Sunday 21, January 2018 by Jessica Combes

S&P affirms rating Ras Al Khaimah with stable outlook


Ras Al Khaimah (RAK) is expected to continue to record fiscal surpluses and maintain its low debt level, according to ratings agency S&P.

On 19 January 2018, S&P Global Ratings affirmed its 'A/A-1' long- and short-term foreign and local currency sovereign credit ratings on the Emirate of Ras Al Khaimah (RAK) a member of the United Arab Emirates (UAE). The outlook remains stable.

The stable outlook reflects the agency’s assumption that RAK's economic growth will pick up gradually in the coming years and its fiscal position will remain strong over the period to 2021. The ratings could be lowered if weaker economic growth resulted in RAK's GDP per capita falling below current expectations, weakening the emirate's wealth levels. The ratings could also come under pressure if debt service costs began to rise beyond projections. S&P could raise the ratings if progress in institutional reforms were to significantly increase institutional effectiveness and policy predictability.

The ratings are supported by RAK's strong fiscal position, low debt level, and the advantages that RAK derives from its membership of the UAE, including low external risks. The ratings are constrained by S&P’s assessment that the emirate's political institutions are at a nascent stage of development compared with non-regional peers in the same rating category. Limited monetary flexibility (given the UAE dirham's peg to the US dollar) and the underdeveloped local currency domestic bond market also weigh on the ratings. These assessments mirror those made on the other emirates in the UAE and Gulf Cooperation Council (GCC) countries.

Institutional and Economic Profile:
Economic growth is expected to rise gradually following a slowdown in 2017. It is estimated that RAK's economic growth slowed to 1.5 per cent in 2017, mostly due to the impact of the UAE boycott on trade with Qatar, coupled with weaker domestic demand in Abu Dhabi and Dubai.

A gradually rising GDP growth is expected, supported by recovery in regional demand and the high level of capital spending in the larger emirates.

The diplomatic rift with Qatar continues to weigh on the economic performance of the emirate. Domestic political stability is expected to continue over the forecast horizon. RAK's economic structure displays a relatively high degree of diversity, when compared with most GCC sovereigns. Manufacturing, including activities in the free trade zones, contributes 36 per cent to RAK's GDP, followed by wholesale and retail trade, and the quarrying industry at nine per cent and eight per cent, respectively.

However, demand for RAK's four key export sectors—stone, mica, glass, and ceramics (85 per cent of total exports)—largely comes in relation to regional construction projects. The secondary effects of commodity price cycles can therefore affect RAK's economic activity. Bahrain, Oman, Kuwait, and the other UAE emirates account for just above 50 per cent of RAK's exports.

However, some progress with the emirate diversifying exports to Asia with India was noted, accounting for increasing shares of quarry exports. Due to weaker demand conditions and low public investment regionally, it is estimated that RAK's economy posted softer growth, at 1.5 per cent in 2017, than in previous years. Spill overs from the boycott on Qatar to some key sectors, particularly the quarry industry in the second half of 2017, also weighed on the emirate's economic performance. RAK's economic expansion will probably accelerate until 2021, with GDP growth averaging 2.5 per cent in 2018-2021. This reflects S&P’s expectation that a modest increase in oil prices compared with 2017 will support regional demand, while an acceleration of business activities ahead of Expo 2020 in Dubai, and capital spending in Dubai in relation to the exposition, will support stronger medium-term growth.

However, Qatar's significant 15 per cent share in RAK's quarry exports will likely take some time to replace, dampening export growth. That said, RAK's GDP per capita is estimated to be at $28,400 in 2018, averaging $29,400 in the forecast horizon. S&P estimates that RAK's real GDP per capita will shrink by about one per cent over 2012-2021, which is below that of peers with similar GDP per capita levels.

On 5 June, 2017, a group of states including Saudi Arabia, the UAE, Bahrain, Egypt, Libya, and Yemen moved to cut diplomatic ties, as well as trade and transport links, with Qatar. Of the GCC countries, it is noted that Qatar's most substantial trade links are with the UAE. The largest single component is the delivery of Qatari gas through the Dolphin Energy pipeline, which transports gas from Qatar, to be used for electricity generation in the UAE and Oman, and some of the Qatari gas supply to the UAE is allocated to RAKGAS LLC. The Dolphin pipeline is expected to remain open, absent a further significant escalation in tensions between Qatar and the UAE. If the pipeline were shut off, this could result in higher fuel costs for national electricity generators and fiscal costs to the individual emirates, including RAK.

RAK's political arrangements are broadly stable and solid. Policy-making is highly centralised in the hands of the ruling family and depends heavily on RAK's ruler, Sheikh Saud bin Saqr al Qasimi. According to S&P, this could undermine institutional effectiveness and policy predictability. Political institutions in RAK are at the developing stage. Still, having ruled RAK since 2010, Sheikh Saud has been instrumental in successfully implementing the emirate's long-term economic and social development objectives. No significant changes are expected in the government's policy stance in the foreseeable future. However, progress in the government's long-term commitment to the establishment of efficient economic institutions have been observed, such as the newly formed RAK Statistics and Studies centre. Nevertheless, shortcomings remain in the dissemination of macroeconomic data in terms of availability and timeliness.

Flexibility and Performance Profile:
The government's fiscal position will likely remain strong over the forecast horizon, with the government's fiscal surplus expected to average two per cent of GDP in 2018-2021, supported by various revenue-raising measures and increased transfer payments from government-related entities.

RAK's debt burden remains low and gross consolidated debt is projected to decline to about 17 per cent of GDP by 2021. As a member of the UAE-wide monetary union, RAK has less policy flexibility than sovereigns with their own central banks. S&P’s ratings on RAK are supported by its strong fiscal position and low debt burden. The emirate has a track record of successful fiscal management, demonstrated by budget surpluses since 2010. Its fiscal risks are generally limited due to the government's strong balance sheet and minimal spending responsibilities because of ongoing indirect financial support from the UAE federal government.

The UAE federal government covers most of the operating expenditures of the seven emirates that comprise the UAE, including RAK. These costs include public health care, education, energy provision, and defence. Major infrastructure and social projects such as the development of schools, hospitals, trunk roads, and the provision of adequate energy generation and distribution are also borne at the federal level.

As a result, RAK's expenditure base as a percentage of GDP remains among the lowest of all rated sovereigns, averaging just under 17 per cent of GDP over the forecast horizon. RAK has limited fiscal obligations, most of which are primarily related to local infrastructure and services, or capital spending to develop emirate-level projects. Consequently, RAK's fiscal risks are seen as low. It is belived that, should RAK face financial stress, it would receive extraordinary financial support from the UAE if needed. However, it is not currently anticipated that such a need will arise.

S&P expects a government budget surplus for RAK of 1.5 per cent of GDP in 2018, up from about one per cent of GDP in 2017, which represents a much weaker outturn than in 2016 (four per cent of GDP), largely due to a five per cent decline in government-consolidated revenues. This predominantly reflects the effect of the boycott on Qatar, which resulted in weaker activity at RAK's ports and quarries, although it is believed that some lost export volumes have been recovered through further diversification of RAK's export destinations.

S&P noted that revenues from the emirate's government-related entities (GREs) and dividends from its shareholdings in listed companies are the largest contributor to the government's consolidated revenue. The ratings agency projected that the fiscal balance will average two per cent of GDP over the forecast horizon to 2021. The improving fiscal story over the forecast period is due to slowly recovering demand, both domestically and in the region.

Government revenues are expected to increase to about 19 per cent of GDP in 2018 from 17 per cent in the previous year. This largely reflects expectations that the introduction of VAT at the beginning of 2018 in the UAE will boost government revenues.

S&P expects the government's fiscal expenditure will remain broadly stable. Capital expenditure remains among the largest single spending items, at 10 per cent of RAK's total budget, and the agency continues to view RAK's debt burden as limited. Gross debt has been declining in absolute terms since 2013 and stands at an estimated 20 per cent of GDP for 2018. Consistent with S&P’s consolidation of GREs' revenues in the government budget, GREs' debt is now also included in the estimate of the total debt stock. All government debt is denominated in US dollars, with two bonds originally denominated in Japanese yen converted to the US dollar floating rate. The UAE's exchange rate peg is expected to remain in place over the next few years and so, to a significant extent, the foreign exchange risk related to the government's debt is viewed as mitigated.

It is likely the Government's net asset position will strengthen as the Government is not expected to raise debt this year, while maturing debt is likely to be repaid rather than refinanced using internally generated funds. S&P projects the consolidated gross debt to decline to about 17 per cent of GDP by 2021. At the same time, the government owns minority shareholdings in a number of listed corporates. Among others, it directly owns 52 per cent of RAK Bank and 23 per cent of Gulf Pharmaceutical, as well as smaller stakes (less than 10 per cent) in a range of companies including the large Gulf Cement and RAK Ceramics.

These minority shareholdings in listed entities are included in S&P’s assessment of government liquid assets. As a result, the Government will likely maintain a positive net asset position at about two per cent of GDP, on average, in 2018-2021. There is very limited external trade, balance of payments, and international investment position data available for RAK and the emirate's external position is therefore based on that of the UAE federation.

Defining the UAE as the "host country," S&P used estimates of its external position as a starting point, then adjusted the initial assessment downward for RAK due to material data gaps, which reduce the visibility of its external risks. Further estimates of the UAE's, and ultimately RAK's, overall external position factor in Abu Dhabi's significant external assets, held by The Abu Dhabi Investment Authority. That said, the UAE's liquid external asset position will probably exceed external debt by, on average, about 123 per cent of current account payments in 2018-2021, although modestly declining over the period. S&P forecast the UAE's gross external financing needs at about 140 per cent of usable reserves of the UAE central bank and current account receipts, on average, over the same period.

RAK is viewed as part of a UAE‐wide monetary union with limited monetary flexibility, given the UAE dirham's peg to the US dollar and the underdeveloped local currency domestic bond market. These assessments mirror those made on the other emirates in the UAE and GCC countries. The agency adjusted its initial assessment of UAE monetary conditions downward for RAK, reflecting that it has less monetary flexibility than sovereigns with their own central banks.

The UAE central bank raised the interest rate on its certificates of deposit by 25 basis points in December 2017 for the third time that year, following the hike in the US Federal Reserve's key policy rate. The UAE is expected to continue tracking the reserve's gradual tightening cycle, given the currency peg. In S&P’s view, the UAE has more than sufficient reserves to defend the peg, while considerations of macroeconomic and social stability are also likely to outweigh the potential benefits of amending the exchange rate regime.



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