Saudi Arabia’s upcoming international sovereign bond sale will be a litmus test of global investment appetite for the Arab world’s largest economy as it embarks on a plan to wean itself off oil dependency.
The kingdom, the world’s largest crude exporter, is said to have mandated Citigroup, JP Morgan and HSBC to manage what is expected by market participants to be a US$10 billion to $15bn bond sale. The timing of the issue is as yet unconfirmed but it could be early next month according to media reports.
That would make it the biggest ever such sale in the region. Pricing is difficult to anticipate as it will be the first ever international sale for the kingdom and there are a number of push and pull factors that may swing the coupon higher or lower, bond investors say.
On one hand, global investors have bought emerging market debt amid low interest rates in the US and $8 trillion of negative yielding bonds in Europe and Japan. But at the same time the supply of debt issued from the region has increased sharply as governments seek to plug deficits.
The Bloomberg US Dollar Emerging Market Sovereign Bond Index has gained 15 per cent this year as global investors hunt for yield.
“Emerging markets and the region in particular still look good in terms of relative value to negative yields in developed markets,” said Mohamed Jamal, managing director of capital markets at Waha Capital who oversees more than $300 million in mostly Middle East and North African stocks and bonds. “On a relative basis, the region still looks OK.”
Saudi Arabia may have to reward bond investors with bigger coupons than some of its neighbours as its deficit swells.
In April, Abu Dhabi’s Department of Finance sold a $2.5bn tranche of five-year bonds yielding 2.125 per cent and another $2.5bn tranche of 10-year bonds yielding 3.125 per cent. Qatar and Oman have also sold bonds this year at higher rates.
Since those sales, the spread on these sovereigns has tightened, amid increased demand, with the five-year Abu Dhabi bond yielding 1.92 per cent, or about 75 basis points above five-year US treasuries. In the region, the spreads on sovereign debt are tightest on Abu Dhabi bonds as it has the highest credit ratings and is considered the safest.
The closest gauge to what Saudi Arabia may have to pay is the credit default swap rate, the cost of insuring debt above the five-year US treasury rate, which is currently at 149 basis points, more than double the cost relative to US treasuries of buying Abu Dhabi bonds.
The urgency in Saudi Arabia to reform its economy is palpable as the government relies on sales of crude to fund more than 75 per cent of its budget and the deficit is understood to be between $80bn and $100bn.
The Saudi budget deficit widened to 14.8 per cent of GDP in 2015 from 2.3 per cent in 2014 amid the collapse of oil prices. Since the summer of 2014, oil has shed more than 60 per cent of its value.
At the heart of the country’s economic transformation plan is reducing the nation’s reliance on revenues from oil and coming up with new ways to raise money through taxes, such as VAT, and privatisations. The planned measures would raise at least an additional $100bn a year by 2020.
Deficits in countries across the region have also widened over the past year as the steep drop in oil prices empties coffers and forces governments to dip into sovereign wealth funds and borrow more money so they can keep spending on infrastructure and social services.
Those governments, as well as related entities and companies and banks, have also been selling bonds in international markets. The UAE accounted for $14.4bn issued in the second quarter, Qatar $9bn and Oman $5bn, according to a report published last week from the Bank for International Settlements.
“There’s finite investor appetite from the region,” said Andy Cairns, the global head of debt origination and distribution at National Bank of Abu Dhabi.
“So as more GCC bonds are issued, we face the prospect that regional investor demand may be insufficient to meet increasing supply. As GCC investors typically buy GCC bonds at tighter spreads than international investors, this will cause upward pressure on pricing as international buyers exert greater influence”.
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