“The affirmation and stable outlook reflect the continued strength of Abu Dhabi’s sovereign balance sheet. This is estimated to be the second strongest amongst rated sovereigns measured by sovereign net foreign assets (SNFA), and conveys exceptional fiscal flexibility. Foreign assets are estimated to have risen again in 2011, despite a dip in investment returns, as the general government budget moved further into surplus, despite a substantial spending increase,” Fitch in a statement said.
Foreign assets held in Abu Dhabi’s main sovereign wealth fund (ADIA) are estimated by Fitch to be around $300billion. This is at the low end of the range of independent estimates and compares with just $3billion of direct sovereign external debt after the maturing of a $1billion eurobond earlier this year. SNFA of an estimated 131% of GDP at end-2011 are second only to Kuwait’s (AA’/stable). On current oil price assumptions ($110pb in 2012, falling to $100pb in 2013-2014) gross assets are forecast to continue rising, despite a projected weakening in the overall fiscal surplus, assuming investment returns are positive. ADIA’s average return in the 20 years to 2011 dropped slightly to 6.9% from 7.6% in the 20 years to 2010.
The agency estimates the overall fiscal surplus, including ADNOC dividends and ADIA investment income, improved sharply in 2011 despite an almost one-third rise in expenditure and net lending. This follows a deficit in 2009 – only the fourth in 30 years – when fiscal policy was determinedly countercyclical and exceptional assistance was provided to Abu Dhabi (AD) state-owned enterprises (SOEs), banks and other government related enterprises (GREs) as well as to Dubai.
The resumption of spending growth in 2011 after virtually no increase in 2010 followed the go-ahead given to key projects after completion of a comprehensive review. Exceptional support for private construction firm Aldar accounted for one quarter of the total spending increase, similar to the increase in support for SOEs. Current spending (excluding transfers to the UAE government) rose by over 20%.
Ongoing budget support to SOEs, including Mubadala, IPIC and TDIC (all aligned with the sovereign rating by Fitch) averaged over 10% of GDP in 2009-2011. Ad hoc and ongoing support for AD public and private enterprises demonstrates the potential cost of contingent liabilities. However, AD’s ability to provide such support without so far seriously denting its balance sheet also emphasises its considerable fiscal flexibility. There is a risk that AD will have to dedicate more resources to meeting contingent liabilities, but Fitch considers the amount that will crystallise is still small compared with sovereign resources.
A shock similar to 2008-9 – a sharp oil price fall coinciding with weak investment returns that causes revenues to fall and spending to increase – remains the main threat to the rating. Sustained double-digit growth in spending, well above Fitch’s expectations, could see budget deficits recur more frequently and would leave the sovereign credit profile more exposed to this kind of shock and thus could exert downwards pressure on the ratings.
However, spending in 2012 is budgeted to rise only slowly as one off items drop back, although development spending will see another large increase. On this basis, and assuming spending remains at current high levels (40% of GDP) in 2013-2014, the breakeven oil price will rise to $70pb over the forecast period, from $60pb last year. With public spending a key driver of the non-oil economy, non-oil real GDP growth will likely slow from the 5% average estimated for 2009-2011.
AD’s overall balance sheet, taking into account both public and private sector external debt, remains stronger than AA/AAA medians but is weaker than some AA peer countries and weaker as a percentage of GDP than before the 2009 crisis. However, SOE/GREs also have external assets which Fitch’s analysis cannot take into account in the absence of a comprehensive balance sheet for “Abu Dhabi Inc.”
AD has the second-highest per capita income of any rated sovereign, founded on a high per capita hydrocarbons endowment. However, human development and business environment indicators (albeit for UAE as a whole) are generally weaker than ‘AA’ medians. Political stability is high and UAE has seen no significant contagion from ‘Arab Spring’ protests in the region. However, checks and balances on executive power and governance are weaker than for typical ‘AA’ sovereigns.
Financial and oil wealth offset weaknesses such as high economic and fiscal dependence on oil, limited transparency and weak data provision compared with most other ‘AA’-rated sovereigns. Although transparency regarding external debt and the quality of economic statistics is improving, greater clarity on the level of foreign assets would be a necessary condition for any positive rating action.
The biggest downside risk to the ratings, other than balance sheet deterioration, would be a major geopolitical event. This year’s inauguration of the Abu Dhabi Crude Oil Pipeline has helped mitigate geopolitical risk somewhat. It will allow up to 70% of oil exports to bypass the Straits of Hormuz, giving AD a strategic advantage compared to some of its oil exporting neighbours in the event that regional hostilities led to the straits’ closure.