Market analysis: Reliable fixed income returns

UAE bank deposits climbed to Dh22.1 billion in December 2015, the biggest monthly increase on record since May 2014. Silvia Razgova / The National

Regional fixed income in­dexes generated solid returns last month.

Liquidity worries with respect to some GCC economies ebbed somewhat, with bank deposits in the UAE climbing to Dh22.1 billion in December 2015. This was their biggest monthly increase on record since May 2014, and followed another rob­ust Dh14.1bn increase from November 2015. In addition to quelling some region-specific liquidity concerns, this development also helped to ease interbank rates.

In a February report from Fitch Ratings, the agency stated that it believed the timing and size of bond issuance from the UAE is uncertain, but assumed Dh40bn in local market issuance for 2016, and an additional Dh60bn for 2017, effectively replacing the Dh100bn in certificates of de­posit issued by the UAE Central Bank and held by local banks.

Saudi Arabia is also expected to utilise domestic sources of liquidity in 2016. The manner in which GCC economies will finance forecast budget deficits and refinance bonds – possibly in a scenario featuring continued low oil prices and rising rates on top of ratings downgrades – remains a focus for analysts.

Among the many ongoing reforms that are being planned or enacted by GCC member states, in February the group fin­ally agreed to implement a region-wide 5 per cent valued-added tax, which is scheduled to take effect latest by January 1, 2019, with some essentials being exempted.

Ratings changes

The ratings agency Standard & Poor’s downgrades of several oil-exporting economies, based on revisions in oil price assumptions were notable in February.

The sovereign credit ratings of Saudi Arabia, Oman and Bahrain were among those downgraded. Saudi Arabia was downgraded two notches, from A+ to A-, Oman was downgraded from BBB+ to BBB- and Bahrain was downgraded from BBB- to BB, marking the first time since 1999 that a Gulf state has been rated below investment grade.

Several corporate issuers were also downgraded as a result of the actions on sovereign ratings, including Saudi Electricity and Sabic, plus some banks and issuers in other industries. Oman’s long-term issuer rating was also downgraded by Moody’s Investor Service, to A3 from A1, again due mainly to oil prices.

Issuance

Bahrain made two attempts to tap two of its outstanding issues last month. A first attempt was retracted because its timing coincided with the previously mentioned ratings downgrade. The sale was revived later, with US$275 million tapped from Bahrain’s 2021 bond, at a yield of 5.95 per cent, and $325m tapped from its 2026 bond, at a yield of 7.65 per cent.

Both issuances exhibited material concessions from pre-downgrade levels, and both appeared to attract investor interest.

Market outlook

While the GCC does not face the same concerns regarding the outlook for currencies as other emerging markets, its fixed income markets did post strong returns last month, buoyed by the improved risk sentiment, and delivered performance in line with emerging markets. The Citi Mena Broad Bond Index was up 1.8 per cent and the Dow Jones Sukuk Index rose 1.09 per cent.

This was, to some degree, a normalisation of an uncharacteristically weak January – which we continue to believe was a temporary dislocation – and a reflection of the attractive valuations currently on offer in the market.

The real focus will ultimately be on the credibility and efficacy of policy initiatives that are being developed or already commenced, and that need to be communicated by the governments of the GCC as they adapt to current economic realities.

While there remains some discussion in the broader investment community as to whether the actions undertaken are sufficient or if more reforms are needed, we remain reassured that the changes signal a serious commitment from GCC governments to greater financial discipline and economic improvement and diversification.

We believe current reform measures have worked towards addressing some of the deficits and pressure on foreign exchange reserves, and continue to caution that the current array of economic reforms is likely to cool growth in the short term, but will leave the GCC economies stronger in the medium and long term.

Furthermore, we will monitor the impact of the reform measures on corporate results, in addition to public finances.

Mohieddine Kronfol is the chief information officer for fixed income and global sukuk at Franklin Templeton Investments (ME).

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