(Editor's Note: This report revises our views on the economic impact of the widening COVID-19 epidemic. It follows our Feb. 16, 2020, report "Coronavirus Increases Risks For Gulf Economies ". )
- COVID-19 will weigh on the economies of the Gulf Cooperation Council (GCC) region as weakening global demand drags down oil prices and hampers important industries such as tourism and real estate.
- As global financing conditions deteriorate, funding costs for more-leveraged borrowers are rising and investor appetite for less-creditworthy issuers could fade.
- The high level of uncertainty regarding the duration and eventual severity of the crisis will increase downside risks.
What Has Changed?
The COVID-19 epidemic has broken through China's containment. Confirmed cases of the disease are spiking in South Korea, Italy, and Iran, and it has spread to more than 100 countries. Aside from the human toll, the increasing economic implications are casting a darker shadow over the global growth outlook, which has direct implications for the GCC. Regional markets have been hit by travel and human-movement restrictions imposed by governments, and consumer and business responses. The outbreak is no longer just an issue for China and its closest economic partners, nor just restricted to the supply chain. Both supply and demand effects are in play, and being amplified by tightening financial conditions, which significantly complicates any impact analysis.
Our 2020 Oil Price Assumptions Fall To $40 Per Barrel From $60
Weaker global demand will strain GCC economies, and the effect will be amplified by key trading partner concentrations. Since our previous publication, we have revised down our assumptions on global growth to 2.8% from 3.3%. In commodities, we now expect oil prices to fall in 2020. The GCC region's goods exports are almost entirely hydrocarbon-related. Worse still, just four countries--China, South Korea, Japan, and India--buy about 40% of the region's exports (see chart 1). This leaves the GCC vulnerable to more-severe disruption in those markets.
We now expect China's growth to be 90 basis points lower in 2020 than we forecast at year-end 2019 (see Related Reseach). Consumption is likely to weaken, as consumer confidence wanes and authorities restrict activity. Consequently, we think GCC countries' economies will be impacted.
Exports to countries with a high or currently spiking number of cases--China, South Korea, Japan, Italy, France, Germany, Spain, and Iran--are at risk. We estimate that the volume of vulnerable goods exports ranges from 53% of total exports for Oman to about 17% for Bahrain (see chart 2). As the volume of exports falls, the region's external and fiscal balances will suffer. At OPEC meetings late last week, oil producers failed to agree to further production cuts in response to expected significant reductions in global demand. Russia's refusal to agree to an additional 1.5 million barrels per day (mmbbls/d) of cuts on top of the existing 2.1 mmbbls/d set to expire on March 31 prompted a strong response. Following the meetings, Saudi Arabia surprisingly announced it was immediately slashing its official selling price and would increase its production above 10 mmbbls/d after the existing cuts expire. The kingdom cut April prices for all crude grades by $6 per barrel (/bbl)-$8/bbl. These actions possibly signal that Russia and OPEC have engaged in a price war with the intention of maintaining market share and relevance, despite a collapse in global demand. It is currently unclear how high Saudi production will go and for how long, but it is believed that the kingdom can produce approximately 12 mmbbls/d. There remains the possibility that Russia and Saudi Arabia could re-engage in discussions. However, given the apparent confrontational rhetoric and failure to reach an agreement, we don't expect this to occur within the next few months.
Travel, Tourism, And Consumer Spending Will Decline
The GCC's hospitality industry, which includes sectors like airlines, hotels, and retail, will see lower revenue because of decreased tourism and business flows, as travel aversion and restrictions bite during the peak tourism season. These factors will also reduce transit and outbound travel by visitors and residents respectively. Several GCC states have suspended their travel connections with countries where virus cases are high or currently spiking. For example, Saudi Arabia banned foreign nationals from visiting the holy city of Mecca until March 31. In the United Arab Emirates (UAE), the Ministry of Foreign Affairs issued a ban on travel to Thailand and Iran for UAE citizens and connections with certain countries/cities were suspended. Furthermore, Qatar has reportedly imposed entrance restrictions on visitors from several countries.
We have yet to see whether COVID-19 will dent the number of pilgrims traveling to Saudi Arabia. Both the kingdom and neighboring UAE would take a hefty economic hit in 2020 if the pilgrimage season, which starts in July, or Dubai's hosting of the 2020 World Expo (Expo 2020), which starts in October, are affected. Saudi Arabia received 23.6 million tourists in 2018, with a large portion visiting for religious reasons. In the UAE, Dubai received 16.7 million tourists in 2019 and the tourism sector contributed 11.5% of GDP at year end. Expo 2020 was expected to receive 25 million visitors in just six months. Officials anticipated that more than 70% would come from outside the UAE.
If the coronavirus is not contained, visitor numbers will be lower than expected. However, despite this potential disruption and the uncertain recovery path, we do not expect all activity to be lost. Instead, it could be postponed--visits and events in the region could be rescheduled to later dates.
For the UAE, the real estate sector is also an important consideration. The sector has been under increasing strain for the past three years, and the spread of COVID-19 is exacerbating the situation. Over the first two months of 2020, the volume of real estate transactions in Dubai proved relatively resilient. The Real Estate Regulatory Authority reported that sales totaled UAE dirham (AED) 14.0 billion, up from AED13.9 billion during the same period in 2019 (see chart 3).
We expect sales volumes to decline or, at best, stabilize across the whole of 2020 because of lower demand, offset in part by cheaper mortgages. For Qatar and Saudi Arabia, we anticipate that lower economic growth will intensify the downward pressure on real estate prices. In Kuwait, the recovery we had previously expected for residential real estate prices might be delayed.
For Low-Rated Issuers, Market Access Is Likely To Be Curtailed
Until mid-February, markets seemed quite sanguine about the effects of COVID-19, but that has all changed.
Across most major bourses, prices have declined sharply. A spike in risk aversion pushed the Chicago Board Options Exchange's Volatility Index (VIX) up to its highest level since 2015. Meanwhile, a flight to quality increased the price of safe-haven assets, such as high-quality bonds and reserve currencies. Spreads on lower-quality borrowers in both the sovereign and corporate spaces widened substantially.
For the GCC region, this means issuers that have weaker credit quality or significant direct exposure to affected industries will find it difficult to access capital markets. A few bond and sukuk issuances have been cancelled because of the less-supportive market conditions, even though performance in the first two months of 2020 was strong. The volume of sukuk issued increased to $8.6 billion in the first two months of 2020, from $5.8 billion in the same period of 2019. Similarly, the volume of bond issuances was stable at $18 billion in the first two months of 2020, compared with $17.9 billion in 2019.
It remains to be seen how the reduction in interest rates will play out for issuers in the region. However, we anticipate that rising pressure on cash flows and earnings will test the ability of certain players to access the market. Lower-rated issuers and those most directly exposed to the travel, tourism, and consumer spending industries will suffer most. Issuers based in Oman or Bahrain, plus some of those in Dubai, may face obstacles in refinancing their maturing debt or deficits.
GCC Banks' Creditworthiness Is Likely To Suffer In Line With Clients
The knock-on effects of lower economic growth and oil prices will further slow lending growth and increase the overall stock of problem assets (Stage 2 and Stage 3 loans) at GCC banks. As a result, we anticipate that cost of risk will edge up. At the same time, interest margins will decline because the U.S. Federal Reserve Board and other local central banks have cut interest rates. Combined, these shifts will weaken banks' profitability.
In the UAE and Bahrain, regulators have allowed banks to implement measures such as rescheduling loans, granting temporary deferrals on monthly loan payments, and reducing fees and commissions for affected customers. Other regulators in the region could follow suit in the next few weeks to help banks cope with the effects of the economic slowdown on their profitability. However, any loans shown forbearance of this sort will likely be classified as Stage 2 loans.
Capitalization is unlikely to be affected by these changes and it should continue to support bank ratings. On the funding side, the lower oil price is likely to slow deposit base growth because government and government-related entities still represented 10%-34% of total deposits on June 30, 2019. The effect of this trend on banks' funding and liquidity profiles will be tempered by slower expansion in lending.
- Unrestrained Supply Swamps Oil Outlook: S&P Global Ratings Revises Oil & Gas Assumptions, March 9, 2020
- Global Credit Conditions: COVID-19's Darkening Shadow, March 3, 2020
- Coronavirus Impact: Key Takeaways From Our Articles, Feb. 12, 2020
- Global Credit Conditions: Coronavirus Casts Shadow Over Credit Outlook, Feb. 11, 2020
- Coronavirus To Inflict A Large, Temporary Blow To China's Economy, Feb. 7, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Mohamed Damak, Dubai (971) 4-372-7153;|
|Secondary Contacts:||Dhruv Roy, Dubai (971) 4-372-7169;|
|Benjamin J Young, Dubai (971) 4-372-7191;|
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