Bond market lacks depth in Gulf states

 

(DENNIS B MALLARI)  

 

 

The trading scene in GCC securities is heavily focused on equities and over the past five years, volumes have picked up and the range of industries that investors have exposure to has continuously expanded with more IPOs. But the frothiness in the equities markets, the rapid growth in real estate, and even the increase in money supply can all be attributed to the lack of a deep debt market, both corporate and sovereign.

 

Moody’s, the ratings agency, issued a report last month predicting that corporate bond issuances in the GCC could reach $50 billion (Dh184bn) over the next 12 to 18 months, up from $23.7bn in 2007. While this may seem like a pretty healthy number, the debt markets in the region are significantly smaller than those in developed and developing countries.

 

In 2007, according to IMF figures, the combined GDP of the GCC was about $750bn, so the percentage of corporate bonds issued last year equalled 3.2 per cent of the gross domestic product. In the US, the ratio was 112 per cent last year and 10 per cent in China.

 

The weakness of the debt market has a direct role in increasing volatility in equities, and may exert more pressure on the robust real estate market. This dynamic has been playing out in India, where companies issued bonds equivalent to one per cent of the country’s GDP in 2007. Alan Rosling, a director of Indian conglomerate Tata Sons, told Business Week: “If there were more debt available, some institutional investors would buy and hold rather than join the hot money rushing in and out of equities.”

 

The remedy to this problem is not as simple as it seems – increasing corporate debt by a $100bn will not do the trick. The problem is twofold, first trading activity is nonexistent, and second, companies do not have benchmarks in order to price issuances.

 

Abdul Kader Hussain, CEO of Mashreq Capital and an expert in fixed-income, told Emirates Business “in the region, even the most liquid bonds are very illiquid” and with the credit crunch, the debt markets “are completely motionless”.

 

Investors are normally reluctant to park large sums of cash in dormant markets. Hussain noted that some trading does exist and “brokers do send out daily quotes” but the trades are done in very small sizes.

 

Hashem Montasser, managing director and head of asset management at EFG-Hermes, agreed that trading in the debt markets is weak. “If you are taking in $5-10m, there is a market, but for $100m, it would need to be bought and sold over a week.” He explained that the quality of some debt issues, specifically from de facto sovereigns (government-backed corporation), has led some investors to hold on to the debt. But he predicts this will change. “Sooner or later, banks in the region will want to stop sitting on sukuk.”

 

Solving the problem of liquidity relies on a number of factors. Increasing the size of the market, through more issuances, could be the most straightforward fix, but this cannot happen without creating a benchmark so risk can be properly priced. Montasser said the market must be re-examined and structured so it can flourish.

 

“The way that fixed-income markets evolved is that it usually started with sovereigns – countries issued debt, which resulted in a yield curve, a sovereign yield curve,” Montasser said. The resulting yield curve then serves as the benchmark for company debt issues.

 

Sovereign bonds are usually the highest grade debt, and other issuances within the same country should have wider spreads, but the GCC governments have no need to issue debt because they are posting surpluses, a trend that should continue for many years. Montasser said the macroeconomic outlook is working against the emergence of a mature debt market, but there are some positive developments.

 

“The more sophisticated sovereigns have recognised that issuing debt is not a matter of needing the money, but it is for them to establish benchmarks that corporations can then use to establish a debt market and a liquid yield curve.” Dubai and Abu Dhabi have issued bonds recently, but Montasser noted that “they are still too few and far between. What’s needed is multiple five-year yield curves,” and more longer term bonds (15, 25, and 30 years).

 

Without more government issued bonds and sukuk, it seems that the region’s debt markets will remain small and illiquid for the foreseeable future. The resulting implications of the fledgling market will continue to feed asset bubbles, and reduce the power of central banks in the GCC to control the money supply.