Here’s why Saudi Arabia’s record bond sale is a bright spot for MENA

Saudi Arabia’s record international debt sales, in terms of both US dollar and other currencies, will continue to grow next year, apart from remaining a dominant source of capital inflows not only for the Kingdom but for the MENA region as well, say analysts.

So far in 2019, Saudi Arabia has dominated the regional bonds market and claimed top issuance in the MENA region, issuing bonds worth $25.6 billion in the first half of this year. Bond volumes soared by 101% from $12.7 billion in H1 2018 to $25.1 billion in H1 2019, according to data by Debtwire Par.

The Washington-based Institute of International Finance (IIF) estimates that the kingdom’s bond issuance, mostly by sovereign and quasi-sovereign entities, amounted to $26.5 billion in the first 10 months of this year.

As the Kingdom continues to spend higher on various development sectors, and moves ahead with a series of economic reforms in line with Vision 2030, debt sales are expected to continue being a key source to finance soaring budgetary expenditure in order to ensure long-term fiscal health as well as economic growth.

“The US-dollar denominated Saudi bond market has grown significantly since 2016 and is expected to continue to grow as oil prices required for fiscal breakeven remain high,” Rick Lacaille, Executive Vice President and Global Chief Investment Officer, State Street Global Advisors (SSGA), London, told Argaam.

He further added that Saudi Arabia has put in significant efforts in developing its local bonds market by trying to set up a local yield curve, and encouraging local savings institutions to being more visible in capital markets.

“These are very beneficial measures in setting up a strong and liquid local capital markets in the Kingdom,” he added.

Balancing debt and deficit

Last year, Saudi Arabia announced a plan to issue around SAR 120 billion ($32 billion) of bonds in 2019 year to help finance its deficit. For next year as well, higher budget deficit is expected to drive bond sales, say analysts.

According to the ministry of finance’s preliminary budget estimates, expenditure for the 2020 state budget is expected to reach SAR 1.020 trillion, with estimated revenue of SAR 833 billion. Public debt is forecast to SAR 678 billion this year and SAR 754 billion in 2020.

“The combination of subdued oil prices as well as falling interest rates has forced Saudi Arabia to tap the international bond markets this year. The decline in oil price means that there will be a deficit to finance the social sector, as well as Vision 2030 projects,” said Arun Leslie John, Chief Market Analyst, Century Financial.

He further added that the rise in US oil production as well as new supply expected from giant oil fields in Norway and Brazil means that crude oil price faces substantial downward pressure.

“This could impact the revenues of the Kingdom and deficits are likely to stay at elevated levels in the coming years as well. So we can expect continued Saudi Arabian bond issuance in the coming years till it completes its major projects,” he maintained.

However, higher fiscal deficit is just one of the fundamental factors driving issuance of international bonds by Saudi Arabia. Reduction in borrowing costs and low oil prices remain the other significant pull factors for the GCC sovereigns, including the Kingdom to tap the overseas bond market.

Besides, Saudi Arabia’s creditworthiness with an A rating and stable outlook from all the credit rating agencies augurs well for debt papers issued by the country. Furthermore, the inclusion in the JPMorgan EMBI has also increased the demand for the country’s papers in the secondary market.

Investors appetite

Sovereigns and quasi-sovereigns are the dominant Saudi bond issuers, compared to corporates/ private companies for which investor demand continues to be robust.

According to a report by IIF, with global negative-yielding debt hovering around $15 trillion, the GCC debt market is becoming increasingly appealing to foreign investors.

IIF also maintained that large financial buffers in Kuwait, Qatar, the UAE, and Saudi Arabia, solid returns, and a natural currency hedge given the dollar pegs make debt an attractive alternative to riskier securities in other EMs, especially in times of elevated volatility.

“Investor demand of Saudi fixed income has also been rising as evident by the tightening yield spreads, and with interest rates becoming increasingly favorable it is no surprise that issuers in KSA would be looking to take advantage of the current market,” said Iyad Abu Hweij, Managing Partner, Allied Investment Partners PJSC.

He added that the current market conditions and the ambitious projects undertaken in the Kingdom will require the financing momentum to persist and more issuances to take place.

“Investors, encouraged by the structural and fundamental changes in the Kingdom, will increase demand for private as well as sovereign issuances,” Hweij maintained.

However, there’s a huge difference in the types of global investors in the dollar-denominated bonds issued by Saudi as well as MENA sovereigns.

For instance, as data by SSGA show, the 10-year and 30-year dollar bonds issued by Saudi borrowers have attracted largest demand from US investors (cornering 40% and 45% of demand respectively), followed by UK investors. Investor share from the MENA remains surprisingly low at 3% and 2% respectively.

“This is largely because the local currency-denominated bonds appeal more to investors based within the region, than those based outside. In contrast, dollar bonds are preferred by globally active asset managers having presence in multiple geographies,” Lacaille of SSGA explained.

Going forward, declining interest rates (thanks to dovish Fed), large fiscal financing needs, investors’ search for yield, and lower oil prices will keep Saudi, and the larger MENA region’s bond issuance at high levels in the near future, analysts maintained.

Write to Sunil Kumar Singh at sunil.kumar@argaamplus.com