The Persian Gulf’s Huge New Export: Debt

The energy-producing states of the Persian Gulf are issuing bonds at the fastest clip ever, showing how the oil bust is reshaping the region’s finances despite a near doubling of crude prices this year.

The Gulf Cooperation Council states of Saudi Arabia, United Arab Emirates, Bahrain, Kuwait, Qatar and Oman together have raised a record $18 billion in 2016, according to Dealogic, helping refill coffers depleted by sharp revenue declines.

Investors expect issuance to increase further, as governments brace for lower prices than they were budgeting only a few years ago. Saudi Arabia is expected to raise up to $15 billion more in the coming weeks, and total issuance by the Gulf nations could reach $35 billion this year, according to J.P. Morgan Chase & Co., more than doubling the previous high set in 2009.

The issuers are paying slightly higher costs than other emerging countries with similar ratings, reflecting uncertainty over how successful they will be in opening up their economies, the region’s geopolitical risks and the murky outlook for oil prices, analysts and portfolio managers said.

But the bond sales generally have been successful, driven by strong demand from local investors and banks, improving market sentiment due to the oil rebound, and a persistent decline in global interest rates that is putting a premium on securities with better yields.

In May, Qatar raised $9 billion in an offering that drew more than twice that sum in orders. The five-year notes issued by the nation of 2.5 million trade at 2.13%. That is more attractive when compared with 1.83% on the comparably rated bonds issued by Korea National Oil Corp., according to Anita Yadav, head of fixed-income research at Emirates NBD.

Nearly half of the Qatari five-year and 10-year bonds were bought by Middle Eastern investors, mainly local banks, who were attracted by the yields, according to Andy Cairns, global head of debt origination and distribution at National Bank of Abu Dhabi. Many foreign managers remain cautious about these bonds, saying higher yields are tempting but warning that many of these nations are in the early stages of economic and political overhaul efforts that will likely prove difficult.

“Once you start an ongoing bond program, you have to have the revenue to pay for it,” said Michel Del Buono, global strategist at Makena Capital, which has $20 billion of assets under management. “At this point, I don’t think long-term investors have enough information to make the distinction.”

Qatar and Saudi Arabia have set up debt-management offices recently to monitor the markets and manage their new debt loads, a sign they intend to establish a long-term relationship with investors.

Many Gulf countries are relatively debt free, reflecting the fruits of a decade-plus surge in oil prices starting around the turn of the century. Total external public debt declined to 10.5% of gross domestic product in 2014 for GCC countries, the lowest level ever, according to the Institute of International Finance.

The oil-price collapse brought new fiscal pressure. Even after a strong rebound this year, oil prices in New York are barely half the level at which they routinely traded in 2014, a decline that has opened large holes in budgets already strained by expansive social services and trophy projects.

Saudi Arabia has pledged to further reduce government spending by 14% this year. Kuwait has cut fuel subsidies and Dubai has recently introduced a departure tax on international flights.

But progress is hard won: Moody’s Investors Service last month raised its forecast for this year’s average oil price to $40 a barrel from $33 but maintained its negative outlook on Bahrain, United Arab Emirates, Kuwait and Qatar.

Most of the oil exporters “are now persuaded that prices of oil will stay low for a prolonged period of time, which means they’ll have to continue implementing fiscal and other reforms,” said Garbis Iradian, chief economist for Middle East and North Africa at the IIF.

For many of these countries, returning to the international debt market wasn’t an easy decision. Saudi Arabia and Oman have prided themselves for being debt-free for years. When oil prices began their plunge two years ago, governments tapped into their reserves and borrowed from local banks.

But that strategy has hit its limit as prices remained low and foreign-exchange reserves shrank. Saudi Arabia alone spent more than $100 billion of reserves in 2015, reducing its fund by one-sixth.

Late last year, Qatar sought help from banks to raise up to $10 billion through a syndicated loan to plug its first budget deficit in 15 years. The government was immediately told it couldn’t get as much as hoped, according to bankers familiar with the deal.

Deposits are falling at local banks, as governments have been withdrawing money to close budget holes. Interest rates in domestic markets have risen as a result.

Meanwhile, global banks are constrained by stricter capital requirements on large loans, among other factors. In the end, Qatar raised $5.5 billion in December from a group of banks.

Interest rates on loans are typically lower than bond yields, which were pushed up in part because of a slew of credit-rating downgrades early this year on Gulf countries. But the shift to the bond market is a positive step for the region to diversify its funding sources away its heavy reliance on banks, said Michael Grifferty, president of the Gulf Bond and Sukuk Association.

Despite the higher borrowing costs, “the silver lining to weaker oil prices is a healthier financial structure and more sustainable economy,” said Stuart Anderson, regional head of Middle East at S&P Global Ratings.