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Rating Action:

Moody's downgrades Sharjah's ratings to Baa3, changes outlook to negative

11 Feb 2021

New York, February 11, 2021 -- Moody's Investors Service, ("Moody's") has today downgraded the long-term foreign and local currency issuer ratings and the foreign-currency senior unsecured rating of the Government of Sharjah to Baa3 from Baa2, and changed the outlook on the issuer ratings to negative from stable.

The downgrade to Baa3 from Baa2 is driven by Moody's expectation of a sharp deterioration in Sharjah's fiscal strength, as the economic shock brought on by the pandemic continues to have a marked and lasting impact on the emirate's revenue after a severe drop in 2020. Combined with Moody's expectation that government expenditure will continue to grow steadily, in line with the government's strategic social and economic development objectives, material fiscal consolidation is unlikely in the foreseeable future.

The negative outlook captures the risk that the government's debt burden and its interest bill rise further than Moody's currently expects, further restraining Sharjah's capacity to respond to future shocks.

The downgrade of the rating to Baa3 from Baa2 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 of the notes issued by these entities, 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)Baa3 from (P)Baa2.

RATINGS RATIONALE

SHARJAH FACES A SHARP AND LASTING FISCAL DETERIORATION WITH LIMITED SCOPE FOR ADJUSTMENT

Following a steady increase in its debt burden in recent years and large widening of the budget deficit during 2019, Sharjah's fiscal deterioration accelerated during 2020 as the economic shock triggered by the pandemic sharply cut the government's narrow revenue base. Moody's expects that Sharjah will continue to run sizeable deficits in the next few years. As a result, the government's debt burden will rise to very high levels in relation to revenue. At the same time, debt affordability will worsen markedly. Moody's fiscal outlook for Sharjah incorporates an assessment of the economic and institutional constraints on the government's ability to introduce new revenue measures and cut spending.

The coronavirus shock led to an estimated 30% drop in government revenue stemming mainly from a lower collection of business license fees, various temporary reductions in other government fees, fines, and levies, and lower revenue from customs duties. However, the widening of the general government deficit to more than 8% of GDP in 2020 (after consolidating the state-owned Authority for Initiatives, Implementation and Infrastructure Development, Mubadara) from 4.9% of GDP in 2019 was also a result of a continued rise in government spending (unabated since 2015, taking into account spending now on Mudabara's balance sheet here and throughout this analysis), reflecting the government's increased focus on the provision of public services and social-assistance programs for the citizens and on supporting growth and promoting economic development of the less-advanced regions of Sharjah.

In 2021, Moody's expects that overall government expenditure will rise by more than 18%, partly reflecting Mubadara's plan to accelerate contractor payments relative to a previously agreed upon schedule with the view to helping jump start the economy. To offset some of the planned increase in spending, the 2021 budget assumes a 15% rebound in revenue relative to the preliminary 2020 outcome. However, virtually the entire budgeted revenue increase of AED1.2 billion (1% of GDP) hinges on the government's success in executing an unusually large volume of land sales that would more than offset the expected slump in value added tax revenue and budget contributions from the government related entities. Given the current economic and financial situation in Sharjah and in the broader GCC region, Moody's assumes that only about half of the budgeted land sales are likely to materialize.

Rapid fiscal consolidation is unlikely in subsequent years as Sharjah is limited in its ability to raise revenue. The government's scope to independently introduce new revenue measures (such as increases in existing fees and taxes or an introduction of new taxes) will remain constrained by the high level of competition (and mobility) between the individual United Arab Emirates (UAE) emirates and the fact that the right to set taxes is currently reserved for the UAE federal government. Meanwhile the government's emphasis on supporting the economy is likely to prevent material spending restraint.

Overall, Moody's expects that the government's debt burden will rise to nearly 60% of GDP and more than 700% of revenue by the end of 2023, at which point government interest payments will likely exceed a quarter of all revenue.

Some of this expected sharp deterioration in Sharjah's debt and debt affordability metrics, well beyond most Baa-rated peers, is mitigated by the implicit 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, which in turn frees up a greater portion of fiscal revenue for debt service compared to most other sovereigns. 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.

RATIONALE FOR THE NEGATIVE OUTLOOK

The risks to Sharjah's fiscal strength and credit profile are skewed to the downside.

Facing a slower than currently expected economic recovery, the government may opt to maintain financial support to its citizens at higher levels and for longer than Moody's assumes. Should the recovery in revenue be slower than embedded in Moody's projections, fiscal adjustment would likely be limited given the institutional and social constraints explained above.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Sharjah's ESG Credit Impact Score is neutral to low (CIS-2), reflecting moderately negative exposure to environmental risks, balanced against governance strength which supports the government's capacity to respond to these risks. Exposure to social risks is low.

Sharjah's moderately negative exposure to environmental risks, reflected in its E-3 issuer profile score mainly related to its dependence on desalinated water and exposure to rising sea levels. The vast majority of Sharjah's water is produced by desalination plants, which are highly energy intensive, and vulnerable to oil spills from marine traffic in the Gulf. Moreover, Sharjah City, where most of the emirate's population reside, is a coastal city. As climate change intensifies, the UAE is among the sovereigns most exposed to rising sea levels in the future, with up to 10% of the population exposed under a scenario where sea levels rise by one meter, thus increasing its sensitivity to environmental risk. The UAE is also one of the world's top ten most arid states, and rapid growth in recent decades has further increased challenges surrounding water sustainability, which are relevant to Sharjah.

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. However, the very low proportion of citizens relative to the labor force and overall population helps to mitigate this challenge.

While Sharjah shares some aspects of its institutions and governance profile, such as monetary policy and banking regulation, with the UAE, other aspects such as fiscal policy and production of statistical data are emirate-specific. Governance is broadly in line with other sovereigns and does not pose specific risks (G-2 issuer profile).

GDP per capita (PPP basis, US$): 37,625 (2019 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 0.6% (2019 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): -3% (2019 Actual)

Gen. Gov. Financial Balance/GDP: -4.9% (2019 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: [not available]

External debt/GDP: [not available]

Economic resiliency: baa2

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

On 8 February 2021, 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 not materially changed. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer's susceptibility to event risks has not materially changed.

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

The negative outlook indicates that an upgrade is unlikely in the near term. The introduction of fiscal consolidation measures that would be sufficient to materially slow or arrest the upward debt trajectory would likely support a stable outlook, particularly if accompanied by a stronger than expected and sustained recovery in government revenue.

WHAT COULD CHANGE THE RATING DOWN

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

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, 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 this rating 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 at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

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.

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 www.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://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

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 www.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 www.moodys.com.

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: 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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