Armed confrontation with Azerbaijan negatively affects international ratings of Armenia

By Orkhan Baghirov

As the armed confrontation between Azerbaijan and Armenia continues, with Azerbaijan liberating its territories that have been under illegal Armenian occupation for about 30 years, not only is Armenia’s political environment aggravated, but its economic situation is also worsening. Even before the armed clashes began, because of pandemic-related restrictions, Armenia faced with serious economic and social problems. Increasing military expenses and financial security risks have exacerbated these problems.

The new economic condition in turn has negatively affected international economic ratings of Armenia. In its last assessment, Fitch Ratings has downgraded Armenia's Long-Term Foreign-Currency Issuer Default Rating to 'B+' from 'BB-' with the Stable Outlook. In the report regarding the assessment that was published on October 5, it is noted that despite Armenia's institutions facilitating an orderly political transition, robust macroeconomic policy framework, and credible commitment to reform, economic problems such as high and growing net external debt, large structural current account deficit, a reliance on remittances and weak FDI inflows remain in place. Consequently, these problems are negatively affecting the rating of Armenia.

The agency also considers the military confrontation with Azerbaijan as one of the main factors that has affected the rating of Armenia. That was also the main reason of delayed publication of the report, which was initially planned to be published on October 2. Regarding the armed confrontation, experts of the agency think that the extent to which concessions are viewed as politically acceptable is uncertain. Significant risk of a resumption of hostilities over time represents a material downside risk to the economic and fiscal projections of Armenia.

To determine the new rating of Armenia, the agency evaluated and predicted different economic indicators. Based on calculations of the agency, Armenian economy will contract by 6.2% this year, below the 'B' median of a 4.8%. Whereas, at a previous review, the agency forecasted a 0.5% growth. The main factors affecting downward forecast are the low economic activity, fall in investment and tourism, the impact of lockdown measures and weaker private consumption. The agency also decreased the GDP forecast for next year from 5.5% to 3.2%.

Despite the low budget revenues, the financial situation in Armenia necessitates increase of budget expenditures which significantly widens the budget deficit. Thus, the agency forecasts the budget deficit to widen by about 0.8% compared to last year and to reach 7.6% of GDP this year. To prevent the budget deficit of reaching risky levels, the government has activated the escape clause in its Fiscal Rule, which demonstrates seriousness of the financial problems in Armenia.

The high level of budget deficit creates another problem - high Debt to GDP Ratio, as Armenia has to attract foreign debt for financing increasing budget deficit. Therefore, the agency forecasts Debt to GDP ratio to rise from 53.5% at the end of 2019 to 63.9% this year and 65.6% in 2021. It is expected that this ratio will remain elevated over the medium term, because of weaker growth and further spending pressures. In order to reduce risks, the Armenian government is planning to bring Debt to GDP ratio below 60% within the next five years. However, Fitch considers that it will not be possible, as there is uncertainty related to the implementation of a fiscal consolidation program and the need for additional fiscal measures to support the economy.

The predictions of Fitch Ratings on different economic indicators of Armenia show that in the coming years, the country will be faced with serious economic problems. Dependence of Armenian economy on foreign assistance and foreign debt has made it sensitive to foreign shocks. Thus, the pandemic significantly affected the Armenian economy and the recovery process has been slow. With the start of the armed confrontation, even the slow recovery process has halted. Instead of leaving the occupied territories of Azerbaijan peacefully, Armenia chose a nationalistic approach which has now led to the armed confrontation. Heavy losses of Armenia in this confrontation will have severe economic implications for the country in the coming years. These implications, in turn, will continue having a negative impact on Armenia’s international ratings.

Orkhan Baghirov, a leading advisor at the Center of Analysis of International Relations (AIR Center) in Baku, Azerbaijan, especially for News.Az.

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