Fitch Affirms Kazakhstan at 'BBB+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed Kazakhstan's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB+' and 'A-', respectively. The Outlooks are Stable. The issue rating on Kazakhstan's senior unsecured foreign currency bonds has also been affirmed at 'BBB+'. The Country Ceiling has been affirmed at 'A-' and the Short-term foreign currency IDR at 'F2'.
KEY RATING DRIVERS
Kazakhstan has sustained a severe shock as a result of a sharp fall in oil prices, compounded by a recession in Russia and weaker growth in China - key trading partners. The policy response, including a sharp devaluation of the exchange rate, fiscal and monetary tightening has contributed towards maintaining the 'BBB+' rating. In Fitch's view, oil prices will likely remain lower for longer, eroding medium-term growth prospects. Large fiscal and external buffers remain a key rating strength, although they will fall over the forecast horizon, in our view. The macroeconomic adjustment to the terms of trade shock is still underway, with difficult policy choices ahead.
Kazakhstan's strong sovereign balance sheet - sovereign net foreign assets exceed 44% of GDP and gross general government debt is less than 20% of GDP - affords it sizeable fiscal space, without unduly compromising sovereign creditworthiness. In November 2014, the authorities announced 'Nurly Zhol - Bright Path', a fiscal stimulus package part funded by drawing down USD9bn over three years (2015-17) from the National Fund of the Republic of Kazakhstan (NFRK) for infrastructure projects and set up a problem loan fund to purchase non-performing loans from the domestic banking system.
The authorities now appear to be taking a more cautious stance to fiscal policy, under the assumption that oil prices are expected to remain lower for longer, scaling back non-priority infrastructure projects and limiting foreign borrowing. The 2016 Budget sees the state budget narrowing to 1.6% of GDP, from an expected 3.1% in 2015, largely as a result of cuts in capital expenditure (1.3% of GDP). Improving the efficiency of tax collection is expected to support revenue. By 2018, the authorities expect to balance the budget, assuming an oil price of USD50/b.
Fitch expects the general government balance (a broader measure than the state budget that includes the net inflow to the NFRK) to move to a deficit of 2.9% of GDP in 2015 (previously 3.2% of GDP), due to higher revenues following the sharp depreciation of the tenge, as well as efforts to contain expenditure. In 2016, Fitch expects the budget deficit to narrow to 0.2% of GDP, largely as a result of a higher oil price assumption of USD60/b, against the authorities' conservative assumption of USD40/b. Fitch expects the budget to return to surplus in 2017.
The National Bank of Kazakhstan (NBRK) has ostensibly moved to a free float of the tenge, leading to a 40% depreciation since August, but pressure on the currency remains and the authorities have continued to intervene. However, the real effective exchange rate against the rouble and other CIS countries appears overvalued, relative to historical trends. Fitch expects negative pressure on the currency to persist. Rising foreign currency deposits, which rose to 59% of the total in August, up 9pp since June, suggest that confidence in domestic policies remains limited.
The NBK moved to inflation targeting in August 2015. The new policy rate was introduced in September 2015, and was hiked in October to 16%, up from 12% in September. The new interest rate was introduced to better align the policy rate with current money market rates. Monetary policy effectiveness remains weak relative to rating peers, with the new policy rate unlikely to significantly influence banks' funding costs.
Reserve burn has continued, despite the sharp depreciation in the tenge. The NBRK used USD1.7bn in foreign exchange reserves to defend the currency between 19 August and 9 October. Prior to August, foreign exchange interventions had totalled USD10bn according to media statements quoting the President, bringing the annual total to USD11.7bn.
Significant market intervention stands in contrast to reserves (including the national oil fund), which have fallen by only USD4.6bn to USD96.1bn in September 2015. This likely reflects a number of factors, including the use of swap facilities, increased dollar deposits in the banking system, as well as modest dollar purchases. Despite the fall in reserves, import cover remains high above 15 months of current external payments, well above the 'BBB' median of 5.4 months.
International investment position data shows that external assets fell by USD8.2bn in the six months to June 2015, largely due to the sale of government holdings of external debt securities as well as the private sector bringing foreign currency deposits back to Kazakhstan. Fitch expects growth to reduce sharply to 1.5% in 2015 and 2.3% in 2016 from 6% in 2011-14 and below the 'BBB' median of 3%, reflecting weaker expected growth in both external and domestic demand, the latter held back by falling real income, deteriorating confidence, and slower investment growth. The government's reform agenda, combined with the onset of oil production at the Kashagan field in 2017, will support medium-term growth. Per capita income has fallen to USD9,900 in 2015 from USD14,054 in 2013, and is expected to drop below the 'BBB' median of USD9,200 by 2016.
Fitch assigns a low average Viability Rating of 'b' to Kazakhstan's banking system. The banking system remains a rating weakness, reflecting the fact that adjustment to the external shock inflicted in 2008-2009, which cost the sovereign 10% of GDP, remains incomplete. The system has been slow ridding itself of NPLs, which are expected to fall to 10% by end-2015 from 32% in 2012, with most of the decline explained by write offs and reclassification of bad loans. With 30% of assets in foreign currency mostly owed by unhedged borrowers in the real estate and importing sectors, the NBK expects NPLs to rise between 3%-4%, as a result of the sharp fall in the exchange rate. Despite the fall in the exchange rate, banking system deposits have remained stable, indicating no immediate risks to financial sector stability. The authorities plan to spend KZT300bn (1% of GDP) to compensate depositors for the depreciation of the tenge.
Structural factors are an important determinant of Kazakhstan's sovereign ratings. The current ratings acknowledge that commodity dependence is high, while Kazakhstan scores weakly on World Bank indicators for governance and institutional strength.
The following risk factors individually, or collectively, could trigger negative rating action:
- Policy mismanagement and/or prolonged low oil prices leading to a weakening in the sovereign external balance sheet.
- Renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign.
- A political risk event.
The following factors, individually or collectively, could result in positive rating action:
- Moves to strengthen monetary and exchange rate policy.
- Steps to reduce the vulnerability of the public finances to future oil price shocks, for example, by reducing the non-oil deficit, currently estimated at more than 9% of GDP.
- Substantial improvements in governance and institutional strength.
Kazakhstan's ratings are based on a number of key assumptions:
- Continued commitment to fiscal responsibility
- Brent oil averages USD60/bbl in 2016 and USD70/bbl in 2017