Several GCC governments are planning to revive or increase their sovereign bond issuance programmes as lower oil prices and high spending on infrastructure and social services lead to budget deficits.

Following three years, when $100-plus oil allowed healthy surpluses and expansionary spending, a return to debt markets signals a significant shift in Gulf fiscal policy. Local and international banks welcome the move, and have consistently shown a strong appetite for GCC sovereign debt. More frequent issuance will stimulate debt markets and establish a yield curve, clarifying pricing for lenders.

Saudi Arabia, the world’s largest oil exporter, is expected to run a budget deficit of $80bn-$106bn in 2015, according to Riyadh-based Jadwa Investments. The kingdom had drawn down on its external reserves by $64bn at the end of May 2015, leaving them at $672bn, down from a record high of $736bn in August 2014.

The government has spent a long time building up its assets, but how quickly should it draw them down

Paul Gamble, Fitch Ratings

To reduce the pressure on reserves, the Saudi government is expected to fund half its deficit by issuing sovereign bonds on the local market for the first time since 2007. This implies that between $40bn and $53bn of bonds could be sold, starting in the next three months, according to Jadwa figures.

Oman has already stepped up its government development bond programme in the first quarter of 2015, issuing $519m. It plans to sell about $1bn more of debt in 2015, on both the domestic and international markets, but this could change depending on how Oman decides to fund its deficit, which could be more than the projected $6.5bn. The next issuance is rumoured to be a $779m sovereign sukuk (Islamic bond), the first for the sultanate.

Only Bahrain has a regular programme of debt issuance that fully develops the yield curve. This programme is expected to accelerate in 2015 as Manama maintains its high spending.

Kuwait, Qatar and the UAE have either smaller populations or higher oil revenues, and their reserves will easily cover their high infrastructure spending plans. Analysts expect that any sovereign bond issuances will be small and aimed at establishing debt markets in the longer term.

Saudi Arabia bonds

For Riyadh, the decision to issue bonds is strategic and still under discussion.

“The question is on the asset side,” says Paul Gamble, senior director, sovereign group at London-based Fitch Ratings. “The government has spent a long time building up its assets, but how quickly should it draw them down, and what for?”

Saudi Arabia has more than $1.2 trillion of infrastructure projects in the pipeline, important investments that will allow it to diversify its economy and improve living standards. The focus areas are manufacturing, transport, housing and electricity.

“During the earlier low oil price period in 2009, the government used reserves,” says Fahad Al-Turki, chief economist and head of research at Jadwa Investments. “But this time, with the major development projects and commitments, it will go for debt to reduce the pressure on reserves.”

The bonds would be issued in regular auctions, allowing the central bank, Saudi Arabian Monetary Agency (Sama) to manage both the government deficit and banking sector liquidity.

Sovereign ratings
Country Fitch Moody’s Standard & Poor
Saudi Arabia AA Aa3 AA-
Oman Not publically rated A1 A-
Bahrain BBB- Baa3 BBB-
Source: MEED

Presently, the kingdom’s domestic banks have too much liquidity, with excess assets deposited in Sama. Combined sector deposits at the central bank stand at $27bn, according to Sama, and show no sign of falling.

The banks could, therefore, enthusiastically absorb the sudden issuance of $40bn or $50bn in sovereign bonds.

Sovereign bonds will offer better returns for local banks and mop up some of the excess liquidity without seriously affecting their ability to lend. However, the cost of lending on the Saudi market will rise slightly as the bonds soak up liquidity and competition to provide credit eases. Investing in low-risk, easily tradable government bonds will also help banks balance their assets and liabilities.

Sovereign bond issuances play an important role in building yield curves and helping banks price their own lending. An active debt market is also important for ratings.

“We have been calling for regular issuances for three or four years,” says Al-Turki. “The government should not retire debts, to deepen the yield curve. Lending costs are also lower than returns on reserves. Lower oil has put this into context, and hopefully policymakers will realise the benefits.”

When oil prices were high between 2010 and 2014, Saudi Arabia was paying off older debt as well as increasing spending. It is, therefore, starting from a position of low external debt, at 2.6 per cent of GDP in 2014. This could increase rapidly, as Riyadh is expected to run a fiscal deficit of 20 per cent of GDP in 2015, according to the IMF’s Article IV consultation report published in June.

Oman’s strong position

Oman, with its smaller economy and lower oil revenues, finds itself in a slightly different position. It has already issued a third of its projected $1.6bn of sovereign debt for 2015. The sultanate’s banks are less liquid and it plans to issue debt internationally before the end of the year. Banks are welcoming the issuance as a low-risk investment and an opportunity to develop yield curves.

Oman is starting from a strong position, with debt making up just 4.8 per cent of GDP in 2014, according to the Central Bank of Oman (CBO). This means any increases this year to fund a $6.5bn deficit, equivalent to 8 per cent of GDP, are sustainable.

Muscat is also planning to draw down on its assets by $1.8bn. The CBO’s net foreign assets stood at $16.1bn at the end of 2014. Meanwhile, total government assets stood at $62.3bn, or 80 per cent of GDP, in 2013, according to US-based Moody’s Investors Services.

“Oman is starting from a very low base,” says Gamble. “They have plenty of space to borrow and they are drawing down on assets too. There is a choice, to cut spending, issue debt or use their assets.”

However, the IMF has warned that Oman’s spending plans, which include a $100bn-plus infrastructure investment and current expenditure of $24.9bn a year, would raise government debt to 70 per cent of GDP by 2020.

It is also concerned that Oman’s 2015 deficit may reach 14.8 per cent of GDP due to this spending and lower-than-budgeted oil prices, suggesting that borrowing this year could be higher than expected.

With Oman and Saudi Arabia looking to debt markets to finance their deficits, analysts see the next step being regular issuances to manage yields and liquidity, rather than to satisfy immediate funding needs.

“Bahrain is a frequent issuer, so you have a very clear view of what the sovereign curve is for pricing. But Oman issues debt infrequently, so we don’t have that curve to reference for a longer-term view,” says an international banker working in the Middle East.

“If they become a regular issuer, they would build the curve for banks here, and a lot of people have appetite for Omani risk. The more transparency you get in the curve, the better for banks.”

Bahrain sophistication

As a marginal oil producer, Manama’s borrowing is more sophisticated than any other GCC country; it auctions bonds with a variety of maturities on a weekly basis, both conventional and Islamic.

The rolling programme of short-term bonds should keep about $5.8bn in domestic debt markets throughout 2015.

Bahrain’s domestic banking system, the longest-established in the region, has plenty of liquidity to keep the auctions well-oversubscribed. Manama is also experienced at tapping international bond markets, with periodic eurobond issuances, which tend to be more than $1bn.

Although on a global scale Bahrain’s debt levels are little cause for concern, it does have the highest debt in the GCC, and it is rapidly increasing.

Fitch forecasts a current account deficit of 10.9 per cent of GDP in 2015, while government debt is expected to reach 54.2 per cent in 2015 and 58.6 per cent in 2016, if spending trends continue. Bahrain has negative outlooks from both Standard & Poor’s and Moody’s, while Fitch downgraded its sovereign debt rating to BBB- in June.

Analysts warn that cuts will be necessary in the future to bring Bahrain’s spending in line with projected revenues. This will require some difficult decisions on social and infrastructure spending.

“We expect a fairly large deficit over the next few years,” says Gamble. “There are structural rigidities in the budget, such as the wage bill and subsidies, which are difficult to cut given the political context.”

Similar decisions also lie ahead for Muscat and Riyadh, albeit with less urgency.

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