The fallout from the Iran war is spreading beyond the initial shock of a surge in global oil prices to concerns about a broad decline in sovereign creditworthiness across Middle Eastern countries. The old formula that "when international oil prices soar, oil-producing economies grow with them" has not held in this war.
On the 30th (local time), global credit rating agency Fitch kept Qatar's sovereign rating at AA but newly placed it on Rating Watch Negative. Fitch cited as a key reason for moving Qatar's outlook into the downgrade risk category that "Iran struck the Ras Laffan industrial city in Qatar, causing large-scale damage to LNG facilities."
In the latest Iranian bombardment, state-owned QatarEnergy lost 17% of its LNG production capacity. According to experts, it could take up to five years to repair and normalize the facilities. As the energy hub that had been the source of formidable financial power suffered physical damage, the impact spread beyond short-term export disruptions to a fundamental sovereign credit risk.
When a sovereign credit rating falls, the country must pay higher interest rates to borrow in capital markets. Yields on Government Bonds issued to raise funds rise, the refinancing burden of issuing new bonds to cover maturing ones increases, and the country comes under pressure. As foreign investors pull out, foreign exchange reserves in the treasury dry up quickly, and as the currency value plunges, upward pressure on the exchange rate intensifies uncontrollably. To curb prices, subsidies that were distributed to ordinary people and the capacity for public investment to drive economic growth also shrink. State-owned energy companies, major banks, and private infrastructure operators running massive ports or power grids face a surge in funding expense as well.
Fitch assigned Israel, which started the war, an A rating but kept its long-term outlook at negative. Israel has avoided an immediate downgrade, but defense spending on advanced weapons purchases and maintaining large troop levels is ballooning and weighing on the economy. Since the war began, the timetable for reducing the fiscal deficit has been delayed indefinitely, and severe political instability over whether to prosecute Prime Minister Netanyahu has compounded matters. Fitch said that the longer a full-scale war drags on, the greater Israel's downgrade risk will grow, leaving it in a precarious state.
Countries in the heart of the Middle East that lack energy resources and have weak fundamentals are facing an even greater survival crisis. Global credit rating agency Standard & Poor's (S&P) singled out Bahrain, saying, "Most Gulf countries have strong buffer resources, but Bahrain is a clear exception." Although Bahrain is not a belligerent, the financial losses it suffers from rising funding costs will far outweigh the benefits from higher oil prices, meaning it will lose more than it gains from this war.
In fact, Egypt halted its attempt to cut interest rates after the Iran war broke out. That is because energy import expense has surged sharply while revenue from tourism and Suez Canal tolls, key sources of foreign currency, has fallen significantly, creating a double blow. The Egyptian government has taken emergency measures to delay ambitiously state-led infrastructure projects and even cut internal fuel allocations. The Egyptian finance minister said next year's liability service burden is expected to increase by about 5% from the previous estimate. Even if a country is not a Gulf state directly facing incoming missiles, the shock waves of war are erupting more clearly in neighboring countries with chronically weak fiscal fundamentals.
Global investment capital has moved past its initial focus on the possibility of a Hormuz Strait blockade or oil price spikes from energy supply disruptions. Instead, attention has quickly shifted to which country can financially withstand the war's macroeconomic shock for a long time. Experts said the nature of the geopolitical risk surrounding the Iran war has evolved, with its backbone shifting from an energy shock to a sovereign credit shock.
Even if the Hormuz Strait shipping lane reopens and a full-scale escalation halts, global capital markets are unlikely to treat the Gulf as an ultra-low-risk energy supply region as they did before. Energy columnist Ron Bousso told Reuters, "The rising risk premium in the world's largest energy-producing region is already clearly reflected in long-dated oil prices," adding, "Even if major oil companies seek alternatives in other producers such as West Africa or Brazil, those substitute regions also require massive expense, such as deepwater field development, and carry other political risks, so they are not perfect alternatives."