A combination of factors has led to a rise in bond issuance from GCC members in 2016. Over the year, bonds and sukuk (Islamic bonds) issued in the GCC hit $66.5bn, more than doubling the $27.6bn total recorded in 2015, and rivalled only by the $60.9bn issued during 2009. A $17.5bn historic bond sale from Saudi Arabia accounted for 26.3% of the 2016 total.
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 oil prices – 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 longterm 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 continues to remain a priority.
Second, bond issues are just one way of financing deficits, but they have become increasingly attractive compared to the alternatives available to GCC nations. Gulf countries had previously looked to their substantial cash reserves to cover budget shortfalls but became increasingly wary of dipping into them excessively, as reserves are seen as an important guarantor of macroeconomic stability and the region’s fixed exchange rates. In 2015 sovereign wealth funds in the Gulf also came under increased scrutiny, with some liquidating holdings in certain areas to finance government spending.
Lower oil prices have also contributed to a liquidity squeeze on some domestic banks in the Gulf, making them less able to finance government spending. As the amount of financing required to bridge the current deficits is beyond the means of most banks in the region, many Gulf countries have chosen 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. Bonds, particularly sovereign issues from countries as stable as those in the GCC, were widely viewed as a safe bet. Hunger for these assets by 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 further stoked demand. Even with lower growth and larger deficits, Gulf countries offer a solid outlook for bond investors as they tend to possess low debt-to-GDP ratios, large fiscal buffers, and reform programmes that should help consolidate finances and boost diversification.
Starting The Year
The year’s first issue was by Abu Dhabi in April 2016, selling $5bn in sovereign paper in its first bond float since 2009. The issuance was evenly split between a $2.5bn tranche of five-year bonds yielding 2.22% and maturing in May 2021, and a $2.5bn tranche yielding 3.15% 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 of major international players indicated the size and importance of the issue, which was significantly larger than the $1.5bn, 10-year paper Abu Dhabi had issued in 2009.
The sale’s success 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 interest from geographically diverse foreign investors. The 10-year bonds in particular attracted large sums from outside the immediate region – with 26% going to US investors, 17% to the UK, 13% to other European investors, 6% to Asian nations and 38% purchased from the Middle East. The five-year tranche, meanwhile, saw 47% of the total allocated to Middle Eastern countries, 18% to European investors, 15% to Asia, 12% to US participants and 8% to UK-based buyers.
Market Mover
At the time, analysts predicted that Abu Dhabi’s bond sale could herald a surge of debt issues across the Gulf. This indeed proved to be true. In May 2016 Qatar issued a $9bn eurobond, the biggest ever in the Middle East.
The move surprised markets, which had been primed for a sale of approximately $5bn, and the eurobond 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 of this bond, 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 Oman became the next country in the Gulf to tap the bond markets, selling $2.5bn split between five-year notes with a coupon of 3.63% and 10-year paper at 4.75%, international press reported. Again the issue was oversubscribed, with demand totalling a reported $7bn. Like its neighbours, Oman issued bonds against the backdrop of a growing budget deficit – estimated at 17% of GDP in 2016 – due to lower oil prices. The size of Oman’s deficit contributed to the bigger yields on its debt.
Enter Saudi
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, a first for the kingdom. The Financial Times reported in June 2016 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 – approximately SR300bn ($80bn) in 2016 – and to implement an ongoing economic transformation programme. In April 2016 Saudi Arabia agreed to a $10bn loan with a consortium of international banks in a successful move widely seen as paving the way for its first international debt issue. Then in October, in line with predictions, the kingdom made history with a record-breaking $17.5bn bond issue.
On The Up
The appetite for Gulf sovereign bonds in 2016 was in stark contrast to the market in late 2015. Bahrain’s $1.5bn issue priced five-year bonds at 5.88% 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 their $600m offer, despite having been downgraded to junk status by ratings agency Standard & Poor’s just one week earlier. Yields on the offering were only a little higher than those posted on a $750m issue that was 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 over Bahrain’s deficit and political outlook.
Developing Market
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. 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 2016 was not just notable for sovereign issues. In June of that year the Abu Dhabi National Energy Company issued $1bn in two tranches of $500m, comprising five-year and 10-year tenures, with coupons of 3.63% and 4.38%, 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 international press reported that 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 reportedly preparing a bond offering. Government-owned investment vehicles, somewhat reliant on oil earnings until this point, may also join the move to market. The Saudi government similarly sees its international sovereign issue as a model for state-linked entities to follow.
Downside Risks
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 region.
While 2016 has seen a flurry of bond activity, it is by no means the first set of issues for the region, and there already exists a large pool of debt to finance across the Gulf. Simon Williams, chief economist for the Middle East at HSBC, told the Financial Times that the GCC member states already have to either repay or refinance $94bn in bonds in 2016 and 2017.
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