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Euromoney Country Risk

Azerbaijan stands out in a region still succumbing to increased risk

The sovereign has become comparatively safer in Euromoney’s country risk survey as its CIS neighbours find it hard to escape the blow-back from Russia’s meltdown and currency devaluations prompted by the new oil metrics.

Azerbaijan election-R-600

Azerbaijan’s political risks are supported by the absence of elections until 2018

Azerbaijan is one of the former Soviet Union’s more southerly outposts and is managing to defy the rising risk trend across the region this year, gaining two points and climbing five places in the global rankings to 73rd out of 186 countries surveyed.

The improvement has seen the sovereign become safer than Russia and move within two places of Kazakhstan, the safest country in the region, within the fourth of ECR’s five risk groups.

Azerbaijan’s strengths are relative – the Commonwealth of Independent States (CIS) region offers extreme, or merely high risks at best, to emerging and frontier market investors – but its resilience is still remarkable considering the plunging risk scores for Russia and Ukraine, amid falling oil prices weighing on the region’s currencies.

This should be also imparting a heavy blow on Azerbaijan in the light of it being another large oil producer. Oil and gas accounts for 95% of the nation’s exports earnings, and around 70% of budget revenue.

Diminishing real incomes and cutbacks in public spending mean economic risk scores have been, in fact, downgraded this year, notably so for currency stability after a devaluation of the manat in February.

The currency adjustment is pushing inflation higher, though not excessively so, having risen slightly above 3% year-on-year in April.

Yet Azerbaijan has some redeeming features. Its banking system is rated slightly stronger than Kazakhstan’s, as are one or two political indicators, while more favourable debt and capital-access scores also make it a stronger credit.

GDP growth, too, was quite high in the first quarter of 2015, increasing by 5.3% year-on-year compared with 2.8% average growth in 2014.

The European Bank for Reconstruction and Development (EBRD), in its latest (May 2015) Regional Economic Prospects update, states this was exaggerated by a low base, but also believes it was due to increased capital spending on large infrastructure projects.

The EBRD also notes the devaluation, while negatively affecting domestic demand and the banks, has – by raising dollar value – helped to “buttress the fiscal revenue impact of declining oil revenues and competitiveness”.

The IMF predicts real GDP growth will flatten out at 0.6% this year, before rebounding to 2.5% in 2016. The EBRD predicts 1.6% growth this year, which is not as drastic as other countries in the region.

Armenia, Belarus, Moldova, Russia and Ukraine are expected to contract, according to the EBRD and IMF, with Russia still declining in 2016.

Unlike Kazakhstan and other countries in the region, Azerbaijan’s political risks are supported by the absence of elections until 2018. This boosts factor scores for the regulatory and policy environment (given continuity), and government stability in spite of the continuing autocratic rule of president Ilham Aliyev.

Lilit Gevorgyan, senior economist and country risk analyst with IHS Global Insight, believes the pace of economic expansion will slow down soon, while noting the European Games to be held in Baku in June and other related infrastructure projects have provided a lift.

There are substantial risks associated with “corruption, nepotism and policy unpredictability”, she says, underlining why Azerbaijan, like every other country in the CIS region, scores less than half the 100 risk points allocated in ECR’s survey.

However, she adds: “Azerbaijan’s economic troubles are unlikely to turn into a serious political movement that could in any way threaten the tight grip of the president.”

A region in decline

Investor risks for virtually all of the former Soviet CIS countries have increased since the negative oil shock began midway through last year.

Russia (74th out of 186 countries in the ECR survey), Ukraine (147th) and Belarus (154th) have seen double-digit score declines over the past five years.

All three countries have been further downgraded since 2014 as the crisis in eastern Ukraine continues to create financing problems for Kiev, Russia is mired in a deep recession, and Belarus feels the downdraft from its close economic relations and acute fiscal vulnerabilities.

Other countries have similarly struggled to convince the risk experts of their merits, with all of the highest risk, tier-five sovereigns – Moldova, Uzbekistan, Turkmenistan, Kyrgyzstan and Tajikistan – marked down these past five years, with many continuing their descent in 2015… and not one of them improving.

Armenia, perhaps, is one of the more exposed to the Russian crisis. Its exports have seen a serious contraction since the start of 2015, not least because Armenia’s rapid accession to the Eurasian Economic Union (EEU) delivered an unexpected negative impact on its trade flows to Russia and other CIS countries.

The free-trade zone comprises Armenia, Belarus, Kazakhstan and Russia, and surprisingly might also rake in Egypt by the end of 2016, current speculation suggests.

“The new regulations have proven to be confusing and at times discouraging to continue established trading partnerships,” says Gevorgyan.

Low gas prices were one of the key arguments for closer relations with Russia, but the decision by Armenia’s Russian-owned national power distribution company Electric Networks of Armenia to increase the tariffs by 40%, the third increase since 2013, questions the decision.

Trade generally in the region has been floundering.

Iikka Korhonen and his team at the Bank of Finland Institute for Economies in Transition note the links between Russia and other CIS countries.

“Trade with Ukraine fell by nearly 60% year-on-year during Q1 2015,” he says, noting: “A year ago Ukraine was still Russia’s biggest CIS trading partner.

“Russian imports from Armenia fell even more than imports from Ukraine. Russian trade also fell considerably with Belarus and Kazakhstan, which are partners with Russia in the EEU.”


Anxiety in Almaty

Kazakhstan is one of the region’s largest and relatively safer investor options, a high-ranking tier-four sovereign lying 71st on ECR’s global scale.

However, its Euromoney risk score is more in line with a speculative investment grade than the triple-B credit ratings from Fitch, Moody’s and Standard & Poor’s, with the sovereign deteriorating this year alongside others in the region.

Hans Holzhacker, chief economist at ATF Bank Kazakhstan, which is part of the UniCredit Group, says: “Up to 2007, Kazakhstan’s growth was helped by oil production and cheap foreign money – a significant part of which was channelled to real estate.

“In 2009 to 2013, there were terms-of-trade gains, but these sources of growth are all gone.”

Kazakhstan’s meagre 2.2% real GDP growth in the first quarter of 2015 is an indication it must find a new growth model. Political initiatives are in the offing, but it is unclear to what extent these will transpire into something tangible.

Holzhacker also believes the reluctance of the Kazakh authorities to let the currency, the tenge, follow the rouble’s depreciation raises questions about the working of the EEU.

The question now is whether it is Azerbaijan, not Kazakhstan, which will offer CIS investors the lowest risk returns. ECR survey trends suggest it will.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.   

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