GCC Sovereigns: Credit Rating Recap - A New Divergence At The Top

PART 1/2 - Kuwait, UAE and Qatar

Full paper available here

Last week was a busy one for GCC sovereign ratings: UAE and Kuwait were both stabilised by Moody's at Aa2/Stable but Qatar was downgraded to Aa3/Stable, consistent with S&P's recent AA outlook change to negative on the 3rd March 2017, and Fitch remains at AA/Stable. This short article provides some insights into the credit drivers of recent actions - full PRs are public on each agency website.

Downside Oil Scenarios Have Moderated but Asset Correlation Remains Very High Despite Ongoing Diversification Efforts

For all of the GCC credits, despite ongoing diversification, oil prices are the key risk driver that drives a very high level of asset correlation across the region. Thus stabilisation of oil prices in the $40-60 range is an obvious key credit positive, driving reduced fiscal deficits and even a return to modest surplus in some cases. This recovery has helped reduce the material tail risk of a sustained $30 oil prices of early 2016 and moderated the downside risk scenarios for the rating agencies.

US Shale remains the biggest constraint on prices despite renewed signs of global growth although the 'low hanging' production gains seem to be 'picked'.

The chart from Rystad Energy, shows how dramatically extraction costs have fallen. However, in the May edition of the Oil and Gas Financial Journal they note that more investment is required for shale production to meet the expected demand or "call on shale". Acreditus believes this should help support price stabilisation in the $40-60 range well into 2018, especially when coupled with the extended and (newly) targeted OPEC cuts to US supplies that should hopefully dent the very transparent levels of US inventories.

Debt/Sukuk - An Important [and Still Cheap] Tool for Public Finances

As a result of the price shock, 2016 was a breakout year for GCC credit with cheap, QE driven USD liquidity compressing GCC spreads - overriding the impact of the region's weakening fiscal and economic fundamentals. This has helped fund over $70Bn of debt/sukuk, with each issuance oversubscribed multiple times and often pricing tighter than guidance.

Indeed the Sultanate of Oman managed to price its seven-year sukuk at mid-swaps + 235bp, from initial guidance of about 270bp despite being downgraded to BB+/Neg by S&P on May 12. It remains investment grade however with Moody's at Baa1/Stable and now (recently) Fitch at BBB/Stable - creating a very unusual divergence in opinions that provide investors with a good spread of risk scenarios.

Despite the recent volumes however, bank financing continues to dominate and the absence of local capital markets (and much needed institutional investors) continues to reduce the resilience of economies to shocks and changes in external risk perception of the region.

Kuwait, UAE & Qatar - Three Of A Kind?

In the case of Kuwait (Aa2/Stable, AA/Stable, AA/Stable) the slower pace (and perhaps need) of reform is broadly offset by an incredible balance sheet (KIA assets estimated at 550%/GDP ~$600bn) with govt debt trending to ~35%/GDP. Public spending in the country has continually lagged its peers so the improved pipeline of projects should provide improved growth opportunities going forward.

The UAE/Abu Dhabi* (Aa2/Stable, AA/Stable*, AA/Stable*) balance sheet is also strong (ADIA assets estimated at 155%/GDP ~$580Bn) with UAE debt/GDP trending towards ~20% (Dubai's debt is a component of Moody's UAE rating). A key stabilisation driver has been the effectiveness of policy responses thus far, market engagement and corporate rationalisation efforts. The economic diversity of the country is also key and all these positive trends - amongst the strongest in the region - look set to continue.

For Qatar, (Aa3/Stable, AA/Neg, AA/stable) despite sizable QIA reserves (estimated at 200%/GDP ~$300Bn), it has regularly tapped the market to leverage its strong credit profile. This (likely) helps improve the overall returns/profitability and diversification of the sovereign balance sheet. As such, govt Debt/GDP looks set to trend to the 50% level.

In addition to the above, the Qatar banking sector's foreign liabilities have climbed dramatically, outpacing foreign asset growth - hence confidence sensitivity is climbing for the system. Foreign liabilities have climbed to 33% of GDP ($51Bn) up from 22% a year ago (in Feb '17) and is mostly composed of interbank liabilities and non-resident deposits. Qatar's recent political isolation further heightens the risk around these exposures.

With expected US interest rate rises and attractive investment opportunities in a recovering Europe, the funding environment will be tighter in 2018, hence market transparency and investor communications around downside risk scenarios are key to moderating potential systemic risks and possible contingent impact on Qatar. This was also a key factor in S&P's March rating action.

Finally, also key and perhaps more fundamental is Qatar's 'corporate strategy' or what Moody's describes as "Uncertainty over the sustainability of Qatar's growth model beyond the next few years." Front-loaded infrastructure capex and recent expenditure is the current and primary growth engine but it seems Moody's needs more tangible efforts, strategies and communication around what happens after.

Nonetheless, despite the downgrades, international investor appetite for GCC credit remains strong and Qatar's is still a AA/Aa credit for all agencies which puts them amongst the highest rated sovereigns globally.

The author, Khalid Howladar is the Managing Director and Founder of Acreditus, a ratings, risk and Islamic finance advisory. He was formerly head of Moody's GCC Banking team and Global Head of Islamic Finance based in Dubai, UAE.