Wednesday 5 August 2020

Jean-Michel Saliba

EMBI inclusion ‘could trigger $30bn inflows to GCC’

DUBAI, August 5, 2018

Potential EMBI (Emerging Market Bond Index) inclusion could lead to an estimated $30 billion of inflows into GCC, leading to tighter spreads and making primary market access easier, said the Bank of America Merrill Lynch (BofAML) in a new report.

Potential EMBI inclusion is a swing factor for GCC credit (ex-Oman), BofAML added in its latest Global Emerging Markets Weekly report.

“Saudi Arabia, Qatar, UAE, Kuwait, and Bahrain sovereign bonds will make up a sizeable portion of the index; we estimate 10 - 11 per cent of the EMBI diversified. In theory, flows could reach $40 billion which should be supportive for credit performance in the coming months. Sovereigns will also now be able to issue debt to a new audience of EM credit-focused investors, which should increase primary demand,” said Jean-Michel Saliba, Mena economist at BofAML.

“However, we think the ultimate flow number will be lower since many EMBI funds appear to already hold off-benchmark GCC sovereigns in their portfolios. Using a sample of funds suggests an average allocation of nearly 3 per cent already (source: EPFR), so flows could be closer to $30 billion.

“These new sovereigns will be introduced gradually over an expected 6m period from 2019, although funds may well pre-empt the move in the coming months, particularly after a final decision is made by JP Morgan,” he added.

Kuwait and Bahrain should benefit from the EMBI diversified weighting approach which reduces the weight of the largest issuers relative to their amount outstanding. Flows could reach around 50 per cent of Kuwait's outstanding external bonds, with Bahrain also benefiting. Flows into large issuers such as Saudi Arabia and Qatar will be smaller in percentage of debt outstanding terms (we estimate 25 - 33 per cent). Again, given existing holdings, the ultimate figures are likely to be smaller.

“Qatar and Saudi Arabia both stand-out as wide to same-rated peers, trading more in line with triple-B names like Panama, Hungary, Romania, and Colombia. Indeed, moving from Russia into Saudi Arabia 5y bonds loses only around 13bp for a 4 - 5 notch rating improvement for example,” said Saliba.

“We see no fundamental reason for these countries to trade at such an implied rating given low debt, strong reserves, and current supportive oil prices.

“Wider spreads currently can be explained by high issuance (Saudi has issued $11 - 22 billion a year since 2016) and regional political tensions (in the case of Qatar) in particular. However, with a supportive oil price backdrop, we think EMBI inclusion can finally push spreads tighter. Qatar and KSA are unlikely to trade flat to Abu Dhabi given its stronger credit profile (rated Aa2/AA/AA), but could tighten another 20bp (5y bonds) based on current relative valuations,” he added.

Bahrain - a clear beneficiary from inclusion

Bahrain emerges as the biggest beneficiary out of EMBI inclusion. This will provide not only large flows as a per cent of debt outstanding, but is also likely to be crucial for future external financing needs, the research report said.

One of the clear benefits of being a member of a major benchmark is that investors generally have at least some exposure to each country (particularly if it is reasonably large like Bahrain) to avoid deviating too much from the benchmark.

“As we recently highlighted, GCC support for Bahrain is likely to focus on restoring market access for the country, particularly with FX reserve pressure and a $750 million sukuk maturity in November. The country's credit outlook remains unclear at this stage and we await clarity on fiscal reforms and the form of support. Nonetheless, EMBI inclusion should make market access easier and this benchmark governance review has come at a very helpful time for the country,” Saliba said.

“We also expect the differential between BHRAIN Eurobonds and sukuk to narrow in time helped by index inclusion. However, in the short-term, we expect sukuk to remain tighter until there is more clarity on the support package for the country and on fiscal reforms,” he added. - TradeArabia News Service

Tags: GCC | BofAML |

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