S&P Global Ratings affirmed its ‘AA/A-1+’ long- and short-term foreign and local currency sovereign credit ratings on Abu Dhabi. The outlook is stable. At the same time, we affirmed our ‘AA’ long-term foreign currency issue rating on the sovereign-guaranteed bond of senior unsecured debt issued by Waha Aerospace B.V.
The stable outlook on Abu Dhabi reflects our expectation that economic growth will steadily recover and that the country’s fiscal position will remain strong over the next two years, although structural and institutional weaknesses will likely persist.
We could consider raising our ratings on Abu Dhabi if we observed pronounced improvements in data transparency, including on fiscal assets and external data, alongside further progress in institutional reforms. Furthermore, measures to improve the effectiveness of monetary policy in Abu Dhabi, such as developing domestic capital markets, could also be positive for the ratings over time.
We could consider a negative rating action if we expected a material deterioration in Abu Dhabi’s currently strong fiscal balance sheet and net external asset position. If fiscal deficits or the materialization of contingent liabilities led liquid assets to drop below 100% of GDP, pressure on the ratings would develop. A negative rating action could also follow domestic or regional events that compromised political and economic stability in Abu Dhabi.
The exceptional strength of the government’s net asset position provides a buffer to counteract the effect of oil price swings on economic growth, government revenues, the external account, and increasing geopolitical uncertainty in the Gulf region.
Limited monetary policy flexibility (given the UAE dirham’s peg to the U.S. dollar); gaps and delays in the provision of macroeconomic, fiscal, and external data; as well as the underdeveloped local currency domestic bond market, also weigh on the ratings.
Institutional and Economic Profile: We expect economic growth will average 2.3% in 2018-2021
-The economy contracted in real terms in 2017, mainly owing to OPEC’s oil production cuts.
-We forecast gradually rising real GDP growth, on the back of recovering oil prices and production, and a revival in investment.
-We expect regional geopolitical developments will have a limited impact on Abu Dhabi and expect continued domestic stability.
Abu Dhabi’s economy and public finances depend heavily on oil. Therefore, to act as a buffer against oil price volatility, the government has accumulated one of the largest net asset positions of all of our rated sovereigns. Abu Dhabi currently derives 50% of its real GDP and about 90% of central government revenues from the hydrocarbon sector, including oil taxes and royalties, plus dividends from state-owned oil producer, refiner, and distributor Abu Dhabi National Oil Co. (ADNOC).
We revised our oil price forecasts in September 2018 and we now assume an average Brent oil price of $70 per barrel (/bbl) for the rest of 2018, $65/bbl in 2019, $60/bbl in 2020, and $55/bbl in 2021.
We expect a continuation in government policy to pursue economic and revenue diversification and engage the private sector, but we believe the hydrocarbon sector will continue to dominate and gains will likely trickle down over the longer term.
Abu Dhabi maintains one of the highest levels of GDP per capita in the world, and the emirate’s very strong net government asset position, mostly in foreign currency, makes its economy resilient to shocks in the commodity market. We estimate Abu Dhabi’s GDP per capita at close to $82,000 in 2018.
We understand that population growth may have slowed in 2018, owing to the restructuring and consolidation of several government-related entities (GREs) and the overall slowdown in the economy, but it will likely increase again as the economic cycle improves.
In 2017, Abu Dhabi’s real GDP had contracted by 0.5%, mainly due to cuts in oil production to meet the UAE’s commitment to the OPEC-Russia supply-control agreement. In addition, non-oil sector growth was weaker than expected, given lower government spending over the past three years, weaker private-sector credit growth, and a slowdown in the real estate market.
We estimate real GDP growth will reach 1.5% in 2018, supported mainly by higher oil production in the second half of the year. We project that growth will rise gradually to 3.0% by 2021, on the back of increased oil production, higher investment, and recovering domestic credit growth bolstered by higher oil prices and improving demand in the region.
We assume that ADNOC will gradually increase oil production, subject to renewed OPEC production limits, in line with its target to increase production capacity to 4 million barrels per day (bpd) to 2020 and 5 million bpd by 2030, from 3.1 million bpd currently.
ADNOC also recently announced new discoveries of oil and gas–1 billion bbl of oil, which would add 1% to previously proven reserves, and 15 trillion standard cubic feet of gas, which would add 7% to current gas reserves. We understand that ADNOC has a five-year investment plan of AED 485 billion (approximately 10% of GDP annually) in upstream, midstream, and downstream segments.
Of this, AED165 billion will be targeted to downstream operations, including the expansion of the Ruwais complex with a third refinery, expanding capacity by 600,000 bpd to reach 1.5 million bpd by 2025.
We expect the government will moderately increase spending to support a revival in growth. In early June 2018, the Abu Dhabi government announced a stimulus package of AED50 billion over the next three years (approximately 1.8% of GDP annually) to encourage foreign investment and improve the business operating environment.
The UAE also introduced a new foreign investment law that would allow 100% foreign ownership in certain sectors, which could support a rise in investment, subject to the scope of implementation.
Flexibility and Performance Profile: Net asset position will remain strong over 2018-2021
-Abu Dhabi’s fiscal position is underpinned by the oil price movement, notwithstanding government efforts to increase non-oil revenues and moderate spending.
-We project that Abu Dhabi Investment Authority’s (ADIA’s) assets will average more than 220% of GDP in 2018-2021.
-We expect the UAE Central Bank will maintain the currency peg to the U.S. dollar, backed by a large level of foreign reserves and assets. We expect Abu Dhabi will maintain its extremely strong net fiscal asset position averaging almost 240% of GDP in 2018-2021.
This is one of the highest net government asset ratios among the sovereigns we rate, second only to Kuwait. ADIA’s 2017 annual review reported a 20-year annualized return of 6.5%. In 2018, the government’s fiscal position has benefitted significantly from higher oil prices, resulting in higher taxes and royalties from oil and dividends from ADNOC. We estimate that Abu Dhabi’s general government fiscal surplus (including our estimate of investment income from ADIA’s assets) will rise to 9.3% of GDP in 2018, from 8.8% in 2017.
At the same time, we believe non-oil revenues have increased, though from a very small base, helped by the recent introduction of 5% VAT from Jan. 1, 2018, and excise taxes on tobacco and certain beverages in October 2017. With higher oil prices, the government has moderately increased spending, though this increase has likely been directed more toward current spending and foreign aid. We forecast an average general government fiscal surplus of 7.1% over 2019-2021.
Although it was announced that 30% of the receipts from VAT would be shared with the federal government and 70% with the individual emirates, it is still not clear how the 70% will be divided between the seven emirates. Still, Abu Dhabi stands to benefit directly from higher non-oil receipts and indirectly from a larger revenue pool for the federal government, which could result in lower transfers from Abu Dhabi’s budget. Abu Dhabi’s contribution to the federal government in the form of cash contribution and payment toward security and defense spending comprised 44% of total Abu Dhabi’s expenditures in 2017.
We do not expect Abu Dhabi will issue any debt in 2018, and it has financed its central government fiscal deficit (which excludes ADIA’s investment income) this year through the outstanding cash balance of the previous year’s Eurobond issuance and contributions from ADIA. Abu Dhabi issued $10 billion in international bonds in 2017 in five-year, 10-year, and 30-year tranches, after issuing $5 billion in 2016.
As a result, general government debt more than doubled in 2017 to 7.8% of GDP, from 3.7% in the previous year, albeit remaining at very low levels. The government’s deficit financing strategy has evolved from reliance on government deposits and asset drawdown in 2015 toward a mixture of asset drawdown and external debt to ease liquidity pressures in the banking system and avoid crowding out of the private sector.
The authorities plan to issue domestic bonds in 2019 for the first time, subject to administrative and regulatory processes. In October, the UAE federal government issued a law permitting the federal government to issue sovereign debt for the first time. This legal framework could help other emirates issue their own domestic bonds, but could also delay Abu Dhabi’s issuances due to coordination issues.
We estimate the debt of Abu Dhabi’s GREs (excluding government-owned banks) at about 23% of GDP at end-2017.
We project that the UAE’s narrow net external asset position, of which we expect Abu Dhabi’s assets will comprise the majority, will average about 156% of current account payments in 2018-2021, albeit showing a declining trend. We expect the dirham’s exchange-rate peg to the U.S. dollar will remain in place over the next several years.
Liquidity in the banking sector has improved and, in our view, banks are adequately capitalized and enjoy strong profitability. The banks’ financial situation should allow them to absorb the recent uptick in nonperforming loans in the small and midsize enterprise and retail sectors.