S&P Global Ratings: In a Credit FAQ titled “Potential Implications Of Qatar Boycott For Gulf Cooperation Council Sovereigns,” published today, S&P Global Ratings responds to questions that have surfaced in recent discussions with issuers and investors about the implications of the Qatar boycott by a group of states for the Gulf Cooperation Council (GCC) sovereigns.
S&P Global Ratings believes that the impact of a group of states cutting diplomatic ties, as well as trade and transport links, with Qatar on June 5, 2017, may not be confined to within Qatar’s borders. We expect that political tensions within the GCC will persist over the next few years, and believe that the boycott of Qatar has illustrated deeper fissures within the group than were previously evident.
For the most part, we have viewed the GCC as a stable political alliance in the Arab region. The GCC broadly maintained this stability through the global financial crisis and the Arab Spring. Numerous regional economic initiatives, suggestive of a cohesive vision, have been launched, such as financial support packages for Oman and Bahrain, and the planned introduction of VAT across the region in 2018. In our view, these initiatives indicated a desire to ensure the political and financial stability of the GCC and its individual member states. While we do not think that this desire has changed significantly, in our view, the current tensions weaken the cohesiveness of the GCC and complicate policy predictability.
The boycott of Qatar comes at a time when regional sovereign financing requirements are at a historic high in the GCC. The boycott creates the potential for financial flows to be disrupted, and for the reversal of prior investment decisions and financing lines, including those to financial institutions. However, absent a material further escalation in the boycott, we do not expect these risks to materialize to a significant extent. The group of states boycotting Qatar includes Saudi Arabia, United Arab Emirates, Bahrain, Egypt, Libya, and Yemen. Only a rating committee may determine a rating action and this report does not constitute a rating action.
FREQUENTLY ASKED QUESTIONS
How does S&P Global Ratings currently evaluate institutional risk in the GCC?
While each GCC sovereign has its own characteristics, we generally categorize our GCC institutional risk assessment as a neutral factor for our sovereign ratings (see “Middle East And North Africa Sovereign Rating Trends Midyear 2017,” published July 12, 2017). This categorization results from balancing the GCC’s track record of relative political stability against what we view as limited institutional transparency and predictability. Contributing factors to this view are the centralized decision-making associated with regional monarchies; the nascent stage of the development of political institutions; uncertainties over succession; and data shortcomings, particularly with regard to data on government assets.
Irrespective of how the boycott of Qatar develops, in our opinion, it reveals a deep political division within the GCC and limitations on the visibility of political relationships between the member states. Ultimately, the boycott has affected our view of GCC solidarity, a concept that we had believed the member states embraced more strongly. If, in future, the boycott also prevents financial support from reaching the needier member states, negative pressure could develop on their ratings. We premise our ratings on Oman and Bahrain on the assumption that regional financial support for these countries would be forthcoming from the GCC if needed.
How important is regional GCC trade to member states?
Given the almost uniform concentration of GCC member states’ exports on hydrocarbons and the lack of strong agriculture or manufacturing sectors in the region, trade between member states is relatively limited, with most exports going to extra-regional destinations (see “Middle East And North Africa Sovereign Rating Trends Midyear 2017,” published July 12, 2017), and most imports coming from outside the region.
Nevertheless, the physical closure of Qatar’s land, air, and sea borders with the boycotting nations will affect trade linkages in both directions. We therefore expect the boycott to adversely affect the trade balances of boycotting countries that previously had trade surpluses with Qatar, particularly Saudi Arabia. The countries not participating in the boycott, such as Oman and Kuwait, may benefit from diverted trade routes. As Qatar’s trade numbers are relatively small, a change in trade volume is unlikely to significantly influence the key metrics, including current account receipts and fiscal revenues, of the countries that trade with it. In 2016, goods exports from Qatar to the GCC and Egypt accounted for 11% of Qatar’s total exports, or roughly 6% of current account receipts ($6 billion).
Although intra-GCC trade is relatively limited as a proportion of total exports or imports, this is not to say that its complete suspension would not be meaningful from a ratings perspective. For example, the UAE, with which Qatar has the most substantial trade linkages, depends on gas imports from Qatar through the Dolphin pipeline to meet about 30% of its energy needs. We expect that the Dolphin pipeline will remain open, absent a further significant escalation in tensions between Qatar and the UAE. Should the pipeline be shut off, this could result in higher fuel costs for national electricity generators and fiscal costs for the individual UAE emirates.
For some of the smaller emirates, such as Ras Al Khaimah (RAK), Qatar is also an important customer, importing roughly 12% of RAK’s limestone production for use in its infrastructure program. We understand that RAK’s quarrying companies are making efforts to expand into new markets. Without this offsetting growth, Qatar’s boycott could ultimately harm RAK’s fiscal position, as government revenues are closely tied to the profitability of government-related entities.
What are the possible implications of weaker relations between GCC member states for economic growth?
We expect that the impact of weaker relations on economic growth through reduced investment, regional trade, and lower corporate activity will intensify the longer the situation lasts, but that the overall impact should be relatively limited. The GCC economies are largely dependent on their hydrocarbon sectors (see “Gulf Sovereigns Will Find It Hard To Diversify Away From Hydrocarbons,” published July 25, 2017). In our view, a substantial portion of regional growth is linked to governments maintaining public expenditure at relatively high levels, be it through spending on infrastructure projects or maintaining high public sector wages and benefits, or both. We do not expect this fiscal stance to change, therefore economic growth should continue to be supported.
While some foreign inflows may be deterred, we note that foreign direct investment (FDI) to the region is relatively limited, with inbound FDI averaging just under 1% of GDP per year over 2014-2016 for the GCC as a whole. At the same time, we expect direct extra-regional participation in the hydrocarbons sector to continue. Such participation can be broadly characterized as joint ventures between the oil and gas majors and GCC state-owned hydrocarbon producers, and accounts for the bulk of foreign investment in the GCC. Therefore, in our view, the impact of a sharp fall in oil prices would be more material for overall economic activity in the GCC than a drop in foreign inflows.
Perhaps more damaging for economic growth would be capital outflows related to extensive financial sector sanctions, or a confidence shock should a significant challenge arise to GCC member states’ ability, or wealthy states’ willingness, to defend the GCC’s pegged exchange-rate regimes.
Are regional pegged exchange rates at risk?
Under our base case, we assume that GCC exchange-rate pegs will remain in place. In our view, these pegs have provided stable nominal anchors for the GCC economies and broadly stable levels of inflation. Rules of thumb suggest that adequate reserve coverage would be about three months of imports (our measure looks at coverage of total current account payments) and 20% of broad money (a wide measure of money supply). We include central bank gross international reserves and government external liquid assets in our definition of reserves in chart 2 below, as in our view, governments’ sovereign wealth fund assets would likely be utilized should the GCC pegs come under speculative attack. Bahrain has, on average, fallen below full coverage of its monetary bases for prolonged periods of time, reflecting much smaller foreign-exchange reserves than other GCC member states (see chart 2). However, we expect Bahrain to maintain its peg, if necessary with the support of wealthier GCC sovereigns.
To what extent is the GCC dependent on external financing?
GCC sovereigns rank among the world’s largest net external creditors, which provides a key support for the ratings and a buffer should their economies experience capital flight or pressure on their exchange-rate arrangements. In such a case, GCC sovereigns could liquidate part of their external assets. Despite a strong external asset position, some GCC sovereigns have relatively weak external liquidity ratios, with gross external financing needs averaging 124% of current account receipts in 2017 (excluding Bahrain, which is an outlier at 350% of current account receipts as a result of its wholesale banks). As a result, we would assess some GCC sovereigns as being more dependent on external financing.
We view Bahrain’s external financing needs as manageable because, to a large extent, the high gross external financing needs ratio reflects the operations of Bahrain’s large wholesale banking operations, and as such, Bahraini banks have recourse to liquid external assets of similar value. Furthermore, these banks have limited linkages with the domestic economy and would therefore be unlikely, in our view, to receive support from the government.
The majority of GCC sovereigns’ external financing needs relate to a very large import bill, reflecting both the limited extent of domestic production and also large infrastructure development plans. The former can be difficult to adjust in a short space of time, while capital investment projects may be postponed at relatively short notice. In addition, GCC economies have a meaningful amount of external short-term debt, mainly related to financial institution liabilities consisting of both non-resident deposits and interbank lines. Saudi Arabia is the exception, with Saudi banks exhibiting generally low external liabilities, of which the short-term component is also low, estimated at less than 10% of the total.
In a broader context, the GCC sovereigns have some of the highest annual external financing needs among emerging markets. Between 2014 and 2017, annual external financing needs fell for most emerging market countries, whereas we estimate that such needs increased by an average of 50% in the GCC. This reflects the GCC’s narrow export base–and the extent of the hit to current account receipts from lower oil prices–but also material increases in the absolute amounts that GCC member states owe to the rest of the world.
The average increase in nominal short-term debt among GCC member states was 30% between 2014 and 2017, and the increase in long-term debt coming due (which remains a small proportion of total debt) was 50%. The former increase typically relates to a rise in banking system external indebtedness, which was a key factor in us revising Qatar’s outlook to negative from stable in March 2017. Despite the implementation of fiscal consolidation measures, growth-boosting public capital expenditures have remained large and import demand strong, supported by high GDP per capita.
Will the boycott have fiscal implications?
We think that the loss of government revenues to the boycotting states will be relatively limited, in line with their trade linkages. However, depending on how the situation evolves, investors could ask for a higher risk premium in relation to GCC debt and there could be an impact on government debt service costs, which in turn could affect our fiscal deficit financing assumptions.
GCC sovereigns (Bahrain and Oman to a lesser extent) have the option of financing deficits through debt or drawing on assets (see “GCC Sovereigns’ Financing Needs In 2015-2019 Could Total $560 Billion,” published Oct. 17, 2016). One consideration for governments is whether the cost of issuing debt is lower than the return they may make on their assets. Therefore, a higher cost of funding may mean that drawing down on assets becomes preferable. Bond yields for almost all GCC sovereigns have risen since the boycott began (see chart 5).
What effect would Qatar’s departure from the GCC have on the other member states?
In a hypothetical scenario where Qatar leaves the GCC, which we expect would only be a consequence of a prolonged or materially escalated boycott, we would not expect any material additional impact on trade linkages, as these have already been halted following the boycott. Rather, we expect that one of the main effects would be on confidence in the region’s stability, which in turn could deter investment flows, hamper growth, and put a spotlight on political relationships between the remaining member states. It could also bring into question the GCC’s future policy course, including the introduction of joint revenue-raising initiatives, such as VAT, assuming that the GCC would be less likely to put itself at a potential cost disadvantage to Qatar.