GCC Bond Issuance Reaches Record Levels
GCC governments and corporations borrowed $110bn in the first eight months of 2016 – a record amount – and more borrowing is expected in the final months of the year. The Arab Bankers Association spoke to Anita Yadav, the Head of Fixed Income Research at Emirates NBD bank, to find out what has been driving the GCC borrowing spree, who has been lending, and how the bonds and loans have been priced.
Arab Bankers Association: Why have GCC governments and corporations been borrowing so heavily in 2016?
Anita Yadav: High oil prices in the first decade of this century saw GCC governments enjoying substantial surpluses in their current and fiscal accounts. Capital market growth was stunted because the region had plenty of capital and governments had little need to borrow. However, the arrival of a period of low oil prices has created a vastly different environment in which government budgets are severely strained and sizeable budget deficits need funding.
The corporate world in the GCC region is dominated by large corporations that are owned directly or indirectly by governments or are related to governments in some way. A lot of these corporations were directly or indirectly funded by the government. Falling oil revenues have reduced the ability of governments to inject capital into these institutions and they in turn are feeling the need to raise money in the global capital markets alongside their governments, who are themselves raising money to cover their budget deficits. Within the last 18 months, the GCC has gone from being a capital surplus region to a capital deficit region. Its funding needs are being met not only through borrowing in the local markets but also from international sources.
Excluding bilateral bank loan facilities, GCC issuers raised about $36 billion in the dollar denominated bonds and sukuk in the first eight months of the year, and $75 billion in the syndicated bank loans. This is an all time high.
Who has been buying these bonds?
Historically, GCC bonds were mainly bought by local investors, and particularly for banks’ ALM books in the region and by private bank clients. Even when the primary deals were placed offshore, the bonds gradually found their way back into the hands of local investors. In 2014, less than 25% of GCC bond holdings were in the books of international investors. This situation has now changed.
Recently, the majority of primary deals have been placed outside of GCC with particular interest being shown by European and Asian clients. Also, the dripping back of these issues into the local hands has slowed. In terms of type of holders, there is an increasing trend for bonds to be bought by real money and private clients rather than the bank books. In the syndicated loan space, European and Japanese banks have been most active although large regional banks continue to play some role.
Has the pricing of the issues been in line with your expectations?
The primary market in the Middle East was been quiet over the July August months owing to the summer lull. Prior to July, most new bond/sukuk deals were being priced around 25bps to 40bps wider than the secondary market trading levels on similar bonds. Although the new prices are slightly more expensive than those that issuers could have achieved two years ago, overall it has been within expectations.
How have the credit rating downgrades affected the ability of Gulf sovereigns to issue bonds?
The downgrades have not impacted issuers’ ability to borrow, but the price that the issuers are having to pay has certainly gone up. Even after the downgrades, GCC sovereigns remain highly rated. Given low debt levels and sizeable foreign exchange reserves, investors remain comfortable with the GCC risk providing they are priced correctly.
Is there a pricing differential between conventional bonds and sukuk?
The price differential between sukuk and conventional bonds is fast disappearing. During the era of high oil prices, the Islamic world had plenty of liquidity and as a result sukuk enjoyed stronger bids and better pricing than conventional bonds. However now that the liquidity in the region has thinned and most investors are from the international market, there is no incremental demand for sukuk over bonds and so there is not much price difference either.
Are you expecting more borrowing by Gulf sovereigns in 2017?
Given the need to fund budget deficits we expect more sovereign issuance in the coming few months. Overall we expect 2016 to record around $50 - $60 billion in total new dollar denominated bonds and sukuk issues. In addition, syndicated loans could easily touch the $100 billion mark. Governments are also increasing their issuance in the local currency market - this is now much greater than it has been in the past.
Do you think the profile of investors who will buy sovereign bonds in 2017 will change?
Sovereign bonds are attractive for local GCC banks, not only as investments in themselves but also because, as domestic government risk, they receive zero risk weighting for capital adequacy calculations. I think the bank ALM books will continue to be big buyers of sovereign bonds in 2017. In addition, cheack liquidity from the developed world is finding its way into GC bonds adn investors from those markets will be looking to add more GCC risk.
Anita Yadav is Head of Fixed Income Research at Emirates NBD. In her current role, she focussed on global fixed income markets with a particular emphasis on the GCC region, covering rates and products that encompass regional sukuk and bonds. She is on the advisory committee of the Gulf Bond and Sukuk Association and is a frequent commentator on global fixed income issues.