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Fitch Affirms Kazakhstan at 'BBB'; Outlook Stable
October 20, 2017 / 8:06 PM / a month ago

Fitch Affirms Kazakhstan at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) LONDON, October 20 (Fitch) 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 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 volatile macroeconomic performance compared with 'BBB' peers. The economy's adjustment to the oil price shock of recent years continues, facilitated by exchange rate flexibility, monetary policy reforms, restructuring of the banking sector and fiscal stimulus. The IMF-defined general government deficit is forecast to widen to 6.5% of GDP in 2017 from 4.1% in 2016, due to the one-off cost of the recapitalisation (at an estimated cost of 4.2% of GDP) of the country's largest bank, Kazkommertsbank (BB-/Stable, KKB). The recapitalisation is also being part-financed by domestic debt issuance. A narrowing of the deficit, to 2.5% of GDP, is projected in 2018, given the absence of the transfer for the financial sector and the winding down of the Nurly Zhol stimulus programme. Planned progressive cuts to the guaranteed transfer from the National Fund of the Republic of Kazakhstan (NFRK) leading to reduced expenditure commitments at the state budget level and rising oil revenue will underpin a Fitch-forecast narrowing of the deficit to 1.4% of GDP by 2019. NFRK assets underpin a strong sovereign balance sheet. Although NFRK assets have fallen in 2017 to finance the larger deficit, they are forecast to end the year at 37% of GDP, supporting a net debt position of -14% of GDP, compared with a peer median of 32.1%. Fitch expects NFRK assets to remain above 30% of GDP over the forecast period to end-2019. Higher privatisation revenue presents an upside to the forecast of NFRK assets, as IPOs of minority stakes in Air Astana, Kazakhtelecom and Kazatomprom are planned for 2018, with the revenue to be transferred to the NFRK. The current account deficit is forecast to narrow to 3.3% of GDP in 2017 from 6.4% in 2016, due to higher oil and other commodity export revenue. A significant improvement in the trade surplus is being partially offset by a rise in net income outflows resulting from payments to the largely foreign consortium that developed and operates the Kashagan oilfield. Higher oil production and prices will lead to a further narrowing of the deficit to 2019, though high imports related to foreign direct investments (FDI) and income outflows will keep the current account in deficit over the forecast horizon. Fitch expects the deficit to be fully financed by FDI. External balance sheet metrics are very strong. Sovereign net foreign assets are forecast at 51% of GDP at end-2017 compared with a 'BBB' median of 3.6%, due to foreign assets of the NFRK and large FX reserves (which combined are equivalent to 15 months of current external payments). Net external debt, forecast at 21.8% of GDP at end-2017, is higher than the peer median of -1.1%, but mostly reflects FDI-related indebtedness in the energy sector; 63% of private sector gross external debt was inter-company debt at end-2016. Fitch forecasts that net external debt will fall over the forecast period due to robust FDI and smaller lower current account deficits. Given the low share of short-term external debt, Fitch's liquidity ratio is also very comfortable, at a projected 303% at end-2017 compared with a peer median of 177%. Monetary and exchange rate policy adjustment continues, but the framework remains weak relative to peers. Inflation has been within the central bank's 6%-8% 2017 target range for the whole year (7.1% in September), and 12-month household inflation expectations were 6.5% in September. Monetary policy has contributed to this outturn, but transmission channels are weak. Recent bouts of tenge weakness prompted the central bank to announce it was intervening, moves that appear consistent with its policy of only intervening to smooth the path of the currency. Deposit dollarisation remains high, but has fallen to 48.7% at end-September. The banking sector is very weak relative to peers, with a Fitch-defined Bank System Indicator of 'b', but is being cleaned. The acquisition of the dominant bank, KKB, by Halyk Bank (BB/Stable), has been completed, leaving a more financially sound main player. The authorities are turning their attention to the next tier of banks. A central bank subsidiary has been created to support the recapitalisation of banks with minimum total capital of KZT45 billion, at a cost estimated by the government at KZT500 billion-KZT700 billion (1%-1.3% of GDP), contingent on existing bank shareholders providing new capital. Fitch believes that the cost may be higher due to a weak loan reporting framework and uncertainty over the source of capital injections by private shareholders. Recapitalisation needs are manageable compared with the sovereign's assets. Economic growth is recovering and the five-year growth rate is in line with the peer median despite the oil price shock and related fallout. Growth is forecast to rise to 3.4% in 2017 due to the restart of production at the giant Kasahgan field. Mining and manufacturing exports are benefitting from a stronger external environment. Consumer demand is reviving, despite a continued fall in real incomes, after slowing for several years. Growth prospects remain solid. Production at Kasahgan will be ramped up in 2018 and 2019 before hitting full capacity in 2020. Work on the Tengiz expansion (costing USD36 billion between 2017 and 2022) is on track. Structural reform is progressing in some areas, though it will take time to filter into stronger non-oil growth. Governance indicators, as measured by the World Bank, compare unfavourably with 'BBB' medians, partly reflecting the centralisation of powers in the presidency. However, constitutional amendments approved in March 2017 have formally handed over some of the president's wide-ranging powers to the government and parliament. 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 NFRK projected at 37% of GDP at end-2017; - External finances: +1 notch, to reflect sovereign external assets that are the largest in the rating category; and - 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 rating action are: - A weakening in the sovereign external balance sheet; - Materialisation of significant contingent liabilities above those already identified from the banking sector on the sovereign balance sheet; and - Policies that hamper fiscal consolidation or undermine monetary policy credibility. The main factors that could, individually or collectively, trigger positive rating action are: - A sustained recovery in external and fiscal buffers; - Sustainable improvement in the health of the banking sector; and - Steps to reduce the vulnerability of the public finances and the economy to future oil price shocks. KEY ASSUMPTIONS Fitch assumes that Brent crude will average USD52.5/b in 2017 and 2018 and USD55/b in 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 Paul Gamble Senior Director +44 20 3530 1623 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Erich Arispe Director +44 20 3530 1753 Committee Chairperson Shelly Shetty Senior Director +1-212-908-0324 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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