Fitch Ratings has upgraded Armenia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘BB-‘ from ‘B+’. The Outlook is Stable.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The upgrade of the IDR reflects the following key rating drivers and their relative weights:
High
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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.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
– 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.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
– 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.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
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.
Country Ceiling
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.
BEST/WORST CASE RATING SCENARIO
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. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
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.
