OREANDA-NEWS. Responsible for all phases of the oil and gas industry in Qatar--to remain profitable. Its strategy has been to diversify into all major markets, adjusting the mix of destinations and contract types according to market needs. Moreover, the majority of its gas exports are underlong-term contracts, which provides some certainty regarding the volumes sold.

We expect that Qatar will maintain its cost advantage over many new projects in other countries. In January 2016, the renegotiation of RasGas' (Qatar's second-biggest LNG producer) contract with Petronet LNG (India's biggest gas importer) at a discount of almost 50% indicates an increasingly competitive environment for natural gas and LNG sellers over the medium term. Existing LNGbuyers committed to long-term contracts and other potential buyers may try to renegotiate or achieve similar commercial terms in an environment of persistently low prices.

Falling oil and gas prices and the government's public investment program haveled to a deterioration of the fiscal balance, beginning in 2014. We expect thegeneral government balance to average a deficit of about 5% of GDP in 2016-2019, after many years of surpluses. Our outlook assumes that the sharp drop in hydrocarbon revenues will be somewhat offset by cuts in current spending, which was reduced by 9.5% in 2015 and is expected to fall further in2016 as line ministries are closed or merged, slow moving projects are scrapped, subsidies removed, and certain taxes introduced, including an increase in stamp duty. Capital spending will likely continue to slightly increase as infrastructure projects advance.

We also project a further decline in government hydrocarbon income, namely in the financial transfers from Qatar Petroleum, which come to the government budget with a six-month lag. We expect that the government will finance fiscaldeficits through debt, both on the domestic and international markets, rather than by drawing upon its assets at Qatar Investment Authority (QIA), which aredesignated for future generations and not intended as a stabilization tool. The government issued US$9 billion of Eurobonds in May 2016 to this end.

Consequently, we expect that gross debt will increase to nearly 50% of GDP over the next few years, but actually decline on a net basis. This is because we expect investment returns on Qatar's substantial assets (which we base on various global indices' performance) to improve in 2016, above the accumulation of new debt. However, we note that the average change in debt over the coming years is high, which will add to interest costs as a proportion of fiscal revenues. We also note high public sector indebtedness--reflecting the debt of various public enterprises--which we estimate at 85% of GDP in 2016.

Over the coming budget cycles, we understand that the government also intends to rationalize and outsource part of its operations and to award more projectsto the private sector, though whether the desired level of private sector participation can be achieved remains to be seen, in our view.

In the context of lower hydrocarbon revenues and high levels of capital spending, the government is prioritizing existing projects by channeling funding to the most important and most strategic investments. The government'sinvestment program focuses on infrastructure, education, and health, and we expect the majority of these projects to be completed ahead of the 2022 FIFA World Cup, which Qatar is hosting.

Alongside government investments funded through the budget, public-enterprise and private-sector spending on the national development strategy is likely to be largely funded by borrowing from domestic financial institutions. This may cause banks' net external liability positions to widen and their loan-to-deposit ratios to rise, as we expect deposit growth in the Qatari banking system to continue decelerating due to low hydrocarbon prices. The ratio of domestic credit to total deposits in the Qatari banking system was 127% at the end of the second quarter of 2016, up from 117% at year-end 2015.

We project Qatar's external surpluses will worsen substantially in the medium term as export receipts fall sharply in 2016, while import demand will remain strong; however, 2015 data show current account performance to be better than we had previously expected, likely linked to the lag effect of falling prices feeding through long-standing contracts. The transfer and income accounts of the current account will likely remain in deficit, the former due to remittance outflows as a result of the expatriate population and the latter due to payments to the foreign firms that partner with Qatari companies in theoil and gas industry. We expect that foreign reserves will fall over the next year as net portfolio outflows, linked to QIA's activities, are likely to remain strong thereby keeping the financial account in deficit.

Qatar's net external asset position will remain strong, at about 290% on average of current account receipts in 2016-2019. Qatar has accumulated considerable foreign assets over the past decade, as a result of developing its natural resources. We forecast that the general government net asset position, estimated at about 130% of GDP in 2016, will also stay robust in 2016-2019.

Domestic political and social stability prevails, despite what we view as onlygradual political modernization and a highly centralized decision-making process. In our view, the country's public institutions are still relatively undeveloped compared with those of most 'AA' rated sovereigns. Executive powerremains in the hands of the emir. In our view, the predictability of future policy responses is tempered by weak political institutions, although in our base case we assume that policy will continue to focus on prudent development of the hydrocarbon sector, alongside further economic diversification. In addition, material data gaps exist and transparency is limited, by international standards. In particular, the government neither discloses nor reports the level of its fiscal assets.

In our view, the fixed exchange rate of the Qatari riyal to the U. S. dollar leads to limited monetary flexibility, and we expect the currency peg to be maintained. Qatar's real effective exchange rate has appreciated by 12% since early 2014. In our view, this represents a deterioration in international competitiveness of the country's modest tradeables sector and a dampening of non-hydrocarbon GDP growth, absent any offsetting factors, such as improved efficiency or technological capacity. Liquidity conditions in the Qatari banking system and banks' borrowing costs are expected to further tighten amidfalling public deposits, coupled with a modest increase in loans and future increases in U. S. interest rates.

OUTLOOK

The stable outlook reflects our view that Qatar's economy will remain resilient, although we anticipate continued institutional weaknesses and only a moderate increase in hydrocarbon prices over the next two years.

We could lower the ratings on Qatar if developments in hydrocarbon production and prices, or in the banking sector, were to significantly weaken the country's external or fiscal positions; for example, if the government's grossliquid assets fall significantly below 100% of GDP, by our estimates, or if interest payments accounted for more than 5% of government revenues.

We could raise the ratings on Qatar if we saw domestic institutions mature faster than we expected, alongside significant improvements in transparency regarding government assets and external data quality.