2018 in review – how the GCC outperformed peers in bond markets
Against a backdrop of slower global growth, the GCC bonds and sukuk market had a reasonably constructive year
by Anita Yadav, Senior Director and Head of Fixed Income Research, Emirates NBD, and Vice Chair Gulf Bond and Sukuk Association
18 December 2018
This year has been one of the worst on record this decade for global bond markets. While the key driver for negative returns has been rising benchmark interest rates, expectations of slower global growth and a wavering outlook on oil prices also played their part in dampening investor demand and causing credit spreads to widen. Against this backdrop, the GCC bonds and sukuk market had a reasonably constructive year.
The GCC fixed rate USD-denominated bond and sukuk universe increased by 17 per cent from total outstanding issues of $264 billion (Dh969.54bn) as at December 2017 to $310 billion as of mid-December 2018. New bonds issued in 2018 surpassed the $77 billion mark. Though this is less than the $85 billion recorded in 2017, it was achieved as oil revenues were on the rise, helping government budget deficits to narrow and their external funding needs to diminish.
The secondary market performance of new issues was lackluster, largely attributed to rising interest rates instead of any idiosyncratic negative perception on any given issuer. A refreshing development was the increase in corporate issuance with several new corporates tapping the bond market for the first time in 2018. Corporate issues accounted for 18 per cent of the total this year compared with 12 per cent last year. The average deal size fell as there were fewer jumbo sovereign deals this year. A total of 220 issues accounted for the total $77 billion raised compared with 191 issues for $85 billion in 2017.
At mid-December, the total return on Barclays GCC bond index was a small gain of +0.03 per cent compared with a loss of -2.93 per cent on the wider emerging market USD bond index. The GCC’s outperformance was facilitated by several positive developments during the year – the key one being the decision by JP Morgan to include the sovereign and quasi-government bonds from Bahrain, Kuwait, Qatar, KSA and UAE into its widely followed emerging market bond index (EMBI Index) from January 2019 onwards. The inclusion of the bonds and sukuk market in the index will occur in a phased manner over nine months between January and September 2019. In the end, the GCC will account for 11 per cent of the total index.
In the GCC, activity in the primary market, liquidity in the secondary market and general changes in the credit quality of the issuers – all are impacted by the level of oil prices. Driven by continued global growth and discipline around production levels, oil prices followed an ascending trajectory in the first three quarters of this year which in turn helped boost sentiment on GCC bonds. There were more positive changes to credit ratings and outlooks than negatives during the year.
Bahrain’s stretched public finances had been a concern for some time. Even though some support from Saudi Arabia was always expected, investors panicked after the Bahrain government failed to complete a funding exercise in March and April. The eventual announcement of a $10 billion aid package from neighbours KSA, Kuwait and the UAE adequately negated the default risk which otherwise could have had material detrimental impact on regional markets. In a similar light, the constructive resolution of the Dana Gas default further stabilised investor sentiment of the region.
Looking ahead, the GCC bond market is expected to continue growing with local currency markets picking up pace. Unlike in the USD-denominated bond space, the UAE lagged behind its GCC neighbours in issuing local currency denominated bonds. In this regard, 2018 marked a big milestone, with the government announcing finalisation of the Federal Debt Law (FDL). Under the law, the UAE government is expected to establish a federal Debt Management Office, seek a credit rating and begin issuing bonds and sukuk soon. The FDL is expected to pave the way for the establishment of a dirham-based government yield curve which in turn will likely be soon followed by corporate issuances.
In 2019, the negative impact of rising US interest rates is expected to be counterbalanced by coupon collection. Potential fallout from ongoing trade tensions between the US and China on GCC bonds is likely to be mild and indirect. China is one of the largest importers of oil and any decline in China’s GDP growth may have repercussions for oil prices and the GCC’s oil revenues. That said, despite headwinds, we expect GCC bonds and sukuk to continue outperforming their emerging market peers in the coming months.