Rating of Kazakhstan... Goes Down
Ben Faulks, Primary Credit Analyst, Sovereign Ratings, Standard & Poor’s
Luc Marchand, Secondary Credit Analyst, Sovereign Ratings, Standard & Poor’s
In early October the long-term foreign currency sovereign credit rating on the Republic of Kazakhstan was lowered to 'BBB-' from 'BBB', to reflect funding problems in the Kazakh financial system. Starting July, falling domestic depositor confidence and difficulties in rolling over maturing international syndicated loans and cross-border interbank deposits forced Kazakh banks to obtain short-term funding from the National Bank of Kazakhstan (NBK, the central bank) to support their liquidity. As of early October, this support totaled about Kazakhstani tenge (KZT) 1.3 trillion, equal to roughly three-quarters of the nation's monetary base. As a consequence of tighter liquidity conditions, domestic interbank deposit rates had risen to 9% from 6%, and domestic credit growth (which had been rising at 50% year-on-year) had sharply decelerated. Standard & Poor's Ratings Services now expects economic growth to slow sharply from its current rate of 10% to 6% in 2007 and 5% in 2008. We also expect asset quality concerns to emerge in many Kazakh banks.
In addition, international reserves fell by about $6.0 billion to $17.4 billion over August and September, as NBK supported the currency. We expect pressure on NBK's international reserve position to persist, both because NBK heavily manages the float of its currency and due to the mismatch between assets and liabilities in the banking system. Kazakh banks have $4 billion of external debt amortization due in the fourth quarter of 2007, with a further $6 billion due in the first half of 2008. Should the liquidity problems in the banks fester, the government may eventually have to assume NBK's large advances.
If the government is called upon to use public money to recapitalize its banks, it will do so from a position of strength. At end-October, the government held $20.1 billion in external fiscal reserves (apart from monetary reserves) in its National Fund of the Republic of Kazakhstan (NFRK) and the general government’s net asset position is estimated at 13.5% of GDP at end-2007.
We expect that policymakers will be able to contain the spillover effects to the Kazakh economy and to public finances in a manner consistent with an investment-grade rating. Although we expect continued pressure on international reserves as banks roll over less than 100% of their maturing external debt and as NBK remains committed to maintaining confidence in the tenge, we do not expect the NFRK to be used for quasi-fiscal activity. We also expect energy prices to support investment in the productive sectors of the economy. That said, the ratings would come under renewed pressure should the policy response prove insufficient to prevent a broader erosion of public confidence. Such an erosion would deepen the banks’ problems and cause more lasting damage to the real economy.
· Kazakhstan's net public sector external asset position compares favorably with 'BBB' rated peers.
· Kazakhstan’s real economic growth will fall in 2007-2008 but long-term trends compare favorably with most peers.
· Transparency over policy-making and political succession are weaker than in most peers.
· Per capita income remains lower in Kazakhstan than in most peers.
Stronger public external and fiscal indicators than in 'BBB' peers. The ratings on Kazakhstan are mainly supported by its comparatively strong public sector external and fiscal positions. Kazakhstan's net public sector external asset position is estimated at 65% of current account receipts (CARs) in 2007, up from 37% in 2005. This compares favorably with the 'BBB' median of about 20% 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 without refinancing of a Eurobond in late 2004 and in 2007, Kazakhstan's general government debt is expected to decrease to 12.1% of GDP in 2007, which is considerably lower than the 'BBB' median of 30% (see chart 2). Moreover, Kazakhstan's general government is expected to post a budget surplus of 5.3% of GDP in 2007 before transfers to the NFRK (or a marginal surplus after the transfers), which is far better than the 'BBB' median of a 0.2% deficit in 2007 (see chart 3).
Despite falling, GDP growth trends remain above the median. GDP growth is expected to decline in 2007-2008 from the stellar rates of recent years (see chart 4), as growth in domestic credit extension falls sharply (see chart 5). However, at 5%-6% growth will still be in line with the ‘BBB’ median. Growth is expected to accelerate again from 2009 to well ahead of the ‘BBB’ median rates as banks emerge from their current difficulties and lending picks up (albeit to more prudent rates of growth). Growth will be underpinned by FDI in the oil sector and rising hydrocarbons production and exports, which in turn will underpin continued strong (but not excessive) government spending.
Nevertheless, the Kazakh economy remains narrowly based and dependent on commodities, which leaves it vulnerable to external shocks. This is similar to Mexico (BBB+/Stable/A-2; all references to ratings hereafter are to foreign currency sovereign credit ratings), and The Russian Federation (BBB+/Stable/A-2), both of which export significant volumes of commodities sensitive to international price fluctuations. In addition, Kazakhstan remains a medium- to low-income country: GDP per capita is estimated at about $5,900 in 2007, which still compares unfavorably with the 'BBB' median of $8,100 (see chart 6). Nevertheless, due to its substantial natural resources and low population growth, Kazakhstan's per capita income is rising rapidly, having more than doubled since 2004–a rate of growth far in excess of that of the 'BBB' median over the same period.
Continuing FDI inflows will be crucial to developments in GDP and per capita growth. In this respect, Kazakhstan's track record is significantly stronger than that of its peers (see chart 7). Nevertheless, despite higher receipts, current account payments–especially those linked to FDI–are increasing. As a result, external liquidity remains moderate compared to peers. In 2007, external financing needs represent an estimated 112% of official reserves and CARs (see chart 8), much in line with the 'BBB' median. Liquidity is expected to deteriorate to a position weaker than the ‘BBB’ median in 2009 as banks run into a heavy debt amortization schedule following the rapid growth in borrowing of recent years.
Slow political liberalization relative to peers. As a result of the highly centralized nature of its political system, risks associated with leadership succession and transition weigh more heavily on Kazakhstan. This renders policymaking less predictable than in most of its peers, including the republics of Romania (foreign currency BBB-/Negative/A-3), Bulgaria (BBB+/Stable/A-2), 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 Russia 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.
Higher contingent liabilities than for peers. The contingent liability risks stemming from banks have increased, and are greater in Kazakhstan than in many other economies in transition. This is due to the rapid growth in lending of recent years, particularly to untested markets (personal and mortgage loans), and because of an increasing reliance on external borrowing. In 2007, the total maximum loss that the sovereign would face in the event of a banking crisis (gross problematic assets) is estimated at 30% of GDP (50% of total loans), compared with 27.2% in Russia, and about 20% for the 'BBB' median.
At 59.4% of CARs in 2007, the net external debt of the Kazakhstan financial sector as a percentage of CARs is far higher than that of peers such as Russia (24.4%), Bulgaria (a net asset position equivalent to 7% of CARs), Hungary (BBB+/Stable/A-2; 21.2%), Tunisia (6.5%), and South Africa (net asset position of 10.2% of CARs; see chart 9).
Major Rating Factors
· Prudent fiscal policies which are steadily strengthening public finances
· A strong external position, despite the recent rapid rise in external borrowing by commercial banks
· Substantial resource endowment and strong demand for main exports
· An increased risk that contingent liabilities arising from the commercial bank will crystallize
· The centralized and opaque nature of governance, along with weak institutional and legal systems
· A weak, albeit strengthening, economic structure
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