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Gulf looks to bonds to brigdge funding gap

One lesson Gulf sovereigns and corporates have learned from the financial crisis is that they must diversify their funding sources to better manage their debt maturities effectively.

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 This realisation has prompted most regional governments to take initiatives in recent months to create markets for debt instruments of various maturities.

Discussions are already progressing at the highest levels of policymaking to set up active markets for issuance in both local and foreign currencies.

Over-reliance on short-term syndicated loan markets to fund long-term projects has been one of the main causes of financial troubles that Gulf governments and companies have faced recently. A sustainable solution to the problem lies only in finding long-term funding sources, say experts.

“For the GCC economies, and the rest of the Middle East, the hydrocarbon wealth provides a nearly unmatched level of long-term financial stability. However, it is in our interest to develop … a mature bond market to protect [against] external vulnerabilities,” says Dr Omar Bin Sulaiman, Governor, Dubai International Financial Centre (DIFC) and Vice-Chairman, UAE Central Bank.

Historically, the region overlooked the option of developing debt capital markets, as governments were surplus savers and net capital exporters. However, with heavy investment in infrastructure development and diversifying away from dependence on oil revenue, debt financing is emerging as a key component in managing those projects against future oil incomes.

“There is nothing unusual about deficit financing by governments and leveraged investments by corporations. But the key lies in managing the maturities of these debts. It is imperative that longer term projects should have longer maturity debt financing,” says Masood Ahmed, Regional Director, International Monetary Fund, Middle East and Central Asia.

Nearly $50 billion (Dh183.7 billion) worth of refinancing or loan redemptions are due from Gulf borrowers over the next year. The GCC has been the largest borrower from the banking market in the Middle East and North Africa (Mena) region. The overall reluctance of banks to lend long-term or roll over credit on existing terms is resulting in higher refinancing costs for most borrowers.

“The region has been excessively dependent on bank funds for projects. Banks have relatively short-term resources, and when these are deployed long-term it is likely to cause asset-liability mismatches. In a crisis situation like the one we faced last year, banks tend to cut short the credit lines of long-term projects,” says Dr Nasser Saidi, Chief Economist, DIFC Authority.

The migration of Gulf borrowers from bank lending to debt capital markets is, according to experts, becoming more systemic rather than a temporary deviation from their traditional borrowing mix.

The practice of name-lending to family-owned businesses in the region has received a big setback due to the huge corporate scandals such as that involving Saudi Arabia’s Saad and Alghosaibi Groups, which together left a trail of $15 billion in non-performing loans on the books of nearly a dozen regional and international banks.

Viable route

Analysts say many firms will consequently be forced to look at capital markets as an alternative. With equity markets yet to recover from the slump, corporate bond issues are seen as the only viable route.

For governments and semi-government entities too, bank financing is becoming more difficult. “Despite the substantial injection of liquidity into the banking system, lending across the world continues to be shrinking. In this context, Gulf central banks and governments should move fast to set up active bond markets,” says Mustafa Azia Ata, Director, Global Capital Markets of HSBC.

Infrastructure spending by Gulf countries is expected to reach $205 billion by 2013, according to latest estimates by Standard Chartered Bank. Saudi Arabia alone accounts for more than 50 per cent of regional infrastructure spending, with $105 billion in investments planned in projects such as hospitals, roads, railways and airports.

“In the Gulf region infrastructure largely falls under the regional government’s fiscal expansionary spending. In Dubai, for example, the state budget has set aside close to 40 per cent for expansion and development of the transportation network,” said David Barclay, an analyst with Standard Chartered.

Despite short-term cashflow issues with some governments and government-related entities (GREs), there has never been any serious doubt as to Gulf governments’ ability to fund projects.

Analysts and bankers do not foresee a default situation arising. According to various estimates, Dubai has $40-$46 billion of debt obligations maturing between now and the middle of 2013. The repayment burden is heaviest in 2011, when $23 billion matures. The largest maturities over the period are: Nakheel’s $3.52 billion 2009 bond; Ports, Customs and Free Zone World’s $6.8 billion 2011 loan; Investment Corporation of Dubai’s $4 billion 2011 loan.

Concerns about Dubai’s ability to service its debt obligations, which peaked in February when the sovereign five-year credit default swap (CDS) was trading at close to 1,000 basis points (bps), have eased considerably following the $10 billion bond taken up by the UAE central bank. “We have a positive view of the ‘one-country’ approach adopted within the UAE, and we expect further funding for Dubai,” says Victor Lohle, an analyst with Standard Chartered.

Inherent strength

“The huge oil wealth of the Gulf states will keep their financial systems in good health, and the aftermath of the global financial crisis has once again proved the inherent strength of Gulf economies,” says Dr Bin Sulaiman.

According to Institute of International Finance estimates, the GCC’s foreign liabilities have increased from $300 billion in 2006 to a forecast $485 billion in 2009, while the region’s foreign assets have kept pace, rising from $1.03 trillion to $1.49 trillion.

Saudi Arabia’s asset position is the most robust relative to its external debt, with an assets-to-debt ratio of 12 times, followed by Kuwait with eight times and the UAE with three times.

The IMF estimates that the Gulf’s external reserves will improve by more than $100 billion in 2010, as oil prices rebound. Assuming an oil price of $50, a recent DIFC study estimates the oil and gas reserves of the six GCC countries at $18.3 trillion. If oil prices were to average $100 per barrel and gas $15 (oil-equivalent), the value of GCC energy reserves would be $37.7 trillion.

The IMF’s Ahmed believes that the recent efforts by the regional governments, central banks and financial centres such as the DIFC to create a debt capital market are steps in the right direction to suit the fiscal and monetary management needs of the region in the longer term. “In the macroeconomic context, debt markets provide the most powerful tool in both monetary and fiscal management of economies. At micro level, a mix of funding sources such as debts of various maturities evens out the cyclical fluctuations in the capital markets,” he says.

Recent initiatives by regional governments are already showing results. Abu Dhabi made the first move in April this year by announcing its sovereign bond programme, and the pricing has substantially eased ever since. The emirate and its various GREs have issued more than $12 billion worth of bonds in 2009. According to bankers, various sovereign and quasi-sovereign issues have attracted orders of $56 billion in bids, signalling a growing appetite for Gulf debt issues.

Bankers and analysts agree that a positive market response to the sale of government debt — and the generation of a benchmark yield curve — could prompt a flurry of corporate bond issuance.

“Over the past few months the CDS of Abu Dhabi, Qatar and Saudi Arabia have stabilised below 100 [bps] levels, and Dubai’s CDS is below 300 compared to its peak above 900 in the first quarter of this year. With risk-appetite improving, and oil prices stabilising above $60, global investors are keen to take exposure in the regional bond issues,” said HSBC’s Ata.

Currently there is about $110 billion of outstanding sovereign and corporate bonds in the Gulf, the majority having been issued by governments and financial institutions. That amounts to only about a tenth of the region’s gross domestic product, leaving huge potential for future issues.

Armed with top ratings, most Gulf governments and GREs are better positioned to issue bonds. In many cases those issues are targeted at providing the much-needed benchmark yield that government companies can eventually use to improve pricing.

In recent months regional issuance of sukuk (Islamic bonds) too have picked up pace. The value of sukuk issued rose 82 per cent in the third quarter. Data from’s Sukuk Monitor shows the value of Islamic bonds issued worldwide in that period rose to $6.2 billion, from $3.4 billion for the same quarter of 2008, while primary sukuk issued out of the Mena region accounted for 59 per cent of the total volume of global sukuk.

Well received

Recent sukuk issues such as Islamic Development Bank’s (IDB) $850 million, Abu Dhabi National Energy Company’s (TAQA) $1.5 billion, and the $1 billion for Abu Dhabi’s Tourism Development and Investment Co (TDIC), were well received by global investors.

TDIC’s five-year sukuk was priced at 230 basis points over mid-swaps, and was almost seven times oversubscribed. By region, the distribution was 60 per cent to the Middle East and 20 per cent each to Asia and Europe. “This issue is further evidence of the re-opening of the sukuk market in 2009, and the strong international interest that sukuk are receiving from investors all over the world,” says Mohammed Dawood, Director, Debt Capital Markets, HSBC Amanah.

Although a large number of bonds and sukuk were issued in the Gulf pre-crisis, and now post-crisis the window is open again, secondary market trading across the region remains limited.

Saudi Arabia is trying to boost its secondary market, and launched an electronic trading platform for bonds on its stock exchange, the Tadawul, in June. It provides a number of services, including listing, order submission, trade execution, clearing and settlement and price dissemination, enabling investors to diversify their investments by buying and selling sukuk and bonds through existing brokerage firms.

Newfound enthusiasm

The tenors of Gulf debt issues are usually short and little is traded. Bankers expect the newfound enthusiasm in the bond market to push the development of a viable secondary market, where bonds are actively traded, while creating a market for issues with varying maturities.

DIFC and Nasdaq Dubai have initiated efforts to list as many as possible of both conventional and Islamic bond issues and create an active secondary market for regional debt.

There have been notable developments within the past few weeks.

On October 22 the International Finance Corporation (IFC), an investing arm of the World Bank Group, listed its debut $100 million sukuk on Nasdaq Dubai. “We have plans … to fund various development and infrastructure projects we are supporting in the region, [and] intend to tap the market at regular intervals of 12 to 18 months,” said IFC treasurer Nina Shapiro.

“The IFC issue will serve as a benchmark for future sukuk issues by the international agencies and corporations,” said Jeff Singer, Nasdaq Dubai’s CEO.

Then, On October 28, the government of Dubai sold $1.25 billion in dollar-denominated bonds and Dh2.5 billion worth of Islamic bonds in a five-year debt offer. It is not part of the $20 billion bond programme the government had announced earlier this year, but is perceived as a bold step towards lowering risk premiums and creating a benchmark for government-related entities, banks and private sector firms intending to raise money from the bond market.