Rethink on Gulf bond sales as costs stay high

High pricing will deter regional companies and governments from selling bonds, despite facing a liquidity crunch, according to a top US money manager.

Franklin Templeton Investments expects issuers to seek out cheaper funding routes as governments grapple with rising deficits and companies seek funds for expansion or to repay old borrowings.

“If the bond market pricing remains elevated, we will see more local issuance, we will see more syndicated loans, maybe some multilateral-type funding. So I wouldn’t just take it for granted that budget deficits equals a tremendous increase in issuance,” said Mohieddine Kronfol, the chief investment officer for global sukuk and Mena fixed income at Franklin Templeton Investments.

Gulf bond sales last year fell by 22 per cent to US$26 billion, according to Bloomberg data.

Gulf governments last year dipped into bank deposits, tapped their foreign reserves and sold local bonds to meet their fiscal needs amid a sharp drop in oil prices. Some countries, including Saudi Arabia, have indicated that they plan to tap the international bond market this year to help plug their fiscal deficits.

Sovereign, financial and corporate borrowers in the GCC must repay or refinance $94bn in bonds and loans this year and next, HSBC predicts. The region’s debt maturity profile continues to rise until 2020, the bank said in a report this week, with the UAE making up the biggest chunk of repayment or refinancing obligations in that period.

The IMF warned in October that Gulf countries would have a combined fiscal deficit exceeding $700bn between 2015 and 2019 if they do not cope with the era of low oil prices. Saudi Arabia could burn its reserves in five years if it does not rein in spending, the fund said in October.

Gulf governments will find it more expensive this year to tap the international bond markets after the rating agency Standards & Poor’s downgraded Saudi Arabia two notches to A- from A+, Oman two notches to BBB- from BBB+ and Bahrain two notches to BB from BBB-, the first Gulf country to have reached junk status because of the effect of the weak oil price on its budget.

Nonetheless the downgrade has not stopped Gulf governments from issuing international bonds.

Bahrain sold a $600 million bond this month after the downgrade, receiving orders of $900m, a sign that there is demand for sub-investment grade Gulf paper. The smallest Gulf economy had earlier cancelled a $750m bond sale because of the downgrade.

“Bahrain could now attract a different set of investors by virtue of it being downgraded to sub-investment grade,” said Mr Kronfol.

“Most of the banks and most of the sovereigns in the region [that hold Bahrain paper] have made an exception for Bahrain, so you are not going to see the type of selling that you would expect.”

A compression of spreads on investment grade Gulf bonds by 20 to 30 per cent this year compared with last year could occur, leading to higher regional bonds sales, said Mr Kronfol.

But a number of factors will influence the tightening of spreads such as the stabilisation of financial markets and oil prices, the Chinese economic slowdown and potential of US interest rate hikes, he said.

Gulf bonds are attractive to investors because of the region’s still-high credit rating, fiscal reforms, ample reserves and low debt-to-GDP ratio, among other factors, Mr Kronfol said.

“If you take the combination of factors, we are still solid investment grade, prices are cheap, you have low correlation to oil and you have an interesting dynamic evolving, which makes GCC bonds a much more attractive asset class than it was, say, six months ago and certainly when you compare it to other fixed-income sectors, more attractive than it has been in a long time,” said Mr Kron­fol.

Separately, Templeton said equity investors should focus on defensive sectors such as consumer staples, health care and transport, according to Bassel Khatoun, the chief investment officer for Mena equities at Franklin Templeton.

The market has good valuations and is trading at a 30 per cent discount compared with its historical performance.

“The market is pricing in a lot of negativity at this stage,” said Mr Khatoun.

“We view these valuations as highly attractive in these markets, in particular where it relates to sectors and industries that are much more resilient to the current economic environment.”

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Dania Saadi

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