Market Analysis: High oil prices do not eliminate risks to GCC Sovereign Ratings
GCC governments are set to ease up on fiscal austerity in 2018, benefiting from higher oil prices and from the measures they have taken in the past few years to restrain spending, reform subsidies and raise non-oil revenue.
However, by raising government spending and focusing on social stability and economic diversification, governments risk returning to the pro-cyclical policies of recent years, leaving themselves ill-prepared for the next oil price downturn.
Meanwhile, geopolitical risks are elevated after a whirlwind of events in 2017.
Average Brent oil prices, at around $70 per barrel so far this year, are approaching the fiscal break-even level in Saudi Arabia (A+/stable) and Oman (BBB-/negative). Fitch Ratings estimates that, under current forecasts for spending, both would post budget surpluses if Brent averages above $80 per barrel in 2018.
However, this more benign fiscal environment could prompt both countries to loosen the purse strings, preventing stabilisation of their external reserve levels and leading to a continued build-up of debt. Saudi Arabia, facing lacklustre non-oil growth, already introduced a new stimulus programme just days after announcing an expansionary 2018 budget. It has also pushed out its target of reaching fiscal balance to 2023 (from 2020 originally).
Oman’s 2017 budget deficit was in excess of what had been budgeted, despite higher-than-expected oil prices. Having to diversify the economy and provide jobs to a young, rapidly-growing and underemployed population of Omanis, the government will find it tough to let spending drop off as existing projects are completed. Whether Oman sticks to its spending targets, thereby helping stabilise its public and external debt ratios, will be key to any resolution of the negative outlook on its ratings.
Bahrain, which Fitch Ratings recently downgraded to BB-/stable, is facing a challenging year even if the recent strength in oil prices is sustained, with a fiscal break-even Brent price of around $100 per barrel. Some subsidy reforms and spending restraint notwithstanding, the government has yet to identify a clear medium-term strategy to tackle high deficits. With government debt approaching 90 per cent of gross domestic product and interest costs eating up savings elsewhere on expenditure, investors are reportedly demanding clearer expressions of support from other GCC countries before committing additional funds. Meanwhile, Fitch Ratings estimates that the recent $1 billion sukuk covered only around 30 to 40 per cent of Bahrain’s external financing needs this year.
In both Oman and Bahrain, concerns about social stability limit the government’s ability to rein in fiscal deficits. More broadly, the GCC countries remain exposed to the risk of terrorism as a result, to varying degrees, of regional tensions, speed of social change, and earlier oil-driven austerity measures.
In the geopolitical arena, tension between Saudi Arabia and Iran will persist and risks escalating proxy conflicts, particularly in Yemen. Increased assertiveness on the part of Saudi Arabia; Iranian influence across the region; and the direction (or sometimes perceived lack thereof) of US foreign policy under the US President Donald Trump administration including its opposition to the nuclear deal with Iran have heightened risks in this area.
We do not expect an imminent resolution to the dispute between Qatar (AA-/stable) and the Saudi/UAE-led coalition. Our recent stabilisation of Qatar’s outlook partly reflected the government’s management of the fallout from the rupture of relations with neighbours.
In Saudi Arabia, the threat of domestic challenges to reforms remains even as Crown Prince Mohammed bin Salman has strengthened his position.
In conclusion, Fitch views the current level of oil prices as temporary. Our June Global Economic Outlook has prices moderating to an average of $65 per barrel in 2019 and $57.5 per barrel in 2020. The scale of the oil price shock, deterioration of fiscal and external balance sheets and the insufficiency of policy responses in the past years has led to rating downgrades in Bahrain, Saudi Arabia and Oman. Geopolitical developments directly contributed to the downgrade of Qatar’s rating last year.
Of the seven GCC sovereigns that Fitch rates, only Oman remains on a negative outlook, but geopolitics and the further deterioration of fiscal and external positions are risk factors for the ratings of all GCC sovereigns. Only Abu Dhabi and Kuwait (AA/stable) have maintained their ratings owing to the strength of their balance sheets and small fiscal deficits.
Jan Friederich is Head of Middle East & Africa Sovereign Ratings and Krisjanis Krustins a director in the MEA team at Fitch Ratings, which is a member of The Gulf Bond and Sukuk Association.