Dubai: The UAE's top legislative body, the Federal National Council, yesterday passed a draft law on public debt, paving the way for the creation of a sovereign bond market in the country.
The legislation seeks to limit government debt to 25 per cent of the country's gross domestic product, or Dh200 billion.
The bill provides a legal framework for creating a government bond market in the UAE with public debt instruments traded on the financial markets.
Analysts believe the creation of a legal framework for a sovereign bond issue will be a first step towards the creation of an active debt capital market and a local currency debt market that will have huge monetary policy significance.
"I think the law is the critical first step that was required towards the creation of a local currency debt. Once you get a local market established that will promote the vibrancy of the debt markets," Abdul Kadir Hussain, chief executive of Mashreq Capital, told Gulf News.
Catalyst
Analysts say the law will be a catalyst in the creation of an active regional debt market and is likely to inspire other countries in the region to take a similar step.
Because of the growing long-term funding needs of local projects and increasing demand to fund maturing bank debts, regional corporates and sovereign related entities are looking to raise funds through bond issues. According to estimates by the Royal Bank of Scotland, the Gulf region has more than a $60 billion refinancing requirement in the next 12 months.
While the Gulf region is a net capital exporter, bankers say creation of domestic and regional debt capital markets can solve most of the funding requirements within the region.
The move by the UAE Federal government to issue sovereign bonds is viewed as a first step towards creating a domestic benchmark. According to bankers, it is high time the government started a public borrowing programme that will create a platform and benchmark for domestic bond issuers.
Bankers said the UAE's efforts to create an active debt capital market and the effective use of the government debt market as a monetary policy mechanism to control liquidity and interest rate requires a legal framework.
"Whether the governments are in need of money or not, it is important to have a benchmark against which corporate issuers can mark up their issues. As far as domestic bond issues are concerned they are important tools for the government to fine-tune the fiscal and monetary policies," Masoud Ahmad IMF Middle East and Central Asia Department Director, told Gulf News in a recent interview
At the height of the liquidity boom between 2004 and 2008, the UAE experienced average credit expansion in excess of 30 per cent. Last year the credit growth was about 4 per cent.
"An active government debt market could have prevented such huge fluctuations in the bank credit," said a banker.
In the context of opening up the domestic capital markets and attracting foreign institutional investments (FIIs), well-structured bond markets function as a hedge for the investors and cushion against the impact of hot money movements.
"The entry and exit of foreign institutional investors can increase the volatility on the local stock market. A well developed domestic bond market will function as a liquidity balancing mechanism that will control the surges and ebbs of the market," said Ahmad.
Yield curve
Government bonds function as the reference point for the pricing of corporate bonds and asset backed securities. Thus, the backbone of the bond market is a benchmark yield curve, which is constituted by government bonds of various maturities.
Given the huge liquidity available within the UAE, and shortage of bank credit, local and regional corporates have the opportunity to raise local currency debt to finance many of the large scale projects.
Analysts say the unique federal structure of the UAE could pose some difficulty in creating a single benchmark for the country as a whole. "To start with, we may have to settle for different benchmarks for different emirates before arriving at a single yield curve for the country. It looks like a long drawn process given the different debt profiles of different emirates," said an analyst.
But going by the overall trend towards raising funds through bond issues in the UAE there is a growing demand for a domestic debt capital market to fund long term projects.
