OVERVIEW
- Azerbaijan’s external position remains strong and we forecast continued
current account surpluses over 2015-2018, although weaker than in recent
years primarily because of the decline in oil prices.
- We are therefore affirming our ‘BBB-/A-3’ long- and short-term ratings on
Azerbaijan.
- The outlook remains negative, reflecting the risks of Azerbaijan's fiscal
buffers weakening and thereby reducing the economy’s capacity to counter
potential economic shocks.
RATING ACTION
On July 31, 2015, Standard & Poor’s Ratings Services affirmed its ‘BBB-/A-3’
long- and short-term foreign and local currency sovereign credit ratings on
the Republic of Azerbaijan. The outlook remains negative.
RATIONALE
Our ratings on Azerbaijan remain supported by the sovereign’s strong external
and fiscal positions, primarily reflecting the sizable foreign-invested
sovereign oil fund SOFAZ, which has assets in excess of $35 billion (about 60%
of estimated 2015 GDP). Nevertheless, we forecast a steady downward trend in
the government’s net asset position to below 50% of GDP. In our view, this
could weaken the economy’s capacity to counter potential economic shocks.
The ratings are constrained by Azerbaijan’s modest income levels, relatively
weak institutional effectiveness, and limited monetary flexibility. We believe
the latter has reduced further in the aftermath of the February manat
devaluation. Rapid dollarization of the economy has occured over the last
several months.
In our view, the economy is currently facing a number of pressures related to
the sizable decline in the oil prices over the last year. Azerbaijan remains
heavily dependent on the hydrocarbons sector, which amounted to about 40% of
GDP and 95% of merchandise exports in 2013-2014.
After several years of the exchange rate remaining stable, the Central Bank of
the Republic of Azerbaijan (CBA) devalued the Azerbaijani manat (AZN) against
the U.S. dollar by 33% (manat per dollar rate) in February 2015. The decision
followed a sustained decline in CBA’s foreign-exchange reserves in the
preceding months to about $15 billion at the start of February 2015 from $17
billion in November 2014. In our view, the stability of the manat since the
devaluation suggests that the currency remains largely pegged to the U.S.
dollar, even though CBA has announced a move to a regime targeting a
euro-dollar currency basket. At present, we do not project a further
devaluation during our 2015-2018 forecast horizon.
We expect CBA's foreign-exchange reserves to remain stable through the rest of
the year: they continued to decline during February to April but stabilized in
May. We nevertheless believe that the rapid dollarization in the aftermath of
the February devaluation will further hamper the already-weak monetary
flexibility: as of end-May foreign currency deposits exceeded 70% of total
deposits, a significant increase from 50% in January.
Given the small banking system and shallow domestic capital markets, we
believe CBA will continue to find influencing domestic monetary conditions a
challenge. In an attempt to stimulate non-oil growth and support SME and
mortgage lending, CBA lowered the refinancing rate to 3.0% from 3.5% from July
13. We do not expect this to have a significant effect, however. We forecast
credit growth to reduce to 12% this year from 24% in 2014, reflecting banks
consolidating balance sheets following the February devaluation. In our view,
monetary policy will also face conflicting goals as CBA attempts to ease manat
liquidity conditions at a time when inflation will surpass 8% owing to the
effects of devaluation.
In our view, the February 2015 devaluation will also have a negative impact on
household purchasing power and we forecast that domestic consumption will
decline this year for the first time since 1999 (with the exception of 2010).
We also forecast exports to contract in real terms owing to reduced oil
production, which primarily reflects the main oilfields aging. We understand
that, absent sustained investment, oil production will likely reduce by 1%-2%
a year.
At the same time, we also project imports to contract following the
devaluation and expect net exports to contribute positively to GDP growth,
forecast at 2.2% in 2015, down from 2.8% in 2014. From 2016, a gradual
recovery in consumption and stronger investments will support stronger
economic performance, which nevertheless will remain much weaker than during
the pre-2008 boom years when it consistently exceeded 20% annually.
Over the long term, Azerbaijan should benefit from production at new gas
fields, which we expect to partly compensate for stagnating oil production. In
2018, the major Shah Deniz II field, which will bring gas from Azerbaijan to
Europe, is expected to come on stream. Gas will be transported via the
Trans-Anatolian (TANAP) and Trans-Adriatic (TAP) pipelines. We understand that
the project remains on track and the construction of TAP and TANAP started as
planned earlier this year.
At present, the ratings on Azerbaijan remain supported by the sovereign’s
strong fiscal position. The government controls sizable liquid assets
currently estimated at about 60% of GDP. These primarily reflect the State Oil
Fund of the Republic of Azerbaijan (SOFAZ), a fiscal reserve fund which is
invested externally. Given the government’s low debt burden, we estimate its
net asset position at about 52% of GDP in 2015.
Following more than a decade of general government budgetary surpluses, we
project a sizable deficit of 8.9% of GDP in 2015. When calculating the general
government balance, we consolidate the state budget revenues and expenditures
with those of the social protection fund and SOFAZ. SOFAZ provides transfers
to the state budget, which comprise about 40% of the consolidated government
revenues. Based on our current oil price assumptions of $55/barrel in 2015, we
project consolidated revenues to drop by about 20% compared to 2014.
We expect the government will partly counterbalance weaker revenues with
fiscal consolidation measures, primarily by cutting capital expenditure. In
our view, Azerbaijan currently benefits from a high level of fiscal
flexibility, given that capital investments comprised over 30% of total
expenditures in 2014 and were budgeted at similar levels for 2015. We expect
state expenditures in 2015 to amount to only 90% of the planned spending,
broadly in line with the government’s plans.
Also in line with the government’s policy of maintaining low debt levels, we
expect the consolidated deficit to be primarily financed by drawing down on
the existing fiscal reserves with only one-third being financed through
external borrowing. We expect that one-third of the consolidated deficit will
be financed by Treasury deposits at CBA and another third through a net
drawdown of the assets of SOFAZ. We anticipate that the general government
sector will return to a surplus position from 2016 onward in line with a
gradual recovery in oil prices.
We expect SOFAZ assets to decline to $33 billion in 2015 from $37 billion in
2014. This partly reflects the pronounced depreciation of the euro against the
dollar (SOFAZ's assets are primarily invested in foreign fixed-income
securities with about 30% of total denominated in euro) and a roughly $2
billion allocation for the financing of the aforementioned consolidated
deficit.
SOFAZ's assets will gradually return to growth from 2016 onward as oil prices
start to recover. However, we expect nominal GDP growth to be stronger and, as
a result, the government’s net asset position as a percent of GDP may weaken
over the forecast period, absent stronger fiscal consolidation.
We expect Azerbaijan’s current account surpluses to persist over the next four
years. That said, the surplus will moderate to 2.2% of GDP in 2015 from over
13% of GDP last year reflecting the oil price decline. At the same time, we
expect imports to contract following the manat devaluation.
In the next few years, we expect current account surpluses to grow again but
to remain below pre-2015 levels. This is largely explained by our oil price
forecasts (which we project to be at 55$/bbl in 2015, 65$/bbl in 2016, and
$75/bbl thereafter) and stagnating oil production. The current account should
be supported from 2019, when Azerbaijan starts exporting higher volumes of
natural gas to Europe from the Shah Deniz II gas field. Overall, we expect
Azerbaijan’s net external asset position to remain strong, averaging a sizable
76% of current account receipts over 2015-2018.
Azerbaijan continues to face a number of domestic political and geopolitical
risks. In our view, decision-making is highly centralized and lacks
transparency, which can reduce policymaking predictability. The outbreaks of
violence with neighboring Armenia over the Nagorno-Karabakh territory became
more frequent in 2014, but we don't expect them to escalate into open, armed
confrontation over the medium term.
OUTLOOK
The negative outlook reflects risks of Azerbaijan's fiscal buffers weakening
and thereby reducing the economy’s capacity to counter potential economic
shocks.
We could lower the ratings over the next year if we were to conclude that the
government’s fiscal consolidation efforts are insufficient to arrest the
projected material decline in its net asset position. We could also lower the
ratings if we believed that the growth outlook had deteriorated compared to
our current projections. This could be the case, for instance, if oil
production declines faster than we currently anticipate while growth in
Azerbaijan’s non-oil sector is not sufficient to compensate.
We could revise the outlook to stable if pressures on Azerbaijan’s fiscal
accounts abate, for instance as a result of a timely and credible response
from the government, while Azerbaijan's external position remains strong.
| Republic of Azerbaijan Ratings Score Snapshot |
|---|
| Key rating factors | |
|---|
| Institutional assessment | Neutral |
| Economic assessment | Neutral |
| External assessment | Strength |
| Fiscal assessment: flexibility and performance | Strength |
| Fiscal assessment: debt burden | Strength |
| Monetary assessment | Weakness |
Source:
Standart&Poor's
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