Fitch Affirms Kazakhstan’s rating at 'BBB'; Outlook Stable

/Fitch Ratings, Moscow, April 17, 2018, heading by KASE/ – Fitch Ratings has affirmed Kazakhstan's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Kazakhstan's 'BBB' IDRs reflect the following 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 governance indicators and higher inflation compared with 'BBB' peers. The economy's adjustment to the oil price shock of recent years continues, facilitated by greater exchange rate flexibility, monetary policy reforms, continued restructuring of the banking sector and fiscal stimulus. Real GDP growth rebounded to 4% in 2017, largely reflecting rising oil production as the Kashagan oil field production resumed. Economic diversification and promotion of the private sector remain high on the authorities' agenda, but Fitch sees diversification as a medium-term prospect. In the meantime, and given the expected rise in output in 2018-2022 associated with Kashagan and the Tengiz oil field expansion, commodity dependence will remain a weakness of Kazakhstan's sovereign credit profile. Monetary conditions and the foreign exchange market have further normalised in recent months, as illustrated by declining inflation (6.5% yoy at February 2018), diminishing deposit dollarisation (45.2% at February 2018), and improving stability of the exchange rate. This reflects the gradual strengthening of the central bank's monetary policy framework, but also a supportive oil price and production environment. Transmission channels of monetary policy remain constrained given the level of dollarisation and the weakness of banks' balance sheets, and the commitment to a floating exchange rate and inflation targeting policy remains to be tested if oil price volatility resumes. Public finances remain a rating strength, despite the widening of the general government deficit to 6.6% of GDP in 2017, according to Fitch's estimates, as the recapitalisation of Kazkommertsbank (KKB) absorbed around 4% of GDP. Fitch projects the 2018 budget deficit to contract to around 2.2% of GDP (broadly in line with the 'BBB' median) as the Nurly Zhol stimulus programme is phased out, and spending is constrained by the implementation of a new fiscal rule. The sovereign's balance sheet remains strong, with a low public debt (19.8% of GDP at end-2017, against a 'BBB' median of 41%), and assets in the National Fund of the Republic of Kazakhstan (NFRK) worth 36.9% of GDP at end-2017. After three consecutive years of asset depletion, Fitch expects the rise in oil prices and production, together with the reduction in transfers to the budget under the fiscal rule, to strengthen NFRK assets from 2018. However, the ongoing legal freeze of USD22.6 billion (equivalent to 14% of 2017 GDP) of NFRK assets as a result of a disputed legal case between Kazakhstan and Moldovan businessmen for a claim totalling around USD500 million, adds a degree of uncertainty on the availability of the assets for the sovereign. Fitch considers the freeze to be temporary and therefore includes the entirety of NFRK assets in our assessment of the sovereign's balance sheet. Fitch also understands that the government has the option to lift the freeze by depositing USD500 million in an escrow account. Evidence that the freeze would be longstanding and/or involve additional assets could lead us to exclude the frozen assets from our computation of Kazakhstan's external solvency and liquidity metrics. The country's external finance metrics are sound. Net sovereign foreign assets amounted to 47.3% of GDP at end-2017 (BBB median: 4.9%), reflecting NFRK assets and high FX reserves, which cover nearly 15 months of current account payments. Fitch anticipates a contraction in the current account deficit below 3% of GDP from 2018 on the back of rising oil prices and exports (2017: 3%), which would further strengthen external assets over the forecast horizon. Net external debt, at an estimated 19% of GDP at end-2017, is higher than 'BBB' peers, but largely reflects FDI-related indebtedness in the energy sector, for which refinancing and repayment risk are more moderate in Fitch's view. The banking sector remains weak, with a Fitch-defined Bank System Indicator of 'b'. The restructuring is ongoing, with the authorities completing the merger of Halyk Bank with KKB, and providing subordinated debt worth 1.3% of GDP to five ailing banks at end-2017. This improved the sector capital adequacy ratio to 21% at end-2017. NPL, at an official 9.3% of gross loans, remain underreported and could add to recapitalisation needs of the sector over the forecast horizon, but Fitch deems them manageable given the moderate size of the banking sector (total assets amounted to less than 50% of GDP at end-2017) and improvements in terms of banking supervision. Human and financial development indicators are broadly in line with 'BBB' medians, but governance indicators have long represented 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 expect any significant change in political risk and governance over the forecast horizon. 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. RATING SENSITIVITIES The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently balanced. The main factors that could, individually or collectively, trigger negative 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. 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 KEY ASSUMPTIONS Fitch assumes that Brent crude will average USD57.5/b in 2018 and 2019. The full list of rating actions is as follows: Long-Term Foreign-Currency IDR affirmed at 'BBB'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'BBB'; Outlook Stable Short-Term Foreign-Currency IDR affirmed at 'F2' Short-Term Local-Currency IDR affirmed at 'F2' Country Ceiling affirmed at 'BBB+' Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'BBB' Contact: Primary Analyst Erich Arispe Director +44 20 3530 1753 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Ed Parker Managing Director +44 20 3530 1176 Committee Chairperson James McCormack Managing Director +44 20 3530 1286 Media Relations: Julia Belskaya von Tell, Moscow, Tel: +7 495 956 9908, Email: julia.belskayavontell@fitchratings.com [2018-04-17]