The prolonged period of low oil prices has put a strain on government budgets across the region, exposing the dependence that GCC economies have on oil revenues. This development over the past 18 months indicates that there are challenging times ahead for GCC countries. To address that there is an urgent need to transition from the over reliance on income from crude oil to a more diversified economic model.
Consequently, this period has encouraged GCC governments to accelerate initiatives to implement economic reforms and exercise greater budgetary discipline. Moreover, the current climate has channelled GCC issuers tap into the bond market to address the growing requirement for additional funds. Although fiscal and economic reforms are lengthy processes, GCC markets have seen a significant surge in bond and sukuk issuances over the past year. Indicative signs of what lies ahead was visible during the first six months of 2016 (first half of 2016), when GCC bond issuances totalled approximately $39 billion (Dh143 billion) (including Sukuks) — almost 15 per cent of the total outstanding amount of bonds as of June 30, 2016. It is interesting to note that the amount of bonds issuances (excluding short term) in the first half of 2016 by GCC issuers is almost equal to the amount they issued during 2015.
Sovereign issuances have recently dominated the GCC bond market with a total of $20 billion, or 51 per cent of total bonds issued in 1H 2016. While the end of 2015 saw a $2.1bn issue of 5-year and 10-year bonds by the Bahrain Government, new records are being set in 2016 for big sovereign issuances from the region.
Yield-thirsty fixed income investors have been holding out for high-grade GCC sovereign bond issuances for a long time, and they have come at an opportune time to meet investor appetite. In 2016, the most prominent issuances have been the $5 billion bond by the Abu Dhabi Government in April; $9 billion by the Qatar Government in May; and $3 billion by the Oman Government in June. All of these issuances were oversubscribed by the investors and are currently trading at tighter spreads over benchmark Treasury yields than the issued levels, which reflect investor interest in GCC sovereign bonds.
However, the supply of GCC bonds is expected to continue to grow in order to meet budget deficits, which would increase risk premium and consequently widen the spreads on these bonds. Two of the major issuances expected in the coming months from the region are by the governments of Saudi Arabia and Kuwait, which have already hired lead managers to tap the bond market. Going by recent trends, the size of budget deficits, and investor appetite, the total bond issuance by the Saudi Arabian and Kuwaiti governments in the coming months could exceed more than $20 billion.
GCC bond market in a nutshell
As of 30 June 2016, the total outstanding bonds issued by GCC entities are approximately $263 billion. Interestingly; the overall market composition is equally distributed between sovereign, banking and other corporate issuers. However, the noteworthy characteristic of the GCC bond market is the significant number of government related corporate/banking sector issuers that have their credit quality directly linked to the government’s rating. This makes the GCC bond issuances sync with the financing requirements of the government; or more fittingly, in sync with the oil prices.
Issuers in the UAE represent about 45 per cent of the total outstanding GCC bond market and are at the forefront of bond issuances in the region followed by the issuers in Qatar (26 per cent), Saudi Arabia (15 per cent), Bahrain (8 per cent), Oman (4 per cent) and Kuwait (2 per cent). However, in the UAE, the bond market composition is largely composed of banking and financial services issuers, who constitute almost half of the UAE’s outstanding bond issuance. This is an expected market characteristic given the prominence that the UAE has achieved as a financial hub for the GCC.
Bond market presents a good opportunity to GCC Issuers
Despite the high levels of expected supply, GCC bonds receive strong bids from investors in primary as well as secondary markets. This reflects investors search for better yields in the current low interest rate environment as well as the strong credit quality of GCC issuers (given that the UAE, Qatar and Kuwait are AA rated economies and Saudi Arabia is rated A).
In prior years, high oil revenues ensured low debt levels and high reserves for the GCC governments; however, the situation has recently changed dramatically and will continue to do so. The silver lining is the prevailing low interest rate environment, which provides a great opportunity to take on debt at very low fixed rates and secure this borrowing cost for a longer term. In this context, issuing bonds would be the least expensive way of fund raising. It would also facilitate the development of a robust debt capital market for the GCC issuers with strong liquidity and availability of benchmark yield-curve. It is worth noting that the GCC bond market is only 16 per cent of the region’s overall GDP and thus offers enough scope for fund raising via bond issuance. Notwithstanding the fact that the growing leverage will lead to increase in the risk premium, it makes a good financial sense for GCC issuers to capitalise on the bond market amid the current low interest rate environment.
Deepak Mutha, CFA, member of CFA Society Bahrain