A turning point for EM primary bond markets arrived in October 2016.
With oil prices under pressure, the Kingdom of Saudi Arabia issued its debut Eurobond for $17.5bn, followed shortly after by others including Abu Dhabi and Kuwait.
There’s been no looking back since, writes FIM Partners’ emerging market debt chief investment officer Francesc Balcells.
Total Gulf Cooperation Council issuance since 2016 has risen to $415bn, an average of $85bn per year, compared to $30bn per year during 2010-15.
GCC sovereign issuance has accounted for 30% of all EM issuance in 2020; while issuance from the Middle East, a broader universe than the GCC, has accounted for almost 45% of total EM issuance in the year to end-September.
With GCC countries becoming such large and recurrent borrowers in primary markets, J.P. Morgan added them to its family of EM indices in 2018.
Today, GCC accounts for 17% of the bellwether EMBIGD index (vs. just 2% before), which includes only sovereigns and 100%-owned quasi sovereigns (excluding other large issuers from the region such as Aramco, which is 95% government owned following its 2019 IPO).
To put things into perspective, Saudi Arabia is now the fourth largest name in the EMBIGD, larger than EM staples Brazil, South Africa and Russia, and ranking only just behind Indonesia, Mexico and China.
This trend is likely to continue with more foreign borrowing expected by the Gulf countries for the foreseeable future.
Fiscal balances for the region, which up until 2015 had averaged surpluses of 9% of GDP in the preceding five years, are now expected to average annual deficits of 3-5% of GDP through the end of 2024.
A challenging outlook for oil prices, at least judging by oil-price futures, as well as demographic and political constraints are likely to continue to exert pressure on public finances.
From a macro perspective, the higher quality sovereign issuers have room for further issuance.
Government debt ratios among single and double-A GCC credits stand around 35% of GDP and while climbing, are only near half of more mainstream EM economies.
The level of FX assets remains elevated and debt affordability is strong albeit declining. This is not the case, however, for the lower-quality GCC credits – including Oman and Bahrain – whose debt capacity is already stretched.
An expanding menu of options
Further, as sovereigns consolidate their presence in global markets, one might anticipate corporate and quasi sovereign issuance to become increasingly more relevant than it is today.
Since 2016, roughly half of the total GCC issuance has come from non-sovereign entities.
The likes of Aramco, DP World, and Qatar National Bank have been big players in global debt markets, having issued $26bn collectively over the last three years.
Indeed, debt issuance is becoming the financing vehicle of choice for M&A activity (Aramco’s purchase of Sabic) and buy outs (DP World’s acquisition by Dubai World, a 100%-owned Dubai government entity).
We expect the corporate market in the GCC to grow and the type of financing structures to expand.
What started mostly in trade finance, cross-border deposit flows and syndicated loans is now fast evolving into a wealth of structures including sukuks, green bonds, perpetual and convertible bonds (in addition to conventional bonds).
Such diversity opens up new markets, attracts new types of investors and allows for a more efficient and targeted allocation of risk by global and regional investors.
A different risk profile
GCC issuers have introduced a unique risk profile to global debt markets.
The combination of relatively solid balance sheets along with a high geopolitical-risk premium and supply concerns have brought to the table a rare mix of long-duration and highly-rated issuers trading at attractive yields.
For example, the average yield of a 10-year USD bond issued by the top quality GCC sovereign issuers ranges between 1.7–2.3%, 2.0–2.5% for quasis, and 3–4% for corporates, compared with 1–1.5% for a similarly rated U.S. corporates today.
In addition, the top quality GCC names exhibit a lower correlation to global risk markets and to the broader EM index than the more mainstream EM names.
This is due to the GCC names’ higher credit standing and broad investor base, which makes them diversifiers and risk-return enhancers in a portfolio.
Moreover, since their inclusion in the EMBIGD index, GCC countries have produced the highest Sharpe ratios among regional return-buckets.
The attractive risk profile of GCC names has appealed to a wide variety of investors, above and beyond dedicated EM fund managers, including global fixed income funds, regional investors, Asian life insurers and other insurance companies.
This trend has a good likelihood of continuing as global funds hunt for uncorrelated and high risk-return opportunities.
It also has changed some of the characteristics of EM debt itself, adding duration, and credit quality while lowering volatility.
An indispensable GCC view
All of these factors make the GCC region not only an appealing investment opportunity for global fixed income investors on its own merits, but also an integral part of the EM opportunity set.
At the turn of the millennium, prudent and profitable investing in EM debt markets required nuanced understanding of the opportunities coming out of the likes of Brazil and China.
Today, to be abreast of the some of the most attractive EM debt opportunities, a close focus needs also to be applied to the GCC region.
This article was written for Expert Investor by Francesc Balcells, EMD chief investment officer at FIM Partners.