Monday, 7 March 2016

Rating downgrades propagate the oil price shock

By reducing the funding available to oil-dependent governments, the recent rating downgrades could lead to slower growth than previously expected.

A number of oil-producing countries in the region were subjected to rating downgrades, a re-assessment of their ability to pay back loans or make timely interest payments. Saudi Arabia’s credit rating was cut by Standard and Poor’s (S&P), one of the three major rating agencies, on 17 February. Despite the downgrade, Saudi Arabia still maintains medium/high credit worthiness. The same cannot be said about Bahrain, which was assigned a junk status by both S&P and Moody’s, another major rating agency. This means that Bahrain has a high risk of failing to service its debt. The credit worthiness of Oman, another of the countries downgraded, is somewhere in between its two Gulf neighbours.

Low oil prices are the main reason behind the downgrades. They are leading to budget deficits among the region’s oil producers, increasing the risk attached to each of them.

But not all oil-producers were subjected to rating downgrades. Kuwait, Qatar and the United Arab Emirates maintained their high credit worthiness by S&P. They are assessed to have accumulated significant savings during the last oil boom, especially in relation to the size of their economies. However, they were still put on negative watch by Moody’s with a possible downgrade further down the line. Outside the Gulf, Iraq’s credit rating was also maintained by Fitch, the third major rating agency, although two caveats are in order. First, Iraq was also put on negative watch with a possible downgrade in the future. Second, it had already been assigned a junk status associated with a high risk of default.

Almost all of the region's oil-exporters intend to borrow from investors to finance their deficits, and the downgrades make this task more difficult. Saudi Arabia has plans to borrow $30bn; Oman and Qatar up to $10bn each; and Iraq $2bn. The downgrades would reduce investors’ appetite to lend to these countries. Even if they were willing to lend, investors would charge higher interest rates to compensate for the additional risk.

The recent experience of Bahrain highlights this issue. The downgrade of Bahrain by S&P happened while the country was finalising a deal to borrow $750m from international investors. The downgrade led to a change in the terms of the deal. The amount Bahrain borrowed was lowered to $600m and the interest rates increased by 0.25%. The change in rates was small suggesting that markets were partially expecting the downgrade. But further deterioration in the ratings could worsen the terms of borrowing further.

In summary, the rating downgrades are propagating the oil price shock experienced by oil-producers. Low prices are leading to budget deficits and the downgrades make these deficits harder to finance. If rating downgrades result in reduced resources for the governments to spend, then the impact on growth could be even worse than previously anticipated.

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