One of the more notable global economic trends observed during the second half of 2014 was the sustained slide of oil prices. After trading above the $100 mark since 2011 and starting 2014 around $110, from August 2014 Brent North Sea Crude began a decline, which saw it dip below $70 by early December 2014 and end the year at $56. Naturally, attention turned to hydrocarbons-fuelled economies in the GCC and elsewhere, with analysts running through fiscal budgets, crosschecking estimated break-even prices and attempting to divine the final destination of the trend. For Abu Dhabi, however, this has not been a significant concern, and in October 2014 the ratings agency Standard & Poor’s (S&P) demonstrated its confidence in the emirate’s economy by keeping its long-term debt rating at “AA” with a stable outlook, stating in its rationale that falling oil prices would not threaten Abu Dhabi’s fiscal or current account surpluses.
Stable Ratings
All three of the major rating agencies have maintained their favourable assessments of the Abu Dhabi economy over the past year. S&P credited its decision to affirm both its long-term and short-term ratings (which stands at “A-1+”) to the emirate’s “strong fiscal and external positions, which afford it fiscal policy flexibility. The exceptional strength of Abu Dhabi’s net asset positions also provides a buffer to counter the negative impact of oil price volatility on economic growth and government revenues, as well as on the external account.” The government was also credited with strengthening its oversight of public sector debt and making efforts to ensure the financial stability of the economy.
This is in large part a reference by the agency to the work of the Debt Management Office, which oversees sovereign and quasi-sovereign debt issuance and reports directly to the Abu Dhabi Executive Council, and the Financial Stability Unit, which has been established within the Central Bank of the UAE to examine the macroeconomic situation of Abu Dhabi and the wider UAE. Looking ahead, S&P sees continued economic growth based on high public spending, rising oil production and a broadening of the economy’s production base into growth areas such as services and manufacturing.
Fitch, meanwhile, offers a similar argument for its affirmation of the emirate’s “AA” long-term and “F1+” short-term sovereign rating. The company notes that Abu Dhabi’s external sovereign balance sheet is estimated to be the second strongest of all countries rated by the company, and that sovereign net foreign assets at the close of 2013 were sufficient to cover five years of government spending. It also highlights the growing role played in the economy by the non-oil sector, and anticipates that its growth will remain buoyant thanks to continued project spending and positive domestic sentiment. Moody’s, in its assessment of Abu Dhabi’s economy, highlights the government’s prudent management of the emirate’s oil reserves. Granting Abu Dhabi sovereign long-term debt an “Aa2” rating, Moody’s places it in the same bracket as countries such as Norway, Singapore and Switzerland. Again, the government is lauded for playing a central role in Abu Dhabi’s economic development, with the agency pointing out that it has spent in the region of $160bn over the past five years on infrastructure projects. Future economic growth, according to the agency, will be driven by high hydrocarbons processing and the emirate’s continued economic diversification.
Oil Prices
Oil prices will certainly remain of key interest to the ratings agencies over the coming year. S&P predicates its growth forecast for Abu Dhabi on a price of around $100 per barrel in 2016 and beyond. Fitch refers to the possibility of falling oil prices over the coming year. For example, it foresees an oil price of around $95 per barrel by 2016, and takes into account the negative effect this will have on government revenues. Nevertheless, it anticipates that Abu Dhabi will comfortably maintain its long record of current account surpluses, forecasting a surplus of 7.6% of GDP in 2016 (down from the approximately 16% of GDP seen in 2013).
Consequences
Since the global economic crisis of 2008-09, the relationship of sovereign ratings and the cost of debt has become a prominent issue in financial circles. After all, while the mechanisms that underpin bond pricing are some of the more opaque aspects of the debt markets, research has demonstrated a linkage between sovereign risk and corporate risk, particularly for companies with revenue structures largely based within the country and those that are owned, or partially owned, by the government. Better sovereign ratings, it has usually been found, are associated with lower spreads for sovereign debt – although this is not an iron rule, as the downgrade of the US by S&P from “AAA” ( outstanding) to “AA+” (excellent) in 2011 famously demonstrated that rather than falling in price, Treasury bonds gained in value while the dollar rallied against the euro and the pound sterling.
Nevertheless, an IMF working paper on the issue has pointed to a number of studies that suggest a one-notch upgrade can reduce spreads on sovereign debt by an average of 14% (or 70 basis points for an initial spread of 500 basis points). Indeed, for an emerging market with the characteristics of Abu Dhabi, a high sovereign rating is a valuable asset when it comes to issuing debt, and the emirate’s current rating status certainly places it at the right end of the scale. Indeed, all of the major agencies rate Abu Dhabi comfortably above the bar for investment grade asset class, which is “BBB-” or above for S&P and Fitch, and “Baa3” or above for Moody’s.
Even so, the question of sovereign debt issuance, and the importance of sovereign ratings to it, remains a moot one in Abu Dhabi. The most recent sovereign issuance by the Abu Dhabi government came in April 2009, with the successful offering of a five-year, $3bn bond. This offering came on the back of two similar five-year sovereign issuances, and together with them formed the beginnings of a yield curve by which subsequent corporate offerings might be made. The development of a vibrant primary and secondary debt market in Abu Dhabi and the wider UAE would bring manifold benefits, most obviously in acting as an alternative source of funding for the emirate’s growing companies, which presently rely on lending by banks. Yet, despite ongoing press speculation, the 2009 offering has yet to be followed up, and this dearth of sovereign issuances has had a negative effect on the growth of the corporate debt market, which in turn, in the eyes of some, has acted as a brake on the emirate’s growth.
Financial forecast
Therefore, should Abu Dhabi decide to issue more sovereign debt in order to establish a yield curve, it would not be the first nation with large fiscal surpluses and no real borrowing requirements to do so. That said, while the financial community does await this possibility, both the national and emirate-level authorities have over the past year made a considerable effort to boost the incipient debt market through regulatory change (see Capital Markets chapter).
Despite the lack of sovereign issuances in recent years, the high-quality sovereign ratings enjoyed by the emirate are certainly a welcome endorsement of Abu Dhabi in its own right. All three major agencies base their findings on not only the obvious macroeconomic indicators, such as external public debt, domestic public debt, broad money and exports, but also on a range of social and political factors.
The attainment of a high rating should therefore be regarded as representing an overall vote of confidence in Abu Dhabi, including potential political risk, rather than a straightforward sounding of major economic indicators alone. This could have ramifications for all kinds of economic activity in the emirate, from trade to foreign direct investment. As a result of this outlook, the forecast for decreased oil prices will not be a major concern for the emirate.
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