Oil price weakness clouds outlook for Arabian Gulf corporate bonds

There are, however, some factors that could encourage existing and new issuers to tap the capital markets, writes Karim Nassif of Standard & Poor's.

Oil’s retreat has triggered a slowdown in government spending across the region. Phil Weymouth / Bloomberg

The dramatic decline in crude oil prices over the past year has left some corporate and infrastructure companies in the GCC region facing a much weaker operating environment.

It is not hard to see why this is the case. Oil’s retreat has triggered a slowdown in government spending, on which many of these companies largely depend. A weakening global economy is also making potential issuers increasingly cautious about investment at home and abroad.

In the year that ended on August 31, the value of corporate bonds and sukuk issued fell 58 per cent to about US$7 billion, compared with the previous 12-month period.

This decline in issuance was partly because of the tightening of budgets at key government-related entities (GREs) that carry out important roles in infrastructure projects on behalf of their respective governments.

In some cases, limited government budgets have prompted the cancellation of infrastructure projects.

The extent of the fallout, for now, is manageable. We observe that GCC governments continue to invest in large projects.

The real risk is that oil prices remain near current low levels and we see more government-linked infrastructure plans postponed, or even dropped.

Nevertheless, in the coming year there are some factors that we believe could encourage existing and new issuers to tap the capital markets.

Declining liquidity at GCC banks, a consequence of reduced deposits from government and public sector deposits, could help to spur issuance activity.

Opening up markets to foreign investment, as in Saudi Arabia this year, is another event that could propel new issuance.

We note that GCC sovereigns are trying to create more attractive conditions for the private sector and international foreign investment to more equally distribute the burden of infrastructure spending and alleviate fiscal constraints on government coffers.

Another factor to be considered over the coming year is refinancing risk.

By our estimates, about $25bn of corporate and infrastructure sukuk and bonds will mature over 2016 to 2018.

The resulting refinancing needs could also support capital market issuance by corporate and infrastructure entities over the same period.

Although some of these events may spur GCC capital market issuance over the next 12 months, we consider that these currents will be somewhat offset by pressure on governments to reduce capital expenditure and curb subsidies, which could hamper domestic consumption and prompt headwinds for issuance.

Despite our forecast for a tougher pricing environment ahead, we still expect that GCC issuers will have sufficient financial headroom to withstand the stress of major monetary events such as a rate hike by the US Federal Reserve.

Even if the Fed were to raise rates by 150 to 200 basis points, this, in our view, would not rock the creditworthiness of the Gulf entities that we rate.

Energy subsidy cuts by Bahrain, Oman, and the UAE governments have shown that governments in the region are becoming increasingly cost-conscious.

This could increase financial pressure on downstream corporates in the region. Governments are currently protecting large public sector investment budgets to support economic growth. Yet the longer the oil price remains near its current lows, the more likely it is that these could be postponed or cut.

Karim Nassif is an associate director at Standard & Poor’s in Dubai.

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