London, 5 March 2011

Amid the growing popular unrest in the Middle East and North Africa ( MENA) region in recent weeks, Standard & Poor's Ratings Services has downgraded various sovereigns in the region based on our reassessment of political risks.

We lowered the ratings on Tunisia, Egypt, Jordan, Bahrain, and Libya in the early part of 2011 as a result of our view of heightened political risks in these countries, and our expectation of consequently lower expected economic growth and amplified fiscal pressures. None of the rating movements exceeded one notch. However, the ratings on all these sovereigns are currently either on CreditWatch with negative implications (Bahrain, Egypt, Libya, and Tunisia), or have a negative outlook as in the case of Jordan (see table 1).

Below, we answer some questions from market participants on far how these unfolding events could further affect the credit quality of the 14 sovereigns we rate in the MENA region.

Frequently Asked Questions

Do you expect to take more negative rating actions on sovereigns in the region as a result of political unrest?

The CreditWatch placements with negative implications on Bahrain, Egypt, Libya, and Tunisia, and negative outlook on Jordan, all indicate the potential for further downgrades. In the case of the sovereigns on CreditWatch, such rating changes could occur within a relatively short time span (up to three months), while the negative outlook on Jordan speaks to a more medium-term time horizon of six to 12 months. Clearly, there's a great deal of uncertainty regarding how political environments will develop. But should we see a sustained weakening or disruption of political and key government institutions, a disruption of economic activity, or a deterioration in public finances, these could lead to further negative rating actions, both for the above-mentioned sovereigns on which we have already taken rating actions, as well as for sovereigns that so far have not been affected by political protests and unrest.

Are any MENA sovereigns immune to contagion from the unrest?

In our view, two sets of factors underlie the recent protests in the region: The first are economic factors, reflecting poor economic prospects and a loss of belief in economic progress for a considerable section of the population. Indicators reflecting this include high unemployment, particularly among the young, a young and rapidly growing population, a skewed distribution of wealth, comparatively low per capita incomes, and relatively low real GDP per capita growth. The second set of factors is political in nature. This includes lack of political representation and participation, restricted civil liberties, restrictions on free speech and free media, perceptions of pervasive corruption, self-enriching elites, and heavily regulated economies. Some, or even many of these factors can be found to a varying extent in almost all MENA countries.

Social unrest has spread to all of the sovereigns we identified as vulnerable to similar risks in our report published following Tunisia's revolution (see "Tunisia's Jasmine Revolution Is Adding To Political And Fiscal Risks In The MENA Region," published Jan. 27, 2011), namely Egypt, Jordan, Algeria, and to a lesser degree Morocco. However, protests have spread even further, to oil exporters Bahrain, Libya, and, most recently, even to Oman. In our view, this underlines the importance of the political dimension of the protests. We still consider that, all other factors being equal, high income levels and fiscal reserves, which allow some governments to engage in additional wealth redistribution and social spending, can reduce the likelihood of political unrest emerging. However, the fact that oil-exporting countries, which are considerably more wealthy and boast many more fiscal reserves than Tunisia, Egypt, and Jordan, have now also been experiencing political upheaval, puts into perspective the extent to which wealth and fiscal spending can contain such pressure.

As a result, we consider that the possibility of political unrest can't be excluded for the remaining MENA sovereigns where political upheaval has as so far been modest or absent. Still, in our view, the likelihood of such events decreases with levels of wealth and fiscal resources.

As political protests and unrest have spread from Tunisia and Egypt to other parts of the MENA region, have you applied one broad brush in assessing the rating implications for regional sovereigns?

Our rating actions are driven by our published criteria for rating sovereign issuers (see list of related articles). In each individual rating review we undertake on a sovereign, we consider the particular characteristics of the case at hand and not summary assessments.

In all recent rating actions on MENA sovereigns, the decisive factors have always included our concerns about:

Political instability and a weakening of political institutions at least in the short-term, which could directly and negatively affect a sovereign's willingness and ability to serve its debt in full and on time; and

The adverse effect that demonstrations, unrest, or revolt could potentially have on a sovereign's economic performance, economic growth prospects, potentially on its external accounts, and particularly its public finances.

These similar factors have led us to take similar rating actions. But there are also a number of MENA sovereign ratings that we have not revised because these factors are so far not present. This is notably the case for Morocco and the Gulf Cooperation Council states, excluding Bahrain.

Despite recent protests in Morocco, you have not taken any rating action on the sovereign. Why is that?

Morocco saw only one day of large and mostly peaceful protests in mid-February. In contrast to the situation in neighboring countries, concerns and demands expressed by protesters presented a less fundamental challenge to the current institutions, calling for more social justice, a change in government, a crackdown on corruption, and a constitutional change to limit the powers of the king. We perceive social and economic tensions to be lower in Morocco than elsewhere in the region. King Mohammed VI initiated a gradual political and economic liberalization more than a decade ago when he succeeded his father. Therefore, while we believe the protests could lead to some political and economic policy changes, we currently don't expect this to lead to significant risks to political stability and trigger a change in the rating. Nonetheless, we note that the doubling of food and fuel subsidies that the government announced in February could lead to a large deterioration in Morocco's fiscal deficit. The impact of such spending measures on the rating will in our view depend on whether the government announces offsetting budget cuts or revenue measures.

One common theme among the MENA countries for which S &P has recently lowered sovereign ratings is a democracy movement challenging autocratic governments. Does this mean that S&P favors autocratic governments?

Our criteria for sovereign ratings do not favor any particular type of government. Our role is to assess a sovereign's creditworthiness and, as such, to evaluate how political institutions may affect a sovereign's ability and willingness to repay its debt on time and in full. As a result, our analysis of a sovereign's political risk focuses on the predictability and accountability of its institutions, as well as the effectiveness and transparency of its policymaking. More specifically, we assess how those factors impact a government's capacity and willingness to stabilize its credit fundamentals following economic or political shocks and how they avoid producing those shocks in the first place. Succession risks or a high concentration of power are factors that we consider can pose a risk to institutional stability, thereby affecting continuity in credit characteristics and weighing negatively in our assessment. On the other hand, we observe that democratic governments do not systematically produce predictable and effective policymaking either.

We believe history shows that episodes of transition between different political regimes can, to varying degrees, lead to a significant period of political instability, often associated with social unrest, capital outflows, economic downturn, and in some cases can undermine the sovereign's willingness and ability to meet its financial obligations. Our recent rating decisions on MENA sovereigns were partly driven by these types of concerns.

Now that a process of political dialogue and reform has started in a number of MENA countries, we believe the resulting changes to political institutions and policies, increase in transparency, and diffusion of social and political tensions that could come from it, could reduce political risk over the medium to longer term. Should this be the case, it would be positive for the respective sovereign ratings.

Now that the turmoil has escalated to some of the oil exporting nations, what could be the geopolitical impact if unrest spread to the largest exporter, Saudi Arabia?

Saudi Arabia shares many of the risk factors that were present in other MENA sovereigns that have seen political upheaval, in our view. It has a very young population, relatively high unemployment, particularly among the young, a skewed income distribution, and political, civil, and economic liberties are very limited. Furthermore, because King Abdullah bin Abdul Aziz Al Saud is 87 years old and Crown Prince Sultan bin Abdul Aziz Al Saud is 83, Saudi Arabia faces the prospect of (potentially multiple) leadership succession during a time of heightened domestic and regional uncertainties. We believe that the recent announcement of a sizable package of extra social spending, wage increases, and additional public sector jobs underlines that the Saudi government is mindful of potential risks, and is trying to assuage social pressures by tapping its sizable fiscal reserves. So far, however, we haven't seen any significant popular protests or political upheaval in Saudi Arabia. Also, the ruling Al Saud family, which founded Saudi Arabia in 1932, has a long track record of withstanding domestic and external challenges to its rule, in our view.

If there were to be political upheaval in Saudi Arabia, a scenario which we currently consider unlikely, the ramifications, both geopolitical and well as geo-economical, could be severe. Any concerns about oil production and the export capacity of Saudi Arabia, which is the world's largest oil exporter, could potentially lead to a further spike in oil prices, in a similar fashion that the shutdown of much of Libya's oil exports (which are about 20% of Saudi Arabia export levels) recently pushed Brent oil prices to up to $120 per barrel. Depending on the nature of such hypothetical events in Saudi Arabia, the oil price could rise beyond historical peak levels, and if sustained, would have a tangible adverse economic impact on oil importers and the global economy.

Geopolitical implications of political upheaval (again, depending on its nature) in Saudi Arabia could also be severe if they were to disturb the delicate balance of power in the region, in our view. Saudi Arabia is a key regional ally of the U.S. As the largest Sunni-dominated country in the region it is also the main counterweight to Shia-dominated Iran. Saudi Arabia exerts political influence among a number of regional sovereigns, including in nearby Bahrain, where a predominantly Shia population is governed by a Sunni minority. Saudi Arabia also has influence in Lebanon, where it supports Sunni political factions, while Shia political factions, most notably Hizbollah, are backed by Iran and Syria.

What other geopolitical risks do you see in the region?

The main geopolitical risk that we continue to see in the region stems from Iran's development of its nuclear fuel program, to which the West and regional Arab powers strongly object. An escalation of this conflict could in the extreme lead to U.S. or Israeli military strikes against Iranian nuclear facilities. This, in turn, could provoke Iranian retaliation against oil and gas infrastructure and supply routes in the Gulf region. We currently don't anticipate that the stand-off between Iran and the West will reach this point. In the unlikely event it does, the outcomes are very uncertain and downside risks, at least in the short term, could be significant for regional sovereigns. However, mitigating the sovereign credit risk from such an event are the substantial fiscal assets that the Gulf oil producers can draw on in response to any disruption to oil production and transportation.

We also believe the Iranian regime is likely to seek ways through which it can strengthen its position in the new geopolitical landscape. In our view, the potential for the regime to "test the waters" through small-scale provocation is arguably greater when the geopolitical balance is uncertain, as it is likely to be in the near future. Any sign of provocation from Iran would likely have a major effect on oil prices, while a more direct challenge against Middle Eastern oil production facilities and transit routes has the potential for more significant effects on the Gulf oil producers, and indeed the global economy.

Developments in Egypt, especially, will also significantly influence the geopolitical balance, given the country's large population, strategic location, the strong support provided to it by the U.S., and its alliance with Israel.

Could the uprisings positively affect MENA sovereign creditworthiness over the longer term?

The current unrest could potentially quicken the pace of structural reform, in our view, if MENA governments perceive these reforms as longer term solutions to the current political disturbances. However, structural reform typically requires a strong and stable government that is able to make difficult and often unpopular decisions. For several MENA countries, we believe it could take some time for their political environments to advance to the point where the government could be in a position to pursue a comprehensive reform agenda. At least in the near term, we think that governments are more likely to respond to the political disturbances through higher levels of spending. We see two issues arising from this. First, such spending is a palliative that fails to address the structural issues that have contributed to the high levels of unemployment and have left some households unable to meet their food and energy needs. Second, higher government spending is also likely to increase fiscal imbalances, particularly due to the effect of the political disturbances on economic growth and fiscal revenues. This could in turn heighten the long-term fiscal risks for macroeconomic stability. Therefore, we see the possibility that ongoing political disturbances could halt the reform momentum, or in the worst case, start to undo the positive.

Nonetheless, we believe that improvements in sovereign creditworthiness could also come from the process of political reform that has been initiated in a number of MENA countries. Where the outcome of that reform process is a more inclusive political system, strengthened political institutions, and reduced potential for political, ethnic, or sectarian strife, it would support sovereign creditworthiness. There are numerous historical examples where autocratic regimes have collapsed and been replaced ultimately by stronger, less volatile institutions, such as parts of the ex-Soviet Union, South Africa, Spain, and Portugal. (Of course, there are also plenty of examples with the opposite outcome.) A crackdown on corruption and nepotism could also enhance governance and growth prospects, which would be positive for sovereign ratings, in our view.

We do not expect that such changes could occur overnight, however. In many cases, the path toward a more resilient political framework is going to be uneven and bumpy, not least as some of the high hopes that protesters may have will invariably not materialize, leading to popular disappointment along the road. There is of course also a chance that new, reformed institutions turn out to be equally insufficient as pre-existing ones, or that the reform process stalls and the void left by deposed rulers and governments is filled by new faces and old policies.

Ends --

(Editor's note:This article is part of a Standard & Poor's Ratings Services special report looking at the potential credit implications of the current unrest in the Middle East and North Africa on various global industries and sovereign entities).

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