A big bad bond market

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A local bond market in the UAE got a big boost last week with the passage of a federal law that would establish regulations for the issuance of sovereign bonds. Pointedly, the law sets limits on how much the UAE's federal government and individual emirates can borrow. The federal government can borrow 45 per cent of GDP under the law, while individual emirates can borrow 15 per cent, setting a theoretical maximum of 60 per cent of the country's overall GDP.

This seems to be an indication that the federal government will play an increasingly prominent role in raising money for infrastructure and other long-term development projects in the country. The new law would severely limit, for example, what the Dubai government can borrow; the emirate has at least $20bn in direct government debt, compared to a GDP of $82bn last year.

It remains unclear how the new law will affect the $70bn debt load of the so-called "Dubai Inc." government-controlled companies, but speculation so far has centered around the idea that the aura of government support for these companies may dim a bit because of the law. If Dubai as a sovereign entity has limits on its borrowings, it can by definition provide less support for government-owned companies if they run into trouble.

It's mere speculation at this point, but according to SJS Markets, a Swiss brokerage, the new law could even cause Dubai's government-owned companies to sell assets in order to pay down debt and reduce its overall borrowings. Says SJS in a research note:

The new law if enacted could limit Dubai's debt financed growth as the second largest emirate in the UAE has debt load of ~$70 bn while its GDP is ~$55 bn.  However Dubai's assets are estimated at $1.3 trillion and we feel the government could sell assets to pay down debt.

That, SJS reckons, could mean things like selling a minority stake in DP World, which the company is already contemplating offloading on Abraaj Capital, the region's largest private equity firm. That transaction alone could raise around $1.3bn, SJS says.

The more important issue here, though, is that establishing a framework for bond issuances could establish a long-awaited benchmark for bond markets. When the government issues five-year, ten-year and 30-year bonds, their yields form a basis from which all kinds of other bonds can be priced.

With a super-safe government floor to work from, investors know better what kind of added risk they're taking when they buy shares in the corporate debt of, say, one of the UAE's big developers. That, in turn, means that more companies find it easier to issue debt, both locally and internationally, simply because investors have more certainty about how their bonds are being priced.

Establishing just such a benchmark has long been a goal of regulators, policymakers and economic experts in the UAE, and last week's news appears to be a stride towards realising it.