Our Thoughts on the QAR Peg

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Qatar is fending off the pressures stemming from the Saudi-led embargo.  Yet while the QAR peg appears safe, we believe Qatari officials could have handled the situation better. 

POLITICAL OUTLOOK

Saudi Arabia, Egypt, Bahrain, and the UAE broke off economic and diplomatic relations with Qatar on June 5.  The group claims Qatar is supporting terrorist groups and submitted a list of 13 demands that Qatar must fulfill before the embargo is lifted.

The deadline has passed with no deal in sight.  So far, Qatar has rejected all 13 demands by the Saudi-led group.  A new set of demands appears likely.  A new set of demands appears likely but it remains to be seen what they might be.

US Secretary of State Tillerson is in the region this week, meeting with diplomats in Kuwait, Qatar, and Saudi Arabia in an effort to secure a deal.  It seems the US is allowing Kuwait take the lead in mediating for now, but the row puts US in a difficult position since it involves US allies on both sides.  Indeed, after first seeming to support the actions against Qatar, the US subsequently sold Qatar $21 bln worth of weapons.

ECONOMIC OUTLOOK

The IMF just completed its annual Article IV consultation with Qatar in April.  The tone was generally upbeat, coming before the diplomatic crisis that started in June.  Specifically, the IMF “Directors concurred that Qatar’s fixed exchange rate regime remains appropriate. They noted that further strengthening the monetary policy framework as well as deepening domestic financial markets, particularly the domestic debt market, will prove helpful as the economy diversifies.”

The economy was already sluggish as energy prices remain low.  GDP growth is forecast by the IMF to accelerate modestly to 3.4% in 2017 from 2.7% in 2016.  However, this latest leg down in oil should highlight downside risks to the growth forecasts.

The IMF noted that fiscal policy has already been adjusted for the new environment of lower energy prices.  Yet despite significant subsidy cuts, the government has issued a significant amount of debt (both external and internal) to finance ongoing budget deficits.  The central budget deficit came in at an estimated -9.0% of GDP in 2016 vs. a 1.2% surplus in 2015.  The gap is seen narrowing to –7.7% 2017.

The external accounts are likely to worsen further.  Low energy prices have hurt exports, and the current account deficit was an estimated -3.5% of GDP in 2016.  The IMF forecast the current account to move back into surplus in 2017 and 2018, but this seems too optimistic in light of low energy prices.

Qatar’s main export markets are Japan, Korea, India, and China, which together account for nearly three quarters of the total.  These exports are mainly natural gas and crude oil.  Indeed, Qatar is the world’s largest exporter of natural gas, accounting for nearly a third of global shipments.  Qatari officials say that the Saudi-led embargo has had little impact on exports.

INVESTMENT OUTLOOK

The Qatari riyal came under pressure after the Saudi-led announcement on June 5.  USD/QAR has been officially pegged at 3.64 since 2001 under a decree that the central bank would “buy the dollar at a rate not exceeding 3.6385 riyals and sell the dollar at a rate not exceeding 3.6415 riyals to the banks operating in the State of Qatar.”  In practice, however, the peg has been in place longer than that.

Indicative pricing on Bloomberg suggests that USD/QAR traded as high as 3.7884 on June 27.  Whilst Qatari markets were closed for holiday during the week of June 25, offshore banks had no onshore counterparties and so were forced to price QAR deals in the blind.  From our understanding, these were offshore prices that may or may not have been actually transacted.

We did see actual onshore trades filled in the 3.65-3.66 area before the week-long holiday, but nothing close to the rates that Bloomberg shows.  After markets reopened, the central bank has reportedly supplied USD onshore at the peg rates that prevailed before the diplomatic row began.  Through it all, there has been a lack of clarity over what official policy is.  Given how nervous the markets already were, we are surprised that officials were not more proactive.

Foreign reserves have steadied after falling over the course of 2015 and 2016.  At $34 bln excluding gold ($40 bln including gold) in April, they cover nearly 7 months of import and nearly all of its stock of short-term external debt.  However, the central bank Governor said that its Sovereign Wealth Fund has $300 bln of liquid assets at its disposal and so it would seem that for now, the peg is safe.

Yet the fact that the central bank allowed ANY trades away from the 3.64 peg rate is very surprising.  Pegged Currencies 101 has taught us that the central bank should NEVER allow any trades away from the peg rate, lest markets take that as a sign of weakness and investors head for the exits.  Some analysts suggest that this is not a hard peg, but for all intents and purposes, it is.  At some point, the central bank may find it needs to issue a stronger statement of commitment to the peg, something we do not think it has done yet during this diplomatic crisis.

Qatari equities are underperforming EM after a weak 2016.  In 2016, MSCI Qatar rose 2.5% vs. 7.3% for MSCI EM.  So far this year, MSCI Qatar is -13% YTD and compares to +17.5% YTD for MSCI EM.  This underperformance should continue, as our EM Equity model has Qatar at an UNDERWEIGHT position.

Our own sovereign ratings model already had Qatar’s implied rating at A/A2/A back in April.  To state the obvious, things have gotten worse and suggests even stronger downgrade risks ahead to actual ratings of AA-/Aa3/AA.  All three agencies have reacted to these increased risks.  S&P downgraded Qatar a notch on June 7 and put it on negative watch, Moody’s downgraded a notch on May 26 and then moved the outlook to negative on July 4, and Fitch put Qatar on rating watch negative on June 12.