Gulf Arab governments may be pressured into increasing sovereign borrowing next year to raise funds on behalf of state-linked companies, as wide credit spreads make raising corporate debt expensive.
This year, Bahrain, Qatar and Dubai issued sovereign bonds, and all paid hefty premiums demanded by investors because of the turmoil in global financial markets. Even AA-rated Qatar paid a new-issue premium of about 40 basis points on the five-year tranche of its $5 billion mega bond in November.
Corporations have faced even more scepticism from investors, so the vast majority of the Gulf's non-sovereign bond issuance this year has been by banks or top-rated government-related entities (GREs), with many other potential borrowers forced to delay issuance plans until pricing improves.
Middle East issuance of international bonds totals about $29 billion this year, according to a preliminary estimate by Thomson Reuters, compared to issuance of about $32 billion last year in the Gulf Cooperation Council alone. At the beginning of this year, analysts had expected 2011 volumes to be much higher.
Most major corporations in the Gulf are government-owned or connected to the state in some way -- for example, through large stakes held by sovereign wealth funds or ruling families. So if market conditions remain tough, governments will be tempted to increase their sovereign issuance and then funnel some of the money raised to companies via cheap loans or other channels.
"The challenging macro environment globally has driven costs of funding significantly higher, and this is likely to raise the question of whether governments in this region should consider borrowing centrally on behalf of the GREs," said Chavan Bhogaita, head of the markets strategy unit at National Bank of Abu Dhabi.
At the same time, the need for companies to issue bonds may soon become pressing. The region faces massive corporate refinancing needs next year, at over $50 billion according to some estimates. Tapping the bond market has become more important as the euro zone debt crisis has caused the international syndicated loan market to freeze up for all but the top credits.
Saudi Arabia may already be moving towards issuing debt in order to reduce the funding burden on companies. The Saudi Arabian Monetary Agency is talking with local and international banks with operations in the kingdom about issuing a riyal-denominated sukuk as early as in the first quarter of 2012, banking sources told Reuters this month. It is expected to be the country's first substantial issue of government debt for several years.
Bond price movements in recent months show how attractive a strategy of central financing for corporations might be. The yield on AA-rated Abu Dhabi's $1.5 billion, 6.75 per cent sovereign bond due 2019 was at 3.25 per cent on Wednesday, having dropped about 75 bps since early October, when the euro zone crisis took a turn for the worse.
By contrast, AA-rated International Petroleum Investment Co (IPIC), a state-owned Abu Dhabi investment fund, had to pay through the nose when it reopened Gulf bond markets in October with a bumper three-tranche, $3.75 billion issue. The $1.5 billion, 5.5 per cent 10-year tranche was at 5.6 per cent this week, roughly flat from the time of issue.
Abu Dhabi National Energy Co also paid a premium for its $1.5 billion deal in early December, of around 25-35 bps for the five-year portion and 20-30 bps for the 10-year tranche.
Some believe new sovereign issuance could help lower financing costs for a wide range of companies, effectively setting a new benchmark for corporate fund-raising.
"Government bonds should help set new benchmarks," said one regional fixed income trader. "Qatar sovereign would surely be able to raise money at lesser cost than say Qatar National Bank or Rasgas."
But such a strategy of centrally financing companies' debts would carry risks. Increasing government bond issuance could weigh on sovereign pricings, and by shielding companies from direct pressure in the capital markets, it might set back efforts to make company managements more efficient and accountable.
"This puts too much responsibility on the sovereign," the trader said, adding that governments should incentivise companies to improve their financial management and performance rather than giving them a safety net.
Martin Kohlhase, analyst at Moody's rating agency in Dubai, said: "Corporates tapping the market individually rather than centrally help to increase transparency, promote accountability, and ensure the efficient use of capital when the price of debt is adequately reflecting the associated risks of the underlying credit.
"Central funding would hamper these efforts and might result in an increase of interest rates of the fund-raising entity depending on its capacity to raise debt."
Entities in Dubai in particular may need to rely on some form of government support to help refinance existing debt or raise new debt from capital markets. Dubai-based GREs could struggle to raise funds next year because of tough markets globally and the fallout from the 2009 Dubai debt crisis.
The head of Dubai's supreme fiscal committee said this month that the government might look into refinancing part of some $4 billion in GRE debt maturing next year, presumably through issuing new bonds or loans.
Investors remain concerned not only about individual Dubai entities but about Dubai as a whole, however; the sovereign's five-year credit default swaps are near 450 bps, far above 125 bps for Abu Dhabi. So government borrowing to help individual Dubai GREs might not instil much confidence in the emirate's overall ability to handle its debt problems.
Bhogaita said a centralised funding strategy should only be a short-term solution.
"Otherwise there would likely be adverse consequences such as negative impact on the development of the regional bond markets and on investor sentiment, both of which would undo some of the valuable work done up to now by governments and issuers in the context of global capital markets."