Gulf countries are trying to plug their growing fiscal gaps by raising debt on capital markets. Mission impossible?
It's not often you can describe Saudi princes as penniless. But after 12 months of steadily declining oil prices there's no denying they’re feeling the pinch. Here’s a proof: for the first time since 2007, the Kingdom returned to the domestic bond market in August. It plans to raise as much as $27 billion by the end of the year.
The country indeed needs cash. It has drawn heavily on its foreign reserves, which have shrunk by 11 percent from around $740 billion a year ago. The IMF predicts a Saudi budget shortfall of 20 percent for 2015, at a time when Riyadh is waging a war in Yemen, bankrolling the al-Sisi presidency in Egypt and financing mammoth infrastructure projects.
But if that can be of any consolation to the Saudis, they’re not the only ones feeling kinda thrifty. Qatar raised $4.1 billion via bonds two weeks ago, while Oman's lately increased bond issuance too. Kuwait is also looking to borrow via the capital markets, having announced a $27 billion deficit for the 2015/2016 fiscal year. Even war-torn, impoverished Iraq is contemplating its first issuance since the end of the US occupation.
In a context where European banks are packing up, and where domestic lenders have their hands increasingly tied by regulation, it makes sense for Gulf countries to go to the bond markets. As oil prices stay low and public finances continue to deteriorate, they will no doubt seek to raise more.
Their success is not a done deal. After experiencing strong growth in 2014, bond issuance in the region has slumped. This is particularly true of Islamic bonds: borrowers have raised $6.9 billion through sukuks so far in 2015, 45 percent less than during the same period last year and the least since 2011. With investor appetite for emerging markets ebbing fast, Gulf countries may be forced to pay hefty interest to entice bondholders. Rates could even reach double-digit for a country like Iraq, insiders reckon.
A decision by the Fed to raise interest rates could make things worse. It would strengthen the dollar, luring money out of developing economies and further weakening investor demand for riskier assets. Outflows from emerging market equities and bonds totalled $40 billion last month alone.
But a US rate increase could also entice more borrowers to try their luck. Persisting doubts about when the Fed would start bumping up rates has been a major cause behind the sluggishness of issuance in the Gulf this year, as it has deterred issuers by creating uncertainty around pricing. A decisive move by US central bankers could be a catalyst for their return.
And although they’re now being confronted with fiscal challenges, most Gulf economies still enjoy strong fundamentals. They retain ample reserves, have sovereign funds they can tap and rank among the least indebted countries in the world, so have room to borrow. Their sovereign ratings are strong, limiting funding costs.
Some of them are also making efforts to deepen their bond markets, which could pay great dividends in the medium to long term. Kuwait is working on legislation to issue its debut sukuk, for instance; new instruments meant to lengthen the yield curve, such as long-tenor and perpetual bonds, are being created elsewhere. Regulation on conventional and Sharia-compliant instruments is slowly moving closer to international standards, and a secondary market may soon emerge.
So Gulf countries shouldn’t struggle too much to find willing lenders – at least for now. Their economies are still overwhelmingly dependent on the black stuff, and their populations are growing fast. Diversifying away from oil and creating jobs should be their priority. So far it is not.