Last month was eventful for Saudi Arabia, marked by the death of King Abdullah. However, the orderly succession of Crown Prince Salman to the throne and the nomination of his half-brother, Prince Muqrin, as the new crown prince provided a reassuring sense of continuity.
Furthermore, the appointment of Prince Mohammed bin Nayef as deputy crown prince is an important development, as he is the first from the younger generation liable to inherit the kingship.
A supplementary US$30 billion spending programme aimed at boosting the income of Saudi citizens was also introduced (amounting to about 4.5 per cent of GDP). The moves towards intergenerational succession and the spending package showed swift decision making and addressed major investor concerns regarding the kingdom.
In addition, the Saudi authorities remained adamant that budgeted spending plans, which are set to expand by 0.6 per cent this year, would be maintained, with continued priority given to key infrastructure projects.
A 145bn Saudi riyal (Dh142bn) deficit is projected (4 per cent of GDP) for this year, but this can be comfortably managed given the country’s net foreign assets (close to 100 per cent of GDP) and debts outstanding that represent less than 2 per cent of GDP.
Saudi Arabia’s GDP, adjusted for inflation, expanded at an annual rate of 2 per cent in the fourth quarter, much lower than growth of 3.6 per cent last year as a whole.
Growth forecasts for the GCC countries were revised downwards, with the IMF slashing its 2015 growth forecast for the UAE from 4.5 per cent to 3.5 per cent. Yet in January, Dubai unveiled a $11.1bn budget for 2015, 9 per cent higher than in 2014. In a sign of the emirate’s expectation that conditions will improve, the budget is based on a zero deficit.
We acknowledge the recent data misses in the United States in areas such as retail sales and manufacturing, as well as the slowdown in overall GDP growth in the fourth quarter compared with the high rate (5 per cent annualised) in the third.
However, we believe that the recent decline in Treasury yields does not necessarily reflect prospects for the US economy — growth continues apace and the full impact of falling oil prices and rising employment has yet to be felt. Yet the Treasury market ended the month at levels that pushed market expectations of the first rate increases well out towards the end of this year, on the basis of what was perceived as a January policy-meeting statement by the Federal Reserve.
Given the dichotomy between market expectations and our expectations of rate normalisation in the US, we believe the play-off between risk and reward is not attractive enough to take active-duration risk. By contrast, we continue to focus on credit stories that we think benefit from the continuing growth of GCC countries and their bond markets.
The decline in oil prices is naturally an area of concern for the region and can pose challenges to member countries of the GCC.
But thanks to the large surpluses they have accumulated in recent years, most GCC governments have maintained large spending programmes, even if it means running deficits this year and next.
There are also signs that the drop in oil prices is spurring reform to energy subsidies throughout the region.
The reduction in subsidies is well advanced in oil-importing countries such as Egypt, but even oil producers such as Kuwait and Oman have moved to raise the price of hydrocarbon products in recent months. On a more clear-cut positive note, oil prices do seem to be stabilising. The 8 per cent surge in oil prices on the final day of last month in reaction to a bigger-than-expected decline in the number of rigs drilling in the US suggests the market may be in the early stages of returning to balance.
The fundamentals of GCC bond markets remain broadly intact, and recent market volatility has created quite a few attractive opportunities, in our view, that require assuming neither interest rate risk nor currency risk, providing a compelling rationale for continued GCC bonds outperformance this year.
Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments Middle East.
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