Overview

• We expect spillovers from the recession in Russia and the complications for Kazakhstan arising from sanctions on Russia to weigh on Kazakhstan's economic growth, slow the pace of fiscal consolidation, and increase pressure on macroeconomic stability.
• We understand that recent weather-related damage to the loading terminal of the Caspian Pipeline Consortium (CPC) pipeline, which carries about 70% of Kazakhstan's total oil exports to Europe, should be repaired within three weeks to restore the pipeline to full capacity.
• We expect Kazakhstan's strong government and external balance sheets, along with elevated oil and gold prices, to help mitigate external shocks to the economy.
• We therefore affirmed our 'BBB-/A-3' foreign and local currency sovereign credit ratings on Kazakhstan and maintained the stable outlook.

Rating Action

On April 1, 2022, S&P Global Ratings affirmed its 'BBB-/A-3' long- and short-term foreign and local currency sovereign credit ratings on Kazakhstan. The outlook remains stable.

We also affirmed our 'kzAAA' national scale rating on Kazakhstan.

The transfer and convertibility assessment remains 'BBB'.

As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Kazakhstan 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 2022 EMEA Sovereign, Regional, And Local Government Rating Publication Dates," published Dec. 16, 2021, 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 was to allow us to assess the risks to Kazakhstan's external and fiscal position from the disruption of oil exports through the CPC pipeline. The next scheduled publication on the sovereign ratings on Kazakhstan will be on Sept. 2, 2022.

Outlook

The stable outlook is predicated on our understanding that the reduction in capacity at the Caspian Pipeline Consortium (CPC) pipeline is temporary. Over the next two years, we expect Kazakhstan's strong fiscal and external balance sheets to mitigate spillover on the economy from a recession in Russia.

Downside scenario

We could lower the ratings if oil exports decline for a significant and sustained period, weakening the economy's external and the government's fiscal positions.

Further destabilizing factors, such as increasing dollarization, persistent inflation, or a deterioration in domestic stability, shown via further incidents of severe civil unrest, could also lead to a downgrade.

Upside scenario

We could raise the ratings if the banking sector's health improves. This could, for example, be supported by further advances in regulatory oversight or improvements in corporate governance, strengthening our view on monetary policy effectiveness and reducing risks to the government's fiscal position.

We could also raise the ratings if we see improvements in institutional and policymaking effectiveness through, for instance:

• Significant progress on devolution of power,
• Increased transparency and accountability of institutions, and
• A strengthened business environment.

Rationale

On March 22, it was announced that a storm in the Black Sea damaged the loading terminal of the CPC pipeline, near the Russian city of Novorossiysk. We understand that up to two of the three offshore loading facilities are not operating and the third was temporarily closed for inspection. As of March 25, one facility is operating, capable of keeping the pipeline open at about 75% capacity. The Russian government (which, via state-controlled Rosimushestvo and Transneft, controls a 31% stake in the CPC) has warned that repairs on the third facility could take up to two months and that sanctions on Russia could complicate sourcing necessary supplies for the repairs. Although the Ministry of Energy of Kazakhstan has stated that the second facility will be repaired within three weeks and that all parts needed for repairs are onsite. The terminal can operate at 100% capacity with only two of the three facilities operational, the third being a backup. The other main shareholder of CPC is KazMunayGas (19%), with the balance held by various private entities including global oil majors Chevron, Mobil, Rosneft-Shell, BG, and Eni. The CPC board has yet to publish an official joint statement on the cause (weather-related or otherwise) and full extent of the damage.

Oil is the key economic sector in Kazakhstan, directly accounting for about 15% of GDP, more than 30% of general government revenue, and over half of exports. While oil prices remain high and well above the average $85 per barrel for 2022 that is the basis for our current projections, a 25% reduction in the volume of oil exported will weigh on economic activity, external performance, and fiscal metrics (see "S&P Global Ratings Raises Near-Term Oil And Gas Price Assumptions Following Russian Invasion Of Ukraine," published Feb. 28, 2022, on RatingsDirect). However, we do not expect this situation to last more than one month.

The CPC pipeline is Kazakhstan's main oil artery, connecting the Tengiz, Kashagan, and Karachaganak oil fields (together accounting for about 70% of total oil production) to the Black Sea. From there, oil is loaded onto tankers and delivered to customers in Europe, Kazakhstan's largest export market. The largest buyers are in France, Greece, Italy, and the Netherlands. The CPC pipeline has capacity of 67 million tons (m/t) per year, of which Kazakhstan uses 53.7 m/t--equivalent to about 1 million barrels of oil per day. In 2020, Kazakhstan exported 51.8 m/t through the CPC pipeline, 73% of total oil and gas condensate exports and approximately 35% of total goods and services exports.

While the loss of capacity for three weeks until the second facility is fixed should be manageable, the shutdown highlights the risks to Kazakhstan given its dependence on a single pipeline, particularly because of the high geopolitical risks in the region. A large part of the pipeline goes through Russia and terminates at a loading facility off the Russia coast close to the Crimea region. If the pipeline is closed for an extended period, we think Kazakhstan can redirect some oil exports, but it will be logistically difficult and more costly. There are two other major pipelines. The Atyrau-Samara pipeline, with capacity of 17.5 m/t per year, also goes through Russia, making it a less-desirable route because of the economic sanctions on Russia. The Atasu-Alashankou pipeline, with a capacity of 20 m/t per year, connects Kazakhstan to China, and could be the best option for redirecting exports, although it cannot replace the capacity of the CPC pipeline on its own. Kazakhstan could also transport oil across or around the Caspian Sea to Baku, Azerbaijan, but that is a logistically difficult route. The shallowness of the Caspian Sea limits the size of oil tankers.

Uncertainty about the extent of the damage to the pipeline and the reasons for it remain. However, our assumptions are based on the up-to-date information the Kazakhstani authorities provided to us. We have updated our forecasts to reflect the short partial reduction of capacity at the CPC pipeline and ongoing macroeconomic effects on Kazakhstan of Russia's military action in Ukraine, as seen in the sharp 18% depreciation of the Kazakhstan tenge (KZT) against the dollar since late February, although the value has since strengthened from its low point. The tenge and ruble were closely correlated because of the similar economic structures and close trade ties between the two countries. However, the sanctions on Russia have distorted the link between the two currencies.

We expect real GDP growth of 2% in Kazakhstan this year--down from our previous expectation of 3.6%, as exports decline and economic activity slows, weighed down by the estimated 6.2% contraction in Russia, one of Kazakhstan's key non-oil trading partners. Even with a full reopening of the CPC pipeline, the secondary hit from sanctions imposed on Russia could make it more difficult for Kazakhstan to trade with or export its oil through Russia, as seen, for instance, in increased risk premiums for tankers operating in the Black Sea. However, the U.S. government explicitly excluded Kazakh-origin crude oil from the CPC pipeline from its sanctions related to the prohibition of dealing in oil of Russian origin.

Kazakhstan's external asset position is substantial and gross external financing needs are relatively low. We expect a modest current account deficit in 2022 of 2.2% of GDP, down from 3% in 2021, as the tenge's devaluation will likely reduce demand for imports, somewhat offsetting the decline in export revenues. A slight reduction in the volume of oil exports and the discount relative to Brent prices because of higher risk premiums for shipping in the Black Sea will prevent the economy from taking full advantage of the currently high oil prices. A modest reduction in export receipts and use of reserves to support the value of the tenge will weaken the external position, but we think the gross external financing needs of the economy will remain below 100% of current account receipts and usable reserves.

Reserve assets at the National Bank of Kazakhstan (NBK) were $33.5 billion as of Feb. 28, down from $34.4 billion at the end of 2021. We expect reserves will further decline over the year as they are used to smooth volatility in the KZT market. About 70% of Kazakhstan's reserves are gold. We have revised our assumption for the price of gold to $1,800 per ounce in 2022 (from $1,600) and $1,600 in 2023 (from $1,400), supporting our measure of usable reserves (see "Metal Price Assumptions: Shortages Worsen And Prices Spike As Conflict Roils Metals Trading," published March 17, 2022).

The government's fiscal position will be somewhat more constrained in 2022. We expect revenue to contract compared with 2021 as weaker economic activity affects tax receipts. On the expenditure side, pressure will build for the government to support the economy and the incomes of the population, due to decline in real wages stemming from higher inflation, slowing the post-COVID-19 fiscal consolidation. We could see increased drawdowns from the National Fund of the Republic of Kazakhstan (NFRK) compared with previous expectations. We expect the higher deficit and large currency depreciation to lead to a jump in debt to almost 33% of GDP, but the government should remain in a net asset position of about 2% of GDP.

At 8.7% in February, inflation remains above the NBK's target of 4%-6%. The KZT weakening makes imported goods relatively more expensive, raising inflation pressures and expectations. Instability in the KZT also raises risks of increased dollarization of the economy, which could further inhibit monetary policy transmission. In Kazakhstan, dollarization of deposits ended 2021 at 36%, down from a peak of 70% at year-end 2015.

The NBK moved quickly to maintain stability of the tenge by increasing its base rate by 325 basis points (bps), to 13.5% on Feb. 24. This occurred only a few weeks after the NBK raised the base rate 50 bps to 10.25% (after three tightening rounds of 25 bps each in the second-half 2021) to combat inflation. Although further tightening is possible, the NBK will have to weigh the risks to economic growth. To maintain the attractiveness of tenge deposits, the government and the NBK announced a tenge deposit protection scheme, funded by the budget, that will provide compensation of 10% on some tenge deposit accounts in second-tier banks if depositors refrain from withdrawing their deposits for at least a year. The scheme should help to keep dollar deposit rates stable, but it seems unlikely we will see a decline in dollarization this year, as we have in the past few years.

Russia is Kazakhstan's largest trading partner and a key destination for non-oil exports. Of total trade turnover for the first nine months of 2021, 24% was with Russia, with 12% of Kazakhstan's goods and services exports to Russia and 41% of imports from Russia. Kazakhstan mostly exports iron ore and uranium to Russia while importing cars, semi-finished goods, coal, and refined petroleum. Unlike other Central Asian sovereigns, remittances from Russia are not an important source of income for the country, at about 0.3% of GDP in 2021. Kazakhstan, along with Armenia, Belarus, and Kyrgyzstan, and Russia are members of the Eurasian Economic Union, a customs union that provides tariff-free trade and uniform custom tariffs for trade with non-member states. The Eurasian Economic Union ensures the free movement of goods, services, labor, and capital between the states, and Kazakhstan expects an influx of high-skilled Russian emigres since the conflict's onset. On March 18, it was announced that the customs union would use rubles for reimbursement of customs fees with Russia and Belarus.

Russia is also a key source of investment, accounting directly for about 5% of Kazakhstan's total external liabilities, although this figure could be larger since investment in Kazakhstan's oil and gas and mining sectors is often recorded through the Netherlands and U.K.

Although Kazakhstan is a member of the Collective Security Treaty Organization (CSTO), a mutual defense organization with members from ex-Soviet states, we view it as unlikely that it will be directly involved in Russia's military intervention against Ukraine. We understand the government has not recognized the breakaway Luhansk People's Republic and the Donetsk People's Republic and abstained on the UN vote to condemn the invasion of Ukraine, affirming its policy of neutrality, similar to when Russia annexed Crimea.

In response to severe protests and civil unrest in January, the government requested assistance from the CSTO and peacekeeping troops, mostly from Russia, arrived quickly to restore order. Should domestic instability flare up, for example, in response to higher inflation or weaker economic conditions, it is unclear whether Russia has the resources to support Kazakhstan as it did in January.

The direct negative impact from sanctions imposed on Russian banks is limited for Kazakhstan's financial sector, in our view. Domestic subsidiaries of Russia-based sanctioned banks (Sberbank, VTB, and Alfa Bank) contribute about 15% of Kazakh's banking sector assets. Despite some liquidity strain and operational disruption caused by sanctions, we understand that these subsidiaries continue to operate, and local financial authorities are committed to curbing any potential broader negative impact for the sector.

Key Statistics

Table 1

Ratings Score Snapshot

Table 2

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Methodology For National And Regional Scale Credit Ratings, June 25, 2018
• Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

• Sovereign Ratings Score Snapshot, March 8, 2022
• Sovereign Ratings List, March 3, 2022
• Sovereign Ratings History, March 3, 2022
• Global Sovereign Rating Trends 2022: Despite Stabilization, The Pandemic Threatens The Recovery, Jan. 27, 2022
• Sovereign Risk Indicators, Dec. 13, 2022; a free interactive version is available at http://www.spratings.com/sri
• Banking Industry Country Risk Assessment: Kazakhstan, Dec. 2, 2021
• Default, Transition, and Recovery: 2020 Annual Sovereign Default And Rating Transition Study, April 12, 2021

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

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