The regional debt markets have been a source of financing which governments and corporations are increasingly turning towards in order to fill their financial shortfalls. According to Bloomberg, there is currently $125 billion foreign issued government debt outstanding from the GCC, with $54.5 billion having been issued so far in 2016. With Saudi Arabia’s largest emerging market debt issuance of $17.5 in October this year, it is clear that there is significant investor appetite for GCC issued debt. Michael Grifferty, the president of the Gulf Bond and Sukuk Association (GBSA), noted that the GCC is starting to firmly establish itself among other emerging markets due to its foreign issuances and the development of its regional bond market.
To develop regional debt markets, the most important short-term goal is establishing government bond yield curves for each country in the GCC. In order to accomplish this, governments must regularly issue short duration and long duration debt, which adds liquidity and enables issuers, as well as investors, to accurately value and price debt. With GCC countries expected to have a 10.4% fiscal deficit in 2016 (according to the World Bank), governments are deeply aware of the need to regularly issue debt.
Over the medium-term, the Gulf needs to develop a local currency debt market and deepen the current dollar denominated debt market. The GCC, similar to other emerging markets, must progressively supplement its foreign borrowing with more local borrowing. In order to develop a liquid local debt market, governments start with short duration debt and progressively issue longer duration debt at a market rate on a regular basis. This helps pave the way for corporations to have a market to issue local debt to. Establishing a local debt market is vital for efficiently allocating investor capital, managing foreign exchange risk and ensuring corporations can borrow efficiently.
Corporations still primarily utilise bank financing to raise capital, as it tends to be less expensive, slightly more flexible and easier to access. However, with Central Bank regulations in the GCC, there are increasing restrictions on banks and the amount they can lend to individual institutions. At present, there is a perception that the time required to issue bonds is long and that the issuance costs are high. Moreover, secondary trading in GCC issued bonds and sukuk is somewhat restrained as a large portion of bonds are bought by banks who tend to hold to maturity. This lower liquidity makes the bonds less attractive to investors, which is one likely reason that the bonds trade at higher yields than other similarly rated emerging market debt.
There are a few key objectives that will significantly improve the GCC debt market. The GBSA is currently working with regulators to streamline the process and reduce the administrative and legal burden of issuing debt. Specifically, it is important to maintain the ability to privately place debt, as this lowers the regulatory burden and legal costs compared to publicly issued debt. Continuing to broaden the local and foreign investor base will enhance the depth and liquidity of the bond market. In most developed countries a large portion of corporate and government debt is purchased by pension funds and insurance companies. Currently, when employees leave a company, they are entitled to an end of service benefit and many firms do not necessarily set aside cash to fund this sizeable liability. If the GCC was to supplement this with private pension schemes, it would create institutions that are ideal long-term bond investors, as they need to match their long-term funding liabilities with long-term bond assets.
Overall, the fixed income market in the GCC is fairly positive; interest rates are attractive and there continues to be a global search for yield. With robust investor demand and fiscal deficits motivating GCC countries to develop debt markets, there is a strong trend in deepening the bond markets, which should ultimately lead to efficient capital allocation and stable economic growth.
Steven Downey, member of CFA Society Emirates
