Standard & Poor's economic outlook for the GCC region looks positive in the mid to long term. While the contagion effect of recent regional political events, the euro-zone crisis and investor perception of geopolitical risks may drag on growth in the short term, the region has demonstrated its resilience. S&P expects that our forecast average Brent oil price of US$100 to $120 per barrel this year will support the region's growth.
However, we do not think that oil revenue and existing reserves alone can finance the immense investments, including huge infrastructure projects planned by GCC countries, particularly Saudi Arabia. As European banks wind back their exposure to the region while their domestic economies falter and capital requirements increase, this means access to domestic and international capital markets will be even more important for funding the region's next growth phase.
In this context, ratings agencies have a vital part to play in creating deeper and more liquid capital markets in the region. Without ratings, capital markets investors and lenders would be less inclined to provide capital to borrowers. As the IMF and other authorities have recognised, publicly available ratings improve the flow of information about credit risk and consequently the efficiency and liquidity of capital markets. Ratings may help investors to price risk better, which in turn may enable regional issuers such as governments, banks and companies to tap pools of investment capital across the world. Ratings also play an important role as one of the tools used by banks and insurers to improve their risk diversification options, and for asset and wealth managers to find new investment opportunities.
Since the onset of the global financial crisis in 2008, some have suggested that ratings methodologies should be changed and the influence of ratings agencies reduced. We support regulation and oversight to the extent that it enhances the quality, independence and transparency of ratings; builds market confidence in ratings providers; increases competition and fosters a wide diversity of research and views on credit risk. However, we feel that some of these discussions have overlooked the generally strong performance of ratings in most asset classes and regions since 2008.
The performance of ratings can be measured by how they correlate with defaults and by the rate at which they change. A look at the performance of rated corporate entities over the past few years shows the higher the issuer rating, the lower the frequency of default, and vice versa. Between 2008 and 2010 - spanning the worst economic downturn for decades - the global average default rate for corporates rated "investment grade" (above "BB plus") was 0.9 per cent, compared with 13.9 per cent for those with speculative-grade ratings. None of the 81 rated companies that defaulted in 2010 began the year at investment grade, and nearly 90 per cent started 2010 at "B minus" or below. Furthermore, of the record 289 defaults among rated companies and financial institutions in 2009, 86 per cent had a first - original - rating of "BB minus" or lower.
However, we have acknowledged that the recent performance of certain ratings in two specific areas - US residential mortgage-backed securities and related collateralised debt obligations - has been disappointing, and we have taken major steps to address that.
We have learnt from the crisis and have taken significant steps to strengthen the quality and transparency of our ratings. We believe it is up to the market to determine which ratings are credible and useful.
Ratings agencies have occasionally faced criticism that the models they use to evaluate regional companies - in particular government-related entities - should be changed for the region. However, S&P believes strongly in applying consistent rating methodologies across different markets and sectors. Similarly, investors want us to apply the same criteria to the sovereign governments we rate so that investors can obtain a comparable view of credit risk around the world.
At the same time, S&P fully understands the importance of local factors. Robust ratings benefit not just from consistent methodology, but also from a sound understanding of local and regional issues. Since entering the Middle East in the early 1990s, S&P has steadily increased its coverage to become the largest provider of credit ratings in the region, rating more than 130 issuers across the GCC, Egypt, Jordan and Lebanon, including five of the six Gulf sovereigns and 25 leading Gulf banks, leaving us well positioned to evaluate local factors and subtleties. S&P also remains at the forefront of rating criteria for sukuk and takaful structures, helping global investors better understand Islamic finance, which in turn may broaden their investment opportunities.
Over the coming years, S&P seeks to support the development of a more independent and integrated regional economy and financial marketplace by continuing to provide independent and objective views about credit risk. We believe our rating opinions and research enhance the transparency and efficiency of the GCC and wider Middle East capital markets, generating worldwide exposure for issuers, and contributing significantly to their development and diversification to the benefit of investors, intermediaries and issuers.
Yann Le Pallec is the executive managing director at Standard & Poor's ratings services in Europe, the Middle East and Africa