S&P AFFIRMS CREDIT RATINGS OF REPUBLIC OF KAZAKHSTAN, OUTLOOK NEGATIVE

13.09.16 11:56
/Standard & Poor's, Moscow, September 9, 2016, KASE headline/ – S&P Global Ratings affirmed its 'BBB-/A-3' long- and short-term foreign and local currency sovereign credit ratings on the Republic of Kazakhstan. We also affirmed the Kazakhstan national scale ratings at 'kzAA'. The outlook on the long-term ratings is negative. RATIONALE Our ratings on Kazakhstan remain primarily supported by the government’s strong balance sheet built on past budgetary surpluses, accumulated during the era of high commodity prices. The ratings remain constrained by Kazakhstan’s limited institutional effectiveness owing to the highly centralized political environment; the country’s moderate level of economic development characterized by high commodity dependence; and limited monetary policy flexibility. Kazakhstan's economy depends heavily on the oil sector: official estimates suggest it directly comprised about 15% of GDP and accounted for over half of exports by value in 2014. We anticipate that, as oil prices remain low, Kazakhstan will this year register its weakest economic performance since 1998, with output stagnating in real terms. We believe export volumes will decline not only due to price effects but also due to the aging of the main oil fields, resulting in flat or slightly reducing oil output. At the same time, private consumption will contract in real terms as consumer purchasing power is hurt by the considerable Kazakhstani tenge depreciation in 2015. We project that the economy will return to moderate growth rates from 2017 with output expansion averaging 2% over 2017-2019. The projected macroeconomic dynamic will be supported by stronger investments and recovering private consumption. Importantly, it will also be supported by stronger export performance as the oil price outlook improves (see "S&P Lowers Its Hydrocarbon Price Deck Assumptions On Market Oversupply; Recovery Price Deck Assumptions Also Lowered," published Jan. 12, 2016 on RatingsDirect) while the giant Kashagan oil field will finally be launched after a long string of delays. The latter should lead to a substantial growth in oil production volumes. We believe that the weak global commodity environment has also had a number of negative implications for Kazakhstan beyond the deceleration in headline growth. Specifically, it has exerted pressures on the country’s fiscal position. 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 - largely consisting of the predominantly foreign-invested National Oil Fund of the Republic of Kazakhstan (NFRK) and government deposits at the central bank - will amount to roughly 50% of GDP at the end of 2016. (We have excluded NFRK’s tenge financing of Kazakh state-owned enterprises [SOEs] from our calculation of liquid assets because these loans and bond purchases are generally characterized by concessional rates, very long maturities, and uncertain repayment prospects.) Given a relatively low debt level of about 20% of GDP, the government therefore remains in a net creditor position of over 30% of GDP. However, the government’s budgetary performance has deteriorated notably over the last two years in tandem with the fall in oil prices. We have refined our revenue and expenditure calculations to better capture the general government sector's fiscal stance (the general government comprises the central government, local governments, and NFRK). Specifically, we have started to explicitly include the government off-budget economic support programs, channeled through SOEs and financed by the NFRK, in our calculation of general government expenditures. In contrast to the authorities, we also do not count the upward revaluation effect of NFRK's foreign currency assets expressed in tenge (such as the one stemming from last year’s sizable tenge depreciation) in our general government revenue calculations. We estimate that, under the revised approach, the general government deficit deteriorated to a high 8.6% of GDP in 2015 from an average annual surplus of about 3.5% of GDP during the preceding five years. Our baseline forecast envisions a gradual budgetary consolidation with deficits steadily declining over the next three years and reaching a slight surplus in 2019. We base our expectations on the following assumptions: A gradual increase in the oil price (see "S&P Lowers Its Hydrocarbon Price Deck Assumptions On Market Oversupply; Recovery Price Deck Assumptions Also Lowered") and oil production volumes as the Kashagan oil field in the Caspian Sea becomes operational. Both should support higher NFRK revenues. Containment of capital spending. We believe that the current high share of capital spending in the overall general government expenditures affords the government additional flexibility because this spending could be reduced to keep deficits under control. We anticipate that over the next several years, the government will increasingly concentrate on priority projects while some expenditures – including under the Nurly Zhol infrastructure program – will be implemented over a period longer than initially planned. Improved government revenue performance. The authorities plan to improve tax administration and collection as well as focus on optimizing tax legislation, for example through raising VAT thresholds, which should generate additional income. At the same time, there are a number of risks that could derail the projected consolidation and ultimately put pressure on the sovereign ratings. We believe the government may find it challenging to control spending for political reasons, while further unanticipated delays in bringing Kashagan on-line could lead to revenue underperformance. We also see some risks from contingent fiscal liabilities even though we assess those as limited under our methodology. Specifically, some of these could materialize if the government were called to support one of its many SOEs (the non-government portion of debt for which is estimated at over 20% of GDP) or a systemic bank, such as KKB (see "Kazakhstan-Based Kazkommertsbank JSC Rating Lowered To 'CCC+' On Weakened Financial Performance; Outlook Negative," published on May 16, 2016). In our view, Kazakhstan’s external profile remains under pressure, although it is still relatively strong and supports the ratings. The current account posted a deficit of 3.2% of GDP in 2015 ending a five-year string of consecutive surpluses averaging 2% of GDP. We expect the deficit will peak at 4% of GDP in 2016 but gradually tighten thereafter as oil prices recover and the Kashagan oil field becomes operational. In the short term, the current account will remain supported by the reduction of import volumesas private consumption declines in the wake of sizable tenge depreciation last year. We continue to see balance of payments risks from Kazakhstan’s sizable stock of inward foreign direct investment (FDI) of a debt-like nature. We estimate this was about $80 billion in 2015, which is close to 45% of GDP or over 140% of current account receipts. We understand that debt-type FDI is principally concentrated in the oil and mining sectors. Although it generally presents smaller risks to the financial account of the balance of payments than confidence - sensitive flows, we note that repayment of inter-company advances is easier to effect than declarations of large dividends. Our ratings on Kazakhstan are constrained by the limited flexibility of its monetary policy. The central bank announced a switch to a floating exchange rate and inflation targeting in August 2015. The subsequent exchange rate adjustment has eased the accumulated external pressure. That said, we believe that the implementation of effective inflation targeting will take time as appropriate instruments are developed and credibility is improved. In our view, the National Bank of Kazakhstan's (NBK) full commitment to the stated policy and ability to keep inflation within the stated target band remains to be seen. We believe NBK could also be subject to political influence as exemplified by some activities in which it has participated over the last year. These have included becoming a shareholder of the National Company KazMunayGas and compensating tenge-denominated deposits after last year’s currency depreciation. We also view the high level of resident deposit dollarization in the economy as limiting Kazakhstan’s monetary flexibility. Although the share of foreign currency deposits to total deposits has recently fallen to below 60% from a peak of about 70% at the end of last year, the level remains high. Foreign currency denominated bank deposits at NBK also comprised about half of international reserves at the end of 2015. In addition, NBK is engaged in currency swaps with domestic banks of about $4 billion (close to 15% of international reserves) to support the banks' local currency liquidity, effectively shifting these external assets from the banks to NBK. In our view, Kazakhstan’s banking system remains weak. We expect a rise in reported nonperforming loans (NPLs) this year as last year’s tenge depreciation affects the capacity of some borrowers to service their foreign-currency denominated loans. We also believe that the official NPL statistic of close to 8% as of July 2016 underestimates the credit risk in thesector. This is because some banks have created special purpose vehicles to which they have offloaded NPLs at face value. Adjusting for this effect, the underlying NPL level is likely to be considerably higher. Our ratings on Kazakhstan also remain constrained by the sovereign’s weak institutional effectiveness. We believe that decision making remains highly centralized, which can reduce policymaking predictability. The government has announced a number of institutional reforms over the last two years but it remains to be seen if these will be fully implemented. Considerable uncertainties surround the eventual presidential succession. There have been no precedents of transfer of power since Kazakhstan’s independence in 1991, with President Nursultan Nazarbayev (currently aged 76) having governed ever since. That said, Kazakhstan has benefited from one of the most stable political environments in the region during the past 25 years. OUTLOOK The negative outlook reflects our view of risks to Kazakhstan's external and fiscal profiles over the next 18 months in the current weak and volatile global commodity environment. We could lower our long-term ratings if Kazakhstan's fiscal, external, or economic performances do not improve in line with our baseline expectations. Further delays to Kashagan coming on-stream is one example of a development that could negatively impact the country’s credit profile. The ratings could stabilize at the current levels if the present balance of payments pressures abated or monetary policy flexibility improved. The latter could occur if resident deposit dollarization reduced substantially, improving the ability of the central bank to influence domestic economic conditions RATINGS LIST Rating To From Kazakhstan (Republic of) Sovereign Credit Rating Foreign and Local Currency BBB-/Negative/A-3 BBB-/Negative/A-3 Kazakhstan National Scale kzAA/--/-- kzAA/--/-- Transfer & Convertibility Assessment BBB- BBB- Senior Unsecured Foreign and Local Currency BBB- BBB- Short-Term Debt Local Currency A-3 A-3 Primary Credit Analyst: Karen Vartapetov, Moscow (7) 495-783-40-18; karen.vartapetov@spglobal.com Secondary Contact: Maxim Rybnikov, London (44) 20-7176 7125; maxim.rybnikov@spglobal.com Additional contact: SovereignEurope; SovereignEurope@standardandpoors.com [2016-09-13]