Moody's downgrades Armenia outlook to negative from stable

PanARMENIAN.Net - Moody's Investors Service has downgraded Armenia's issuer and government bond rating to Ba3 from Ba2, and changed the outlook to negative from stable.

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.

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, Moody’s said, 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 U.S. 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.

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.

Moody's would consider changing the outlook back to stable if Armenia were to maintain adequate fiscal and external reserve buffers amid a weaker than expected economic fallout from Russia's economic downturn, and if debt levels were to stabilize. Upside rating pressure would result from an improved potential growth outlook as a result of structural reforms and enhanced competitiveness.