Bond markets to stay afloat despite oil price

GCC bond markets performed remarkably last year, when returns were competitive and relatively uncorrelated to other fixed-income sectors and traditional asset classes. Arabian Gulf bonds exhibited important diversification benefits for global and emerging market portfolios. This year, too, we think these attributes will persist.

The Mena Broad Index, which significantly outperformed the Emerging Markets Bond Index Global Diversified and the Citigroup World Government Bond Index in the final quarter, is a case in point.

However, the continuing fall in oil prices poses obvious issues for many GCC countries. Over the past decade, oil producers across the Middle East have used their oil-income windfall to assuage rising political activism with an almost four-fold boost to public spending. If oil prices were to stabilise at recent levels, and planned spending were left unchanged, GCC oil producers probably would start to experience fiscal and, in the case of Oman, current-account deficits shortly.

UAE officials asserted that financial surpluses amassed in recent years would continue to support expenditure on development projects and pointed out that the UAE budget was the least oil-dependent of any GCC state.

Saudi Arabia’s large foreign exchange reserves meant that public spending plans for this year remained unchanged in spite of an expected shortfall in revenues. Early in December, an ailing King Abdullah announced sweeping government cabinet changes in a move widely seen as an effort to accelerate the pace of economic and political reform.

Qatar’s public spending plans for the next financial year remained intact, while the country’s assets were helped by recent reassurances that, despite much controversy, the Fifa World Cup will go ahead in Qatar in 2022, as well as by improved diplomatic relations with Qatar’s GCC neighbours and Egypt.

One of the largest beneficiaries of falling hydrocarbon prices in the Mena region has been Egypt. The fall in prices has cushioned the blow of major cuts in government fuel subsidies, and Egypt’s budgetary position continued to improve considerably throughout the fourth quarter.

Nevertheless, we retain our positive medium-term outlook for GCC countries and their bond markets because of strong non-oil growth and their financial strength.

GCC countries have generated such large surpluses over the past decade that they have some of the lowest debt-to-GDP ratios in the world, and collectively have accumulated the equivalent of 189 per cent of GDP, or US$3.1 trillion, in public foreign assets that can be used as cyclical buffers.

Saudi Arabia and other countries in the region will likely be able to maintain pro-growth spending and continue to diversify their economies away from oil.

Although the fears regarding GCC countries and potential medium-term budget deficits are legitimate in some cases, such a development might bring new, interesting issuers to the bond market, and potentially accelerate structural reforms in areas such as fuel subsidies, taxation and financial market development.

In addition, the pegging of GCC currencies to the dollar should lessen the effect of prospective interest rate hikes in the United States this year (as it did last year), although the effect on the GCC of monetary policy normalisation in the US will need to be monitored.

In some instances, we believe higher US base rates may actually have a positive effect (for example, GCC banks would be able to increase their interest-rate margins).

The fundamentals for credit in the GCC also remain broadly intact, and we expect significant issuance from a range of sectors, including banks, real estate, transportation, energy and education. These sectors will, we believe, benefit from favourable operating environments, healthy margins, suitable liquidity, low default rates and attractive relative pricing.

We believe the GCC fixed-income markets are still well positioned in global fixed income, supported by an environment of moderate economic growth and abundant liquidity. GCC fixed-income markets have benefited from a strong and stable demand base, a steady stream of new issuers and an exciting growth and development story that has supported diversification and potentially competitive risk-adjusted financial performance.

Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments Middle East

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