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Rating Action:

Moody's downgrades Sharjah's ratings to Ba1, changes outlook to stable

19 Jul 2022

New York, July 19, 2022 -- Moody's Investors Service ("Moody's") has today downgraded the long-term foreign and local-currency issuer ratings and the foreign-currency senior unsecured ratings of the Government of Sharjah to Ba1 from Baa3, and changed the outlook on the issuer to stable from negative.

The downgrade to Ba1 is driven by Moody's expectation of further significant deterioration in Sharjah's fiscal strength over the next few years, and the absence of a credible fiscal adjustment plan that would arrest and eventually reverse the upward trend in the emirate's debt burden and the weakening of its debt affordability metrics. This demonstrates weaker governance and in particular a lower level of fiscal policy effectiveness than previously assessed.

The stable outlook reflects Moody's view that at the Ba1 level the risks to Sharjah's ratings are balanced. The Ba1 rating is consistent with further fiscal deterioration that Moody's expects in the medium term. Downside credit risks stem from the deteriorating global macroeconomic environment. Upside risks relate to potentially more positive effects than currently assumed from the government-led infrastructure and real-estate development projects on Sharjah's growth and from the planned introduction of the federal corporate tax on revenue. Sharjah's government liquidity and external vulnerability risks stemming from the tightening global financing conditions and rising interest rates are mitigated by the financial benefits that Sharjah derives from its membership in the UAE (United Arab Emirates, Government of Aa2 stable) federation, including UAE's highly credible currency peg and the government's reliable access to financing from the UAE's liquid and well-capitalized banking system.

The downgrade of the rating to Ba1 from Baa3 also applies to the backed senior unsecured debt ratings of Sharjah Sukuk Limited and Sharjah Sukuk Programme Limited. In Moody's opinion, the payment obligations related to the notes issued by these entities, which are fully owned by the Government of Sharjah, are direct obligations of the government and rank pari passu with other senior, unsecured debt issuances of the government. The provisional rating of the senior unsecured MTN program of the Government of Sharjah and the provisional rating of the backed senior unsecured MTN program of Sharjah Sukuk Programme Limited have also been downgraded to (P)Ba1 from (P)Baa3.

RATINGS RATIONALE

FURTHER WEAKENING OF DEBT AND DEBT AFFORDABILITY METRICS IN THE ABSENCE OF A MEDIUM-TERM FISCAL ADJUSTMENT PLAN

Sharjah's trend fiscal deterioration, which began in 2017 and deepened in 2020, continued during 2021 as government revenue struggled to recover from the coronavirus shock while government spending rebounded by more than 12% mainly on the back of the government's infrastructure projects. As a result, Sharjah's fiscal deficit widened to 8% of GDP in 2021 from 7.1% of GDP in 2020 (significantly wider than the average of 1.7% of GDP during 2012-16 and 3.4% during 2017-19) driving a rapid increase in government debt to 41% of GDP (622% of revenues) in 2021 from 34% of GDP (486% of revenues) in 2020 and only 13% of GDP (200% of revenues) in 2016.

Moody's expects that this trend erosion in Sharjah's fiscal metrics will continue in the medium term, with the debt burden rising by another 10 percentage points of GDP by the end of 2023, and likely exceeding 60% of GDP by 2025, even as revenue recovers above the pre-coronavirus level. The key driver behind this expectation is Moody's view that the government will continue to prioritize its social and economic development objectives, which – in the absence of a comprehensive medium-term fiscal adjustment program – will be reflected in continued growth in government spending, albeit likely at a slower pace than the 10% average annual growth rate during the past 10 years, while the ability to introduce new revenue measures will be constrained by economic competitiveness considerations. The latter is the consequence of the high level of competition and mobility between the individual UAE emirates, which limits the capacity to increase the cost of business license and other government fees, and the fact that the prerogative to set both direct and indirect taxes that support Sharjah's government revenues rests with the UAE federal government.

As government debt increases in line with Moody's baseline projections, Sharjah's debt affordability metrics will also weaken with interest payments rising to 1.9% of GDP (more than 26% of revenue) in 2023 from 1.3% of GDP (19.6% of revenue) in 2021. Sharjah's interest payments-to-revenue ratio is already among the highest decile of sovereigns rated by Moody's.

The Ba1 rating is supported by Sharjah's high GDP per capita (nearly $32,000 in purchasing power parity-adjusted terms in 2021) and its diversified economy compared to most sovereigns in the Gulf Cooperation Council region. Sharjah also benefits from institutions and governance that it shares with the rest of the UAE, including its overall macroeconomic and monetary policy effectiveness and banking regulation by the Central Bank of the UAE.

Furthermore, the vast wealth of the neighboring emirate of Abu Dhabi (Abu Dhabi, Goverment of Aa2 stable) provides credit support to the UAE federal government as well as the other fellow emirates, including Sharjah. This view reflects deep ethnic, cultural, religious and reputational ties between the members of the UAE federation and the track record of providing support in the case of the emirate of Dubai in 2009.

RATIONALE FOR THE STABLE OUTLOOK

The risks to Sharjah's fiscal strength and the overall credit profile at the Ba1 rating level are broadly balanced. While Sharjah's debt burden and debt affordability metrics are set to deteriorated further (and in the case of its debt-to-revenue and interest-to-revenue ratios they are already weaker than most Ba-rated sovereigns), the emirate's overall fiscal strength will likely remain in line with the Ba-rated median over the next few years.

Furthermore, some of the expected deterioration in Sharjah's fiscal strength metrics is mitigated by the credit support that Sharjah derives from its membership of the UAE federation. This support stems mainly from off-budget public spending by the federal government on behalf of Sharjah. For example, unlike most sovereigns rated by Moody's which allocate around 2% of GDP on average to military and defense spending, Sharjah does not have to incur this expense, which in turn frees up a greater portion of its fiscal revenues for debt service compared to most other sovereigns. The federal government also supports public education and healthcare for the UAE citizens in Sharjah as well as some infrastructure projects. Furthermore, the UAE credit support also derives from the highly credible exchange rate peg of the UAE dirham to the dollar, which mitigates the downside fiscal risks associated with Sharjah's large and increasing share of foreign currency debt in total government debt, which reached 78% of total (or 32% of GDP) in 2021.

Near-term downside credit risks stemming from the deteriorating global macroeconomic environment are balanced by some upside risks to Sharjah's growth potential from the ongoing infrastructure and real-estate development projects implemented by the government of Sharjah. Over the next five years we expect Sharjah's economy to expand at an average annual rate of around 3% (below the average of 4.3% during 2010-19), which could increase if the ongoing improvements in infrastructure lead to stronger growth in the tourism and the real estate sector. Meanwhile, upside risks to government revenues stem from the planned implementation of the federal corporate tax on business profits, which has been announced to commence in June 2023, although there is still a high degree of uncertainty about how much revenue could be collected, what share would be retained by the federal government, and what would be the distribution formula for the individual emirates, including Sharjah.

Government liquidity and external vulnerability risks stemming from the tightening global financing conditions and rising interest rates are mitigated by the financial benefits that Sharjah derives from its membership in the UAE. This includes UAE's highly credible currency peg, which we except to remain in place for the foreseeable future, and Sharjah's reliable and tested access to funding from the UAE's liquid and well-capitalized banking system, which is further supported by a zero capital charge for lending to the Government of Sharjah.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Sharjah's ESG Credit Impact Score is neutral to low (CIS-2), reflecting its moderate exposure to environmental risks, balanced against institutions and governance that benefit from Sharjah's membership in the UAE federation, and support the government's capacity to respond to shocks. Social risks are low.

Sharjah's moderately negative exposure to environmental risks, reflected in its E-3 issuer profile score, is mainly related to its freshwater scarcity and its exposure to rising sea levels. The UAE, including Sharjah, is one of the world's top ten most arid states, and rapid economic and population growth in recent decades has further increased challenges surrounding water sustainability. Around 95% of Sharjah's water is produced by seawater desalination plants, which are highly energy intensive and potentially vulnerable to oil spills from marine traffic in the Gulf. However, Sharjah is implementing projects to significantly improve efficiency of water production and has domestic natural gas resources that provide ample and affordable energy for seawater desalination. Furthermore, majority of the emirate's population resides in coastal areas. As climate change intensifies, Sharjah will be among the sovereigns most vulnerable to rising sea levels, with up to 10% of its population exposed under a scenario where sea levels rise by one meter.

Exposure to social risks is neutral to low (S-2 issuer profile score). The main source of pressure arises from the young demographics, which will drive rapid growth in the labor force over the coming decades. The effectiveness of labor market nationalization policies in keeping unemployment low among citizens will remain an important consideration for social risks for the foreseeable future. Although Sharjah's very low proportion of Emirati citizens to the overall population (less than 20%) and the labor force helps to mitigate this challenge, the challenge is compounded by the pressure and desire to maintain comparable living standards to the citizens living in the other wealthier emirates.

Sharjah's governance benefits from its membership in the UAE federation, where it shares some aspects of the institutions and governance profile with the federal government, including monetary and overall macroeconomic policy effectiveness and financial sector regulation. However, other aspects such as fiscal policy effectiveness and production of statistical data are emirate-specific and weigh on the assessment of Sharjah's governance profile. On balance, Sharjah's overall governance is broadly in line with the median of other sovereigns and does not pose significant credit risks (G-2 issuer profile).

GDP per capita (PPP basis, US$): 31,770 (also known as Per Capita Income)

Real GDP growth (% change): 5.0% (2021) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 2.8% (2021)

Gen. Gov. Financial Balance/GDP: -7.9% (2021) (also known as Fiscal Balance)

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

External debt/GDP: [not available]

Economic resiliency: baa3

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

On 14 July 2022, 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 economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

WHAT COULD CHANGE THE RATINGS UP

An introduction of new significant fiscal consolidation measures, increasing the likelihood that Sharjah's upward debt trajectory will be arrested or reversed in the next few years, would likely support a path back to a higher rating, particularly if implemented in the context of a credible and comprehensive medium-term fiscal adjustment program.

WHAT COULD CHANGE THE RATINGS DOWN

Increasing evidence that government debt is likely to rise significantly higher and/or faster than Moody's currently expects may prompt a rating downgrade. Such additional fiscal erosion would likely indicate weaker institutions and governance than Moody's current assessment.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.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 Alexander Perjessy, +971 (423) 795-48.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

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 issuer/deal page for the respective issuer on https://ratings.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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.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 issuer/deal page on https://ratings.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: 44 20 7772 5456
Client Service: 44 20 7772 5454

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

No Related Data.
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