Saudi's sleeping giant

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After years in which the growth of Saudi Arabia’s bond market lagged its economy, the market is taking off as local companies rush to issue debt — though low returns are keeping foreign investors on the sidelines.

Traditionally, Saudi companies and other entities have relied on bank loans and retained earnings to finance their expansion. For debt market traders, that has made the Arab world’s biggest economy a case of unfulfilled potential.

In recent months, that pattern has started to change as companies become more familiar with bonds, a wide range of investors demand them, and banks bump up against the limits of how much they can lend to individual companies.

This has caused a burst of riyal-denominated debt issuance. In Saudi Arabia, such issuance is entirely in the form of Islamic bonds, or sukuk, which are structured to obey Islam’s ban on interest and instead pay returns on assets.

“Saudi Arabia had traditionally been considered the sleeping giant of regional debt capital markets, but this has certainly changed in the past eighteen months as we have seen an upsurge in riyal sukuk issuance,” says Stuart Ure, partner at law firm Clifford Chance in Dubai.

Bank loans are still growing rapidly in Saudi Arabia because of strong economic growth; lending to the private sector climbed 15.6 percent from a year earlier in February to SAR1.02 trillion ($272bn).

But sukuk issuance is now expanding much faster. Last year about SAR27.2bn worth of riyal-denominated sukuk were issued, according to HSBC, up from SAR11.3bn in 2011. In the first quarter of this year, SAR10.3bn were issued.

Three sukuk deals have closed in the past week alone: a SAR1.3bn deal from construction giant Saudi Binladin Group, SAR1.3bn from dairy firm Almarai Co, and SAR7.5bn from Sadara Chemical Co, a venture between Saudi Aramco and Dow Chemical.

Some Saudi banks have run up against their internal lending limits for companies, an issue which is particularly acute for firms such as Saudi Binladin, which require large amounts of finance to undertake construction projects. This is pushing some companies towards sukuk.

At the same time, sukuk have advantages for companies; they often carry longer tenors than the short maturities commonly offered on Saudi bank loans, and they allow the borrower to diversify its funding sources.

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