Until recently, oil rich Gulf states could afford to ignore global bond markets.
While developed and developing countries issued record sums of debt in the years after the financial crisis, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates used the vast oil wealth to propel themselves to affluence.
The states — members of the six-country Gulf co-operation council — built skyscrapers, schools and motorways while bestowing generous subsidies, creating government jobs and imposing few taxes on their citizens.
But the drop in oil prices below $30 a barrel last year, from more than $100 a barrel in June 2014, forced a rethink. A series of mammoth bond deals across the Gulf raised $66bn in international markets last year — a record high, according to figures from Thomson Reuters.
Saudi Arabia dominated proceedings with a $17.5bn debut — a record-breaking issue that generated so much interest from international investors that bids for the bond reached $67bn.
The rush of first-time bond sales in a previously untapped region has created a new centre of gravity in capital markets — pushing total emerging market debt sales to a new high. Excluding China, borrowers in emerging markets issued bonds worth $482bn in 2016, up 46 per cent on the year before.
With budget deficits in Gulf states still substantial, bankers say 2017 could break that record.
Although government budgets have been pared back, public spending frozen and Saudi Arabia in the midst of plans to sell shares in state-run oil company Saudi Aramco — estimated to be the world’s most valuable company — rating agency Moody’s estimates aggregate deficits will be equivalent to 7.5 per cent of gross domestic product this year.
To finance those deficits, banks such as Bank of America Merrill Lynch and Danske Bank forecast higher bond issuance in the Gulf in 2017, despite oil prices rising back above $50 per barrel.
The recent increase in crude prices has only helped “stop the bleeding” in Gulf states, says Jakob Ekholdt Christensen, head of emerging market research at Danske Bank. Prices are unlikely to go back to the previous decade high and the region’s economies remain highly dependent on oil exports, with only UAE and Bahrain relatively diversified.
“Despite the rise in oil prices, notably Saudi Arabia, Oman and Kuwait, as well as Egypt, face a significant fiscal adjustment in coming years, including in their public investment budgets. We believe the adjustment will weigh on their growth prospects in years to come,” says Mr Christensen.
This week, a fund used by Dubai to support government-related entities in the aftermath of the 2009 debt crisis will return to international markets, suggesting Gulf borrowers are likely to be a sustained presence in international markets.
The Investment Corporation of Dubai, which holds state assets such as national airline Emirates, has hired banks to raise more than $1bn in debt, marking the influential fund’s first return to global capital markets since 2014.
Saudi Arabia has also said it plans to tap debt markets again this year, and Kuwait has been finalising plans for a $10bn debut as early as March. Companies and banks are also expected to use benchmark rates set by government debt sales to launch their own bonds.
By 2018, Moody’s expects debt-to-GDP across the region to reach 32 per cent, from just 10 per cent in 2014.
The rating agency also warns creditworthiness may deteriorate in the GCC, as economic growth is expected to be weak by historical standards, an average 1.6 per cent across the region.
Investors, however, appear sanguine. Compared with other emerging market bond issuers, Gulf states are regarded as highly unlikely to default on low levels of external debt. The difference between bond yields for US Treasuries and those for bonds issued in the Gulf have narrowed over the past 12 months, helped by rising oil prices.
Even US President Donald Trump’s plans for tax cuts, which have pushed the dollar higher at the expense of emerging markets, have not dimmed demand for bonds.
Stuart Culverhouse at Exotix says there remains a bullish case for emerging market debt, thanks to the rebound in commodity prices and the possibility stronger US growth will boost economies in the developing world.
“The bulk of the disruptive move in US Treasuries is now behind us and the outlook for US bond yields from here is fairly benign, which might limit any further sell-off in emerging market debt,” he adds.
A supportive market gives Gulf borrowers freedom to explore greater diversity in their bond plans. After proving global demand with vanilla, dollar-denominated sales, countries and companies are now planning bonds issued in euros and so-called sukuks, debt compliant with sharia law.
For instance, Dubai’s Investment Corporation bond sale will be a sukuk. According to one banker close to the deal, Dubai is open minded about the size of the issue: its borrowing ambitions will be determined only by demand.