x Abu Dhabi, UAEThursday 27 July 2017

Gulf credit risk under scrutiny after the storm

For other Gulf nations, the most important factor with Dubai's debt restructuring is how it will affect their ability to borrow from international financial markets.

For other Gulf nations, the most important factor with Dubai's debt restructuring is how it will affect their ability to borrow from international financial markets. Sovereign risk assessment is back with a vengeance and it is no longer enough to borrow as though the funding was endless and on easy terms. The immediate reaction of the rest of the world to the Dubai restructuring was predictable - higher rates for credit default swaps (CDS), the abandonment of some global bond launches such as Gulf International Bank's dollar bond, and a general reassessment of Gulf credit risk.

Coming after defaults by Saudi family businesses such as the Saad and Al Gosaibi groups, it has been a bad time for Gulf financial market confidence. But Dubai and the Gulf are not that easily written off. Dubai is no Iceland. It has assets, including a sizeable sovereign wealth fund. Predictably, Standard & Poor's Ratings Services downgraded its credit rating on some of the big Dubai Government-related companies in March and again after Dubai's announcement last week. It had assumed that the government would stand behind these entities, an assumption that now seems to have been over-optimistic.

Everyone also assumed that Abu Dhabi would make sure there was no hint of default. That was over-optimistic too. One unanswered question arising from the events is whether Abu Dhabi had any inkling of what Dubai was planning when it announced its debt restructuring. The credit rating agencies are not all-seeing, all-knowing bodies, but are staffed by mortals who try to see the financial forest despite the trees.

The agencies take in a huge amount of data when assessing a country, going far beyond the actual size of the debt and rate at which it is being added to or paid down. There are many difficulties, such as the rear-view mirror problem: that the agencies have to work with the data they have got, and that things change. And when it comes to a country rather than a company, it is not just about accounting: political will is crucial. Companies are different, as they can go broke in a way a sovereign country cannot.

One benchmark about the health of sovereignty has been the recent obsession with the size of sovereign wealth funds. The largest sovereign fund is Abu Dhabi's, a critical factor in the bigger picture for those who contemplated lending to Dubai. Even in this ranking, Dubai did not do so badly, as it ranked number 10. This also contributed to the mistaken assumptions that any country with a large pile of assets would be a secure borrower.

However, as the turn of events in Dubai has vividly illustrated, even countries that do build up such funds and have a strong asset position can still run into trouble if they mismanage the debt side of their balance sheet. Norway's and Singapore's sovereign funds are rare exceptions. After the debt restructuring announcement by Dubai, the Gulf will see a move to differentiate the good assets from "risky" assets. Indeed, Dubai did this by excluding DP World from the restructuring.

But markets take time to adjust and differentiate between good and bad assets, or "good credit" and "bad credit". Dubai's five-year CDS spreads are at three-month highs, and there is further upside risk. The increase in the cost of credit is not only going to hurt governments, but also private-sector companies. And corporates in the region that were also preparing to tap into the international bond market might now defer their plans until risk is readjusted for the entire region.

The tenor of borrowing is now also a consideration for borrowers in the light of Dubai's mistaken assumption that maturity did not matter, as it could always be rolled over. The Dubai debt restructuring comes shortly after Qatar, the world's top exporter of liquefied natural gas, sold US$7 billion (Dh25.71bn) in bonds last month, subscribed mainly by investors in the US and UK. Qatar did this on the basis of low leverage and debt.

In the longer term, the issue of debt will be a key one for the Gulf countries and how they are perceived by rating agencies, as global investors will need to differentiate between those Gulf economies that are debt-burdened and those whose leverage levels are low by global standards. For example, Saudi Arabia, the world's biggest oil exporter, has among the lowest levels of public debt in the Group of 20 leading and developing economies, with domestic debt levels at 13.4 per cent of GDP last year versus 50 per cent in the US. It also holds foreign assets of 1.46 trillion riyals (Dh1.43tn), most of which is held in low-risk, liquid investments.

There will be a flight to quality, with foreign funds favouring Saudi Arabia, Qatar and Abu Dhabi. Abu Dhabi is bound to suffer from the Dubai fallout in the short term, but it is expected that the capital will be in a position to overcome any risk-profile pressure. The Al Gosaibi and Saad defaults forced creditors to reassess the risks involved with lending to different entities and to categorise them accordingly. Corporates that are willingly more transparent will begin to reap the benefits of finance from within the region and outside.

In a similar way, Dubai's debt problems will compel creditors to re-categorise sovereign risk. Its entities will have their work cut out to bring back confidence on the state-enterprise model of Dubai, which is based on high leverage and a constrained income base. Dr Mohamed A. Ramady is a former banker and currently a visiting professor of finance and economics at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia