YEREVAN, NOVEMBER 23, ARMENPRESS. Fitch Ratings has upgraded Armenia's Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) to 'BB-' from 'B+'. The Outlook is Stable, the Central Bank of Armenia told Armenpress.

The upgrade of Armenia's IDRs reflects the following key rating drivers and their relative weights:

High

Armenia's institutions have facilitated a peaceful and orderly political transition and could strengthen further through structural reforms. The majority government under Prime Minister Nikol Pashynian has demonstrated its commitment towards a stable macroeconomic policy agenda and to the implementation of structural reforms, including the fight against corruption and monopolies and enhanced institutions and governance. Armenia's composite World Bank governance indicator improved substantially in 2018 to a 46% ranking, from 42.2% in 2017, reflecting a marked improvement in the 'Control of Corruption' (to 42.8% from 32.7%), 'Political Stability', 'Government Effectiveness', and 'Voice and Accountability' sub-indicators.

In spite of external volatility, domestic political shocks, and a period of rapid growth, Armenia has preserved macroeconomic and financial stability with inflation (3.8% in October) remaining below the Central Bank of Armenia (CBA) target of 4%, versus 3.4% for the current 'BB' median, due partly to the contractionary impact of public demand in 1H19 and a stable exchange rate. The CBA cut its refinancing rate by a cumulative 50bp in 2019 to 5.5%, after keeping rates stable since February 2017. Fitch expects inflation to pick up to 2.5% in 2020 and 3.3% in 2021, from 1.7% in 2019, supported by a more expansionary monetary policy.

Fitch has greater confidence in the government's commitment to put debt on a downward trajectory, as reflected by the adoption of a revised fiscal rule in 2018 aimed at bringing central government debt to below 50% of GDP by 2023. Fitch forecasts gross general government debt (GGGD) to decrease to 51.2% of GDP in 2019, and 48.4% in 2021, from a peak of 58.9% in 2017, supported by a prudent fiscal policy and low effective interest rates. Debt is exposed to exchange rate risk with 82% of government debt being foreign currency-denominated, versus a 'BB' median of 55.6%.

Medium

Fitch expects fiscal policy to remain prudent in line with the principles underpinning the updated fiscal rule. The fiscal deficit is on track to be better than budgeted at a projected 1% of GDP in 2019, versus 2.2% in the 2019 State Budget and well below the current 'BB' median of 3%. Improved tax efficiency and strong nominal economic growth will lift revenues by a forecast 1pp to 24.1% of GDP, while capex under-execution will contain expenditure growth.

The fiscal deficit will likely widen to 2.2% in 2020 and 2.1% in 2021 as the Medium-Term Expenditure Framework entails a 2.2% of GDP increase in capex (to 5% of GDP), in line with the objective of shifting the structure of spending towards a more growth-friendly composition. The tax reform adopted in June 2019 provides for the introduction of flat income tax rates and lower corporate tax. Revenue measures, including an increase in excise taxes and gambling and financial sector licence fees and removal of tax exemptions will compensate for the estimated impact of about 1% of GDP annual revenue losses in the near-term. Higher-than-expected GDP growth over 9M19, at 7.1% yoy driven by robust credit-led private consumption and dynamic private investment in the construction sector, led to revise upwards the forecast for 2019 to 6.5% (from 4.6% previously), versus a five-year average of 4.5% and a 'BB' median of 3%.

The banking sector is well-capitalised but profitability is low and loan growth remains high, at 15.4% yoy at September-end 2019, boosted by mortgage loan and consumer lending. This partly reflected a decrease in the informal economy, higher household real income and increased risk appetite from banks given pressures on profitability. Asset quality is strong.