The shocking, yet expected, decision of Standard & Poor’s (S&P) to cut the U.S. level one notch to AA+ from its top AAA rating has negatively affected most of the markets worldwide, including the Middle Eastern and African ones. But, how far would this slump affect the oil industry, worldwide in general and in the Arab world in specific?

Described as the first time ever in America’s history, the downgrade announcement resulted in a profound tremble all over the stock markets and simultaneously increased the borrowing costs of the U.S by tens of billions of dollars. The country’s reliability for paying its debts has become doubtful and questionable and what has made the situation more critical is S&P’s negative outlook, in which the organization expects to further lower the rating level in the coming two years. Such a prediction has been translated into expected higher interest rates and borrowing costs in the U.S, where the economic situation has further deteriorated. According to the AP, the debt burden is equal now to 100% of the GDP and it has already reached $14.6 trillion.

Commenting on S&P’s decision, the U.S President Barack Obama, who will face a tough electoral season to maintain office, said, “Markets will rise and fall, but this is the United States of America. No matter what some agency may say, we have always been and always will be a triple-A country.” He added that the U.S. problems are “imminently solvable’’ but that political gridlock has made compromise extremely difficult and has contributed to a picture of economic uncertainty, reported Fox Business News.

Following S&P’s announcement early last month, the prices of crude oil have dropped from $100 in July and near $115 in May to an average of $80. In a report published by Barclays Capital, “A drastic weakening of sentiment has brought oil prices down sharply, with sovereign debt fears key in a mounting loss of faith in economic, and hence demand, prospects”.

The worldwide effect of S&P rating reduction was witnessed immediately when stock markets reopened. Focusing on the Middle East in specific and the Arab World in general. In Egypt, the benchmark EGX30 index fell by 4.8%, which is the lowest over the past two years. The Head of the Egyptian Exchange, Mohamed Abdel-Salam declared that the drop was due to the decline in world markets, “rather than the fundamental value of the country’s companies”.

“Definitely what we are seeing in the market today is a direct reaction to what is going on in the global markets… Many clients are afraid to buy stocks even at low prices,” Tarek Abaza, Trading Manager at Naeem Brokerage in Cairo told Daily News Egypt.

Similarly, the Dubai Financial Market’s benchmark index suffered from one of the sharpest declines in the region as it closed down 3.7%.
Compared to the Egyptian stock exchange, the Abu Dhabi and Qatar market indexes were less affected, as both went through a downfall of 2.5%.

In Kuwait, the index fell by 1.3%; a seven year low, while in Oman, the index witnessed a 1.8% decline.

In an interview with Forbes, Farouk Miah, an analyst at the National Commercial Bank (NCB) Capital in the Saudi capital Riyadh, declared, “Mideast traders are concerned that debt problems in the West could cut demand for crude and drag on oil dependent economies in the region”. He clarified that most financial analysts expected the downgrade, but the concern now is about the possible fall of oil price due to decreased demand.

Amidst these downfalls, the Kingdom of Saudi Arabia took the hardest hit. The powerful OPEC member witnessed a plunge of 5.5% on the first day after the historic downgrade, as reported by Forbes.

Impacts on OPEC’s Powerhouse, Saudi Arabia
Analyzing the effects of the downgrade of the U.S credit rating, the Jeddah-based NCB published a recent report entitled “The S&P’s downgrade of US and its Implications on the Saudi Economy,” where they highlighted that the possible impacts of the downgrade will come through three main factors; crude oil demand and price, US dollar response against most currencies and official holdings of US treasuries. The first factor, tackled the oil demand and prices, can be of a positive impact as when oil prices drop, the markets expects a demand growth. Moreover, the NCB affirmed, “even if oil prices fall below the $80 a barrel level, Saudi Arabia will not have a great impact as the Kingdom enjoys a large reserve to meet its planned spending”.

Secondly, the NCB report stated, “The US dollar response against most currencies will likely follow broader market developments. As equity and commodity markets keep falling globally, investors are likely to cut long positions in equities, and commodities. These are mainly funded by short US dollar, so whether or not the safe-haven status of the US dollar is impaired over the long-term, a downward shock to markets is likely to be US dollar positive in the near term.”

Thirdly, the fact that the official holdings of US treasuries, believed to constitute the majority of Saudi’s net foreign assets that count for more than $492 billion, can have a direct impact on the Saudi economy. “The downgrade is actually more of a referendum on the dollar rather than US treasuries, due to the fact that US’s ability to pay its debt obligations remains a fundamental certainty because the dollar remains the world’s reserve currency and the US government can continue to print money to fund its obligations. Therefore, holders of US treasuries like Saudi Arabia should not be concerned that they may not receive interest payments on US bonds. However, the value of those payments will essentially decline, given the fact that with more dollars in circulation due to the printing presses, the value of each dollar by definition declines,” stated the report.

“Given that the Kingdom is keeping much more than enough to maintain the peg of the Saudi riyal to the US dollar, it is advisable that the Kingdom should opt for diversifying future excess revenues away from US Treasuries into other real assets across different currencies and regions,” the NCB report said.

Financial and petroleum experts are keeping a close eye on the short-term and long-term impacts of the S&P’s U.S downgrade, specifically on the Kingdom. Being the core of OPEC, any impact on Saudi Arabia can result in a wide effect on the oil market. The latest unprecedented downgrade has shocked investor confidence in the world’s largest economy, who are inquiring one main question, how far would the U.S credit rating downfall affect our economy?

By Yomna Bassiouni

Download