The Middle East’s debt markets have had a robust first half of the year as more and more sovereign wealth funds look to help their countries diversify their economies away from oil and gas. By Jason Mitchell.
Eurobond issuance out of the Middle East started to surge in 2023 and strong momentum has continued into this year. From the beginning January to June, issuance from the region amounted to US$66bn in 61 separate transactions, compared with US$69bn across 98 deals for the whole of last year, according to LSEG data. In 2022, it totalled US$41.4bn with 86 deals. Yet last year's issuance remained below that of 2020, a bumper year, when it amounted to US$111.4bn across 161 deals.
Analysts say emerging market governments have sold almost US$100bn of dollar and euro-denominated bonds in the first few months of 2024, setting it up to be one of the busiest years on record. The Middle East is making up a significant chunk of the total issuance.
During the first quarter, many issuers – after a long hiatus from capital markets – sought to lock in lower funding costs following a steep drop in US Treasury yields since October.
Between 2019 and June 2024, Saudi Arabia was the biggest Eurobond issuer in the Middle East region with a total volume of US$50.4bn (eight transactions), followed by Israel at US$26.7bn (36 deals) and Abu Dhabi at US$22.3.4bn (six transactions).
The international sukuk market out of the Middle East is also thriving – between the start of this year and June 3, there were 27 issues for US$26bn, compared with US$30.6bn across 32 transactions for the whole of last year, according to LSEG. In 2022, US$15.6bn was raised across 18 deals, while in 2021, US$28.9bn was secured through 31 deals. Sustainable bond issuance from the region is also surging – last year, 12 green bonds were issued raising US$14.6bn, compared with only six that raised US$5.7bn in 2022. From the start of this year until June 3, green, social, sustainable and sustainability-linked bond issuance out of the Middle East totalled US$10.6bn in 12 transactions.
Furthermore, the debt capital market of the Gulf Cooperation Council – comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – is on track to cross the US$1trn threshold, having reached US$940bn outstanding by the end of the first quarter of 2024, according to Fitch. Around 37% is in the form of sukuk.
Moreover, many Middle Eastern states are pursuing economic diversification strategies away from oil and gas. This is reflected in their increased issuance of conventional bonds and sukuk, aiming to finance projects across an array of business sectors such as tourism, education, healthcare, manufacturing, logistics and finance. One of the main ways in which they are achieving this is through their highly capitalised sovereign wealth funds, which are investing in specific companies or backing specific projects. Furthermore, more and more SWFs are raising capital to achieve their goals through the issuance of conventional bonds and sukuk, including green and sustainable ones.
"This year has been very busy from the get-go," said Iman Abdel Khalek, head of Central and Eastern Europe, the Middle East and Africa debt capital markets at Citigroup. "While not dissimilar to most years with sovereigns and banks de-risking early on, volumes during the first quarter this year were elevated as issuers tried to benefit from the rally in rates at the start of the year."
Analysts say the recovery in the Middle East’s DCM market during the first few months of the year was mostly driven by the decline in US Treasury yields at the end of 2023. At its December meeting, the Federal Reserve's economic forecasts signalled that inflation would fall towards 2% by the end of 2024, meaning the central bank would be able to cut interest rates in 2024.
However, inflation has proved to be quite sticky and benchmark borrowing costs are now expected to remain at their current 23-year high of 5.25–5.5% for a bit longer. Nonetheless, some experts believe momentum in the Middle East’s bond markets is now so strong that it will continue despite no let-up in the Israel-Gaza conflict.
"A couple of issuers could decide to wait for lower rates but I think most will still get their funding done," said Abdel Khalek. "You cannot always perfectly time the market, and the prospects of lower rates have now moved further out."
Lengthy list
This year has already thrown up a lengthy list of sovereigns and government-related entities tapping the markets.
On May 28, Saudi Arabia successfully issued US$5bn in triple-tranche Islamic bonds. The sukuk, with tenors of three, six, and 10 years, were initially guided at around 85bp over Treasuries for the US$1.25bn three-year tranche, 100bp for the US$1.5bn sixes and 110bp for the US$2.25bn 10s. Final pricing was tighter than initial guidance, reflecting robust demand, the bonds coming in at plus 60bp, 75bp and 85bp. The sale secured almost US$20bn in orders.
Just a few days before, Qatar had successfully raised US$2.5bn through its first green bond offering, marking a significant milestone for emirate. The bonds were split between two tranches: a US$1bn five-year at 30bp over Treasuries and a US$1.5bn 10-year at plus 40bp.
At the tail-end of the previous month, Abu Dhabi Developmental Holding Company – a SWF with assets of US$196bn – successfully listed its inaugural US$2.5bn bond issuance on the London Stock Exchange, as part of its effort to diversify its funding sources. The paper attracted peak demand of almost US10bn. At pricing, the US$1.25bn five-year tranche came in with a yield of 5.498% and the US$1.25bn 10-year 5.565%.
The week before that, the Abu Dhabi sovereign sold its first Eurobonds since 2021, raising US$5bn and issuing five, 10 and 30-year tranches. The US$1.75bn five-year priced at 35bp over Treasuries, giving it a yield of 4.966%. The initial guidance was 70bp. The longest tranche, also US$1.75bn, came at a spread of 90bp and a yield of 5.615%. This issuance is widely expected to pave the way for further supply from Abu Dhabi's government-related entities later this year.
In March, Sharjah issued a 12-year dollar-denominated 144A/Reg S senior unsecured sustainable bond, raising US$750m. It attracted an order book exceeding US$4bn and was priced at a spread of 195bp over Treasuries, significantly tighter than initial guidance of 235bp. The reception indicated a strong appetite among international investors from outside the region, who accounted for 67% of total demand.
In January, the Saudi sovereign also sold US$12bn of bonds – its largest deal since 2017. The kingdom placed six, 10 and 30-year notes with respective yields of 4.877%, 5.13% and 5.908%. Ten-year US Treasuries were trading around 4% at the time. Investors placed over US$30bn of orders at final pricing for the deal, proceeds of which are equivalent to more than half the fiscal deficit the government is projecting for this year.
Additionally in January, the Public Investment Fund, Saudi Arabia's SWF with US$925bn in assets, issued US$5bn of paper. The triple-tranche bond sale generated strong demand, with over US$27bn of orders placed. Final spreads narrowed from the initial guidance to reach 115bp over Treasuries for a five-year tranche, 145bp for a 10-year and 205bp for a 30-year.
Early June then saw PIF add another string to its bow when it made its sterling debut, selling £650m across five and 15-year offerings. Before PIF issued, there were no outstanding sterling bonds from Saudi Arabian issuers, meaning the diversification play worked both ways, with the issuer gaining access to a new investor base and accounts having the chance to buy A1/–/A+ rated risk at spreads notably wider than much of the erstwhile available government-related and high-quality corporate paper.
Investment requirements
"GCC countries are in the midst of aggressive economic restructurings that require a large amount of economic investment," said Omar Al-Ubaydli, director of research at the Bahrain Center for Strategic, International and Energy Studies (Derasat), a think tank.
"The goal is to diversify the economy away from hydrocarbons towards a variety of other sectors. With oil prices below US$120 for the foreseeable future, they cannot self-fund, hence the courting of international lenders. Other Middle Eastern sovereigns may tap markets but are more likely to address transient budget deficits rather than to fund long-term investments.
"The Gulf countries in particular are cognisant of the need to 'greenify' their economies as part of their sustainability commitments and to make their own economies more attractive to foreign investors. Capital markets are gradually squeezing the credit available to countries that do not exhibit a sufficient effort at decarbonising the global economy, and so the Gulf countries are looking to cultivate a reputation as progressive green thinkers to avoid being subject to these restrictions.
"Hence, green bonds are likely to become an increasingly frequent element of the Middle East and North Africa capital markets, most often relating to the variety of renewable energy projects that countries such as Saudi Arabia and the UAE are pursuing."
Until a few months ago, Saudi Arabia, the world’s biggest oil exporter, was expecting to post fiscal surpluses until at least 2025. But it has since revised those forecasts, with crude prices at the start of the year below what it requires to balance its budget (estimated at US$86 per barrel). It is also planning to boost spending on mega projects championed by Crown Prince Mohammed bin Salman to diversify the economy, as part of its Saudi Vision 2030 programme.
"The Middle East needs a lot of capital to achieve its growth objectives and bond sales will remain part of a toolkit to diversify funding to support those ambitious diversification agendas," said Scott Livermore, the chief economist of Oxford Economics Middle East. "Saudi Arabia’s recent borrowing plan, for instance, explicitly outlines that both domestic and international debt instruments (both conventional and sukuk) – as well as loans – will continue to be utilised to access funding. Elsewhere, this might be more opportunistic depending on market conditions. Many countries’ securities are high quality and will likely remain in demand as global central banks gradually pivot to rate cuts.
"In addition to sovereign bond sales, we’re also likely to see more regular debt-raising activity by SWFs – including by PIF – as they seek funding for current and planned projects."
Furthermore, Saudi Arabia is expected to be one of the most active sukuk issuers this year. Fitch is forecasting the kingdom will have a budget deficit of 3% of GDP this year and 3.4% in 2025. The UAE is expected to be running a surplus this year but wants to diversify its funding by issuing sukuk. Fitch says Bahrain will remain dependent on DCM access and GCC funding amid wide deficits. Meanwhile, Qatar and Oman are expected to continue to repay part of their debt stock, including sukuk, in 2024.
"A lot of sovereign capital markets activity depends on the status of fiscal budgets in the region and a lot of it depends on commodity prices," said Khaled Darwish, head of CEEMEA debt capital markets at HSBC. "When commodity prices are on the high side – as they have been in recent years – some GCC governments have used that as an opportunity to deleverage and buy back some short-term debt. They have generally avoided the primary market.
"Examples are Oman, which has not issued in two years or so, and Qatar, which has not been in the market in three years. While a few sovereigns have not visited the capital markets for some time, others have issued more frequently as part of their fiscal budget financing plans, such as Saudi Arabia, Sharjah and Bahrain. They come to the market once or twice a year with differing sizes depending on the scale of their needs. Some GCC sovereigns could also choose to pre-fund for next year or refinance early for upcoming maturities."
SWF alternatives
SWFs are emerging as key players in the Gulf’s debt markets, seeking funding for myriad projects and investments. They have been actively investing in sports and gaming, renewables, hi-tech, tourism and infrastructure. Some SWFs are moving away from their traditional role of safeguarding wealth to more high-risk strategies to diversify national economies away from oil and gas dependence. They are promising high returns at the same time.
"Some sovereigns issue and fund the sovereign wealth fund and the government-related entities directly," said Darwish. "In some countries, we can see both the sovereign and its SWF issue. We see this in Saudi Arabia – which has its own yield curve and its own deals – and its Public Investment Fund, which also has its own curve and its own deals. There is no overlap between the two.
"Another example is the UAE. It has SWFs like Mubadala Investment Company and ADQ; both issue their own bonds and do not go to the government to secure bond financing. Other examples include Qatar, where its wealth fund, Qatar Investment Fund, does not issue directly but accesses government funding and the bank loan market. The Kuwait Investment Authority has never issued a bond, while Bahrain’s fund, Mumtalakat, has done its own funding. So we can see a mix of the two models."
Moreover, Gulf governments would like to develop their debt markets and drive sukuk issuance so they can reduce their reliance on banks. Today, GCC countries make up 35% of the global outstanding sukuk (Malaysia remains the biggest such market globally, with almost 60% of its ringgit debt capital market in sukuk), according to Fitch. Saudi Arabia has a significant Islamic banking sector – more than 84% of its finance is Islamic finance or sukuk.
Sukuk clarification
In February, Oman published its sukuk and bond regulation, which added regulatory clarity to the market. Meanwhile, the absence of a debt law is constraining Kuwait’s funding options, according to experts.
As of June, the Accounting and Auditing Organisation for Islamic Financial Institutions Sharia Standard No 62 on sukuk was in exposure draft format and could be finalised this year. The standard could alter the credit profile of sukuk from asset-based to asset-backed.
"The sukuk is a significant part of the funding story in the GCC," said Bashar Al Natoor, global head of Islamic finance at Fitch. "If you zoom in further, Saudi Arabia and the UAE are the most active and biggest players in the sukuk market in the region. The whole sukuk story has evolved during the past few years. If we go back to 2017, we can sum up three main drivers for the whole region – first, it’s about a diversification of funding; second, it’s about developing the capital markets; and, third, it’s about releasing the pressure on the banking system, so that corporates and projects are less reliant on banks to finance them.
"Each country has its own story. In the case of Saudi Arabia, as a government, it only issues sukuk in the local currency; when issuing in international markets, it issues conventional bonds and sukuk. In the case of the UAE, the picture is more fragmented. Historically, some emirates such as Sharjah and Ras Al Khaimah have issued sukuk but the main driver has been more the banks and the corporates, where they tap more into the international sukuk markets – the US dollar – rather than the dirham. The UAE as a federation started issuing local currency sukuk only last year.
"A lot of the investors in the Gulf region are Islamic banks and Islamic investors. For an issuer to be able to cater for the regional conventional side and the Islamic side, if it issues a sukuk, both will be able to go for it. If it issues only a bond, only the conventional investors will be able to go for it."
In short, the Middle East's debt capital markets are flourishing as countries try to diversify their economies away from oil and gas and seek additional sources of funding. This year is seeing a surge in conventional bond and sukuk issuance and it could turn out to be one of the hottest years on record, with the momentum expected to continue for the rest of 2024 unless the Israel-Gaza conflict worsens.
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