Fitch affirms stable outlook for Azerbaijan

By Aynur Jafarova

International Rating Agency Fitch Ratings has affirmed Azerbaijan's long-term foreign and local currency issuer default ratings (IDR) at 'BBB-' with a stable outlook.

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'.

Fitch said Azerbaijan's sovereign balance sheet is one of the strongest of any rated sovereign and underpins the rating.

Azerbaijan's state oil fund SOFAZ reached $37.6 billion in the first half of 2014. Adding $15 billion in foreign-exchange reserves at the Central Bank of Azerbaijan (CBA), the sovereign's gross external assets are equivalent to 69 percent of GDP.

Fitch expects further modest growth in sovereign assets as the current account registers (diminishing) surpluses in 2014-2016. This should provide a buffer against oil price or production shocks and support the manat's (AZN) peg to the USD at AZN 0.78/USD 1.

The state budget ran a smaller surplus in the seven months of 2014 than in the corresponding period of 2013. Fitch projects a small general government deficit in 2014, albeit below the original target of 3 percent of GDP owing to higher than expected oil prices.

Fitch forecasts that the general government will run deficits of 1-2 percent of GDP annually in 2015-2016 as the authorities keep current and capital spending high against a backdrop of diminishing revenue.

"SOFAZ transferred 4.9 billion manats ($6.3 billion) to the state budget in the first half of 2014, or 52 percent of total revenue. The government's long-term aim is to reduce the budget's dependence on the SOFAZ transfer, and thus oil prices. The success of this strategy will crucially depend on the ability to develop a strong, sustainable non-oil economy," Fitch said.

Fitch forecasts that GDP growth will slow to 3.3 percent in 2014 from 5.8 percent in 2013, and remain in the 3.5-4 percent range in 2015-2016. Non-oil sector growth will be the driver of economic activity, with growth in hydrocarbons output stagnating as existing oilfields age and large ongoing gas projects have yet go on-stream. In the medium term, the government will pursue the twin aims of developing large gas reserves while continuing to diversify the economy in order to reduce its strong commodity dependence.

"The key risk to Azerbaijan's economy is a sudden and prolonged drop in oil prices. Indirect risks from the effect of sanctions of the Russian economy are contained, given the limited overall exposure to the Russian economy. However, the manat's effective exchange rate has appreciated in 2014 owing to the steep depreciation of the Russian rouble, and if carried forward, this could hamper efforts to develop the non-oil economy," Fitch said.

The CBA has undertaken macro-prudential measures to curb consumer lending growth, which consequently fell to 29 percent year on year in July 2014 from 40 percent in January. Nevertheless, the banking system remains a relative weakness. Majority state-owned International Bank of Azerbaijan (IBA), which controls one-third of the banking system's assets, has asset quality problems, despite an ongoing 500 million recapitalization.

The stable outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. Nonetheless, the following risk factors individually, or collectively, could trigger positive rating action:

- Steps to correct the gradual deterioration of Azerbaijan's budgetary position since 2010, sufficient to increase Fitch's confidence in the longer-term sustainability of Azerbaijan's sovereign balance sheet strengths.

- A credible strategy for sustainable economic diversification, supported by reforms to improve governance and transparency.