Fitch Ratings has affirmed Armenia's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at 'B+' with a Stable Outlook.

“Armenia's 'B+' IDRs reflect fairly high government and external indebtedness, relatively weak external finances and geopolitical tensions that have the potential to escalate into military conflict. These are balanced against high income per capita; governance, development and ease of doing business indicators that outperform the 'B' rated median; and institutions that have facilitated orderly political transitions and weathered the 2020 pandemic shock and six-week war with Azerbaijan. It also has a robust macroeconomic and fiscal policy framework, and credible commitment to reform, both of which are underpinned by the IMF stand-by arrangement (SBA)”, Fitch said.

“Fitch expects that prime minister Nikol Pashinyan's 'My Step' alliance should be able to maintain a working majority coalition in parliament at the 20 June 2021 snap elections. After Pashinyan signed a Russia-brokered and maintained ceasefire agreement on 9 November 2020 to end the Nagorno-Karabakh conflict, the country has seen a period of heightened protests and political interventions by the military calling for his resignation. Although we expect Pashinyan to retain power, support for his government has diminished since the war and could exacerbate the challenges of implementing structural reforms and tackling corruption.

The effects of Armenia's defeat in the Nagorno-Karabakh war are likely to persist, with the influx of refugees to Armenia numbering in the tens of thousands, and the need to re-establish diplomatic efforts through the previously failed OSCE Minsk Group process. Despite the presence of Russian peacekeeping forces, tensions in Nagorno-Karabakh have the potential to reignite due to the absence of a demilitarised zone. The war has also further entrenched Armenia's reliance on Russia for security and economic relations”, Fitch said.

“We forecast debt/GDP to peak at 67.6% at end-2021, before falling gradually to 63.5% by end-2025 as the government re-implements its medium-term fiscal rules and targets to reduce the metric to 60% by end-2026. Weaker growth due to economic scarring from the 2020 shocks and spending pressures to support the economy constrain the potential for faster public debt reduction. Foreign-currency denominated debt represents 77% of public debt, increasing the country's vulnerability to dram depreciation.

The consolidated fiscal deficit widened to 5.1% of GDP in 2020 (compared with a forecast of 7.6% at our October 2020 review), from 0.8% in 2019, driven by higher expenditure, including to support the economy during the pandemic. A budget amendment in 4Q20 widened the state budget deficit and reallocated spending for the war effort, but under-execution of capital expenditures limited the 2020 deficit outturn. We forecast the consolidated fiscal deficit narrow gradually to 4% in 2021 and 2.8% in 2022, due to a continuation of several fiscal-support measures under the economic recovery plan in 2021, and our expectation of some improvement in capital spending execution.

Potential additional fiscal measures to support a weaker economic recovery is a key risk to our projections. The 2021 deficit will be financed primarily by a USD750 million Eurobond issued in February 2021, with 71% of the annual financing requirement completed by end-February.

Armenia has committed to key structural reforms relating to public financial management under the IMF SBA, including to maintain its medium-term fiscal trajectory, improve revenue mobilisation, fiscal risk management, and efficiency of capital expenditure budgeting and implementation. However, in Fitch's view, additional recovery spending needs and diminished political support could slow progress of the reform agenda.

External finances are a key weakness for Armenia, with a high commodity export dependence (41% of 2020 current external receipts) that raises vulnerability to copper and precious metal price fluctuations, and fairly weak foreign direct investment (FDI) inflows. Net external debt (NXD) is high, at 55.1% of GDP at end-2020 ('B' median of 32.3%) and we forecast it to rise to 62.2% by end-2022.

The authorities' overall commitment to exchange-rate flexibility resulted in the dram depreciating 9% in 2020. The Central Bank of Armenia maintains its commitment to intervene only to prevent disorderly adjustments in financial markets, making net foreign-exchange (FX) sales of USD147 million in 2020 (2019: net purchases of USD566 million). Broad adherence to the exchange-rate framework under the IMF's SBA underpins strong access to international financial institutions (IFIs) and external commercial financing.

We estimate the current account balance in 2020 to have remained broadly resilient despite the shocks, improving to a deficit of 4.3% of GDP (2019: deficit 7.2%). This was due to sharp compression of goods and services imports, and a spike in non-resident transfers since 2Q20 driven by large diaspora transfers akin to the increases during the 2008 and 2013 election crises.

Fitch forecasts the current account deficit (CAD) to widen to 6.1% in 2021 and 6.8% in 2022 ('B' median average of 4.3%) as private consumption and capital expenditure recover and as anti-crisis diaspora transfers fade, more than offsetting the effect of stronger terms-of-trade from decade-high copper prices. Net FDI inflows are expected to cover only a quarter of the 2021 deficit, with the February 2021 Eurobond and IFI borrowing financing the bulk.

The twin shocks resulted in real GDP contracting 7.6% in 2020 ('B' median: 4.5% contraction), with construction and real-estate activities, trade and tourism-related services being worst hit, while public services, healthcare and financial services supported output. Fitch forecasts real GDP growth to rebound to 3.2% in 2021 and 4% in 2022, partly due to base effects and supported by expansionary policy stances, especially in public investments. The ongoing third-wave of Covid-19 infections based on official data is rising above the 2Q20 first wave but still below the peak of the 4Q20 second wave. Despite growing infection rates, and a vaccination programme slower than regional peers', Fitch does not expect significant economic and travel restrictions to be reinstated”, Fitch said.