GCC sovereigns Resort to the Bond Market
In recent years, the issuance of sovereign debt by GCC governments has been quite limited to Bahrain and Oman in light of the enormous surpluses accrued in light of the once-soaring oil prices. In fact a few sovereigns, and sub-sovereigns like Abu Dhabi, did not even have credit ratings. Instead most of the limited bond issuance was by government-linked companies throughout the region. Yet, and as we have explained in a recent piece, with the reversal in hot money, in addition to the the losses and continued losses in the region’s equity markets, the cost of long-term borrowing sky-rocketed, highlighting the vulnerability of relying on external finance even as new revenues began to fall as investment returns and oil revenues fell sharply. Also, with external finance expected to grow at a slower pace in the face of the continued global liquidity crunch, GCC countries are left with no other option but to try to explore other sources of financing to tap the latent funds available in the region and from foreign investors looking for relatively safer credit risks.
Bond market development, an important pillar of financial development, is a possible source.As Robin Wigglesworth notes in the FT:
“Successful bond issues could contribute to establishing a regional yield curve and form the basis for an increase in corporate bond issuance in the region which has been little developed”. This may, in turn, lessen the need for the dependence of the corporate sector on bank funding for their financing needs, which has been the case in the past.”
Compared to other regions, corporate capital raising has primarily come from banks, an increasing share from equities and relatively little (10% or so) from bonds.
However, this sort of sovereign bond issuance is of course for now another vehicle to tap primarily external financing, which may come at a significant cost. Abu Dhabi’s 5-year notes will pay 400 bps above treasuries and the 10 years will pay 420, which some analysts like Mohieddine Kronfol quoted by Bloomberg suggest is generous. But doing so may be required to have the bond issue be attractive, especially as it may be the first of several – Abu Dhabi may issue as much as $10 billion in debt meaning the planned $3b issuances is but a third.
Source: NCB Capital. GCC Debt Capital Markets; An Emerging Opportunity? March 2009
Sovereign issuance could come at the expense of corporate issuance in the near term. In this way GCC countries are following global trends, the raft of sovereign debt issuance in advanced economies like the US and many others are offsetting the declines in corporate issuance even as doing so facilitates government efforts to provide more liquidity and investment to offset the contraction in private demand. Sovereign capital raising could enable the governments to come to the aid of their cash-strapped state-linked companies, as Dubai’s government has done. Governments in the GCC have already used some of their past savings to provide capital to their
Either way this is another reflection of how weaker oil prices are changing the balance of payments in the GCC. Even at current oil prices ($50 area) most GCC countries are likely to run small current account deficits and in most cases small fiscal deficits which would reaffirm the need for the issuance of bonds. Most GCC countries do still have large net foreign asset positions, but their portfolios are less liquid then many may hope. So raising capital might avoid selling illiquid assets on the cheap.
In the case of Abu Dhabi, this would be the first sovereign (or rather sub-sovereign) issuance after it recently received a AA credit rating from Fitch. HSBC notes that a successful bond issuance by Abu Dhabi might ease concerns about Abu Dhabi’s ability to support Dubai and avoid selling assets at current. Most of Abu Dhabi’s oil surplus was channeled through the Abu Dhabi Investment Authority (ADIA) or other investment vehicles and invested in equities and alternative assets as well as fixed income.
One question is whether or not we shall see a sovereign rating for the UAE as a whole from S&P (it already has one from Moody’s) rather than for Abu Dhabi only. It is worth noting that Dubai and Ras Al Khaimah began undertaking some measures to acquire a sovereign rating to issue bonds in 2007. The two Emirates have indeed issued bonds and Sukuks (Islamic bonds) in 2008 although a sovereign rating was not yet provided. With expectations that more sovereign bonds will be issued, an overall sovereign rating might seem like the natural next step in light of lower oil prices.
Despite its underdevelopment in the area of bonds, the GCC are not alone in the region in issuing debt. Egypt recently reopened a deferred bond issue. This raft of issuance comes as several other emerging and frontier markets (especially in Sub-Saharan Africa) have deferred or scaled back on their bond plans. Ghana, Nigeria and Tanzania have withdrawn or deferred some of their planned issuance. At a time where sovereign debt issuance (especially by advanced economies is reaching record levels) attention is being drawn to the relative credit worthiness of different sovereigns. Even though EM debt spreads with respect to US treasuries have narrowed in the last two months they are still much wider than they were a year ago. Cheap funding for sovereigns may be at an end. But with their relatively strong net asset positions, GCC sovereigns should still seem like good credit risks at least compared to some of their peers, and moving to diversify capital raising seems like a good step for GCC sovereigns particularly if it helps to start develop the domestic capital markets.