/Standard & Poor's, September 8, 2017, heading by KASE/ – S&P Global Ratings
revised its outlook on the Republic of Kazakhstan to stable from negative. At
the same time, the 'BBB-' long-term and 'A-3' short-term sovereign ratings were
affirmed. We also affirmed the Kazakhstan national scale rating at 'kzAA'.
OUTLOOK
The stable outlook reflects our expectation that we have captured the fiscal
costs of the authorities' banking sector recapitalization plans in our
projections and that economic activity will remain relatively robust over the
period to 2020.
We could raise the ratings if, outside of our expectations, recent political
reforms result in a significant strengthening of institutions. We could also
upgrade Kazakhstan if the government's diversification strategy were to result
in a more broadly based export basket, reducing the economy's exposure to
volatile terms of trade dynamics.
The ratings could come under pressure if Kazakhstan's external performance
deteriorates beyond our base-case expectations. For example, if our projections
for gross external financing needs were to rise beyond 100% of current account
receipts plus usable reserves.
We could also lower the ratings if previously destabilizing factors re-emerge,
for example, if resident deposit dollarization were substantially to increase
or if our estimate of Kazakhstan's trend growth rate (weighted average of real
per capita GDP) were to fall below 1%, a floor level we consider common for
economies at similar levels of development.
RATIONALE
We have assigned a stable outlook to reflect our assessment that Kazakhstan's
monetary policy flexibility has become less constrained thanks to the sharp
decline in resident deposit dollarization in the economy. The share of foreign
currency deposits to total deposits was 48.7% as of Aug. 1, 2017, having peaked
at almost 70% in January 2016. We also view balance-of-payments pressures as
contained. Given the steady inflow of foreign direct investment (FDI) into the
economy--largely into the oil and gas sector--punctuated by a surge in 2016, we
no longer view this sizable external liability as a potential capital flight
risk.
We have included the fiscal costs of the authorities' banking sector
recapitalization in our projections and, although we have increased our
projections for government debt service to marginally above 5% of government
revenues on average over 2017-2020, we also expect the government to remain in
a net asset position of about 12% of GDP by 2020.
Our ratings on Kazakhstan remain primarily supported by the government's strong
balance sheet, built on past budgetary surpluses accumulated in the National Oil
Fund during the era of high commodity prices. Kazakhstan's strong liquid
external asset position (exceeding external debt) also supports the ratings.
The ratings remain constrained by our view that future policy responses may be
difficult to predict, due to the highly centralized political environment; the
country's moderate level of economic wealth; and remaining challenges to
monetary policy credibility, despite a switch to a floating exchange-rate
regime.
Institutional and Economic Profile: Constitutional changes likely to have
limited immediate effect:
- Constitutional changes pave the way for the possible strengthening of
Kazakhstan's institutions following the eventual transition after President
Nazarbayev's rule.
- We expect that real economic growth will pick up to 3% on average over
2017-2020, supported by the government's infrastructure programs and rising
oil production at the Kashagan field.
- We estimate that trend growth in real per capita GDP (which we proxy by
using 10-year weighted-average growth) will amount to about 1.4% during
2011-2020, at the lower end of the range (1%-4%) for peers that display
similar levels of development.
Our ratings on Kazakhstan remain constrained as, in our view, decision-making
remains highly centralized, which can reduce policy-making predictability. There
have been no transfers of power since Nursultan Nazarbayev became president
following Kazakhstan's independence in 1991. As a result of President
Nazarbayev's hold on power, Kazakhstan has benefited from one of the most stable
political environments in the region since the breakup of the Soviet Union. The
president has stated that he expects to serve his full term to 2020.
Considerable uncertainties surround the eventual presidential succession.
In early March 2017, Kazakhstan's parliament passed constitutional changes,
announced by President Nazarbayev, to increase the role of the cabinet and
parliament at the expense of the president. We view these as an effort to
prepare institutions for the eventual transition from President Nazarbayev, but
we do not expect the constitutional changes to have any practical impact until
that time.
Oil is the key sector in Kazakhstan. It directly accounts for about 15% of GDP,
over half of exports, and 35% of general government revenues. Although
supportive of the economy when prices are high, we view these oil revenues as
exposing Kazakhstan to volatility in terms of trade and the government to a
volatile revenue base.
We marginally improved our economic growth forecasts to show an expansion
averaging 3% over 2017-2020 (compared with 2.5% previously). We expect growth
to be supported by government investment spending and stronger exports as the
oil price outlook marginally improves and oil production from the Kashagan field
accelerates (see "S&P Global Ratings Raises Its Oil And Natural Gas Prices
Assumptions For 2017," published Dec. 15, 2016, on RatingsDirect).
Flexibility and Performance Profile: Strong fiscal position from both a stock
and flow perspective
- We note improving monetary policy effectiveness in relation to declining
resident deposit dollarization in the economy.
- The government's debt-servicing costs have worsened, by our assessment,
but remain modest, rising marginally above 5% of government revenues on
average over 2017-2020. However, the government also remains a strong net
creditor.
- We expect the current account to strengthen gradually over the forecast
horizon through 2020, supported by rising oil production and more competitive
non-oil sector exports following the 2015 devaluation of the exchange rate.
In August 2015, the central bank announced a switch to a floating exchange rate
and inflation targeting. In our view, the subsequent exchange rate adjustment
has eased the accumulated external pressure. However, our assessment of
monetary flexibility remains constrained by the still short track record of the
float.
Challenges to monetary policy credibility remain, in our view, including excess
tenge liquidity in the context of muted bank lending growth and an incomplete
yield curve, given the limited supply of medium- and long-term government
bonds. In our view, this results in a shortage of collateral for interbank
transactions and limits the ability for market participants to pricetheir own
financial products and make investment decisions.
Nevertheless, we note that inflation has fallen from double-digit rates in 2016
to within the 6%-8% target band of the National Bank of Kazakhstan (NBK, the
central bank) in 2017 (annual inflation was 7% in August 2017). In our view,
the NBK could be subject to political influence, as exemplified by some
activities in which it has participated in recent years that we believe fall
outside the usual remit of a central bank. These have included becoming a
shareholder of KazMunayGas, the state- owned oil and gas company, and
compensating tenge-denominated depositors after the 2015 currency depreciation.
We also acknowledge that one constraint on monetary policy effectiveness appears
to be alleviating as resident deposit dollarization in the economy has been
trending downward. The switch to a floating exchange rate and inflation
targeting had resulted in sharp exchange and interest rate volatility in late
2015 and early 2016. As a hedge against further falls in the tenge, the share
of foreign currency deposits to total deposits rose to a peak of close to 70%
in January 2016. However, since then, the NBK has undertaken various measures
to stabilize markets and improve liquidity, including easing reserve
requirements and raising the recommended ceiling for interest rates on tenge
deposits. A pick-up in oil prices and a more stable tenge, along with the NBK's
various measures, resulted in deposits being changed back into tenge from
dollars, with the dollarization rate at 48.7% as of Aug. 1, 2017.
The Kazakhstan authorities are engaged in a process of recapitalizing the
banking system. Absent any significant change in the government's plans, we
believe that we have incorporated the majority of the fiscal costs associated
with the recapitalization into our fiscal projections. The government's 2017
budget included a sharp increase in spending in relation to a recapitalization
of the distressed asset fund (amounting to 4% of GDP) to allow the fund to
purchase a nonperforming loan (NPL) that Kazkommertsbank (KKB) had provided to
BTA Bank. We also understand that an additional Kazakhstani tenge (KZT) 500
billion-KZT700 billion (1%-1.4% of GDP) will be provided to Kazakhstan's banks
in late 2017, by a subsidiary of the NBK, the Stability Fund of Kazakhstan
(SFK). The SFK will provide the banks with the funds (money created by the
NBK), which the banks will then use to buy NBK notes, which means that NBK is
going to issue KZT500 billion-KTZ700 billion of additional NBK notes. Where a
central bank issues debt for nonmonetary policy purposes, we typically include
the debt in our general government debt measure (see "What's The Link Between
Central Banks And Government Debt?," published June 22, 2017).
The NBK made a statement suggesting that NPLs, including restructured loans,
are around 25% of the loan portfolio in its Aug. 9, 2017, report on its banking
sector recapitalization plan. However, adjusting for off-balance-sheet loans
and NPLs under International Financial Reporting Standards, we believe problem
loans could be in the range of 35%-45%. Given our more conservative assessment
of the level of problem loans in the system, we do not expect the authorities'
recapitalization program to be sufficient to significantly improve banks'
ability to act as credit intermediaries in the economy. We project credit
growth in the economy to average 1.5% over 2017-2020. We currently classify
Kazakhstan in group '8' under our Banking Industry Country Risk Assessment, on
a 1-10 scale with '10' being the weakest score (see "Banking Industry Country
Risk Assessment: Kazakhstan," published Sept. 26, 2016, on RatingsDirect).
Our calculation of the general government balance covers the central government,
local governments, and National Fund of the Republic of Kazakhstan (NFRK)
revenues. We explicitly include the government's off-budget economic support
programs, channeled through state-owned enterprises and financed by the NFRK,
in our calculation of general government expenditures. In contrast to the
authorities, we exclude the revaluation effect of NFRK's foreign currency assets
expressed in tenge in our general government revenue calculations. We estimate
that, under our approach, the consolidated general government deficit improved
to 4% of GDP in 2016 from closer to 9% in 2015. However, we expect the deficit
to increase up to 7% of GDP in 2017, largely taking into account the
approximately 5% of GDP the government is spending to recapitalize the banking
system.
We expect a new tax code to increase revenues by about 3% of GDP, indicative of
a greater level of fiscal flexibility than many of Kazakhstan's peers. The tax
code update presents an opportunity to reduce distortions and raise revenues by
rationalizing exemptions and preferential treatments, thus broadening tax bases
and supporting fiscal consolidation. Changes include increases in excise taxes,
expansion of the value-added tax system and amendments to natural resource
taxation. We will track the progress of these initiatives against our 3% of GDP
benchmark.
At present, we continue to view the government's strong balance sheet as a key
factor supporting our ratings. We forecast that general government liquid assets
will amount to a sizable 40% of GDP at the end of 2017. Government assets
consist mostly of the NFRK, which predominantly invests abroad. Given relatively
low debt of about 21% of GDP, the government therefore remains in a net creditor
position of 18% of GDP in 2017.
Government debt service increased to 6% of general government revenues in
2016, from 5% the year before. This was partly due to the depreciation of the
tenge, as about half of government debt stock is in foreign currency. The uptick
in the debt-service ratio was exacerbated by the depreciation-induced rise in
annual inflation to 14.6% as the government's stock of inflation-indexed debt
is around 16% of the total (see table 4 in "Sovereign Debt 2017: Global
Borrowing To Drop By 4% To US$6.8 Trillion," published on Feb. 23, 2017).
However, even with some of those one-off effects fading, we expect government
interest costs to marginally increase above 5% of revenues on average over
2017-2020.
We expect Kazakhstan's external position to improve gradually, partly due to the
lagged effects of the sharp tenge depreciation in 2015. We expect the current
account to strengthen, mostly supported by rising oil production. In our view,
Kazakhstan's strong narrow net external debt position and modest gross external
financing needs support the ratings. We note that the outstanding amount of
inward FDI of a debt-like nature was about $91 billion at year-end 2016 (63% of
the total stock of inbound FDI), which is close to 60% of GDP or 191% of
current account receipts. They constitute a foreign liability of the economy
and could exert balance of payments pressures in case of accelerated
repatriation of profits and equity. However, we do not expect such an event to
take place over the forecast horizon. This is supported by our observations
that FDI tends to be much stickier than portfolio flows; this debt-type FDI is
principally concentrated in the strategic oil and mining sectors of Kazakhstan.
A large share of the income from the stock of FDI in Kazakhstan is re-invested
in the sector, providing further evidence of the long-term commitment of
investors to their projects.
We now subtract our estimate of the NBK's year-end outstanding currency swaps
(notional amount) with domestic banks from usable reserves. With an offsetting
liability, we assess these reserves as not being readily available for foreign
exchange operations or repayment of external debt. The swaps are provided to
support the banks' local currency liquidity, effectively shifting these external
assets from the banks to the NBK. The quality of the NBK's international
reserves is also diminished, in our view, by offsetting liabilities in the form
of foreign currency bank deposits (correspondent accounts) at the NBK, placed
by domestic commercial banks. That being said, we note that the share of these
liabilities has fallen to about 20% of the NBK's international reserves, down
from closer to 50% in 2015.
The full press release is available on KASE website (in Russian) –
http://www.kase.kz/files/mix/sp_kazakhstan_rating_080917.pdf
[2017-09-11]