Azerbaijan 'BB+/B' Ratings Affirmed; Outlook Stable

  • In view of the sharp fall in international oil prices, we have significantly lowered our oil price assumptions for 2020-2021.
  • Nevertheless, Azerbaijan's government and external balance sheets are currently strong and provide a buffer against external shocks.
  • We are affirming our 'BB+/B' foreign and local currency ratings on Azerbaijan and maintaining our stable outlook.

Rating Action

On March 26, 2020, S&P Global Ratings affirmed its 'BB+/B' long- and short-term foreign and local currency sovereign credit ratings on Azerbaijan. The outlook is stable.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Azerbaijan are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2020 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 20, 2019, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is a sharp drop in hydrocarbon prices and our revised price assumptions for 2020 and 2021. The next scheduled publication on the sovereign rating on Azerbaijan will be on July 24, 2020.

Outlook

The stable outlook indicates our view that the sovereign's fiscal and external position will not materially deteriorate beyond our current expectations, even though prospects for volume production in the oil sector appear limited and prices could remain low. We assume the de facto manat exchange rate peg to the U.S dollar will remain in place, supported by the government's large external assets.
Downside scenario
We could lower the ratings if Azerbaijan's public finances, external position, or growth expectations materially weakened compared with our forecasts. This could happen, for example, as a result of hydrocarbon revenues declining further and beyond our assumptions, without fiscal spending being pared back in response. Such weakening could also entail larger or prolonged current account deficits and quicker drawings on liquid external assets, due to the high vulnerability of external flows to terms of trade volatility.
The ratings could also come under pressure if challenges emanating from Azerbaijan's exchange rate regime destabilized the macroeconomic environment, including higher credit risks in the financial system and highly leveraged state-owned enterprises.
Upside scenario
Conversely, we could consider an upgrade if external surpluses were higher than base-line projections, resulting in a faster accumulation of the government's fiscal assets. This could happen, for example, if hydrocarbon revenues markedly increased in contrast to our assumptions and we expected the higher level to be sustained.
Upside to the ratings could also build if the government devised and implemented reforms addressing a number of Azerbaijan's structural impediments, such as limited economic diversification and substantial constraints to monetary policy effectiveness.

Rationale

On March 19, 2020, S&P Global Ratings materially lowered its oil price assumption for 2020. This follows an earlier significant downward revision of its price assumptions on March 9, 2020. Prices for crude oil in spot and futures markets are more than 55% lower than levels observed during the summer of 2019 when prices increased due to rising geopolitical tensions. When we last reviewed Azerbaijan ("Azerbaijan 'BB+/B' Ratings Affirmed; Outlook Stable" published Jan. 25, 2020, on RatingsDirect), we expected Brent oil prices to average $60 per barrel (/bbl) in 2020 and to gradually decline to $55/bbl from 2021. We now assume an average Brent oil price of $30/bbl in 2020, $50 in 2021, and $55/bbl from 2022 (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 19, 2020).
Oil prices plummeted following OPEC's failure to agree on further production cuts during meetings on March 6. OPEC+ did not agree to a proposed reduction of 1.5 million barrels per day (mmbbl/d) to address an expected significant drop in global demand partly due to the spread of the coronavirus. The proposed reduction was in addition to the current 2.1 mmbbl/d production decrease set to expire at the end of March. Shortly after the meetings, Saudi Arabia announced that it was immediately slashing its official selling price and would increase its production to over 12 mmbbl/d in April after the current production cut expires. These actions possibly signal that, despite a collapse in global demand and shrinking physical markets, Russia and OPEC have engaged in a price war to try and maintain market share and market relevance. Oil markets are now heading into a period of a severe supply-demand imbalance in second-quarter 2020. In line with our economic outlook, we anticipate a recovery in both GDP and oil demand through the second half of 2020 and into 2021 as the most severe effects from the coronavirus outbreak moderate (see "Economic Research: COVID-19 Macroeconomic Update: The Global Recession Is Here And Now," published March 17, 2020).
Azerbaijan derives about 40% of its GDP, 50% of government revenues, and more than 90% of exports from the hydrocarbons sector. This makes Azerbaijan's undiversified economy and credit profile vulnerable to a steep and sustained decline in oil prices, notwithstanding government's policy to encourage non-oil private-sector growth. We expect lower oil prices will weigh on Azerbaijan's economic prospects. Risks to growth in the short term could be exacerbated by reduced activity due to the COVID-19 pandemic, which could exert significant pressure on the economy, specifically the trade, retail, and hospitality sectors. We expect a mild economic contraction in 2020 and project a rebound with growth averaging about 2.5% over the remainder of our forecast period 2020-2023.
Nevertheless, the ratings are supported by Azerbaijan's very strong external and fiscal positions, which are underpinned by relatively low central government debt and significant foreign assets built up over several years. In view of our revised oil price assumptions, we project that the general government balance will record a deficit of 4.8% of GDP in 2020, before reverting to small surpluses, with net government assets averaging 49% of GDP over 2020-2023. Mirroring developments on the fiscal side, Azerbaijan's external balance will record a deficit of about 7.6% of GDP this year before reverting to a surplus of 5.3% on average through 2023. Azerbaijan's strong external balance sheet will remain a core rating strength, reinforced by the large amount of foreign assets accumulated in the sovereign wealth fund, SOFAZ. We now estimate external liquid assets will surpass external debt by 74% of current account payments in 2020 and gradually rise to 93% by 2023.
In our view, amid the volatile oil price environment, pressure on the manat has increased. Nonetheless, we assume Azerbaijan will retain the manat's de facto peg to the U.S dollar at AZN1.7 manat to $1, supported by the authorities' regular interventions in the foreign currency market. In our view, should oil prices remain low for a prolonged period, the authorities could allow the exchange rate to adjust to avoid a similar substantial loss of foreign currency reserves as in 2015.
The ratings remain constrained by Azerbaijan's still-weak institutional effectiveness, narrow and concentrated economic base, limited monetary policy flexibility, and shortcomings in relation to the completeness and accuracy of external sector data.

Key Statistics

Table 1

Azerbaijan Selected Indicators
2014201520162017201820192020202120222023
Economic indicators (%)
Nominal GDP (bil. LC)59546070808265798589
Nominal GDP (bil. $)75533841474838465052
GDP per capita (000s $)7.95.53.94.24.84.83.84.64.95.1
Real GDP growth2.81.1(3.1)0.11.42.2(0.7)2.92.22.2
Real GDP per capita growth1.5(0.1)(4.2)(1.0)0.51.3(1.5)2.11.41.4
Real investment growth1.4(5)(15)4.51.1(3.5)(10)(4.0)1.72.0
Investment/GDP26.627.925.724.420.119.822.617.816.816.7
Savings/GDP40.227.522.128.533.028.315.021.523.122.6
Exports/GDP43.337.846.448.554.148.738.744.345.344.7
Real exports growth(1.1)(0.5)(1.4)(5)2.3(0.2)(0.3)3.82.61.5
Unemployment rate4.95.05.05.04.95.04.94.94.94.9
External indicators (%)
Current account balance/GDP13.6(0.4)(3.6)4.112.88.6(7.6)3.66.25.9
Current account balance/CARs28.3(1.0)(7.1)7.621.415.7(17.2)7.512.612.1
CARs/GDP47.942.450.554.460.054.444.048.649.448.7
Trade balance/GDP25.211.011.115.020.917.26.013.515.214.8
Net FDI/GDP3.21.65.10.7(0.8)1.01.51.01.01.0
Net portfolio equity inflow/GDP0.00.0(0.0)(0.0)(0.0)0.00.00.00.00.0
Gross external financing needs/CARs plus usable reserves63.382.3111.8104.784.587.8110.9102.894.991.8
Narrow net external debt/CARs(84.2)(86.0)(58.4)(62.4)(59.1)(80.8)(87.1)(74.9)(78.5)(81.5)
Narrow net external debt/CAPs(117.5)(85.2)(54.6)(67.5)(75.2)(95.9)(74.3)(81.0)(89.8)(92.8)
Net external liabilities/CARs(72.3)(64.4)(26.3)(35.1)(40.5)(59.5)(50.8)(46.2)(50.4)(51.8)
Net external liabilities/CAPs(100.9)(63.8)(24.5)(38.0)(51.5)(70.6)(43.3)(50.0)(57.6)(58.9)
Short-term external debt by remaining maturity/CARs16.431.634.131.021.822.435.226.524.123.6
Usable reserves/CAPs (months)6.67.32.92.32.93.13.82.12.42.9
Usable reserves (mil. $)13,7585,0173,9745,3355,6266,2583,5624,3225,4375,906
Fiscal indicators (general government; %)
Balance/GDP3.4(4.0)0.50.87.68.1(4.8)0.41.71.7
Change in net debt/GDP3.5(24.1)12.03.9(6.9)(8.8)5.8(0.3)(1.5)(1.5)
Primary balance/GDP3.6(3.7)1.01.38.48.8(3.8)1.12.42.3
Revenue/GDP39.133.934.334.138.640.436.136.335.935.5
Expenditures/GDP35.737.833.733.331.032.440.936.034.233.8
Interest/revenues0.40.81.31.51.91.72.72.12.01.9
Debt/GDP8.322.336.638.032.431.038.032.330.629.9
Debt/revenues21.265.9106.8111.784.076.8105.488.985.484.3
Net debt/GDP(42.5)(70.1)(51.1)(40.0)(42.0)(50.0)(57.4)(47.3)(45.3)(45.0)
Liquid assets/GDP50.792.487.778.174.481.095.479.775.974.9
Monetary indicators (%)
CPI growth1.44.012.412.92.32.63.33.64.14.0
GDP deflator growth(1.3)(8.9)14.716.312.3(0.2)(20.4)18.65.91.7
Exchange rate, year-end (LC/$)0.781.561.771.701.701.701.701.701.701.70
Banks' claims on resident non-gov't sector growth20.520.7(28.3)(35.7)14.915.25.65.15.15.1
Banks' claims on resident non-gov't sector/GDP34.645.329.216.216.318.424.621.220.620.8
Foreign currency share of claims by banks on residentsN/AN/AN/AN/AN/AN/AN/AN/AN/AN/A
Foreign currency share of residents' bank deposits36.276.464.467.657.254.955.055.055.055.0
Real effective exchange rate growth11.5(25.0)(17)3.25.6(0.5)N/AN/AN/AN/A
Sources: The State Statistical Committee of the Republic of Azerbaijan and Central Bank of the Republic of Azerbaijan (economic indicators); The State Statistical Committee of the Republic of Azerbaijan, Central Bank of the Republic of Azerbaijan, and IMF (monetary indicators); Ministry of Finance of Azerbaijan (fiscal indicators); Ministry of Finance of Azerbaijan, Central Bank of the Republic of Azerbaijan, and IMF (debt indicators); IMF, Central Bank of the Republic of Azerbaijan, Ministry of Finance of Azerbaijan, State Oil Fund of the Republic of Azerbaijan, and Bank for International Settlements (external indicators).
Adjustments: General government liquid financial assets adjusted by including assets of State Oil Fund of the Republic of Azerbaijan.
Definitions: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. e--Estimate. f--Forecast. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Ratings Score Snapshot

Table 2


Azerbaijan Ratings Score Snapshot
Key rating factorsScoreExplanation
Institutional assessment5Future policy responses are difficult to predict because of highly centralized decision making, as well as an uncertain and untested succession process. Power remains in the hands of long-standing President Ilham Aliyev, impairing transparency and making future policy choices difficult to predict. Respect for the rule of law is not assured, owing to high perceived corruption and interference by political institutions in the free dissemination of information.
Economic assessment5Based on GDP per capita ($) as per the Selected Indicators in Table 1.
External assessment2Based on narrow net external debt and gross external financing needs as per the Selected Indicators in Table 1.
Azerbaijan's external data lacks consistency. Limited data on balance of payments and international investment position will likely lead to an underestimation of external risks on the basis of available statistics.
Fiscal assessment: flexibility and performance1Based on the change in net general government debt (% of GDP) as per Selected Indicators in Table 1.
Based on liquid assets/GDP as per Selected Indicators in Table 1. Those assets are held by the sovereign wealth fund SOFAZ.
Azerbaijan has a volatile revenue base since more than half of the general government revenue is based on hydrocarbon production.
Fiscal assessment: debt burden1Based on net general government debt (as a % of GDP) and “GG interest paid/GG revenues (%)” as per Selected Indicators in Table 1.
Monetary assessment5We view the exchange rate as a soft peg. We expect the central bank will allow the manat to adjust promptly should oil prices prove less favorable than expected.
Monetary policy effectiveness remains constrained by the still-weak domestic banking system, shallow capital markets, high financial dollarization, and the limited operational independence of the central bank.
Financial dollarization is still high with over 50% of deposits denominated in foreign currency.
Indicative ratingbb+As per Table 1 of "Sovereign Rating Methodology."
Notches of supplemental adjustments and flexibility0
Final rating
Foreign currencyBB+
Notches of uplift0We do not believe that default risks apply differently to foreign- and local currency debt.
Local currencyBB+
S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.
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