Saudi Arabia plans follow-up to debut bond deal

Saudi Arabia plans to follow its record breaking debut on global debt markets with an Islamic bond issue in a sale that could come as early as February.

The sharia-compliant sukuk will form part of a pipeline of bond sales to finance the kingdom’s budget deficit and invest in economic diversification away from oil and is likely to appeal to regional investors in the Gulf.

Last year, Saudi Arabia set a record for developing countries with its first sovereign bond sale, attracting $67bn in investor bids for a $17.5bn issue.

Not all of the 10 banks appointed to help arrange the initial bond offering are expected to be hired to manage the second transaction, although joint global coordinators Citi, HSBC and JPMorgan are in a strong position to be mandated, according to a person connected to the deal.

As the world’s largest oil producer, Saudi Arabia has been sharply affected by a collapse in energy prices since 2014 — cutting government spending, raising debt and making plans for the world’s largest initial public offering in state-owned Saudi Aramco to help manage the shortfall. Although crude prices have stabilised at $55 per barrel following a deal between Opec members in November, they are not expected to return to the $100 per barrel levels seen three years ago.

“Diversification is natural for any emerging market, but the fall in oil prices have made it a necessity for exporters like Saudi Arabia,” said Bashar Al-Natoor, global head of Islamic finance at Fitch Ratings. “Lower oil prices have led to a drop in government reserves held in banks, which in turn has had an impact on their willingness to lend — so they have to look for alternative sources of financing.”

Gulf states including Qatar, Abu Dhabi, Oman and Bahrain have all turned to capital markets in the wake of falling oil prices and Fitch Ratings believes borrowers in the Gulf are likely to increase sukuk issuance as the market grows — with some companies limited to only sharia-compliant borrowing by their own rules and other issuers keen for inclusion in Islamic investment funds.

Sukuk offer an alternative to conventional bonds by generating regular returns for investors without infringing Islamic law, which prohibits riba or interest. This is typically managed through shared ownership of underlying tangible assets.

Last year, governments in countries including Pakistan, Indonesia and Malaysia sold $9.4bn of sukuk, according to Dealogic — an increase from $6.3bn sold in 2015.

However, credit analysts say there is still a need to improve market standardisation if sukuk issuance is to rise.

“We believe the complexity of sukuk issuance will continue to weigh on issuance volumes, unless counterbalanced by tangible results on standardisation or the establishment of large issuance programmes,” said S&P Global Ratings’ global head of Islamic finance, Mohamed Damak.

Prices for Saudi bonds have fallen since the sale, raising the yield on Saudi Arabia’s benchmark 2026 bond from 3.25 per cent to 3.7 per cent. However, the move is in line with weakness across global bond markets and the spread over equivalent US bonds has fallen slightly — down about 30 basis points to 130bp.

The kingdom drew down its international reserves and borrowed on local and global debt markets to finance its SR297bn ($79bn) deficit last year. The finance ministry will nonetheless need to rely on debt markets to invest in efforts to diversify the economy, including SR42bn for the National Transformation Programme that seeks to boost private enterprise by 2020.

Announcing the budget in late December, Mohammed al-Jadaan, the finance minister, said the government would return to debt markets when the right “window opened”.