On the back of strong foreign investor demand, Banker Middle East looks at how the appetite for GCC debt is expected to continue in 2018 despite precarious oil prices and geopolitical instability.
The year 2017 witnessed a series of landmark events: record year of issuance despite elevated geopolitical instability and rating downgrades; Dana Gas’s Sukuk restructuring, with minimal impact on the broader Sukuk markets; heightening fears that higher oil prices may weaken the momentum of reform initiatives. According to a joint whitepaper produced by Fisch Asset Management and ENBD Asset Management, these milestones had a major impact on regional debt markets and will likely shape them going forward.
Last year was the first time GCC federal governments (except for the state of Qatar) all tapped the international debt capital markets. With issuances over $70 billion, 70 per cent of the region’s issuances came from sovereigns as they were necessitated by the persistent need to fund twin deficits because of lower oil prices. The bond offerings were comfortably met by non-GCC investors, who absorbed over 75 per cent of the amount issued in the primary market.
The whitepaper suggested that the strong international demand for GCC sovereign and quasi-sovereign papers was underpinned by a range of idiosyncratic factors, including benchmark eligibility (Sultanate of Oman), attractive pick-up over strategic neighbours’ bond yields (Kingdom of Bahrain), strong evidence of fiscal consolidation (Kingdom of Saudi Arabia) and a dearth of supply (United Arab Emirates).
A key driver for better access to the GCC bond market was hard currency issuance. In Central and Eastern Europe, Middle East and Africa (CEEMEA) region, hard currency issuance has historically been dominated by Russia and Turkey. By contrast, in 2017 the GCC held the lion’s share: four of the top five sizable deals ($5 billion+) in emerging markets came from GCC sovereigns (two from Saudi Arabia, one from Abu Dhabi and one from Kuwait).
“What are the key take-aways of 2017? Firstly, the market’s ability to absorb a significant uptick in bond issuance without a real price disruption speaks strongly for the GCC’s appeal to a broadening investor base—most notably in Asia and the US. While events such as the Qatar dispute can be price disruptive, they also bring investment opportunities. For example, we moved to an overweight position during the summer to take advantage of wider Qatar credit spreads,” said Philipp Good CEO at Fisch Asset Management.
On the Islamic front, the industry feared for the repercussions of the contentious Dana Gas litigation. Contrary to popular expectation, the Dana Gas Sukuk litigation, which emerged in June 2017, did not impact credit spreads across the broader Sukuk markets or impede GCC issuers’ ability to issue Islamic debt. Between June and December 2017, GCC issuers raised $2.25 billion in Shari’ah-compliant debt, which attracted strong order books and was an encouraging confirmation that investors understand risk in the GCC well enough to isolate esoteric events.
Oil prices and regional unrest is something that the region has never been able to escape. The unforeseen embargo of Qatar was followed by the equally unexpected and heavily publicised anti-corruption measures in Saudi Arabia, both of which caused shockwaves, leading to widening of the credit default swap spreads. Oil on the other hand, which had shown negative price momentum in the first part of the year, reversed the trend to finish 2017 trading at a two-year high. According to the whitepaper, the policy implications of higher energy prices will become an important topic in 2018. Furthermore, from a credit standpoint, a sustained increase in Brent crude is one of the greatest risks for 2018, as the temporary reprieve that the recovery has provided will likely test the resolve of governments to maintain structural reform initiatives.
Usman Ahmed, Head of Investments at Emirates NBD Asset Management added, “Emerging market fixed income ended 2017 on a strong note and the positive sentiment has carried over into 2018. Looking ahead, we expect to see synchronised global growth in conjunction with monetary policy tightening, which would mean that the beta rally of 2017 will not be repeated in 2018. Investors will need to be far more vigilant in picking markets and credits, especially in the GCC, where the combination of attractive yields, structural reforms, choppy oil prices and geopolitical factors could throw a curveball at fixed income investors.”
The widely expected stability in Brent crude prices should provide some reprieve to sovereign balance sheets but is unlikely to address the twin deficits, which should sustain in 2018. Consequently, the trend of large sovereign and quasi-sovereign issuance is set to continue, with the GCC likely to continue to play a prominent role in 2018’s new issue market. Net new issuance may increase, which will test current strong market technicals. In 2017, the Qatari sovereign, quasi-sovereign and bank issuers were notable absentees from the market, but with a budget deficit expected to reach over $7 billion, both ENBD and Fisch expect the sovereign to be a strong candidate for a new issue this year.
Within its outlook for 2018, the whitepaper indicated that convertible bond issuances were overdue an uptick, but that until rates rise further the straight debt market will continue to dominate. While convertible bonds have been a feature of GCC markets for more than 10 years, with around 20 issues totalling at $23 billion to date, there remains a relative lack of supply to meet investor demand.