Saudi credit rating still too high despite S&P downgrade

By:
Jeremy Weltman
Published on:

Depressed oil prices are sending shockwaves through the Kingdom as it looks at ways to mitigate the macro-fiscal implications.

Saudi flag-R-600
Saudi Arabia's national flag at the border with Yemen, home to the Houthi rebels


Saudi officials reacted with horror to S&P’s downgrading of the Kingdom’s sovereign credit rating.

The one notch reduction to A+ in October was unjustified, they claimed, citing the higher ratings awarded by Fitch (AA) and Moody’s (a stable Aa3) as more accurate reflections of its creditworthiness.

They have a point.

Saudi Arabia has ample foreign-exchange reserves and other net assets worth more than the Kingdom’s GDP.

It can certainly handle temporary periods of distress.

However, Saudi Arabia is one of the few countries in Euromoney’s country risk survey to have endured a downgrading of all of its 15 economic, political and structural risk factors this year.

Its country risk score has slipped 1.5 points to 63.2 out of 100, and a one place fall in the global rankings to 35th out of 186 countries has seen it slip into the third of five tiered categories, which is equivalent to a BB+ to A- rating.

That is lower than its actual credit rating, and would also rank Saudi below Oman, which S&P presently has rated BBB+, also recently downgraded from A-.

 

Multifaceted rise in risk

That the risks have increased is undeniable.

Worst affected is the government finances indicator, but also government stability, given that the change of leadership and new appointments have alienated members of the ruling family, and risk allowing a power struggle to develop.

The Kingdom is embroiled in the regional conflagration, taking up arms against the Iranian-backed Houthi rebels in Yemen as the Sunni-Shia conflict flares, adding to its political risks.

Meanwhile, property-market regulation constraining sales has pushed up rentals, contributing to fairly high inflation by Saudi standards.

Almost all of Saudi Arabia’s economic and political risk indicators score less than Oman’s:

 

Experts taking part in the survey have also taken on board the Kingdom’s pursuit of market share rather than oil prices, and the impact on fiscal indicators, which now makes reforms doubly urgent.

The oil price fall has blown a huge hole in the fiscal balance, delivering a 20%-of-GDP deficit this year, to be financed by domestic debt issuance and drawing on reserves.

The debt accumulation – reaching 30% of GDP by 2020, and reserves falling to 65% of GDP by then – is well short of a disastrous projection, but that assumes the authorities do not need to use additional assets to lend further support to the currency peg.

The problem is no one knows how long low oil prices will last, or indeed whether they will fall further given the prospect of a continuing supply-demand imbalance.

"As 90% of Saudi Arabia’s budget resources stem from oil, the fiscal balance is a critical issue amidst the plunge in oil prices," says Riwa Daou, part of the economics team at BlomInvest Bank.

An overhaul of the economy means simultaneously lowering public expenditure and diversifying the Kingdom’s sources of wealth.

Yet entrenched resistance is inevitable, with most departments still requesting huge increases in spending, and King Salman showering the civil service with higher salaries.

James Reeve, deputy chief economist at Samba Financial Group, expects overall fiscal spending to fall slightly in 2016 for the first time since 2002, as salaries, energy subsidies, inefficiencies and waste are reviewed. The IMF is calling for the introduction of VAT as well.

The deficit will still be around 18% of GDP next year, but Reeve says: "From 2017 onwards the fiscal position is set to improve as subsidies on oil consumption are gradually lifted and as the recovery in oil prices becomes more meaningful."

The banks should be able to easily absorb the debt issuance, but fiscal cutbacks will invariably harm economic growth, which is manifested in government contracts under review.

Samba predicts GDP growth will slow from 3.1% (real terms) this year to just 0.6% in 2016.

Saudi investors should be watching closely.

This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.