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]