GCC credit outlook is positive amid economic resilience and pro-market initiatives

Mohieddine Kronfol

An agreement between Greece and euro-zone leaders this week that opens the way for a third bailout reduces the risk of a Grexit in the short-term and possibly excessive volatility in the markets in the quarter ahead.

Comments from the Federal Reserve chairwoman Janet Yellen point increasingly to a rate hike before the end of this year.

A modest move in the direction of monetary policy “normalisation” in the months ahead would remove another of the uncertainties that continues to hang over markets.

With that in mind, it is worth noting that credit spreads globally, including in the GCC, remain wider than the levels of last summer. In combination with the recent rise in benchmark yields, we thus think that the outlook for credit looks attractive in the second half of this year.

Looking back, the continued low correlation between GCC bonds and the rest of the world, and in contrast with global and emerging market bond indexes, the Citi Mena Broad Bond Index had a mildly positive quarter, returning 0.04 per cent (in US dollars) in the second quarter.

GCC members benefited from some stabilisation of oil prices during the second quarter, sound economic data, and a number of pro-market policy initiatives.

The most prominent of these was the opening of Saudi Arabia’s stock market to direct foreign investors last month, which was regarded as marking an important step in the progressive financial market reforms being undertaken by the kingdom to attract greater overseas investment and expertise.

Indeed, the Saudi authorities announced last month that they might shortly tap the domestic debt market. By setting a benchmark, a Saudi government bond issue would be a positive development for Saudi financial markets in general.

Meanwhile, the Saudi economy has continued to hold up well, thanks to the increase in government spending to compensate for lower oil prices. The purchasing managers’ index (PMI) softened after a particularly buoyant first quarter (when the economy grew at an annual rate of 2.4 per cent), but remained strong, while domestic demand appeared to firm ahead of Ramadan. The government continues to support growth by using existing large financial buffers, leading Saudi foreign currency reserves to drop for the fourth consecutive month in May.

The UAE has also remained relatively buoyant. The PMI reading for May was slightly down from April, but still indicated solid economic expansion, while passenger numbers at Dubai International Airport exceeded 6.5 million in three of the first four months of this year. Meanwhile, final GDP figures for last year were released, showing that real GDP in the UAE grew 4.6 per cent.

The second quarter ended on a tricky note. The upsurge in bond markets volatility, abetted by the Greek situation, resulted in record outflows from global high-yield exchange-traded funds (ETFs) and classic mutual funds.

However, the broad price impacts of a possible Greek exit from the euro zone and of flight from high yield have arguably been more muted than expectations.

Furthermore, credit spreads have proved relatively resilient to the volatility of benchmark rates in recent weeks.

As for GCC bonds, we believe that the intrinsic strengths of GCC countries help to explain why spreads on debt in the region have remained comparatively low in spite of the growing volatility in global bond markets.

We are optimistic about the potential for reform in the GCC region. Examples include the progress made in the UAE towards the introduction of corporate tax and value-added tax, which should go a long way towards alleviating some of the fiscal vulnerabilities to oil price swings. We also expect an expansion of the Saudi corporate bond and sukuk markets to help companies raise money efficiently as state finances and bank liquidity come under pressure from last year’s steep drop in oil prices.

Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments Middle East.

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