FITCH AFFIRMS RATINGS OF REPUBLIC OF KAZAKHSTAN, OUTLOOK STABLE

/Fitch Ratings, Moscow, October 28, 2016, KASE hedline/ – Fitch Ratings has affirmed Kazakhstan's Long-Term Foreign and Local Currency Issuer Default Ratings at 'BBB' with a Stable Outlook. The issue ratings on Kazakhstan's senior unsecured foreign currency bonds are also affirmed at 'BBB'. The Country Ceiling is affirmed at 'BBB+' and the Short-Term Foreign-Currency and Local-Currency IDRs at 'F2'. KEY RATING DRIVERS Kazakhstan's 'BBB' Long-Term IDRs reflect the following key rating drivers:- The economy is gradually adjusting to a significant shock caused by lower oil prices and weaker demand in key trading partners. Economic growth is resuming and the erosion of the strong sovereign balance sheet, which underpins the ratings, is slowing. The banking sector is a significant weakness compared with peers. Greater exchange rate flexibility is supporting the adjustment of the balance of payments, with official reserves rising USD3.5bn over the first nine months of 2016, to USD31.4bn. The current account deficit is forecast to narrow to 2.3% of GDP in 2016, from 3.2% in 2015, and will be fully financed by net foreign direct investment inflows. Rising oil and metals prices are forecast to return the current account to a small surplus in 2017. Increasing sovereign net foreign assets (forecast at 62% of GDP at end-2016; 'BBB' median 2.6%) and bank deleveraging will offset the rise in net external debt of the non-bank private sector caused by the financing of energy projects. This in turn will reduce net external debt to a forecast 13.7% of GDP at end-2018, compared with a forecast 20% at end-2016 and a forecast peer median of 0%. Lower spending will reduce the IMF-defined general government deficit (which includes off-balance sheet spending) to a forecast 4.7% of GDP from a 16-year high of 6.9% in 2015. The deficit on the Republican budget is also projected to narrow to 2% of GDP in 2016 from 2.2% in 2015. The budget was revised in September with spending increased to take advantage of above-target revenues stemming from higher-than-planned oil prices and improved collection of non-oil revenues. The new 2017-2019 fiscal plan (based on an oil price of USD35/b; Kazakhstan export crude) assumes a gradual narrowing of the deficit on the Republican budget to 1% of GDP by 2019, based on keeping spending growth below nominal GDP growth and the unwinding of stimulus spending. No new revenue-raising measures are proposed with the government instead planning to improve the tax administration and adjust tax exemptions. Fitch expects the general government deficit to narrow to 2.4% of GDP by 2018, based on our higher oil price assumptions. Government savings are large, with assets of the National Fund of the Republic of Kazakhstan (NFRK), a fiscal reserve fund, at USD64.4bn (49% of Fitch-projected 2016 GDP) at end-September. Fitch expects a modest drawdown of the NFRK over the forecast period to end-2018 for deficit financing. General government debt is projected at 19.6% of GDP at end-2016, compared with a peer median of 40.3%. Fitch expects it to drop to 15.9% at end-2018 due to high nominal GDP growth and exchange rate appreciation (around 45% of debt is foreign currency-denominated). The banking sector is a credit weakness with a Fitch Banking System Indicator of 'b'. Headline NPLs have been stable during the year, at 7.9% of total loans at end- September. However, there are significant volumes of lightly provisioned restructured/distressed loans on most banks' balance sheets. Further asset-quality deterioration risks stem from foreign currency loans, currently classified as performing, that were mostly provided to unhedged borrowers. Government capital injections into the sector are possible, but are unlikely to be large relative to the sovereign's capacity to support the sector. Economic growth is set to pick up modestly from 0.4% year-on-year in the first three quarters of 2016. Lower real incomes, tougher credit conditions, a weak external environment, falling oil production and the adjustment to the external shock have depressed growth, with government capex and agricultural output providing the main positive dynamic. Growth is forecast to rise to 2% in 2017 as production at the Kashagan oil field is ramped up, new mining projects come on stream and private consumption picks up. Large investment in the energy sector will support medium- term growth. Nonetheless, average growth for 2016-2018 of 1.9% will be well below the average of the previous decade (5.6%) and the 2.9% peer median. Official intervention in the exchange rate market is declining and the monetary policy framework is gaining credibility. However, still high dollarisation (58.3% at end-September versus a 'BBB' median of 36%) highlights weak confidence in the currency and continues to hamper the transmission mechanism. Inflation should fall to high single digits by end-2016 as the impact of the devaluation drops out, from 16.6% in September, but will stay at a five-year average (to end-2016) of 7.9%, compared with a 2.7% peer median. Governance indicators are well below the peer median, particularly for voice and accountability, based on World Bank rankings. Independent observers believe that the president retains his popularity despite the economic downturn. A cabinet reshuffle in September, at which a new Prime Minster was appointed, is not expected to lead to policy changes. 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 IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign Currency IDR by applying its QO, relative to rated peers, as follows: - Public Finances: +1 notch, to reflect large government savings in the NFRK. - External Finances: +1 notch, to reflect high sovereign external assets. - 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 Long-Term Foreign Currency 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. RATING SENSITIVITIES The following risk factors individually, or collectively, could trigger negative rating action: - Policy mismanagement or prolonged low oil prices leading to a further weakening in the sovereign external balance sheet. - Materialisation of significant contingent liabilities from the banking sector on the sovereign balance sheet. The following factors, individually or collectively, could result in positive rating action: - A sustained recovery in external and fiscal buffers. - Steps to reduce the vulnerability of the public finances to future oil price shocks, for example, by reducing the non-oil deficit. - A sustained recovery in the economy supported by substantial improvements in the business climate and governance and greater diversification. KEY ASSUMPTIONS Brent crude is forecast to average USD42/b in 2016, USD45/b in 2017 and USD55/b in 2018. Contact: Primary Analyst Paul Gamble Senior Director +44 20 3530 1623 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Amelie Roux Director +33 144 299 282 Committee Chairperson Jan Friederich Senior Director +852 2263 9910 Media Relations in Moscow: Julia Belskaya Von Tell, Moscow, Tel: +7 495 956 9908/9901, julia.belskayavontell@fitchratings.comт [2016-10-31]