Capital markets to play bigger role in GCC project financing

Dubai: Fiscal pressures exerted by low oil price are expected to increase the role of private sector and capital markets in the financing of hundreds of billions worth of project financing in the GCC countries according to analysts and investment bankers.

Based on Zawya data, rating agency, Standard & Poor’s estimate that $604 billion (Dh2.2 trillion) worth of project contracts need funding through 2019. Assuming there are no further cancellations, reprioritisations, or deferrals of projects through 2019, the rating agency expects $140 billion-$160 billion in contract awards per year. The countries awarding the most projects will be Saudi Arabia, the UAE, Kuwait and Qatar.

Among Saudi Arabia’s key projects in pre-execution are the $15 billion Al Mozaini Riyadh East Sub Centre, a mixed-use commercial, retail, and residential high-density development for Riyadh. In the city of Mecca, a $8 billion project for metro lines B and C is to be awarded to help transport pilgrims around the city.

In the UAE, the largest project is Dubai World Central, the extension of Al Maktoum International Airport, currently budgeted at $32 billion. Another huge project in the Emirates is in Abu Dhabi, the Al Gharbia Chemicals Industrial City, planned at $20 billion. Plus, Dubai is pressing ahead with key projects ahead of the Expo 2020.

Shrinking banking sector liquidity

Qatar’s largest projects are in pre-execution phase and involve QRail, which in turn is looking to connect Qatar to neighbouring countries ahead of the World Cup. Kuwait’s largest projects in pre-execution, refinery projects, are all related to Kuwait National Petroleum Co.

Out of the projects planned and under way in 2016 of $140 billion, about 48 per cent involve real estate; oil and gas, 17 per cent; and infrastructure, 17 per cent.

Shrinking banking sector liquidity and rising rates are expected to increase cost of bank funding for projects across the GCC.

“Overall bank liquidity in the Gulf region started to weaken visibly in the second half of 2015, and we expect a similar trend this year. Gulf banks traditionally generate the bulk of their funding from locally raised deposits, and GREs [government related entities] are important depositors in these markets. Given lower energy prices, we have seen erosion in this segment, which triggered a slowdown in the growth of local deposit markets in 2015, particularly in the UAE and Qatar,” said Standard & Poor’s credit analyst Karim Nassif.

Although Gulf banks operate with healthy liquidity pools, given the slowdown in deposit generation, the amount available to them is gradually eroding. As a result of the gradually eroding liquidity conditions, local interest rates such as the EIBOR [Emirates Interbank Offered Rate] and SAIBOR [Saudi Interbank Offered Rate] have been climbing in 2015. Analysts expect a relatively similar picture in 2016 and 2017.

More selective

“Given our expectations for continued weakness in deposit growth, we believe banks will be more selective in their balance sheet allocations, particularly toward longer-tenor lending facilities, and we generally expect the cost of bank borrowing to increase in the Gulf,” said Nassif

With bank funding becoming more expensive, alternatives like the capital markets may become more attractive. However, because domestic banks historically have generated the bulk of the Gulf economies’ credit requirements, the debt capital markets are at a nascent stage. The rising interest rates and a repricing of corporate and infrastructure fixed-income risk in the Gulf is narrowing the arbitrage gap between bank and bond borrowing, which may also support increased capital market activity in the region.

Factbox: Public private partnerships to gain traction

Declining liquidity in the banking sector and the rising cost of funding are expected to increase the participation of private sector in the implementation of key infrastructure projects across the GCC countries.

“We see them [projects] turning to alternative means of funding such as public private partnerships (PPPs). The concept isn’t entirely new in the Gulf, where it is established for power and water, and which could be a model for other sectors. Plus, we see that governments are starting to pave the way for this sector to grow,” said Standard & Poor’s credit analyst Karim Nassif.

In Kuwait, the country introduced a new PPP law in March 2015, following by one in November in Dubai. Both countries previously had PPP frameworks in place that the market, especially Sharia-compliant banks, considered too restrictive.

Dubai has paved the way for PPPs to become an important part of its energy plans. The Emirate updated its PPP law to allow a framework to be put in place in sectors other than just power and water. Such plans include Dewa’s PPP solar schemes, coming on the heels of plans by Dubai’s Supreme Energy Council (with the support of Dewa) to diversify the Emirates’ energy mix so that 7 per cent of demand is by renewable sources by 2020.

Potential for PPPs

While Oman is preparing regulations to enable the use of PPPs to develop major infrastructure and housing projects, in Qatar, the potential for PPPs is significant, considering its $125 billion infrastructure investment programme to support its National Vision 2030 economic development plan.

Saudi Arabia’s aviation sector set a regional precedent by using a PPP for the development of the $1.2 billion Prince Mohammed bin Abdulaziz airport in Medina. The Kingdom is now pre-qualifying developers and investors for a second airport PPP in Taif.

“Given the gap between the Gulf’s huge infrastructure capital needs and the ability and willingness of sovereigns to continue to foot most of the bill, as well as their moves to develop PPPs in their countries, we believe that the private sector and the capital markets will be playing a larger role this year and years to come,” said Nassif.