Fitch affirms Abu Dhabi at ‘AA’; with ‘stable’ outlook

Fitch Ratings has affirmed Tuesday Abu Dhabi’s Long-term foreign and local currency Issuer Default Ratings (IDR) at ‘AA’ with ‘Stable’ Outlooks. The issue ratings on Abu Dhabi’s senior unsecured foreign currency bonds have also been affirmed at ‘AA’. The Short-term foreign currency IDR has been affirmed at ‘F1+’ and the UAE Country Ceiling at ‘AA+’; this Ceiling applies to Abu Dhabi and Ras al Khaimah.

KEY RATING DRIVERS

Abu Dhabi’s key credit strengths are its exceptionally strong fiscal and external metrics and high GDP per capita, balanced by high dependence on hydrocarbons, a relatively weak policy framework, and weak data availability compared with peers. Sovereign net foreign assets were an estimated 222% of GDP at end-2015, and debt was 1.7%, all of it external. Erosion of these buffers will be slower than in other Fitch-rated oil exporters, due to a low fiscal break-even oil price of USD54/b. Consequently, the emirate has time to adjust its public finances to an expected 41% drop in oil revenue between 2014 and 2016.

The 2015 budget deficit widened to 13.2% of GDP from 7.2% of GDP in 2014. These numbers exclude the dividend paid by the Abu Dhabi National Oil Company ( ADNOC ) but include estimated investment income of 5.3% of GDP. The widening deficit reflected a drop in oil and natural gas income to 17% of GDP from 26.6% of GDP, compensated somewhat by reductions in non-current spending. Under our baseline oil price assumptions, we expect the general government deficit to decline to 11.6% of GDP in 2016 and 5.3% of GDP in 2017. The 2016 budget is still under discussion but we expect further reductions in non-current expenditure.

The drop in oil revenues has accelerated reform efforts at the UAE level, and these benefit Abu Dhabi as the largest contributor to the federal budget. The UAE removed transport fuel subsidies in August 2015 and its energy minister announced the intention to remove remaining subsidies for electricity and gas. Water tariffs have been introduced for UAE nationals in Abu Dhabi and increased by between two and five times for expatriates, depending on consumption levels. Electricity tariffs were increased by between 30% and 100%. The government estimates that it could raise significant non-oil revenue by increasing charges for goods and services provided by the public sector.

The debt of government-related and state-owned enterprises (GREs and SOEs) peaked at AED277bn (30% of GDP) in 2012 and had fallen to AED246bn by 1H15, reflecting the authorities’ commitment to containing indebtedness. We expect GRE and SOE debt to continue to fall as the Department of Finance exercises greater control over their capital spending and debt issuance plans. Explicit contingent liabilities are clearly delineated and are not material compared with Abu Dhabi’s assets.

We expect the government to finance its 2016 and 2017 deficits through a combination of transfers from the Abu Dhabi Investment Authority ( ADIA ), the dividend from ADNOC , issuance of bonds and some further draw-down of general government deposits. Fitch expects ADIA assets to fall to USD475bn at end-2016 from an estimated USD502bn at end-2014 as outflows outpace investment returns. However, we expect ADIA assets to rise again in 2017, when the ADNOC dividend should be sufficient to cover the budget deficit. Government deposits in UAE banks fell 16% to AED 158bn over 2015, but remain substantial at around 11% of GDP. The overall level of liquidity in the banking sector is still high.

The Abu Dhabi Department of Finance has intensified consultations with the central bank and commercial banks on local debt issuance. The timing and size of bond issuance remains uncertain, but we assume issuance of AED40bn of bonds in the local market in 2016 and a further AED60bn in 2017, effectively replacing the AED100bn in certificates of deposit issued by the central bank and held by local banks. This would help stem depletion of ADIA assets, which are likely to have a higher expected rate of return than Abu Dhabi debt. Local issuance could also help develop the domestic financial market and pave the way for future issuance by domestic entities, including SOEs and GREs. Foreign-currency issuance is also being considered.

We estimate that real GDP rose 5.4% in 2015 on the back of a 6.8% rise in oil production volumes. Oil production is expected to rise 2% in 2016 and 2017, partially reflecting ADNOC ‘s plans to increase capacity to 3.8m b/d by 2018. We estimate that non-hydrocarbon growth slowed to 4% in 2015 from 6% in 2014, and we expect it to dip to 3.5% in 2016 as the negative effects of lower oil prices, lower banking sector liquidity and government retrenchment affect confidence and demand in the private sector. Nevertheless, investment will continue to be a driver of growth.

Structural indicators are mixed relative to peers. GDP per capita is above the ‘AA’ median. Governance and business environment scores have improved in recent years and are significantly above those of other GCC countries but below the ‘AA’ median. Fitch considers geopolitical risks to be elevated compared with rating category peers.

Major gaps in the availability of data remain despite recent improvements. In particular, standard international investment position and balance of payments data are unavailable, and there is less information on the sovereign balance sheet than in peers. Data shortcomings reflect a weak economic policy framework, particularly at the federal level. Authorities have few options for absorbing shocks beyond resorting to fiscal and external buffers.

RATING SENSITIVITIES

The main factors that, individually and collectively, could lead to negative rating action are:

– A sustained period of oil prices sharply lower than Fitch expects, leading to rapid erosion of fiscal and external buffers.

– Spill-over from a regional geopolitical shock that impacts economic, social or political stability.

The main factors that, individually or collectively, could lead to positive rating action are:

– Strengthening of economic policymaking institutions and greater availability of key data.

– Reduction of the economy’s dependence on oil.

KEY ASSUMPTIONS

Fitch forecasts Brent crude to average USD 45/b in 2016 and USD55/b in 2017.

Fitch assumes that regional geopolitical conflicts will not impact directly on Abu Dhabi or on its ability to trade and that the domestic political scene will remain stable.

No major change is expected in ADIA ‘s investment policy or in its relationship with and use by the Emirate of Abu Dhabi.