Azerbaijan

Fitch Confirmed Azerbaijan’s Issuer Default Ratings

by Shahriyar Aliyev

On July 17, international rating agency Fitch Ratings confirmed Azerbaijan’s long-term issuer default ratings (IDR) in local and foreign currencies at “BB +”. The outlook on the ratings was confirmed as “negative”.

Many local and foreign experts expected this confirmation of Azerbaijan’s ratings. Overall, the rating was based on a very strong national and external balance sheet and flexibility in budget funding, thanks to the assets of the State Oil Fund of Azerbaijan. On the other hand, it should be noted that the economy is highly dependent on oil, weak governance indicators, and a lack of forecasts and transparency in decision-making, especially regarding the exchange rate regime.

The negative outlook reflects the impact of combined shocks from lower oil prices, the COVID-19 pandemic on Azerbaijan’s external reserves and the risk of a devastating macroeconomic adjustment. External pressure proved most intense from March to April 2020, when prices for Brent crude oil fell to an average of $ 26 per barrel and SOFAZ sold $2.5 billion at foreign exchange auctions to satisfy growing private sector demand and maintain the exchange rate at 1.7 AZN / USD. A re-intensification of demand for foreign exchange or a fall in oil prices could renew devaluation pressures.

In addition, the high level of dollarization of deposits (61% at the end of 2019) and dollarization of loans (35%) remain problematic for the Azerbaijani economy. The level of dollarization declined after the 2015 crisis but remains above 2014 levels — posing an economic risk in the event of a devaluation of the national currency.

Fitch believes that the outbreak of COVID-19 and lower oil prices will continue to affect the quality of bank assets. Banks in Azerbaijan continue to recover from asset quality problems originating from the 2015 devaluation but remain weak. The share of problem loans remains at a moderate level and slightly decreased to 7.3% in May 2020 from 8.3% at the end of 2019. This can be traced to the revocation of licenses from four banks by the Central Bank. After a debt restructuring in 2017, the largest bank in the country, International Bank of Azerbaijan (IBA) returned to profitability with large capital buffers and an improved asset quality. However, despite the reduction in its open foreign exchange position from $1.9 billion in 2017, the unhedged position remains substantial at $0.7 billion in June 2020.

The oil shock that prompted Fitch’s rating outlook to negative in April has been exhausted. The oil market has stabilized as evidenced by the continued trend of rising oil prices after the OPEC+ decision to ease production restrictions in August. The price of Brent crude has more than doubled from its lowest level in mid-April when Fitch lowered its forecast. Concurrently, the Central Bank of Azerbaijan’s consistent policy stance to maintain a stable exchange rate of the manat in the face of a sharp decline in oil prices will prevent the growth of devaluation expectations despite repeated oil shocks and ensure macroeconomic stability. Given the stabilization of oil prices and the normalization of the situation in the domestic foreign exchange market, it is possible that in November, Fitch may improve its rating outlook to “stable”.

Fitch predicts a GDP growth of 2.5% in 2021 and 2.8% in 2022 as oil prices and aggregate demand recover, but growth is constrained by the impact of low oil prices on investment in the oil and gas sector. Azerbaijan is highly dependent on energy resources: oil and gas account for about 40% of its GDP, 81% of revenues from exports of goods and services, and two-thirds of tax revenues in 2019. The current account deficit is projected to worsen to 4% of GDP in 2020 (a surplus of 9.1% of GDP in 2019), but will return to surpluses of 4.4% of GDP and 6.1% of GDP in 2021 and 2022, respectively.

Analysts from the Russian Gazprombank speculate that if economic activity in Azerbaijan begins to recover in the fall, the economic recession that may reach 2.5% by the end of 2020 will be replaced by GDP growth in 2021 at the level of 1.2%. However, the current war with Armenia that began in September 2020 further complicates uncertainty and risk, undeniably altering all the above projections and ratings. Azerbaijan’s military expenditures and government expenditures for a post-war recovery will create large budget deficits, which in turn will decrease private investments and income from the tourism sector.