Fitch Ratings-London-28 August 2015: Fitch Ratings has affirmed Azerbaijan's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' with a Stable Outlook. The issue ratings on Azerbaijan's senior unsecured foreign currency bonds have also been affirmed at 'BBB-'. The Country Ceiling has been affirmed at 'BBB-' and the Short-term foreign currency IDR at 'F3'.
KEY RATING DRIVERS
Azerbaijan's ratings reflect the sovereign's low debt (14% of GDP in 2015) and large stock of net foreign assets (72% of GDP), accumulated with the help of double-digit current account surpluses and high oil prices since 2006. The affirmation reflects our expectation that the authorities are committed to making the adjustments to capital spending and tax revenue that will ensure the preservation of these buffers. The high dependence on oil and gas is a key rating weakness, with hydrocarbons accounting for 95% of goods exports, 50% of budget revenues and 40% of GDP in 2015. Governance and political risk also weigh on the rating, with the country scoring half the 'BBB' median on World Bank governance indicators.
Under our baseline oil price assumptions, the general government budget deficit in 2015 will amount to 4% of GDP (AZN2.3bn), as oil-related revenues fall to roughly 20% of GDP from 24% of GDP a year earlier. We forecast that the government budget will be in balance by 2016 and have a surplus of around 4% of GDP in 2017. This improvement will be driven by a reduction in capital spending from 14% to 10% of GDP and a gradual recovery of oil prices. We also expect non-oil revenue to improve to 15.0% of GDP by 2017 from 12.5% in 2015, as the authorities' efforts to boost tax collection pay off.
The authorities have expressed a strong commitment to preserving the assets of the State Oil Fund of Azerbaijan (SOFAZ), which receives most of the government's oil-related revenues and makes transfers that fund the budget. SOFAZ's assets were 49% of GDP (or USD37bn) at end-2014, and we expect them to rise to 57% of GDP by end-2017. This is under the assumption that the transfer to the state budget will remain fixed in nominal terms as oil revenues recover. The 30% devaluation of the manat in February has been a key support to the value of the oil fund and fiscal ratios, as oil receipts are denominated in foreign currency but expenditures and transfers are budgeted in local currency.
The effects on domestic activity and confidence from the oil price fall and manat devaluation appear to have been benign, with real non-oil growth expected to reach 5% in 2015 and overall real GDP growth expected to reach 2.3%. Data for 1H15 shows robust growth in non-oil industrial production, construction, and retail trade. Key energy projects, chiefly the USD28bn Shah Deniz Stage Two gas development, are still expected to go ahead and support the growth outlook by boosting investment and increasing oil and gas capacity after 2017.
Some support to non-oil activity should also come from the restoration of price competitiveness. Consumer prices rose 3.5% yoy in June 2015, with services prices rising just 1.3% yoy and wages rising 3.9% yoy. We expect consumer prices to climb 5.5% yoy over 2015, with the muted inflation outturns likely reflecting a high incidence of controlled prices, compression of business margins, and the politically sensitive nature of the currency devaluation.
Loss of confidence in the domestic currency has led to a spike in dollarisation, with the share of foreign currency deposits in the banking sector reaching a peak of 73% in May-April, up from 51% at end-January. The resulting currency mismatches further worsened loan quality, eroded capitalisation ratios and created a shortage of local currency liquidity in the banking sector. After average real growth of 29% over the past 10 years, we expect credit growth to be subdued in 2015-2017 and growth in 2015 will be mostly due to valuation effects.
Although the banking sector is an area of weakness, its small size (with assets at 50% of GDP in 2015) allows the government to provide support as needed. In July, the authorities announced the intention to recapitalise, clean up, and privatise the International Bank of Azerbaijan, which accounts for 35% of banking sector assets. The government will contribute AZN100m (0.2% of forecast 2015 GDP) to the recapitalisation. We forecast that the government's explicit contingent liabilities could increase by several percentage points of GDP as a result of government-guaranteed bonds issued to finance the purchase of the bank's troubled assets.
RATING SENSITIVITIES
The following risk factors individually, or collectively, could trigger negative rating action:
- A failure to adjust expenditure or revenue to the lower oil price environment, resulting in a draw-down of oil fund assets beyond 2015.
- A prolonged period of low oil prices.
- A regional geopolitical shock severe enough to disrupt Azerbaijan's economic or financial stability, such as a full-scale conflict over Nagorno-Karabakh.
The following risk factors individually, or collectively, could trigger positive rating action.
- An improvement in the budgetary position, beyond the measures currently envisaged, sufficient to increase Fitch's confidence in the longer-term sustainability of Azerbaijan's sovereign balance sheet strengths.
- Sustainable economic diversification, supported by reforms to improve governance and transparency.
KEY ASSUMPTIONS
The ratings and Outlooks are sensitive to the following assumptions:
- Fitch forecasts Brent crude to average USD65/b in 2015, USD75/b in 2016 and USD80/b in 2017.
- Oil production in Azerbaijan stays broadly stable over 2015-2017.
- Domestic political stability is preserved.
Contact:
Primary Analyst
Krisjanis Krustins
Analyst
+44 20 3530 1487
Fitch Ratings Limited
30 North Colonnade
London E14 5GN
Secondary Analyst
Paul Gamble
Senior Director
+44 20 3530 1623
Committee Chairperson
James McCormack
Managing Director
+44 20 3530 1286
Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
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Applicable Criteria
Country Ceilings (pub. 20 Aug 2015)
Sovereign Rating Criteria (pub. 12 Aug 2014)
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