Hello, Mr. Bond


2016 marks the largest collective history of bond and sukuk issuance in GCC history. Tipping the scales at USD66.5 billion, this outstripped 2009’s USD60.9 billion, which was almost double the […]

2016 marks the largest collective history of bond and sukuk issuance in GCC history. Tipping the scales at USD66.5 billion, this outstripped 2009’s USD60.9 billion, which was almost double the next largest annual total. Bond issuances alone accounted for USD60.8 billion of 2016’s total, and just as in 2009 when the property market collapsed and the financial crisis was at its peak, the activity of 2016 was nothing more than a reaction to the drop in commodity prices. The sovereign bonds accounted for 69% of total issuances, with the banks making up 15%.Ü

The GCC witnessed Saudi Arabia’s first sovereign bond issuance, an eye-watering USD17.5 billion package, as the Kingdom looked to plug a budget deficit that had shrunk marginally to USD79 billion in 2016. Abu Dhabi made its first move in seven years with a USD5 billion issuance, Qatar then issued a record USD9 billion in May, and Oman went to the market for USD2.5 billion. Independent of fixed-income securities, Egypt received a USD12 billion loan from the IMF, which came with a package of fiscal reforms, including the long-anticipated devaluation of the Egyptian pound.

This in turn raises a potential sticking point; with the dollar continuing to strengthen against global currencies, the Emirati dirham’s peg could work against the country when it comes to repaying the issuances. The local inflation of the dirham operates independently of the dollar and, as any peg does, creates an artificial value to the pegged currency. While the same number of dirhams created will be required to pay the value of the issuance, the economy has to work harder to earn that number of dirhams. In essence, an investment that will come from the bond issuance will only generate the same number of dirhams, but have to pay off a stronger dollar and the dollar-denominated interest. The same principle applies to all the regional currencies, which are in one form or another linked to the dollar.

Other issues that surround the bond issuance of the Gulf nations is the negative outlook that credit rating agencies have placed on the region. The UAE is no exception. May 2016 saw Moody’s confirm the Aa2 long-term issuer rating but assigned a negative outlook; the long- and short-term currency bond and deposit ceilings retained their Aa2 and Prime-1, respectively. The danger of this is that borrowing becomes more expensive for state-owned companies, such as banks, utility companies, ports, and airports, of which the credit ratings are directly linked to the sovereigns. This could compound issues of a liquidity shortfall, making it more expensive for these privately operating but government-owned companies to raise their own capital. S&P downgraded Sharjah’s outlook to negative in August 2016, and then dropped its credit rating in January 2017. This could cause worry as the main reason cited was the increase in the debt burden, while also serving as an unkindly reminder of how fortune can change with the rating agencies.

On a positive note, investor appetite for sovereign paper remains strong. The equity markets made similar returns but traded within a range of 20%, almost triple what can typically be expected for the bonds. Abu Dhabi’s USD5 billion issuance received 600 orders totalling USD17 billion. The five and 10-year tranches were priced at 85 and 100bps, respectively. The sovereigns also benefit from the low interest rate environment, as it provides a cheap option for raising liquidity.

In this case, the metaphor of fixing the roof while the sun is shining has been implemented too literally in the Gulf, and the sovereigns re-decked the patio and employed an extra gardener to water the plants on the weekends whilst oil revenues were high. A sizeable share of the calamity caused by the severity of the decrease in hydrocarbon revenues was compounded by the fact that regional governments had not been particularly prudent. The UAE’s slice of the OPEC production cap will at least have been incorporated into budget plans, and should the sovereigns need to raise capital, it will be part of a wider sense of prudence during rainy days.