The balancing act

Tapping the international debt markets will help the GCC countries to plug their budget deficits as well as current account shortfalls without having to draw from their sovereign wealth funds

The outbreak of the COVID-19 pandemic and its impact on the price of oil, which is the backbone of the GCC countries’ revenues, forced regional governments and corporates to calibrate their budgets in line with the current conditions. Given the importance of hydrocarbons as a component of GDP, exports and revenues for Gulf countries, the high correlation between oil prices and GCC financial markets will remain a permanent fixture for now.

According to S&P Global, “Normally, issuance and GDP are positively correlated – as GDP rises (or falls), so does bond issuance.” But this relationship was reversed throughout 2020 and changes are expected to be seen through 2021.

The stimulus packages that Gulf central banks unveiled at the height of the pandemic last year are available through most part of 2021 making a significant difference, especially in rejuvenating market confidence by providing a backstop. After a record issuance in 2020, industry experts do not expect Gulf states to tap international debt markets as much in 2021 amid economic recovery on the back of rebounding oil prices and well-coordinated inoculation programmes.

Despite the recovery of the economy, GCC countries and regional corporates still needs to borrow, and countries in the region will continue to issue bonds through December 2021. Tapping international debt markets will help the GCC countries to plug their budget deficits as well as current account shortfall without having to draw from their sovereign wealth funds.

Saudi Arabia projected a budget deficit of $37.6 billion (SAR 141 billion) in 2021, Oman foresees a budget deficit of $5.7 billion (OMR 2.2 billion) while Bahrain expects to post a deficit of $3.20 billion (BHD 1.2 billion).

Though a decline in debt issuance is expected in 2021, other supporting factors include still-favourable financing conditions, corporates’ CAPEX needs, increasing amounts of sovereign debt with negative yields and a rejuvenated merger and acquisition pipeline for corporations, said S&P Global.

Enabling conditions

In 2020, international debt markets conditions were favourable to the extent that some of the corporate sectors that saw a surge in bond issuance compared to the previous five years were those most negatively affected by the economic fallout from the coronavirus pandemic.

Last year’s conditions did not only allow many issuers to issue new debt, but the markets were also receptive that yields continue hitting all-time lows on new issuances for both corporates and sovereigns. Similarly, alongside very low yields, debt maturities have been lengthening, particularly for investment-grade - rated ‘BBB-‘or higher – corporations in developed countries as well as emerging markets.

S&P Global said that these conditions have raised leverage for many, which will likely act as a headwind to issuance in 2021 as corporates try to lower leverage but these favourable conditions could

see some reversal given that GCC countries are on track with their vaccines rollouts campaigns and macroeconomic conditions are starting to improve.

“Middle East bond markets have outperformed wider emerging bond markets over the last few years, and we expect the trend to continue for this year amid favourable macroeconomic conditions and improving credit profiles of issuers,” said Christophe Lalandre, Senior executive officer at Lombard Odier ADGM Branch.

Despite these enabling conditions, GCC central banks availed record economic stimulus packages in response to low oil prices and the impact of the pandemic on the economy in a bid to support corporates and preserve the productive capacity. As such, regional banks can meet most of the economies’ financing needs. Fitch Ratings expects banks’ lending capacity to increase by low- to mid-single digits across the Gulf region this year and for some loans to be at subsidized rates hence there’s little incentive for corporates to issue bonds.

Additionally, several GCC corporates’ postponed projects and investments which also reduced their financing needs and capital expenditure amid changing operating environment.

Sovereign issuances

According to First Abu Dhabi Bank, the GCC Eurobond market got off to a strong start this year and the improvement in the general external environment across the region should bode well to support investors’ sentiment for GCC credits.

Lombard Odier’s Lalandre said, “Middle East debt markets across both sovereign and corporates have structurally changed and grown exponentially since the oil crisis of 2015, as the region recognized the need to develop sovereign and corporate bond curves across tenures as well as to invest for non-petroleum industry growth.”

Around $11 billion of bonds were issued in the GCC region in Q1 2021, led by high yield sovereigns like Oman and Bahrain, along with blue-chips financials. In February, Saudi Arabia issued $1.8 billion (EUR 1.5 billion) bonds following its $5 billion deal at the end of January. Oman and Bahrain also raised a combined $5.25 billion earlier in Q1 2021.

Structural reforms

GCC sovereigns have for long relied on their large oil reserves which accounts for around three-quarters of the six-nation bloc’s spending. However, Oliver Wyman said that the emergence of sustainable clean sources of alternative energy and electric vehicles, the drop in oil prices due to a slump in demand and production cuts in line with the OPEC pledge mean this model will have to come to end at some point.

The structural reforms that are being implemented across the Gulf countries are beginning to have a positive impact on the economy as the regional governments seek to diversify their economies away from reliance on hydrocarbons.

In 2017, the Gulf governments agreed to introduce a 5% value-added tax (VAT) to boost their revenues. The UAE and Saudi Arabia implemented a 5% VAT on most goods and services in January 2018, while Bahrain came on board a year later with Oman scheduled to introduce VAT this month.

“We believe various governments across the Middle East are bringing wide-ranging, structural and long-term reforms to transform the respective countries GDP growth profile, fiscal metrics and business environment,” said Love Sharma, Head of India and Middle East Credit Research at Lombard Odier ADGM Branch.

Last month, Saudi Arabia also enacted changes to its labour regulations to allow greater job mobility for expatriates, which according to Emirates NDB is expected to result in better alignment of salaries for expats and citizens as well as improve the attractiveness of the kingdom for more highly skilled employees.

Similarly, the kingdom also said that from 2024, the government and stateowned entities will stop signing contracts with foreign companies that base their Middle East headquarters in any other country in the region, a move that is aimed at curbing “economic leakage” and boost job creation, according to Bloomberg.

Across the border, the UAE, the Middle East’s trade and business hub, is leading the strongest overall reform momentum in the region. The UAE eased foreign ownership limit restrictions in 2019 and several banks and entities in the Arab world’s secondbiggest economy, have increased foreign ownership limits on their securities in a bid to attract more external investors.

Similarly, the introduction of legislation allowing 100% foreign ownership of onshore companies and several new and expanded visa schemes as well as the recently introduced Emirati citizen scheme for foreigners are a key component of the recently announced industrial development strategy, which aims to double the size of the UAE’s manufacturing sector over the next decade by attracting and retain investment and talent.

“UAE’s recent decision to allow qualified foreigners to get an Emirati nationality is one such step that was perhaps unthinkable few years back, said Dhiraj Bajaj, Head of Asia Fixed Income at Lombard Odier ADGM Branch. “Such steps establish confidence in the government and significantly improve the business sentiment,” he added.

In the Sultanate of Oman, the government plans to reform labour laws, introduce new taxation, and end some “long-standing” subsidies as part of the country’s medium-term fiscal balance plan which runs through 2024.

Political bickering in Kuwait has stalled reform as the government and parliament remain at loggerheads over how best to cut spending and secure alternative sources of income. In January, the country forecasted a $40 billion (KWD 12.1 billion), its eighth consecutive budget deficit for the year starting April 1, 2021. Kuwait is expected to emerge as the biggest sovereign issuer in the Gulf region due to its funding requirement if the country’s debt law makes it through the parliament.