Friday, January 16 2015 15:29

On Jan 15, Moody's Investors Service downgraded Armenia's issuer and government bond rating to Ba3 from Ba2, and changed the outlook to negative from stable. 

Moody's reports that the key drivers for the downgrade are the following: 

1) Armenia's increased external vulnerability due to declining remittances from Russia, an uncertain outlook for foreign direct investment (FDI), an elevated susceptibility to exchange rate volatility, and expected pressure on foreign exchange (FX) reserves; 

2) The country's impaired growth outlook, compounded by negative growth spillovers from Russia, weak investment activity, and constraints on trade with countries outside the Eurasian Economic Union (EEU) that are expected from Armenia's recent EEU accession.

In a related action, Moody's has also lowered the local-currency bond and deposit ceilings to Ba1 from Baa3, the foreign-currency bond ceiling to Ba2 from Ba1, as well as the foreign-currency deposit ceiling to B1 from Ba3. The short-term foreign-currency bond ceiling and the foreign-currency deposit ceiling remain at NP. 

According to Moody's, the first driver of the downgrade is Armenia's increased external vulnerability driven by declining remittances from Russia and risks to expected FDI inflows. Remittances represent about 15% of GDP, with over 90% of the total stemming from Russia. Given the sharp recession expected in Russia, the adverse impact of reduced remittance inflows on the country's balance of payments will potentially put pressure on Armenia's FX reserves, which were at 4.5 months of import cover at the end of 2014. Moreover, Armenia's position as a significant net international borrower exposes the currency to elevated depreciation risk. Approximately 83% of Armenia's government debt is denominated in foreign currency, mostly in Special Drawing Rights (SDR) and US dollars. The Armenian dram's depreciation of over 15% since November 2014 has the potential to put additional pressure on Armenia's FX reserves, which remain subject to intervention by the Central Bank of Armenia to counteract excessive volatility. 
The second driver of the downgrade is pressure on Armenia's economic growth prospects, which is compounded by the negative growth spillovers from Russia's economic downturn. Moody's expects that Russia's GDP will contract by 5.5% in 2015, weakening Armenia's economic activity given its historically strong correlation with Russia's growth cycle via remittances and trade channels, with Russia accounting for 23% of total Armenian exports. Further exacerbating the slowing dynamics for potential growth -- excepting some more active sectors such as the information technology industry -- are Armenia's weak investment activity and its slow productivity growth since the global financial crisis, in addition to its adverse net migration dynamics. In addition, trade constraints with respect to non-EEU countries likely as a result from Armenia's EEU accession in January 2015 also affect the country's medium-term growth outlook. In this context, Moody's expects Armenia's integration process into the EEU to be more challenging than for Belarus, Kazakhstan or Russia, owing to (1) the lack of a common border to establish trade routes without customs checkpoints, even as "pass-through" rules with Georgia as Armenia's main transit route are being negotiated; and (2) the imposition of higher tariffs for non-EEU country imports, taking into account that temporary exemptions have been negotiated for a series of products, such as cars, medicines, basic food items, and agricultural and industrial inputs for a total of about 800 exemptions for the next five years. 

To note, according to the National Statistical Service of Armenia, in Jan-Dec 2014 inflation in Armenia made up 4.6%. As compared with Jan-Dec 2013, inflation made up 3% and 3% in Dec 2014. In Jan-Dec 2014 the AMD depreciation against USD was 14.1%, in Dec alone the depreciation made up 10%. In Dec 2014 the average AMD/USD exchange rate was 462.5 AMD/$1 versus 405.3 AMD/$1 in Dec 2013. In Jan- Nov 2014 versus Jan-Nov 2013, the economic activity rose by 3.8%, having dropped by 12.2% in November alone. In Jan-Nov 2014 the foreign trade turnover grew by 2.3%, with exports rising by 2.7% and imports - by 2.1%, however, in November alone these indices declined by 10.1%, 15% and 11.8%, respectively. In the foreign trade turnover of Armenia, the export of commodities and services to Russia dropped by 7% over year and the import rose by 8.3%. As of 1 Dec 2014, the foreign debt of Armenia amounted to $3.7 bln versus $3.9 bln in early 2014 (5.1% decline). According to the Central Bank of Armenia, as of early Dec 2014 the international reserves of Armenia totaled $1.6 bln versus $2.3 bln in early 2014 (27.3% decline).