Economic diversification would boost Gulf Cooperation Council sovereign ratings

Even in the context of high oil and gas prices, Standard & Poor's Ratings Services said in a report published today titled "Oil Boom Provides Reform Opportunity For Gulf Cooperation Council Sovereigns." The report analyzes aggregate and individual economic and fiscal performances for the five rated GCC states--Bahrain, Kuwait, Oman, Qatar, and Saudi Arabia--and for the unrated United Arab Emirates.

"The GCC countries are traditionally oil economies, and have on the whole become more prosperous than ever as a result of the recent boom in oil prices that has occurred over the past three years," said Standard & Poor's credit analyst Farouk Soussa.

"It is notable, however, that the authorities have not responded to the current oil boom with a propensity to squander windfalls through unproductive expenditures, as was arguably the case in the booms of the 1970s and 1980s."

In this regard, increases in total expenditure by GCC states have been limited relative to oil-driven revenue growth, and have mainly focused on capital expenditures. This reflects improved fiscal policies and economic management, as well as lower expenditure pressures, as infrastructure and social needs have diminished over time. As a result, GCC states have achieved extremely robust budget surpluses.

Nevertheless, it is not yet clear whether the oil windfalls will be viewed as a window of opportunity for pursuing necessary structural and labor market reforms, or whether they will relieve the urgency of such reforms and thus lead to complacency. So far, indications are generally positive, but certain GCC countries have sought to grasp the opportunity more dynamically than others. Perhaps unsurprisingly, those with the least oil reserves, such as Bahrain or Oman, have been most aggressive in instituting economic reform to diversify their economies and to enhance private sector activity.

The transformation of GCC economies to better-diversified, private-sector-led economies is a long-term aspiration, whereas the impact of geopolitical risk is a more immediate constraint on the GCC sovereign ratings. In particular, the security situation in Iraq has deteriorated, and tensions between the U.S. and Israel on the one hand, and Iran on the other, have increased. These developments have an impact on the economic and political stability of the Middle East.

"The balance sheet strength of the rated GCC states means that the possibility of these risks materially affecting the sovereign's creditworthiness, even were they to materialize, is in practice small," said Mr. Soussa.

"Nevertheless, these risks differentiate the GCC states from higher-rated sovereigns, and the positive ratings prospects for most will continue to be tempered by the higher-risk political environment that prevails in the region."