OREANDA-NEWS. Fitch Ratings has affirmed Macao's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at 'AA-' with a Stable Outlook. The Country Ceiling is affirmed at 'AA+' and the Short-Term Foreign-Currency IDR at 'F1+'.

KEY RATING DRIVERS
The affirmation of Macao's IDRs with a Stable Outlook reflects the following key rating drivers:

- Macao's ratings are underpinned by exceptionally strong public and external finances, a credible policy framework, and high income levels. The ratings are constrained by the territory's volatile macroeconomic performance, high concentration in the gaming industry and mainland China, as well as some relatively weak structural indicators.

- Fitch estimates the 2015 budget surplus declined to a still-strong 7.9% of GDP despite a 34% contraction in gaming revenues. The 2016 budget was announced on 4 January 2016 and targets a fiscal surplus of MOP3.5bn (1.0% of GDP) based on relatively conservative assumptions that include a further 14% contraction in gaming revenues. Fitch forecasts a higher 2016 budget surplus of 2.9% of GDP, principally driven by the view that gaming revenues will fall by a more-modest 5%. The agency expects Macao to achieve balanced budgets or modest fiscal surpluses over the medium term as stipulated in its Basic Law.

- Macao has no general government debt and nine consecutive years of fiscal surpluses have contributed to the accumulation of large fiscal buffers. Fitch estimates that fiscal reserves, including provisional reserves yet to be transferred to the Fiscal Reserve, grew to 126% of GDP at end-2015. Outstanding fiscal reserves represent 5.2x of the government's projected 2016 budget expenditure, which provides policy makers substantial flexibility to manage external shocks or sustained periods of weak economic performance.

- External finances are among the strongest across Fitch-rated sovereigns. The territory is a large net external creditor (211% of GDP at end-2015) and has run consistent current account surpluses averaging 32% of GDP since the authorities began reporting balance of payments statistics in 2002. The currency board arrangement has served as a credible policy anchor since its inception in the 1980s and is supported by USD19bn in foreign exchange reserves, equivalent to 4x the monetary base. Sovereign net foreign assets, which include both fiscal and foreign exchange reserves, are the fourth highest globally at 167% of GDP as of end-2015.

- Macroeconomic performance suffered a sharp contraction in 2015, with real GDP falling by 20.3% due to a collapse in gaming revenues across both VIP (-40%) and mass-market segments (-26%). The agency forecasts real GDP to contract by a further 6.5% in 2016, due to further projected declines in gaming revenues that will only partly be counterbalanced by moderate growth in consumption and investment from ongoing resort construction. Steady gaming revenues in recent months give some indication the sector may be stabilising, but aggressive promotional campaigns during Chinese New Year are likely to have exaggerated the February release.

- Macao's high concentration in the gaming sector and China is a key rating constraint. Direct tax revenues from gaming represent 76% of government revenues and the sector accounts for 21% of employment. Tourists from mainland China represent 66% of visitor arrivals, but contribute an even higher share of gaming revenues and retail spending. A material slowdown in China's economy could impact Chinese demand for gaming services. There are also broader China policy risks, including significant changes to visa policies or gaming regulations, though we believe the latter is unlikely to occur in the near-term.

- Fitch continues to view Macao's large banking system exposures to China as a potential risk to its credit profile, even though asset quality remains high. The Monetary Authority of Macao (AMCM) estimated mainland China exposures were MOP364bn as of June 2015 (27% of banking sector assets). The majority of mainland-related customer loans (60%) are supported by guarantees from Chinese banks, but bankruptcy procedures are largely untested. Direct risks to Macao's sovereign balance sheet are nevertheless mitigated by the fact that the banking sector is almost entirely foreign owned, with mainland Chinese banks accounting for the largest share of assets.

- Domestic housing prices have fallen by around 20% over the past year, but three rounds of macro-prudential tightening measures implemented since 2010 including lower caps on loan-to-value and debt service ratios have thus far preserved the credit quality of bank's mortgage portfolios. The AMCM estimates that less than 1% of mortgages are in negative equity and a recent survey suggests about 80% of loans were issued at a loan-to-value ratio of 50%.

- Structural characteristics including weak governance indicators and the economy's small size also stand out as credit weaknesses compared with 'AA' category peers. However, Macao also has one of the highest per capita incomes in the world at approximately USD78,000.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced.

The main factors that could lead to negative action, individually or collectively, are:
- A severe economic shock from China, in light of the close economic and financial linkages.
- A sustained decline in gaming revenues, particularly if it leads to erosion of the sovereign balance sheet.
- A sharp deterioration in financial-sector stability.

The main factors that could lead to positive action, individually or collectively, are:
- Diversification of the economy into sectors less reliant on gaming and China.
- Sustained improvement in Macao's sovereign balance sheet strength.

KEY ASSUMPTIONS
- China avoids a hard landing or banking crisis.
- China's policy on the legality of gambling in Macao does not change.