As governments across the Middle East and North Africa (Mena) region plan to run deficits, and large companies face lower banking sector liquidity, 2016 is set to be a strong year for conventional bond issuance.

Issuance in 2015 has been lower than usual as the region adjusts to lower oil prices.

From the investors’ perspective, bonds are providing a safe haven as equity and real estate markets are hit by volatility and continuing falls.

Economic headwinds and low levels of liquidity could still make issuing debt difficult.

The price of borrowing is going up for bonds as well as bank debt. With banks both the main buyers and issuers of bonds in the Middle East, the difficult outlook they face is likely to continue pushing up pricing.

Some companies may just rethink their spending, postponing plans to raise funds as economic growth in the GCC slows.

The final weeks of 2015 are expected to be quiet, as books are closed and issuers and investors wait for government policy responses to  lower oil prices to become clear. But a pick-up is expected in early 2016.

Government issuances

Many GCC governments have publically confirmed plans to issue debt on domestic and international markets. They are expected to run a combined deficit of 12.6 per cent of GDP in 2016, according to the Washington-based IMF, while the entire Mena fiscal deficit is projected at 10.1 per cent of GDP.

“With the budget deficits governments are likely to face, over the next five or ten years there’s a very significant opportunity for growth,” says Mohieddin Kronfol, chief investment officer for global sukuk (Islamic bonds) and Mena fixed-income at the US’ Franklin Templeton Investments.

“We expect sovereigns to issue more debt, with different reasons for each one.”

But this increase in public and international debt issuance has been slow to materialise.

Aside from protecting reserves and key spending by financing deficits, a regular programme of sovereign bond issuance would help develop debt markets in the region. Government bonds provide a yield curve to better price other issuances.

“From a policy perspective we think all of them should be moving much more aggressively to develop their local domestic money and bond markets because they need that to have more stable, more effective financial markets,” says Kronfol.

“One of the shortcomings in our region is that you don’t have sufficiently developed debt capital markets; this is a negative the entire region suffers from, especially in times of stress.”

Government-related entities such as utilities and oil and petroleum companies are also major issuers. They have tended to look to bank debt this year, but some refinancing is inevitable. Spreads are widening significantly, so issuances and reissuances will mean taking a hit on price.

Corporate bonds

Corporate bond issuance also slowed in 2015, although a flurry of transactions is expected in early 2016.

This was caused by companies taking their last opportunity to borrow cheaply from banks, as well as uncertainty over future plans given lower oil prices and weaker economic growth.

“The liquidity squeeze has meant recent pricing has been higher, and is also having a delaying effect on transactions,” says Steven Drake, partner and head of capital markets advisory at the UK’s PwC.

“Lower oil prices and more cautious expectations are having some impact as investors are now keeping their cash.”

International investors are also looking at oil prices, while global liquidity is falling. They tend to make up about a third of investors in major issuances.

Banks remain the primary debt issuers in the Middle East. They are being pushed to access debt markets by incoming Basel III tier one capital requirements and falling deposits. The lenders are already finding their debt more expensive, leading one – Abu Dhabi Commercial Bank – to pull a benchmark bond.

“Pricing for banks has widened a little, but it is still fairly competitive,” says Kronfol. “It has gone from 100 basis points over Libor [London inter-bank offered rate] to 120 or 140. This is entirely consistent with widening investment grade spreads globally, so the headwind is the price of credit internationally.”

The expected US Federal Reserve interest rates rise in December will push pricing up further, but is not expected to hit the Middle East especially hard.

Other sectors have seen their pricing rise significantly, especially those connected to the oil and gas sector.

Liquidity challenge

The fact that banks are also the main buyers presents a liquidity challenge, although the sector in general remains healthy.

“One challenge is that there is not much depth and diversity to the investor base,” says Kronfol. ”Banks still dominate, and we have too little in the way of insurance companies, pension funds and non-bank financial investors. This means bond markets are heavily influenced by the health of that one buyer.”

GCC banking sector liquidity is expected to tighten further in 2016. More companies may turn to Islamic fixed-income finance to tap liquidity in this segment.

“Sukuk are in a slightly different situation,” says Drake. “Islamic investors are only able to invest in Islamic products, so there is more liquidity there and possibly more attractive pricing for issuers.”

The pipeline of companies readying issuances for early 2016, both conventional and Islamic, is strong. But they might not go to market if issuers are unhappy with appetite and pricing.

The main factor in investor confidence will be governments’ policy responses to economic headwinds. Otherwise, this market, which in 2015 has been stable and seen steady returns, could become more volatile.