Government-related entities (GREs) in Saudi Arabia have recently raised or are likely in the near future to raise significant amounts of debt, prompting questions by investors about the possible implications for sovereign ratings.
In September 2018, the Public Investment Fund (PIF) took out an $11 billion international syndicated loan to diversify its long-term funding. Beginning in July 2018, Saudi Aramco raised the possibility of acquiring a strategic stake in Saudi Basic Industries Corp. (SABIC) from PIF.
So far, the level of GRE debt and the potential for these contingent liabilities -- obligations that have the potential to materialize on a government's balance sheet or more broadly affect its fiscal profile -- being realized has not led to negative rating actions for GCC sovereigns. If contingent liabilities do materialize, they have the potential to negatively affect sovereign ratings.
In its recent report titled “What are the implications of sovereign ratings when GREs raise debt?”, S&P Global Ratings answers questions from investors about how GRE debt may affect sovereign ratings, focusing on rated GREs in the GCC.
Characteristics of rated GREs
The majority of ratings on GREs in the GCC are either equalized with the sovereign rating or benefit from some uplift to their stand-alone credit profile (SACP). This is broadly to be expected, as GREs are usually created to serve a specific policy role or provide a key product or service to the population.
Five ratings on GREs in the region are equalized with the government owner's local currency rating, indicating the likelihood of sufficient and timely extraordinary government support, should the entity experience financial distress, as almost certain.
Ten ratings on GREs in the GCC that are not equalized with the sovereign rating benefit from some SACP uplift in the ICR. Six entities have SACPs sufficiently strong to achieve a rating equal to the sovereign without any additional extraordinary government support being factored in.
Three entities have SACPs higher than the sovereign local currency rating, meaning that their final ratings are constrained at the level of the sovereign.
GRE uplift to projects is rare given that governments typically award a concession or contract using a project finance structure to shift risks of constructing and operating an infrastructure or social asset to a private enterprise. Project finance transactions with GRE status are more prevalent in the GCC than elsewhere.
Contingent liabilities in the context of sovereign ratings
Some of these liabilities may be difficult to identify and measure, but they can generally be grouped in three broad categories, including financial institutions' related contingent liabilities, nonfinancial public-sector enterprises (NFPEs), and guarantees and off-budget contingent liabilities.
NFPE contingent liabilities largely relate to GREs outside the financial sector. These are enterprises often partly or wholly under government control that we believe are likely to benefit from extraordinary government intervention during periods of financial stress.
Impact of GRE contingent liabilities on sovereign ratings
Contingent liabilities related to NFPEs may weigh on a sovereign rating if two conditions are met. Firstly the sovereign's exposure to the entity or a group of entities is material, worsening the assessment of the government's net debt stock; and secondly, government support for the entity or a group of entities is deemed significant, as evidenced by a large rating uplift from the entity's SACP or from the estimated stand-alone creditworthiness, if not rated.
As it stands, none of the ratings on GCC sovereigns have been negatively affected by the assessment of their potential contingent liabilities.
Effect of currency or ownership of the GRE debt
It doesn’t matter when assessing whether the GRE debt is or is not a contingent liability. However, if GRE foreign currency debt crystalizes on a government's balance sheet, it may worsen the assessment of the government's debt servicing costs and also the structure of the government's debt stock.
Rising levels of nonresident holdings of GRE debt if, for example, Saudi Aramco were to borrow $70 billion from abroad to finance its potential purchase of SABIC, would increase the external debt of Saudi Arabia and be reflected in the country's external balance sheet and our external assessment of the sovereign.
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