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Sat 2 Jun 2018 12:50 AM

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Opinion: why there's no end in sight to Gulf borrowing

Despite earlier doubts, the GCC debt market outlook for 2018 looks pretty strong and might yet exceed 2017

Opinion: why there's no end in sight to Gulf borrowing

After a record year for new debt issuance in the GCC in 2017, with more than $70bn from sovereigns and corporates combined, it was believed that 2018’s levels would naturally dip, especially as both the oil price and liquidity recovered. However, we’re still looking at the potential for similar levels this year, if not more. The first quarter of the year saw a series of sizeable issuances in the regional market, with EEMEA running 60 percent ahead of Q1 2017 – a large portion of which came from the Gulf.

The chart opposite tracks new issuances by GCC sovereigns and corporates; on a year to date (YTD) basis in 2018, $55bn in debt has already been printed, making it likely that the total for the year could exceed $85bn, smashing last year’s level.

There are several drivers governing sustained investor appetite for participation, which continues to meet the uptick in supply. Among those are the fact that debt levels in the GCC remain at healthy levels and, in some cases, have risen sharply. That being said, the recent and robust recovery of oil prices has made most Gulf sovereigns neutral – and in some cases positive – on their current accounts. Those fundamentals, along with ongoing economic and social reform in these markets, make them attractive investment prospects.

Verifiable intelligence suggests a healthy issuance pipeline, and 2018 looks set to match the bumper levels of last year”

Another important driver for investors, whose demand encourages new supply, has been a widening of spreads as a consequence of rising interest rates in the US. Until a new equilibrium in the rate market is found, emerging markets (EM) remain attractive alternatives for allocation, with GCC countries among the most appealing of all. In addition, traditionally attractive EMs such as Turkey, with twin deficits, are experiencing growing pressure – encouraging EM investors to reallocate to markets such as those in the GCC.

One negative characteristic of the region is that net new supply is the highest of all emerging markets, which carries the risk of a glut outstripping investor appetite – we aren’t there yet, but it is something that issuers will be mindful of as 2018 progresses. Credit downgrades carry further risk, although in the case of most sovereigns this is mitigated by substantially improved oil revenues.

Banks and corporates are more exposed to potential downgrades, with the recent example of the National Bank of Oman’s re-rating to BB+ by Fitch in May 2018 – putting it into the High Yield category. Credit events of this kind usually lead to repricing, as certain investors are forced to sell bonds due to rating constraints. Overall, we are not foreseeing a great deal of rating pressure for the region in 2018, but any downgrades that do occur always carry the possibility for adjustments to investor sentiment.

What is the outlook?

For the remainder of the year, we are confident of seeing issuance from Kuwait on both the sovereign and corporate side, with a good chance Saudi Arabia will issue opportunistically in the second half of the year, with the other GCC countries likely to contribute less supply. In terms of the split between sovereign and corporate issuance, we expect to see a ratio of about 3:1, implying minimal change on recent deal trends.

Current supply from the EEMEA region, in which the GCC holds a sizeable share, makes it abundantly clear how different the complexion of supply levels is compared with markets such as Latin America and Asia. On a YTD basis, corporate hard currency issuance from EEMEA is just shy of $40bn, compared with $35bn for the same period in 2017 – increasing by ten percent as compared to declines of 11 percent and four percent for Latin America and Asia. On the sovereign side, issuance from EEMEA has increased 39 percent YTD to exceed $65bn, with Latin America and Asia behind at 31 percent and 11 percent supply growth.

Based on current supply, and verifiable intelligence that suggests a healthy issuance pipeline, 2018 looks set to match the “bumper” levels of last year. Geopolitically, there is not a great deal happening at present that we foresee putting downward pressure on sovereign ratings, and this will be important for reinforcing investor confidence after a series of downgrades for countries including Oman and Bahrain.

Increasing supply

Where will supply come from, and who will issue it? We think Saudi Arabia is likely to issue again later in the year, having delivered a well-publicised and substantial opportunity to the international market in 2017. But the most exciting prospect is Kuwait.

Our expectation is that Kuwait is likely to issue more than the $7.5bn it printed last year and, as perhaps the strongest sovereign credit in the region, it possesses considerable pricing power. It is true that EM has suffered a setback in the wake of rising US yields, with appetite among certain investor categories dimmed, but tides can turn quickly and the strongest names will be the ones to tap the market – among which Kuwait is certainly a player.

Having issued five-year and ten-year instruments in 2017, it’s likely the Kuwaiti sovereign fund will issue a 30-year paper, in addition to another five-year and another ten-year. This would make sense for the issuer, and extend the credit curve – directly benefitting potential corporate issuers such as Equate Petrochemicals, NBK and Kuwait Projects – who could also come to the market.

In short, the pipeline for 2018 is clearly robust, and there is an appetite to match it. It’s impossible to say if supply will exceed the levels of 2017, but there is a good chance. There remain a number of promising opportunities for sovereign and corporate issuers offering hard currency deals to international debt investors, and those investors in turn remain attracted to the strong fundamentals of GCC bonds.

Philipp Good, CEO and Head of Portfolio Management, Fisch Asset Management

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