JUN Market Update 2017 Qatar’s Diplomatic Gulf Saudi Arabia, Bahrain, the United Arab Emirates (UAE), and Egypt severed ties with Qatar on 5 June, which included the expulsion of Qatari citizens from all these countries but Egypt. The Saudi-led coalition has cited Qatar’s financial and political support for radical Islamic terrorism as a reason for ostracising the country. The coalition has also called for an end to construc- tive relations with Iran, with which Qatar is jointly developing the world’s largest gas field. Tensions have escalated following an attack on 7 June on Iran’s parliament, with the Islamic State claiming responsibility. Qatar’s small landmass belies its strategic role (Exhibit 1). It is home to the most important US military base in the Middle East, is a major regional air hub, and is the world’s largest producer of liquefied natural gas (LNG). We believe a diplomatic solu- tion to the current suspension in international relations is possible, as Qatar has come to the negotiating table in the past, most recently in 2014 when diplomatic relations were severed with Saudi Arabia, the UAE, and Bahrain. In this update, our analysts in Dubai evaluate the economic and trade aspects of this regional strife that they believe will be focal points for decision makers over the coming months. Exhibit 1 Qatar Is Strategically Located Jordan Iraq Pakistan Kuwait Iran Persian Gulf Bahrain Straut of Qatar Hormuz Gulf of Oman Egypt United Arab Red Saudi Arabia Emirates Sea Oman Arabian Sea Sudan Yemen Source: Lazard Immediate Concerns The Arabian Peninsula is home to the world’s largest contiguous sand desert, the Empty Quarter, and is largely unsuitable for growing crops. This means that most countries of the Gulf Cooperation Council (GCC), formally known as the Cooperation Council for the Arab States of the Gulf, are either highly or partially reliant on food imports, as is evident in data on food imports per capita. In addition to securing food supply channels by land, sea, and air, these countries have sought to purchase large LR28489 2 quantities of farmland abroad (i.e., in Africa and South America) as Exhibit 2 a solution. This diplomatic crisis deprives Qatar of trade and trans- Qatar Could See Food Shortages, Rising Prices portation links, and could result in a domestic food shortage. Value of Food Imports Per Capita Per Capita ($) Data Year Our calculations indicate that the average value of food imports Qatar 1,334 2015 per capita for Qatar amounts to $1,334 compared to a weighted UAE 1,984 2014 average of $994 for the region (Exhibit 2). Saudi Arabia has the Saudi Arabia 655 2015 lowest-valued food imports per capita, partly due to local production Bahrain 1,189 2015 in its more temperate territories, as well as local farming aided by Kuwait 1,143 2015 consumption of non-renewable ground water resources. Weighted Averagea 994 In relation to Qatar’s food imports from the rest of the GCC, we Simple Averagea 1,261 know that Almarai, a major Saudi dairy producer, derives 5% of its As of June 2017 revenue from Qatar (approximately $45 million), which in 2015 a Calculated by Lazard amounted to about 1.5% of Qatar’s food imports. Qatar has no Source: Trading Economics other land borders except with Saudi Arabia, so fresh milk will likely become scarce and more expensive. Media reports also indicate that 100% of Qatar’s white sugar imports are shipped through the UAE. However, Qatar does have viable alternative food sources, which include Iran, Oman, Pakistan, and India, and its seaborne shipments can be rerouted to neighbouring ports in Oman, for example. Overall, its food imports have been growing steadily and are expected to continue on an upward trend as the development of infrastructure and FIFA projects (Qatar is hosting the World Cup in 2022) gathers momentum. International and Intra-GCC Trade In 2015, about one-half of Qatar’s imports came from five countries, namely China (13%), the United States (13%), Germany (9%), Japan (7%), and the United Kingdom (6%), while a total of 18% came from its GCC neighbours, mainly the UAE (10%) and Saudi Arabia (5%). As for Qatar’s exports, they mainly comprise LNG shipped directly via Qatar’s “floating pipeline” of LNG vessels to buyers in Japan, South Korea, and India. The LNG vessels pass through the Strait of Hormuz (shared by Iran and the UAE) on their way to global buyers, and this supply is unlikely to be disrupted, according to the Qatari government. We believe Qatar will most keenly feel the loss of trade with the UAE, its largest trading partner of any GCC country. In terms of intra- GCC trade, Qatar exported $4.7 billion worth of goods to the UAE in 2015, whereas the UAE imported just $773 million worth of goods from Qatar. We suspect the discrepancy relates to goods re-exported from the UAE to other countries either in containers through Jebel Ali Port or as hydrocarbons through Fujairah Port. A Predominantly Hydrocarbon Exhibit 3 Economy Expected Support to Qatari Economy from Stronger Oil Prices Qatar remains an economy driven by hydrocarbons. The International Monetary Fund (IMF) estimates that at least 82% GDP ($M) 2015 2016E 2017E of Qatar’s exports in 2016 were hydrocarbon-related. LNG is the Nominal GDP ($) 164,643 156,731 173,654 biggest subcomponent, followed by condensates and crude oil. This Real GDP 3.6 2.7 3.4 Growth Rate (%) LNG concentration means that Qatar’s current and fiscal accounts Nominal 63,462 44,780 54,231 remain heavily influenced by oil and natural gas prices, despite Hydrocarbon GDP ($) dividend contributions from its large international investment % Change Y/Y -29 21 portfolio, the Qatar Investment Authority (QIA). % of GDP 39 29 31 Sensitivity to hydrocarbon prices is still high as evidenced by Brent Average 52 44 56 nominal hydrocarbon-driven GDP, which is estimated to have Price/bbl ($) contracted by 29% in 2016 as Brent oil fell by 16% (Exhibit 3). % Change Y/Y -16 28 However, the IMF expects Qatar’s GDP to significantly rebound in As of June 2017 2017 as oil prices recover. Source: IMF Qatar 3 Current Account Pressured by Workers’ Exhibit 4 Remittances Qatar’s Current Account Dynamic Qatar’s trade balance is estimated to drop by 40% in 2016 year-on- Current Account ($M) 2015 2016E 2017E year as the value of its hydrocarbon exports fell, leaving its estimated Current Account Balance ($) 13,800 -3,500 1,200 trade balance at $29.6 billion or 19% of GDP (Exhibit 4). However, % of GDP 8.4 -2.2 0.7 the current account deficit in 2016 has been heavily weighed down Trade Balance ($) 48,800 29,600 35,700 by $13 billion worth of foreign workers’ remittances, which is % of GDP 30 19 21 equivalent to 8.3% of GDP and 44% of the trade surplus. Workers’ Remittances ($) -12,000 -13,000 -13,700 Hydrocarbon prices might recover in 2017, but the burden of % of GDP -7.3 -8.3 -7.9 workers’ remittances is likely to worsen as Qatar invests heavily in % of Trade Surplus 25 44 38 infrastructure development that can only be executed with the help As of June 2017 of foreign manpower. Source: IMF Qatar Vicious Debt Cycle Plausible Prior to the escalation in political tensions, Moody’s downgraded Exhibit 5 its rating for Qatar from “Aa2, Negative Outlook” to “Aa3, Stable Risks from a Higher Debt Burden Outlook.” Qatar’s government debt amounted to 48% of GDP in Debt ($M) 2015 2016E 2017E 2016 versus 35% in 2015 (the highest debt burden in the GCC) Central Government Gross 57,460 74,604 87,174 and this was partly responsible for the downgrade (Exhibit 5). Debt ($) The country’s loss of diplomatic ties in the region raises the risk of % of GDP 35 48 50 further downgrades. External Debt ($) 182,095 222,714 241,379 In an effort to finance its economic development, Qatar has been % of GDP 111 142 139 borrowing both directly and indirectly through Qatar National Bank (QNB). QNB is the single largest bank ($197 billion in Ratings 2015 2016 Current assets) in the GCC union and typically raises funds from abroad, S&P AA, Stable AA, Neg AA-, Neg relying on its high credit ratings (thanks to government deposits) Moody’s Aa2, Review Aa2, Neg Aa3, Stable in order to obtain cheap funding. QNB lends to government entities. Therefore, ratings downgrades can result in a higher debt As of June 2017 burden for QNB, which may exert further pressure on government Source: Trading Economics finances and potentially cause a vicious cycle. Fiscal Position Remains Comfortable for Now Despite running twin deficits, trade and budget, the Qatari government’s financial position remains comfortable for now. This is based on accumulated wealth held at the QIA ($335 billion, equivalent to 2.1 times nominal 2016 GDP) and the central bank ($30 billion of foreign reserves). As a result, we believe the Qatari riyal’s peg to the US dollar can be protected as long as it serves the national interest. Fiscal capital expenditures accounted for 33% of total expenditures in 2015, and are estimated to be 42% of GDP in 2016 and 45% in 2017 (Exhibit 6). The spending growth is driven by Qatar’s need to develop infrastructure in general and build venues related to the upcoming FIFA World Cup. Market Update Shorter term, Qatar has financial buffers in place, primarily Exhibit 6 through its sovereign wealth fund, which should help minimise the Capital Expenditures Are Projected to Increase disruption to its economy.