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Rating Action:

Moody's downgrades Sharjah's rating to Baa2, and changes outlook to stable

18 Feb 2020

New York, February 18, 2020 -- Moody's Investors Service, ("Moody's") has today downgraded the long-term foreign and local currency issuer ratings of the Government of Sharjah to Baa2 from A3, and changed the outlook to stable from negative.

The downgrade to Baa2 reflects Moody's lower assessment of Sharjah's institutions and governance strength than previously assessed. Evidence of significant slippage on fiscal targets and incurrence of contingent liabilities denotes more reactive fiscal policymaking than previously assessed. Moreover, a significant widening of the fiscal deficit has contributed to a much faster than expected accumulation in debt last year and, in the absence of any fiscal consolidation measures, is likely to result in a markedly higher debt trajectory over the medium term, indicating weaker fiscal strength than Moody's had previously estimated.

The stable outlook reflects a number of factors pointing to resilience at the Baa2 rating level, including low external vulnerability risks and a credible currency peg afforded by membership in the federation of the United Arab Emirates (UAE), ample funding sources, and high income levels contributing to shock absorption capacity. The Baa2 rating takes into account Moody's expectations of a further rise in the debt burden. It also includes analysis showing that under various plausible negative scenarios, Sharjah's fiscal strength is unlikely to deteriorate significantly further, indicating a degree of resiliency at this rating level. Conversely, the rating also takes into account the relatively low probability of a significant improvement in fiscal strength.

The downgrade of the rating to Baa2 from A3 also applies to the backed senior unsecured debt ratings of Sharjah Sukuk Limited, Sharjah Sukuk (2) Limited and Sharjah Sukuk Programme Limited. The provisional rating of the backed senior unsecured MTN programme of Sharjah Sukuk Programme Limited has also been downgraded to (P)Baa2 from (P)A3. In Moody's opinion, the payment obligations of the notes issued by these entities are direct obligations of the government and rank pari passu with other senior, unsecured debt issuances of the government.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO Baa2

The downgrade to Baa2 reflects Moody's assessment of weaker institutions and governance, and fiscal strength in light of recent developments that reveal a significantly wider deficit, higher government debt and an absence of measures that may stem a further increase in the debt burden. Moody's assesses that weaknesses in fiscal policy effectiveness largely account for the significant increase in debt in 2019, which are unlikely to be addressed in the near term.

Sharjah's fiscal deficit widened to 6.1% of GDP in 2019 -- significantly above the 2.3% of GDP that was budgeted. After ringfencing social security revenues, the borrowing requirement arising from government spending was equivalent to 7.2% of GDP. An increase in discretionary spending was the primary driver behind the increase in the fiscal deficit, with accelerated payments on public infrastructure projects resulting in a significant over-spend on contractor payments. While the fiscal data are preliminary, Moody's believes they represent a reasonably finalized portrayal of government accounts for 2019.

In addition, the deterioration in the macroeconomic environment also contributed to weaker than expected government revenues. Notably, receipts from land sales were substantially lower than expected in the 2019 budget, in part due to continued pressure on the UAE's real estate sector. Increased competition for business among the free-zones amid the slowdown in the UAE's non-oil economy also resulted in lower transfers from Sharjah's government-related entities.

Partly due to the wider than budgeted fiscal deficit, Sharjah's debt burden rose rapidly in 2019, reaching 33.6% of GDP, from 25.4% of GDP in 2018. The transfer of government-guaranteed debt from a real estate developer to the government's balance sheet also contributed to the increase in the government's debt burden, as did the government's policy of ringfencing social security funds, rather than using these funds to finance government expenditure. Despite increases in the revenue base arising from the distribution of VAT revenues in 2019, debt-to-revenues reached a new high of 292%, which is significantly higher than the median level for both Baa1 and Baa2 rated sovereigns.

In Moody's view the recent track record of missed fiscal targets and the assumption of guaranteed debt is evidence of more reactive fiscal policy making than previously assumed. Meanwhile, the absence of timely and publicly-available macroeconomic and fiscal data remains an institutional constraint at emirate level, reflected in slow progress on the publication of constant-price and quarterly national accounts data, which may impair the formation of accurate fiscal projections.

This view is supported by the fact that the 2020 budget suggests limited prospects for fiscal consolidation in the short term. No new revenue-raising measures are currently planned for the upcoming fiscal year and in the absence of new fiscal measures, improved government revenues will remain contingent upon an acceleration in the macroeconomic environment. However, Moody's expects growth in the UAE's and Sharjah's non-oil economy to remain materially below historical rates.

After removing ringfenced social security funds from the 2020 budget, Moody's estimates that the net increase in government debt will be equivalent to 6.5% of GDP in 2020. As a result, Moody's expects Sharjah's debt burden is likely to rise above 40% of GDP by end-2020, which would be more than four times the debt burden when the initial A3 rating was first assigned in 2014.

In addition to wider fiscal deficits, Moody's expects that the government's plan to underwrite a second rights issue for Invest Bank up to AED 785 million as part of a package of remedial measures will further contribute to the increase in the government's debt burden. While the timing of this remains subject to change, Moody's expects it could occur in the relatively near term.

RATIONALE FOR CHANGING THE OUTLOOK TO STABLE

Sharjah's membership in the federal structure of the UAE provides numerous credit strengths which support the rating at the Baa2 level, including a highly credible currency peg, strong banking sector oversight and indirect financial support via spending on infrastructure and social projects.

Furthermore, Sharjah continues to benefit from a relatively diversified economy, which is more diversified than the UAE on aggregate reflecting the small size of the hydrocarbon industry in the emirate. Sharjah also benefits from relatively high incomes in global terms, above the median for Baa-rated sovereigns although substantially lower than in neighbouring Abu Dhabi (Abu Dhabi, Government of Aa2 stable) and Dubai.

Moreover, under its baseline scenario Moody's expects Sharjah's debt burden to continue to increase. However, even under various negative scenarios, Moody's does not expect the fiscal strength of Sharjah will deteriorate significantly, indicating a degree of resiliency at this rating level.

Event risks stemming from Sharjah's government liquidity risks or the UAE's balance of payments are low in Moody's view given the UAE's sizable foreign assets. Notwithstanding the increase in recent years and likely further rise in the debt burden, a liquid banking sector, which acts as a key creditor to the emirate, supporting Moody's view of low government liquidity risks.

ENVIRONMENTAL SOCIAL AND GOVERNANCE CONSIDERATIONS

Environmental risk is material to Sharjah's credit profile. The UAE is one of the world's top ten most arid states, and rapid growth in recent decades has further increased environmental risks surrounding water sustainability, a challenge which also applies to Sharjah given that water generation is handled at the emirate level. The majority of the UAE's (and Sharjah's) water is produced by desalination plants, which are highly energy intensive. Growth and/or fiscal constraints would rise if water supply is unable to keep pace with demand.

Social risks currently exert limited impact on Sharjah's credit profile, although the effectiveness of labour market nationalisation policies in keeping unemployment low among citizens will remain an important consideration for social risks for the foreseeable future.

Governance risks are material to Sharjah's credit profile and a driver of the rating downgrade. As explained above, the risks relate to the limited transparency on fiscal policy, in particular the recent track record of missed fiscal targets and the incurrence and assumption of government guaranteed debt point to reactive fiscal policy formation.

WHAT COULD CHANGE THE RATING UP/DOWN

A sustained decline in the debt burden relative to revenues, whether arising from a significant sustainable expansion of the revenue base and/or through substantive expenditure restraint achieving primary balance surpluses, would likely exert positive pressure on the rating. Furthermore, evidence of decreasing volatility in government revenues which would provide greater comfort over the capacity of Sharjah to carry a higher debt burden could also support a higher rating.

Further significant deterioration in fiscal strength, resulting from wider fiscal deficits for longer than Moody's currently projects and/or a more marked increase in government debt, would likely lead to a downgrade, revealing yet weaker institutions and governance than Moody's now assesses.

GDP per capita (PPP basis, US$): 33,050 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 0.7% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.7% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -4% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: [not available] (also known as External Balance)

External debt/GDP: [not available]

Economic resiliency: baa2

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 13 February 2020, a rating committee was called to discuss the rating of the Sharjah, Government of. The main points raised during the discussion were: The issuer's institutions and governance strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

The local market analyst for these ratings is Thaddeus Best, +971 (423) 795-06.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Jaime Reusche
VP - Senior Credit Officer
Sovereign Risk Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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