Moody’s Investors Service has cut its outlook for the debt ratings of Saudi Arabia and three other Gulf states while lowering Bahrain’s rating to junk, citing concern over the impact of low oil prices on their finances.
Saudi Arabia’s Aa3 rating was placed on review for a possible downgrade, Moody’s said late on Friday, adding that it would study whether Riyadh’s efforts to expand its non-oil revenues and diversify its economy were likely to work.
“At around 650 billion (or roughly 95 percent of forecast 2016 gross domestic product) at the end of September 2015, the country’s foreign currency assets are large,” it said.
“But potential calls on these funds are growing emanating from the need to finance future current account and budget deficits, and from use in small-scale currency interventions to defend the currency peg amid rising speculation.”
Moody’s also put the United Arab Emirates, Kuwait and Qatar on review for downgrades – countries which are widely seen in the debt markets as more able to cope with an era of low oil prices because of their huge financial reserves relative to small populations.
It acknowledged that the UAE planned tax reforms and that its economy was more diversified than most in the region, but added: “The structural shock to the oil market is weakening the UAE’s government balance sheet and its economy, and therefore its credit profile.”
Moody’s cut Bahrain’s rating by one notch to Ba1, below investment grade. It kept the rating on review for a further downgrade; Bahrain has much smaller reserves of money and oil than its wealthy neighbours.
Central to the agency’s analysis was its view of oil prices. It said it had recently cut its forecasts for Brent crude to 33 per barrel in 2016 and 38 in 2017, rising slowly to 48 by 2019. In December, it had predicted Brent at 43 in 2016.
Late last month, Moody’s cut the rating of Oman, the other member of the Gulf’s six wealthy oil exporters, by two notches to A3 and kept the rating on review for a further downgrade.
Moody’s actions followed a mass downgrade of oil producers by Standard & Poor’s in mid-February. S&P cut countries including Saudi Arabia, Bahrain and Oman. Saudi Arabia was cut by two notches to A-minus, three notches below Moody’s rating, while Bahrain was lowered to junk.
Kuwait is highly dependent on hydrocarbons to drive economic growth and to finance government expenditure. Oil and gas accounted for over 90% of total goods exports and roughly 63% of nominal GDP in 2014, the latest date for which full-year official statistics are available. It also provides around 77% of total government revenues.
Between September 2014 and September 2015, the oil price roughly halved. Since then, it has fallen a further 40%. Moody’s recently revised its oil price assumptions for Brent to 33 per barrel in 2016 and 38 per barrel in 2017, rising only slowly thereafter to 48 by 2019.
The structural shock to the oil market is weakening Kuwait’s government balance sheet and its economy, and therefore also its credit profile. Moody’s projects that between 2013 and 2015, revenue as a percentage of GDP declined by 17.5 percentage points and the fiscal balance turned into a deficit of 1.1% of GDP in 2015 from a surplus of almost 35% in 2013. Moody’s estimates that, during the same period, the country’s current account surplus relative to GDP fell to 6% from around 40%, and nominal GDP contracted by more than 30%.
Assuming a limited policy response, the depressed oil prices for the coming years would imply a further reduction in government revenues of around 16% in 2016 and only a gradual recovery thereafter, with total revenues only recovering to 2009 levels in nominal terms by the end of 2019. With average annual expenditure growth of about 4.5% per year between 2016 and 2019, this would result in an average fiscal deficit of around 5% of GDP for the time period. Assuming a funding mix of 80% via debt issuance and 20% from government reserves, this would imply a rise in Kuwait’s general government debt stock to around 25% of GDP by 2019, up from 7.6% in 2014. That would shift Moody’s assessment of the government’s fiscal strength to ‘Very High’ from ‘Very High ()’.
Set against that negative impact, the government retains very significant financial buffers. While transparency is limited, Moody’s estimates that total government assets managed by Kuwait Investment Authority amounted to around 580 billion (or roughly five times of estimated 2015 GDP). In addition, foreign currency reserves at the Central Bank of Kuwait were 25.7 billion at the end of 2015.
Kuwait operates a slightly more flexible exchange rate system than its Gulf Cooperation Council peers. The Kuwaiti dinar is pegged to a basket of currencies, rather than to the US dollar. However, while no official basket composition is published, it is likely to be dominated by the US dollar. During 2015, the Kuwaiti dinar has depreciated by about 3.7% against the US dollar, but has gained about 1.2% since beginning of the year. As such, the impact from currency depreciation on the local currency value of the government’s hydrocarbon revenues has been very limited. However, foreign exchange reserves at the Central Bank of Kuwait have fallen to 25.7 billion in December 2015, from US29.3 billion a year earlier, thereby reducing Kuwait’s external buffers against future shocks somewhat.
The government has introduced a limited number of measures to mitigate the impact of low oil prices on its economy and balance sheet, such as a partial fuel subsidy reform in early 2015, and reduced allowances for government entities’ travel expenses and overseas medical treatment for Kuwaiti nationals. While it has stated its intention to consider wider-reaching fiscal reforms, including further subsidy rationalization, prioritization of capital projects, and revenue-enhancing tax reforms, there is little clarity on the likely content or effectiveness of these measures.
The rating review will allow Moody’s to assess the credibility and sustainability of those plans and the government’s ability to mitigate the impact on its credit standing. It will assess the clarity, scope and ambition of the government’s plans relative to the scale of the task, the time required for them to bear fruit, and the reliance that can therefore be placed on them to sustain Kuwait’s credit strengths.
In addition, during the review period, Moody’s will evaluate the outlook for Kuwait’s medium-term economic diversification plans and how these will affect the rating agency’s assessment of Kuwait’s economic strength, currently scored as ‘Very High (-)’.
Moody’s will also assess how far the country’s extraordinarily strong fiscal buffers (including the Sovereign Wealth Fund) mitigate the negative impact of the oil price shock on growth and finances, factoring in the limited degree of transparency surrounding the composition of these assets.
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