Fitch Ratings Cuts Outlook on Azerbaijan to Negative, Criticizes Series of Actions

46 international rating agency Fitch Ratings has revised its forecast for long-term issuer default rating in foreign currency (IDR) for Azerbaijan to Negative from Stable and affirmed the IDR at BB +.

The agency’s report noted that “events in the country required deviations from the schedule for revising the Fitch sovereign rating for Azerbaijan, which was previously scheduled for July 17, 2020.”

According to the agency’s experts, in 2020 GDP will fall by 4.8%, whereas earlier Fitch predicted growth by 2.2%, and the Azerbaijani government – growth by 3%, which under current conditions seems unrealistic.

The explanation is based on the fact that “a sharp drop in oil prices and measures to curb the spread of the coronavirus COVID-19 will lead to a decrease in economic activity in Azerbaijan in 2020.”

“Fitch predicts a 4.8% drop in GDP in 2020, as income, consumption, and the oil and non-oil sectors will suffer from quarantine restrictions. But we predict that GDP growth in 2021 will amount to 2.5% as oil prices recover and aggregate demand, ”the agency said in a statement.

Fitch forecasts inflation in Azerbaijan this year at 1.5% (the January forecast of this rating agency was 3.3%).

Fitch also believes that the consolidated fiscal deficit in 2020 will be at 6.8% of GDP in 2020, while three months ago the forecast was in the form of a surplus of 4.4% of GDP.

“A sharp drop in oil prices will significantly reduce fiscal revenues from oil flowing to the State Oil Fund (SOFAR), while current spending on social benefits and benefits will increase as the unemployment rate rises to 8% from 5% in 2019. Fitch expects fiscal rules to be temporarily suspended to allow the government to respond to the crisis,” the agency emphasizes.

Fitch believes that the state debt of Azerbaijan is low (19.1% of GDP at the end of 2019), but it will increase this year to 23.8% of GDP, as part of the funds will be used to finance part of the state support measures during the COVID-19 pandemic.

The agency estimates that due to lower oil prices, the current account deficit of the balance of payments of Azerbaijan will amount to 2.8% of GDP, while in 2019 there was a surplus of 9.3% of GDP.

Azerbaijan will be able to return to a 5.2% surplus in the current account in 2021 amid a recovery in oil prices.

Fitch recommendations for currency policy

“The authorities are persistently defending the rate of 1.7 AZN / USD, despite the fall in prices for Brent crude oil by 32% since the end of February. It is becoming costly and unsustainable. In Azerbaijan, hydrocarbons account for approximately 40% of GDP, 90% of exports and two-thirds of tax revenues. Since the beginning of the year, the State Oil Fund (SOFAZ) sold $ 2.9 billion in foreign exchange auctions, with $ 1.9 billion in March. Sales from SOFAZ at foreign exchange auctions of the Central Bank amounted to 45% of its annual transfer to the state budget of $ 6.7 billion. We believe that it is necessary to amend the budget law to allow further sales of currency at CBA auctions outside the limits of the annual transfer of SOFAZ,” the rating agency notes.

Experts point out that the CBA’s foreign exchange reserves amount to $ 6.4 billion, but they are “below four months of the current level of Azerbaijan’s foreign (external) assets (CXP) since the last jump in oil prices. FX volumes are sold both individually and in regular mode.

“Even with a decrease in demand for foreign currency in April, the pace of its sales will require a “drawdown” in Azerbaijan’s assets to protect the manat against low oil prices. Sovereign foreign assets, including the CBA and SOFAZ foreign exchange reserves, amounted to $ 49.5 billion or 27 CXP months by the end of 2019. Azerbaijan needs to remember the risk of erroneous actions in monetary policy, and remember the experience of 2014-2015. The still high dollarization of deposits (61% at the end of 2019) and loans (35%) strengthens the potential for uncontrolled devaluation of the manat,” Fitch said.

Fitch believes that the quality of bank assets in Azerbaijan will be affected by the Corona Virus pandemic and low oil prices.

“Banks in Azerbaijan have not yet fully recovered from problems with the quality of inherited assets (from the devaluation of 2015), remain weak, which is reflected in the Fitch Banking System (BSI) indicator rating “B”. Non-repaid loans in the aggregate banking sector are still high,” the rating agency writes.

After debt restructuring in 2017, the IBA returned to profitability with improved asset quality. However, despite the decline in its open currency from $ 1.9 billion in 2017, the unhedged position remains large at $ 0.8 billion.

Attracting significant non-oil foreign direct investment (FDI) to diversify the economy could help Azerbaijan, but this is hardly possible in 2020.

Also, Azerbaijan still has a low level of responsibility in the management system, weak rights to participate in the political process, uneven application of the law and a high level of corruption.

All this impedes the implementation of effective reforms so that the Azerbaijani economy is less at risk from external shocks.



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