New York, August 18, 2017 -- Moody's Investors Service (Moody's) has downgraded the government
of Azerbaijan's issuer and senior unsecured debt ratings to Ba2
from Ba1 and changed the rating outlook to stable, concluding the
rating agency's review for downgrade initiated on May 19,
2017. Moody's also downgraded to Ba2 from Ba1 the senior
unsecured debt rating of Southern Gas Corridor CJSC (SGC), whose
bonds are backed by the government's guarantee, and changed
the rating outlook to stable.
The rating downgrade reflects the significant and long-lasting
weakening of Azerbaijan's fiscal and economic strength, which
is driven by the ongoing impact of lower oil prices, the country's
declining oil production potential and its very weak banking system.
Together these factors will continue to constrain growth and pose material
contingent liability risks to the sovereign.
The stable outlook reflects Moody's expectation that the growth
of additional direct debt and contingent obligations, including
government guarantees stemming from financial support to Azerbaijan's
banking sector restructuring and its large hydrocarbon sector projects,
will level off by 2020. The stable outlook also assumes that,
over time, the government will manage fiscal policy and its own
balance sheet and the assets of its sovereign wealth fund in a way that
will improve flexibility and capacity to effectively buffer the impact
of lower-for-longer oil prices and ongoing declines in oil
production.
Azerbaijan's local currency debt and deposit ceilings are lowered
to Ba2 from Ba1. The foreign currency bond ceiling is also lowered
to Ba2 from Ba1. The foreign currency deposit ceiling is lowered
to Ba3 from Ba2.
RATINGS RATIONALE
RATIONALE FOR THE RATING DOWNGRADE TO Ba2
The downgrade of Azerbaijan's government debt rating to Ba2 reflects
a steep rise in government indebtedness, both direct and indirect
in the form of guarantees, beyond the rating agency's expectations
when the rating was lowered to Ba1. Moody's does not expect the
deterioration to reverse.
The increase in gross government debt was initially a consequence of the
large depreciation of the exchange rate in 2015-16 but has been
exacerbated by the additional costs of supporting state-owned entities
(SOEs), primarily the country's biggest, state-owned
bank, the International Bank of Azerbaijan (IBA). Following
the restructuring of IBA, the government will assume about $2.45
billion in external debt from the bank. Prior to this transaction,
that support entailed the issuance of government guarantees in support
of Aqrarkredit (the vehicle into which IBA's non-performing
loans have been transferred). The bulk of these guarantees are
in the form of very long-term (30-year with a 5-year
grace period) manat-denominated promissory notes carrying a 0.15%
rate of interest. The remaining guarantees, which were meant
to back the bank's external liabilities, will be cancelled following
the transfer of most of those obligations to direct debt of the sovereign.
Moody's consolidates the explicit guarantees issued by the government
in support of Aqrarkredit and to a number of other SOEs into its overall
assessment of government indebtedness. This interpretation reflects
the rating agency's view that, for example, the likelihood
of guarantees in support of Aqrarkredit being triggered is high,
given the poor quality of the assets transferred at face value from IBA.
It also reflects the close operational relationship between the government
and the SOEs, as illustrated by the periodic transfer of funds by
SOFAZ and the government to pay the debt service of SOEs. Overall,
explicit guarantees amounted to about 60% of the government's
gross debt at the end of 2016. That proportion will diminish slightly
to around 55% at the end of 2017.
On that basis, gross government debt in Azerbaijan is relatively
high for a developing country that is highly dependent on a single volatile
source of foreign currency income -- hydrocarbons -- that will
continue to shrink in the years ahead. Gross government debt accounted
for roughly 51% of GDP at the end of 2016 and Moody's expects that
number to rise to about 52% of GDP by the end of this year and
to more than 55% of GDP by the end of next year.
Accordingly, Moody's expects that gross debt (including explicit
guarantees) will continue to climb towards 60% of GDP through 2020
before tapering off. Moreover, both SGC and its owners,
the government and the 100%-state-owned State Oil
Company of the Azerbaijan Republic (SOCAR), have additional financial
commitments for various development projects both domestically and abroad,
some of which are not explicitly guaranteed by the government.
With the large rise in gross government debt, Azerbaijan's
fiscal strength has continued to weaken beyond previous Moody's forecasts.
That said, the even-larger financial assets of the State
Oil Fund of Azerbaijan (SOFAZ), which were equivalent to about 88%
of GDP at the end of 2016, contain the deterioration in fiscal strength
and maintain the government's position as a net creditor. Assuming
a relatively stable manat exchange rate against the US dollar and little
change in the dollar value of SOFAZ assets, Moody's expects the
government's net creditor position (defined as the difference between
SOFAZ assets and the government's direct plus guaranteed debt) will contract
by roughly one-third as a share of GDP by the end of 2018 from
42% of GDP at the end of 2016.
Meanwhile, the financial demands on SOFAZ have increased significantly
and highlight the blurred line between the state budget, SOFAZ and
state-owned entities.SOFAZ is the backstop for the public
sector and funds most of the state budget's non-oil deficit,
which came in at 27% of non-oil GDP in the first half of
2017. SOFAZ has also provided foreign-currency liquidity
to the central bank used to pay principal and interest on SGC's
and SOCAR's external debt, likely in order to preserve the
central bank's foreign currency reserves that have fallen to about
$5 billion from a peak of $15.2 billion during 2014.
A transfer from SOFAZ to the central bank of up to AZN 7.5 billion
(around $4.4 billion at current exchange rates) was approved
for 2017, of which AZN1.4 billion was transferred thus far.
Moody's expects that, going forward, in the quite likely event
that oil and gas revenues are insufficient for SGC and SOCAR to finance
their own debt service in full, additional transfers will be made.
Economic strength has been undermined by the deterioration in fiscal strength
and pro-cyclical fiscal policy
The erosion of fiscal strength limits the scope for accommodative fiscal
policy, which weighs on economic strength. We expect real
GDP to decline by around 1.5% this year after a contraction
of nearly 4% in 2016. The recovery from 2018 onwards is
expected to be gradual, since Azerbaijan's economic dependence
on a natural resource sector that is in long-term decline continues
to pose severe economic challenges. Oil production has fallen by
almost a quarter in the last 6 years, and international organizations
such as the International Energy Agency expect it to fall further.
Revenue from new gas export pipelines, one of which is scheduled
to start operating in June 2018, will offset only part of the decline
in crude oil exports.
In Moody's view, Azerbaijan's economic weakness is exacerbated by
the limited scope for counter-cyclical fiscal policy, compounding
the challenges posed by a fragile banking system and highly dollarized
economy. This limited policy maneuver was demonstrated by the government's
decision to reduce SOFAZ transfers to the 2016 state budget and then not
to go forward with the originally planned fiscal stimulus, instead
cutting government capital expenditure to reduce pressure on the exchange
rate. The fiscal stance will remain tight in 2017, further
contributing to the economy's ongoing contraction, and fiscal
policy is likely to remain pro-cyclical over the coming years.
RATIONALE FOR THE STABLE OUTLOOK
STABLE RATING OUTLOOK REFLECTS EXPECTATIONS FOR STABILIZATION OF GROSS
DEBT RATIOS
The stable rating outlook reflects broadly balanced risks to the sovereign
credit profile over the medium term. Most importantly, and
despite the steep rise in gross government debt, Azerbaijan is expected
to remain a net creditor, which provides significant support to
the Ba2 rating.
Moody's expects that the growth of government debt and contingent
obligations including government guarantees will taper off by 2020,
partly as a result of the implementation of a set of fiscal rules intended
to shrink the government's non-oil budget deficit from 2018
onward.
Upside risks would involve higher than expected oil and gas revenues that
would lower the dependence of SOCAR and SGC on SOFAZ support for debt
service. Downside risks derive from potentially large government-funded
investment in the oil sector in order to ameliorate the persistent decline
in oil production capacity, which could further increase government
debt and erode fiscal strength.
WHAT COULD CHANGE THE RATING - UP
Upward pressure on the rating would derive from decisive action to address
the principal challenges in the country's credit profile,
namely the erosion in fiscal strength, the lack of economic and
export diversity and the weak banking sector. A sustained stabilization
in the government's direct and indirect debt burden, most
likely reflecting economic recovery and a healthier banking system,
would be credit positive. However, any stabilization would
be unreliable if founded solely on rising oil prices, as distinct
from a gradual diversification of the economy to address the high dependence
on oil, and a more strongly capitalized, liquid banking system.
WHAT COULD CHANGE THE RATING - DOWN
The ratings would come under negative pressure if the government's
balance sheet deterioration were to continue beyond 2018, particularly
were that to be associated with further banking sector shocks and increased
budgetary reliance on SOFAZ assets that further eroded the country's
net creditor position. Also negative would be an escalation of
the geopolitical conflict in Nagorno Karabakh or increased uncertainly
within the domestic political environment, such as related to presidential
succession.
GDP per capita (PPP basis, US$): 17,439 (2016
Actual) (also known as Per Capita Income)
Real GDP growth (% change): -3.8% (2016
Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 15.6%
(2016 Actual)
Gen. Gov. Financial Balance/GDP: -1.2%
(2016 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -3.6% (2016 Actual)
(also known as External Balance)
External debt/GDP: 37.3% (2016 Actual)
Level of economic development: Low level of economic resilience
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 14 August 2017, a rating committee was called to discuss the
rating of Azerbaijan, Government of. The main points raised
during the discussion were: The issuer's economic fundamentals,
including its economic strength, have materially decreased.
The issuer's fiscal or financial strength, including its debt profile,
has materially decreased. The issuer has become less susceptible
to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings
published in December 2016. Please see the Rating Methodologies
page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used
in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the credit rating action on the support provider and in relation to
each particular credit rating action for securities that derive their
credit ratings from the support provider's credit rating.
For provisional ratings, this announcement provides certain regulatory
disclosures in relation to the provisional rating assigned, and
in relation to a definitive rating that may be assigned subsequent to
the final issuance of the debt, in each case where the transaction
structure and terms have not changed prior to the assignment of the definitive
rating in a manner that would have affected the rating. For further
information please see the ratings tab on the issuer/entity page for the
respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
support from the primary entity(ies) of this credit rating action,
and whose ratings may change as a result of this credit rating action,
the associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
if applicable to jurisdiction: Ancillary Services, Disclosure
to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Kristin Lindow
Senior Vice President
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653
Atsi Sheth
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653
Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653
