Saudi Arabia’s first sovereign bond issue has been a success. The bond raised US$17.5 billion, the largest ever by an emerging market country, was around four times subscribed, totalled orders of $67bn, and since its issuance last week it has performed well in the secondary market.
This bond issue was well distributed globally, especially among investors in the Americas, who covered close to half of the order book. There is not much else that a debut sovereign issuer can ask for.
This is an important event from an economic perspective, and important for corporate bond issuers in the kingdom and the wider Arabian Gulf, particularly in the UAE. It’s important the issuance went well as the kingdom plans to be a prolific issuer through 2020, with about $100bn of it.
This could easily have been a much bigger offering and priced more aggressively. It was smart by banks and issuers to leave some upside for investors – a window has been left open for future deals.
True, investors demanded a bigger premium over similarly rated US Treasuries to hold the Saudi bonds than in recent offerings by Qatar and Abu Dhabi. That is a given – Saudi is rated A1 by Moody’s, two steps lower than Qatar – but the gap is narrowing fast.
More than 1,500 accounts put orders in for the 30-year bond. Spreads are tightening, and the five, 10 and 30-year bonds, which were all issued below par, are heading higher. The kingdom raised $5.5bn in the five and 10-year bonds and $6.5bn in 30-year debt.
That is a clear sign of a not-too-greedy issuer that is also skilful in pushing for long-dated debt. Investors were happy to take up 30-year bonds, which is a testament to the country’s long-term debt sustainability and credibility.
Saudi Arabia priced the 30-year note at the same spread that higher-rated Qatar printed its similarly dated bonds in May, at 210 basis points over Treasuries.
Investors provided an affirmation of Saudi Arabia’s long-term diversification plans and Deputy Crown Prince Mohammed bin Salman’s much-needed economic overhaul programme.
Saudi Arabia’s debt to GDP, including the latest bond, is among the lowest in the world at 12 per cent. In contrast, Italy and Portugal have surpassed 125 per cent and Greece is at 177 per cent.
Given Saudi Arabia’s dollar peg, it has tools available on two fronts during an era of low oil revenue – fiscal policy and oil. Saudi is fiscally consolidating and reducing profligate spending. On oil, it is proactive on output cuts.
Saudi Arabia’s minister of energy and industry Khalid Al Falih said many nations are willing to join Opec in cutting production to secure a continued improvement in oil prices.
Russia has said it is considering an output freeze or a reduction. Brent could assume levels above $60 next year and $70 in 2018. Higher oil prices will eventually help to tighten spreads (cost of borrowing) for the current tranche of bonds as well as future ones.
The bond provides a fiscal bonus that can over time alleviate some domestic liquidity pressure to support pro-cyclical fiscal policies and provide dollars to the system. It seems that investors have been prepared to overlook, for now, the damage low oil prices are inflicting on Saudi Arabia’s economy. A rising budget deficit is forcing the country to cut generous subsidies.
This first bond offering will go a long way in reassuring investors that there is change and fiscal consolidation is taken seriously.
However, financing productive public investments that spur private sector growth, confidence and consumption are central. They will also allow the country to start repaying debts to its contractors.
The IMF has projected a fiscal deficit of 13 per cent this year, compared to 15.9 per cent last year and 9.5 per cent for next year.
Saudi Arabia had $73bn in direct government debt as of the end of August, $63bn of which was raised from monthly sales of local currency debt from local banks.
The Saudi riyal offerings and a drop in deposits as well as lower confidence have tightened liquidity in the country’s banks, prompting lenders to raise the interest rates they charge one another for loans.
The three-month Saudi interbank offered rate has climbed for 15 straight months, more than trebling to 2.38 per cent over the past year, the highest level in more than seven years.
Nevertheless, markets are responding favourably to the changes in Saudi Arabia. Five-year credit default swaps have been falling over the past month. The cost to insure Saudi debt against default has fallen this month as a reflection of improved fiscal outlook.
The sense that foreign investors are prepared to give Saudi time to adjust is also likely to have an effect on local confidence. The sense of success in the bond market will also be reflected in the equity market outlook.
Equity market liberalisation, in particular Saudi’s ultimate inclusion in the MSCI benchmark, should be a centrepiece of this. It is broadly expected that MSCI will add Saudi Arabia to the watch list next year for a potential announcement of an emerging market inclusion by 2018, and eventual implementation by 2019.
There are also other benefits – now there is a benchmark from which to price Saudi corporate bonds, as they will find it far easier to issue bonds at more competitive pricing. The debut sale will allow for other issuers in the region as well. Jordan is preparing another bond and others won’t be far behind.
The bond issue should relieve pressure on Gulf markets more broadly. Uncertainties about the implications of a slowing economy and rising fiscal dangers have spilled over into regional markets, also depressing valuations there. For the reasons discussed above, this doubtfulness can potentially wane.
The UAE, which has the best underlying story, is set to benefit over the short to medium term.
John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh.
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