FOR Gulf Arab industrial projects in search of financing, there has rarely been a better time to borrow than the present. International banks are queuing up to lend for eight years or more to a region once regarded as a serious political risk. At the same time, the cost of borrowing has fallen sharply.

An early beneficiary of the trend was Equate, a petrochemicals plant set up by Union Carbide of the US and two Kuwaiti companies. Equate raised $1,200 million from banks in 1995 to pay for its construction costs, at an interest rate of 162.5 basis points (bp) over Libor during the construction period and 187.5 bp thereafter. Now, bankers say, Equate is planning a refinancing which could secure an interest rate as low as 80 bp over Libor.

A similar case is the Saudi Petrochemical Company (Sadaf), which raised $700 million in project finance in 1995 at 124 bp over Libor. Sadaf reduced this to 85 bp through a refinancing last year, and bankers say another borrowing this year could cut it to as low as 50 bp.

The main reason for this dramatic fall in pricing is that a long period of low interest rates in the industrialised countries has created a huge pool of liquid funds, slopping round the world's financial markets in search of higher yields. At the same time, the Gulf is seen as a less risky place to lend to than in the past.

It is six years since Iraq's armies were driven out of Kuwait and most international bankers do not see any major threats to regional stability on the horizon, though relations between the US, Iran and Iraq remain tense and there are rumblings of political dissent within some Gulf Arab states.

The trend is welcome for the Gulf Arab countries, whose governments are trying to cut back public spending and get the private sector to pay more of the costs of economic growth. Joint ventures from the region - often from the petrochemicals industry - are frequent visitors to banks for financing, and borrowers are willing to make concessions to attract international lenders. The Sadaf financing, for example, was made subject to English rather than Saudi law.

Nonetheless, borrowers are increasingly in a position to divide and rule their lenders. Bankers say that the sponsors of another Saudi chemicals project have instructed the banks arranging the financing not to talk to each other privately about what the pricing of the loans should be, on pain of being thrown out of the arranging group. Some people believe, however, that interest margins cannot fall much further. 'It won't be long before we get to the bottom of the pricing, and before some banks get to the bottom of their country limits,' says one Western banker.

There is another new factor putting pressure on the banks - the bond market. The success of a $1,200 million bond issue earlier this year by Qatar's Rasgas, a natural gas export project, has shown that money managers in the US and elsewhere are now confident about taking on the risk of putting their money into the Gulf for long periods. The size of the bond issue was tripled from an original $400 million, taking away a big chunk of the total $2,400 million cost of the project which was to have been provided by commercial banks and export credit agencies.

'The banks were very upset, and it was not unreasonable to be upset because the bond exercise was attempted while the deal was fully underwritten [by the banks]. The banks were not compensated throughout the underwriting period,' says Nureddin Farrag, the chief executive of the Arab Petroleum Investments Corporation (Apicorp). Owned by a number of Arab governments, Apicorp is a major player in project finance in the Gulf (see page 36).

Farrag expects banks to learn from the Rasgas experience and insist on knowing in advance whether a bond issue is planned and if so, how large it will be. This appears to be the case for another gas project, Oman LNG, which has set a maximum limit of $500 million for its forthcoming bond issue, out of total financing costs of $2,000 million. With at least one more project-related bond due out this year - a refinancing for a private power plant in Oman - bonds seem to be joining commercial loans and export credit agency funding as a staple ingredient in the project finance mix.

However, future bonds are more likely to come from the less wealthy GCC countries - Oman, Qatar and Bahrain - than from their richer neighbours where there is more liquidity in the local banking sector and governments are less comfortable with the levels of public disclosure that a bond issue requires.

Simon Eyers led the Rasgas deal for its lead manager, Goldman Sachs, before moving to CS First Boston - a co-lead manager on the issue - to head its project finance department. He believes that there will be strong demand for project finance bonds for some time to come from US money managers who want high yields and diversified portfolios.

'The net effect of project finance having been discovered as an asset class is that people decide that half a percent or 1 per cent of their portfolio should be in project finance bonds. There's far more money looking to be invested than there are bonds, so that demand will be there for a long time, regardless of what happens to interest rates,' he says.

Competition from the bond markets should also be a good thing for borrowers because it will compel the commercial banks to improve their service, Eyers adds. 'Ras Laffan really shook up people's complacency. Banks are now offering terms and a speed of execution that is dramatically better than it used to be.'