Thursday 06, April 2017 by Nabilah Annuar

Moody's assigns (P)A1 rating to Saudi Arabia's Trust Certificate Issuance Programme

Moody's Investors Service has assigned a provisional programme rating of (P)A1 to the global Trust Certificate Issuance Programme (the Programme) established by the Government of Saudi Arabia (A1 stable).

KSA Sukuk Limited, a special purpose vehicle incorporated in the Cayman Islands and wholly owned by the Government of Saudi Arabia, will issue Trust Certificates under the Programme. The payment obligations associated with these Trust Certificates are direct obligations of the Government of Saudi Arabia, and the programme rating mirrors the Government of Saudi Arabia's long-term issuer rating of A1. Moody's expects to assign definitive rating(s) to Trust Certificates issued under the Programme upon closing of the issuance and review of the terms of the final transaction documents. It also notes that its programme rating does not express an opinion on the structure's compliance with Shari'ah law.

The long-term (P)A1 rating assigned to the Programme is at the same level as the long-term issuer rating of the Government of Saudi Arabia because, in Moody's opinion, the Government of Saudi Arabia's payment obligations associated with these Trust Certificates are direct obligations of the Government of Saudi Arabia, ranking pari passu with all other unsecured external indebtedness of the Government of Saudi Arabia and the holders of the Trust Certificates will therefore effectively be exposed to Saudi Arabia's senior unsecured credit risk. Under no circumstances shall the certificate holders have any right to cause the sale or other disposition of any of the Trust Assets except pursuant to the Transaction Documents and the sole right of the certificate holders against the Government of Saudi Arabia shall be to enforce the obligation of the Government to perform its obligations under the Transaction Documents.

Saudi Arabia's A1 stable long-term issuer rating reflects very high levels of fiscal and economic strength, high institutional strength, and a moderate susceptibility to event risks. Strong growth in oil revenues until the oil price shock in 2014 allowed for the build-up of a sizeable asset cushion and sharp debt reduction. Although the decline in oil prices pushed the budget balance into deficit, eroding the government's reserves and prompting it to issue bonds on the international market for the first time in 2016, the fiscal position remains strong. Despite rising funding requirements over the rating horizon, Moody's thinks that the government has access to ample sources of liquidity, both from domestic and international capital markets and is unlikely to encounter problems financing fiscal deficits. While foreign exchange reserves have fallen in light of a large current account deficits since 2015, they remain sizable, at $514 billion (equivalent to around 80 per cent of GDP) as of February 2017. External debt is rising, but from a low base, and Moody's expects annual external debt repayments to remain significantly below the critical threshold of 100 per cent of foreign exchange reserves over the coming years.

Saudi Arabia's credit challenges include the economy's high dependence on oil, as well as a rigid government spending structure and government revenues that are vulnerable to oil price volatility. Saudi Arabia has historically experienced strong growth rates, but real GDP growth has decelerated since 2014, mainly due to fiscal consolidation in response to lower oil prices. Low growth illustrates both the ongoing economic pressures on economic strength from the oil price shock, but also the fiscal challenges given the plan to get to a balanced budget by 2020. The government has announced ambitious and comprehensive plans to diversify the economy and government finances in its National Vision 2030. However, implementation is still at an early stage, and Moody's thinks there is a risk that the reform progress might slow down in a scenario of higher oil prices and/or growing public discontent. In Moody's view socio-economic challenges are visible in strong population growth and high unemployment, and the rating also incorporates an element of geopolitical risk, driven by regional instability and the country's strategic rivalry with Iran.

Given that the programme rating is tied to the long-term issuer rating of the Government of Saudi Arabia, the same factors and considerations apply.

Fulsome implementation of planned fiscal and economic reforms would be credit positive and could support a higher issuer rating. The success of such reforms would likely be reflected in fiscal deficits falling more quickly than currently envisaged, the government debt burden peaking at a lower level and growth recovering earlier and more rapidly from a broadening economic base. Such developments would be more positive if they resulted from sustainable structural reforms, than from cyclical or temporary increases in the price of oil. A reduction in regional political and security threats would also exert upward pressure on the rating.

The following developments would be credit-negative, and could lead to a negative action on the issuer rating: loosening fiscal consolidation, such as fiscal deficits staying wide and government debt ratios rising faster than in Moody's baseline scenario; renewed pressure on the exchange rate and a faster depletion of foreign exchange reserves; difficulties to fund large fiscal and current account deficits; an escalation of regional geopolitical risks and/or signs of deteriorating domestic political and social stability.

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