Fitch Revises Qatar's Outlook to Stable

 
Ritz Carlton Hotel in Doha, Qatar

On this date last year, a heavy blocade was imposed on Qatar. Today, Fitch upgraded its rating of Qatar from Negative to Stable affirmed its Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA-'.

KEY RATING DRIVERS

The revision of the Outlook to Stable reflects the following key rating drivers: Qatar has successfully managed the fallout from last year's rupture of trade, financial and diplomatic relations with the Quartet consisting of the UAE, Saudi Arabia, Bahrain and Egypt. Public sector liquidity injections have stabilised the banking sector and stemmed the outflow of non-resident funding. The fiscal deficit has narrowed sharply and we expect it to turn into a surplus in 2019. The economy has reconfigured its supply chains and continues to grow at a robust pace. There has been no escalation of measures against Qatar.

Around USD10 billion in non-resident funding has flowed back into the banking system since November 2017, after falling by USD30 billion in June-October 2017, mainly due to withdrawals of deposits by Saudi Arabia and UAE-based clients. A return of non-resident funding has allowed the public sector to pare back its liquidity assistance to the banking sector by USD10 billion in January-April 2018, from cumulative injections of USD40 billion in June-December, consisting mainly of placements by the Central Bank, the Ministry of Finance, and the Qatar Investment Authority (QIA).

We estimate that sovereign net foreign assets (reserves plus other government assets less external debt) were USD236 billion (141% of GDP) in 2017, down from USD250 billion in 2016 but still far above most 'AA' and 'A' peers. The decline is driven by a reduction in official Central Bank reserves to USD15 billion as at end-2017, down from USD32 billion at end-2016. We estimate other government external assets at around USD270 billion as at end-2017, little changed from 2016 and mainly in the QIA. Strong asset market returns are estimated to have offset much of the impact on QIA external assets from repatriating liquidity into Qatar's domestic banks.

The government fiscal deficit narrowed to 2.8% of GDP in 2017 from 6.3% of GDP in 2016, including the estimated investment income on the QIA, as falling spending offset weakness in hydrocarbon revenue (which reflects price movements with a lag). The immediate budgetary costs of the boycott appear to have been minimal and mostly relate to forgone revenue from the postponement of excise tax and VAT implementation. The spending decline was led by a 20% drop in capital spending, with the government not having to make payments for some project milestones that had slipped. Current spending also fell.

We expect the government budget to be balanced in 2018 and to post a surplus of 2.9% of GDP in 2019 as higher oil prices seep through to public finances, excise tax and VAT are implemented in 2019 and growth in current spending is restrained. We expect capital spending to bounce back in 2018 and plateau at QAR100 billion per year in 2018 and 2019.

Our forecasts for the government budget are based on a baseline Brent oil price assumption of USD57.5/bbl (in line with our March 2018 Global Economic Outlook). We estimate that a USD10/bbl increase in oil prices could lead to an improvement in the fiscal balance of around 4% of GDP relative to our forecast, all other things equal.

There are prospects for further medium-term improvements to public finances. Government infrastructure spending is likely to moderate after 2020, even if (as we expect) the government adds some new projects to the pipeline in order to sustain non-oil economic activity. This should help offset the fiscal effect of additional capital spending by Qatar Petroleum in 2020-2022 related to the planned 20% expansion of LNG exports from the North Field. The government faces less pressure to increase public sector employment and maintain social benefits than many of its regional peers, given the small number and high level of wealth of Qatari citizens (only a small fraction of Qatar's total population).

Real GDP expanded by 1.6% in 2017, and we expect a pick-up to 2.3% in 2018. Non-hydrocarbon GDP grew by 4.2%, down from 5.2% in 2016. Imports have recovered to their pre-June 2017 levels, reflecting the establishment of new shipping routes through Oman and India to Qatar's recently-opened Hamad port.

The government's narrow tax base means revenues depend far more on hydrocarbons than on the rest of the economy, but steady economic performance will allow the government to press on with fiscal reforms and reduce the need to support the private sector.

The tail risks of military confrontation or a blockade hitting Qatar's gas exports have receded, helped by the clarification of the US's stance. Domestically, support for the Emir and the government appears to have strengthened. Attempts by the Quartet to force companies or countries to pick sides in the dispute have not gained much traction, beyond the decisions by some banks to scale back their activities in Qatar.

Qatar's 'AA-' ratings also reflect the following key rating drivers:

The country's large banking sector relies heavily on non-resident funding and has concentrated exposures to a weak domestic real estate sector, which had been facing falling prices and overcapacity even before the Quartet's economic boycott. The central bank's real estate price index was down 9.3% yoy as of March 2018, having picked up slightly since January. The CPI sub-index for housing expenditure was down 4.5% in April, reflecting falling rents. Nevertheless, for now, banking sector profitability is sufficient to absorb foreseeable pressure on funding costs and asset quality, and capitalisation levels remain adequate.

Government debt rose to 58% of GDP in 2017, above the 'AA' median of 42% of GDP, and a 27% of GDP increase over 2014, including T-bills and government overdrafts with local banks. The government borrowed heavily from domestic banks in 2017, while maintaining government and broader public sector (QIA) deposits in them. In our view, this reflected the government's desire to not formally draw down on the QIA or borrow abroad while the market conditions facing Qatar remained relatively unfavourable. As a result, deposits from the QIA and other public sector entities effectively funded bank lending to the government. As non-resident inflows returned, the government used overdraft facilities to engineer a withdrawal of liquidity support.

Qatar's government will have little need to seek new international financing after a USD12 billion international bond issue in April 2018, which will cover its net financing requirement for 2018-2019. Despite the issuance, we expect the debt ratio to be broadly stable in 2018, as the government will reduce overdrafts to regular levels.

Although Qatar's dispute with neighbours has not escalated, it appears no closer to being resolved and highlights Qatar's relative vulnerability to regional geopolitical shocks. Kuwait's mediation efforts appear to have stalled, while calls from the US for a resolution have not produced results. The UAE and Qatar have accused each other of airspace violations on a number of occasions, and Qatar has recently banned the import of goods from the Quartet.

Qatar's 'AA-' ratings also reflect one of the world's highest ratios of GDP per capita, balanced against hydrocarbon dependence, government debt levels above those of rated peers, and mediocre scores on measures of governance and doing business (both below the 70th percentile). Although the government has proposed reform measures to improve the business environment, including sweeping changes to the foreign ownership regime, these will take time to review and implement.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Qatar a score equivalent to a rating of 'A' on the Long-Term Foreign-Currency (LT FC) IDR scale.

In accordance with its rating criteria, Fitch's sovereign rating committee decided not to adopt the score indicated by the SRM as the starting point for its analysis because the SRM output has migrated from 'A+' to 'A', but in our view this is only a temporary deterioration.

Assuming an SRM output of 'A+', Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:
- Public finances: +1 notch, to reflect exceptionally large government assets. Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to negative rating action are:
- An escalation of tensions between Qatar and its neighbours that threatens economic and financial stability.
- A further increase in public debt, for example due to renewed widening of fiscal deficits or a materialisation of large contingent liabilities.
- A further deterioration in Qatar's external balance sheet.

The main factors that could, individually or collectively, lead to positive rating action are:
- A marked and sustained reduction in public debt.
- A substantial improvement in Qatar's external balance sheet.

KEY ASSUMPTIONS
Fitch assumes that Brent crude prices will evolve in line with its March 2018 Global Economic Outlook.

Fitch assumes natural gas prices will evolve broadly in line with oil prices.

Fitch assumes that Qatar will continue to be able to export hydrocarbons and trade with countries that are not currently party to its dispute with neighbours.

Fitch assumptions on the actual value of QIA assets are based on its top-down estimates and guidance provided by the Qatar authorities. Fitch further assumes that the majority of these assets can be monetised over time to meet liquidity needs as they arise.

The full list of rating actions is as follows:

Long-Term Foreign-Currency IDR affirmed at 'AA-'; Outlook revised to Stable from Negative
Long-Term Local-Currency IDR affirmed at 'AA-'; Outlook revised to Stable from Negative Short-Term Foreign-Currency IDR affirmed at 'F1+'
Short-Term Local-Currency IDR affirmed at 'F1+'
Country Ceiling affirmed at 'AA'
Issue ratings on long-term senior unsecured foreign-currency bonds affirmed at 'AA-'

Contact:
Primary Analyst
Krisjanis Krustins
Director
+852 2263 9831
Fitch (Hong Kong) Limited
19/F Man Yee Building
68 Des Voeux Road Central
Hong Kong
Secondary Analyst
Ed Parker
Managing Director
+44 20 3530 1176

Committee Chairperson
Jan Friederich
Senior Director
+852 2263 9910

Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email:
peter.fitzpatrick@fitchratings.com
Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email:
wailun.wan@fitchratings.com
Additional information is available on www.fitchratings.com
Applicable Criteria
Country Ceilings Criteria (pub. 21 Jul 2017)
(https://www.fitchratings.com/site/re/901393)
Sovereign Rating Criteria (pub. 23 Mar 2018)
(https://www.fitchratings.com/site/re/10024428)

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