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CI affirms UAE sovereign ratings

July 12, 2014

Capital Intelligence (CI) has announced that is has affirmed the United Arab Emirates' (UAE) Long-Term Foreign and Local Currency Sovereign Ratings of 'AA-' and its Short-Term Foreign and Local Currency Sovereign Ratings of 'A1+'. The Outlook for the ratings is 'Stable'.

The UAE's ratings reflect the following factors: the overall strength of the country's public and external finances and the resultant capacity to absorb economic shocks; moderate levels of public debt; and generally favourable macroeconomic performance. The ratings also take into account the vast hydrocarbon reserves and financial assets of Abu Dhabi, and CI's expectation that the emirate would be willing to support federal institutions in the unlikely event of financial distress.

The UAE economy is expected to have grown by about 4.8 per cent in real terms in 2013 compared to 4.4 per cent in 2012, underpinned by the robust performance of non-oil sectors. Medium-term prospects are broadly favourable as downside risks to growth are becoming less pronounced, partly thanks to progressive reforms aimed at further diversifying the economy.

The public finances remain sound, supported by prudent fiscal management and the implementation of a small number of fiscal consolidation measures. The consolidated budget position is expected to have posted a large surplus of around 10.1 per cent of GDP in 2013 (13.2 per cent in 2012) and is expected to remain in significant albeit narrowing surplus in the short to intermediate term, fortifying the government's balance sheet and further strengthening its capacity to introduce countercyclical measures to absorb economic shocks or manage contingent liabilities.

Consolidated government debt, of which only a small proportion relates to the federal government, continues to decline and is reasonably low at around 12.3 per cent of GDP in 2013 (16.6 per cent in 2012). Public debt is higher at around 60 per cent of GDP and primarily reflects the borrowings of commercially-oriented government related entities (GREs), most of which are not formally guaranteed by Emirati governments. Implicit contingent liabilities stemming from GRE obligations are significant; however, most GREs are currently able to rollover or repay maturing debt obligations.

The consolidated government debt stock is almost fully matched by government deposits in the banking system and is probably dwarfed by public external financial assets. There is limited disclosure of the latter, but it is estimated that the Abu Dhabi Investment Authority (ADIA), the largest of the UAE's several wealth funds, manages assets of around 160 per cent of GDP. While the consolidated net creditor position is not an indicator of the solvency risk of individual emirates, CI would expect Abu Dhabi, as the wealthiest emirate, to provide financial assistance to the federal government and the Central Bank if required.

The country's external finances remain very strong. Preliminary data indicate that the current account surplus exceeded 16 per cent of GDP in 2013, buoyed by a solid pickup in non-hydrocarbon exports. Official foreign exchange reserves of about $72 billion (18.1 per cent of GDP in 2013) provide solid backing for the currency peg and an adequate buffer against external liquidity shocks and are expected to remain at comfortable levels in the intermediate term, supported by the continuation of double-digit current account surpluses.

Gross external debt is manageable at an estimated 44.1 per cent of GDP or 43.3 per cent of current account receipts (CARs) in 2013. About 92 per cent of the debt stock represents the foreign liabilities of the private sector, especially the UAE's large banking sector, and is comfortably exceeded by banks' foreign assets. The rest of the debt represents various conventional and Islamic debt instruments issued to complete the restructuring of GREs.

The UAE's sovereign ratings are principally constrained by weaknesses in the country's economic structure and institutions, as well as by some structural fiscal shortcomings. Despite the strong growth of the non-hydrocarbon sectors, estimated at 5.2 per cent in 2013, it is too soon to conclude that the UAE has substantially diversified its economy. Oil and gas still account for about 82 per cent of consolidated government revenues, 32.5 per cent of total exports, and (directly) 31.5 per cent of GDP. Moreover, the government's budget structure is relatively weak in view of the overreliance on oil, the limited tax base and high expenditure rigidities.

The quality of economic data is relatively weak, although it is slowly improving. Fiscal accounts are neither comprehensive nor, at the consolidated level, compiled in line with international standards. Information on government external financial assets is not disclosed, hindering assessments of balance sheet strength and flexibility.

The banking system is broadly sound with high levels of capitalisation. Although asset quality is improving, the sector's non-performing loans (NPLs) to gross loans ratio remains comparatively high, partly due to the problems of the real estate sectors in the major emirates and the ongoing financial restructuring of loans owed by a few government of Dubai entities. Liquidity ratios have eased in recent years and several banks have comfortably repaid their Tier 2 debt capital received from the government in the early days of the financial crisis. Credit growth regained momentum in 2013, while the rules on credit concentrations introduced by the Central Bank help to cap the exposure of the banks to the real estate market.

The short-term economic outlook for the UAE remains broadly favourable. CI foresees limited impact of the unwinding of the quantitative easing in the United States on the country. Both the government and the banking sector are well positioned to secure adequate cross border funding at favourable costs. That said, an abrupt reversal of capital inflows could affect debt rollover or raise borrowing costs for GREs and private borrowers.

The Outlook for the ratings is 'Stable', meaning that the UAE's sovereign ratings could remain unchanged within the next 12 months, provided that key metrics evolve as envisioned in CI's baseline scenario and no other credit quality concerns arise.

The 'Stable' Outlook balances the strength of the government's sound fiscal and external positions against the institutional weaknesses, reliance on hydrocarbon revenues and susceptibility to exogenous shocks, including factors such as protracted periods of subdued oil prices and geopolitical risk.

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Source: CPI Financial

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