Fitch reaffirms Azerbaijan at BB+, outlook negative

By bne IntelliNews August 29, 2016

Fitch has reaffirmed Azerbaijan's foreign and local-currency issuer default rating at BB+ keeping a negative outlook. The rating reflects the country's strong external balance sheet and low government debt, as well as its heavy reliance on oil, underdeveloped policy framework and weak banking sector, the ratings agency said on August 26.

The drop in oil prices since 2014 has affected the Azerbaijani economy, which has experienced a 3% y/y contraction in manat terms in the first seven months of the year, while its currency has lost more than half of its value and key sectors like banking, construction and real estate posted double-digit dips in turnover. Government spending, which used to finance the majority of large-scale construction and infrastructure projects, has plummeted in 2016, Fitch notes, with capital expenditure (capex) a mere 31% of the budgeted amount in the first half-year as a wary Baku sought to contain its growing budget deficit.

The deficit is forecast to reach 7.3% of GDP by the end of 2016, double the level of other ratings peers but down from 12.5% of GDP Fitch originally predicted for 2016 thanks to the low capex.

Meanwhile, the delayed and poorly communicated exchange rate devaluation of 2015, which saw the manat lose 50% of its value, is "reverberating across the economy"  and increasing strains in the banking sector, the ratings agency notes. While authorities acknowledge the need to reform the state-led capital spending-driven growth model that has prevailed in the last decade, they have yet to prove their capacity to implement change and willingness to tackle vested interests.

The decline in capex has hit growth, with the non-oil economy shrinking by 5.4% y/y in the first half of the year. This is particularly alarming for Baku, which has invested heavily in diversifying its economy away from oil and gas. The contraction has been slowing in recent months, however, and Fitch anticipates that the non-oil economy will return to growth in 2017.

The banking sector, in the meantime, saw its asset quality further eroded, as the rate of non-performing loans (NPLs) rose to 8.4% at end-June, from 6.9% at end-2015, according to the central bank. However, Fitch notes weaknesses in reporting standards. Other observers place the overall NPL rate in the double digits, and as high as 40%. Consumer price inflation, which has been growing in the double digits this year, should return to single-digit growth in 2017, the agency adds, although it will remain relatively high at 6%.

On the upside, Azerbaijan's ample buffers, saved in oil fund Sofaz and exceeding $35bn at end-June, should enable Baku to finance its budget deficit. Transparency at Sofaz is higher than at higher-rated sovereign wealth funds, Fitch adds. Government debt to GDP is expected to rise to 31% by end-2016, up from 12% a year earlier, the agency adds.

At $5.5bn, the country's official foreign exchange reserves are in line with other ratings peers, but have plummeted from $16bn in November 2014 as the central bank sought to unsuccessfully defend the manat from oil price pressures for too long, losing two thirds of its reserves in the process before floating the currency in February 2015.

Despite the fall in oil export revenues, the external balance sheet remains strong, Fitch says, with sovereign net assets forecast to reach 84.3% of GDP by end-2016. Azerbaijan is a major investor in Turkey and some Balkan countries through the Southern Gas Corridor (SGC) project. Banks are also net external creditors. In addition, the compression in imports should return the current account to surplus in 2016.

Security concerns stemming from the conflict with Armenia over Nagorno-Karabakh are "a potential rating consideration", Fitch concludes, noting that the security situation in the region has deteriorated following a four-day armed conflict between the two countries in April, which left hundreds of victims. 

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