The rising cost of lending

Published in MEED, 22 February 2018

With global economic growth picking up and concerns about rising inflation, the chances of interest rates increasing this year appears relatively high. In particular, there is speculation the US Federal Reserve could increase interest rates on the dollar as soon as March.

Given the currency pegs that many Middle East countries have to the dollar – as well as the high proportion of debts that are dollar-denominated – that is likely to feed through into higher interest rates and higher borrowing costs in the region, not least in terms of project finance deals.

The cost of borrowing has already been rising in some key markets in the past few years. Having been below one per cent for most of this decade, the three-month Saudi Interbank Offered Rate started to climb in late 2015 and by October 2016 had reached more than 2.3 per cent. It fell back for a while, but in recent months has been rising once more and at the end of 2017 it stood at 1.87 per cent.

Across the border in the UAE, the three-month Emirates Interbank Offered Rate has been increasing more consistently, rising from 0.677 per cent at the start of 2015 to 1.87 per cent by January this year.

The threat of higher borrowing costs comes at a time when governments are continuing to add to their debts in order to sustain capital investment programmes and other spending commitments. In the Gulf, oil-producing countries have enjoyed higher oil revenues in the past six months or so, but prices still remain far below what is needed for most governments to balance their budgets.

It is not just rising interest rates that are forcing borrowing costs higher. Credit ratings agencies have also been marking down many of the region’s economies. Over the past year there were at least nine downgrades or cuts to the outlook for Middle East and North Africa (Mena) sovereigns by the three main agencies, compared to just two upgrades. As it stands, eight sovereigns have at least one rating at non-investment grade, or junk status, and several countries have multiple junk ratings, including Bahrain, Egypt, Iraq and Lebanon. With each downgrade, the cost of borrowing can rise.

The situation is also not helped by geopolitical tensions, from the wars in Iraq, Libya, Syria and Yemen, to the standoff between Qatar and its erstwhile GCC allies and the cold war between Iran and its Arab Gulf rivals.

“Rising polarisation and uncertainty within the GCC is credit negative for the region as a whole, especially because of its impact on investor confidence, which has already translated into an increase in borrowing costs across the GCC,” says senior credit officer of Moody’s, Steffen Dyck.

Among the GCC countries, the difficulties are most serious for Bahrain and Oman, he adds, given their greater reliance on external financing and, therefore, greater exposure to any dip in confidence.

Despite all these problems and risks, there are still plenty of financiers willing to lend and cost is not necessarily the main problem. “Financing is not the issue. There is an awful lot of financing available,” says one senior industry executive working in the fast-developing renewable energy sector. He says the main issue is finding “bankable projects” that make commercial sense and can be developed in a timely fashion. That is an issue that others echo. “There is no lack of capital in the marketplace for good projects. The problem is, there are not enough good projects,” says another energy industry executive.

That situation might explain why the project finance market performed relatively poorly in 2017. According to Thomson Reuters, $9.6bn worth of project finance loans were made across six Mena countries last year: Bahrain, Egypt, Oman, Saudi Arabia, Tunisia and the UAE.

That was 75 per cent less than the $38.9bn-worth of lending in those markets in 2016. The number of deals rose from 20 in 2016 to 25 last year, but that meant the average loan size fell from $1.9bn to just $383m.

Given these market conditions, project developers need to explore a wide range of financing methods. One area that has been relatively strong in recent years has been export credit finance, with some major deals including the $2.5bn of finance for the UAE’s Emirates Nuclear Energy Corporation provided by the Export–Import Bank of Korea in 2016 and, more recently, a $3bn line of credit extended by the US Exim Bank to Iraq to help with the rebuilding of its infrastructure.

Another area of growing activity is public-private partnerships (PPPs). While there have been problems with these deals in some markets, such as Kuwait, in general PPPs are now seen as a vital element in the financing mix, particularly given the limited ability of many governments to take on the burden of expensive infrastructure schemes.

The issue of affordability is often most acute in countries outside the high-income economies of the Gulf. Among this group, debt has been rising in recent years. According to the World Bank, total external debt across the region’s low- and medium-income countries rose from $190bn in 2014 to $225bn in 2016.

Any rise in interest rates will affect these countries, given that some 58 per cent of this group’s public debts are in US dollars. As it is, average interest rates on new public and publicly guaranteed debts have been rising in the past few years, from 1.7 per cent in 2013 to 2.7 per cent in 2015 and 2016.

Some countries face even higher borrowing costs – the average interest rate on new public debt in Lebanon was 6.5 per cent in 2016, while in Iran it was 10 per cent.

Domestic issues also often play a role in rising borrowing costs, however. In Egypt, for example, a senior analyst at Moody’s, Elisa Parisi-Capone, points out that “measures like a value-added tax hike and cuts to energy subsidies have also fuelled inflation and translated into higher domestic borrowing costs”.

In Lebanon, the IMF warned in mid-February that the government’s planned $16bn capital investment programme – which it is undertaking in part to alleviate the strain being placed on the economy by the presence of some one million Syrian refugees – could increase borrowing costs there, too.

Despite the expense, however, the pressing need to invest in infrastructure is something that cannot be easily ignored. Across the region, borrowers may simply have to get used to higher costs in the coming years.