Citing expectations of notable slowing in economic growth andconcerns about fiscal and current account deficits widening, S&P has downgraded Qatar from AA to AA- as credit risk premia hit 2017 highs.
Qatar credit risk is at 2017 highs (but remains well below Jan 2016 recent highs…
Full Statement from S&P…
- On June 5, 2017, a group of governments including Saudi Arabia, United Arab Emirates, Bahrain, Egypt, Libya, and Yemen moved to cut diplomatic ties, as well as trade and transport links with Qatar.
- We believe this will exacerbate Qatar's external vulnerabilities and could put pressure on economic growth and fiscal metrics.
- We are therefore lowering our long-term rating on Qatar to 'AA-' from 'AA' and placing it on CreditWatch with negative implications.
- The negative CreditWatch encompasses numerous downside risks to the rating as a consequence of recent events, reflecting that we could lower the ratings if domestic political risks were to substantially increase or if government indebtedness increases materially quicker than we currently expect. We could also lower the ratings if our assessment of contingent liabilities from the banking system or the government's related entities were to increase, or if Qatar's external financing lines were withdrawn.
RATING ACTION
On June 7, 2017, S&P Global Ratings lowered its long-term rating on the State of Qatar to 'AA-' from 'AA' and placed the rating on CreditWatch with negative implications. The 'A-1+' short-term rating was affirmed. The Transfer & Convertibility assessment is 'AA'.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the State of Qatar are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Calendar Of 2017 EMEA Sovereign, Regional, And Local Government Rating Publication Dates published Dec. 16, 2016, on RatingsDirect). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case, the reason for the deviation is a significant geopolitical development impacting creditworthiness. The next scheduled rating publication on the sovereign rating on the State of Qatar will be on Aug. 25, 2017.
RATIONALE
On June 5, 2017, a group of states including Saudi Arabia, the United Arab Emirates (UAE), Bahrain, Egypt, Libya, and Yemen moved to cut diplomatic ties, as well as trade and transport links, with Qatar. The measures imposed include a blockade of land, sea, and air access and the expulsion of Qatari officials, residents, and visitors from the group of states. We believe this will exacerbate Qatar's external vulnerabilities and could put pressure on its economic growth and fiscal metrics. The negative CreditWatch encompasses numerous downside risks to the ratings as a consequence of recent events. At this stage, we note that there are numerous uncertainties regarding Qatar's response, the extent to which these measures will be imposed, and their longevity. We expect to review this and the potential impact on our projections as further details emerge and by our next scheduled review, on Aug. 25, 2017.
We understand these moves to be motivated by Qatar's apparently more conciliatory stance toward Iran amid allegations that Qatar is financing terrorist activity. We note that Qatari authorities vigorously deny these allegations, and that Qatar's exact policy response is uncertain at the moment.
Supporting the ratings, Qatar holds the third-largest proven natural gas reserves in the world, and is the largest exporter of liquid natural gas (LNG). We expect Qatar's reserves to provide many decades of production at the current levels. GDP per capita is among the highest of rated sovereigns, estimated at US$62,500 in 2017. The hydrocarbon sector contributes about 50% of Qatar's GDP, 90% of government revenues (oil and gas taxes and royalties, plus dividends from Qatar Petroleum), and 85% of exports.
Nonresident deposits in Qatar's banking system increased over 2016 by 17% of GDP, which has weakened Qatar's external liquidity position as related external short-term obligations have increased (see our ratio of gross external financing needs); the average maturity of these deposits is under one year. Over the same period, bank credit directly to the government increased by a similar amount, and the funds were generally used to finance Qatar's ongoing significant infrastructure program. This dynamic has therefore increased pressure on our external stock metric (narrow net external debt), as the increase in external liabilities was not matched by external liquid assets. While we no longer expect the continued accumulation of these external liabilities, in our opinion recent events have the potential to destabilize these nonresident deposits and provoke an outflow.
Although we do not expect this potential outflow to pose immediate and significant issues for Qatar's banks (see "A Sharp Rise In External Debt Leaves Qatari Banks More Vulnerable," published May 8, 2017), it could mean that government support would be needed in some form to offset any potential major outflow, including the potential use of QIA (Qatar Investment Authority, the sovereign wealth fund) assets, in addition to the central bank's contingency reserves. Moreover, we now consider risks to external financing lines to the whole economy, including foreign direct investment, portfolio flows and to the financial sector to be elevated, and this could lead to pressure on Qatar's pegged monetary arrangement. We subtract Qatar's monetary base from usable reserves, which we view as consistent with maintaining confidence in a pegged currency. We estimate government liquid external assets to be worth 170% of GDP, which remains a key rating support.
Qatar's fiscal and current account deficits could widen as related revenues from regional trade diminish. In 2016, 10% of Qatar's exports was to the group of states that have blocked trade. We believe this figure includes gas exports through the Dolphin pipeline, the position of which under the embargo is currently unclear. The same group of states provides 15% of Qatar's imports, potentially causing substantial shortages of key materials, including those used for construction projects, and food. Furthermore, the imposition of air travel restrictions could have significant implications for Qatar Airways' profitability. We note that debt of government-related entities (GREs) accounts for approximately 85% of GDP. There is currently no indication that Qatar's main trade partners (Japan, South Korea, China, and India), who purchase the bulk of Qatar's LNG production, will reconsider their existing trade arrangements. These four countries account for 55% of Qatar's total exports.
Although still very strong, the government's net asset position (net general government assets are 120% of GDP) could weaken as a result of deploying these assets to support revenue shortfalls and because the potential for debt financing at similar prices to recent issues appears unlikely. Additionally, government support to the banking system (as was the case during the financial crisis) and to its GREs, which also require external financing, could place an additional burden on government assets. These developments could weigh on our external analysis to the extent that they act as a drain on liquid external assets and reduce coverage of external debt. At the moment, we expect that Qatar will continue with its substantial infrastructure development, the bulk of which is not related to the 2022 World Cup, but rather developing road and sewerage networks, schools, and public transportation networks.
As a result of these factors, we expect that economic growth will slow, not just through reduced regional trade, but as corporate profitability is damaged because regional demand is cut off, investment is hampered, and investment confidence wanes.
The policy response of Qatari authorities to falling oil prices since 2015 has been very visible and is illustrated by reigning in current expenditures, merging line ministries, and implementing numerous cost-saving initiatives within its core GREs. In comparison with regional peers, fiscal deficits have been modest as a result and their financing strategy clear. In our opinion, the government has been clear with its stated ambitions on economic diversification and its supporting infrastructure development plan. We do not expect that the aims of the authorities will deviate as a result of the embargo, but that achieving them while maintaining the current level of creditworthiness will now require additional fiscal effort, which therefore raises some uncertainty on the exact policy response. We expect details to emerge in the next few weeks. We do not consider the recent lifting of the moratorium on Qatar's North Field in our assessment because the potential related revenues fall outside of our rating horizon. Less certain still, in our opinion, is Qatar's policy response to the apparent demands of the group of states and Qatar's position in the Gulf Cooperation Council. We view these factors as damaging to overall policy predictability.
We believe the fixed exchange rate of the Qatari riyal to the U.S. dollar leads to limited monetary flexibility, and we expect the currency peg to be maintained. Qatar's real effective exchange rate has appreciated by 14% since early 2014. In our view, this represents a deterioration in international competitiveness of the country's modest tradeables sector and a dampening of nonhydrocarbon GDP growth, absent any offsetting factors such as improved efficiency or technological capacity.
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Interestingly S&P expects the currency peg to be maintained – something the market strongly disagrees with…
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