Moody's: Gulf states' spending hikes could have future ratings impact

Although the consequences for governments' creditworthiness -- and thus ratings -- are limited in the short to medium-term, there could be longer-term adverse implications, the rating agency cautions.

According to Moody's, available data show a clear trend of accelerating government expenditure: the GCC's unweighted average nominal growth in government spending rose from 4% in 2002 to 22% in 2006 and expenditure growth is likely to have again been very strong across the GCC as a whole
in 2007.

GCC governments face multiple pressures to raise expenditure. "Firstly, as the primary source of income -- hydrocarbon export revenues -- accrues directly to governments through their ownership of oil and gas producers, they feel socially obliged to redistribute oil wealth through higher public spending, typically resulting in a pro-cyclical fiscal policy," explains Tristan Cooper, a Moody's Vice-President / Senior Analyst and author of the report.

"In addition, the economically justified desire to raise public investment levels in order to stimulate private investment, foster economic diversification, and raise potential growth rates has been another key driver of the expenditure increases. There is a clear need to raise productivity levels across the GCC to support growth over the longer term and through the oil price cycle,"

Mr Cooper says.

"However, an increasingly important and potentially troubling driver of government expenditure hikes is inflation. Inflation rates have risen sharply across the GCC over the past two years, thus eroding purchasing power, leading to demands for increases in government salaries and subsidies and significantly raising the cost to governments of purchasing goods and services," Mr Cooper adds.

Although governments' attempts to offset the effects of inflation by raising salaries and subsidies may provide short-term relief to citizens, they risk exacerbating price growth by stimulating demand, which would in turn generate further calls for spending hikes. "Such an inflationary spiral would be difficult to control in the absence of other policy options: Gulf states' fixed exchange rate pegs and open capital accounts rule out a significant tightening of monetary policy. In fact, monetary policy has had to be loosened in response to recent interest rate cuts in the US," Mr Cooper cautions.

Moody's acknowledges that, over the short to medium-term, the robust creditworthiness of GCC governments is unlikely to be undermined by strong spending growth. This is because oil prices remain at historically high levels, generally wide fiscal surpluses are being maintained despite spending increases, and GCC governments have accumulated large cushions of net assets with which to meet potential future liabilities.

"However, there could be longer-term adverse implications: the danger is that governments will find themselves dependent on ever higher oil prices to balance their budgets, making it more difficult for them to adjust in the event of a downturn in revenues. Large increases in current
expenditure are of particular concern as they are more difficult to reverse than hikes in capital spending in the event of a potential downturn in revenues," Mr Cooper concludes in the Special Comment entitled "GCC: Inflation-Fuelled Government Expenditure Hikes Could Have
Future Rating Implications".