Author: Alex Nanijanian

YEREVAN, December 3. /ARKA/.Fitch Ratings has affirmed Armenia’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘B+’ with a Positive Outlook, saying in a press release that  Armenia’s ratings balance a credible monetary policy framework and stronger income per capita and governance indicators relative to peers against high public and external debt and tense relations with some neighboring countries. 

The Positive Outlook reflects Armenia’s stronger growth outlook relative to peers, the start of a fiscal consolidation process that we expect will deliver a gradual decline in government debt over the medium term, and institutions that have underpinned macroeconomic and financial stability through a period of significant political change.

The fiscal deficit in 2018 is on track to be better than budgeted, and well below the current peer median, due to an under-execution of spending. Fitch projects the state budget deficit to decline to 2.2% of GDP (4.3% current peer median) from 4.8% in 2017, and a target of 2.7%. The new government is reviewing spending across all areas to understand its structure and pinpoint inefficiencies, which has slowed execution. Fitch expects a widening of the deficit to 2.6% of GDP in 2019 and 2020, slightly above the 2.2% and 2.3% government projections, reflecting our expectation of slower revenue growth and faster execution of expenditure. The government is hoping to build fiscal space to allow higher but deficit-neutral allocations to social spending and public sector wages. The 2019 budget was the first to be consistent with new fiscal rules.

Fitch projects a small primary surplus in 2018 and a broadly balanced position in 2019 and 2020, supporting a gradual decline in public debt. General government debt/GDP is forecast to fall to 56.2% at end-2020 from 58.9% at end-2017, compared with a current ‘B’ median of 60.5%. Debt is exposed to exchange rate risks; at end-October 2018 80.8% of government debt was foreign-currency denominated. 

The political transition that began with large-scale public protests and forced the resignation of the prime minister earlier in the year looks set for completion, following the scheduling of snap legislative elections for 9 December. The coalition headed by Nikol Pashinyan, the figurehead of the protest movement, appears on course for a parliamentary majority, which will smooth the implementation of an agenda that is focused on fighting corruption and tackling the monopolies and vested interests associated with the previous administration. Fitch notes that the transition process has been peaceful and in line with constitutional mechanisms. Governance indicators, as measured by the World Bank, are slightly better than the current peer median. 

Armenia’s traditional foreign policy approach balancing relations with Russia, the US, EU and Iran has been maintained and external powers do not appear to be exerting undue influence on the new administration. Borders are closed with two neighbors and the long-standing conflict with Azerbaijan over Nagorno-Karabakh has the potential to escalate. 

Armenia has continued to demonstrate macroeconomic and financial stability throughout this year’s political volatility as well as increased geopolitical tensions related to Russia and increased emerging market risk aversion, reflecting the policy framework’s credibility and improved capacity to absorb economic and political shocks. Inflation (2.8% in October) has remained below the central bank’s medium-term target of 4%. The central bank has kept interest rates at 6% since February 2017 and stated its readiness to tighten policy if demand pressures increase. Fitch expects inflation to average 2.7% in 2018 and move toward the medium-term target in 2019, still below the forecast 5% for the current ‘B’ median. 

Economic growth is moderating, but remains robust and is forecast at 5% in 2018. Private consumption and investment have led growth this year, with the former driven by rising credit growth and remittances and the latter benefiting from a strengthening construction sector. Growth is forecast to ease to 4.2% in 2019 and 4.0% in 2020, with the forecast 2018-2020 average of 4.4% higher than the 3.6% current ‘B’ median for the same period. The halt to construction of a foreign-owned gold mine due to local residents’ protests over environmental concerns has created some uncertainty about prospects for the sector. 

Strong domestic demand has put pressure on the current account deficit, which is projected to widen to 5.1% of GDP in 2018 (rising above the projected current peer median of 4.1%) from 2.4% in 2017. Ongoing import growth in line with higher planned public investment will keep the deficit average at 4.3% in 2019-2020, despite healthy performance in exports, remittances and tourism. Public sector external borrowing and equity FDI will finance the bulk of the deficit, although there are dual-sided risks to Fitch’s forecast. Net external debt/GDP, at a projected 47.8% at end-2018 is almost double that of the current peer median of 25.3%. 

External liquidity indicators are weaker than peers, with the international liquidity ratio projected at 125.4% at end-2018, below the 145% current peer median. Foreign exchange reserves of USD2.08 billion at end-October were down by 10% from end-2017, but had recovered somewhat from their low point of USD1.99 billion at end-June. We forecast reserves to end the year equivalent to around 3.5 months of current external payments in line with the current ‘B’ median. Exchange rate flexibility and access to external financing reduce the risk of near-term balance-of-payment pressures. The authorities are keen to agree a non-disbursing programme with the IMF after the elections.

The banking system remains stable and did not experience destabilizing liquidity pressures in April-May. Capitalization levels remain adequate and the non-performing loan ratio (up to 270 days overdue) was 6.3% in June, down from 6.6% in April. Despite a gradual declining trend, financial dollarisation remains high, at 53% for deposits and 56% for borrowings at end-October. The central bank has discouraged foreign currency loans (through differentiated reserve requirements and risks weights) and required banks to maintain a balanced FX position. -0-