Fitch : Affirms Armenia at 'B+'; Outlook Stable

22 Jan 2016 4:10 PM EST

Fitch Ratings-London-22 January 2016: Fitch Ratings has affirmed Armenia's long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B+' with a Stable Outlook. Fitch has also affirmed the issue ratings on Armenia's senior unsecured foreign currency bonds at 'B+'. The Country Ceiling has been affirmed at 'BB-' and the Short-term foreign currency IDR at 'B'.

KEY RATING DRIVERS
The 'B+' rating reflects the following factors:

Armenia's ratings are supported by its relatively high human development and governance indicators, favourable business climate and increasing economic resilience. However, they are weighed down by vulnerabilities to external shocks, high levels of external and foreign currency debt and political risks.

The Armenian economy is vulnerable to external shocks and has been adversely affected by the recession in Russia and drop in global commodity prices, which caused severe financial pressure in late 2014 and a sharp contraction in domestic demand in 2015. In 2014 Russia accounted for 80% of remittances (14% of GDP), 20% of exports and 44% of FDI; while copper accounted for 22% of exports, and other metals, minerals and gold for another 26%. Total remittances dropped by 33% YoY - the equivalent of 4.5% of GDP - in the first three quarters of 2015, while copper prices were down 28% YoY in December 2015.

However, Armenia has proved remarkably resilient to the magnitude of this shock, reflecting a strong trade performance, access to international financing and an effective policy response, under the aegis of an IMF programme. Nevertheless, with oil prices, the Russian rouble and copper prices well below their average 2015 levels and still under downward pressure, it is too early to declare the external shock over, in Fitch's view.

Fitch estimates GDP growth was 2.7% in 2015, revised up from its forecast of 1.5% in July. It estimates domestic demand fell by 4.9%, but net trade underpinned growth. Imports dropped 26% YoY (in USD terms) in the first three quarters of 2015, while exports fell only 1%, supported by the opening of the Teghut copper mine and strong growth of agriculture output. Fitch forecasts GDP growth at 2% in 2016, before picking up to 2.8% in 2017, but the outlook depends on external conditions.

The remarkable rebalancing of the economy and access to funding has eased pressures on Armenia's external finances. Fitch estimates the current account deficit narrowed to 4.3% of GDP in 2015, from 7.3% in 2014, despite the drop in remittances. Foreign exchange reserves recovered to USD1,771m in December 2015 from USD1,261m in February 2015, helped by the issue of a USD500m eurobond in March (USD300m net of the buyback of the eurobond due in 2020), USD100m from the Eurasian Fund for Stabilisation and Development as well as funding from the IMF and World Bank. Nevertheless, net external debt is high, at an estimated 46.5% of GDP at end-2015, compared with the 'B' category median of 21.5%.

The dram has been fairly stable against the USD following a 14% depreciation between October 2014 and February 2015. Inflation declined to 1.2% in November 2015, and the central bank (CBA) cut its refinancing policy interest rate to 8.75% from 10.25% in October. The banking sector had a capital adequacy ratio of 15.9% as of end-October 2015 and will raise further capital to manage the increase in minimum capital ratios to AMD30bn from AMD5bn. Bank credit growth has slowed sharply after prior rapid expansion. Non-performing loans increased to 8% in October 2015, from 6.7% a year earlier, although the CBA estimates this is equivalent to 3.8% on international definitions. Nevertheless, dollarisation of deposits and loans is high at around 65%, exposing the system to exchange rate depreciation.

Fitch estimates the budget deficit widened to 4% of GDP in 2015, from 1.9% in 2014 and compared with a budget deficit target of 2.3%. The deterioration reflected weaker-than-expected growth as well as policy measures to support the economy and social protection, including to eliminate the minimum profit tax, reduce the turnover tax rate, extend VAT payment dates on imports from the Eurasian Economic Union (EEU) and a subsidy to compensate some consumers for the increase in electricity tariffs. Nevertheless revenues held up well given the magnitude of the fall in domestic demand (the tax-rich part of GDP). However, the government also increased net lending to the economy, representing a quasi-fiscal policy loosening. The 2016 budget envisages a narrowing of the deficit to 3.5% of GDP, helped by an increase in excise duties in May.

Public debt increased to an estimated 47.8% of GDP at end-2015, from 43.6% at end-2014, below the 'B' category median of 52%, but above the 'BB' category median of 44%. Some 85% of government debt stock is in foreign currency, exposing Armenia to exchange rate depreciation, but it has a long average maturity of 9.7 years and much of it is concessional at low interest rates.

The IMF has revised down its estimates of medium potential growth to 3.5%, from 4.5%-5% before the shock, partly reflecting the outlook for Russia and commodity prices. The ratio of investment/GDP declined to an estimated 19% of GDP in 2015, from an average of 36% in 2005-2009. Armenia improved its ranking in the World Bank Doing Business Survey to 35th in 2015, from 38th in 2014, although the survey does not fully capture factors such as weak competition and geographic isolation. The government is planning reforms to the tax code and business regulations and inspections.

Armenia's referendum on constitutional reform on 6 December 2015 was approved with 66.2% of votes on a turnout of 50.5%, just above the required 50% threshold. However, independent observers allege cases of irregularities. EU and US statements called on the Armenian authorities to fully investigate credible fraud allegations in a transparent manner. The constitutional amendments will reduce the powers of the presidency and increase those of parliament.

Armenia's geopolitical environment weighs on the rating. The latent conflict with Azerbaijan over the disputed Nagorno-Karabakh region entails the tail risk of escalating. No resolution is expected in the near term. Armenia's close relations with Russia have been strengthened further by Armenia's accession to the EEU. However, Armenia retains strong trade access to the EU.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced.

The main risk factors that, individually or collectively, could trigger positive rating action are:
- An improvement in external economic conditions, for example a recovery in the Russian economy, or Armenia's sustained resilience to them.
- A decline in the government debt-to-GDP ratio.

The main risk factors that, individually or collectively, could trigger negative rating action are:
- Severe adverse spill-over from worsening economic conditions in Russia or lower commodity prices.
- A marked drop in foreign exchange reserves.
- Fiscal slippage leading to a significant rise in the government debt-to-GDP ratio

KEY ASSUMPTIONS
Fitch assumes that Armenia will continue to experience broad social and political stability and no significant escalation in the conflict with Azerbaijan regarding Nagorno-Karabakh.

Contact:

Primary Analyst
Ed Parker
Managing Director
[phone]
Fitch Ratings Limited
30 North Colonnade
London E14

Secondary Analyst
Richard Grieveson
Director
[phone]

Committee Chairperson
Jan Friederich
Senior Director
[phone]

Media Relations: Peter Fitzpatrick, London, Tel: [phone], Email: [e-mail].

Additional information is available on www.fitchratings.com

Applicable Criteria
Country Ceilings (pub. 20 Aug 2015)
Sovereign Rating Criteria (pub. 12 Aug 2014)

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy

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