Fitch Ratings affirms Azerbaijan at 'BBB-'

By AzerNews

Fitch Ratings affirmed Azerbaijan's long-term foreign and local currency IDRs and its senior unsecured bonds at 'BBB-' on October 17.

According to Fitch, the Outlook on the IDRs is Stable. The Country Ceiling is affirmed at 'BBB-', and the Short-term foreign currency IDR at 'F3'.

Oil output is stabilizing after a 20 percent decline since 2010, improving the short-term outlook for growth and public finances. Fitch expects oil production will increase slightly by 2015. Longer-term, oil output will fall, given natural decline rates in the main oilfield.

Fitch expects overall real GDP growth of 5 percent in 2013, up from 2.2 percent in 2012. Government spending will drive growth of 10 percent in the non-oil economy in 2013, but provide less impetus in 2014 and 2015. Growth prospects outside the oil sector are also hampered by a poor business climate, although the government is piloting improvements.

Public finances recorded several years of large surpluses prior to 2013, making Azerbaijan's sovereign balance sheet one of the strongest among rated sovereigns and mitigating the budget's high dependence on oil revenues. Sovereign assets held in Azerbaijani State Oil Fund (SOFAZ) reached US $34.7bn (49 percent of GDP) at end-June 2013, having grown US $600m since end-2012.

Public spending has grown rapidly in recent years and rose 19 percent in 7M13 to reach 40 percent of GDP. The recent draft 2014 budget calls for a slowdown in spending growth and a lower transfer from SOFAZ to the budget of AZN9.34bn (2013: AZN11.35bn). However, Fitch still expects the consolidated budget deficit to widen to 5 percent of GDP by 2015 from 1 percent of GDP in 2013.

The 2014 state budget assumes a wider deficit of AZN1.7bn, 2.9 percent of forecast GDP, based on an oil price assumption of US $100 per barrel, implying higher borrowing.

Government debt will rise from a low starting point of 14 percent of GDP (including guaranteed debt) at end-2012. But the lower projected drawdown from SOFAZ points to SOFAZ assets stabilizing through 2015 rather than falling as Fitch had forecast in April.

Fitch expects Azerbaijan to run a current account surplus of 17 percent of GDP in 2013, down 4pp of GDP from 2012 but still one of the strongest surpluses of any Fitch-rated sovereign. The surplus will narrow further but remain comfortable, barring an oil price shock, leading the external balance sheet to strengthen.

The banking system is a weakness relative to 'BBB'-rated peers. International Bank of Azerbaijan, partly state-owned and the largest bank in the system, now meets minimum standards for regulatory capital after receiving capital injections from the government totaling 0.5 percent of GDP. However, Fitch believes it may require more capital to help clean up its balance sheet, which would be manageable for the government.

The Stable Outlook reflects Fitch's view that upside and downside risks to the rating are balanced.

Positive including sustained action to reduce risks to the public finances from oil price shocks via a credible medium-term fiscal strategy would increase confidence in the sustainability of the public finances.

Fitch assumes that the price of oil, Azerbaijan's main export and source of budget revenue, will average US $105 per barrel in 2013, and US $100 per barrel in 2014 and 2015.

Growth and fiscal projections are sensitive to oil production assumptions. Fitch assumes that oil production stabilizes in 2014 and increases 3 percent in 2015, before resuming a mild decline.

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 following the presidential election in October 2013.

Fitch assumes that the government broadly adheres to the draft 2014 budget submitted to parliament in October.