UAE sees shifts in its sovereign debt dynamics

11 October 2018
Higher hydrocarbons revenues have bolstered the UAE's coffers, reducing the immediate need for debt issuance to plug budget gaps

After a sustained period of tapping debt capital markets to raise funds as part of a mission to meet spending requirements in the context of low hydrocarbons revenues, the UAE government and its quasi-sovereign affiliates are scaling back their debt-raising activities this year.

The first half of 2018 saw just $1.3bn in sovereign fixed income raised – a figure dwarfed by the $14bn of corporate issuance emanating from the UAE, according to figures from Markaz Fixed Income Research.

The cause is simple enough. An increase in oil prices in 2018 has helped swell government coffers in Abu Dhabi, reducing the immediate need to plug budget gaps through external financing.

“Issuance is down a lot this year and the driver behind that is clearly that oil prices have picked up and we’ve seen a significant rise in hydrocarbons revenues, which should return the UAE consolidated budget to surplus this year,” says Thaddeus Best, a UAE-based analyst at Moody’s Investors Service.

According to the Institute of International Finance, a sizeable fiscal consolidation over the past three years should put the UAE’s fiscal stance on a more sustainable footing over the medium term. It sees the fiscal balance shifting from a deficit of 1.8 per cent in 2017 to a surplus of 1.7 per cent in 2018 as higher oil revenues more than offset the significant increase in government spending.

 

Stimulus package

The oil price revival has shifted the two largest emirates’ debt dynamics. Whereas Abu Dhabi and Dubai adopted quite different approaches in the post-oil-shock years – Abu Dhabi had a much tighter fiscal stance whereas Dubai was run on an expansionary fiscal policy running up to Expo 2020 – that could change with the announcement of the AED50bn ($13.6bn) stimulus package announced by Abu Dhabi in September.

“I expect the UAE to continue to issue paper and I see the stimulus programme that Abu Dhabi announced as something that could trigger additional requirements. You will continue to find issuers needing to fund their activities,” says Mohieddine Kronfol, chief investment officer of Global Sukuk and Mena fixed income at Franklin Templeton Investments.

Pace of issuance

While Abu Dhabi is unlikely to match the $10bn in sovereign debt issued in 2017, there are expectations that it could make further fund-raising moves before the year is out.

Dubai will also continue to need to tap the debt market, with the emirate expected to run a deficit between now and 2020 that will require funding. However, notes Moody’s Best, Dubai has typically funded itself through either domestic issuance or, where it has gone international, through export credit agencies – as with the Dubai Metro extension.

But even if the figures so far suggest relatively low levels of sovereign debt issuance from the UAE, this may not signal a major change in strategy.

“Funding is only one of the reason to issue,” says Kronfol. “There is also the advantage of building liquidity, supporting a yield curve and developing debt markets. So while the pace of issuance might come down, it should still remain robust and healthy.”

In any case, UAE debt issuance has not traditionally been led by the sovereign, although a number of government-related entities have issued paper over the years.

Since the UAE has a lower dependence on oil prices than other Gulf economies, analysts do not view the weaker oil revenues as necessarily the primary motivation for debt issuance.

Panda bond

Some of the new debt issuance will emanate from other emirates. Sharjah has already set an example, with a series of debt-raising moves under way. One of the more innovative measures came in February, when the government of Sharjah became the first Gulf sovereign issuer to tap the Chinese interbank bond market, issuing a RMB2bn ($318.4m) so-called Panda bond.

Sharjah is increasingly looking to the debt market to help fund its infrastructure spending commitments, and in March closed a book on a $1bn dollar-denominated sukuk (a form of Islamic debt security).

Issuing at federal level

There are also some potentially significant changes taking place at the federal level, which until now has never issued debt. All sovereign issuance has been at emirate level.  However, a draft law is under consideration that would introduce federal-level debt issuance.

Although the volume of spending at the federal level is small relative to the emirates’ spending, being able to issue debt could transform the fiscal dynamic in the UAE.

“It would be a very positive development to see the UAE set up a federal sovereign debt management office, and issue paper backed by all the emirates. It would be more efficient, and a good way of developing federal UAE agencies that now have revenues attached to them. It’s an important milestone for the UAE,” says Kronfol, who adds that issuing sovereign paper in local currency would be a real step forward.

Questions raised

While the long-delayed draft law might not signal a more fundamental shift in the fiscal structure of the UAE as a federation, it does raise interesting questions as to who is ultimately liable for the debt.

For example, if only Abu Dhabi and Dubai contribute to federal government revenues, and then debt is issued at the federal level, is the obligation then to all the emirates – or only to those that contributed to the federal budget?

“Although the move to issue debt at federal level has raised some questions from observers about the fiscal structure of the UAE, our view is that the federal government is fully backed by the government of Abu Dhabi, and we don’t expect to see a significant shift in the fiscal structure of the UAE, even if federal debt issuance starts,” says Best.

“We expect that any debt issued by the UAE federal government would be wholly the liability of the federal government, noting the federal budget receives the majority of revenues from sources which are independent of the grants that it receives from Abu Dhabi and Dubai.”

The main beneficiary of the domestic debt market would likely be the local banking sector, which at present places excess liquidity domestically at the central bank in the form of relatively lower-yielding certificates of deposit.

“The creation of domestic bonds would provide a stable supply of relatively higher-yielding, high-quality liquid assets for this excess liquidity, and help to develop a domestic yield curve,” says Best.

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