments difficulties. Following the recent completion of the second review, the Armenian authorities have been granted access to a cumulative amount of $73.3 million. Despite the availability of funds, the government continues to treat the SBA as precautionary financing line and no withdrawals have been made so far. We believe the Armenian government is leveraging the program to maintain confidence in its commitment to economic reforms and fiscal discipline.
Foreign reserves stood at $3.6 billion in January 2024, marking a 3% decrease from the same period a year earlier. Notably, reserves had reached a peak of $4.2 billion in August 2023 largely due to the CBA's net purchases of FX to absorb excess FX inflows. These inflows were primarily driven by increased tourist arrivals and higher remittances. However, reserves declined following sizable external debt repayments, including the government's buyback of Eurobonds worth $186.8 million in the second half of 2023. For the coming three years, we expect reserves to remain broadly stable.
The consumer price index (CPI) in Armenia decreased by 0.9% in January 2024, marking a pronounced reduction from the 8.1% a year ago. This decline can be attributed to a combination of factors including an appreciation of the dram leading to reduced import prices and the CBA's tight monetary policy stance. We expect CPI to rise and average 3.7% in 2024, spurred by base effects and a potential weakening of the dram. We anticipate that average inflation will return to the CBA's target of 4% in 2025. Given our outlook on inflation, we expect the CBA to continue taking steps to gradually decrease 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 adequately capitalized and fairly profitable with flows from Russia fueling profitability over 2022-2023. Credit growth has been strong over the past few years, particularly in second half of 2023 reaching 21% year over year on a currency-adjusted basis and resulting in asset price appreciation, specifically real estate. The sector has been stable from asset quality perspective with the exception of exposures to the previous Republic of Nagorno-Karabakh, which have been subsequently partially assumed by the government of Armenia."
According to the Central Bank's forecast, Armenia's GDP growth will slow down to 6.1% in 2024. The IMF and the World Bank expect a more noticeable slowdown in Armenia's GDP growth in 2024, to 5% and 4.7%, respectively.
In particular, the World Bank, forecasting stable growth of 3.3% for the South Caucasus region in 2024- 2025, expects that the influx of remittances from Russia will continue to decline, and re-exports and tourism will continue to support economic activity. However, according to the World Bank, long-term growth will continue to be hampered by dependence on raw materials, weak transport communications and logistics, as well as the likelihood of escalation of relations between Armenia and Azerbaijan. According to IMF expectations, in the medium term the growth of the Armenian economy will reach its potential of approximately 4.5%. The IMF believes that the authorities' efforts to increase labor force participation and reduce structural unemployment, improve access to finance, diversify exports and strengthen governance will improve economic resilience and potential growth.