Sovereign Debt Analysis - Sovereign Risk: Broad Deterioration In Creditworthiness - MAR 2017


BMI View : Sovereign creditworthiness in the MENA economies will broadly deteriorate over the coming quarters given rising interest rates, tightening liquidity and still - large fiscal deficits , even with higher oil prices . While the GCC is well positioned, the outlook is more concerning f or Egypt and Lebanon.

Sovereign debt risk will increase across the MENA economies due to large fiscal deficits, tightening liquidity as governments draw down local deposits, and rising interest rates. We see four key themes in sovereign risk:

1. Debt levels to rise across MENA economies as sovereigns tap capital markets

2. UAE, Kuwait and Qatar much better placed than Bahrain and Oman

3. Lebanon: Few reasons for optimism

4. Egypt: Worst is yet to come

Large Fiscal Deficits Of Particular Concern
Sovereign Risk Heatmap
Source: BMI, 2017 forecasts. Long-term political risk scores are out of 100 where a higher number indicates greater political stability.

1. Debt l evels t o r ise as sovereigns tap capital markets: We forecast only a modest uptick in oil prices over the coming years, with prices remaining far off the average price of USD107.6/bbl recorded between 2011 and 2014. We project Brent to average USD57.0/bbl in 2017 and USD60/bbl in 2018. This stands below the budget breakeven levels for nearly all MENA oil producers and will force most sovereigns to tap debt markets in 2017 and beyond. The oil importers will benefit from low prices compared with previous years, however, in the case of Lebanon and Egypt this is outweighed by the negative impact of modest economic growth, tightening liquidity and, in the latter's case, our expectation for further depreciation in the currency. We forecast rising fiscal deficits across the oil exporters and only a slight improvement in the fiscal position in the oil importers over the coming year; indeed only Qatar will register a budget surplus in 2018. These deficits will broadly be financed by turning to the debt markets, resulting in some large increases in debt as a percentage of GDP (see chart).

Debt To Rise Across Region
MENA - Total Government Debt As % of GDP
Source: BMI, Bloomberg

2. UAE , Kuwait and Qatar over Bahrain and Oman : The Gulf States are turning to the market at a time of hardening investor sentiment given rising interest rates, although this has been partly mitigated by higher oil prices. An increasing supply of bonds across MENA, combined with more modest support from local investors (owing to growing liquidity constraints) will also put pressure on the Gulf's overseas debt issues over 2017, forcing governments to issue at higher yields than has been the case in recent years.

That said, we expect investors to differentiate between Bahrain and Oman on the one hand, and the UAE, Kuwait, and Qatar on the other. In the case of the former, limited foreign reserve buffers increase the vulnerabilities; Oman's ability to defend the currency against speculative outflows is thus more limited than its peers, and Bahrain already has an elevated debt ratio by emerging market standards. By contrast, the UAE and Qatar have been proactive in carrying out fiscal reform, and can rely on extensive sovereign wealth fund holdings (as can Kuwait). Their bonds are likely to remain popular with investors.

3. Lebanon: Few reasons for optimism: In Lebanon, we expect a gradual deterioration in the sovereign risk environment as interest rates rise in line with the US in 2017 and 2018 (by 75bps in total), in order to preserve exchange rate stability with the dollar. This will result in higher debt-servicing costs for the country, putting greater pressure on the country's fiscal account and crowding out already-limited public spending on capital projects. Interest payments already accounted for 30% of total public spending in 2015, and we see this share rising to 35% by 2019 and 40% by 2024 as both bond yields and the debt stock remain on an upward trend.

Improving, But Not Fast Enough
Select Countries - Fiscal Deficit As % of GDP
e/f = BMI estimates / forecast. Source National Sources, BMI

Key metrics paint a worrying picture for Lebanon and we see little chance of improvement. Lebanon's stock of public debt amounts to 135% of GDP, and we forecast the country's budget deficit reached 7.4% of GDP in 2016, even accounting for the positive impact of lower oil prices on the state finances. While more sustainable sources of income are badly needed, Lebanon has not ratified a budget since 2005, and political paralysis means that the government will struggle to implement any major fiscal reforms over the coming years.

Despite our expectation for more difficult market conditions from next year onward, the government remains some way off from a refinancing crisis. A large share of the debt stock is held by the Lebanese banking sector and the Bank of Lebanon, the latter of which regularly intervenes in Treasury bill auctions to cover demand shortfalls. External interest in Lebanese securities is likely to wane over the next few years as other sovereigns tap the debt market (most notably Saudi Arabia).

4. Egypt: Worst is yet to come: Egypt's sovereign creditworthiness has deteriorated significantly over the past quarters, and we expect the situation to worsen before stabilising. Sovereign bond yields have headed broadly lower since the start of the year, a move we do not think is justified given the weak economic position. Indeed, we see no near-term recovery for the tourism industry given ongoing political instability and the travel bans in place by the British and Russian governments.

Heading Higher Over 2017
Egypt - USD2020 Bond Yield, %
Source: BMI, Bloomberg

At the same time, the budget deficit has swelled (we forecast to 10.0% of GDP in 2017) and will decline only slowly despite subsidy reform and lower oil prices. In addition, yields on Egypt's bonds will inevitably rise over the coming quarters given anticipated further hikes in interest rates in 2017 by 50bps to 16.25% and our expectation for a 15% depreciation in the Egyptian pound against the US dollar by the end of 2017. Slightly mitigating the implication of these trends is that while the country's debt is relatively high (about 80% of GDP), only 19% of GDP is denominated in foreign currency, thus reducing exposure to currency movements.

MENA - Sovereign Credit Ratings
Fitch Ratings Fitch Outlook Moody's Moody's Outlook S&P S&P Outlook
Source: Bloomberg, Trading Economics
Bahrain BB+ Stable Ba2 Negative BB- Stable
Egypt B Stable B3 Stable B- Stable
Iraq B- Negative - - B- Stable
Israel A+ Stable A1 Stable A+ Stable
Jordan - - B1 Stable BB- Negative
Kuwait AA Stable Aa2 Negative AA Stable
Lebanon B- Stable B2 Negative B- Stable
Morocco - - Ba1 Stable BBB- Stable
Oman - - Baa1 Stable BBB- Negative
Qatar AA Stable Aa2 Negative AA Stable
Saudi Arabia AA- Negative A1 Stable A- Stable
Tunisia BB- Negative Ba3 Negative BB- Negative
UAE AA Stable Aa2 Negative AA Stable