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Kuwait stable outlook reflects strong fiscal position – GCC sovereigns continue to face fiscal financing needs, expected to exceed $100 bln in 2016

Overall sovereign creditworthiness in the Middle East and North Africa (MENA) region has continued to deteriorate since we published “Middle East And North Africa Sovereign Rating Trends 2016,” on Jan 18, 2016.

Overview

n Since January, we have lowered the ratings on Saudi Arabia, Oman, and Bahrain, based mainly on the fiscal and external effects of lower oil prices.

n Eight of the 13 MENA sovereigns we rate are investment grade. Egypt, Iraq, Jordan, Lebanon, and Bahrain are speculative grade.

n GCC sovereigns continue to face unprecedented fiscal financing needs, expected to exceed $100 billion in 2016 alone.

n We have revised our outlook on Egypt and Jordan to negative from stable since our January publication. Lebanon also has a negative outlook. The ratings on the rest of the region’s sovereigns have stable outlooks.

We rate eight of the 13 MENA sovereigns in the ‘BBB’ rating category or above. The average MENA sovereign rating is now close to ‘BBB’, one notch lower than in mid-2015 (see chart 2). When weighted by GDP, the average moves closer to ‘BBB+’. This average, weighted by nominal GDP, has fallen more sharply than the unweighted average over the past 12 months mainly because we have lowered the rating on the region’s largest economy, Saudi Arabia. While the ratings on the regional net hydrocarbon importers — Jordan, Egypt, Morocco, Lebanon, Ras Al Khaimah (RAK), and Sharjah — have remained unchanged, we have revised the outlook on Jordan and Egypt to negative. Our ratings on Lebanon also have a negative outlook.

Broadly, ratings in the region are split between the net hydrocarbon exporters and importers, the former having a higher average rating (close to ‘BBB+’) than the latter (close to ‘BB+’). The first half of 2016 saw an intensification of downward rating pressure on some net-hydrocarbon exporters, with the downgrades of Saudi Arabia, Oman, and Bahrain. The net exporters’ average rating was close to ‘A+’ in July 2015, some three notches higher than currently. There is also a notable division in ratings within the net exporter grouping, with Abu Dhabi, Kuwait, and Qatar continuing to be rated at ‘AA’. Ratings for the net importers have remained static over the same period, as negative factors emanating from fiscal and external pressures, as well as ongoing regional conflict, have muted the benefit of lower import bills.

In February 2016, we lowered our rating on Saudi Arabia to ‘A-’ from ‘A+’, on Oman to ‘BBB-’ from ‘BBB+’, and on Bahrain to ‘BB’ from ‘BBB-’. We now rate Saudi Arabia three notches lower than we did in mid-2015, Oman two notches lower, and Bahrain two notches lower.

The rationale behind lowering these ratings relates to the sharp fall in oil prices and consequent revision of our price assumptions. We lowered our assumptions for Brent by $15/bbl (to an average of $40) for 2016 and by $20/bbl (to an average of $48/bbl) for 2017 onward. Given the high fiscal and external dependency among exporters on related revenues we amended our projections to reflect a prolonged period of lower hydrocarbon receipts and their impact on real economic activity. The scale of this revision is substantial and illustrates the extent to which the structure of public finances among hydrocarbon exporters has tended toward increasing expenditure since hydrocarbon prices started to rise in the early 2000s. The average fiscal balance of GCC countries plus Iraq (excluding RAK and Sharjah but including Abu Dhabi rather than the UAE) will have deteriorated from a 9 percent of GDP surplus in 2013 to an estimated 9 percent deficit in 2016, which includes our estimates of fiscal consolidation.

The ratings on Abu Dhabi, Qatar, and Kuwait, although similarly exposed to changes in hydrocarbon prices, have remained stable. Their large asset stocks mainly explain this resiliency. Summarizes the relative strengths and weaknesses of the factors that, in accordance with our sovereign methodology, contribute to sovereign ratings. We assess these contributing factors as a strength, neutral, or a weakness in relation to the universe of all rated sovereigns. We view most MENA sovereigns’ external and debt assessments as strengths. However, we no longer view most fiscal assessments in the region as a strength, which was the case before January 2016, reflecting the large swing in fiscal performance and the consequences for government balance sheets. We also point to this factor in explaining the divergence of ratings within the net hydrocarbon exporter group. Rating constraints common to all MENA sovereigns, under our criteria, are their institutional and monetary assessments. There is no rated MENA sovereign for which we view these factors as strengths.

Of the 13 MENA sovereigns we rate, eight currently have a stable outlook despite the challenging political and economic backdrop. This reflects a balance of risks at lower rating levels. Egypt, Jordan, and Lebanon, have negative outlooks. Our rating outlooks are intended to indicate our view of the potential direction of a long-term credit rating, typically over six months to two years for investment-grade ratings, and six months to one year for speculative-grade ratings. A positive or negative outlook is intended to designate at least a one-in-three likelihood of a rating change in the indicated direction.

We revised the outlook for Lebanon to negative in September 2015, stemming from our view that political uncertainty and regional tensions will continue to weigh on economic growth in the medium term. In our opinion, the proper functioning of the Lebanese government is impaired.

We lowered our outlook on Jordan to negative in April 2016 because the consequences of regional political instability and conflict continue to build and are obstructing meaningful policy course. Jordan’s debt burden is high and expenditure pressures remain substantial, despite ongoing external support.

In May 2016, we revised the outlook on Egypt to negative from stable. We expect Egypt’s economic recovery to slow as fiscal and external vulnerabilities increase.

Given the uniformly high dependence among GCC sovereigns on receipts from hydrocarbon exports, the consequences of a sharp fall in prices are clearly visible in both fiscal and external data. While the resulting imbalances differ in scale and duration, one commonality among GCC sovereigns is the emergence of almost unprecedented fiscal financing needs. In Bahrain, Oman, and Saudi Arabia we expect fiscal deficits to average 12 percent of GDP per year in 2016 and 2017. Although much lower, fiscal deficits for Abu Dhabi and Qatar are nonetheless above 5 percent of their GDPs. We estimate the combined fiscal deficits for GCC sovereigns to total over $100 billion (9.2 percent of GDP) in 2016, similar to 2015.

We see two main options for meeting these funding needs. A government can issue debt to finance its fiscal deficit, or, if available, draw on its assets — which could include diverting investment income generated by assets. Meeting these larger funding needs will either entail increasing the annual incurrence of debt and/or reducing asset positions.

How to finance these deficits is rather a new question for regional sovereigns and the answer will probably need to take on board numerous considerations. Aside from the scale of existing asset stocks and debt burdens, determining factors will likely include: (i) restrictions around assets and related income (for example, in Qatar’s case the mandate of QIA, unless in an extreme scenario, is based on savings rather than a mechanism for economic stabilization); (ii) basic economics, in that it may be cheaper to issue debt than forego investment earnings on assets; and (iii) how receptive various markets might be. Monetary policy could also be a consideration. We don’t expect any changes to regional currency pegs, but we don’t anticipate policy makers will tolerate persistent declines in foreign reserves. Therefore, for most sovereigns we include in our projections a mix of asset draw-downs and debt issuance.

Aside from Bahrain, GCC sovereign debt issuance had been relatively sparse prior to 2016, particularly in foreign currency, and usually reserved for benchmarking or monetary policy purposes.

So far in 2016, both Abu Dhabi and Qatar have tapped international markets with sizeable issues; Abu Dhabi issued a total of $5 billion in two maturities of equal size in May, the five-year one attracting 2.125 percent, and the 10-year 3.125 percent. Also in May, Qatar issued a total of $9 billion in three separate series; $3.5 billion five-year maturities at 2.375 percent, $3.5 billion 10-year maturities at 3.25 percent, and $2 billion 30-year maturities at 4.625 percent. For Saudi Arabia, we take into consideration a reported $10 billion syndication and a $25 billion increase in domestic bank holdings of government paper, which together cover roughly half of the anticipated 2016 fiscal deficit. Consequently, financing for the year is not yet complete. We believe the receptiveness of both international and domestic markets is changing, which could present funding challenges.

International market volatility — reflecting weaker demand from China, uncertainty stemming from Brexit, and the potential for a change in stance from key monetary authorities on global liquidity — could deter issuers from Eurobond placements for some time. Further, deposit growth in GCC domestic banking systems has slowed dramatically from double-digit growth over 2012-2014; hydrocarbon-related public-sector entities are the main depositors. Overnight rates have started to increase, reflecting tightening liquidity particularly in Saudi Arabia and the UAE, the largest banking systems. We note that the former contributes the vast majority of the total 2016 financing need for the region, at roughly $80 billion. As a result, we expect upward pressure on the price of debt.

Balance sheet strength remains a characteristic of the region, however. Only Bahrain is in a fiscal net debt position, for example. That said, funding deficits with assets alone — if this were possible — would have a marked impact on this strength. Currently, we expect Bahrain’s net debt position to increase almost six-fold between 2014 and 2019, Oman’s net asset position to decline by almost 90 percent and Saudi Arabia’s by 35 percent over the same period.

Absent a substantial increase in the scale and speed of fiscal consolidation, or oil prices, we expect that regional financing needs will remain elevated for some time thereby weakening government balance sheets.

Creditworthiness in the region is at its lowest ebb since 2003, before hydrocarbon prices embarked on their decade-long climb.

Sovereign Summaries

Kuwait (AA/Stable/A-1+)

n Analyst: ravi.bhatia@spglobal.com

n Latest published research update: Kuwait Ratings Affirmed at ‘AA/A-1+’ Despite Lower Oil Price Assumptions;

Outlook Stable, Feb 12, 2016

Rating score snapshot

n Institutional assessment: Neutral

n Economic assessment: Strength

n External assessment: Strength

n Fiscal assessment, budget performance: Strength

n Fiscal assessment, debt: Strength

n Monetary assessment: Neutral

Outlook: Stable

The stable outlook reflects our expectation that Kuwait’s fiscal and external positions will remain strong, backed by a significant stock of financial assets. We expect these strengths to offset risks related to the current low oil price, Kuwait’s undiversified oil economy, and what we assess as a vocal and unpredictable political system, in addition to geopolitical tensions in the region.

We could lower the ratings if a continued fall in oil prices or slow growth were to undermine Kuwait’s wealth levels, measured by GDP per capita, if Kuwait’s domestic political stability were to significantly deteriorate, or if geopolitical risks were to escalate.

We could raise the ratings if political reforms were to enhance institutional effectiveness and improve long-term economic diversification, and if geopolitical risks fade significantly, and prospects for the oil sector improve.

Abu Dhabi (AA/Stable/A-1+)

n Latest published research update: Emirate of Abu Dhabi ‘AA/A-1+’ Ratings Affirmed; Outlook Stable, Feb 5, 2016

Rating score snapshot

n Institutional assessment: Neutral

n Economic assessment: Strength

n External assessment: Strength

n Fiscal assessment, budget performance: Strength

n Fiscal assessment, debt: Strength

n Monetary assessment: Neutral

Outlook: Stable

The stable outlook on Abu Dhabi reflects our view of balanced risks to the ratings over the next two years. We believe that Abu Dhabi’s economy will remain resilient and its fiscal policy will remain prudent, but we also anticipate continued structural and institutional weaknesses.

We could consider raising the ratings on Abu Dhabi if we observed pronounced improvements in data transparency, including on fiscal assets and external data, alongside further progress in institutional reforms. What’s more, measures to improve the effectiveness of monetary policy, such as developing domestic capital markets, could be positive for the ratings over time.

We might consider a negative rating action if we expected a deterioration in Abu Dhabi’s currently very strong fiscal balance sheet and net external asset position.

If fiscal deficits or the materialization of contingent liabilities led to a drop in liquid assets to below 100 percent of GDP, downward pressure on the ratings would mount. A negative rating action could also occur if domestic or regional events compromised political and economic stability.

Bahrain (BB/Stable/B)

n Latest published research update: Kingdom of Bahrain ‘BB/B’ Ratings Affirmed; Outlook Stable, June 10, 2016

Rating score snapshot

n Institutional assessment: Weakness

n Economic assessment: Neutral

n External assessment: Neutral

n Fiscal assessment, budget performance: Weakness

n Fiscal assessment, debt: Weakness

n Monetary assessment: Neutral

Outlook: Stable

The stable outlook reflects our expectation that Bahrain’s modest economic growth will offset ongoing fiscal and external pressures over the next 12 months. If Bahrain materially outperforms our fiscal and external forecasts, we could consider raising the ratings. Conversely, if these constraints intensify, we could consider a negative rating action. We could also consider lowering the ratings if social unrest increases, given the possibility that this could derail fiscal consolidation efforts.

Egypt (B-/Negative/B)

n Latest published research update: Arab Republic of Egypt Outlook Revised To Negative; ‘B-/B’ Ratings Affirmed, May 13, 2016

Rating score snapshot

n Institutional assessment: Weakness

n Economic assessment: Weakness

n External assessment: Weakness

n Fiscal assessment, budget performance: Weakness

n Fiscal assessment, debt: Weakness

n Monetary assessment: Weakness

Outlook: Negative

The negative outlook reflects our view that Egypt’s external and fiscal vulnerabilities might increase further over the next 12 months, slowing the country’s economic recovery and heightening sociopolitical tensions.

We could lower the ratings if external imbalances increase beyond our current expectations, for example, if foreign exchange reserves decreased more quickly than we currently expect. We could also lower the ratings if current account financing, including from GCC countries, became less forthcoming. Deteriorating domestic fiscal funding options, increased political risk, or a weaker institutional environment could also lead us to lower the ratings.

We could affirm the ratings at their current levels if external and fiscal deficits reduce, and if GDP growth picks up.

Iraq (B-/Stable/B)

n Latest published research update: Republic of Iraq ‘B-/B’ Ratings Affirmed Despite Lower Oil Price Assumptions; Outlook Stable, Feb 26, 2016

Rating score snapshot

n Institutional assessment: Weakness

n Economic assessment: Weakness

n External assessment: Neutral

n Fiscal assessment, budget performance: Weakness

n Fiscal assessment, debt: Neutral

n Monetary assessment: Weakness

Outlook: Stable

The stable outlook reflects our expectation that Iraq’s large fiscal and external deficits will be financeable, and that its conflict with IS will be contained. It also incorporates our forecast of a return to strong growth from 2016 thanks to the increases we project in Iraqi oil production and oil exports.

We could lower our rating on Iraq if the assumptions mentioned above do not hold.

We could raise the rating if Iraq’s security situation and its public finances improve substantially.

Saudi Arabia (A-/Stable/A-2)

n Latest published research update: Ratings On Saudi Arabia Affirmed At ‘A-/A-2’; Outlook Stable, April 8, 2016

Rating score snapshot

n Institutional assessment: Neutral

n Economic assessment: Neutral

n External assessment: Strength

n Fiscal assessment, budget performance: Weakness

n Fiscal assessment, debt: Strength

n Monetary assessment: Neutral

Outlook: Stable

The stable outlook on Saudi Arabia reflects our expectation that the Saudi authorities will take steps to prevent any deterioration in the government’s fiscal position beyond our current expectations, over the next two years.

We could lower our ratings if we observed further deterioration in Saudi Arabia’s public finances. Such fiscal weakening could entail prolonged double-digit GDP deficits, a quicker drawdown of fiscal assets, or an unexpected materialization of contingent liabilities. The ratings could also come under pressure if we observed a significant increase in domestic or regional political instability or a renewed marked weakening of terms of trade.

We could raise the ratings if Saudi Arabia’s economic growth prospects improved markedly beyond our current assumptions.

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