Fitch affirms Azerbaijan at 'BBB-'; Outlook Stable
LONDON. March 16 (Interfax) - Fitch Ratings has affirmed Azerbaijan's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-', the agency said in a press release.
The Outlooks are Stable.
The issue ratings on Azerbaijan's senior unsecured foreign and local 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'.
"Lower oil prices have delivered a negative shock to Azerbaijan's oil-dependent economy; hydro carbon exports account for over 90% of total merchandise exports," Fitch said. "However, Fitch expects the policy response to mitigate pressure on public and external finances, and limit damage to the sovereign's strong net creditor position, which underpins the rating," it said.
"On 21 February, the Central Bank of Azerbaijan (CBAR) abandoned its longstanding fixed exchange rate policy, devaluing the manat by 34% against the US dollar, to AZN1.05:USD1 from AZN0.78:USD1, and re-pegging it to a dollar/euro basket. The manat's peg to the US dollar had led to sharp real effective exchange rate appreciation, accentuated by the decline in the Russian rouble and Turkish lira, while interventions to support the currency caused reserves to fall from USD16.4bn in October 2014 to USD11bn in February 2015 (although they remain high at over six months of imports).
Devaluation is broadly neutral for the sovereign profile. It will assist fiscal and external adjustment to the lower oil price, but will also push inflation up to around 10%, negatively impact private consumption and may lead to pressure on bank asset quality, requiring some sovereign support for the banking sector. Consequently, lingering public dissatisfaction and some loss of confidence is to be expected after such an abrupt change in exchange rate policy.
The government is revising the 2015 budget based on a lower oil price assumption; the budget approved by parliament in November targeted a state budget deficit of 2.8% of GDP, at an average oil price of USD90/b. A weaker exchange rate will cushion the blow to oil revenues in manat, while the government will reduce infrastructure expenditure from very high levels by delaying non-essential upcoming projects. This combination should prevent the general government from going into a sizeable deficit. The general government ran a surplus of 2.9% of GDP in 2014.
As a result, the authorities are likely to avoid a large net draw-down of the state oil fund, SOFAZ. The fund's assets totalled USD37.1bn or 49% of GDP at end-2014. SOFAZ was due to transfer AZN10.4bn to the state budget in 2015, but this will likely be reduced in line with the reduction of budget expenditure.
The banking sector remains a relative weakness, and manat devaluation has been a considerable shock. Dollarisation increased prior to the devaluation. Banks had a short on-balance sheet FX position of USD1.7bn, or 43% of system equity, at end-2014, only partly hedged. Foreign-currency loans comprised 27% of total lending at end-2014. We estimate that devaluation will have caused a reduction of just under 2ppt in the sector's total regulatory capital ratio, which was high at 19% at end-2014. However, the impact is likely to vary between banks. Slower growth and government spending restraint will add to pressures on bank asset quality.
The current account surplus is narrowing but will remain substantial. We estimate that the current account surplus fell to 13.7% of GDP in 2014, from 16.6% of GDP in 2013, and forecast that it will decline further, to around 6% of GDP in 2015, before recovering to around 8% of GDP in 2016 as the oil price rises.
Economic growth slowed to 2.8% in 2014, reflecting stagnating hydrocarbons output. Growth picked up to 4.4% in January 2015, driven by the good performance of the non-oil sector, but this is unlikely to be sustained. We forecast that growth will fall to 1.5% in 2015 as the devaluation of the manat pushes down previously buoyant household consumption growth, investment falls and oil output continues to decline. A stabilisation in oil output and the pass-through from a rise in oil prices will support an acceleration to growth of 3.5% in 2016.
Progress in diversifying the economy away from hydrocarbons will be limited by the weak business climate. Governance is weaker and political risk higher in Azerbaijan than in the median of the 'BBB' category, according to World Bank governance indicators. Exchanges of fire along the ceasefire line between Azerbaijan and Armenia in the disputed territory of Nagorno-Karabakh have been at their most deadly since the ceasefire in 1994. Continued intermittent clashes appear likely, and the risk of a more serious escalation of fighting will persist.
The following risk factors individually, or collectively, could trigger negative rating action:
- A failure to adjust expenditure to the lower oil price that resulted in a sharper draw-down of sovereign assets.
- 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.
The global economy develops broadly in line with the assumptions in Fitch's Global Economic Outlook.
Oil production broadly stabilises in 2015-2018, although fluctuations are inevitable.
Domestic political stability is preserved," Fitch said.