Gulf countries’ sovereign credit ratings update

What are sovereign credit ratings?

Sovereign credit ratings are measures of the perceived risk associated with a country’s ability to pay back a public debt. To access the international bond markets, governments are usually expected to have recent credit ratings from two of the three largest rating agencies: Standard & Poor’s (S&P), Moody’s, and Fitch¹. Sovereign credit ratings are updated either on a periodic basis (for countries with routine and regular bond issuances) or when a country is looking to issue a publicly traded eurobond (a bond not denominated in the local/domestic currency).

The rating agencies use a different methodology to determine a credit rating, but they tend to evaluate similar dimensions, as follows.

1. Institutional responsiveness: are government institutions and policy makers adequately able to assess and act on economic and fiscal pressures/constraints/risks? This also includes ability to respond to economic or political shocks, the level of government transparency, historical repayment ability, and geopolitical risks. 
2. Structure and growth of economy: is the economy adequately diversified and growing at a reasonable level to support repayment of debts? GDP per capita and the ability to raise government revenues are also considered.
3. External liquidity: Does the government have adequate reserves or access to capital to repay the debt?
4. Fiscal performance (debt & contingent liability): Does the government’s current fiscal position limit its ability to repay now or in the future?
5. Monetary flexibility (money supply, interest rates, controls on credit): Does the country have stable monetary policy while also having adequate ability adjust when needed? Countries with fixed/pegged currencies often have less flexibility to use monetary policy to support the economy in times of sugglish growth.

Each rating agency perceives risks under these dimensions differently based on their assessment methodologies. Recent movements on Saudi Arabia’s credit rating illustrate this: whereas Moody’s (A1; stable) and S&P (A-; stable) largely affirmed their credit ratings, Fitch downgraded the Kingdom to A with a stable outlook² (bringing it in-line with Moody’s and S&P) in September 2019 citing geopolitical risks.

Why do sovereign credit ratings matter?

Sovereign credit ratings are updated either on a periodic basis (for countries with routine and regular bond issuances) or when a country is looking to issue a publicly traded eurobond (a bond not denominated in the local/domestic currency). A credit rating matters for three main reasons:

• It determines the ability of the sovereign to  access the international capital markets. As most bond investments are carried out by institutional investors, many have guidelines as to what they are able to invest in. Most pension funds, for instance, may only invest in investment grade bonds (see ratings table above). 
• It helps guide on expected interest rates. The lower the rating, the higher the interest rate and the higher the cost of borrowing for the government seeking funding.
• It determines the type of issuance options available. Higher rated sovereigns can often issue multiple tranches of debt and longer maturities in multiple markets (i.e. European and American markets for instance) because more parties are willing to buy the bonds.

There are also impacts a sovereign credit rating can have on the broader domestic economy:

• Within a geographic region, countries with higher sovereign credit ratings tend to attract more foreign direct investment (FDI) than their lower rated neighbors³. Similarly, following a credit downgrade, countries can experience FDI outflows.
• Sovereign credit rating downgrades also tend to translate to short-term sell-offs in the domestic stock market for emerging market economies.⁴
• Companies closely linked to the government - such as financial services, utilities, and government owned enterprises (GREs) - can also see their credit ratings changed or their cost of borrowing costs change. Oman’s experience in May 2017 serves as an example: S&P downgraded the sovereign to BB+ (the first rater to list Oman as non-investment grade). Following this downgrade, several state-owned entities (Oman Power and Water Procurement Co., OmanTel, and Oman Electricity Transmission Company) and private financial services players (among them Bank Muscat and Oman United Insurance Co.) also saw either their credit rating downgraded or their credit outlook adjusted to negative.

^{(1)  Each of the big three have developed a letter grade credit rating system (see table below). The letter grade is partnered with a “credit outlook” (usually positive, stable, or negative) to help forecast potential upcoming upgrades/downgrades in the credit rating in the next six-to-twelve months. A table is provided at the end to summarize this.
(2) Fitch, “Fitch Downgrades Saudi Arabia to 'A'; Outlook Stable,” 30 Septmeber 2019.
(3) Cai, P., Kim, S., & Gan, Q., “The Effects of Sovereign Credit Rating on Foreign Direct Investment,” The University of Sydney Business School.
(4) Martell, Rodolfo, “The Effect of Sovereign Credit Rating Changes on Emerging Stock Markets,” Purdue University. 12 March 2015.}