Fitch Ratings - Hong Kong: Fitch Ratings has affirmed the United Arab Emirates' (UAE) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'AA-' with a Stable Outlook.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

Rating Strengths and Weaknesses: The 'AA-' rating reflects the UAE's moderate consolidated public debt level, strong net external asset position and high GDP per capita. This benefits from Abu Dhabi's sovereign net foreign assets, which are among the highest of Fitch-rated sovereigns. These strengths are balanced by weak governance indicators relative to rating peers, the UAE's high dependence on hydrocarbon income and the significant indebtedness of some of the Emirates and their government-related entities (GREs).

The 'AA-' rating applies to the federal government (FG) of the UAE. Fitch evaluates the creditworthiness of the UAE FG based on the consolidated fiscal and external position of all the Emirates as is standard practice for federal entities, as well as the FG's standalone fiscal position and institutional set up.

Budget Surpluses: We expect the UAE to post a consolidated budget surplus of 9.4% of GDP in 2022, after 5.8% in 2021. High oil revenues and tax and fees collection will more than offset higher outlay towards foreign aid, subsidies and other domestic spending.

We project surpluses to decline to 4.4% of GDP in 2023 and 0.9% in 2024 as oil prices fall to USD85 and USD65 per barrel, respectively. We project the UAE fiscal breakeven oil price will average USD63 per barrel in 2023-24. The Emirates of Dubai and Sharjah will progressively reduce their budget deficits while Abu Dhabi will continue to register surpluses as rising oil production from 2024 will partly offset lower oil prices. We expect fiscal policy to remain pro-cyclical, driven by Abu Dhabi, but to a lower extent than pre-pandemic.

Small Federal Government: The FG's budget is small at about 3.5% of GDP and its remit is centred around the provision of essential public services such as infrastructure, health, education and police. The FG is required by law to balance its current budget and has a record of broadly balancing the overall budget. Although its revenues and outlays are relatively stable, the FG has limited fiscal flexibility in view of its small revenue base and limits on running deficits and issuing debt. The FG is likely to receive a share of corporate income tax proceeds from 2024, but this is unlikely to materially change its fiscal profile, with a large share of revenue coming from grants from Abu Dhabi and dividends and royalties from federally-owned telecom SOEs Du and Etisalat.

Moderate Consolidated Government Debt Level: We forecast consolidated UAE government debt at 29.2% of GDP in 2022, below the 'AA' category median of 47%. It will rise to about 34.3% of GDP by 2024 due to the moderation of oil prices affecting nominal GDP, and continued fund raising by some Emirates. Individual Emirates have varied debt profiles, with the Emirate of Dubai standing out with debt forecast at close to 81% of its GDP in 2022, according to Fitch's estimates.

Federal Debt Issuances Capped: The FG issued USD7 billion on international markets and has reached the cap set by the Cabinet, although the debt law would allow the FG to issue more. We do not project additional US dollar issuances in 2023 and 2024. All the proceeds were placed with the Emirates Investment Authority for long-term investment.

The FG started issuing debt in local currency in 2022 and will continue to increase this until the outstanding amount reaches about AED45 billion, with the objective of building a domestic currency yield curve rather than funding deficits or projects. All the proceeds are invested in highly rated international government bonds, mostly US, with matching maturities. GREs will likely be the first other entities to issue local-currency bonds in the UAE.

High Leverage in the UAE: Despite a moderate government debt/GDP ratio, Fitch views the UAE as characterised by a high degree of leverage in its economy. We estimate overall contingent liabilities from GREs at about 75% of UAE 2021 GDP and gross non-bank private external debt stands at over 50% of GDP. A large share of SOE debt is owed by healthy SOEs presenting little risk, but there is less visibility on Dubai Inc. The banking sector's debt stood at 30% of GDP in 2021. The sector is large with assets forecast at about 167% of GDP in 2022, but risk is limited by the sectors increased net interest margin and strong liquidity.

Close Links with Abu Dhabi: We judge that the close political and budgetary links, along with the strong influence of Abu Dhabi (AA/Stable) over the FG budgeting and the essential nature of public services it provides place the FG higher in Abu Dhabi's support hierarchy than individual Emirates, should it be required. However, Abu Dhabi does not provide an explicit guarantee that would ensure unconditional and timely support to the FG.

Growth to Slow: Fitch forecasts overall GDP growth to slow to 1.8% in 2023 and 2.7% in 2024 after close to 6% in 2022 driven by the recovery from the pandemic, improving construction sector trends and higher oil production. We expect non-oil growth of 4.2% and hydrocarbon GDP to rise by 11% in 2022. We project non-oil growth to slow to 3% in 2023 and 2.1% in 2024, but remain relatively robust despite global headwinds. The hydrocarbon sector will contract slightly in 2023 due to OPEC+ production caps but the non-oil sector will benefit from higher government spending in Abu Dhabi and the GCC and a dynamic real estate sector.

Security Risks Remain: In our view, geopolitical risks are high relative to 'AA' rated peers. Tensions between Iran and Israel and the US still pose a risk to the region, in particular to Abu Dhabi's hydrocarbon infrastructure and to Dubai as a trade, tourism and financial hub. Although it has scaled back its military presence, the UAE remains involved in the Yemen civil war, which led to drone attacks in early 2022.

ESG - Governance: The UAE has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. The UAE has a high WBGI ranking at the 67th percentile, reflecting its record of domestic political stability, strong institutional capacity, effective rule of law and a low level of corruption.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Public Finances: A deterioration in Abu Dhabi's sovereign credit profile.

- Public Finances and External Finances: Substantial erosion of the external position of the UAE and/or of individual Emirates' fiscal position, for example due to a sustained period of low oil prices or a materialisation of contingent liabilities;

- Structural Features: A geopolitical shock that negatively affects economic, social or political stability.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Public Finances: Increased confidence that Abu Dhabi would provide unconditional support in the event of need, for example due to a guarantee for the timely service of the FG debt.

- Structural Features and Macroeconomic Policies: Improvement in structural factors such as a reduction in oil dependence, a strengthening in governance and the economic policy framework, and/or a reduction in geopolitical risk while maintaining strong fiscal and external balance sheets.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns the United Arab Emirates a score equivalent to a rating of 'AA-' on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR.

Fitch removed the +1 notch on public finances as the SRM score increased to 'AA-' from 'A+', reflecting the improvement in GDP per capita, and public finance ratios linked to the rise in oil prices and the economic recovery.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

The following data limitations were identified and addressed: a) Standard International Investment Position data for the UAE is not available; b) there is no disclosure on the size of Abu Dhabi's external assets (mostly relating to the Abu Dhabi Investment Authority, ADIA).

a) The main elements of external assets and liabilities are available from emirate sources, creditor sources and the IMF/World Bank/BIS; b) there is a degree of disclosure on the assets' composition and returns of ADIA and Fitch is provided with some guidance on inflows and outflows. Fitch's estimates of Abu Dhabi's external assets are derived by compounding estimated government cash surpluses using assumptions about returns and asset allocations.

The mitigants above provide us with sufficient confidence in our analysis of the credit profile to maintain or assign the rating.

ESG CONSIDERATIONS

The UAE has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As the UAE has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.

The UAE has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As the UAE has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.

The UAE has an ESG Relevance Score of '4' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As the UAE has a percentile rank below 50 for the respective Governance Indicator, this has a negative impact on the credit profile.

The UAE has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for the UAE, as for all sovereigns. As the UAE has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.