OREANDA-NEWS. Fitch Ratings has affirmed Belarus's Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at 'B-' with a Stable Outlook. The Short-Term Foreign-Currency and Local-Currency IDRs are affirmed at 'B' and the Country Ceiling at 'B-'.

KEY RATING DRIVERS

Belarus's ratings balance high external vulnerabilities and a track record of frequent crises with solid public finances and structural indicators; notably, GDP per capita and human development well above peers.

External liquidity is a key credit weakness. Belarus's gross external financing requirement as a percentage of FX reserves is 182%, among the highest of Fitch-rated emerging market sovereigns, reflecting international reserves of just 1.6 months of current external payments. Net international reserves of the central bank are negative. Ad hoc support, generally from Russia, has enabled Belarus to maintain a clean external debt service record. Net external debt, at 50% of GDP, is well above the peer median of 20%.

Financing the current account deficit (forecast at 3.4% of GDP in 2016) and sovereign foreign currency debt servicing obligations of USD3.2bn will partly rely on external support. The government secured a USD2bn loan from the Eurasian Development Bank earlier in 2016 and has received the first two tranches. The next Eurobond is due to mature in January 2018; the government expects to pre-finance this in 2017. Political commitment to securing an IMF programme is uncertain.

Belarus's economy has experienced frequent crises stemming from loose fiscal and monetary policy. Tighter fiscal and monetary policy and the move to a flexible exchange rate from 2015 has allowed a degree of economic and financial stability in the face of the external shock in 2015 that has aggravated structural weaknesses. Reforms to utility prices and pensions have been implemented and directed lending cut in 2016, and conditions attached to a loan from the Eurasian Development Bank set out a road map for further reform. Belarus remains one of the least transformed CIS economies and state-owned enterprises have an outsized role.

Macroeconomic performance is much weaker than peers. Fitch estimates average real GDP growth over the five years to 2016 at -0.1%, with the economy contracting 2.5% year-on-year in 1H16. Fitch expects a return to modest growth in 2017, driven by an improving external environment, but domestic demand will remain weak. Potential growth is estimated by the IMF at less than 2%, which in part reflects adverse demographic trends. Inflation has averaged above 20% over the past decade, but has stabilised around 12% so far in 2016 due to tighter policy and weak demand. The effectiveness of monetary and exchange rate policy is constrained by high levels of dollarisation.

Policy measures have improved the performance of public finances, but they continue to be distorted by quasi-fiscal activities, including directed and off-balance sheet lending. The consolidated budget, which includes the republican budget (central and local government) in addition to the Social Protection Fund, has recorded modest surpluses since 2010 (1.5% of GDP in 2015). Tighter policy (including public sector pay restraint, higher excise duties and the elimination of some VAT exemptions) raised the surplus to 2.9% of GDP in 1H16. Fitch assumes a modest reduction in the surplus for 2017 as the government slightly eases restraint on spending.

The public debt ratio is in line with the 'B' median, but has risen rapidly to 48.5% of GDP in 2015, largely owing to currency depreciation (67% of debt is in foreign currency), from 22.2% in 2009. Fitch includes government guarantees, totalling 9.3% of GDP, in its total debt calculations, due to the high likelihood that the state will need to meet state-owned enterprises' repayment obligations. Potential banking sector support costs could add to the government debt burden.

Fitch assesses the banking sector as fundamentally weak. Non-performing loans jumped to 13.4% of total lending at end-June 2016, from 6.8% at end-2015, due to recession and exchange rate devaluation. Banks' large exposure to the public sector, around 50% of assets, results in significant correlation with the sovereign credit profile. High corporate leverage and lending in foreign currencies heighten credit risks. An asset quality review is close to completion and a strategy to clean the balance sheets of the state banks is being developed.

Structural indicators are neutral for the credit profile. GDP per capita is nearly 50% greater than the peer median, while the Human Development Index is more than double the peer median. Doing Business indicators are well above the peer median. However, Belarus scores below 'B' peers on the composite World Bank governance indicator, reflecting weak voice and accountability as well as rule of law scores.

Political power is concentrated in the hands of President Lukashenko who has been in power since 1994. The opposition is weak, and Fitch assumes that Lukashenko will remain in power over the medium term, with parties close to the president securing a comfortable victory in the legislative elections scheduled for September. Belarus has close ties with Russia, although the relationship can at times be strained.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns a score equivalent to a rating of 'B+' on the Long-Term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LTFC IDR by applying its QO, relative to rated peers, as follows:

- Macro: -1 notch, to reflect a history of poor economic policy management leading to frequent crises and weak potential growth relative to peers

- External finances: -1 notch, to reflect a very high gross external financing requirement, negative net international reserves and reliance on often ad hoc external financial support to meet external debt obligations.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LTFC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to negative rating action are:

- Materialisation of severe external financing stresses, leading to macroeconomic and financial instability and increased risk of failure to meet foreign currency debt repayment obligations.

- Deterioration in public finances resulting in a significant rise in government debt.

The main factors that could, individually or collectively, lead to positive rating action are:

- A reduction in external financing pressures, supported by a recovery in international reserves.

- An improvement in Belarus's medium-term growth potential, stemming from implementation of structural reform agenda.

KEY ASSUMPTIONS

Fitch's assumes that Belarus will continue to benefit from ad hoc financial support from Russia.