Fitch Affirms Kazakhstan at ‘BBB’; Outlook Stable

Fitch assigns 'BB' IDR to Kcell JSC; Outlook Stable

Fitch Ratings-Paris/London-21 April 2017: Fitch Ratings has affirmed Kazakhstan’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at ‘BBB’ with Stable Outlooks. The issue ratings on Kazakhstan’s senior unsecured foreign-currency bonds have also been affirmed at ‘BBB’. The Short-Term Foreign- and Local-Currency IDRs have been affirmed at ‘F2’. The Country Ceiling has been affirmed at ‘BBB+’.

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 a volatile macroeconomic performance compared with ‘BBB’ peers. The economy’s gradual adjustment to the large oil price shock of recent years is continuing, 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 7.7% of GDP in 2017 from an estimated 5.0% in 2016, due to the recapitalisation (at an estimated one-off cost of 4.2% of GDP to the budget) of the country’s largest bank, Kazkommertsbank (CC/Rating Watch Evolving, KKB). The recapitalisation is part of a process that should see KKB acquired by the second-largest bank, Halyk Bank (B/Rating Watch Negative). The authorities intend to narrow the budget deficit in 2018-2019 by ending the Nurly Zhol stimulus programme and reforming the tax code. Fitch expects deficit reduction to be supported by higher oil prices, and assumes no additional recapitalisation costs after 2017.

The state’s fiscal balance sheet is very strong, reflecting assets in the National Fund of the Republic of Kazakhstan (NFRK) of 45.8% of GDP at end-2016. Net government debt at end 2016 was -22.3% of GDP compared with a peer median of 33.1%. The NFRK will be used to partly finance the higher deficit in 2017, but Fitch expects its assets to remain above 30% of GDP over the forecast period. A new fiscal rule was introduced in December 2016 to reduce guaranteed transfers from the NFRK to the state budget from 2018.

Commodity dependence is high (oil exports account for around half of current account receipts) and lower oil prices have pushed the current account deficit to 6.4% of GDP in 2016 (BBB median: -1.8%). Non-oil exports have not yet benefited from exchange rate depreciation given economic weakness in the main trading partners. External prospects are better for 2017 and 2018 due to an expected oil price recovery, but high FDI-related imports and income outflows will keep the current account in deficit over the forecast horizon. Fitch expects the deficit to be fully financed by FDI, which will remain strong as the USD37 billion Tengiz oil field expansion starts next year.

External balance sheet metrics are very strong. The sovereign is a net external creditor (58.8% of GDP at end-2016 versus a BBB median of 2.9%) thanks to foreign assets of the NFRK and large FX reserves, accounting for around 18 months of current account payments. Net external debt of 22.9% of GDP at end-2016 is higher than the peer median of 0.5%, but mostly reflects FDI-related indebtedness in the energy sector; 63% of private sector gross external debt was intercompany debt at end-2016. Fitch estimates that net external debt will peak at end-2017 before declining to below 20% of GDP at end-2018 due to robust FDI and lower current account deficits. Given the low share of short-term external debt, Fitch’s liquidity ratio is also very comfortable, above 300% at end-2016 (peer median 154.7%).

Macro-financial risks have receded. The inflation targeting regime established in 2015 is gaining credibility. Inflation has fallen to within the 6%-8% target range, standing at 7.7% in March 2017, after overshooting in 2016 (8.5% at end-year), and the NBK intends to further strengthen its monetary policy framework. It has not intervened in the exchange rate market since September 2016, and the tenge slightly appreciated during the year. Deposit dollarisation, although still higher than the ‘BBB’ median at 54.6% at end-2016, is also declining, illustrating improved confidence in the currency.

The banking sector is very weak, with a Fitch-defined Bank System Indicator of ‘b’. The authorities appear committed to financial sector restructuring, as illustrated by the support to KKB and the intention to hold an asset quality review in 2018. At 6.7% of gross loans, official NPLs are moderate, but may significantly underestimate lightly provisioned restructured or distressed loans on most banks’ balance sheets. Further recapitalisation needs may appear in the coming years, but Fitch would expect them to be manageable compared to the sovereign’s assets.

The economy continued adjusting to the 2015 exchange rate devaluation and lower oil revenues throughout 2016. Real GDP growth was 1.0% last year after 1.2% in 2015, supported by the government’s countercyclical stimulus programme. Fitch expects real GDP growth to pick up to 2.2% in 2017 as oil output increases (the Kashagan oil field has restarted operations), FDI remains strong and the stimulus programme continues. However, even if rising oil output and energy-related FDI imply more favourable medium-term economic prospects, continued commodity dependence means macroeconomic volatility is likely to be higher than ‘BBB’ peers over the forecast horizon.

Debt tolerance is compromised by weaker governance indicators, as measured by the World Bank. Constitutional amendments approved in March 2017 meant to hand over some of the president’s wide-ranging powers to the government and parliament are unlikely to trigger a short-term improvement in governance indicators, in Fitch’s view.

Fitch’s proprietary SRM assigns Kazakhstan a score equivalent to a rating of ‘BB+’ on the Long-Term FC IDR scale.

In accordance with its rating criteria, Fitch’s sovereign rating committee decided not to adopt the score indicated by the SRM as the starting point for its analysis because, in the committee’s view, the migration of the SRM output from ‘BBB-‘ to ‘BB+’ is a temporary deterioration.

Assuming an SRM output of ‘BBB-‘, Fitch’s sovereign rating committee adjusted the output to arrive at the final LT FC 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 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.

The main factors that, individually or collectively, could trigger negative rating action are:
– A further 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
– Policies that hamper fiscal consolidation or undermine monetary policy credibility

The main factors that, individually or collectively, could trigger positive rating action are:
– 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 environment and governance and greater diversification
– Substantial improvement in the performance of the banking sector

Fitch assumes that Brent crude will average USD52.5/b in 2017 and USD55/b in 2018

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