Analysts in the Arabian Gulf tend to focus exclusively on oil prices, overlooking a crucial fact – the GCC economy runs on government spending. Of course, oil is the main source of revenue, but it is not the only one.
Debt can play a similar role, just like it did in most of the world in the decade before the 2008 crisis. GCC governments, aware that public spending is crucial to ensure social stability, have increased expenditure steadily over the past five years.
In Saudi Arabia, public spending rose to 40 per cent of GDP from 33 per cent; in Qatar to 37 per cent from 29 per cent; in Oman to 53 per cent from 41 per cent; and in Kuwait to 56 per cent from 39 per cent.
Low oil prices were not a deterrent. In fact, the largest part of the increase took place after the 2014 collapse in prices.
The message is clear – authorities are willing to tap the debt market to fund rapidly growing deficits, especially in Saudi Arabia, where the US$100 billion shortfall is likely to become the norm.
Deficits will increase this year and next, reinforced by the environment of uncertainty brought about by the Brexit vote and the diverging economic cycles in the United States and the rest of the world. Even if oil prices accelerate, the rising pressure of subsidies and entitlements will eventually force governments to rely on the issuance of debt.
The economic and financial implications are significant. First, growth in the Gulf economy will remain relatively stable, probably above 2 per cent, even if the global economy decelerates further. Some expenditure rationalisation will take place, but it will remain limited to secondary aspects without affecting the bulk of salaries and subsidies, the largest components of the budget.
Second, the supply of bonds in the market will increase sizeably. In addition to governments, state-owned companies, which will struggle to obtain cash handouts from their governments, and banks, seeking to improve capital quality to comply with Basel III regulations, will put more bonds in the market. Last year was the turning point – according to Kuwait’s Markaz, the total issuance of bonds and sukuks in the GCC rose 37 per cent to $119bn, about a third of the total equity market capitalisation of the Saudi stock exchange early this year.
The growth came almost exclusively from the sovereign bonds segment – Saudi Arabia issued for the first time since 2007, a total of $30bn. Qatar printed $9bn worth of bonds and Abu Dhabi $5bn, its first time in seven years. The trend is expected to continue this year, with Saudi Arabia and Kuwait preparing bond sales worth more than $30bn this year, mostly for the international market.
By historical standards, yields are not particularly high, at least in the longer-term paper. Saudi Arabia’s 10-year bonds were issued at 2.65 per cent, Abu Dhabi’s at 3.125 per cent and Qatar went above 3.5 per cent.
However, these yields are significantly above those found now in developed economies. Many countries are offering negative rates, and the 10-year American bond is trading at 1.41 per cent. It beats also yields offered by most countries with a credible peg to the dollar. Hong Kong, for instance, offers about 1 per cent in its bonds.
The region also offers a variety of risk-adjusted returns – investors willing to take more risk have a range going up to 7 per cent in Bahrain. More interesting is the short-term paper – a one-year Saudi bond offers 2.5 per cent, compared to a one-year US Treasury yielding 0.45 per cent.
But beyond the yields, these developments are good news for regional investors.
The bond market in the GCC is vastly underdeveloped. Globally, the stock market is half the size of the bond market, while in the GCC stock markets are five times bigger. The current trend will expand the market, strengthening the nascent secondary market. Bonds also fit well with the profile of local investors, who like income-generating products, particularly in volatile times such as these.
Financial institutions will have to start making room in their portfolios for a larger share of bonds if they want to avoid lagging behind the market and losing clients to competitors.
Francisco Quintana is the head of strategy at Foresight Advisors in Kuwait
