Singapore, August 05, 2022 -- Moody's Investors Service ("Moody's") has upgraded the Government of Azerbaijan's long-term issuer and senior unsecured debt ratings to Ba1 from Ba2 and changed the outlook to stable from positive. In addition, Moody's upgraded the foreign currency senior unsecured rating of Southern Gas Corridor CJSC (SGC) to Ba1 from Ba2 and changed the outlook to stable from positive.
The upgrade reflects improvements in policy effectiveness in recent years, which translate into improved fiscal management, and increased capacity to absorb future shocks. Despite the pandemic, fiscal metrics have remained strong and are improving quicker than expected, due to prudent fiscal management amidst an economic rebound and high hydrocarbon prices. Moody's expects the government's anti-inflation measures and the Central Bank of the Republic of Azerbaijan's (CBAR) proactive macroeconomic policy to contain inflation risks exacerbated by the Russia/Ukraine crisis.
The stable outlook balances credit strengths from Azerbaijan's sizeable assets that underpin fiscal strength and lower government liquidity and external vulnerability risks, against credit challenges including still limited prospects for economic diversification, and longstanding (although improving) institutional and governance weaknesses. Geopolitical tensions with neighbouring Armenia remain, while spillovers from the Russia/Ukraine military conflict such as secondary sanctions and disrupted trade or supply chains pose downside risks.
Concurrently, Moody's raised Azerbaijan's local-currency and foreign-currency ceilings by one notch to Baa2 from Baa3 and Ba1 from Ba2, respectively. The two-notch gap between the local currency ceiling and the sovereign rating balances the large footprint of the government in the economy and still weak institutions and governance, against ample sovereign wealth assets that support the country's external and macroeconomic stability. The two-notch gap between the foreign currency ceiling and the local currency ceiling takes into consideration the improving but still limited confidence in the local currency and the de facto currency peg against the dollar despite a de jure flexible exchange rate regime, which raise the risk of transfer and convertibility restrictions.
Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL468495 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and identifies each affected issuer.
RATIONALE FOR UPGRADE
PRUDENT FISCAL MANAGEMENT, GUIDED BY REVISED FISCAL RULE, REINFORCES DEBT AND FISCAL METRICS
Since the 2015-16 oil price shock, Azerbaijan has enhanced its fiscal management, leading to a stronger balance sheet and a return of the debt burden to less than 20% of GDP (including direct debt and that of Azerbaijan Railways). The government contained fiscal deterioration, despite lower economic growth and a decline in hydrocarbon prices during the pandemic. While activating the escape clause of its fiscal rules, Azerbaijan effectively used its sizeable fiscal buffers during the pandemic to provide counter-cyclical spending, limiting deterioration in the government's debt metrics, while enhancing fiscal flexibility.
The debt burden has since consolidated and remains on track to decline further, according to Moody's estimates. In times of high oil prices, Moody's expects the government will maintain fiscal prudence by limiting its reliance on State-Oil Fund of Azerbaijan (SOFAZ) transfers as illustrated by the revised 2022 budget.
The fiscal rules suspended during the pandemic are being revised to allow for increased flexibility in spending non-oil revenues, aimed at boosting economic activity in years where non-oil revenues are higher than expected. For example, non-oil revenues overperformed last year and are expected to do so this year, enabling a reallocation of spending towards reconstruction for Nagorno-Karabakh and anti-inflation measures. Meanwhile, the new fiscal rules reaffirmed the authorities' commitment to reduce the non-oil deficit as a percent of non-oil GDP and implement a ceiling on the debt burden.
Moody's also expects governance reforms to reduce contingent liability risks over time. Through the holding company Azerbaijan Investment Holding (AIH), the authorities have increased their supervision over state-owned entity (SOE) debt. Other reforms such as ameliorating corporate governance, introducing financial disclosure and audit rules are ongoing. Moody's does not expect Aqrarkredit, where toxic assets from the International Bank of Azerbaijan (IBA) were transferred in 2017, to need large capital injections by the government.
SOUND MANAGEMENT OF OIL REVENUES WILL LEAD TO LOWER EXTERNAL VULNERABILITY RISKS
Assets held by SOFAZ, which are foreign currency denominated and invested in liquid markets, continued growing in 2021 despite the pandemic. In time of high oil prices, the accumulation of hydrocarbon revenues at SOFAZ rather than their use for budgetary purposes as per increasingly prudent fiscal management highlighted above enables the sovereign to replenish its significant fiscal buffers, which Moody's expects to exceed 500% of general government debt this year. Based on Moody's oil price assumptions of $50-70 per barrel over the medium term, the size of SOFAZ assets is likely to keep growing over the next few years.
Large SOFAZ assets underpin Azerbaijan's large net creditor position and contain external vulnerability risks, and can be used to absorb external shocks including through lower oil prices. Moody's expects large current account surpluses over the next few years (15-20% of GDP) due to high hydrocarbon prices, higher oil production quotas, and increased gas exports. Including SOFAZ assets, Azerbaijan's elevated external vulnerability indicator (around 80%) would decrease to under 20%.
ENHANCED INSTITUTIONAL FRAMEWORK PROVIDES MACROECONOMIC AND EXTERNAL STABILITY THROUGH PERIOD OF HIGHER INFLATION
Despite strong trade links to Russia, the Russian invasion of Ukraine has had limited impact on the economy, with non-oil real GDP reaching 11% in May 2022. Moody's expects Azerbaijan's real GDP growth to reach 4% this year. After having demonstrated resilience throughout the coronavirus pandemic resulting in a smaller recession than peers and maintaining a stable currency , Azerbaijan entered the Russia/Ukraine crisis with a strong economic recovery bolstered by high hydrocarbon prices.
Moody's expects recent improvements in institutional capacity to mitigate pressure from soaring inflation, which surpassed 14% this year including almost 20% for food. In response, the Central Bank of the Republic of Azerbaijan (CBAR) has increased policy rates by 150 basis points to 7.75% since September 2021 and raised reserve requirements. Following enhanced macroeconomic policy and exchange rate management that have underpinned macro and external stability in recent years, Moody's expects the CBAR to maintain the de facto peg to the US dollar for the foreseeable future.
The government has also implemented anti-inflation measures, such as tax and tariffs cuts or subsidies for food products and food export bans, as well as a stockpile policy. Moody's believes that the government has additional fiscal buffers to provide targeted cash transfers to low-income households if required. Besides, high hydrocarbon prices buffer household incomes and contain social risk, while public sector wages were also increased in 2021.
GDP per capita (PPP basis, US$): 15,882 (2021) (also known as Per Capita Income)
Real GDP growth (% change): 5.6% (2021) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 12% (2021)
Gen. Gov. Financial Balance/GDP: 4.3% (2021) (also known as Fiscal Balance)
Current Account Balance/GDP: 15.2% (2021) (also known as External Balance)
External debt/GDP: 28.9% (2021)
Economic resiliency: ba3
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 02 August 2022, a rating committee was called to discuss the rating of the Azerbaijan, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's institutions and governance strength, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially increased. The issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
Upward pressure on the rating could develop if ongoing and further reforms were to increase the level of governance, transparency, and policy predictability, and in turn the quality of institutions beyond current expectations. Over time, marked progress in economic diversification that reduces the economy's high dependence on hydrocarbons would additionally put upward pressure on the rating.
Downward pressure on the rating could develop if there were signs of erosion in the credibility and effectiveness of the enhanced macroeconomic and fiscal policy framework that in turn raised the likelihood of external instability and/or a sustained increase in the debt burden. Banking sector weaknesses resurfacing and significantly raising contingent liability risks could also put downward pressure on the rating. A renewed escalation of the conflict over Nagorno-Karabakh or significant spillovers from the Russia/Ukraine military conflict with a protracted negative impact on economic activity and government finances would be credit negative.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
The exposure to environmental risk is high (E-4 issuer profile score), as the economy and government finances remain highly susceptible to a global transition away from hydrocarbon fuels over the longer term. The hydrocarbon sector accounts for around 90% of total goods exports and contributes to 60-70% of consolidated government revenue. While the government is emphasising economic diversification through its strategic road maps, tangible benefits will take time to materialise and are limited by human capital and institutional constraints.
The exposure to social risk is moderate (S-3 issuer profile score) as still low education and skills attainment constrain the development of the labour market, while rising inequality and restrictions on voice and accountability tend to be political flashpoints domestically. That said, the deployment of hydrocarbon revenue on public services including in healthcare, education and social infrastructure help address social concerns.
The influence of governance is highly negative (G-4 issuer profile score), reflecting the lack of judicial independence and challenges in the rule of law, control of corruption, governance and transparency. These limit the effectiveness of institutions, prospects for economic diversification, and the resilience of the country to environmental and social risks.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.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.
The List of Affected Credit Ratings announced here are a mix of solicited and unsolicited credit ratings. For additional information, please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com. Additionally, the List of Affected Credit Ratings includes additional disclosures that vary with regard to some of the ratings. Please click on this link https://www.moodys.com/viewresearchdoc.aspx?docid=PBC_ARFTL468495 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and provides, for each of the credit ratings covered, Moody's disclosures on the following items:
Participation: Access to Management
Participation: Access to Internal Documents
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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
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