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Gulf capital markets entering period of continued turbulence
By Saudi Gazette Staff
Published in The Saudi Gazette on 10 - 06 - 2009

“Despite a recent modest recovery of cross border bond issuance, the Gulf capital markets continue to suffer from the turbulence in global capital markets with defaults on the rise, and we expect a challenging credit environment for 2009,” said Jan Willem Plantagie, Middle East Regional Manager at Standard & Poor's.
Standard & Poor's said in its fourth annual Gulf Cooperation Council Credit Survey released on Tuesday the challenging credit environment will continue to put pressure on some ratings and the number of ratings below ‘BBB-' is increasing. Nevertheless, the efforts to develop deep, mature, and sophisticated capital markets require strong transparency, risk management, and corporate governance. S&P said that in developing the capital markets, ratings provide an important information tool for market participants.
“Efforts to develop deep, mature, and sophisticated capital markets require strong transparency, risk management, and corporate governance. We believe that, in developing the capital markets, ratings provide an important information tool for market participants,” Plantagie said.
The recent turbulence in global capital markets has affected the Gulf significantly, and in 2009 S&P said it expects the challenging credit environment to continue. Although the regional bond and loan markets came to a virtual standstill in the second half of 2008, successful rated sovereign bond issuance from the State of Qatar and the Emirate of Abu Dhabi provided a glimmer of hope in early 2009.
However, despite the weak credit markets, the S&P ratings universe has continued to grow. The larger telecom entities in the region - Saudi Telecom, Etisalat, and Qatar Telecom - are now rated. In addition, the Abu Dhabi-based commercial government entity Mubadala Development Co obtained a rating as did the Tourism Development and Investment Co of Abu Dhabi. S&P also added the sovereign rating on Ras Al Khaimah and several new insurance ratings were assigned. The ratings performance of GCC sovereigns has been strong, primarily reflecting S&P's view of their strengthening balance sheets and sound macroeconomic and fiscal policy.
Since 1996, there have been 14 upgrades on GCC sovereign ratings, an average of three notches per credit if we exclude Abu Dhabi and Ras al Khaimah, which S&P started rating relatively recently. It has undertaken no downgrade of any GCC sovereign to date. The average rating of GCC countries currently stands at ‘A+', with four sovereigns rated in the ‘AA' category.
The outlook for all GCC sovereigns is currently stable, although S&P said it believes significant challenges lie in wait in 2009.
These relate mainly to managing the impact of the downturn in the global economy, and from the associated fall in crude oil prices, upon which most GCC economies are highly dependent.
The reduction in global liquidity has reduced the ability of GCC entities to raise financing in international capital markets, particularly for GCC-based corporates and banks. According to BIS (Bank of International Settlements) data, these GCC entities had become increasingly reliant on international financing, with the amount of debt issued in international markets increasing by a factor of around nine since 2005, peaking at almost $85 billion in September 2008.
A similar pattern is evident with respect to borrowing by GCC entities from international banks, which is on a greater order of magnitude than their debt issuance. “We can expect the dip in both forms of financing seen in December 2008 to continue in 2009, as it is likely global markets and risk appetite will remain subdued relative to the past few years, notwithstanding recent successful global bond issues by the governments of Abu Dhabi and Qatar,” the report said.
While the credit crunch has hit the liabilities side of GCC countries' balance sheets, S&P said it believes the fall in global asset valuations, including in domestic GCC capital and real estate markets, has had a significant and detrimental effect on the value of their assets, resulting in lower net asset positions and higher contingent liabilities for GCC sovereigns.
Sovereign wealth funds (SWFs) across the region, but particularly in Qatar, Abu Dhabi, and Kuwait, have seen significantly negative returns on their sizeable foreign asset holdings over the past 18 months. While still very strong, the implied reduction in government net asset positions is nonetheless an erosion of one of the key credit strengths for these sovereigns.
A notable exception to this has been Saudi Arabia, whose foreign assets have been managed by the Saudi Arabian Monetary Agency (SAMA). The value of Saudi Arabia's net foreign assets has risen to almost $440 billion by end-2008, from $300 billion the previous year.
Saudi Arabia's benchmark edged up 0.06 percent to 5,881.74 points on Tuesday. Saudi Basic Industries Corp rose 1.4 percent.
The fall in global asset valuations has also affected the sub-sovereign sectors, particularly banks and other financial institutions, whose exposures to real estate and equity have caused them to make significant write-downs on their investment portfolios in recent months. Different countries have taken different approaches to shore up the capital positions of their financial sectors.
A combination of low oil prices and a decline in oil production will have a significant impact on fiscal outturns across the GCC. We can expect that the average GCC government balance will be barely positive in 2009, compared with surpluses in the order of 23 percent of GDP in the previous three years. Saudi Arabia is expected to fare the worst, as a combination of increased expenditure and reduced revenues will, according to S&P, result in a deficit of around 7 percent of GDP.
That said, a weakening in fiscal outturns is not necessarily a harbinger of deteriorating creditworthiness.
In most cases, GCC countries have opted for a deliberately expansionary fiscal policy in order to counter the impact of the global economic downturn on the non-oil economy. Unlike in previous oil prices cycles in the 1970s and 1980s, GCC policy makers have by and large chosen to smooth government expenditure, which is a critical driver of the non-oil economy, opting to increase expenditure mainly in infrastructure projects.
Saudi Arabia, for example, has opted to increase government expenditure by 16 percent, focusing on infrastructure spending, which will rise in 2009 by some 36 percent, the largest ever increase in infrastructure spending in that country.
Similarly aggressive expansionary policies with a focus on infrastructure are evident in Abu Dhabi, Qatar, Oman, and Bahrain.
One exception to this has been Kuwait, whose budget for 2009/2010 envisages a substantial 36 percent decline in expenditure.
While the majority of this decline is related to the exclusion of a one-off payment on social security that occurred in the previous year, it is notable that the budget still calls for a 27 percent decline in capital expenditure. Kuwait's fiscal policy therefore stands out as containing the least stimulus for the non-oil economy, although at the same time the fiscal balance is expected to be in surplus in 2009 as a result.
Further supporting GCC sovereign creditworthiness in the face of a deterioration in fiscal outturns is the view that GCC governments have exceptional fiscal space to implement such a policy.
Based on analysis of the number of years each of the GCC states can sustain a 10 percent of GDP fiscal deficit without resorting to borrowing, given the expected level of their assets (minus outstanding debt) in 2009.
According to this metric, Bahrain and Oman are in the least comfortable positions, as their oil resources are more limited than other GCC states and they have therefore benefited relatively less from the windfall in high oil prices in terms of accumulation of assets. This relative weakness is reflected in the ratings on both countries, the lowest among GCC sovereigns. __

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