DUBAI: A revival of international bond issues from the Gulf is set to draw heavy demand from local and foreign investors, despite the latest geopolitical upheavals in the Middle East and the approach of higher U.S. interest rates.
Gulf bond issuance has dried up since early July, because of a traditional summer lull in local investor activity as well as global market instability due to the crisis in Ukraine.
Recently, tensions in some parts of the Middle East have worsened dramatically. In June, militants from the Islamic State in Iraq and Greater Syria (ISIS) stepped up a campaign that threatens to break up the country; fighting in Libya has intensified, and Yemen’s government has moved closer to collapse. Israel has launched a war against Palestinian militants in Gaza.
On the face of it, that is a poor environment for a series of Gulf bond issues, which is expected to start next month, and is likely to include a sovereign sukuk from the Emirate of Sharjah as well as a sovereign U.S. dollar conventional bond from the Kingdom of Bahrain.
But the vast majority of investors have decided that the geopolitics do not come close to posing any existential threat to the rich Gulf Cooperation Council economies.
That means next month’s bond issuers will be able to demand favorable terms as investors focus on the GCC’s economic strengths, including big current account and budget surpluses that set it apart from many other emerging markets.
“While geopolitical fears are always on foreign investors’ minds, they are unlikely to temper any demand for solid credit stories in the likes of Abu Dhabi, Dubai and Qatar for example,” said Anthony Simond, a London-based emerging market debt analyst at Aberdeen Asset Management.
Over the last few months, only a small amount of foreign money has been withdrawn from Gulf bonds in response to political events in the Middle East – and it has been easily offset by fresh inflows of money from local funds, said Zafar Nazim, credit analyst for the region at JPMorgan.
“Dedicated emerging market funds are staying put in the region and consider the region a safe haven,” he said, noting that some GCC economies – especially Dubai – were still attracting capital flight from less stable countries in the Middle East, Africa and South Asia.
International bond issuance from the Middle East shrank 16 percent from a year earlier to the equivalent of $22 billion in the first half of 2014, according to data from Thomson Reuters and Freeman Consulting. The drop occurred largely because cash-flush banks in the Gulf are eager to lend and offering rock-bottom pricing on loans.
But the process of loans replacing bonds may be close to reaching its limits, for several reasons. One is that issuers are looking ahead to higher U.S. interest rates as soon as next year, which would work through the Gulf’s currency pegs to boost local loan rates.
Some issuers want to maintain or establish presences in the bond market now, so that they have another option when the loan market eventually starts to tighten.
“Many names are looking to tap the bond/sukuk market to take advantage of low coupons and also to replace bank borrowings, where they see upward repricing risks,” said Stuart Anderson, Middle East head at credit rating agency Standard & Poor’s.
In the United Arab Emirates, there are two additional motives for issuance. Last November, the central bank announced caps on banks’ exposure to local governments and the companies linked to them. Banks have five years to comply with the rules, but in the long run they are likely to push many state-run firms towards financing via bonds.
Also, Dubai is keen to develop itself as a centre for Islamic finance; one way to do so is encouraging sukuk issuance.
These factors are expected to push international bond issuance to resume in September as bankers and investors return from summer holidays and issuers decide they can wait no longer.
Bahrain has hired four banks including Citigroup, Gulf International Bank and Standard Chartered to arrange its sovereign bond issue, and has plans to issue before the end of the year, bankers familiar with the plan said.
Meanwhile, Bahrain’s Gulf Finance House said this month that it planned to issue $200 million of sukuk “in coming months” to repay outstanding debt and for acquisitions; the paper would be listed on NASDAQ Dubai.
Other issues from firms in Dubai and Qatar are possible but less certain in coming months, bankers said.
The primary market is likely to have no problem coping with this surge of issuance, even if geopolitical tensions in the region worsen further. That’s because most investors – foreign as well as local – believe the GCC has managed to insulate itself from the turmoil.
The Arab Spring uprisings of 2011 were seen as potentially a much bigger threat to stability in the Gulf, because they were domestic threats to the stability of governments. Since GCC authorities showed they were able to cope with that crisis, the markets are largely unconcerned about sectarian conflict in non-GCC countries such as Iraq.
“The Arab Spring stress-tested this region and the results were largely positive,” said one international fund manager in Dubai.
In late June, one-year U.S. dollar/Saudi riyal forwards – commonly used as a proxy for risk in the region – briefly jumped to their highest level since 2011 as events in Iraq triggered a burst of hedging activity by foreign banks in thin volume. But forwards began retreating on the following day, and are now back at their previous levels.
More than geopolitics, the biggest threat to the Gulf’s primary bond market may be expectations for U.S. interest rates. The currency pegs mean eventual U.S. rate hikes are expected to feed through into official Gulf interest rates quickly.
But because of its current account and budget surpluses – and in Bahrain’s case, the implicit financial support of Saudi Arabia – the Gulf looks likely to outperform most emerging bond markets if U.S. rate hikes cause global instability.