KUWAIT: Oil prices have fluctuated in recent months, driven in part by a number of technical and temporary supply disruptions, which have contributed to slightly higher prices than at the beginning of 2016. Consequently, we adjusted our short-term estimates for oil prices upward in June, maintaining our medium-term assumptions of $40-$60 per barrel. While our revised oil price estimates were accompanied by positive adjustments in our short-term forecasts for GCC countries’ deficit and debt trajectories, economic, fiscal and external challenges persist. This FAQ explains the limited credit implications of the recent oil price fluctuations.
How do the recent oil price fluctuations affect GCC sovereign creditworthiness? We do not expect the recent oil price dynamics to have a material impact on the credit profiles of GCC sovereigns, which will remain under stress over the medium term.
What are the credit implications of higher oil prices in 2016-17? As we noted at the time of our rating actions in May, cyclical or temporary increases in the price of oil will not on their own change our assessment of GCC sovereign creditworthiness. In the near term, the principal rating driver will be government actions to address structural problems exposed by significantly lower oil prices than in 2014. Which countries benefit most from higher oil prices?
All GCC countries will face some near-term relief from higher oil prices. Under our revised oil price assumptions of $40 per barrel on average this year, Kuwait (Aa2 negative), Qatar (Aa2 negative) and Oman (Baa1 stable) will realize the largest fiscal and current account deficit reductions in the region compared with our previous forecasts given their higher dependence on oil.
Will higher oil prices affect the reform momentum? It may. Saudi Arabia (A1 stable), the UAE (Aa2 negative) and Qatar have been the most proactive in formulating fiscal and economic adjustment plans to date. But a faster-than-expected rise in the price of oil reduces near-term incentives for reform, particularly for countries that have a lower capacity and willingness to institute tough adjustments.
Does the oil price recovery affect the governments’ debt issuance plans? Since most of the expected fiscal deficits in 2016 are now financed, we do not expect higher oil prices to affect debt issuance plans for the rest of the year. However, we expect 2017 volumes to be lower than what we had anticipated earlier this year, assuming that the GCC governments advance their reform agenda as planned.
1. How do the recent oil price fluctuations affect Moody’s view of GCC sovereign creditworthiness?
Our sovereign credit analysis incorporates our central expectations of key variables such as the price of oil in our growth, debt and current account forecasts. Assigned ratings also take into account the uncertainty around those expectations and any upward or downward risks. The high degree of uncertainty around the future price of oil, and the volatility and potential for downside shocks that it implies, is reflected in the significance we place on a broad price range over point estimates over the medium term. While we have upwardly revised our estimated oil prices for the next few years to reflect the recent price recovery, our medium-term outlook remains unchanged at $40-$60/barrel, and we continue to view this as a challenging time for oil market participants. As such, we do not expect recent oil price dynamics to have a material impact on the credit profiles of GCC sovereigns, which will remain under stress in the medium-term. None of the likely oil price recovery scenarios would have a broad, swift impact on our GCC sovereign ratings.
The slight rise in oil prices combined with a slow recovery in demand, prompted us to adjust our forecasts for 2016 and 2017 to $40 and $45, respectively.
The oil market’s recent rise has been supported by transitory factors, including temporary supply disruptions in Canada (Aaa stable) and violence in Nigeria (B1 stable), which has curtailed production, as well as technical factors such as a weaker US dollar and financial market activity.
However, global oversupply will continue to depress oil prices for an extended period. Capital spending, which determines future production capacity, has dropped substantially and the US rig count has declined by about 70 percent. But non-OPEC supply remains at historically high levels and the global competition for market share is not over. Saudi Arabia and Russia (Ba1 negative) have both increased production to their highest levels since the early 1990s, and Iran (unrated) continues to increase its production.
The low oil price environment continues to have material, and in some cases profound, implications for economic growth and the balance sheets of GCC sovereigns, which largely rely on oil and gas to drive growth, finance government expenditures and generate hard currency for servicing foreign-currency-denominated debt. Economic and fiscal strength, liquidity risk and external vulnerability are important factors in our sovereign risk analysis.
In May, we downgraded the ratings of Saudi Arabia (to A1 stable), Bahrain (to Ba2 negative), and Oman (to Baa1 stable), and confirmed the Aa2 ratings of Kuwait, Qatar and the UAE while assigning negative rating outlooks to all three (see Exhibit 2). These actions were driven by our view then, as now, that lower-for-longer oil prices resulted in a material deterioration in the credit profiles of Saudi
Arabia, Oman and Bahrain. While also true to varying degrees in the case of Kuwait, Qatar, and the UAE, the far stronger net asset positions of the latter three sovereigns buffer the negative effect of lower oil prices.
Consistent with our medium-term assumptions for oil prices, those sovereigns’ credit profiles remain weaker than they were before the structural change in the oil market. We expect GCC sovereigns’ net debt positions to continue to erode over the medium term, as debt burdens increase and reserve assets are drawn down. As such, our current ratings are consistent with our medium-term assessment that GCC sovereigns will face continued challenges in adjusting to a ‘lower for longer’ oil price environment.
2. What are the credit implications of higher oil prices in 2016-17?
In the nearer term, a more rapid than expected recovery in oil prices to the top end of our medium-term range could ease some of the more acute fiscal and external pressures facing GCC sovereigns and, should it be sustained beyond next year, could lead to upward rating pressure on a case-by-case basis, provided that the complementary policy measures to reduce structural fiscal vulnerabilities to low oil prices have been taken. Given the significant challenges ahead, the credibility and effectiveness of GCC sovereigns’ policy response will remain key to our analysis and ratings’ outlook.
While most GCC countries are undertaking some expenditure cuts, these are not sufficient to offset large revenue losses and contain budget deficits, even with slightly higher oil price levels than those prevailing at the time of the review. A number of GCC sovereigns have also introduced measures to boost non-oil revenues, including ambitious diversification plans, new taxes and the privatization of state-owned companies, but experience suggests that these are subject to implementation risks and will in any event take time to yield results.
We therefore expect that all GCC sovereigns – and especially Oman, Bahrain and Saudi Arabia given the magnitude of their fiscal and current account deficits – will continue to rely on debt issuance, drawdowns of fiscal reserves, or a combination of both to finance the fiscal deficits. This will result in a sustained, albeit uneven, deterioration of their net asset positions over the near term.
3. Which countries would benefit most from higher oil prices?
The recent uptick in oil prices allows for short-term improvements in GCC governments’ balance sheets by reducing fiscal deficits and slowing the build-up of government debt. Lower current account deficits as a result of higher hydrocarbon export receipts also improve external liquidity and slow the drawdown of foreign-exchange reserves and sovereign wealth fund assets. All GCC countries will face some near-term relief from the recent rise in oil prices. On average, hydrocarbons made up roughly 45 percent of GDP, 80 percent of government revenues and 65 percent of the goods exports in the region in 2014. Countries that are more dependent on hydrocarbon receipts will be more sensitive to changes in oil prices; however, our forecasts also take into account fiscal consolidation measures (or lack thereof) that have been implemented in response to the drop in oil prices by around 60 percent since mid-2014.
We assess the relative benefit of higher oil prices on the GCC countries by quantifying its impact on the fiscal and current account deficits of the GCC countries. Oil prices averaging $40/barrel this year rather than $33/barrel under our previous estimates will allow the largest fiscal and current account deficit reductions for Kuwait, Qatar and Oman, followed by the UAE, Saudi Arabia and Bahrain.
Kuwait, Qatar and the UAE are the most strongly positioned GCC sovereigns in terms of both the size of their financial assets compared to government spending and low fiscal break-even oil prices, while Saudi Arabia, Oman and Bahrain have a higher fiscal break-even oil price along with much lower financial assets on which to draw, which contributes to the ratings gap.
Oil prices averaging $40 this year will not turn fiscal deficits to surpluses in any of the GCC countries, although Kuwait and the UAE may now see a small current account surplus in 2016 (according to the IMF) given their lower external break-even oil prices, which the IMF estimates at $36.7 and $38.7, respectively. Kuwait, which relies on hydrocarbon revenues for around 90 percent of revenues, will be able to generate an additional 6 percent-7 percent of GDP in revenues annually over 2016-17 given higher oil prices, bringing its fiscal deficit down to 3 percent of GDP in 2016 and almost 0 percent in 2017, from our previous forecasts of 9.9 percent and 6.4 percent, respectively (see Exhibit 4). We project fiscal gains of around 4 percent-5 percent of GDP for Qatar and 3.5 percent-4.5 percent of GDP for Oman, and smaller but sizeable gains of 1.5 percent-3 percent of GDP for Saudi Arabia, the UAE and Bahrain over 2016-17.
Under a $40-45 oil price scenario, fiscal deficits would be considerably lower for Kuwait, Qatar and Oman. On the external side, higher oil prices will benefit Kuwait, the UAE and Oman the most by reducing the current account deficits by an average of 4 percent-7 percent of GDP (with Kuwait facing the largest gains), followed by Qatar, Saudi Arabia and Bahrain. Under our previous oil price assumptions, we expected Oman to face the largest fiscal and current account deficits in the GCC of around 19 percent and 23 percent of GDP, respectively, in 2016, but we now forecast lower deficits of 15 percent and 18.5 percent. For Kuwait and the UAE, we now expect a turn from current account deficits to small surpluses in 2017.
Under a $40-45 oil price scenario, current account deficits for Kuwait, the UAE and Oman would improve the most. However, the slight rebound in oil prices will only partly compensate for the overall oil price slump for Oman, Bahrain and Saudi Arabia, and imbalances will remain considerable. The weaker credit profiles of these three GCC countries are characterized by the larger borrowing requirements and lower financial buffers. These countries are also more susceptible to short-term price swings that could impair liquidity. We expect their fiscal and external deficits to persist beyond 2017. Their respective policy roadmaps will influence their ability to attract external funding, maintain investor confidence and minimize the impact of adjustment measures on growth and domestic liquidity.
The credit profiles of Qatar, Kuwait and the UAE remain strong despite the oil price drop mainly due to the availability of large fiscal buffers, which allow more room to adjust without large increases in debt. Higher oil prices would give these countries more time and fiscal space to formulate effective policy responses to absorb deficits. We expect these three countries to post smaller fiscal deficits in 2016-17, which could turn to surpluses from 2020 onwards.
4. Will higher oil prices affect the reform momentum?
During our rating review of 18 oil-exporters, including the GCC countries, we looked at each sovereign’s institutional capacity to implement an effective response to low oil prices. Most GCC sovereigns have outlined policy measures including subsidy reforms, new taxes and structural reforms intended to diversify the economic base. However, the significant challenges of responding to the oil price shock, lack of clarity around specifics and implementation risks prompted us to assign negative outlooks to even the strongest GCC countries and downgrade three of the six countries’ ratings. We believed then, as we do now, that socio-economic factors risk constraining the ability of governments to formulate and to implement policies that support economic diversification and growth without exhausting fiscal and external buffers.
Kuwait is challenged by its long and burdensome executive and legislative processes that have long hampered policy implementation – for instance, it was the last GCC country to announce fuel subsidy reforms (it did so only in August 2016, and the measures will be implemented in September).
However, it faces less pressure to reform given an extraordinarily high level of financial buffers of over 500 percent of GDP. On the other hand, Oman has greater fiscal challenges and lower buffers, and faces high institutional and social constraints due to the highly concentrated decision-making process and succession risks, and relatively lower GDP per capita levels. Our assessment of institutional strength is also weaker in Bahrain and Saudi Arabia than it is in Qatar and the UAE and where the social impact of fiscal reforms is most likely to hamper policy implementation.