Dubai: Saudi Arabia’s initial jumbo $17.5 billion (Dh64.2 billion) sovereign bond will provide vital funding relief for the economy. With domestic funding sources stretched, it should deliver some short-term relief to the banking sector from tightening liquidity conditions.
“We expect a significant portion of the funds raised to be placed as deposits in the domestic banking system. We also expect to see a rise in the net foreign assets (NFAs) of the Saudi Arabian Monetary Agency (SAMA), reflecting the issuance,” said Monica Malik, Chief Economist of Abu Dhabi Commercial Bank.
Analysts expect the kingdom to tap the foreign capital markets in the future which should ease its foreign exchange reserve position and reduce concerns over the sustainability of the SAR’s peg to the dollar.
“We expect that the monthly drawdowns from Saudi Arabia Monetary Agency’s (SAMA’s) foreign exchange reserve will slow to an average $3-3.5 billion per month in 2017, down from $6.8 billion per month in August 2016,” said Malik
Payment delays
On the growth front, there is likely to be an increase in the government’s payment of arrears, supported by this issuance. This comes after signs of increased payment delays in the third quarter and of a further weakening in economic activity.
The bond issue comes at a time when Saudi banks have been facing liquidity challenges. The loan-to-deposit ratio has risen as the government has increased borrowing from the banking sector and utilised its deposits. As such, system-wide deposits have fallen, while credit growth has remained relatively strong. The Saudi government started issuing SAR-denominated bonds to government agencies and local banks in July 2015.
With domestic funding sources stretched, international bond issuance is vital for reducing short-term liquidity constraints. Analysts expect to see further external government debt issuance in the medium term, with the October bond issuance providing temporary respite.
Experts say government’s decision to seek substantial external funding to fill the budget gap will reduce pressure on domestic liquidity. “Increased reliance on external sources of funding will reduce the possibility of crowding out the private sector borrowers. In addition, it is smart move to tap the external markets, when the interest rates are still relatively low,” said Masoud Ahmad, Director, Middle East and Central Asia Department of the IMF.
Declining liquidity
Compared to many GCC peers, despite the domestic bond issues, the decline in the Saudi Arabian government’s share of system deposits is relatively small. “We believe this could be because of the use of foreign reserves rather than domestic deposits. Still, overnight interest rates have started to increase, reflecting declining liquidity, particularly in Saudi Arabia and the UA. The three-month Saudi Arabia Interbank Offered Rate increased 2.4 times and the Emirates Interbank Offered Rate by about 86 per cent between the start of 2015 and early September 2016,” said Benjamin J Young, an analyst at Standard & Poors.
Saudi Arabia still faces a number of medium- to long-term challenges. Despite the country’s deep financial retrenchment programme in 2016, the overall value of fiscal reforms has been relatively small compared to the size of overall spending. This partly reflects the sharp increase in spending over the last decade. The overall financing picture points to a greater deficit than implied by the fiscal data and could warrant greater financing needs.
