Fitch Revises Saudi Arabia's Outlook to Negative; Affirms at 'AA'
KEY RATING DRIVERS
The revision of the Outlook on Saudi Arabia's IDRs to Negative reflects the following key rating drivers and their relative weights:
Twin fiscal shocks are forecast to cause a significant deterioration in the fiscal position. Lower oil prices and increased spending associated with the accession of a new king are forecast to widen the general government deficit to 14.4% of GDP in 2015. The policy response has been limited and primarily consists of a reduction in capital spending that will take time to gain traction. Deficits in the mid-single digits are forecast for 2016 and 2017, assuming reduced capital spending, the absence of new one-off outlays and a gradual recovery in oil prices. Deficits would likely stay in double digits if there was no consolidation. Transparency on fiscal policy and outturns is a weakness relative to rating peers.
We expect deficit financing to erode Saudi Arabia's substantial buffers, a key support for its rating. Drawing down government deposits at the central bank has accounted for virtually all deficit financing so far in 2015. In July, the government held its first bond auction since 2007. Monthly issuance is planned from August for the rest of 2015. Fitch assumes regular further issuance over our forecast period to 2017. Deficit financing and the drawing down of deposits ring-fenced for specific projects is forecast to reduce the government's net creditor position to 36.4% of GDP at end-2017 from 54.2% at end-2014. Nonetheless, Saudi Arabia will still rank as one of the strongest net creditors of any Fitch-rated sovereign at end-2017.
Sovereign net foreign assets (SNFA) will remain well above the peer median, but the level and trajectory compare unfavourably with regional peers Abu Dhabi, Kuwait and Qatar. A drawdown will pull SNFA to a forecast 84% of GDP at end-2017, versus an average of 191% of GDP for other 'AA' rated GCC peers. In 2015, lower oil prices are forecast to cause the first current account deficit since 1998. Higher oil prices and spending adjustment should return the account to surplus in 2016. Fitch does not foresee any change to the exchange rate peg to the dollar, which provides a key policy anchor, even though it constrains policy flexibility.
Saudi Arabia 'AA' IDRs also reflect the following key rating drivers:
The appointment of a Crown Prince from the third generation of the royal family should end uncertainty on the line of succession for a prolonged period. New, relatively young ministers, with private sector experience have been brought into the government in reshuffles. Fitch considers exposure to geopolitical risk to be higher than peers given the Kingdom's prominent role in a volatile region. Saudi Arabia is heading a coalition that has launched military strikes against Houthi forces in neighbouring Yemen from March 2015. Several attacks attributed to ISIS have caused multiple fatalities in recent months.
Real GDP growth is in excess of peers, although it has eased in 2015. Non-oil growth slowed to 3.3% in 1Q15, compared with an average of 7.2% in the five years to 2014, although it continued to outpace oil sector growth. Higher oil production will support headline growth in 2015. Fitch assumes fiscal consolidation will dampen growth over the forecast period, although major new industrial projects and rising consumer spending will underpin non-oil growth of around 4%. Cutbacks in public spending will potentially test the resilience of the private sector. Oil production is forecast to remain flat.
The economy is heavily dependent on oil, which accounts for 90% of fiscal revenues, 80% of current account revenues and 40% of GDP. Spending of oil revenues is a key driver of the non-oil economy. Oil reserves are large, production costs are low and the Kingdom maintains substantial spare capacity. In mid-2015 production, at 10.4m b/d, was around an all-time high, in part reflecting new export refineries.
Progress continues on addressing unemployment and a shortage of affordable housing, both of which Fitch considers potential economic sources of social discontent. Saudi employment in the private sector has risen, with nationals accounting for 15.3% of private sector positions at end-2014, the highest for at least a decade. Measures have been introduced to enhance access to residential real estate and financing, but it is taking time for new housing stock to enter the market.
The banking sector is a strength relative to peers, with Saudi Arabia ranked 'a' on Fitch's banking system risk indicator. This is the strongest of all GCC members, in line with a number of mature advanced economies, and below only 'AAA' rated Australia, Canada and Singapore. Non-performing loans were 1.1% at end-June 2015 and coverage was 163%. Capital adequacy is high, at 19.1% at end-2015, and the system is well regulated.
Structural indicators are generally weaker than peers, despite recent significant improvements in some areas. GDP per capita and World Bank governance indicators are well below peer medians. According to the World Bank measure, voice and accountability is the lowest of all rated sovereigns.
The main factors that, individually or collectively, could lead to negative rating action are:
- The absence of an effective fiscal policy response to the lower oil price environment.
- Continued erosion of fiscal or external buffers.
- Spillover from regional conflicts or a domestic political shock that threatens stability or affects key economic activities.
The main factors that, individually or collectively, could lead to positive rating action are:
- Fiscal consolidation sufficient to stem the depletion of fiscal and external buffers and put the budget on a path to a surplus.
- A sustained period of higher oil prices.
The ratings and Outlooks are sensitive to the following assumptions:
Fitch forecasts Brent crude to average USD65/b in 2015, USD75/b in 2016 and USD80/b in 2017.
Fitch assumes that Saudi Arabia will not be materially affected by any of the conflicts in the region and that the domestic political scene will remain stable.