Fitch Ratings has affirmed Azerbaijan’s Long-term foreign and local currency Issuer Default Ratings (IDR) at ‘BBB-‘. 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’.
KEY RATING DRIVERS
The affirmation reflects Fitch’s expectation that oil production will remain broadly stable for the next five years. Oil production grew 0.3% in 2013, halting a steep decline from the 2010 peak. New wells and a possible extension of the production sharing agreement between the BP-led consortium and the government will mitigate natural output decline rates.
The natural gas export outlook is also more certain, after stakeholders in the Shah Deniz 2 natural gas project chose an export route to Europe in December. The government plans to progressively reduce transfers to the budget from SOFAZ, the State Oil Fund, and generate more non-oil revenue.
Oil revenues will still account for around two-thirds of the budget, underscoring high dependence on commodity prices. The 2014 budget calls for spending growth to halve on the previous year to just 5% in nominal terms, so that spending as a share of GDP, which reached 39% of GDP in 2013, will stop growing.
Azerbaijan issued a debut USD1.25bn 10-year sovereign Eurobond in March, establishing a presence in the bond market. Despite the fiscal consolidation under way, the state budget will run a deficit. The consolidated budget, including SOFAZ, will be close to balance. Azerbaijan’s sovereign balance sheet is one of the strongest among rated sovereigns and underpins the rating. SOFAZ accumulated USD1.7bn in 2013 to reach USD35.9bn (49% of GDP) by end-2013.
International reserves of the Central Bank of Azerbaijan (CBAR) are a further USD14.4bn. Fitch expects further modest growth in sovereign assets, providing a buffer against oil price or production shocks. Fitch estimates the current account surplus at nearly 18% of GDP in 2013, driven by a wide trade surplus. The current account surplus will narrow but remain in excess of 10% of GDP in 2015. Fitch expects growth to moderate to 3%-4% in 2014-2015, as the government seeks to rein in capital spending. Real GDP grew 5.8% in 2013 with non-oil growth exceeding 10%. Inflation will rise from recent lows after the government raised fuel prices in December. The real effective exchange rate has appreciated owing to Russian rouble and Turkish lira weakness.
The Azeri manat remains pegged to the US dollar, backed by large CBAR reserves. CBAR has acted to curb rapid lending growth by increasing the risk weighting on consumer loans and Fitch expects this to slow lending growth. The authorities have given banks until January 2015 to meet a higher minimum capital requirement. The banking system is a relative weakness, given the asset quality problems at the dominant, state-owned International Bank of Azerbaijan (IBA). The government has pledged to inject more capital into IBA.
Governance is weaker and political risk higher in Azerbaijan than in the median ‘BBB’ sovereign, according to World Bank governance indicators.
RATING SENSITIVITIES The Stable Outlook reflects Fitch’s view that upside and downside risks to the rating are balanced. The main factors that individually or collectively could lead to rating action are as follows: Positive: – A longer track record of sound management of the public finances in a context of static oil revenues; further growth in sovereign assets.
– Diversification and development of the non-oil economy, improvements in the businessenvironment and other structural indicators. Negative:
– Rapid spending growth that would erode the country’s fiscal strength in the medium term.
– A prolonged period of low oil prices.
– A domestic or regional geopolitical shock, such an escalation in hostilities over the disputed region of Nagorno Karabakh.
KEY ASSUMPTIONS Fitch assumes that the price of oil, Azerbaijan’s main export and source of budget revenue, will average USD105/barrel (Brent) in 2014, and USD100/barrel in 2015.
Growth and fiscal projections are sensitive to oil production assumptions. Fitch assumes that oil production stabilises from 2014-2018, although fluctuations are inevitable. Fitch assumes that Azerbaijan avoids domestic or regional political shocks, such as no escalation in hostilities with Armenia over Nagorno Karabakh, and domestic political stability is preserved. Fitch assumes that the government broadly adheres to the 2014 budget.
