Dirham bonds key to UAE’s monetary, fiscal policy goals

The UAE’s recently launched dirham denominated government bonds (treasury bonds) is a major progress in the debt capital market development in the country and will be a key tool in achieving both monetary and fiscal policy goals.

Clearly, dirham bonds give government a new domestic funding source to tap into, if needed. From a fiscal standpoint, this would help it diversify sources of funding and reduce reliance on bank financing, external borrowing or drawdowns from reserves in times of fiscal squeeze.

Domestic government debt issuance could help develop an active domestic corporate bond market and interbank repo market.

While availability of local currency denominated government bonds would provide a useful pricing benchmark for other debt issuers in the market, corporate debt issuances would give firms an opportunity to diversify their finances away from usual sources such as bank funding and external borrowings.

As the market develops, smaller companies could follow larger ones in issuing debt. Finally, developing the domestic debt market could attract more foreign investments that could further stimulate domestic economy.

Policy transmission

The local currency bond market has a critical role in achieving the monetary policy goals through active liquidity management. Over the years, the Central Bank of UAE (CBUAE) had been consolidating its framework with a view to keeping money market rates in line with those implied by the currency’s peg through instruments such as certificate-of-deposits and Monetary Bills.

The issuance of dirham bonds with varying maturities is a step forward in providing an active tool for liquidity management and market driven pricing and distribution of funding.

In a typically banks-dominated credit market, government related entities (GREs) and larger corporates tend to corner a big chunk of credit as banks opt for lower risks. With the availability of longer term funding through bonds priced competitively, GREs and large firms have a new funding source, giving more access to lower-rated firms to bank credit.

With the US Federal Reserve normalising interest rates, funding costs for UAE banks will increase as domestic deposit rates and cost of external funding rise.

Clearly, an active local currency bond market gives CBUAE and banks the flexibility of managing liquidity by conducting open market operations [buying and selling of these bonds by CBUAE] and trading of these instruments in the interbank repo market.