Winter 2016

BONDS: The year of the bond

Saudi arabian flagIssuers across the Gulf countries are turning to the debt markets to balance their budgets. Saudi Arabia is the biggest, reports George Mitton. In Saudi Arabia, a police car with its sirens blaring tries to push through a crowd of angry construction workers who are blocking the highway. The mostly south Asian men gather around the bonnet, banging their palms against it in frustration.  According to the video, posted on YouTube on July 31, 2016, the men are employees of Saudi Oger, one of the main construction companies in the kingdom, and have not been paid their salaries in months. Since the oil price began its decline in 2014, Saudi Arabia – the world’s largest oil exporter – has faced a budget shortfall. The protests over unpaid wages show it has not always succeeded in managing the knock-on effects. The country’s landmark bond issue in October is the latest attempt to shore up the kingdom’s finances. Nearly two years after the oil price began to slide, the country made history with the largest emerging-market bond issue to date, raising $17.5 billion. Saudi Arabia is the biggest Gulf issuer turning to the debt markets, but not the only one. For the region, 2016 may come to be known as the year of the bond. BONDS, BONDS
Even before Saudi Arabia sold its bonds, 2016 broke records. There was nearly $44 billion of debt issued in the Middle East in the first nine months of the year, making this period “the strongest first nine months for debt capital market issuance since records began in 1980”, according to Nadim Najjar, regional managing director at Thomson Reuters, which compiled the data. The issues included $9 billion of sovereign bonds from Qatar in May, at the time the biggest-ever bond issue from the Middle East. Saudi Arabia has since nearly doubled that record. Its haul exceeds the $16.5 billion raised by Argentina in April as well as beating its own expectations. Reports prior to the issue suggested Saudi Arabia would raise “up to” $15 billion, but strong demand – the country reportedly received $70 billion of orders – allowed it to borrow more and at better terms than were expected. The thirty-year Saudi bonds were sold at a 4.5% yield, the ten-year bonds at 3.25% and the five-year bonds at 2.375%. The high demand would appear to presage further debt issuance from entities in the Gulf. The markets have indicated there are plenty of buyers. GOOD CREDIT?
Yet opinions are divided about whether Saudi Arabia is a good credit risk. On the positive side, the Saudi state retains sole ownership of what is believed to be the world’s second-largest reserve of oil, clearly reassuring for creditors. (This could change when an initial public offering of Aramco takes place – see box.) On the other hand, the country’s reliance on oil revenues to fund government spending has pushed it into a bind. If it doesn’t reform and diversify its sources of revenue, Saudi Arabia will go bankrupt when it runs out of oil to pump. Mark Dowding, a partner at BlueBay Asset Management, believes the country is not a good risk. “We maintain a negative view on Saudi as a credit risk and feel that the dire fiscal position of the country will see its credit metrics deteriorate over time,” he says. Other critical voices say the high demand for Saudi bonds has less to do with the country’s creditworthiness and more to do with a lack of appealing investment options elsewhere. When sovereign bonds from developed countries are trading at negative market interest rates, a ten-year Saudi bond yielding more than 3% is appealing, even if the fundamentals don’t justify it. OTHER WAY
However, it pays to have some perspective. Jan Dehn, head of research at emerging markets specialist Ashmore, notes that ten years before the start of the decline in oil prices in mid-2014, Saudi Arabia had a government debt worth more than its GDP. The country brought its debt down to just 2% of GDP by 2014 by banking its persistent surpluses. In other words, the country saved when oil was expensive; now, when oil is cheap, it will borrow. Because its debt was so low prior to the oil price fall, “Saudi Arabia has the luxury of adjusting demand slowly in response to lower oil prices”, says Dehn. Other optimists point to the ambitious Saudi Vision 2030 plan – a wide-ranging project to reduce the country’s dependence on oil and stimulate alternative industries. Endorsed by the Saudi cabinet, the project includes a plan to turn Aramco, the national oil firm, into “a global industrial conglomerate”.  There is also a plan to turn the Public Investment Fund into the world’s largest sovereign wealth fund and to manufacture half the kingdom’s military supplies within the country. ARAMCO An address by Mohammad bin Salman Al-Saud, crown prince and chairman of the council overseeing the economic shift, scores high on stirring optimism. At times, the English translation has the breathless feel of a revolutionary speech – as though a new order is about to emerge. “We will expand the variety of digital services to reduce delays and cut tedious bureaucracy,” reads the speech. “We will immediately adopt wide-ranging transparency and accountability reforms.” Later, he adds, “We will work tirelessly from today to build a better tomorrow for you, your children, and your children’s children.” It all sounds very encouraging – just the stuff to reassure bondholders and inspire other investors to lend money to the dynamic new Saudi state. The question is whether the dreams will come true. Is it possible to achieve such a dramatic reorganisation of the Saudi economy in such a short time? And what use are highfalutin phrases if the country’s construction industry can’t afford to pay its workers? Perhaps, only time will tell. “From today’s near-term value perspective, Saudi’s plans for a flourishing post-oil economy remain largely just that – plans,” says Michael Cirami, co-director of global income at Eaton Vance, a US-based asset manager. “The bottom line is that financings by Saudi Arabia and other Gulf countries will play an important role in helping cope with low oil prices. But for now, we would suggest investors consider other emerging-market opportunities offering better value.” ©2016 funds global mena

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