Rating the Middle East for new capital flows

22 December 1995

The Middle East has long been a backwater for the world's ratings agencies. Only the Cyprus-based Capital Intelligence offered a comprehensive coverage of the financial institutions in the region, and sovereign ratings by the leading raters were limited to non-Arab countries, such as Turkey, Pakistan and Israel.

In 1995, the picture has been transformed. The US agencies Moody's Investors Services, Standard & Poor's (S&P) and Thomson Bankwatch, as well as the London-based IBCA have all begun expanding their coverage to include the region. So far, the focus is on the region's financial institutions, but sovereign ratings too will become a more common feature of the financial landscape as the appetite for international capital grows.

The latest international bond issue from the region, was Israel's Yankee bond, that is dollar-denominated paper sold in the US market. The issue raised $250 million and was three-times oversubscribed. It followed the upgrading of Israel's sovereign rating by Moody's and S&P into the A-category. A Yankee bond requires at least two ratings if it is to attract the US pension funds and institutional investors, and an A-category rating reduced the cost of the issue to Israel.

Investors in Eurobond issues, dollar denominated paper sold in the European market, are less demanding, and one rating is usually adequate. In the case of Lebanon even one rating proved unnecessary, after it successfully raised $700 million with two Eurobond issues. However, the success was largely assured by the high price the government was willing to pay, and perhaps more importantly many of the investors targeted were Lebanese who knew the local market.

'The issue is what you get by rating,' says Paul Raphael, managing director at Merrill Lynch (ML). His bank has advised the governments of Israel, Jordan and Tunisia in their approach to the rating agencies. In Lebanon's case a rating would have been superfluous, but for other countries a rating can be advantageous when 'the perception is worse than the reality,' he says.

Tunisia's macroeconomic achievements were underscored when the country achieved an investment grade rating from both Moody's and IBCA. Until now, Tunis has tapped only the samurai bond market, that is yen-denominated paper sold in Japan. But the US ratings will open a broader range of markets, enabling the country to diversify its commercial borrowing, which will also attract a higher international profile. Tunisia is now considering a US or European issue.

Jordan is the only other Arab country to receive a rating from the leading US raters, which indicates an intention to approach the international markets. 'The policy of ratings agencies is to attribute a rating to a specific issue, but it is acknowledged that a rating has other benefits,' says William Mendenhall, vice-president of the ratings advisory service at ML. One of those benefits is that ratings are closely followed by multinationals looking for direct investment opportunities.

Other Arab countries could soon follow the lead set by Jordan and Tunisia. 'Lebanon at some point will have to get rated as it looks for increasing amounts of capital for reconstruction,' says Raphael. Other candidates could be Morocco, Qatar and Oman.

However, the advantages of a rating for other Gulf countries are less clear. Few are ready to have their treasuries opened to public scrutiny, and countries such as Saudi Arabia, Kuwait and UAE can still find cheap funds through loan syndications arranged by close relationship banks.

Yet, for the rest of the Middle East a rating shows the commitment to an open economic policy that international investors demand. 'The mere act of submitting to the external discipline of rating - and it is a very public discipline - shows willingness to give more weight to that sort of financial prudence,' says Mendenhall. The raters are likely to become an increasingly important part of the Middle East's attempts to attract a greater share of international capital flows.

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