The six Gulf Arab states, incorporating several of the biggest, and wealthiest, players in the global oil and gas markets, cannot seem to stop selling debt. And investors, hunting for yield in a global low rates environment, are driving demand for more bond issues from the region. Despite the recent escalation in geopolitical tensions, issuance is likely to remain strong but restricted to sovereign or state-owned entities, able to borrow more cheaply.
Gulf region debt sales on track to reach record levels in 2019
The traditionally debt-averse states of the Gulf Arab region are today among the most active borrowers in global debt capital markets. Over $80bn in record debt was sold in 2017, just marginally more than in 2018. However, already in 2019, hard currency issuance from the Gulf Arab region is more than $50bn, according to data from Bloomberg, with sovereigns and government-related entities accounting for nearly three quarters of all issuance year-to-date.
The oil price collapse of 2014 hit regional governments hard. Still heavily dependent on hydrocarbon revenue, significantly lower oil prices led to current account and budget deficits across the board. All six states have committed to diversifying their economies away from oil and gas, with ambitious economic development plans drawn up which require massive infrastructure and social spending. The urgency to provide social welfare, jobs and government services comes at an additional cost. As oil prices have failed to recover and fiscal breakeven prices remain high, global debt issues have provided an important source of funding for regional governments.
Investors see substantial opportunities in buying Gulf bonds – both in the primary market, and in secondary trading, as higher liquidity and greater volumes encourage a shift away from the previously prevalent buy-to-hold trades seen from the region.
Higher yields for investment grade credits compared with other emerging market bonds and a rapidly maturing yield curve, with a rise in longer-dated issuance, is combined with a perceived low risk of default for the majority of sovereign issuers.
The emirate of Dubai’s 2009 debt crisis, which almost started with a bond default and necessitated a comprehensive restructuring of the emirate’s banking debt, seems a distant memory to many investors keen to boost returns and diversify their fixed income portfolios.
Demand has been boosted by the inclusion of Gulf sovereigns into the JP Morgan Emerging Market Bond indices earlier this year, making regional bonds more appealing to a broader investor spectrum. In addition, with over $13trn in global bonds trading at negative yield, and benchmark 10-year US Treasuries offering a yield of under 2%, bullish investors see more opportunity in emerging and frontier markets.
The total year-to-date return on Gulf US dollar-denominated investment grade bonds as of July 11 was up 9.6% according to the Bloomberg Barclays GCC bond indices, as quoted in a recent credit note by First Abu Dhabi Bank.In comparison, the return on Emerging Market Investment Grade bonds was up 9.2%.
Saudi Arabia substantially increases debt issues
The record rate and volume of Gulf regional bond issuance has helped the primary market mature and diversify, most tellingly with the dramatic entry of Saudi Aramco, the kingdom’s state-owned oil company, which sold $12bn in bonds earlier this year.
Order books for the issue reportedly ballooned to $100bn, allowing the quasi-sovereign behemoth to price its debut bonds inside the sovereign curve. More usually, yields offered on government-related or state-owned entities are reflective of the risk associated with the sovereign. Aramco accounted for over 75% of Saudi Arabia’s annual revenues last year.
Indeed, a sharp increase in Saudi issuance has been one of the most significant developments in regional primary debt markets in the last five years. While in 2015, Saudi Arabia accounted for 10% of the total hard currency issues from the Gulf region, it now accounts for nearly 30%. This growth has been complemented by more diverse issuance from the kingdom, including the first sovereign euro-denominated bond from the region, which raised €3bn , and a debut international sukuk (Islamic bond) issue from dairy company Almarai in February.
Geopolitical tensions unlikely to quell demand for new issues, but limited opportunities to diversify
Although investors may expect higher yields to account for heightened political instability or global event-driven risks, barring a more serious conflict regional debt issues will continue, buoyed by demand for both conventional bonds and sukuk. Lower oil prices and widening budget deficits amid challenging public spending targets, and the need to refinance existing debt, should ensure steady activity in the primary markets.
The Sultanate of Oman, which the IMF forecasts will have a budget deficit of over 7% of GDP this year, raised $3bn from a bond sale late last month, taking advantage of favourable market conditions. The country issued five-year and 10-year bonds, pricing inside the initial guidance as orders poured in.
Meanwhile, opportunities for investors to buy into regional corporates will remain few and far between. Only 4% of outstanding hard currency issuance from the Gulf is corporate, dominated by companies in Kuwait and the UAE. Financial institutions, mainly banks, accounted for just under 25% at the end of April. Corporate issues remain rare for several reasons, key among them pricing, but also the need for increased disclosure, possibly a rating, and more regulatory oversight.
Rachna Uppal is the financial markets analyst at Castlereagh Associates, specialising in the Gulf region.
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