Kazakhstan has sustained a severe shock to its terms of trade, precipitated by a sharp fall in the oil price. The magnitude of this shock has been intensified by the collapse of the rouble (RUB), the prospect of a deep recession in Russia and a slowdown in China, two of Kazakhstan’s largest trading partners, and an ensuing wave of devaluations throughout the CIS, which has left the KZT looking noticeably overvalued relative to trading partners’ currencies.

Like all major oil producers and exporters, the Kazakh authorities have been faced with the challenge of judging whether the current oil price shock is temporary or permanent. On balance, they have chosen to err on the side of caution, revising down the oil price assumption underlying the 2015 budget to USD50/bbl from USD90/bbl and cutting expenditure by 10%. This stance is consistent with a lengthening track record of prudent fiscal management, characterised by recurrent fiscal surpluses and a build-up of foreign-currency fiscal reserves in the National Fund (NFRK).

In Fitch’s view, Kazakhstan’s strong sovereign balance sheet – sovereign net foreign assets (SNFA) exceed 40% of GDP and gross general government debt (GGGD) is less than 15% of GDP – affords it considerable room for manoeuvre, without unduly compromising sovereign creditworthiness. The government has authorised drawings of USD9 bln in 2015-17 from the NFRK for infrastructure projects and capitalised a Problem Loan Fund with USD2.7 bln to address Kazakh banks’ weak balance sheets. In total the government has pledged USD5.5 bln of NFRK funds for financial sector development and lending to SMEs since 2014.

Fitch expects the IMF-defined measure of the general government balance (which differs from the authorities) to move to a deficit of 3.2% of GDP in 2015 from a surplus of 1.9% in 2014, a deterioration of over 5% of GDP. Factored into these projections are extraordinary drawdowns from the NFRK over and above the ‘guaranteed’ USD8 bln annual transfer to the budget, which can be increased or decreased by 15% in any year. As of 1 April the NFRK had fallen by 5.2% since end-2014 to USD69.7 bln; higher oil prices in 2H15 could drive a minor rebound. Consequently, Fitch expects the NFRK to remain flat in nominal terms in 2015, in contrast to annual net injections of USD2 bln in 2011-14, while GGGD may rise to 19.5% of GDP by 2016.

The scale of the fiscal stimulus should allow Kazakhstan to escape recession in contrast to Russia. Nonetheless, Fitch expects growth to slow sharply to an annual average of 1.8% in 2015 and 2.5% in 2016 from 6% in 2011-14. The authorities also face the challenge of addressing the exchange rate misalignment of the KZT, in the wake of the sharp fall in the oil price and the collapse of the RUB.

Monetary and exchange rate policy are weak relative to rated peers. Pervasive dollarisation hinders effective monetary policy, while confidence in the existing ‘managed float’ exchange rate is low. The central bank aims to introduce inflation-targeting over the medium-term, but this would entail a more flexible exchange rate. Such a regime would help to insulate the economy and the public finances from external shocks, and curb dollarisation. Conversely, adherence to a less responsive “managed float” arrangement risks progressive dollarisation and an erosion of SNFAs over time.

Fitch assigns a low average Viability Rating of b to Kazakhstan’s banking system, indicating a weak banking system relative to peers with a high potential for continued sovereign support. Banks have rebuilt their external balance sheets since 2008-09, closing their open forex positions, thereby mitigating the direct impact of future exchange rate shocks. However, they have been painfully slow in addressing legacy non-performing loans (NPLs). NFRK-funded vehicles to strengthen banks’ balance sheets should help to reduce NPLs to around 10% by year-end from recent highs of 30%, but a further sharp depreciation of the KZT could lead to new NPLs, forestalling lending in support of economic recovery.

Incumbent president Nursultan Nazarbayev was elected for a fifth term on 26 April. Early presidential elections – the poll was not due until 2016 – had been justified on the grounds that Kazakhstan needed to preserve domestic political stability in the face of lower oil prices and the uncertain geopolitical outlook. Political risk is dominated by the succession issue given the president’s advanced years – he is 74 – and the absence of an heir apparent. Kazakhstan has not experienced a change of leadership since independence in 1991.

Structural factors are an important determinant of Kazakhstan’s sovereign ratings. The current ratings acknowledge that commodity dependence is high, while Kazakhstan scores poorly on World Bank indicators for governance and institutional strength. Per capita GDP at market exchange rates, a proxy for debt tolerance and resilience to shocks, exceeded the BBB median by 27% in 2014. However, Fitch estimates that this differential could narrow by up to 50% in 2015, if growth and the KZT/USD evolve in line with the agency’s expectations.

Rating SENSITIVITIES

The Outlook is Stable, meaning that the downside and upside risks are evenly balanced. However, the following risk factors individually, or collectively, could trigger negative rating action:

• Policy mismanagement and/or a prolonged fall in oil prices leading to a decline in SNFA allied to reduced economic and financial stability
• Renewed weakness in the banking sector, which leads to contingent liabilities for the sovereign
• A political risk event

Conversely, the following factors, individually or collectively, could result in positive rating action:

• Moves to strengthen monetary and exchange rate policy
• An effective restructuring of banks’ balance sheets
• Steps to reduce the vulnerability of the public finances to future oil price shocks, for example, by reducing the non-oil deficit, currently estimated at more than 9% of GDP
• Substantial improvements in governance and institutional strength

Key Assumptions

Kazakhstan’s ratings are based on a number of key assumptions:

• Continued commitment to fiscal responsibility
• Fitch assumes that the KZT/USD depreciates by a notional 20% over the course of 2015
• Brent oil averages USD65/bbl in 2015 and USD75/bbl in 2016