On 19 January 2018, S&P Global Ratings affirmed its ‘BBB+/A-2’ long- and short-term foreign and local currency sovereign credit ratings on the Emirate of Sharjah, a member of the United Arab Emirates (UAE). The outlook is stable.
The stable outlook reflects our expectation that Sharjah will reduce its government budget deficits in the next two years. The ratings could be lowered if Sharjah’s economic growth was substantially weaer than it is currently expected. The ratings could also come under pressure if the budget deficit widened significantly, accelerating the build-up of government debt.
Alternatively, the ratings could be raised if Sharjah enacted revenue measures or expenditure controls, or a combination thereof, to cut its government balances after capital spending, and its debt-servicing costs fell below five per cent of government revenues.
S&P’s ratings are supported by the strength of Sharjah’s fiscal position, despite a relatively narrow tax base, and the advantages that Sharjah derives from its membership in the UAE, including low external risks. The ratings are constrained by our assessment that the emirate’s political institutions are at a nascent stage of development relative to peers in the same rating category.
Limited monetary flexibility- given the UAE dirham’s peg to the US dollar and the underdeveloped local currency domestic bond market also weigh on the ratings.
Institutional and Economic Profile:
Economic growth is poised to average about two per cent in 2018-2021. An acceleration in GDP growth is expected in 2018, based on the increased economic activity in the real estate and construction sectors and the spillover effects of rising investment in nearby Dubai in relation to its World Expo 2020.
It is unlikely that the current diplomatic rift between the UAE and Qatar will hinder the economic outlook for Sharjah significantly, and domestic political stability is anticipated to continue over the forecast horizon.
In S&P’s view, the economic structure of Sharjah displays a relatively high degree of diversity, particularly compared with most Gulf Cooperation Council (GCC)sovereigns— Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE.
The manufacturing sector contributes the largest share to the emirate’s GDP, at 17 per cent, with real estate, wholesale and retail trade, and financial services sectors all accounting for more than 10 per cent of GDP. The economy is expected to grow gradually at about two per cent on average in 2018-2021, reflecting increased public investment and recovering domestic demand in the region, and a pickup in global trade. Sharjah should also benefit from increased demand from Dubai stemming from the World Expo 2020.
Sharjah’s economic growth prospects are closely tied to those of the region, particularly those of the larger emirates of Abu Dhabi and Dubai. A modest increase in oil prices is expected compared with 2017 with an average Brent oil price of $55 per barrel in 2018-2021.
Nevertheless, downside risks to growth could stem from tightening monetary conditions and increased geopolitical uncertainties in the region. It is estimated that Sharjah’s GDP per capita will be at $18,400 in 2018.
The ratings are supported by the advantages the emirate derives from its membership in the UAE, including low external risks. At this stage, the diplomatic rift with Qatar is expected to have a limited impact on the UAE, including Sharjah.
It is understood that some of the Qatari gas supply to the UAE is allocated to Sharjah Electricity and Water Authority (SEWA), and the Dolphin pipeline from Qatar to the UAE is expected to remain open, absent a further significant escalation in regional tensions. If the pipeline is shut off, it could push up fuel costs for national electricity generators across the UAE, ultimately increasing fiscal costs.
Policy-making is highly centralised and depends heavily on Sharjah’s ruler, Sheikh Dr. Sultan bin Mohammed Al Qasimi. S&P considers this could undermine institutional effectiveness and policy predictability. Political institutions in Sharjah are at a developing stage. Still, having ruled Sharjah since 1972, Sheikh Sultan has been instrumental in successfully implementing the emirate’s long-term economic and social development objectives.
No significant changes in the government’s policy stance is expected, and scope for political participation is limited to the Sharjah Consultative Council, but citizens’ relatively easy access to the leadership strengthens domestic stability, in S&P’s view.
Flexibility and Performance Profile:
The government’s fiscal position will likely remain strong over S&P’s forecast horizon, and there should be an improvement in the fiscal position over the next two years, supported by various revenue-raising measures and increased transfer payments from government-related entities (GREs).
Sharjah’s debt burden remains moderate, as does the the assessed risk of contingent liabilities arising from GREs.
As a member of the UAE-wide monetary union, Sharjah has less policy flexibility relative to sovereigns with their own central banks. Sharjah’s government budget revenue base is limited but diverse; this is largely because the government collects little in terms of direct taxes. The major contributors to government revenues are customs, company registration fees, and municipality’s fees and revenues (largely fines) from the police department that together constitute about 50 per cent of total revenues. The contribution of hydrocarbons has fallen considerably since 2015, making up about 3 per cent of total revenues.
Government expenditure is also small relative to the size of the economy, averaging nine per cent in 2011‐2017. Excluding extraordinary items, the government’s expenditures typically include capital expenditures amounting to about two per cent of GDP on average that the government spends to enhance infrastructure and social services beyond the basics financed at the UAE federation level. As a member of the UAE, Sharjah benefits significantly from a large public works programme and a range of public services provided by the federation, including basic education and health care for UAE nationals, defence and policy initiatives, infrastructure and housing.
That said, Sharjah’s revenue and expenditure base as a percentage of GDP remains among the lowest of all rated sovereigns, averaging 10 per cent and 12 per cent of GDP, respectively, over S&P’s forecast horizon. It was noted that Sharjah’s fiscal deficit widened materially over 2014 to 2016, largely due to stimulus measures to help offset slowing economic activity, coupled with lower transfers from GREs and the postponement of various revenue-enhancing measures.
As a result, net government debt increased by nearly 10 percentage points of GDP over the same period. Nevertheless, the government’s fiscal position remains strong, supporting our investment-grade ratings on Sharjah. A government deficit of 1.8 per cent of GDP is estimated in 2018, compared with about 2.2 per cent in the previous year.
S&P expects the government’s consolidated fiscal revenues will increase by about one percentage point of GDP to 10 per cent of GDP in 2018 and remain close to that level over the period through year-end 2021 on the back of increased transfer payments from Sharjah’s GREs and land sales to property developers. The UAE introduced VAT at the beginning of 2018. However, it is currently unclear how the associated revenues will be distributed across the various emirates. Still, Sharjah’s tax revenues are expected to increase as a result, with the government’s fiscal expenditure remaining broadly unchanged, at under 12 per cent of GDP over the period through year-end 2021.
Capital expenditures remain among the largest single spending items, at 20 per cent of the total budget.
The Government’s interest payments, which have increased in recent years, are likely to average seven per cent as a proportion of revenues over the forecast horizon. Sharjah’s debt burden is still viewed as moderate. Sharjah tapped into international debt capital markets with Sukuk issuances in 2014 and 2016 at $750 million and $500 million, respectively. As a result, general Government debt increased to 17 per cent of GDP in 2016 from less than 10 per cent in 2014.
S&P forecasts the Government’s net debt will reach about 20 per cent of GDP by year-end 2021. Debt denominated in foreign currencies accounts for about one-half of outstanding debt and is all in US dollars. It is expected that the UAE dirham’s exchange rate peg to the US dollar will remain in place and so, to a significant extent, mitigating foreign exchange risk related to the government’s debt. In S&P’s view, apart from SEWA, there is a remote risk of contingent liabilities arising from GREs. Sharjah’s total debt from GREs is estimated at about 12 per cent of GDP in 2017.
There is very limited external trade, balance of payments, and international investment position data available for Sharjah. S&P’s assessment of the emirate’s external position is therefore based on that of the federation, the UAE. Defining the UAE as the “host country,” S&P used its estimates of the UAE’s external position as a starting point and then adjusted the initial assessment downward due to material data gaps, which reduce the visibility of external risks.
S&P’s estimates, which factor in Abu Dhabi’s significant external assets, held by The Abu Dhabi Investment Authority (ADIA), lead the agency to assess the UAE’s, and ultimately Sharjah’s, overall external position as a strength. Still, the UAE’s liquid external asset position is expected to exceed external debt by an average of about 119 per cent of current account receipts (CARs) in 2018-2021, albeit declining over the period.
The UAE’s gross external financing needs are forecast to be at about 141 per cent of usable reserves of the UAE central bank and CARs, on average, over the same period. Sharjah is viewed as part of a UAE‐wide monetary union with limited monetary flexibility given the UAE dirham’s peg to the US dollar and the underdeveloped local currency domestic bond market. These assessments mirror those made on the other emirates in the UAE and GCC countries.
S&P adjusted its initial assessment of UAE monetary conditions downward for Sharjah, reflecting that it has less monetary flexibility relative to sovereigns with their own central banks. The UAE central bank raised the interest rate on its certificates of deposit by 25 basis points in December 2017 for the third time in the year, following the hikes in the key policy rate of the US Federal Reserve. The UAE is expected to continue tracking the gradual US tightening cycle, given the currency peg. In S&P’s view, the UAE has more than sufficient reserves to defend the peg, while considerations of macroeconomic and social stability would also outweigh the potential benefits of amending the exchange rate regime.