Saudi Arabia yesterday reacted sharply to Standard & Poor’s move to downgrade the kingdom’s debt rating.
The debt rating agency said it would downgrade Saudi Arabia’s long-term rating a notch, from AA- to A+ with “a negative outlook”, citing “a pronounced negative swing in Saudi Arabia’s fiscal balance”.
Saudi Arabia’s ministry of finance criticised the move as “reactionary” and not based on its economic fundamentals, which include a net asset position of 100 per cent of GDP and large foreign exchange reserves.
The ministry also said it “would like to make it clear that the agency acted on an unsolicited basis”.
This means that S&P was not employed by the Saudi government to examine its books and issue ratings for short and long-term debt, which is the practice for most of its ratings.
Rating agencies have become more aggressive in their actions after being criticised over the years for having too cosy a relationship with the institutions they rate, particularly in the wake of the 2008 financial crisis, when it was argued that they had worked too closely with Wall Street investment banks and given top AAA ratings to billions of dollars worth of mortgage-backed bonds that turned out to be worthless.
But Saudi Arabia’s finance ministry argued that S&P has gone too far.
“In less than a year, the agency has gone from a positive outlook on the AA- rating to a negative outlook on the A+ rating, on the back of changes in the global oil price dynamics,” the Saudi statement noted. “We believe that S&P’s decision was not only rushed, but analytically inconsistent with the idea of ratings being a medium-term tool meant to look through the cycle while assessing creditworthiness.”
It is not clear what the impact of the downgrade, issued late on Friday, might be. Such action can raise the cost of borrowing for a debt issuer as many large institutional investors are required to adhere to certain levels of debt rating.
But some actions – particularly on sovereign nations – have in the past been largely ignored by investors and have had little effect.
While the A+ rating is still “investment grade”, it leaves the long-term rating just two notches above “junk bond” status, which indicates substantial risk of default.
S&P said its outlook is based on the assumption that oil prices, which have crashed from about US$115 per barrel in June 2014 to about $50 per barrel, will improve only slowly over the next few years.
“The sheer size of the shift in 2015 to a deficit of 16 per cent of GDP from a deficit of 1.5 per cent of GDP in 2014 and a surplus of 7 per cent of GDP in 2013, combined with a high reliance on hydrocarbon revenue (80 per cent of total government revenue) and inflexible current expenditures, point to vulnerabilities in Saudi Arabia’s public finances, in our view,” S&P explained in a statement.
The agency says its view is based on world benchmark North Sea Brent crude prices averaging $63 per barrel through 2018. They have averaged $55.85 so far this year.
Also, it is based on assumptions about Saudi Arabia’s plans to deal with the low oil price environment, including cutting both current and capital projects spending, plus reducing subsidies and raising taxes.
“We could lower the ratings within the next two years if Saudi Arabia did not achieve a sizeable and sustained reduction in the general government deficit, or its liquid fiscal financial assets fell below 100 per cent of GDP,” S&P warned. Indeed, it is forecasting that the government’s net asset position will decline to 79 per cent by 2018.
The other major risk is political. “The ratings could also come under pressure if domestic or regional events compromised political and economic stability,” S&P concluded.
One analyst sides with the Saudis in the dispute.
“The downgrade is impulsive and hugely subjective and unrepresentative of actual economic activity,” said John Sfakianakis, Middle East director of Ashmore Group, an emerging market investment firm.
“All this is happening at a time when the credibility of rating agencies has been shaken since the 2008 financial crisis,” he added. “Growth is still in positive territory against other emerging and G20 economies that are in significant economic trouble. Public debt is negligible and offers ample fiscal support. Since S&P are referring to regional geopolitical uncertainties it will be interesting to see how they would rate others in the region in the coming months.”
He added: “Saudi Arabia will continue to be a safe and politically very stable country, and its track record is a testament to that.”
Follow The National's Business section on Twitter