Societe Generale experts lay out case for caution for the months ahead
GCC sovereigns must keep up with structural reforms to retain strong credit ratings
Member countries of the GCC have traditionally been among the strongest rated sovereigns, maintaining very low debt levels thanks to oil-related fiscal revenues.
The credit profiles of GCC sovereigns remain strong, and the lower oil price environment since 2015, has triggered the sort of crisis which could generate great future opportunities if managed correctly: in other words, through the implementation of deep structural reforms.
International rating agencies provide a key indicator of sovereign creditworthiness and their opinions influence investor decisions and affect the cost of sovereign debt. The “big three” rating agencies (Moody’s, S&P and Fitch) have already reflected the deteriorating credit outlook in the region with 21 rating downgrades among GCC sovereigns since September 2014.
Agencies maintain "negative outlooks" on several sovereigns, indicating the likelihood that more downgrades will follow for countries that do not take sufficient corrective action. Rating opinions are likely to become more relevant as GCC sovereigns access the international capital markets more frequently in order to finance fiscal gaps that are no longer fully covered by oil-related fiscal revenues. Already since January 2015, when oil prices tumbled to average US$40 a barrel, GCC sovereigns have borrowed a record $81 billion in the international capital markets.
In this more volatile environment, protecting their sovereign ratings should become a key objective for GCC governments. They must develop and train internal resources able to interact with rating agencies and investors in their own language, and they must seek expert advice to help them navigate through the nuances of rating agency methodologies and investor perceptions at a time of extraordinary changes. While each country in the Arabian Gulf is affected differently, they all share the need to implement reforms that will secure high standards of living for the future, as well as guarantee social and political stability. Those countries which fall behind in the implementation of these necessary reforms will be under the scrutiny of markets and rating agencies and might eventually have to hear the cost of more expensive financing.
The policies that will protect GCC sovereign ratings from further downgrades (and eventually position them for future upgrades) will be different from country to country, but material progress in the following four areas will contribute to strengthen sovereign credit profiles across the region:
1. A comprehensive fiscal review with the triple objective of reducing current spending, applying stricter financial viability checks on public investment and replacing fiscal oil revenues with less volatile tax revenue sources. It is fair to say that most governments in the region have made at least some progress in this area. Subsidies have been cut; fuel prices increased; capital spending postponed and new taxes (mainly a 5 per cent value added tax) are about to be introduced.
2. A programme to strengthen institutional capacity by developing independent regulatory, statistical, budgeting and auditing bodies within the respective public sectors. Traditionally, institutional depth in the GCC region has been limited by centralisation and by the cushion afforded by high fiscal surpluses. As conditions change, markets and rating agencies will welcome gradual improvements in transparency and accountability of public sector.
3. Increasing productivity in order to raise non-oil growth and to strengthen external current accounts in an environment of low hydrocarbon prices. As is the case with all the other goals, increasing national productivity is a long-term process requiring deep structural reforms carried out over years. We are confident that the current crisis will provide the incentive to accelerate the clock with regards to key reforms to liberalise trade and transportation, reduce labour market constraints, open up key sectors of the economy and privatise parts of the extended public sector.
4. Implementing prudent principles of public debt management: conservative financial policies mean that GCC sovereigns have a solid net external asset position accumulated over a decade of high oil prices. However, the appearance of fiscal and external gaps since 2013 has forced governments to access global debt markets in order to protect their external asset balances. Building up a manageable stock of public debt is not by itself a reason for a credit rating downgrade (let us remember that even after three years of strong increases, GCC public debt represented 21 per cent of the region’s GDP in 2016, compared to 50 per cent for the average of “AA” rated sovereigns and to 89 per cent for eurozone sovereigns). But as debt burdens increase, markets and rating agencies will expect GCC sovereigns to develop new risk management skills.
To summarise, the GCC countries have shown strong resilience to economic downturns in the past and although this one is of a more structural and sustainable nature, they all have the capacity to draw on their experience, resources and expert partners to find a way forward to protect their credit worthiness.
Richad Soundardjee is the chief executive of Societe Generale Middle East and Jaime Sanz is the managing director for sovereign advisory, Societe Generale