In stark contrast with the second quarter of 2018, when emerging market borrowers were preparing to reckon with what was thought to be a protracted and synchronised interest rate hiking cycle (which only partly came to pass) followed quickly by a bear market in EM assets (which very much came to pass), market sentiment is buoyant.
The growth outlook in the near term looks to be improving. GDP growth in the GCC is expected to trend between 2% and 3% according to the IMF, with the UAE forecast to grow 3.5%, according to the UAE Central Bank. This compares favourably with the 2.8% growth seen last year. Non-oil growth is also likely to rebound to 3.4% in 2019, up from 2.6% last year, driven in part by a variety of incentives and stimulus packages introduced by the Abu Dhabi and UAE governments to make it easier to secure investment from partners abroad and launch new businesses. In Saudi Arabia, PMI indicators suggest the country is in the midst of experiencing the strongest non-oil private sector growth since December 2017.
In the UAE and in Saudi Arabia, two of the region’s largest economies, a rise in business confidence in key domestic sectors like manufacturing, professional services, and tourism, blended with concerns over the trajectory of interest rate rises in the US and Europe, has inspired GCC borrowers to tap the market en masse during the first quarter of this year.
GCC Credit: Off to a Strong Start
Investors, seeking relative value in emerging markets with strong fundamentals and political stability at a time when both are being questioned in many traditionally stable countries, have been happy to oblige. Fixed-income investors have poured more than UDS170bn into emerging market hard currency bonds since the first week of January, with nearly one fifth of that sum making its way into debt originating from the GCC region, according to Bloomberg and EPFR fund flow data.
Bond, sukuk and international loan syndication volumes have been robust in most segments of the GCC credit universe. On the sovereign front, Egypt placed USD4bn across three tranches in the international markets, managing to secure strong pricing on its first international transaction of the year – followed promptly by a heavily oversubscribed EUR2bn dual-tranche transaction that saw negative new issue premium. Saudi Arabia placed USD7.5bn in January, and in March, Qatar sold USD12bn across three tranches – including a Formosa tranche marketed specifically to Taiwanese investors, demonstrating strong appetite for GCC credit from investor communities in Asia.
Borrowers in Saudi Arabia have been particularly active during the first quarter. Almarai became one of the first private sector corporates to tap the sukuk market with an impressive five-year transaction, raising USD500mn. In March, the Saudi Mortgage Refinancing Company raised SAR750mn – or roughly USD200mn – through a very well-subscribed sukuk issuance, part of the organisation’s long-term funding strategy that could see it tap the capital markets for up to SAR11bn in the years to come. Saudi Aramco’s landmark debut in the bond markets saw the oil giant establish a curve out to 30 years in one fell swoop, securing record demand for any emerging market issuer.
The FI market has come roaring back, a trend that began in the last few months of 2018. Since January this year, we’ve seen Bank Dhofar tap into the perpetuals market with its OMR40mn trade, while Emirates NBD and Mashreqbank both returned to the dollar markets. First Abu Dhabi Bank returned to the sukuk market following its inaugural transaction the year before, raising USD1bn across two transactions – upsized twice on the back of strong demand. Emirates Development Bank took the opportunity to launch its debut USD750mn bond transaction, becoming the first federal entity to tap the international credit markets following the introduction of the federal debt law in October last year.
The loan markets have been particularly active as well, in Saudi Arabia and the wider region. Some more recent notable transactions include Emirates Global Aluminium’s USD6.5bn term loan facility, Saudi Electricity Company’s SAR15.2bn Murabaha loan, Apicorp’s SAR1.5bn syndication and The Saudi Arabia National Shipping Company’s USD133mn loan transaction, as well as Al Dur’s USD1.3bn five-year transaction, and Empower’s AED1.5bn syndication.
A New Global Risk Paradigm: Where Does GCC Fit In?
But the impressive start to the year in the Middle East stands in stark contrast to what has been seen in emerging markets and high-yield markets more broadly, prompting some of the region’s borrowers to look further afield for clues that could give any indication of whether or when sentiment or the funding environment will shift. Global high-yield issuance is down 20% year to date, as are emerging market bond volumes, driven by declines in Asia (7% down year to date) and Latin America (50% down year to date). According to Dealogic: “Global DCM markets started 2019 with moderate performance, as the first quarter of the year saw a 4.4% decrease with respect to the same period in 2018. A total of $1.89tr was sold in Q1 via 5,152 deals (vs. $1.97tr and 6,012 in Q1 2018). Despite a year-on-year decline, the current issuance represents an improvement with regards to the last quarter of 2018: a hefty 42.1% increase compared to $1.33tr distributed in Q4 2018.”
“We are assessing the markets and noticing many organisations in the GCC have issued in recent months, but are they just trying to get in front of interest rate hikes, or is there something deeper going on?”, asked one CFO. “Is what we are seeing in the rest of the emerging market world a sign of what’s to come in the GCC?”
Jean-Marc Mercier, Global Head of Debt Capital Markets at HSBC thinks that it is too early to tell. He explained that while it’s still a good time to borrow in the international markets, he is concerned by the pace at which the macroeconomic and monetary policy environment is evolving.
“Ordinarily, when you see the yield on 10-year US Treasuries falling, spreads are supposed to widen – but that simply hasn’t happened for most credits, which creates opportunities for borrowers to lock in rates and capture real value from tapping into the international markets.”
“But I am worried by the speed at which we are moving from rate hikes to rate cuts.”
Both the US Federal Reserve and the European Central Bank have shifted their positions significantly from just six months ago, striking a much more dovish tone that could see the former potentially start cutting rates as early as 2020 and the latter opting to keep rates on hold for the remainder of 2019.
For CFOs and Treasurers among others, the overriding concern in this environment is one of reduced visibility, which in the GCC has been exacerbated by other macroeconomic factors that include the varying pace of VAT implementation across the region, which has reduced organisations’ ability to accurately forecast cashflows, and oil price uncertainty, which has a cascading impact on everything from public investment to banking liquidity.
How this environment weighs on the ability for borrowers to secure long-term, cost-competitive funding today was a focal point for the discussion, with some CFOs expressing interest in novel or innovative credit formats that can help them differentiate themselves among global investors.
“Finding long-term credit solutions in an environment, where global growth is lower and cashflow uncertainty is higher, is a big challenge for us,” one Treasurer explained. “We are nervous that investors increasingly prefer shorter-tenor instruments, but we have long-term projects to finance so we need to fill that gap regardless of the market conditions.”
MENA’s Green Shoots
For many organisations in a broadening array of sectors, structuring transactions in a green or ESG-linked format could help fill that gap, particularly from a tenor perspective. Investors that buy green bonds or similar instruments linked with ESG also tend to be more engaged with the organisations they invest into, in part because they need to familiarise themselves with specific projects being financed through these instruments.
“What we’ve tended to see on green versus conventional issuances is that green issuances tend to have better execution characteristics. By issuing green, an asset class where we’ve seen tenors stretch out to 20 and 30 years to match underlying projects, you are anchoring your orderbook with investors – specifically, investors who are keen to engage with you over the long-term because they are financing long-term projects,” Mercier explained.
The commitment to regular reporting typically implied by issuing a green bond or similar instrument linked to ESG outcomes is often seen as an added cost among CFOs and Treasures, particularly in the GCC, where the asset class has struggled to gain traction when compared with other emerging market regions like Asia or Latin America.
But anecdotal evidence suggests that is starting to change. Looking eastward to Indonesia and Malaysia, which have seen rising green sukuk issuance sold both internationally and domestically, GCC-based CFOs and Treasurers are looking at ways of structuring sukuk in a green format to help attract strong local investors, while at the same time elongating tenors beyond what is typically seen in the region’s sukuk markets.
“Reporting should not be seen as a cost; it is in fact an asset, and hugely important. When a downturn happens and investors need to sell to free up liquidity, that relationship is going to pay dividends in the form of investor conviction. Investors that know you, know your organisations and its projects, and like your story, will be less inclined to sell. This is partly why green bonds trade slightly more stable than conventional peers. And at the end of the day, that strong secondary market performance enhances the attractiveness of your credit.”