Moody's reports: Middle East inflation surge sharpens fiscal and political risks

The ratings of poorer, non-oil-exporting countries are more likely to be
affected in the shorter term by high inflation because of their enhanced social and fiscal vulnerabilities. However, even the ratings of affluent, oil-exporting sovereigns could be affected over the longer term if high price growth persists.

"The Middle East is currently experiencing a strong resurgence of inflation. While accelerating price growth is a global phenomenon, the Middle East region has been particularly affected because of a
preponderance of fixed or heavily managed exchange rates, an oil-fuelled liquidity expansion, widespread infrastructure bottlenecks and a reliance in most countries on food imports," explains Tristan Cooper, a Moody's Vice-President / Senior Analyst and author of the report. According to the IMF, the Middle East experienced the highest average inflation rate of all global regions in 2007, at 10.4%, and this is expected to accelerate in 2008.

Although inflation is seldom a direct driver of Moody's sovereign credit ratings, it can affect them indirectly through three main channels --
fiscal, political and economic -- and Moody's is beginning to observe such trends among Middle Eastern sovereigns.

"Given enhanced sensitivities to the risk of social unrest, some governments in the Middle East are finding it difficult to maintain fiscal discipline. Inflation's tendency to aggravate political risk is clearly less acute among oil-exporting countries, which currently have the capacity to expand fiscal expenditure and offset the erosion of citizens' purchasing power. However, poorer countries have less room for
manoeuvre, and therefore the political and fiscal consequences of inflation are of greater short-term concern," Mr Cooper observes. The
analyst adds that, although accelerating inflation has yet to impact real economic growth in the region, which remains strong, there is a risk that it could undermine activity if sustained.

Moody's report -- entitled "Middle East: Resurgent inflation sharpens fiscal and political risks" -- explains that the rating agency has constructed a simple and non-linear rank ordering of the countries it rates in the Middle East with a view to demonstrating the relative sensitivity of their ratings to the effects of inflation, based on three primary considerations -- social vulnerability, fiscal flexibility and inflationary pressure.

"As would be expected, the ratings of non-oil exporting countries that are poorer, fiscally constrained and already experiencing high rates of inflation are more likely to be affected in the shorter term than those of the more affluent Gulf oil-exporters. High rates of inflation are of particular concern in Egypt (whose Baa3 local currency rating is on negative outlook) and Jordan given their social and fiscal
vulnerabilities. Lebanon's very low B3 rating already encapsulates a high degree of political and economic risk," Mr Cooper explains.

Moody's report explains in more detail how inflation can affect sovereign ratings indirectly as well as discussing the implications and drivers of the current surge in inflation in the Middle East.