Fitch Affirms Kazakhstan at 'BBB'; Outlook Stable

02.10.18, 15:18
Fitch Ratings, London, September 28, 2018, translation from English by Fitch Ratings, heading by KASE/ – Fitch Ratings has affirmed Kazakhstan's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook. KEY RATING DRIVERS Kazakhstan's IDRs balance strong public and external balance sheets, underpinned by large government savings and a substantial sovereign net foreign asset position, against high commodity dependence, a weak banking sector, weak World Bank governance indicators and higher inflation compared with 'BBB' peers. Economic growth in Kazakhstan remains heavily influenced by developments in the oil sector. Higher production volumes and rise in international oil prices have contributed to a strengthening of GDP growth and the external current account over the past year. Meanwhile, greater exchange rate flexibility and improved monetary policy credibility have helped cushion the impact of external volatility from increased global risk aversion and spill-overs of US sanctions against Russia. Fitch also considers that continued restructuring of the banking sector and fiscal consolidation sufficient to stabilise robust savings buffers have strengthened Kazakhstan's capacity to absorb shocks compared with 2014-2015. The sovereign's external balance sheet remains robust, with sovereign net foreign assets (SNFA) forecast at 43% of GDP for 2018, the strongest in the 'BBB' category. Fitch expects assets at the National Fund of the Republic of Kazakhstan (NFRK) to reach USD58.3 billion (34% of GDP) at end-2018, while gross international reserves (National Bank of Kazakhstan's international reserves and non-equity assets of the NFRK) will equal USD77.2 billion for 2018 (12 months of current external payments, CXP). Kazakhstan's foreign currency assets are projected to increase gradually in 2019-2020, reflecting still favourable oil prices and currently projected reduction in transfers to the state budget. In line with Fitch's previous assumption that the freeze on NFRK assets stemming from litigation with Moldovan businessmen would not be long-standing, the government obtained a favourable court judgment in July, which led to unfreezing of USD22.1 billion of NFRK assets. Currently, USD530 million of NFRK assets remain frozen pending further litigation in UK courts regarding the validity of an arbitration award. Higher oil prices and increased export volumes will reduce the current account deficit and support stabilisation of foreign currency assets. Fitch expects the current account deficit to narrow to 1.7% of GDP in 2018, reflecting a stronger trade surplus (15.4% of GDP), but also a higher income deficit (13.8% of GDP) derived from dividend and profits remittances. The current account deficit is projected to average 1.1% of GDP in 2019 and 2020 reflecting moderate import growth, still favourable oil prices, as well as larger production volumes, and continued FDI-related outflows. Net external debt, forecast at 22% of GDP in 2018, is higher than 'BBB' peers, but largely reflects FDI-related indebtedness in the energy sector, for which refinancing and repayment risk are relatively moderate, in Fitch's view. Fitch expects growth to reach 3.8% in 2018 boosted by continuing favourable production dynamics in the oil and mining sectors, and improving domestic consumption. The Kashagan oil field will reach maximum production in 2019, private consumption will benefit from real wage and credit growth, as well as government social spending initiatives, and these factors contain our projected slowdown in growth to 3.3% in 2019 and 3% in 2020. In Fitch's view, investment will be heavily influence by activities in the primary sector through the expansion of the Tengiz oil field between 2018-2023 with a positive impact on the construction and logistics sector. The NBK continues to make progress in lowering inflation, which is nevertheless likely to remain above 'BBB' levels. August annual inflation equalled 6%, within the NBK's 2018 band of 5-7%. However, inflationary risks have increased, due to a weaker tenge resulting from increased global risk aversion and sanctioned- related rouble weakening (April and August/September). Fitch expects inflation to finish the year close to the top of the NBK target rage (6.9%) and average 6.6% and 6% in 2019 and 2020, respectively, close to current levels but above the NBK's targeted band, mostly reflecting a more challenging external backdrop. Monetary policy has supported the disinflation process and improved inflation expectations, but greater strengthening of the policy framework continues to be constrained by a weak financial sector, relatively shallow domestic financial markets, still high dollarisation and state-subsidised credit. The banking sector remains weak, with a Fitch-defined Bank System Indicator of 'b'. The official NPL rate was 8.8% in July (with provisions coverage ratio averaging 85% in 2018), but this likely understates the volume of problem loans, made of restructured loans and problem FX loans classified as performing. The NBK has improved its regulatory environment, monitoring capacity and continues with the banking sector clean-up process, for instance withdrawing the license of banks that did not meet capitalisation requirements (Qazaq Bank, Eximbank and, more recently, Astana Bank). Fitch considers that further state support for the sector may be needed, but would not materially undermine the sovereign's balance sheet. In early September, the government and NBK agreed to purchase Tsesnabank's agricultural loan portfolio KZT450 billion (0.8% of GDP). Tsesnabank (together with another four large banks) had been part of a 2017 NBK-led recapitalisation programme equal to KZT654 billion (1% of GDP). Fiscal consolidation is underway. Fitch expects the general government deficit to decline to 1.7% of GDP in 2018, down from a deficit of 6.4% of GDP in 2017 (4% of GDP was spent to recapitalise KKB ahead of its merger with HB). The consolidation is expected to be facilitated by higher oil prices, a weaker tenge, healthy non-oil revenue growth, the unwinding of the Nurly Zhol programme and expenditure restraint. In its forecast, Fitch includes Tsesnabank's problem loan purchases (0.8% of GDP). The government will likely over-perform on its non-oil deficit target of 7.4% of GDP in 2018 (down from 12.8% in 2017, according to the IMF). The fiscal rule includes medium-term targets for the non-oil deficit (expected to tighten to 6% by 2025), and caps transfers from NFRK to the budget at KZT2 trillion after 2020, which would help support macroeconomic stability and replenish NFRK assets over the medium term. Exceptional transfers decided by the president are still allowed to smooth oil price shocks, thereby maintaining some degree of discretion in the fiscal rule. General government debt (state plus state guaranteed) will decline to 19.1% of GDP (19.9% in 2017), half the current 'BBB' median. Government direct guarantees accounted for 0.9% of GDP in 1H18. Since July, Kazakhstan local bonds can now be settled via Clearstream, which could support further development of the local market. Plans for a potential local currency international bond placement have been put on hold due to international markets' volatility. The government remains committed to economic diversification through various initiatives to support develop new economic sectors and improve the institutional framework. Fitch believes that the full impact from these initiatives is likely to take time to materialise, assuming effective implementation and increased private sector participation. In the meantime, Kazakhstan's strong commodity dependence is likely to continue, especially given the current and expected rise in oil and gas production. Human and financial development indicators are broadly in line with 'BBB' medians, but the World Bank's governance indicators, albeit improving, continue to represent a rating weakness, partly reflecting the centralisation of powers in the presidency. Despite a constitution change early 2017 to shift some presidential powers to the government and the parliament, Fitch does not anticipate any significant change in political risk and governance over the forecast horizon. DERIVATION SUMMARY SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO) Fitch's proprietary SRM assigns Kazakhstan a score equivalent to a rating of 'BBB-' on the Long-Term Foreign-Currency (LT FC) IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Public Finances: +1 notch, to reflect government savings in the NFRK - External Finances: +1 notch, to reflect sovereign external assets that are the largest in the rating category - Structural Features: -1 notch, to reflect the weak condition of the banking sector Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM. KEY ASSUMPTIONS Fitch assumes that Brent crude will average USD70/b in 2018 and USD65 in 2019 and USD57.5 in 2020. RATING SENSITIVITIES The main factors that could, individually or collectively, trigger positive rating action, are: - Sustainable improvement in the health of the banking sector. - Improvement in the economy's and public finances' resilience to commodity price shocks. The main factors that could, individually or collectively, trigger negative rating action, are: - Materialisation of additional significant contingent liabilities from the banking sector on the sovereign balance sheet. - Policies that widen the fiscal deficit or undermine monetary policy credibility. DATE OF RELEVANT COMMITTEE 26 September 2018 Full version of the press release is available on Fitch Ratings’ website. [2018-10-02]