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ANALYSIS

Gulf bond market forges global links as it grows

Dubai, August 30, 2012

When Abu Dhabi's biggest bank, NBAD, issued a $750 million bond in August, strong investor demand underlined how well most Gulf banks are riding out the global financial crisis.

The issue also sent another signal: that the region's debt market is growing strongly and, increasingly, integrating with overseas markets.

The seven-year bond from National Bank of Abu Dhabi, which attracted about $4.5 billion of orders from investors, was issued in the third week of the Muslim holy month of Ramadan.

In past years, the Gulf bond market has slowed dramatically during Ramadan, as fasting traders and investors reduce their working hours. So the fact that NBAD's bond emerged during Ramadan this year showed how the market's expansion is changing issuance and trading patterns, analysts and traders said.

"The windows available for issuers have become much tighter and the emphasis is now on swift execution of primary deals. This shows the regional market is maturing, and adapting to global conditions," said Chavan Bhogaita, head of NBAD's markets strategy unit.

"It's largely a matter of perception - people assume that the markets in this region are closed for business during Ramadan, but that is not the case. If market fundamentals are conducive enough, deals will get done."

The bond market's growth could benefit economies in the Gulf by giving corporations a new source of funding as traditional sources languish. Bank lending growth is being constrained in many countries by a pull-back of European banks, which have been hit by problems in their home markets; public offers of shares in the Gulf have been limited by volatile stock markets.

But a bigger bond market in the Gulf also carries risks. When the market was small, its isolation from the rest of the world gave it stability; as it expands and attracts more foreign investors, it may become more vulnerable to the swings in sentiment that have plagued overseas markets during the crisis.

GROWTH

Gulf Arab companies and governments have issued over $25 billion of conventional and Islamic bonds so far this year in both foreign and local currencies, according to Thomson Reuters data. That already matches last year's total of $26 billion, and puts the Gulf comfortably on course this year to exceed the 2010 amount of $30 billion.

Secondary market trading of bonds in the Gulf remains much less active than it is in Europe and the United States, partly because many Gulf investors have traditionally bought bonds to hold them until maturity. But trading has been picking up.

A survey by the Emerging Markets Trade Association of 59 investors, including most major asset managers and funds, showed the Middle East accounted for 7.2 per cent of emerging markets bond trade in the second quarter of this year, down from 7.7 per cent in the first quarter but up from 6.2 per cent in the last quarter of 2011. Turkey dominated activity in the Middle East but the Gulf is becoming more important, traders said.

One reason for the increase in activity appears to be the growth of Gulf investment funds. After 18 months of high oil prices, they are flush with cash, while the global crisis and ultra-low interest rates abroad have made overseas markets less attractive. This has encouraged some funds to keep money in the region, where much of it goes into bonds.

Another reason is increasing foreign investor interest in the Gulf. With economies in the region still growing comfortably and most governments posting big budget surpluses, the region has become a safe haven for some foreign funds.

This trend can be seen in the rising proportions of Gulf bonds sold to foreign investors. Over 70 per cent of NBAD's bond was placed in Europe and Asia, with only 25 per cent allocated to the Middle East; in the past, more than half of most Gulf bond deals could be expected to go to Middle Eastern investors.

"In general, regional markets are getting more integrated with global markets each year, with offshore investors contributing a large part of allocations in primary markets and secondary market trading volumes," said Biswajit Dasgupta, head of treasury and trading at Invest AD in Abu Dhabi.

SPREADS

The surge in demand for Gulf bonds has reduced - though not entirely removed - the "Gulf premium", the higher cost that bond issuers in the region pay compared to issuers with the same credit rating elsewhere in the world.

In the past, investors demanded this premium because of the Gulf market's illiquid nature and the political risks in the region. Political dangers remain, including tensions over Iran's disputed nuclear programme, but these no longer deter yield-hungry foreign investors to the same degree.

Late last year, the yield on Qatar's sovereign dollar bond maturing in January 2022 was 1.1 percentage points above the yield on a similar Chilean bond maturing in September 2021 - even though Qatar's credit is rated two notches higher than Chile's by Standard & Poor's. By this month, the gap had narrowed to 0.7 percentage point.

The yield on the Dubai government's $750 million bond has plunged from 7.75 per cent at issue in October 2010 to about 5.2 per cent currently - an impressive drop for an emirate which lies across the Gulf from Iran and is still repairing the damage from a major corporate debt crisis in 2009.

The arrival of the Gulf's bond market on the global stage is both pleasing and worrying for traders and investors. On the downside, it means local investors now have to compete with foreigners for allocations of popular bonds at issue, and may not get as much as they want.

Flows of foreign money into the region could push bond yields down to unreasonably low levels, some investors fear. And the presence of large amounts of foreign funds could set the market up for a crash if, in response to some global development, those funds suddenly pull out.

"Activity levels during the last few weeks are encouraging for how the rest of the year could be in terms of trading volumes and primary activity," NBAD's Bhogaita said.

"But having an increasingly global investor base, while great for the development of this market, means we are far more correlated to international factors than was previously the case." – Reuters




Tags: UAE | Dubai | Gulf | NBAD | bond market |

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