BACKGROUND: Nowadays, the credit ratings agencies are less interested in telling a debtor’s economic story than in judging its ability to service its debt. On August 19th, Moody’s Investors Service changed its credit outlook on three major Kazakh banks to “positive”, and upgraded the foreign-currency debt rating of both the national oil transport company and another large bank. It based its decision on its belief that Kazakhstan’s government has the wealth as well as the will to support the country’s most important companies in case of distress. Back in September 2002 Moody’s assigned an investment-grade rating to the long-term foreign-currency debt of the government itself, and Kazakhstan became the first country in the former Soviet Union to receive such a rating from a major international credit rating agency. This was made possible by the country’s very rapid economic growth over the last five years. A glance at some of the country’s economic statistics shows the justification for the spate of upgrades and ratings revisions: Kazakhstan’s real GDP growth averaged 10.6% per annum from 2000-2003, and is forecast at 9% for 2004. Its foreign exchange reserves, not including gold, have risen from USD 2.3bn in 2000 to a forecast USD 10.8bn in 2004. Illustrating the effect of the country’s rapid economic growth on the government’s fiscal situation, the ratio of public debt to GDP declined from 25.5% in 2000 to 15.5% in 2003. Remarkably, the groundwork for Kazakhstan’s emergence as a creditor nation was laid in 1995, when the government granted independence to the central bank after the economy went through several years of hyperinflation. The government previously had lent large sums of money to deeply indebted enterprises which used the proceeds to buy hard currency, causing inflation to soar and the value of the domestic currency to plummet. Because of the new financial regulatory structure put in place after the crisis, Kazakhstan’s economy was to some extent protected when Russia defaulted on its domestic debt in 1998, enabling positive GDP growth to resume in 1999. Central bank independence together with a strong government regulatory structure made possible rapid growth in the banking and finance sector, such that by mid 2004 per-capita private bank deposits were the highest in the former Soviet Union.

IMPLICATIONS: The global credit ratings agencies play a very significant role in the capital markets. They provide investors with a snapshot opinion of a borrower’s capacity and willingness to pay back its debt obligations. On the flip side, for borrowers themselves, credit ratings are very powerful determinants of the funding costs they face. Positive ratings can lead to more liquid credit markets by way of lowering the “risk premium” demanded by investors when dealing with scarcity of information regarding a potential borrower. At home, as a nation’s capital markets mature, the need for a viable credit ratings system becomes apparent, and good credit ratings come to be seen as essential for the stability of the corporate sector of the economy. Abroad, positive ratings act to encourage continued flows of capital from foreign investors into a growing, diversifying economy. In the case of Kazakhstan, rapid growth, driven by hydrocarbon exports, has provided much of the raw capital for reliable debt service but is not the sole reason that the capital markets have acknowledged the country’s creditworthiness. Many countries receive abundant foreign exchange from oil and gas exports yet have missed an investment-grade rating. From a ratings perspective, Kazakhstan’s hyperinflation in the early 1990s proved to be a blessing in disguise, because it compelled the government to commit to prudent management of its debt burden to increase its stock of capital, through accumulation of hard-currency reserves and foreign direct investment when needed. In addition, the authorities oversaw the creation of a robust pension funds system which, through its investments in the bonds of local Kazakh issuers, spurred the development of the country’s debt securities market. The gradual upgrades and increasingly positive assessments of Kazakhstan’s debt securities made over the last few years have attracted a wider group of players in the capital markets, so-called “crossover investors”, who look to diversify their investments but are otherwise reluctant to lend money to borrowers they know little about. Their diversification into Kazakhstan has resulted in sizeable profits for many of them. However, the improving ratings have created a perception of investment safety in Kazakhstan’s debt markets that is paradoxically at odds with the goals of other classes of investors, whose appetite for risk leads them on a search for greater yield than can be provided by investing in higher-rated debt. In Kazakhstan, the government is flush with cash and currently does not have much of a need to borrow. Moreover, local corporate businesses that choose to borrow abroad are still largely limited to the banking and hydrocarbon sectors of the economy, in spite of the government’s avowed efforts to promote business outside these sectors. So, until the economy diversifies there is little impetus, or even need, for further inflows of global capital. This paradox is overcome in a nation such as neighboring Russia, whose government is rated like Kazakhstan’s but whose corporate sector, because of its greater diversity, size and risk, offers more opportunity to capture investment yield.

CONCLUSIONS: Although it is a useful and even necessary tool for many investors, a credit rating does not purport to forecast a debtor’s economic future. Nor does it predict the direction or stability of a security’s price, should the debtor borrow by issuing securities. In the view of many investors interested in Kazakhstan, favorable credit assessments cannot obscure the fact that investment opportunities are still limited. Although it is often claimed that Kazakhstan’s market will always be too small and isolated to attract much money to the alternative sectors of its economy, there are more than enough investors who would be willing to provide at least portfolio capital, if the conditions were right. The question is whether a significant number of firms will arise outside the oil and gas sectors and become large enough to source capital in the global markets, as opposed to financing with local banks or through local equity investors. This will depend on how much the mineral wealth stimulates growth of other sectors of the economy, as well as on the degree of the government’s commitment to the diversification of business.

AUTHOR BIO: Peter G. Laurens is Senior Associate, Fixed Income Credit Analysis at FH International Financial Services, Inc.