A combination of factors has led to a rise in bond issuance from GCC member states in the first half of 2016. Over the period, bonds and sukuk (Islamic bonds) issued in the GCC hit $39bn, accounting for 15% of the region’s total outstanding bonds ($263bn) as of June 2016, and nearly equalling the value of issues in the whole of 2015. $20bn, sovereign bonds accounted for 51% of the new debt.
Supply & Demand
A number of elements have coincided to catalyse this bond boom. First and foremost is the desire for financing in GCC nations, which were all in fiscal deficit as of 2016. Budgetary gaps have emerged as the fall in the oil price – still the major contributor to government coffers and overall GDP in the region – has accompanied substantial spending programmes enacted by the region’s governments. While many are now implementing austerity measures to pare back spending, there is understandably some reluctance to cut back on infrastructure projects that have the potential to underpin long-term economic growth and diversification, as well as investments in health and education, which are improving the lives and prospects of citizens. Furthermore, in the wider context of regional instability, defence spending also remains a priority.
Second, bond issues are just one way of financing deficits, but have become increasingly attractive compared to the alternatives available to GCC nations. Gulf countries had previously used their substantial cash reserves to cover budget shortfalls but became increasingly wary of dipping into them excessively, as they are seen as an important guarantor of macroeconomic stability and the region’s fixed exchange rates. In 2015 the region’s sovereign wealth funds (SWFs) also came under scrutiny, with some liquidating holdings in certain areas to finance government spending.
Lower oil prices also contributed to a liquidity squeeze on some domestic banks in the Gulf, making them less able to finance governments. As the amount of financing required is beyond the means of most banks in the region, many countries have had to turn to the international markets.
The global appetite for bonds also increased in 2016, partly due to a perception of increased global economic and political risk, with bonds, particularly sovereign issues from countries as stable as those in the GCC, being widely viewed as a safe bet. Hunger for these assets from investors has pushed yields down, making it cheaper for countries and companies to borrow. Meanwhile, quantitative easing in Europe and the US has increased the pool of liquidity seeking a home, which has also stoked demand. Even with lower growth and bigger deficits, Gulf countries offer a solid outlook for bond investors, as they possess low debt-to-GDP ratios, large fiscal buffers and reform programmes that should help consolidate finances and boost diversification.
Leading The Way
This charge was led by Abu Dhabi, which in April 2016 sold $5bn in sovereign paper in its first issue since 2009. The issuance was split between a $2.5bn tranche of five-year bonds yielding 2.218% and maturing in May 2021, and a $2.5bn tranche yielding 3.154% and maturing in May 2026, the regional press reported, citing market participants. The sale was managed by JP Morgan, Bank of America and Citigroup. Participation by major international players indicated the size and importance of the issue, which was significantly larger than the $1.5bn, 10-year paper issued in 2009.
The sale’s “unmitigated success”, in the words of one JP Morgan analyst, was a clear sign of investor confidence in the emirate and its medium-term economic outlook. The offering was substantially oversubscribed, with more than 600 orders worth over $17bn and great interest from geographically diverse foreign investors. The 10-year bonds in particular attracted large sums from outside the region, with 26% going to US investors, 17% to the UK, 13% to other European investors and 6% to Asia and 38% purchased from the Middle East. The five-year tranche meanwhile, saw 47% allocated to the Middle East, 18% to European investors, 15% to Asia, 12% to US investors and 8% to UK-based buyers.
At the time, analysts predicted that Abu Dhabi’s bond sale could herald a new surge of debt issues across the Gulf. This proved to be true. In May 2016, Qatar issued a $9bn eurobond, the biggest ever in the Middle East. The move surprised the markets, which had been primed for a sale of around $5bn, and it accounted for nearly a quarter of issues by value from the MENA region year-to-date. The float came in three tranches: $3.5bn in five-year notes, a further $3.5bn with a 10-year maturity and a $2bn, 30-year issue. The spreads, larger than those offered by similarly rated Abu Dhabi, contributed to the sale’s oversubscription, with total bids recorded worth some $24bn.
In June 2016 the Omani government became the next country in the Gulf to tap the bond markets, selling $2.5bn, split between five-year notes with a coupon of 3.625% and 10-year paper at 4.75%, the international press reported. Again the issue was oversubscribed, with demand totalling a reported $7bn. Like its Gulf neighbours, Oman issued bonds against the backdrop of a growing budget deficit – expected to come in at a 17% of GDP in 2016 - due to lower oil prices. The size of Oman’s deficit contributed to the bigger yields on its debt.
As of mid-2016, the market was gearing up for what some analysts said could be one of the biggest emerging market bond issues in history by Saudi Arabia, in a first for the Kingdom. It has also been reported that Kuwait is preparing a smaller bond offering. In June 2016 the Financial Times reported that Riyadh had appointed three major international banks to manage the process. The country has been actively courting international financial institutions as it looks to finance its budget deficit – expected to total at 14% of GDP in 2016 – and an ongoing economic transformation programme.
In April 2016 Saudi Arabia agreed a $10bn loan with a consortium of international banks in a successful move widely seen as paving the way to its first international debt issue. The Kingdom had been covering its expenditure from its vast $100bn reserves, but like its neighbours saw an opportunity to tap international markets. Despite slowing growth and a large deficit, Saudi Arabia is a fairly secure prospect for fixed-income investors, with debt below 10% of GDP – albeit forecast to rise to 30% by 2020 – huge hydrocarbon reserves, a strong industrial base and solid plans for fiscal tightening and the expansion of the private sector through the National Transformation Programme unveiled in June 2016.
On The Up
The appetite for Gulf sovereign bonds in 2016 is in stark contrast to the market in late 2015. Bahrain’s $1.5bn issue priced five-year bonds at 5.875% and a 10-year tranche at 7%. This indicated a significant rise in yield from 2014, when it issued a 30-year bond with almost no premium over the secondary-market yields of its previous bonds on offer, a situation found across the region. However, by February 2016, Bahrain was able to attract $900m in bids for a $600m offer, despite having been downgraded to junk status by Standard & Poor’s a week earlier. Yields on the offering were only a little higher than those posted on a $750m offering cancelled on news of the downgrade, but they remained elevated by regional standards, at 5.95% for five-year paper and 7.65% for a 10-year tranche, reflecting concerns about Bahrain’s deficit and political outlook.
It is often the case in emerging markets that sovereign bond issues help pave the way for corporate ones, and this is the expectation in the GCC, where corporate bond markets have traditionally been fairly shallow and dominated by the financial sector. Indeed, reports suggest that GCC states hope government issues will be followed by offerings from state-linked and private companies.
Indeed, the regional bond boom of the first half of 2016 was not just notable for sovereign issues. In June the Abu Dhabi National Energy Company issued $1bn in two tranches of $500m, comprising five-year and 10-year tenures and coupons of 3.625% and 4.375%, respectively. The firm said it would use the issue to pay back an existing $1bn bond and for general corporate purposes, noting that the new bonds’ yields would reduce its financing costs. A month prior, Saudi Arabia’s Bank Al Jazira raised SR2bn ($533.2m) in a sukuk issue to bolster its capital reserves.
A range of other major corporates are also expected to take advantage of market conditions. In August 2016 the international press reported that the National Bank of Abu Dhabi was preparing a “green” bond issue of at least $500m to finance environmentally sustainable projects, while another Abu Dhabi bank was reported to be preparing a bond offering. Government-owned investment vehicles, until now somewhat reliant on oil earnings, may also join the move to market. The Saudi government similarly sees its prospective international sovereign issue as a model for state-linked entities to follow.
A market appetite for bonds and a desire for good-value financing from the Gulf coincided in 2016. This led to yields being fairly low, but in most cases a premium was still priced in due to risk. Ratings downgrades for countries including Saudi Arabia, Oman and Bahrain in 2016 have engendered caution, though sovereign and top corporate ratings on the whole remain investment grade.
One of the biggest potential downsides could arise from oil prices failing to recover or slumping further. This would put an additional squeeze on budgets that are in some cases already running double-digit deficits, and on governments that have limited political space to cut spending further. A sharper slowdown in China or a new crisis in the eurozone would likewise threaten the market, adding to existing concerns about political volatility in the broader MENA region.
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