Fitch downgrades Azerbaijan to junk

By bne IntelliNews February 29, 2016

Ratings agency Fitch downgraded Azerbaijan's long-term foreign and local currency issuer default rating (IDR) from 'BBB-' to 'BB+' with negative outlook on February 26. Just like Standard & Poor's (S&P), which downgraded Azerbaijan's sovereign rating at end-January, Fitch cited the effects of low oil and gas prices on Azerbaijan's fiscal position, foreign debt level, budget deficit and currency.

Hydrocarbons accounted for over 40% of Azerbaijan's GDP in 2013-2014, some 90% of exports and 70% of budget revenues. The 70% decline in oil prices since 2014 has affected Baku's ability to keep its budget commitments, led to a 50% depreciation of the currency, high inflation, and street protests in January. Having reached out to the World Bank and the International Monetary Fund for technical assistance in January, Baku will need additional sources of financing to balance its budget this year, which it said would derive from privatisation, domestic capital markets and, if needed, international financial institutions. Azerbaijan's sovereign wealth fund Sofaz still has some $33bn in reserves which should be enough but the liquidity of its assets has been questioned.

Fitch expects Azerbaijan's budget deficit to increase from 5.3% of GDP in 2015 to 12.5% in 2016 and to then decline to 7.6% in 2017. It also predicted that oil and gas receipts would fall by 30% in 2016, after declining by 40% in 2015. The ratings agency also noted that the floating of the Azerbaijani manat and its subsequent depreciation had failed to reduce its dependence on the oil price and compensate for the reduction in earnings caused by low oil prices.

Meanwhile, Baku's pledge to help population groups whose purchasing power has been most affected will lead to an additional 2% of GDP increase in social expenditure in 2016. Current expenditure in the 2016 budget will increase by 40% to AZN8.6bn (€5bn), while capital spending is to be slashed by 40% to AZN5.3bn (€3.1bn). As for Sofaz, Fitch expects its assets to fall to $31bn by 2017.

"Currency devaluation reduces the draw on Sofaz assets, since its transfer to the government is denominated in manat, but the government will be under pressure to increase transfers from the fund. General government debt, which includes explicit contingent liabilities, jumped to 28.3% of GDP in 2015 from 11.2% of GDP at end-2014. The increase is driven by a guarantee on the bonds of state-owned bank Aqrarkredit, which will buy up the troubled assets of the International Bank of Azerbaijan (IBA). Fitch expects the debt ratio to stay at this level in 2016-17," the ratings agency's report reads.

Meanwhile, the central bank's unsuccessful attempts to defend the manat have led to a decline in its foreign exchange reserves from $15.8bn at end-2014 to $6.1bn at end-2015. With reserves now covering 3.4 months of imports, Azerbaijan falls short of the average 5.6 months worth of imports among 'BBB'-rated countries. Fitch estimates that reserves fell by an additional $1.2bn in January, to $4.9bn, although the regulator has yet to publish statistics about its reserves in 2016.

The ratings agency expects real GDP to contract by 3.3% in 2016 and oil output to fall slightly as a result of a long-term trend of falling oil outputs and of a December fire at one of main offshore platforms in the Caspian Sea. The non-oil economy will also contract by 4% in 2016, Fitch says. Baku reported a 1.1% GDP growth in 2015, although nominally GDP contracted by 7.8% y/y, according to data from the country's State Statistical Committee (SSC).

Inflation is to reach 14% by end-2016, Fitch believes, due to "reports of prices of some products quickly adjusting by 50% [to the devaluation of the currency], indicating that the consumer price index [of 4% in 2015 and 5.8% in January 2016] may understate actual inflation".

The banking sector, which Fitch rates as 'b', has already felt the brunt of currency devaluations, with the rate of deposit dollarisation climbing to 85% in December, a shortage of liquidity and an impaired monetary transmission mechanism sure to aggravate its standing. In 2015, many banks closed in the red, and the regulator revoked the licences of seven banks in January to consolidate the sector. Asset quality has become a problem, although the true extent of the problem is not reflected in official statistics, which place the rate of non-performing loans at 6.8% of total loans in 2015. Nevertheless, the sector is small enough - its assets estimated at some 50% of GDP - for the government to be able to support it if need be, Fitch believes.

Having boasted sizeable current account surpluses in past years, Azerbaijan has become a net importer with a current account deficit of 1% of GDP in 2015. Fitch expects the deficit to increase to 5% of GDP in 2016-2017, and foreign exchange reserves to rise to 4.9 months of import cover by the end of the year.

However, growth is expected to pick up in 2017 and particularly 2018, when the Shah Deniz II offshore field and the Southern Gas Corridor (SGC) are expected to come on stream. SGC will deliver some 16bn cubic metres of Azerbaijani gas to Turkey and Europe at the initial stage.

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