Credit fundamentals of Mideast resilient: Moody's

The Jeddah Islamic Port off the Red Sea. Lending to the private sector in Saudi Arabia was flat in the year through December 2009. (AFP)

There were no downgrades in any sovereign ratings in the Middle East in 2009 by Moody's, which indicates a comparative resilience of the region's credit fundamentals and the sovereign ratings should "stay the course" this year, Moody's said in its first annual "Middle East Sovereign Outlook" report.

According to the rating agency, 2010 should be a year of improvement for the Middle East as a sluggish global recovery gains momentum and investor confidence rebuilds.

Moody's only sovereign rating actions in the region so far this year have been positive: the upgrade of Saudi Arabia's government bond ratings to Aa3 from A1 and Oman's to A1 from A2 based on the strong state of their government finances.

"The Middle East had a relatively 'mild crisis' in that it suffered less damage as a result of the global economic and financial turmoil of the past two years than some other regions. This stands it in good stead as the world economy recuperates," said Tristan Cooper, a Vice-President and Senior Credit Officer in Moody's Sovereign Risk Group.

"Overall, the Middle East sovereigns did not experience anything like the deterioration in credit metrics that we saw in some other regions in 2009 – most notably the advanced industrialised countries and Eastern Europe," he said.

According to the report, financial sectors in the region were not heavily exposed to "toxic" assets or failed western financial institutions during 2008 and 2009.

It attributed the limited exposure to conservative central bank regulation in many countries and partly because the banking sectors of some countries such as Egypt are still rather under-developed and so had limited foreign exposure.

"Most rated countries in the Middle East either did not have significant fiscal or current account deficits last year or, in some cases, posted surpluses. The ones with wide fiscal deficits like Lebanon, Egypt and Jordan relied on their willing local investor bases for financing, as usual," the report said.

Besides, the vulnerability of these sovereign to capital outflows is limited as the proportion of marketable government debt held by non-residents in these countries is minor.

The only significant external current account deficits were in Jordan and Lebanon, said the report.

While for Lebanon, the deficit was financed mainly by inflows of bank deposits and FDI from the wider Lebanese diaspora; in Jordan, the deficit was largely financed by continuing, though lower, inflows of investment from the oil rich Gulf countries, inflows of bank deposits from Jordanians abroad attracted by the positive interest rate differential and unidentified private capital inflows, it added.

 

Oil prices

On the back of Opec production cuts and strong demand in emerging Asia, international oil prices saw a quick recovery after falling below $40 per barrel in the first quarter of 2009.

Oil prices ended the year at around $80 a barrel. Region's oil exporters, as a result, were saved from what could have been a painful year and enabled them to provide fiscal stimulus without running down assets, said Moody's.

It estimated that the 2009 fiscal breakeven point for Gulf oil exporters ranged from around $35/b in Kuwait to $75/b in Bahrain for the benchmark Brent crude. Brent averaged $63/b in 2009 as a whole, it said.

In what reflected the comparative resilience of the region's credit fundamentals, Moody's said it did not downgrade any sovereign ratings in the Middle East in 2009.

"In fact, we upgraded one country, raising Lebanon's government bond ratings from B3 to B2 in April 2009. This rating action was driven by the substantial improvement in external liquidity, the proven resistance of the public finances to shocks and the strengthening ability of the country's banking system to finance fiscal deficits. As the positive trends in Lebanon continued over the course of 2009, we changed the outlook on the government's B2 ratings to positive in December."

There were several adjustments made to sovereign rating outlooks in 2009, mainly for country-specific reasons.

The rating agency changed the outlook on Egypt's sovereign ratings to stable from negative in August. "The reasons were the easing of inflation since its peak in 2008, the government's efforts to contain fiscal pressures, and the relative resilience of the economy and banking system in the face of the global economic turmoil."

Kuwait's sovereign ratings were put on review for possible downgrade in the first quarter of last year. "We subsequently affirmed Kuwait's ratings but maintained its negative outlook."

Moody's also changed the outlook on Bahrain's sovereign ratings to negative from stable in January 2009.

It said the outlook was on account of Bahrain's high fiscal breakeven oil price and concerns over the health of the large banking system given the large run-up in credit. Unlike other Gulf oil exporters, Bahrain does not have an offshore sovereign wealth fund, it said.

The 2010 should be a year of economic improvement for the Middle East, said Moody's.

The degree of fiscal stimulus, oil price and production levels, lending stance of banks and demand for non-oil imports in the US and Europe would be a couple of factors that would determine ratings this year, said the report.

"At the global level, the pace of economic recovery will depend above all on the manner in which advanced industrialised countries withdraw unprecedented levels of fiscal stimulus and shaky financial institutions restore their capital buffers. The health of China's economy will also be a key determinant for global growth," it said.

Oil price and production levels would be another critical factor, the report said.

The rating agency said it expected a moderate increase in the fiscal breakeven of oil prices this year.

While the price of the benchmark Brent crude has averaged $75 per barrel this year, the fiscal breakeven prices for 2010 will depend on the level of oil and gas export volumes and the trajectory of public expenditure, it added.

Moody's said Gulf governments are likely to raise expenditure as they seek to stimulate private sector growth, as is indicated in the budgets published so far for 2010. "However, we also expect oil and gas export volumes to rise moderately in response to building global demand. Taken together, these developments will probably result in a modest rise in the fiscal breakeven oil price for Gulf oil exporters with the exception of Qatar, whose fiscal breakeven point should decline,"?it said.

"Given our current oil price assumption for 2010, average for Brent crude of $72 per barrel, we expect all Gulf governments to post surpluses with the exception of Bahrain," it added.

 

Fiscal stimulus

Fiscal stimulus would be among the most critical factors, said the report.

Governments in the Middle East made efforts to raise their expenditure in 2009 in order to help cushion the effects of the global recession on their private sectors.

"It remains to be seen to what degree fiscal stimulus will be maintained in 2010. For asset-rich Gulf oil exporters, expenditure increases are likely even if oil prices decline below their current level," said the report.

Oil-importing countries in the region are more constrained in their ability to fund further spending rises, it noted, adding that sovereign wealth funds can be drawn down to finance potential fiscal deficits without jeopardising planned investment expenditure.

Gulf oil exporters that have published budgets for 2010 forecast a further boost to spending this year, said Moody's.

Lending appetite of banks took a hit during the crisis. Private activity in 2010 would heavily rely on changes in lending stance adopted by the banking sector in the region.

There was a sharp reduction in credit to private sector in 2009 with an exception of Lebanon which recorded a 10 per cent credit growth in the first 10 months of last year.

 

Dramatic corrections

According to the report, the most dramatic corrections were seen in case of Gulf oil-exporting countries which had experienced booms in private sector credit during the years up to 2008.

However, even oil importers experienced credit shocks. "Private sector credit growth was negative in both Egypt and Jordan during the first 10 months of 2009. In Saudi Arabia, lending to the private sector was flat in the year through December 2009," said the report.

It said Lebanon was an exception in the region, with credit growth exceeding 10 per cent over the first ten months of last year.

With their strong fundamentals, banks in the region maintain healthy capitalisation ratios. However, they are still cautious about lending to local consumers and businesses. The banking sector saw deterioration in asset quality and struggled to maintain a balance between its loans and deposits.

Loans were much higher than the deposits in many cases. "Some banks, especially those in Qatar, Kuwait and Dubai, have been exposed to quite severe real estate price reversals which have affected asset quality. Loan-to-deposit ratios remain high in these countries, and this constrains banks' ability and willingness to extend credit despite government support."

According to the Moody's report, although high oil prices are negative for the region's oil importers in terms of upward pressure on inflation, fiscal costs and factor inputs, they are indirectly beneficial through the channel of inward worker remittances and FDI.

Jordan, Lebanon and Egypt all benefit to varying degrees from current and capital account inflows from Gulf countries, it noted.

In case of Jordan, these inflows are a significant explanatory factor behind the country's ability to sustain a wide current account deficit over the years.

The available data shows that remittances from the GCC to Egypt dropped in the first quarter of 2009 by around 17 per cent, followed by an easing in the rate of decline to around 10 per cent in the third quarter of 2009.

"It is likely that remittance flows have recovered since then as oil prices have held up and most Gulf private sectors have stabilised. We would expect this trend to continue over the course of 2010 based on our assumption that oil prices will remain at historically robust levels," said the report.

 

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