The ENCA region: Vulnerability and Resilience Lúcio Vinhas de Souza, Sovereign Chief Economist
Rated Sovereigns in the ENCA region» Moody s only rates 8 of the 12 ENCA (or CIS) countries: Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Moldova, Russia and Ukraine.» Among those rated, ratings-wise, there is a clear divide between (net) energy commodity exporters and the others, in terms of fiscal and external vulnerability
Our Sovereign ratings in the region.. 2006 2007 2008 2009 2010 2011 2012 2013 2014 Armenia Ba2 Ba2 Ba2 Ba2 Ba2 Ba2 Ba2 Ba2 Ba2 Azerbaijan Ba1 Ba1 Ba1 Ba1 Ba1 Ba1 Baa3 Baa3 Baa3 Belarus -- B1 B1 B1 B1 B3 B3 B3 B3 Georgia -- -- -- -- Ba3 Ba3 Ba3 Ba3 Ba3 Kazakhstan 2 Baa2 Baa2 Baa2 Baa2 Baa2 Baa2 Baa2 Baa2 Baa2 Moldova Caa1 Caa1 Caa1 WR B3 B3 B3 B3 B3 Russia Baa2 Baa2 Baa1 Baa1 Baa1 Baa1 Baa1 Baa1 Baa1 Ukraine B1 B1 B1 B2 B2 B2 B3 Caa1 Caa2 1 Rating at year end. 2 Refers to foreign currency rating Source: Moody's
Some data: GDP and debt/deficit GDP 2012 2013 2014 Armenia 7.2 3.5 4.5 Azerbaijan 2.2 3.5 5.6 Belarus 1.5 1.5 2.5 Georgia 6.2 2.7 4.3 Kazakhstan 5.1 6 5.2 Moldova -0.8 7 3.5 Russia 3.4 1.5 2 Ukraine 0.2 0 1.5 Avg. 3.1 3.2 3.6 Avg. Com-3 3.6 3.7 4.3 Source: Moody's Debt 2012 2013 2014 Armenia 44.1 45.5 44 Azerbaijan 11.6 14.6 14.9 Belarus 41.9 36.9 33.4 Georgia 32.6 32.3 32.9 Kazakhstan 12.4 13.1 13.5 Moldova 23.8 22.9 22.6 Russia 12.6 13.5 14.5 Ukraine 37.4 42.3 47.6 Avg. 27.1 27.6 27.9 Avg. Com-3 12.2 13.7 14.3 Source: Moody's Deficit 2012 2013 2014 Armenia -1.5-2.2-2.1 Azerbaijan 3-5 -7.6 Belarus 0.6-0.6-0.9 Georgia -1.9-3 -2.2 Kazakhstan 4.5 4.8 4.1 Moldova -2.1-1.5-2.7 Russia 0.4-0.7-0.3 Ukraine -4.5-5.4-5.1 Avg. -0.2-1.7-2.1 Avg. Com-3 2.6-0.3-1.3 Source: Moody's
Some data: CAB and EVI CAB 2012 2013 2014 Armenia -11.1-9 -8 Azerbaijan 31.7 34.4 34.1 Belarus -2.7-5.7-4.2 Georgia -11.5-9.4-7.8 Kazakhstan 0.3 0.1 0.9 Moldova -6.8-7 -7.2 Russia 3.6 1.6 1.3 Ukraine -8.2-8.4-6.6 Avg. -0.6-0.4 0.3 Avg. Com-3 11.9 12.0 12.1 Source: Moody's EVI 2012 2013 2014 Armenia 87.6 95.7 104.6 Azerbaijan 15.6 12.3 10.4 Belarus 310.4 248.8 329 Georgia 95.5 107.7 117 Kazakhstan 47.6 29 Moldova 119.9 112 115.9 Russia 36 29.4 22.6 Ukraine 196.4 267.3 295.7 Avg. 113.6 112.8 142.2 Avg. Com-3 33.1 23.6 16.5 Source: Moody's
Region s strengths and challenges» These countries broadly share the same strengths and vulnerabilities» Those include, in the vulnerability side, low diversification, limited institutional strength and vulnerability to geopolitical shocks» On the strength side, they mostly have limited fiscal vulnerability and (if an oil exporter) external vulnerability» There are exceptions to both: namely, the smaller, non-commodity economies have usually better governance indicators and, at the same time, worse fiscal and external positions, than the commodity based economies in the region
Armenia» Armenia Credit Strengths» - The government's commitment to fiscal prudence and macroeconomic stability» - A commitment to structural reforms in support of broadening the economic base and improving the business climate» - The favorable cost of funding due to borrowings from official lenders» Credit Challenges» -Low economic diversification and high exposure to economic and financial spillovers, in particular from Russia» -A vulnerable external position, including a high degree of dollarization» -Geo-political risk, particularly in relations with Azerbaijan and Turkey» Banking Sector Risk» Average Baseline Credit Assessment (BCA) b1» Total Domestic Bank Assets/GDP 61.8» Banking System Loan-to-Deposit Ratio 132.5
Azerbaijan» Credit Strengths» -Sizeable oil and gas reserves that provide substantial revenues to the government over the medium term» -Low level of government debt and interest payments» -High level of foreign assets that buffer against internal and external shocks» Credit Challenges» -Weak governance indicators» -Limited economic diversification» -Geopolitical tensions» Banking Sector Risk» Average Baseline Credit Assessment (BCA) b3» Total Domestic Bank Assets/GDP (2012) 24.7» Banking System Loan-to-Deposit Ratio (2012)161.0
Belarus» Credit Strengths» - A diversified, industrialized economy with a history of strong GDP growth» -Low unemployment rates and relatively high per capita incomes compared to peers» Credit Challenges» -Low foreign exchange reserves relative to debt repayment obligations» -Recurrent balance of payments and inflationary pressures» -Dependence on external financial support for growth» -Very low institutional strength» Banking Sector Risk» Average Baseline Credit Assessment (BCA) b3» Total Domestic Bank Assets/GDP 49.2» Banking System Loan-to-Deposit Ratio 174.8
Georgia» Credit Strengths» -Continued and rapid progress in building social, political and economic institutions» -Credible fiscal and monetary policy frameworks» Credit Challenges» - Low income levels and wide income disparities» - Large, structural external vulnerabilities» -Geopolitical and investment deterrence risks due to a tense relationship with Russia» Banking Sector Risk» Average Baseline Credit Assessment (BCA) ba3» Total Domestic Bank Assets/GDP 54.9» Banking System Loan-to-Deposit Ratio 106.2
Kazakhstan» Kazakhstan Credit Strengths» -High GDP growth» -Very Low public debt and debt servicing costs» -Significant buffer against external shocks due to the National oil Fund» -Abundant oil and gas resources» Credit Challenges» -Weak institutions, issues regarding rule of law and corruption» -High susceptibility to oil price developments» -Uncertainty over presidential succession» Banking Sector Risk» Average Baseline Credit Assessment (BCA) (2013) b3» Total Domestic Bank Assets/GDP (2012) 45.4» Banking System Loan-to-Deposit Ratio (2012) 136.6
Moldova» Credit Strengths» -Low level of public debt and debt-servicing costs» -IMF technical support to improve institutional and fiscal frameworks» Credit Challenges» -An unpredictable political environment» -Narrow economic and foreign-exchange earnings base» -Low per capita income and high (albeit diminishing) level of poverty» Banking Sector Risk» Average Baseline Credit Assessment (BCA) N.A.» Total Domestic Bank Assets/GDP 58.1» Banking System Loan-to-Deposit Ratio 91.4
Russia» Credit Strengths» -Strong government balance sheet, with low debt and sizable assets» -Relatively Low external vulnerability thanks to foreign-exchange reserve cushion» Credit Challenges -Economic, fiscal and external account volatility related to commodity price swings» -Impaired institutions which impede economic diversification» -A capital-intensive economy with large investment requirements» Banking Sector Risk» Average Baseline Credit Assessment (BCA) ba3» Total Domestic Bank Assets/GDP (2012) 77.3» Banking System Loan-to-Deposit Ratio (2012) 119.2
Ukraine» Credit Strengths» -Size of The economy» -Moderate level of government debt» Credit Challenges» -Very high external liquidity risks» -High political risks» -Fiscal pressures and contingent liabilities» -Very Low institutional quality» Banking Sector Risk» Average Baseline Credit Assessment (BCA) (2012) caa1» Total Domestic Bank Assets/GDP (2012) 79.4» Banking System Loan-to-Deposit Ratio (2012) 138.0
Dealing with commodity depedency» Different measures of commodity dependency are strongly correlated. For example, commodity exports as a share of total exports and the share of total fiscal revenue derived from commodity-related revenues are very similar» The share of commodity exports in total exports indicates the degree of export diversification, and by extension, vulnerability to an external demand shock» By those measures, ENCA commodity exporters are roughly average commodity-dependent Sovereigns: 1. Average ENCA export dependency: 28% (all fuel: 27%) 2. Average ENCA rent dependency: 36% (all fuel: 34%) 3. Average ENCA revenue dependency: 35% (all fuel: 52%)
Commodity Revenues vs. Net Exports Fuel exporters Source: World Bank and United Nations Comtrade Database Grants and Other Ravenue (%) 120 100 80 60 40 20 0 Egypt Colombia Canada Bahrain Russia Kuwait Venezuela Kazakhstan Nigeria Rep. of Congo Norway Azerbaijan Algeria Oman Qatar 0 10 20 30 40 50 Net Fuel Export as a share of GDP (%) Rents as a share of GDP vs. Net Exports Fuel exporters Source: World Bank and United Nations Comtrade Database Fuel Rent as a share of GDP (%) 70 60 50 40 30 20 10 0 Egypt Bahrain Russia Colombia Canada Kuwait Iraq Rep. of Congo Gabon Kazakhstan Nigeria Venezuela Norway UAE Saudi Arabia Azerbaijan Algeria Oman Qatar 0 10 20 30 40 50 Net Fuel Export as a share of GDP (%) Source: IMF and World Bank
Mounting fiscal pressure» According to the IMF, fiscal break-even oil prices i.e., the oil prices that would balance the budget of a country- are set to rise between 2012 and their expected 2014 values for many oil exporting countries» In some ENCA countries, the fiscal break-even price of oil is already higher than the current price (notably in Russia) or close to it (in Azerbaijan).» With prices expected to decline further, the gap between market prices and the fiscal break-even prices would narrow further for oil exporters, what could imply potential fiscal pressures for those Sovereigns
140 Fiscal break even prices: up, up and away 120 100 80 60 40 20 0 2008 2009 2010 2011 2012 2013 2014e Saudi Arabia Azerbaijan Kazakhstan Russia Oil Price Source: IMF, Gurvich 2013
Shocking oil prices...» One can use a model-based framework to assess the sensitivity of commoditydependent countries to oil price shocks.» This has the advantage of taking into consideration second round effects, which can be significant: for example, lower oil prices are positive for the global economy and for global oil demand, which cushions the negative effects from the fall in oil prices for some oil exporting countries (say, lower cost producers with spare capacity, like Saudi Arabia)» To illustrate that, we simulate a fall of the Brent spot price to USD 90 by the end of 2018 (around 13% or USD 13.5p/b lower over the forecast period than our current benchmark)» Such a fall in oil prices is modeled as resulting from a combination of a positive supply shock namely, an increase in the US oil production as forecast by the US s Energy Information Administration or EIA- and a negative demand shock more precisely, a fall in emerging markets growth, here proxied by a Chinese growth rate of 5% p.a.)
Oil prices: a (somewhat) gentle decline... Moody's Baseline for World Oil Price [Imputed] China 5% Growth with U.S. Supply Shock 120 110 100 90 80 70 60 50 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Moody s
How vulnerable commodity-dependent ENCA countries could be? Russia as a benchmark» Vulnerable, but not as much as one could expect, at least GDP-wise. Fiscal and external performance are the hardest hit 1. Real GDP: Russia experience real GDP below the benchmark at the end of the forecast by about 0.3% (growth, therefore, would fall from 3.5% to 3.2%: this compares with 1.5% in 2013) 2. Current account: Russia 2018 estimated current account balance worsens from a 0.2% surplus to a 2% points of GDP deficit (compared with almost a 2.9% surplus in 2013), even if the floating exchange rate reduces the deterioration 3. Government balance: The deterioration of government balance in Russia, where around a third its government revenues comes from the energy sector, implies that its estimated budget deficit worsens from 1.5% of GDP to 2.4% of GDP (as a reference, the country had a 0.7% deficit in 2013). However, the floating exchange rate and Russia s fiscal rules cushion part of the worsening
Cushioning the shocks: fiscal frameworks (I)» Buffers and policy tools can be used to cushion the effects of shocks in the more vulnerable fiscal arena» Of course, the starting position is also important: namely, CIS countries would face any shock with limited amounts of public debt and either fiscal surpluses or low fiscal deficits» But again, fiscal frameworks can be effective cushioning tools. These include fiscal rules that reduce discretion in fiscal decisions by governments and institutions like Sovereign Wealth Funds (SWFs)» The ENCA region s Sovereign Wealth Funds (in Azerbaijan, Kazakhstan and Russia) have accumulated resources estimated at around USD 390 billion, or around 17% of their combined GDP, while the region s average public debt stand at around 28% of GDP (and below 14% for the three countries above), and the average budget has a relatively low deficit, at -1.4% of GDP for the region as whole (and at 0.3% for Azerbaijan, Kazakhstan and Russia)
SWFs in ENCA Country Name Assets in USD bil. Year of Creation Russia National Welfare Fund 88 2008 Russia Reserve Fund 86.4 2008 Russia Russian Direct Investment Fund 13 2011 Kazakhstan Samruk-Kazyna JSC 77.5 2008 Kazakhstan Kazakhstan National Fund 68.9 2000 Kazakhstan National Investment Corporation 20 2012 Azerbaijan State Oil Fund 34.1 1999 Turkmenistan Turkmenistan Stabilization Fund n/a 2008 TOTAL 387.9 Source: Sovereign Wealth Fund Institute
Cushioning the shocks: fiscal frameworks (II)» To refine our earlier analysis, we also use a regression framework to asses if policy tools (namely, exchange rate regimes, hard currency reserves and fiscal frameworks i.e., fiscal rules and SWFs) affect the impact of commodity price shocks in variables like debt stock and fiscal balances» The existence of Fiscal frameworks leads to a decrease in the level of government expenditure in ENCA countries» Fiscal frameworks are comparatively more effective in ENCA countries than in Latin America, but less than in GCC countries» This may simply be due to the relatively much larger size of the SWFs fiscal buffers in GCC countries around 100% of their GDP than in either the ENCA or Latin America» Additionally, a flexible exchange rate also has positive cushioning effects in the ENCA
A coda on economic diversification» Economic diversification is frequently touted a solution to the presumed problem of commodity dependency» However, commodity concentration, as far as it reflects relative levels of endowments, should be seen as an optimal economic outcome: Kazakhstan is richly endowed with minerals, oil and gas but has a small population, so it should produce and export oil and gas rich and labor poor goods and services, while India, a commodity poor but labor rich country, should specialize in products which are labor intensive and commodity poor» This is the underlying reason of why diversification efforts towards sectors on which commodity-dependent countries have no comparative advantage frequently do not succeed (but usually do so at great public expense)» This is also the reason why policies designed to manage the effects of commodity dependency, including the use of their rents (the previously mentioned fiscal rules, but also competition and deregulation policies) are usually more effective than diversification ones
Thanks for your attention!
Lúcio Vinhas de Souza Managing Director-Sovereign Chief Economist 1.212.553.1117 tel 1.212.298.6458 fax Lucio.VinhasdeSouza@moodys.com
2009 Moody s Investors Service, Inc. and/or its licensors and affiliates (collectively, MOODY S ). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided AS IS without warranty of any kind. Under no circumstances shall MOODY S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. Moody s Investors Service, Inc. ( MIS ), a wholly-owned credit rating agency subsidiary of Moody s Corporation ( MCO ), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy. 28