Manama: Bahrain faces a dilemma in coming days as it decides whether to issue a sovereign bond at a time of extreme volatility in global markets. It is a dilemma which issuers confront around the world - but in Bahrain’s case it looks particularly acute.

The island kingdom, which is alone among the six oil exporters of the Gulf Cooperation Council in running a sizeable budget deficit relative to its economy, this week completed investor roadshows in the United States, Middle East and Europe for a potential bond issue of at least $500 million (Dh1.83 billion).

Since then, the rout in global debt markets has worsened, after US Federal Reserve Chairman Ben Bernanke said on Wednesday that the US economy was strong enough for the Fed to begin slowing the pace of its bond-buying stimulus this year. He signalled an end to the programme by the middle of 2014.

If Bahrain puts its issue on hold, as most borrowers around the world are doing, it will risk having to pay much more when budget pressures eventually force it to come to market; it has no certainty the market turmoil will ease in coming months.

The 10-year US Treasury yield is at 2.38 per cent after Bernanke’s statement; in the long term it may be heading to around 4.0 per cent, which some consider a “normal” level historically.

But if Bahrain goes ahead and issues its bond now, it will leave itself open to investor speculation that it is simply unable to wait as it needs the money urgently. Because of its weak state finances, that speculation could be damaging.

“Looking to issue in such conditions will raise questions about how desperately Bahrain needs to raise funds from bond markets right now,” said Chavan Bhogaita, head of markets strategy at National Bank of Abu Dhabi.

He added that Bahrain would still be able to get a deal away in current market conditions, if the pricing met investor expectations.

Underperformance

The acuteness of Bahrain’s dilemma is at least partly responsible for the underperformance of its debt since the bout of market instability began.

Its $1.5 billion, 6.125 per cent sovereign bond maturing in 2022, rated BBB by Standard & Poor’s and Fitch Ratings, is bid at a yield of 5.80 per cent, its highest level since last August and up 133 basis points since the end of May.

In contrast, yields on Middle East sovereign bonds have risen 28 bps on average since the start of this month, according to the HSBC Nasdaq Dubai Middle East Conventional Sovereign US Dollar Bond Index.

Bahrain has underperformed countries such as Turkey, which is in the middle of its biggest political crisis in a decade.

The yield on Turkey’s $1 billion sovereign bond maturing in 2022 is up 107 bps since end-May.

Behind the concern about Bahrain is its rising state budget deficit; in May the International Monetary Fund forecast a fiscal shortfall of 4.2 per cent of gross domestic product or roughly $1.2 billion this year, up from the 2.6 per cent deficit reported by the Bahraini government for 2012.

While many investors were willing to ignore the political risk just a few months ago as they searched for yield in a global environment of loose liquidity and falling interest rates, they may become less willing against a background of rising rates.

The long-term economic outlook may be more of a concern than the political outlook, because trends in oil prices and government spending appear to be moving the wrong way for Bahrain. It needs to spend heavily to support the economy during the unrest, but its small oil reserves are expensive to exploit.

Moody’s Investors Service cited these trends last Thursday when it put its Baa1 rating of Bahrain on review for a possible downgrade, with the result to be announced in three months.