Diversification of resource funds needed to survive downturn

The region's debt market needs to be developed not only to create diversification of resource funds but also to be able to pursue non-cyclical policies during times of financial crisis, said officials.

With a three per cent debt-to-GDP ratio, Dr Nasser Saidi, DIFC chief economist, said Mena's debt market remains in its infancy. He said compared to all the other regions in the world, the Middle East was the least to derive its capital from debts.

This is because the region has been primarily reliant on oil and gas revenues and banking finance. But the crisis has demonstrated that the region needs more and deeper pockets. The price of oil dipped to below $40 in the fourth quarter of 2008 from the near-$150 in the second quarter, drastically pulling down oil revenues. And banks tighten their belts and remain virtually closed until the first quarter of 2010.

These factors caused a double whammy and although fundamentally strong, the region also had to cut back on its spending – a pro-cyclical measure.

This would not have been the case if the region had a developed and mature debt market, said Saidi.


Bank lending

The problem was that a lot of companies have been reliant on bank lending/syndication, which uses short-term funds to fuel long-term investments.

According to Mustafa Aziz Ata, Director of Capital Markets at HSBC Bank Middle East, the region lacked a balance among the various channels of financial intermediation.

"Although improving, the region continues to be dominated by the banking sector. This creates systemic vulnerability during crisis. Albeit no asset class has been spared from the turmoil."

Ata said Japan's "lost decade" provided an excellent example of the perils of a bank-dominated market whereas Korea, with an active bond and stock market, recovered rapidly than its peers following the 1997 crisis.

"The need to diversify the bond market is now more important in the new world," said Ileana Boza, Global head of Business Strategy of Client Development at the World Bank's Multilateral Investment Guarantee (Miga).

"One of the results of the crisis is investors and lenders become conservative, thus there has been a reduction in bank financing. Banks are limited by their capital constraints/requirements by Basel II – these are more constraining banks in emerging economies," she said.


Conservative policies

Despite the co-ordinated efforts by governments globally to support the international banking system in various forms of liquidity and capital injections, Ata said lending continues to shrink.

This happens as banks pursue balance sheet deleveraging and they continue to implement more conservative policies. In addition, access to new bank capital remains scarce and expensive.

Saidi said capital injection by the central bank also does not translate to increased liquidity for the private sector. He said the central bank provided liquidity to banks with zero interest, but banks failed to lend to the private sector, and instead invested the new capital in government bonds."This is a perverse phenomenon where the banks take money from one branch of the government and put it back into another branch," he said.

Debt capital markets are thus becoming the main source of liquidity for refinancing and funding gap, said Ata.

"Re-pricing of risk spreads makes corporate bonds an attractive investment proposal for investors. Despite the higher spread environment, low underlying risk-free rates reduce the normal cost of debt for borrowers," he said.

Ata said the migration of borrowers from bank lending to debt capital markets seemed to be systematic rather than a temporary deviation from their traditional borrowing mix.


Long-date loans

"New bond sale volumes across all markets and geographies have exceeded the historical highs year to date," he said. "The new issue supply will remain robust for the remainder of the year although banks show more willingness to lend, thanks to the recovering macroeconomic environment since March 2009."

Lending to long-term projects, however, is expected to remain tight. Ata said bank appetite for long-date loans, most commonly used for project finance, had been reduced and the region must evaluate the long-dated project bond markets to finance the infrastructure requirements of the region.

The appetite for new issuances has been strong driven by internal and external demand. Bond pipeline is also strong.

The National Bank of Abu Dhabi raised $850 million (Dh3,122m) last month. Emirates NBD, the country's largest lender by assets, is considering raising between $500m and $2bn this year if government guarantees are in place by then.

The National Bank of Abu Dhabi is currently busy on its roadshow to raise money through European or global medium-term notes.

Deutsche Bank, Standard Chartered Bank and Bank of America are said to be lead-managing ADCB's bond issue under global medium term note (GMTN) programme, according to banking sources in Abu Dhabi.

According to institutional representatives, who were present in the roadshow on September 28 in Abu Dhabi, the pricing would be in the vicinity of 260 basis points (bps) above five-year United States Treasury, which could work out a pricing of about five per cent.

"Based on the recent transaction in the region, every single issuance was overly extremely subscribed. So there is a lot of appetite and the appetite is coming from all over the world," said Giambattista Atzeni, Mena Strategic Business Development Manager, Bank of New York Mellon. "You will see demand coming from two quarters – internally from both Islamic institution themselves that are very liquid and are looking for securities in which to invest.

We have also seen a lot of internal/foreign demand," said Saidi.

According to Markaz's GCC Bond Market Survey, during the first half of 2009, GCC bonds and sukuk volume reached $18.4bn, an increase of 37 per cent compared to the respective period of 2008.


Sukuk volume

However, the survey said that H1 2009 volumes remain lower than half – 38.3 per cent of the total year volume peak of 2007.

The survey said conventional issuances increased the highest during H1 2009 with $17.3bn representing 93.9 per cent of the total value raised through 32 issues, compared to $1.1bn for sukuk through 12 issues.

During H1 2009, sovereign issuances dominated the majority of the amount raised, raising $12.7bn with a 69-per cent share of the total volume compared to the 2008 trend where corporate issuances dominated.

Sovereign issues totalled $12.7bn. The UAE garnered the majority share of amount issued, raising $6bn, or 38.1 per cent of the total amount.

Next was Kuwait, raising $5.8bn, 31.3 per cent of the aggregate amount raised; Qatar ($4.5bn) followed by Bahrain ($0.92bn).

In terms of the number of issues, Kuwait garnered the majority share of the number of issues, with 22 issues representing 50 per cent of the total issues, followed by Bahrain with 11 issues, representing 25 per cent of the total number of issues. Saudi Arabia had only one issue, raising $0.20bn. Oman did not have any issues during the first half of this year.

Saidi said emphasis should not only be on creating a debt market but also developing its local currency. Instead of using the surplus liquidity in other countries, he said the capital can be redeployed to the home country.

Ata said Mena central banks should develop their local currency bond market by establishing a risk-free yield curve that will reflect the opportunity costs of funds at each maturity.

This can be achieved through the issuance of treasury bills, which is issued by the government short term financing requirements; or government bonds that are issued by the government in the two-year, three-year, five-year and six-year periods. "We believe that the development of an efficient local currency debt capital market is required to ensure a sustainable growth environment for GCC economies," said Ata.


Local currency

According to a Markaz survey, a new trend seen in H1 2009 issuances compared to 2008 was the change in the currency/denomination of issuances back to the US dollar. In 2008, local currencies dominated the currency of issuances.

This was a shift from previous years that saw more US dollar-denominated issuances.

Dirham-denominated issuance represented 49.5 per cent of the total 2008 volume, while the US dollar-denominated issues raised a mere four per cent.

The survey said in the first half of this year, this trend reversed to a pre-2008 era were most issuances were denominated in US dollars raising $12.25bn, representing 66.7 per cent of the total volume of all in H12009.

To date, no dirham-denominated issuance has been placed.


Risk perception on UAE 'good'

The risk perception on UAE is "fairly good", according to a senior
official from a World Bank agency.

Ileana Boza, Global Head of Business Strategy of Client Development Multilateral Investment Guarantee (Miga), said the agency was now open to guarantee projects in the UAE, which has relatively low political risk profile.

Miga, a unit of World Bank, guarantees to help investors obtain project finance from banks.

Miga guarantees loans, which may help reduce the cost of capital and, because it can provide insurance coverage for up to 15 years, it increases the tenor of loans to investors.

"Risk perception on the UAE is fairly good," she told Emirates Business. "We have not covered any investments into the UAE but we have had some request prior to the crisis for a number of large infrastructure projects."

"At that time the question was how much we could provide… we could probably lift the ratings to 'AAA'. The discussion has started with the rating agency but it was never finished," she said.

Boza said there is no specific budget earmarked but they are keener to guarantee infrastructure projects.

"In the UAE we are looking at infrastructure-related projects. There may be some power generation or electricity related projects in the region – all the way from here through Egypt to Lebanon. We have in the past looked at inter-country projects, where we can ensure because one country can affect the others. We can insure both sides," she added.

Dubai International Financial Centre (DIFC) entered into collaboration with Miga last week with the aim to support the development of the region's bond and sukuk markets.

The two institutions are also joining forces on their overall target of promoting Foreign Direct Investment (FDI) into the Mena region.

"In recent years, the bond market in Mena in general and in the Gulf in particular, has grown. Exceptional growth has been witnessed in the Islamic sukuk market.

But it must be remembered that the sukuk is a relatively new instrument and its growth is still minor given the huge potential for the Islamic bond in the mainly Muslim Mena region," said Dr Nasser Saidi, Chief Economist of the DIFC Authority.

"The same is true for the overall FDI situation in the Arab World. Though the numbers have gone up in recent years, they still do not match the potential or the requirements of our region," Dr Saidi said while calling for a cross-border regional policy approach towards dismantling obsolete investment laws and creating opportunities and channels for foreign investments.

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