GCC countries shift emphasis to using external loans to cover budget shortfalls

The summer is a good time to take stock of what has happened so far this year and look ahead to what may be in store in the second half.

So far, 2016 has been full of surprises at the global and regional levels.

January's sharp sell-off in financial markets was something of a shock start to the year, with panic abounding about a "hard landing" in China and oil prices plummeting to under US$30 per barrel. The fears have proved overblown, with recent data showing the Chinese economy growing at a solid rate of 6.7 per cent, in line with official targets. The oil price has also recovered through the second quarter, stabilising in the $45 to $50 range.

Indeed, Emirates NBD has revised its forecast up for the average oil price this year, to $44 per barrel for Brent, up from $39 previously. While this is still too low for the GCC governments to balance their budgets this year, it does make the deficits a little more comfortable.

Come June, however, and financial markets were once again roiled by the unexpected outcome of the UK’s referendum on EU membership. Exactly how this will play out over the next couple of years is still unclear, but one of the main consequences is likely to be lower interest rates for longer around the world.

From an expectation of at least three interest rate hikes by the US Federal Reserve this year, we are now looking for at least one increase in the Fed funds rate this year. The Bank of England is expected to cut its benchmark interest rate in August to 0.25 per cent – or even lower – and the European Central Bank and Bank of Japan are also likely to ease monetary policy in the coming months.

While the GCC is relatively sheltered from the Brexit fallout, the low oil price environment has brought a different set of challenges. The key focus in the first quarter of the year was on budget stabilisation in the face of sharply lower oil revenues. Efforts to cut subsidies, rein in spending and raise non-oil revenue were evident across the region. The Saudis launched an ambitious new economic strategy to tackle key structural changes in their economy and finances.

In the second quarter, the emphasis appears to have shifted to raising external financing to cover expected budget shortfalls. The GCC governments have issued $17 billion in bonds so far this year, more than was issued in the whole of 2009, at the height of the financial crisis. Abu Dhabi and Qatar raised $5bn and $9bn, respectively, in the last quarter, with Qatar’s bond issue at the end of May nearly double the expected size.

There is more to come after the summer, with Saudi Arabia expected to issue $10bn to $15bn in international bonds before the end of September. Kuwait has also indicated it is planning to raise close to $10bn in international bonds this fiscal year, to help plug its projected budget deficit for the 2016 to 2017 fiscal year.

In some respects, the outlook for global interest rates post-Brexit is marginally positive for the GCC. With interest rates in developed markets expected to remain lower for longer, the highly rated bonds issued by the GCC governments are likely to prove very attractive for institutional investors on the hunt for yield.

As regional governments turn to external financing, the pressure on domestic interbank rates should ease as well. Increased government borrowing within the GCC, and in some cases declining government deposits at commercial banks, have contributed to tighter liquidity conditions in the GCC banking sector, pushing up three-month interbank rates in the first half of this year.

Provided oil prices remain around current levels and the GCC governments are able to successfully raise planned external financing during the current quarter, we expect the pressure on the domestic banking system liquidity – and thus interbank rates – to ease in the coming months.

Khatija Haque is the head of Mena research at Emirates NBD.

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