Fitch Ratings has affirmed Kazakhstan's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'BBB' with a stable outlook, the ratings agency said on October 28. While the economy is gradually adjusting to shocks caused by lower oil prices and weaker demand in key trading partners, the banking sector is a significant weakness compared with peers, the agency warns. 

As growth resumes, “the erosion of the strong sovereign balance sheet, which underpins the ratings, is slowing”, Fitch said. Greater exchange rate flexibility is helping the balance of payments adjust, with official reserves rising to $31.4bn over the first nine months of 2016, up from $27.9bn.

Kazakhstan's current account deficit is projected to narrow to 2.3% of GDP in 2016, from 3.2% in 2015 and will be fully financed by net inflows of foreign direct investment. The current account is forecast to return to small surplus in 2017 thanks to rising oil and metals prices.

“Increasing sovereign net foreign assets and bank deleveraging will offset the rise in net external debt of the non-bank private sector caused by the financing of energy projects,” the agency noted. That will reduce net external debt forecast to 13.7% of GDP at end-2018, againstt 20% at end-2016.

Lower spending will reduce the IMF-defined general government deficit to 4.7% of GDP from 6.9% in 2015. Moreover, Fitch forecasts the general government deficit to narrow to 2.4% of GDP by 2018, based on its higher oil price assumptions. The deficit on the republican budget is also expected to narrow to 2% of GDP in 2016 from 2.2% in 2015.

“General government debt is projected at 19.6% of GDP at end-2016, compared with a peer median of 40.3%,” Fitch added. “Fitch expects it to drop to 15.9% at end-2018 due to high nominal GDP growth and exchange rate appreciation.”

The banking sector, however, is a credit weakness. Some of the asset-quality deterioration risks stem from foreign currency loans, which are currently classified as performing, but were mostly provided to unhedged borrowers. Government capital injections into the sector are possible, but are unlikely to be large relative to the sovereign's capacity to support the sector, according to Fitch. 

Kazakh economy is projected to expand by 1.9% on average in 2016-2018, well below the 5.6% average of the previous decade and the 2.9% peer median.

Policy mismanagement or prolonged low oil prices could lead to a further weakening in the sovereign external balance sheet, prompting a downgrade in ratings, Fitch said. The ratings could also be lowered due to “materialisation of significant contingent liabilities from the banking sector on the sovereign balance sheet”.

Fitch would consider an upgrade if steps are taken to reduce the vulnerability of the public finances to future oil price shocks. Among other factors, a sustained recovery in GDP and in external and fiscal buffers could also lead to positive rating action.