Barclays presents research on Armenia’s economy for investors


YEREVAN, November 14. /ARKA/. Armenia’s government is moving decisively towards much-needed structural measures, and although it remains to be seen if the political will is there to ultimately transform Armenia’s economy, some improvements are already noticeable, according to a Barclays’ research, which is at the disposal of ARKA News Agency. The bank’s analysts presents here the most remarkable achievements of Nikol Pashinyan’s government along with some problems waiting for their solutions.

Fiscal correction is welcome

The bank’s analysts say the most notable is the implementation of the fiscal rule which has helped to lower the budget deficit and government debt levels. Moreover, the Stand-By Agreement with the IMF, finalized in May, provides an important anchor for reform and a backstop for Armenia’s remaining external vulnerabilities.
Barclays analysts think a potential rating upgrade by Fitch at its next review date on 22 November (following a similar action by Moody’s in August) could be a positive catalyst for Armenia spreads. Based on relative valuations in the CIS complex, we see c.20bp tightening potential for Armenia ‘25s and ‘29s.
The Armenian economy has held up well, supported by strong consumer spending growth. GDP expanded by 6.9% y/y over the first half of 2019, up from average growth of 5.2% in 2018. There are also some early signs that export growth is recovering after a weak 2018.

Deficits differ

Although the trade deficit has narrowed a little, a deterioration in other accounts has caused the current account deficit to widen further. The shortfall reached around 9.5% of GDP by Q2 2019. This leaves Armenia vulnerable in the event of an external shock. The good news, though, is that the 3-year $248mn IMF Stand-By Agreement which was finalized in May would provide a much-needed backstop in such a scenario. The SBA is precautionary, meaning that the authorities can apply to use some of the credit line if necessary. In addition, Armenia has agreed a new Country Partnership Framework with the World Bank, which could unlock a further $300-400mn of funding until 2023.

In addition to providing emergency external financing, the IMF program is also an important anchor for reform.

With the technical help of the Fund, Armenia made some changes to its fiscal rule at the end of 2017 and the results are already noticeable. After a period of rising government debt levels, the rule has caused the government to tighten fiscal policy. Armenia’s fiscal rule stipulates that government debt levels should not exceed 60% of GDP and includes an automatic corrective mechanism which caps the size of the budget deficit when debt levels get close to this limit. As a result of the fiscal rule coming into force, the budget deficit has narrowed sharply over the past year or so and has now moved into surplus. This has helped to lower debt levels already to around 53% of GDP, down from the peak of 59%. It is worth noting, though, that much of the decline in spending has come at the cost of a sharp drop in budget capital expenditure which bodes poorly for growth.

Fitch and Moody’s ratings

The new government’s reformist agenda instigates a Moody’s upgrade; Fitch could follow
Moody’s moved to upgrade Armenia to Ba3 (with stable outlook) from B1 (with positive outlook) in August on the back of improvements in the composition of growth drivers, a track record of stabilizing macroeconomic policy and measures to strengthen the public finances. The rating agency highlights the importance of continued reform implementation for further improvements.

Meanwhile, Fitch, which currently has Armenia on B+ with positive outlook, seems likely to follow suit at its next review date on 22 November. At least two developments, which Fitch in its latest update in May stated could lead to an upgrade, appear to have happened: “improvements in the economic policy framework and governance and institutional effectiveness are being entrenched” and the government debt-to-GDP ratio has been on a solid downward path (Figure Progress on other reform has been somewhat slow.

Weak impetus for investors

The new government adopted an ambitious reform program at the start of this year, which certainly looks as though it could boost potential GDP growth substantially if followed through. But it is worth pointing out that the program is rather vague on the details of the precise measures, and the progress so far has been slow.
In terms of implementation, there have been some complications. For example, Prime Minister Pashinyan has been slow in ratifying the Istanbul Convention or resolving the conflict at the Amulsar gold mine. And it seems that this is at least in part due to the government’s reluctance to adopt unpopular decisions (the conservative part of Armenia’s society opposes the Istanbul Convention, while works at the Amulsar mine have stopped due to environmental protests). As regards the Amulsar issue, although the Prime Minister has spoken in the Lydian’s (the owner of Amulsar) defense, nothing has been done to stop the protests, meaning that the site remains closed. This is a key case which could have important implications for foreign companies’ willingness to invest in Armenia’s projects in the future and, thus, PM Pashinyan’s hesitation may not be sending the right signal.

Program without specifics

In terms of the key areas of the government’s program, it focuses on a transformation of both the economic and the political system in Armenia: strengthening of the country’s institutions and the rule of law, as well as improving the business environment and boosting economic growth. Among the few specific targets for the period between 2019 and 2023, the government aims to increase the share of investment in GDP to 23-25%, from around 20% now, and to increase the share of exports in GDP to 43-45% from 37% currently. But there are few details on how this will be achieved, and virtually no quantifiable targets in other parts of the program.

At the same time, while the reduction in the budget deficit last year is encouraging, it was driven disproportionately by a drop in capital spending, which is contrary to what the government should do if it wants to boost investment. Anecdotal evidence suggests that one obstacle to executing budgetary capital spending is the past association of such expenditure with corruption, and the resulting reluctance of the new government to push ahead with the planned projects. Admittedly, the draft 2020 budget is more promising in this sense, as expenditure on infrastructure and other capital spending are set to rise, while defense spending is set to fall. But the track record of implementation of public projects has so far been poor.

All in all, if policies are followed through, Armenia’s potential growth could be boosted substantially, but the speed of progress has so far been slower than may have been expected given the high hopes of a rapid transformation after the revolution of 2018.
Meanwhile, the IMF program remains crucial as a backstop for still-substantial vulnerabilities. And although the economy has enjoyed rapid growth in recent quarters, the underlying picture is still one of substantial vulnerabilities.

Growth potential is seen, but pace is slower than expected

While external imbalances are substantial, FX reserves are very low. And Armenia continues to rely heavily on remittances inflows, which currently stand at around 10% of GDP annually. At the same time, there are no signs that FDI is picking up and public sector investment levels remain low as the new government hesitates on implementing financing projects.

Armenia’s shrinking population means that investment and improvements in productivity will need to drive growth in the future. But both of these require decisive action from the government. In order to track the government’s progress, there are a number of factors worth watching closely: the resolution of the conflict at Amulsar, the implementation of the 2020 budget (whether the investment part is implemented more successfully than in 2019) and progress on the anti-corruption legislation as required by the IMF. The government’s speed at meeting the IMF’s required criteria is also key: the Fund visited Armenia in late September and the first review under the current program is due soon. All in all, these weaknesses serve as a reminder that the ongoing strong relationship with the IMF is key in order to keep Armenia on the right track and to offset the remaining external vulnerabilities.


Credit Strategy: Rating transition implies c.20bp of tightening potential; buy Armenia ‘25s and ‘29s
If, as we expect, Armenia receives its second upgrade to the BB- bucket by Fitch later in November (following the upgrade by Moody’s to Ba3; it is not currently rated by S&P), the country’s rating would then be higher than Uzbekistan’s (which has a split B1/BB-/BB- rating). We think such a potential rating upgrade could be a positive catalyst for Armenia spreads as, over time, markets would likely re-adjust relative valuations in the CIS region. In our opinion, this should result in the gap closing between Armenia and Uzbekistan spreads. Hence, ceteris paribus, we see c.20bp of spread tightening potential for Armenia ‘25s and ‘29s. While in the 10y sector this would mean Armenia ‘29s marginally trading inside Uzbekistan ‘29s in Z-spread terms, this would be justified by the former’s c.12 points lower cash price, in our view.


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