Yerevan/Mediamax/. Fitch Ratings has affirmed Armenia\'s Long-term foreign and local currency Issuer Default Ratings (IDR) at \'BB-\'. The Outlook on the Long-term IDRs is Stable.

At the same time, Fitch has affirmed the Short-term foreign currency IDR at \'B\' and Country Ceiling at \'BB\', agency reports.

The rating affirmation reflects the fact that Armenia is gradually reducing its fiscal and external imbalances. The government narrowed the fiscal deficit to 2.8% of GDP in 2011, from 5% of GDP in 2010, through tax collection improvements, revenue surprises and spending restraint. The fiscal deficit is converging on the medium term target of 2% of GDP, although not all supporting measures have been spelled out. This would allow public debt to stabilise at around 45% of GDP. However, this ratio is unusually sensitive to exchange rate movements, given that 84% of public debt is in foreign currency, mainly from multilateral lenders. External and fiscal sustainability are therefore closely linked.

Real GDP grew 4.6% in 2011, driven by consumption and exports, and a rebound in agriculture. Fitch expects growth of around 4% in 2012-14, with risks to the upside in 2012. Mining production could outperform, but exposure to metals prices and the Russian economy are sources of vulnerability. Improvements in the investment climate would lead to more rapid growth in the medium-term.

External finances are a weakness relative to peers. The current account deficit (CAD) narrowed to 11% of GDP in 2011, but was still the second largest in Emerging Europe and the third widest among \'BB\' rated sovereigns. It is well above its pre-crisis level. Slowing growth in export earnings, linked to falling metals prices, will limit further progress in 2012. With only half of the CAD financed by foreign direct investment, the remainder is financed by external borrowing, pushing up net external indebtedness.

The Central Bank of Armenia (CBA) allowed greater exchange rate flexibility in H112 during a lull in foreign exchange earnings. The size of its interventions has declined although it has been a net seller of foreign exchange in 2011-2012.

Armenia will start to make net repayments to the IMF in 2013. CBA and government repayments to the IMF are to peak in 2013 at USD279m (2.6% of forecast GDP or one-sixth of CBA reserves). Reserves will therefore stay flat or decline. Fitch expects the government to seek a successor agreement to the Extended Fund Facility/Extended Credit Facility expiring in June 2013. The government expects to refinance its direct obligations to the Fund from multilateral sources.

Armenia\'s ability to absorb further external shocks is weaker than in 2008, as government and external debt have multiplied. Pressure on reserves or the dram - following an external shock - would lead to negative rating action. Any shortfall in capital inflows would increase risks of currency devaluation. A lower CAD, lower dollarization and more buoyant reserves would be positive for the ratings.

Further progress in reducing the fiscal deficit, preferably via tax collection improvements rather than spending restraint, would help bolster creditworthiness. While government debt service ratios are still low, funding costs will rise over the medium-term, increasing the importance of stabilising or reducing public debt. Pension reform in 2014, though a net fiscal cost in the short term, could help develop local capital markets and reduce reliance on external and bank borrowing.