Sovereign Ratings on the Republic of Kazakhstan: Outlook is Positive
Luc Marchand, Associate Director, Sovereign Ratings, Standard & Poor’s London
On June 13, 2006, Standard & Poor's Ratings Services revised its outlook on the Republic of Kazakhstan to positive from stable, on an increasing government net asset position and strong growth prospects, which outweigh the contingent liability risk stemming from high credit growth and external borrowing in the banking sector. At the same time, the 'BBB-' long-term and 'A-3' short-term foreign currency and the 'BBB' long-term and 'A-3' short-term local currency sovereign credit ratings on Kazakhstan were affirmed.
The ratings on Kazakhstan reflect the government's strong balance sheet and prudent fiscal policy stance, robust external liquidity, and good growth prospects, buoyed by high oil prices. Institutional and governance weaknesses, along with a weak economic structure, remain key constraints on the ratings.
In 2006 and 2007, GDP growth will be sustained at 8.5% and 8.3%, respectively. Despite recent significant increases in wages and social spending, the government has maintained substantial budget surpluses. We expect a fiscal surplus in 2006 of about 5.0% of GDP before tax revenue transfers to the National Fund of the Republic of Kazakhstan (NFRK) and a surplus of about 1.2% after transfers. We project general government debt at a low 8.4% of GDP at year-end 2006, with a continued decrease in the next few years by about 1.0%-1.5% of GDP annually. Additionally, with the NFRK expected to reach about $10.7 billion by year-end 2006, a substantial fiscal buffer has been created.
Despite increased external borrowing by commercial banks, the overall external position remains strong and is a supporting factor for the ratings. We expect public sector net external assets to reach about 63.3% of current account receipts by 2007, compared with an estimated 51.8% in 2006. External liquidity – although slightly lower because of recent payment outflows linked to foreign investments – remains strong, due to current account surpluses and high gross foreign direct investment (FDI) inflows.
The centralized and opaque nature of governance, along with weak institutional and legal systems, renders policymaking less predictable than in similarly rated sovereigns. The ratings also remain inhibited by an economic structure that is characterized by dependence on a few commodities, by low (although rapidly increasing) per capita income, estimated at about $4,367 in 2006, and by large regional development disparities.
The positive outlook on the ratings of the Republic of Kazakhstan reflects our expectation that the government will continue to pursue a fiscal policy that is aimed at decreasing the public sector debt burden, while gradually addressing the need for greater social and infrastructure spending. Risks to the budget from oil price fluctuations have been largely mitigated by the government's accrual of substantial reserves. On the external side, liquidity is expected to remain firm, as the increase in the volume in oil exported will more than balance potential worst-case scenarios of a decrease in oil prices or of an increase in debt service. A continuation of high economic growth and of the rise in the general government net asset position could trigger an upgrade. Conversely, an unforeseen deterioration of the government's financial position due to an oil price decline beyond our worst-case scenario, or further significant increases in banking sector external borrowing without an adequate strengthening of prudential regulation, could cause the outlook to be revised back to stable.
Comparing Kazakhstan with its Peers
The ratings on Kazakhstan are mainly supported by its comparatively strong external and fiscal positions. Net public external debt has decreased sharply, and Kazakhstan is expected to post a net public external asset position of 44% of CARs in 2006, compared with a net debt position of 21% in 2000. The 2006 ratio also compares favorably with the 'BBB' median, which is a net external asset position of about 9.6% of CARs (see chart 1). The Kazakh government's borrowing requirements have been lower-than-average for its peer group, on the back of a stronger macroeconomic performance and more sustainable fiscal policies than in many other 'BBB' rated countries. With the reimbursement of a Eurobond in late 2004, Kazakhstan's general government debt decreased to 8.4% of GDP in 2006, which is considerably lower than the 'BBB' median of 29.4% (see chart 2). As a result, the ratio of interest payments to general government revenues, at 0.9% in 2006, is lower than the 'BBB' median (5.1%). Moreover, Kazakhstan's general government is expected to post a surplus of 5.0% of GDP in 2006 before tax revenue transfers to the NFRK (or a 1.2% surplus after the transfers), which is better than the 'BBB' median of a 0.2% surplus in 2006 (see chart 3).
Overall, Kazakhstan's stabilizing single-digit inflation level, burgeoning production, export, and investment trends, and economic growth (expected at 8.5% in 2006) compare very favorably with its peers. In 2006, the 'BBB' median for per capita GDP growth is expected to reach 4.6% compared with 7.5% for Kazakhstan (see chart 4). Average per capita GDP growth in Kazakhstan has been roughly twice the 'BBB' median over the past five years. This has been due not only to higher oil prices, but also to greater oil and gas export volumes and growth in the nonhydrocarbon sector. The higher oil and gas export volumes were fueled by increased production and export capacities, mostly on the back of FDI.
Conversely, the economy remains narrowly based and dependent on commodities and is therefore vulnerable to external shocks. This is similar to Oman, Mexico, and Russia, which export significant volumes of commodities sensitive to international price fluctuations. In addition, Kazakhstan remains a poor country, with GDP per capita estimated at about $4,367 in 2006, which still compares unfavorably with the 'BBB' median of $7,003 (see chart 5). Nevertheless, due to its substantial natural resources and low population growth, Kazakhstan's per capita income is rising rapidly, having more than doubled since 2003. This should continue, assuming that resources are exploited effectively and new export routes are secured. These developments depend crucially on FDI inflows. In this respect, Kazakhstan's track record is significantly stronger than that of peers (see chart 6). In 2006, the country's external financing needs represent a projected 127% of official reserves and CARs (see chart 7), compared with 118% in 2005 (119% compared with 114%, respectively, when net FDI is excluded). This ratio is slightly higher than the 'BBB' median, but comparable with the median when net FDI is excluded from the external financing needs.
Political liberalization relative to peers remains slow, however. As a result of the highly centralized nature of its political system, risks associated with leadership succession and transition weigh more heavily on Kazakhstan, rendering policymaking less predictable than in most of its peers – Including the Republics of Romania (foreign currency BBB-/Stable/A-3; all references to ratings hereafter are to foreign currency sovereign credit ratings), Bulgaria (BBB/Positive/A-3) and Croatia (BBB/Stable/A-3). The political opposition is relatively weak, however, and the regime of President Nazarbayev is comparatively stable. Moreover, there is a broad consensus within the political elite for market-oriented policies and reforms. Overall, Kazakhstan's institutional organization is comparable with that of The Russian Federation (BBB/Stable/A-2) and the Republic of Tunisia (BBB/Stable/A-3), both of which have very centralized decision-making and poor democratic development beyond the legal parties and trade unions. Opposition is limited beyond the official parliamentary parties. That said, the political liberalization of the past two years permitted greater representation for the opposition than is the case in Tunisia. Moreover, compared with Tunisia, the succession process is clearer.
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