New negotiations between Iran and the P5+1 agreed last week has eased near-term tensions. Outright hostilities are unlikely to break out until the twin track sanctions and talks strategy have had a chance of success. However, a worse-case outcome, while by no means inevitable, is a non-negligible risk, given the history of unsuccessful engagement with Iran and the declarations by both Israel and the US that a nuclear capable Iran is not acceptable. The longer the situation remains unresolved, the greater the risk of outright hostilities.
The rise in oil prices following any attack on Iran would have ramifications beyond the MENA region. A prolonged price spike could significantly slow the global economy and raise inflation, complicating the fiscal and external financing outlook for both advanced and emerging economies. From a narrower regional perspective, among rated sovereigns, Israel and Lebanon would be most directly impacted. Countries that host US military facilities, notably Bahrain, Qatar and to a lesser extent Kuwait and the UAE, could also be drawn in. The regional business environment would suffer, with Dubai perhaps most seriously exposed given its greater regional and global links and reliance on trade and services. For the region’s oil exporters, there would be benefits from higher oil prices, as well as costs, but any prolonged oil price spike would eventually damage oil demand.
Fitch regards prolonged closure of the Straits of Hormuz as a low probability event. Iran would likely attempt such an act only as a last resort, in retaliation to an attack on itself and even then only if most of its oil exports, which have to pass through the straits, were jeopardised. Even if EU sanctions are completely effective and other countries also reduce their imports from Iran, at most half of Iran’s oil exports seem likely to be affected. Closure of the straits is also technically difficult and would swiftly be countered by international naval action.
A worse-case scenario would involve temporary closure for a few weeks at most. Oil prices would spike, allowing the major oil exporters i.e. Saudi Arabia, Abu Dhabi and Kuwait to weather the situation quite comfortably, with price effects outweighing possible temporary volume reductions. Abu Dhabi will be in the strongest position, once its new pipeline is operational in H2, allowing about three-quarters of its oil exports to bypass the straits. Saudi Arabia can also bypass the straits to some extent, but even if existing pipeline capacity was available immediately, the kingdom would still rely on the straits to export almost half its oil. Kuwait and Qatar have no alternative outlets. Fitch considers that oil importers would be most impacted by temporary closure of the straits, through higher oil import bills and subsidy costs.
Political risk is already embodied in Fitch’s sovereign ratings in the region and can reduce ratings by up to four notches. It is currently highest in Lebanon and Egypt and lowest in Abu Dhabi. Higher ratings have less tolerance for increased risk. Any rating action in response to hostilities in the gulf would depend on Fitch’s assessment of the political and economic costs for each country and how much risk was already incorporated in the rating. However, the difficulty of predicting outcomes in such a scenario means that ratings across the region could come under pressure.
Fitch’s six GCC ratings have been stable since 2008, with the exception of Bahrain. This reflects the strong balance sheets and substantial fiscal flexibility of Kuwait, Abu Dhabi and Saudi Arabia, strong growth and lack of contagion from the ‘Arab Spring’. Recently, oil production has risen to compensate for supply shocks elsewhere. Breakeven oil prices have risen, to over $70 per barrel for Saudi Arabia and somewhat less for Kuwait and Abu Dhabi, but remain well below current prices. This allows all these countries to support growth with ambitious physical and social infrastructure programmes aimed at diversification and job creation.
North Africa has seen significant rating pressure over the past year. The Outlook on Egypt and Tunisia remains Negative, reflecting uncertainties over their political transitions and the implications for policy, and increased fiscal and external financing challenges, especially for Egypt. In contrast, Morocco’s ratings remain unchanged with a stable outlook, reflecting Fitch’s view that Morocco will avoid the upheavals of its neighbours. The agency recently affirmed Morocco and Tunisia’s ratings.
North Africa is most exposed to Europe due to strong links through trade, tourism, remittances, FDI and bank flows. This will hold back recovery in Tunisia and Egypt this year and subdue growth in Morocco. External and fiscal pressures have increased over the past year. New governments, overwhelmingly Islamist, have so far been pragmatic, with no lurch to populism or policies that would threaten macro stability. However, all are untested and the demographic challenge – to create jobs for a rapidly growing, young and increasingly educated work force – has increased, with growth falling and unemployment rising. One of the biggest risks to democratic transitions is disappointed expectations of newly empowered electorates.