Standard & Poor’s Ratings Services affirmed its ‘A/A-1′ long and short-term foreign and local currency sovereign credit ratings on Ras Al Khaimah (RAK). The outlook remains stable.
The ratings on RAK are supported by relatively robust economic growth prospects, fueled by RAK’s supply of materials to building and infrastructure projects in the Gulf Cooperation Council (GCC) region and some diversification of export markets. The economy also has little direct reliance on oil and the government has a strong balance sheet. We anticipate that, under certain circumstances, RAK would receive extraordinary financial support from the United Arab Emirates (UAE), although we do not expect that the need will arise.
We have observed some improvements in the supporting organizational structures of RAK’s government and in the availability and quality of economic data. While we still consider the availability of demographic and economic data to be weak, we believe the emirate’s authorities are committed to the long-term development of domestic institutions that will underpin continued economic development and the maintenance of a prudent fiscal stance.
“The ratings are constrained by our view that the emirate has limited monetary policy flexibility, in view of the UAE dirham’s (AED) peg to the U.S. dollar and the underdeveloped local currency domestic bond market. RAK’s political institutions are less developed than those of nonregional peers in the same rating category and this also weighs on the ratings.
“We estimate that RAK’s economy grew strongly in 2014, reflecting solid demand from the neighboring emirates of Dubai and Abu Dhabi, but also from the wider GCC and, increasingly, India. Business licenses in the three Free Trade Zones (FTZs) continued to grow (a 9% year-on-year increase) and the emirate’s tourism offering has expanded. Over the past 12 months, there has been a 42% increase in hotel rooms and these are maintaining an occupancy rate of over 60%. In addition, wholesale and retail trade data point to an increase in overall consumption from within the emirate. RAK’s port infrastructure enables the buoyant manufacturing and trade sectors to capitalize on the emirate’s strategic location. Relatively diversified industrial clusters continue to develop and are pulling new workers into the labor force.
“The manufacturing sector contributes about 25% of GDP to the economy and we consider it relatively diversified in terms of products. However, four sectors–stone, mica, glass, and ceramics–contribute nearly 85% of exports and are largely used in regional construction activity. GCC countries–Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE–accounted for 60% of exports in 2014. Exports to Saudi Arabia were negligible. RAK consequently relies on GCC demand, in our view. Therefore, we anticipate that the oil price-led regional slowdown in economic activity will hamper RAK’s growth, and we have reduced our estimates for 2015 accordingly. That said, large infrastructure projects, including the expansion of Dubai’s metro and airport in preparation for Dubai 2020, are continuing and we expect that this will help support demand, particularly for RAK’s quarries. RAK’s direct linkages to the oil sector are limited, which should also help to limit downside risks. The emirate is increasing trade links with nonregional partners like India; estimates suggest that India contributes the largest portion of foreign direct investment into RAK at just under 30%. Further ahead, we expect increased capacity for new businesses and further diversification of RAK’s export destinations will support economic growth. Thelifting of Iranian sanctions could also boost RAK’s economy, but we do not include this prospect in our projections.
“We expect that we will be able to fully assess the impact of new statistical data on GDP in time for our next scheduled review, on Oct. 30, 2015. We understand that GDP data will be restated to include the contribution of RAK’s three FTZs and that this will lead to an upward revision of approximately AED5 billion, or 18%. Subsequently, we expect that our GDP per capita figures will be revised upward, and that a larger denominator will lower a number of key ratios, including debt, but also fiscal surpluses.
“RAK largely derives its fiscal revenues (75% of total revenues) from dividends and other transfers from government-related entities. Roughly 40% of this or 30% of 2014 total revenues, stems from three core assets involved in quarrying and export activities. Revenues from RAK Gas, the emirate’s energy company, accounted for 15% of government revenues in 2014, down from 26% in 2013, due to weaker profitability. This drop was anticipated, given the depletion of the company’s main gas fields and subsequent higher priced purchases from alternative sources. We expect a further reduction in RAK Gas’ profitability going forward. Therefore, we anticipate moderately lower fiscal surpluses over 2015-2018 (3% of GDP) compared with 4.3% on average between 2009 and 2013. Nevertheless, we factor in that RAK’s fiscal risks are generally limited, due to the government’s minimal spending responsibilities, its strong balance sheet, and its ongoing indirect financial support from the UAE,” the rating agency said.
“The UAE federal government is mostly funded by the Emirate of Abu Dhabi. It covers most of the operating expenditures of the seven emirates that comprise the UAE, including RAK. These costs include health care, education, energy provision, and defense. Major capital costs, 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. Individual emirates, including RAK, have limited fiscal obligations, most of which are primarily related to local infrastructure and services, or capital spending to develop emirate-level projects. Consequently, we see RAK as having low fiscal risks. We estimate that RAK’s net general government asset position will be about 14% of GDP in 2015. This figure includes the government’s recent $1 billion sukuk issuance, which was raised to refinance 2015 maturities and as prefunding for a $400 million redemption due in 2016,” S&P in a statement said.
“Under our criteria, although data on RAK’s balance of payments and external position is not available, we use UAE data to assess external risks in the emirate. We think that RAK’s external risk is limited by the UAE’s extremely strong external balances, combined with its system of fiscal transfers and banking coordination. Using our narrow net external debt metric, we expect the UAE’s external creditor position will average about 115% of current account receipts (CARs) in 2015-2018, although it will likely decline over the period,” it said.
“We estimate the UAE’s gross external financing needs will average about 100% of usable reserves of the UAE central bank reserves and CARs over the same period. We expect the UAE’s current account to show an overall surplus of about 1.4% of GDP in 2015-2018, significantly lower than the average of 2011-2014 of 16% of GDP. RAK’s sole domestically controlled bank, the National Bank of Ras Al Khaimah, sits within the supervisory remit of the UAE central bank. In our view, the UAE’s monetary and banking union limits the external risks of the smaller emirates, including RAK, and would provide a cushion in the event of an external shock.
“The stable outlook balances our expectations over the next two years regarding RAK’s fiscal flexibility and the advantages of its UAE membership, against a lack of monetary policy flexibility and underdeveloped and highly centralized political institutions. We expect continued support for RAK through the UAE’s system of fiscal federalism, and consider that there is a strong likelihood that RAK would receive extraordinary support from the UAE (with Abu Dhabi backing) in the event of financial distress. We also anticipate that RAK will continue to improve the availability of its economic data,” S&P added.
“We could consider lowering the ratings if we observed a pronounced deterioration in RAK’s economic or fiscal performance, potentially due to a sharp drop in regional demand for RAK’s exports. We could also lower the ratings if we assessed the likelihood of extraordinary support from the UAE federal authorities as being weaker than we currently expect. We could raise the ratings if, in contrast with our current expectations, the transparency and strength of political institutions markedly improved.”