Fitch Affirms Qatar at 'AA'; Outlook Stable 

Fitch Ratings has affirmed Qatar's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AA' with a Stable Outlook. The issue ratings on Qatar's senior unsecured foreign-currency bonds are also affirmed at 'AA'. The Country Ceiling is affirmed at 'AA+', and the Short-Term Foreign- and Local-Currency IDRs at 'F1+'.

KEY RATING DRIVERS

The 'AA' ratings reflect the large sovereign assets (sufficient to finance more than 20 years of present budget deficits) of Qatar, along with its fiscal adjustment efforts, a large hydrocarbon endowment and one of the world's highest ratios of GDP per capita. Qatar's hydrocarbon dependence is a key rating weakness, with oil and gas extraction averaging 50% of GDP and 80% of external receipts and government revenue. Other weaknesses include a government debt level above those of rated peers, and mediocre scores on the World Bank's measures of governance and the business environment (both below the 70th percentile).

The fall in oil and gas prices has resulted in sharply lower government revenues, but a fiscal adjustment is under way. Under our baseline oil price assumptions, we expect a fiscal deficit of 4.3% of GDP in 2016, including the estimated income of the Qatar Investment Authority (QIA) of around 5% of GDP (which the government does not report or include in the budget). We expect general government revenues to fall 36% to QAR176bn in 2016, after decreasing 23% in 2015. We forecast expenditure to fall 20% to QAR202bn in 2016, mainly on the back of consolidation of current spending. Non-oil revenue measures and some further recovery of oil prices should bring the budget back to surplus in 2017.

Current spending was down 20% yoy in 1H16, amounting to 45% of the full-year budget for current expenditure. We assume that full-year spending will be close to budgeted amounts, with risks tilted towards overspending given the size of the planned adjustment. The decline in current spending reflects, among other measures, a public sector wage freeze, lay-offs of expatriate workers, reductions in fuel and utility price subsidies, and general restraint on expenses in the public sector (e.g., travel or office expenses). Current spending was first cut in 2014, as fiscal reforms were initiated well before the dramatic souring of the energy price outlook.

Over the past six months, the government has undergone a major effort to re-evaluate its capital spending programme, which had included projects worth a total of QAR350bn (close to USD100bn or 60% of estimated 2016 GDP) for the period between 2016 and 2022. A committee set up by the Minister of Finance has scaled back and optimised projects so as to yield expected savings of QAR65bn over the period. Of these savings QAR28bn will be realised in 2016-2018 and are taken into account in our capital spending forecasts. The committee is still reviewing projects to the value of QAR88bn, and we expect the process to be completed by early next year.

The authorities are financing deficits by issuing debt instead of drawing on assets held by the QIA. The government of Qatar made its debut on the eurobond market by issuing USD9bn of five-, 10-, and 30-year bonds in May 2016 with strong demand from investors. This follows a USD5.5bn loan syndication in late 2015. We assume that local debt will be issued to cover existing local maturities, and that foreign debt will be used to cover any remaining financing needs. This would imply more domestic issuance in 2016 and 2017, and additional external issuance of around USD5bn in 2017. We expect QIA assets, which are not officially disclosed, to rise to an estimated USD338bn (209% of GDP) in 2016 from USD318bn (193% of GDP) in 2015.

Banks have continued to provide net funding to the public sector, but, in a time of sluggish domestic deposit growth, liquidity has deteriorated. Loan/deposit ratios in commercial banks have continued to trend upwards in 1H16 with the ratio of total domestic loans to deposits (LDR) reaching 132% in May.

However, banks were able to fund themselves abroad through market placements and non-resident deposits; as a result, bank net foreign assets declined by QAR87bn (USD24bn) in 1H16. LDRs and interbank rates receded in June and commercial bank balances with the central bank rose. The LDR including foreign loans and deposits, which is closer to the central bank's preferred definition, reached 118% in May.

High but falling government capital spending will not be able to contribute further to GDP growth. Instead, non-hydrocarbon growth will come from private investments on the back of government projects, and from accompanying growth in the services sectors (trade, financial intermediation, and real estate). We expect overall real GDP growth of 3.4% in 2016, after 3.6% in 2015. In our forecast, non-oil growth drops to 6% in 2016 after 8.6% in 2015 and continues to slow in 2017 and 2018.

Hydrocarbon GDP will grow 1% in 2016 and 2% in 2017 after contracting by 0.5% in 2015. The Barzan development should come on stream in 2016 and will add 1.4 billion scft/d (8% increase) of production of gas for local use when it reaches full capacity, on top of additional production of LPG and condensates. The Ras Laffan II refinery should be completed by 3Q16 and will add 146,000 bbl/day of capacity for petroleum products (also a 8% increase). Oil field redevelopments could positively affect hydrocarbon production after 2018.

The outlook for gas prices has weakened in line with that of oil prices. Prices of liquefied natural gas, Qatar's main export, will also be under pressure from additional global capacity coming on stream at a time of weak demand growth. Qatar is protected from the worst effects of the glut by the most of its contracts to supply gas to customers being long-term and based on a certain percentage of moving average oil prices. However, recent experience shows that customers may seek to renegotiate these contracts.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Qatar a score equivalent to a rating of 'AA-' on the Long-Term Foreign-Currency IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:

• Public Finances: +1 notch, to reflect exceptionally large government assets.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign Currency IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to a negative rating action are:

• Sustained weakness in hydrocarbon revenues and a failure to scale back expenditure, eroding fiscal and external positions.
• A materialisation of large contingent liabilities, such as from government-related enterprises or the banking sector, resulting in a rapid draw-down of sovereign assets or build-up of debt.

The main factors that could, individually or collectively, lead to positive rating action are:

• Improvement in structural factors such as reduction in oil dependence, and a strengthening in governance, the business environment and the economic policy framework.

KEY ASSUMPTIONS

Fitch assumes that Brent crude will average USD42/bbl in 2016, USD45/bbl in 2017 and USD55/bbl in 2018.

Fitch assumes natural gas prices will evolve broadly in line with oil prices.

Fitch assumes that regional geopolitical conflicts will not impact directly on Qatar or on its ability to trade and that the domestic political scene will remain stable.