Dubai: The recent sanctions on Qatar by a group of states led by Saudi Arabia, the UAE, Bahrain, Egypt, Libya, Yemen and a few other allied countries is expected to have huge consequences on Qatar’s economy and its financial sector if a resolution takes much time, according to rating agency Moody’s.

“Weaker economic activity could lead to deteriorating asset quality in the banking system and together with an escalation involving sanctions against the financial sector could necessitate a step-up in government liquidity support,” said Steffen Dyck, Senior Credit Officer, Sovereign Risk Group of Moody’s.

Although no such sanction has been applied to date, analysts say such a possibility can’t be completely ruled out.

In addition to rising global interest rates, funding costs for the government and other Qatari-based issuers will increase further and the government’s balance sheet would deteriorate quicker in a scenario of a prolonged stalemate that extends well into 2018. The sovereign has no external refinancing needs until the first quarter of 2018 when a $2 billion (Dh7.3 billion) sukuk issuance made by SoQ Sukuk A Q.S.C. will mature, but corporates including government-related entities and banks are facing more sizeable redemptions over the next 12 months.

Aside from bond and sukuk, Moody’s estimates that total short-term external liabilities amount to more than $115 billion (68 per cent of nominal gross domestic product (GDP) projected for 2017) of which roughly one third is estimated to be due to creditors in the GCC. Moody’s estimates that about half of this is accounted for by non-resident deposits and rollover risks would increase in a scenario of further financial sector sanctions.

The government has sizeable asset buffers, including roughly $35 billion in net international reserves at the Qatar Central Bank and more than $300 billion of assets managed by Qatar Investment Authority (QIA). The government’s significant resources together with liquid foreign assets in the banking system, which amounted to about $30 billion as of May, according to Moody’s estimates, provide a strong mitigant against liquidity issues in the short term. However, a deterioration in economic activities could have strong adverse impact on the financial sector.

Qatar’s key economic indicators that stood resilient in 2016 and in the first quarter of 2017 are now looking bleak as the country faces diplomatic and economic isolation from its neighbours and other Arab nations.

Qatar’s key economic indicators such as liquidity in the banking sector and credit growth were positive until the end of the first quarter.

Total credit facilities continued to grow and stood at a record high level at the end of the first quarter of 2017, with an increase of 1.9 per cent to reach 855 billion Qatari riyals (Dh862 billion). But with the economic sanctions taking their toll on liquidity, Qatar is facing a potential funding shortage and high cost of funds that could curtail credit growth leading to lower GDP growth, especially non-oil GDP growth.

“A de-escalation is likely only gradually. Risk of further escalation remains. The large FX mismatch in the Qatari banking sector keeps it vulnerable to an abrupt withdrawal of GCC funding. We estimate $35 billion (20 per cent of GDP) in banking sector capital outflows within one year if the GCC decides to sever financial ties,” said Jean Michel-Saliba, Mena Economist of Bank of America Merrill Lynch.

Analysts say although QIA’s foreign assets will help the country withstand outflows and defend the peg, prolonged outflows could erode QIA’s balance sheet.

According to Institute of International Finance (IIF), a Washington-headquartered global association of the financial services industry, if the current crisis persists for an extended period and ties deteriorate further, Qatar’s GDP growth could decline to 1.2 per cent in 2017 and 2 per cent in 2018, principally due to lower non-hydrocarbon growth impacted by increased uncertainty weighing on investment and a tighter financial environment and perhaps deposit flight that could raise the cost of funds.

Cuts in financial ties and increased counterparty concerns could hinder ease of doing business and trade finance. “In this scenario, lower than expected non-hydrocarbon revenue could widen the deficit fiscal deficit to 7.8 per cent of GDP in 2017. The external current account deficit could remain at around 2 per cent of GDP as the sharp fall in travel- and transport-related service receipts due the prolonged travel bans of neighbours and airspace closures,” said Boban Markovic, Research Analyst at IIF.