Overview

• Qatar's external liquidity position has weakened with the rapid growth of banks' foreign liabilities and public sector debt, which has pushed up the country's external financing needs.
• Nevertheless, Qatar's sizable stock of external assets means that the country maintains an overall strong net asset position.
• We are revising the outlook on Qatar to negative from stable and affirming the ratings at 'AA/A-1+'.
• The negative outlook reflects the risk that Qatar's external position could deteriorate further should the rapid growth in external debt continue to outpace external liquid asset growth, thereby reducing the buffer provided by its sizable external assets.

Rating Action
On March 3, 2017, S&P Global Ratings revised to negative from stable its outlook on the long-term sovereign credit ratings on the State of Qatar. At the same time, we affirmed the 'AA' long-term and 'A-1+' short-term ratings.

Rationale
The negative outlook reflects the risk that Qatar's external position could deteriorate further should the rapid growth in external debt continue to outpace external liquid asset growth, thereby reducing the buffer provided by its sizable external assets.

Qatar's external liquidity position has weakened with the rapid growth of banks' foreign liabilities and public sector debt, which has pushed up the country's external financing needs. Qatari banks' external liabilities increased sharply by 24 percentage points of GDP over 2016, with nonresident deposits in particular increasing by 17 percentage points of GDP. Public sector external debt also grew by some 14 percentage points of GDP over 2016, reflecting government deficit financing. We now estimate liquid external assets to exceed external debt by 100% of current account receipts (CARs) and gross external financing needs at 167% of CARs plus usable reserves, compared with 147% and 146% respectively in our last publication in September 2016. We subtract Qatar's monetary base from usable reserves, which we view as consistent with maintaining confidence in a pegged currency.

We view the growth of nonresident deposits partly as a response to the slower growth in domestic funding over the past few years, reflecting the lower profitability of oil and gas companies. To offset this stasis, and in support of foreign expansion plans, Qatari banks have attracted foreign deposits both from the region and also Europe. However, liquid foreign assets have not grown in tandem with foreign banking sector liabilities.

This has changed the structure of Qatar's external balance sheet, with coverage of liquid external assets over external debt reducing. Central Bank data indicate that less than half of the increase in foreign liabilities over 2016 were lent abroad. Domestic banks' exposure to the government and 100% government-owned entities increased by roughly 10 percentage points of GDP in 2016. We understand that these nonresident deposits have an average duration of six months, which could also pose a financing risk if incentives for depositors were to reverse suddenly without an offsetting inflow. Future growth of nonresident deposits at a similar pace to 2016--and absent an offsetting increase in liquid external assets--would likely put pressure on the ratings. Still, we view this deterioration in the context of very substantial external assets and, while it is incrementally weaker, we still regard Qatar's external stock position to be a key strength. 

Partial current account data to third-quarter 2016 indicate a wider deficit than we had anticipated, likely related to lower-than-expected gas production and higher capital imports relating to the ongoing infrastructure development program. We expect that current account deficits will narrow over the forecast as receipts are boosted by higher prices (we have revised up our gas price assumptions, see 'S&P Global Ratings Raises Its Oil And Natural Gas Prices Assumptions For 2017,' published Dec. 14, 2016).

We also expect that higher hydrocarbon prices will boost fiscal revenues and contribute to a gradual reduction in fiscal deficits. Still, we expect that the fiscal deficit will be about 7% of GDP in 2017 at the central government level, gradually falling to balance by 2018-2019, and in turn we expect that debt will increase slightly before starting to reduce. We include investment income estimates on government assets in the general government balance and exclude them from the central government balance.

Commensurate with increased debt, interest expenditures now account for over 5% of revenues. Providing some upside to these projections, a delayed gas project--Barzan--could come online over 2017, which could boost Qatar Petroleum revenues and ultimately those of the government.

We expect the financing needs created at the central government level to be met by further debt issuance rather than drawing upon assets. Our base-case revenue and expenditure forecasts reflect broadly flat hydrocarbon production estimates--at 3.5 million barrels of oil equivalent per day--and high capital expenditure, but also a considerable reduction in current expenditures. Excluding wages and salaries, 2016 current expenditure effectively halved compared to fiscal year 2014, reflecting numerous consolidation measures: utility price increases; the merger of several ministries; a substantial efficiency drive in government-related entities receiving transfers; and reduced social benefits including foreign medical treatment.

We will also include the impact of revenue side measures such as the introduction of excise taxes and VAT in 2018. We note that the government has opted to maintain its core capex plan relating to its 2030 Vision. As such, we expect capex to account for nearly 50% of spending in 2017. In our opinion, this level of capex provides the government with flexibility to quickly reduce expenditures should it need to. It also highlights that ongoing expenditures are relatively manageable when compared to current revenue projections.

We expect that government liquid assets will remain around 160% of GDP, reflecting the sizable funds built up from gas related surpluses and subsequent investments.

We also note high public sector indebtedness--reflecting the debt of various public enterprises--which we estimate at 85% of GDP in 2017.

Qatar has one of the world's lowest costs of natural gas production at US$1.60 to US$2.00 per million British Thermal Units, and so we expect state-owned  Qatar Petroleum--responsible for all phases of the oil and gas industry in Qatar--to remain profitable. Its strategy has been to diversify into all major markets, adjusting the mix of destinations and contract types according to market needs. Moreover, the majority of its gas exports are under long-term contracts, which provides some certainty regarding volumes sold.

We expect that Qatar will maintain its cost advantage over many new projects in other countries. In January 2016, the renegotiation of RasGas' (Qatar's second-biggest liquidified natural gas [LNG] producer) contract with Petronet LNG (India's biggest gas importer) at a discount of almost 50% indicates an increasingly competitive environment for natural gas and LNG sellers over the medium term. Higher yield contracts with new customers, for example Pakistan, are likely to act as a counterbalance. In any case, roughly 35% of gas production is flexible in terms of destination, which can also support Qatar Petroleum's revenue.

Qatar holds the third-largest proven natural gas reserves in the world, and is the largest exporter of LNG. We expect Qatar's reserves to provide many decades of production at the current levels. GDP per capita is among the highest of rated sovereigns, estimated at US$62,500 in 2017. The hydrocarbon sector contributes about 50% of Qatar's GDP, 90% of government revenues (oil and gas taxes and royalties, plus dividends from Qatar Petroleum), and 85% of exports. We view Qatar's economy as undiversified.

The concentration of Qatar's economy on a cyclical industry that has faced numerous headwinds over the past few years is reflected in our lower growth assumptions. Flat hydrocarbon production estimates mean that we anticipate most growth will be construction-related and funded by the public sector. That said, we note that the financial services, transportation, and communications sectors are likely to continue growing. Additionally, a new gas refinery should boost overall output starting this year. We expect real economic growth to exceed 3% annually over 2017 to 2020, down from nearly 4%. We had expected gas production increases--related to Barzan--and we now anticipate that fiscal consolidation will weigh on private sector consumption growth.

Although decision making is centralized, we view domestic political and social stability as prevailing. We see the country's public institutions as still relatively undeveloped compared with those of most 'AA' rated sovereigns. Executive power remains in the hands of the emir. In our view, the predictability of future policy responses is tempered by weak political institutions, although in our base case we assume that policy will continue to focus on prudent development of the hydrocarbon sector, alongside further economic diversification. In addition, material data gaps exist and transparency is limited, by international standards. In particular, the government neither discloses nor reports the level of its fiscal assets.

We believe the fixed exchange rate of the Qatari riyal to the U.S. dollar leads to limited monetary flexibility, and we expect the currency peg to be maintained. Qatar's real effective exchange rate has appreciated by 14% since early 2014. In our view, this represents a deterioration in international competitiveness of the country's modest tradeables sector and a dampening of non-hydrocarbon GDP growth, absent any offsetting factors, such as improved efficiency or technological capacity.

Outlook
The negative outlook reflects the risk that Qatar's external position could deteriorate further should the rapid growth in external debt continue to outpace external liquid asset growth, thereby potentially reducing the buffer provided by its sizable external assets.

We could lower the ratings should the pace of increase in external debt continue, for example if nonresident deposit growth continues apace, without a similar increase in external liquid assets. We could also lower the ratings if nonresident deposits in the banking system were to build up to a point where an outflow presented an external financing risk. 

We could revise the outlook to stable if the external position steadies or if fiscal deficits narrow faster than we expect, thereby reducing increases in debt and associated interest costs.