The low oil price caused ratings agencies to significantly lower their assessment of sovereign lenders in the Gulf. Mathias Angonin of Moody’s explains why his agency downgraded three sovereigns in 2016.
Our outlook for sovereign creditworthiness in 2017 among the countries of the Gulf Cooperation Council (GCC) is negative overall, reflecting our expectation for the fundamental credit conditions that will drive sovereign credit over the next 12-18 months.
Although stabilising oil prices and policy responses to date may assist in containing a further erosion in sovereign creditworthiness, GCC countries will continue to face headwinds from subdued economic growth, increasing fiscal and structural reform fatigue and persistent oil price volatility. We expect that all GCC governments will record fiscal deficits (three will record twin deficits) in 2017, which means public debt levels will continue to rise, albeit at a slower pace than in 2016.
The credit pressures exerted by the oil price shock in 2016 prompted us to downgrade three of the eight rated GCC sovereigns by an average of two notches. Five of the Moody’s-rated GCC sovereigns now carry a negative outlook, reflecting our view that credit pressures will persist in 2017.
GOING DOWN
We downgraded Oman (Baa1 stable) by a total of three notches during 2016, reflecting the highly negative impact of the structural shift to lower oil prices on the country’s government finances, balance-of-payments position, and economic performance.
We downgraded Bahrain (Ba2 negative) by two notches based on our expectation of a further significant deterioration in the government’s debt burden and debt affordability over the coming two to three years. We also assigned a negative outlook to reflect heightened government liquidity and external liquidity risks.
We downgraded Saudi Arabia (A1 stable) by one notch, reflecting our view that a combination of lower growth, higher debt levels and smaller domestic and external buffers leave the Kingdom less well positioned to weather future shocks.
STABLE?
We confirmed the ratings of the United Arab Emirates (UAE; Aa2 negative), Abu Dhabi (Aa2 negative), Kuwait (Aa2 negative) and Qatar (Aa2 negative), but changed the outlooks on their respective ratings to negative from stable. The rating confirmation reflected our view of economic and fiscal resilience in a period of lower oil prices based on sizeable reserve buffers, while the negative rating outlooks signal a risk of deterioration and/or institutional challenges to effectively implement government response measures.
Despite oil prices stabilising at higher levels, we expect that economic, fiscal and external challenges will persist over the coming 12-18 months. We expect that real GDP and energy-related government revenue will remain weak by historical standards. Combined with increasing social pressures, this is likely to keep fiscal deficits elevated in some countries and lead to further rises in government debt, albeit at a slower pace than in 2016. Key to the sovereign credit trajectory in the coming two years will be the scope and effectiveness of policy responses. External liquidity pressures might also resurface in 2017 in some countries, but we expect exchange rate arrangements to stay intact.
ON GROWTH
GDP growth will remain weak given the hydrocarbon environment. We expect real GDP growth of 1.6% on average in 2017-18, ranging from 0.7% for Saudi Arabia to 3.3% for Qatar. Slowing hydrocarbon output and lower-for-longer oil prices will offset a marginal pick-up in non-hydrocarbon growth, whilst tightening liquidity and the second-round effects of fiscal consolidation pose downside risks to our forecasts.
Following production increases over 2015-16, hydrocarbon activity will stabilise at best and slow in some cases in 2017, driven by the November Opec agreement to cut crude oil production by 4.6% for the first half of 2017. The largest absolute reduction will be felt in Saudi Arabia. Oman has signalled its willingness to participate in the Opec agreement, but the start of gas production in the Khazzan-Makarem field in late 2017 will support hydrocarbon growth. Bahrain has little capacity to increase output and we expect no growth in oil and gas production there. In Qatar, the Barzan project is expected to come on stream in 2017, while in Abu Dhabi natural gas projects have been delayed.
Reductions in governments’ capital expenditure in 2014-16 will affect small and medium-sized companies, whilst the relative appreciation of the dollar-pegged currencies will hamper foreign investment and tourism activity. But high-frequency indicators point to a stabilisation in non-oil trade. Qatar will record the highest level of non-oil growth, reflecting continued investment in infrastructure, followed by the UAE, where Abu Dhabi’s fiscal consolidation is offset by Dubai’s project spending.
Inflation will remain at historically low levels, despite increases in direct and indirect taxation. Non-housing inflation in the GCC came down to just 1.2% in October 2016, from 2.0% in June, and is back to levels seen at the end of 2015. Low inflation reflects a decrease in asset and goods prices related to the real appreciation in GCC currencies, whilst early 2016 inflation spikes and the subsequent cooling-off reflect the impact of energy subsidy reforms. Inflationary pressures in 2017 will mostly come from increased excise duties on tobacco products and sugary drinks, as well as potential upward moves in retail fuel prices, in line with rising crude oil prices. The planned introduction of a GCC-wide value-added tax from 2018 onwards will pose a one-off source of inflation in early 2018.
Downside risks include tightened liquidity and uncertainty regarding the impact of fiscal measures. Some GCC countries have fared better than others in alleviating liquidity pressures by attracting external funding. However, governments’ increased reliance on domestic debt and asset quality issues at domestic banks could limit the availability of credit to the private sector. Growth in 2018 will also depend on the impact of the second tranche of fiscal consolidation measures, which will mostly focus on revenue in the form of value-added taxes, as well as potential excise and corporate income taxes.
WATCH THE DEBT
The region’s debt levels will continue to rise in 2017 to fund fiscal and current account deficits and will reflect a mix of domestic and international debt issuance. The largest debt increases will be recorded in Saudi Arabia and Bahrain. Although buffers in sovereign wealth funds and foreign exchange reserves will continue to weaken, they offset any credit pressures arising from rising debt levels for most GCC sovereigns – with Bahrain being the exception.
Large fiscal and current account deficits increased debt levels substantially in 2016. Generally, conventional issuance was preferred to sukuk issuance because the issuances were primarily destined for non-GCC investors. GCC-wide international debt issuance reached $49.6 billion in 2016, dominated by Saudi Arabia and Qatar, which has helped to partly relieve domestic liquidity squeezes.
The 2017 funding mix will consist of domestic and international debt issuance as well as government reserves. Debt volumes will be lower in 2017 and 2018 compared to 2016, helped by a reduction in fiscal deficits across all GCC countries. According to our estimates, the debt-to-GDP ratio across the GCC will rise to 31.6% by 2018 from just 10.5% in 2014, adding another $154 billion in government debt in 2017 and 2018.
Mathias Angonin is an analyst at Moody’s
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