Capitalizing On Debt: Middle East Bonds

Published in Forbes Middle East, 10 January 2017

By almost any measure, Saudi Arabia’s bond issue on October 19, 2016 was a success. While analysts had been predicting an issu­ance of between $10bn and $15bn, the final amount was $17.5bn, setting a new record for the largest ever emerging markets sovereign bond—the previ­ous record had been set by Argentina in April 2016, when it sold $16.5bn.

In addition, the Saudi bond was heavily oversubscribed, with demand reaching up to $67bn according to some reports. All this sug­gests the bond sale could mark the starting point of a far more vibrant regional bond market, for both sovereign and corporate issuers alike.

The success of the sale did not come as a sur­prise to many observers, despite the slowdown in the Saudi economy and the effort that policymakers in Riyadh have had to make to adjust to lower oil prices since late 2014.

“The issue was obviously very well received,” says James Reeve, deputy chief economist of local bank Samba Financial Group. “For all its current travails, Saudi Arabia is a G20 country with the world’s largest oil reserves and very little debt.”

The $17.5bn issuance was split into three tranches of varying size, tenor and price. A $5.5bn tranche with a five-year maturity carried a yield of 2.63%; another $5.5bn with a 10-year maturity had a yield of 3.44%; and a $6.5bn, 30-year tranche had a yield of 4.64%. That pricing put Saudi Arabia be­tween other regional sovereign issuers—yields on 10-year bonds from the Qatar government trade at around 3.07% for example, while 10-year debt of the Omani sovereign is at 4.76%.

It is unlikely to be the last big bond sale by the Saudi gov­ernment. The authorities have a pressing need to raise money to cover their budget deficit, and the indications from this is­sue are that raising debt on the international market can be done at an affordable price.

Samba suggests that Saudi Arabia is facing a budget short­fall of some SR945bn ($250bn) in the five years leading up to 2020, including a deficit of SR344bn in 2016. Most of the mon­ey needed can be raised from local banks and public sector bodies such as the General Organisation of Social Insurance and the Public Investment Fund. In addition, the government can draw down some of its savings. But international debt markets will continue to be an important piece of the jigsaw.

Analysts say they expect another international bond to be issued by Riyadh sometime in 2017, although if oil prices rise at the rate expected, subsequent debt issues are likely to be smaller—perhaps around $10bn.

“I think they will return to the markets frequently over the coming years, not necessarily with huge tranches like this but issuance will be sizeable,” says Peter Kinsella, head of emerging markets economic research at Germany’s Commerzbank. “It’s not like their budget deficit will go away anytime soon.”

Bond sales do of course mean that the country’s debt-to- GDP ratio will rise. According to the IMF, government gross debt was just 1.6% of GDP in 2014, rising to 5.8% the follow­ing year. It is predicted to increase to 17.2% by the end of this year and to exceed 50% of GDP by 2021. But even at that level it should be easily manageable.

There are a number of positive consequences for the Riyadh government and the wider Saudi economy from bond sales, beyond the basic inflow of money. Riyadh-based Jadwa Investment says the recent bond should lead to an improve­ment in government deposits and should also allow for stalled payments to contractors to resume, leading to an easing of the tight liquidity conditions in the Kingdom’s banking market. In a note issued on November 1, 2016 Fahad Alturki, chief econ­omist and head of research at Jadwa, also attributed a 10% rise in the local stock market’s main index, the Tadawul All Shares Index (TASI), in October in part to the success of the bond sale, although higher oil prices also played a role.

Jason Tuvey, Middle East economist at Capital Economics, says the success of the recent bond issue also means the pres­sure to devalue the riyal should decrease. “The revenues should cover around a third of the budget deficit over the next year and almost all of the current account shortfall, so the Kingdom’s foreign exchange reserves are unlikely to fall much beyond their current level over the next year,” he says. “This should dampen any lingering concerns that the riyal will be devalued.”

What remains to be seen is how much the recent issue will encourage other issuers to tap into the market. “The yield curve has now been established,” says Reeve. “I expect we will see some banks and government-related entities entering the market. I don’t think it will be a flood though.”

The wider Middle East bond market has been relatively strong this year. According to data from Thomson Reuters, around $86.2bn had been raised by October 20, 2016—a 251% increase on the same period in the previous year. It also points out that the three largest ever deals from the region have all happened in 2016. Along with the Saudi bond, they have in­cluded Israel’s Teva Pharmaceuticals, which raised $15bn in July, and Qatar’s $9bn sovereign issuance in May.

Among the other regional sovereigns to have raised money in 2016 are Abu Dhabi and Oman. Kuwait is also expected to issue. Dubai-based bank Emirates NBD says that total GCC bond issuance has reached $60bn so far in 2016 and it predicts that the full-year total should now climb as high as $70bn, helped by possible debt issuance from the Kuwait government as well as banks and airlines.

As Reeve points out, the sovereign issues have helped to create benchmarks from which other debt instruments in the market can be priced and, according to credit ratings agency Fitch Ratings, that should support the broader growth of capi­tal markets in the region. It points out that the lack of a sover­eign yield curve had been one of several factors holding back corporate bond issuance in the region until now and it sug­gests that corporate activity in this area should now gradually start to take off from 2017.

Other factors will also play an important role in the pop­ularity of such debt instruments. Liquidity conditions have tightened not just in Saudi Arabia but across the region’s bank­ing markets because of low oil prices and declining government deposits. That makes the bond market an interesting option for many companies who had been used to a situation in which bank loans were often easier, quicker and cheaper to access.

“Even when corporates can borrow from banks, the pric­ing difference between the bond and bank markets may nar­row,” Fitch noted, in a report issued on November 1, 2016. New regulatory regimes put in place around the region over the past few years should also encourage more corporate bond issuance, with greater standardisation helping to speed up the process and reduce costs.

Lastly, for investors facing low or negative interest rates in many parts of the world, the yields on Middle East bonds are attractive, which is helping to boost demand, which in turn en­courages more supply. If all this does lead to more corporates accessing the bond market there may be one further benefit for the region’s economies. Investors demand transparency be­fore offering their money and, in a region that has often been notable for the opacity of its businesses, which could lead to a significant cultural shift.