"While Kazakhstan’s crisis-hit banking system remains a source of risk, Fitch’s base case is that the further costs for the sovereign of clearing it up will be containable at the current rating level. Higher oil prices and capital inflows are boosting official reserves, strengthening the sovereign’s balance sheet and further supporting the Stable Outlook," said Andrew Colquhoun, Director in Fitch’s Sovereigns group.

Kazakhstan’s banking system has still to exit a crisis that broke with the dislocation of global capital markets in summer 2007. The ratio of non-performing loans (NPLs, i.e. exposures more than 90 days overdue) to total loans hit 19.7% in October 2009, up from 5.2% at end-2008. The system’s aggregate capitalisation became negative in May 2009 on official figures, as problems at two large failed banks (BTA and Alliance, both ’Restricted Default’) were recognised. However, excluding the failed banks, the NPL ratio was 12.5% at end-October, while capitalisation was positive (11%).

It is too early to say with confidence that the asset quality of Kazakhstan’s banks has stabilised, but Fitch notes that the banks still have significant loss-absorption capacity, although there are concerns over the quality of both loan exposures and capital at some weaker institutions. Deposits have held steady despite the shocks of 2009. After injecting USD4bn in new capital in 2009 (4% of 2009 GDP), Fitch’s base case is that further sovereign capital support for the system is unlikely to exceed low single digits of GDP. Given Kazakhstan’s strong general government balance sheet, this would be within the tolerance of the current ratings level.

An improvement in the balance of payments is supporting the Kazakhstani tenge (KZT) at its re-pegged level of about 150 to the USD, after February’s 25% devaluation, which reduces risks facing the banking sector, where some 51% of loans are FX-denominated. Kazakhstan’s official reserves rose to a record USD23.3bn by end-November, up 17% in the year to date. Counting assets in the National Fund (oil savings), reserves were USD47.5bn, some 44% of GDP. Higher oil prices are bolstering Kazakhstan’s current account; an increase of USD10 in the oil price adds about USD3.7bn to annual exports.

Borrowing by state-owned enterprises (SOEs) and FDI inflows have been strong in 2009 and should be supported in 2010 by large investments expected from China. Fitch’s projections incorporate a USD1bn sovereign eurobond issue in 2010. Kazakhstan’s high gross external debt/GDP ratio of 100% (end-2009 projected) compares unfavourably with the ’BBB’ median of 46%. The ongoing restructuring of the external debt of failed banks could subtract 10% of GDP from the ratio, although Fitch awaits conclusion of the negotiations (expected by 23 March 2010) before adjusting its numbers.

The sovereign balance sheet remains strong. Fitch forecasts general government debt at 13% of GDP at end-2009 and the general government is projected to remain a net creditor to end-2011. However, spending hikes and tax cuts on the non-oil economy have increased dependence on oil receipts, which could start to weigh on the ratings in the longer term.

Continued evidence of stabilisation in the banking system and recovery in the broader economy, combined with consolidation of the external finances, would support the ratings. Conversely, a worse-than-expected outturn in the banking system, particularly if combined with erosion in domestic depositor confidence or renewed downwards pressure on the KZT and reserves, could resume downwards pressure on the ratings.