The GCC is raining debt issuances. From almost nothing a few years ago, all we hear and read these days is the jumbo-sized bond issuances from Saudi Arabia, Qatar, Kuwait, Bahrain, Abu Dhabi etc. The Saudis just closed a successful US$17.5 billion issue that was oversubscribed by more than four times, while Qatar raised $9bn in May followed by a $5bn sale by Abu Dhabi. Even by international standards, these are big-ticket issues.
Why such a sudden rush to issue bonds overseas?
The straight answer should be the growing fiscal deficit or budgetary gap between income and expenses. The IMF expects that GCC deficit to touch nearly $400bn cumulatively between next year and 2021. That’s huge in size measured by any standards. Having missed diversification opportunities several times in the past, it is nearly impossible to bridge this gap through non-oil income such as taxes and levies. More importantly raising non-oil revenues through a reduction in subsidies can be contentious and unpopular. Given the welfare economic model where GCC citizens are taken care of from cradle to grave, such sudden rushes to roll back subsidies can unsettle the social contract that the citizens enjoy. Given these constraints, the deficit can only widen or at best remain where the current estimates lie.
Hence there are only two options: dip into reserves or borrow. Saudi Arabia tried the first method last year, when its reserves drained from $731bn to $615bn. However, it reversed course and resorted to borrowing. It started with domestic borrowing before venturing overseas.
So why are GCC countries sitting on vast reserves and a deep banking sector and resorting to global bond issuances? The answer to the first question is simple: the opportunity cost of reserves is far higher than the cost at which monies can be raised. In other words, monies parked in reserves earn far more than cost incurred to raise similar sums. Although the Fed is on an interest-rate increase mode, rates are still at very low levels. What better time than now to borrow? Regarding the second question as to why global and not domestic, there is capacity issue for local banks. Also governments may fear that local issuances can crowd out credit growth for the private sector.
So are these bond issuances a sustainable strategy for the long term? Given the low debt-to-GDP ratio for key GCC countries, this appears a good and sustainable strategy. Overseas leverage levels are becoming unsustainable thanks to Japan (250 per cent of GDP), Europe (91 per cent) and the US (108 per cent). The current debt level of the GCC, at 15 per cent, appears very modest.
So what should we be worried about?
Many things. Firstly, increased debt-to-GDP ratio raises the risk of a lower credit rating. Already, Bahrain has fallen from investment grade to junk grade. Rapid deterioration in credit rating will mean higher cost of capital for future issuances. Secondly, credit default swap spreads (an indicator of risk perception) will spike. It is already increasing. Thirdly, the spurt in debt issuances is happening without proper debt management infrastructure. GCC governments should install a well-run debt management office if they have to broad base investors in these bonds. Finally, an active secondary market for these issuances is a must to develop the much-needed yield curve. A GCC secondary market totally dedicated to dealing only in bonds can be a good idea given the scale of bonds to be issued but a lot of work would be needed to build it. This would also help corporates jump on the bandwagon of raising debt. Presently, corporates depend near totally on the banking system.
So the fruit may be hanging low, but can be sour if not managed properly.
The article originally appeared in The National | Business