The Daily Update - Saudi Arabia

Earlier this week, Fitch downgraded Saudi Arabia’s credit rating by one notch to A from A+ reflecting ‘rising geopolitical and military tensions in the Gulf region, Fitch’s revised assessment of the vulnerability of Saudi Arabia’s economic infrastructure and continued deterioration in Saudi Arabia’s fiscal and external balance sheets’.

Saudi Arabia’s Ministry of Finance said it was disappointed with Fitch’s ‘swift decision’ to downgrade its rating noting: ‘The downgrade of the rating comes across as somewhat speculative without direct reference to the swift, decisive and effective response to the event’ noting also that the ‘budget deficit is well within the parameters we set for the 2019 budget.

While it is true Fitch had a higher starting rating, we note last Friday S&P affirmed its rating for Saudi Arabia at A- with a stable outlook. They expect oil production to rebound quickly following the September attack and that their estimate of ‘the kingdom’s strong net assets (stock) position on both its fiscal and external balances is a key support for the ratings.’ For S&P, heightened geopolitical risks, sizeable fiscal deficits and ‘limited transparency of its institutional framework and the reporting of government assets’ remain constraints on the rating. However, they expect Saudi Arabia to ‘shy away from a fully fledged direct military confrontation’.

Our base case is that there will not be a significant military escalation from here. We are encouraged by Saudi Arabia’s so far restrained response and efforts to involve the US and UN which suggests a considered approach rather than allowing the situation to escalate. Moreover, in an interview with CBS Prince Mohammed bin Salman indicated a preference for a ‘political and peaceful solution’, a meeting between President Trump and President Rouhani and is reported to have replied when asked if action against Iran needed to be a military response ‘I hope not’. During the course of the interview he also cautioned that a war between Saudi Arabia and Iran would result in the ‘total collapse of the global economy’.

Saudi fixed income bonds already had a knee-jerk sell-off in response to the initial drone attack and have since recovered ground on the back of the resumption of oil production and no escalation of the situation. Saudi International 4.5% 2046 has bounced ~2pts from the September low and continues to trade around these levels implying the Fitch downgrade had largely already been factored in.  Similarly, the KSA 5 year CDS is trading around 76: as we noted last week this is off the September low but is still well down from the January high of 110.9. We continue to see value in a number of Saudi quasi-sovereign issues as part of a diversified portfolio but continue to favour positions in higher rated issues in Qatar and Abu Dhabi.

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