Yerevan /Mediamax/. Fitch Ratings has affirmed Armenia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB-'. The Outlooks are Stable.

The issue ratings on Armenia's senior unsecured foreign and local currency bonds have also been affirmed at 'BB-'.

The Country Ceiling has been affirmed at 'BB' and the Short-term foreign currency IDR at 'B'.

Fitch said that affirmation of Armenia's sovereign ratings reflects the following key factors:

The general government deficit fell to 1.7% of GDP in 2013, against initial projections of 2.8%. This was mainly due to under-execution and delays in the implementation of public investment. The government expects the deficit to rise to 2.4% of GDP in 2014, although further under-execution is possible. The increase in public sector wages, effective from 1 July 2014, will increase public spending by about 0.4% of GDP in 2014 and 2015, but has already been budgeted for and will be compensated by an increase in tax collection.

The general government debt level is expected to remain stable at around 43%-44% of GDP in 2014-15, and could fall in 2016 if GDP growth picks up.

However, with about 85% of public debt foreign-currency denominated, Armenia's debt profile is vulnerable to exchange rate shocks.

GDP growth slowed in 1H14, partly because of the slowdown of the Russian economy, but is expected to pick-up slightly in the second half to average about 4.5% for the year, mainly as a result of base effects and a pick-up in investment. Although the increase in public sector wages may have a positive impact on private consumption, the recurring under-spending of public investment will continue to act as a drag on domestic demand.

Inflation is expected to remain close to the Central Bank's target of 4%. Because of its high dependence on Russia in terms of gas supplies, remittances and military support, Armenia remains particularly vulnerable to developments and policy changes in Russia. Despite the slowdown in Russia, remittances have held up. Net remittances account for about 15% of GDP, of which more than 80% come from Russia. Similarly, nearly 20% of Armenian exports are destined for Russia.

The Armenian government has announced its intention to finalise negotiations for its accession to the Eurasian Economic Union, but diplomatic hurdles remain, Fitch said.

The Central Bank of Armenia is allowing some exchange rate flexibility, but international reserves fell in 1H14, following pressure on the exchange rate and the still large CAD. Reserves are likely to decline slightly over the coming years. Armenia has benefited from a series of IMF programmes and has agreed a further USD128m extended fund facility for 2014-17, which will act as a policy anchor. Armenia has so far fulfilled most of the performance criteria.

Armenia will continue to enjoy support from major international financial institutions, which have been instrumental in most large infrastructure projects.

“Armenia's geopolitical environment is a constraint on the rating. The latent conflict with Azerbaijan over the disputed Nagorno-Karabakh region entails the risk of escalating into a full-scale conflict, Fitch concluded.