GCC debt markets saw little volatility in yields in the second quarter of 2016 (2Q16), even as issuance picked up on the back of healthy sovereign activity supported by stable oil prices and limited global volatility, a report said.

Investor confidence in the region remains fragile as concerns over fiscal sustainability and tightening domestic liquidity remain, added the latest Economic Update from the National Bank of Kuwait (NBK).

In a bid to ease pressures on domestic liquidity, most recent sovereign issuance has been international; central banks have also eased liquidity regulations. Nonetheless, liquidity strains persisted, pushing regional banks towards debt and interbank markets for funding, adding further upward pressure on interbank rates. Appetite for GCC debt is expected to remain healthy, though it may be dampened by external risk factors.

Yields have benefited from the relative stability in global oil markets and a dovish Fed. GCC yields saw little volatility in 2Q16 and continued to steadily trend downwards, as oil prices maintained healthy levels and the Fed rate hike was postponed to the second half of 2016.

Yields also seemed to be little affected by the global fallout that followed the Brexit vote. However, GCC spreads to US treasuries have widened as investors fled to safety. Five to six year paper for Dubai, Abu Dhabi, and Qatar finished the quarter down 21 to 23 basis points, settling at 3.33 per cent, 1.90 per cent, and 2.37 per cent, respectively.

Despite recovering oil prices, CDS rates were up in 2Q16 for most GCC sovereigns following persistent speculation over fiscal sustainability and tightening liquidity. A slew of rating and outlook adjustments, to the downside for most, prompted investor caution. Successfully implementing fiscal reforms and tightening banking liquidity emerged as the main concerns. Saudi Arabia was the most affected, seeing its credit default swaps (CDS) rate jump by 26 basis points in 2Q16, eroding any confidence gained in the past six months.

Meanwhile, the United Arab Emirates appeared to emerge as a regional safe haven. Dubai CDS rates dropped 31 basis points to just under 200 swap points for the first time in almost a year, while Abu Dhabi’s swap rates, the lowest amongst its peers, were mostly flat on the quarter.

GCC debt issuance was strong in 1H16, boosted by sovereign issuance. Gross issuance totalled $55 billion during the first half of 2016, with $36 billion added in 2Q16 alone. This compares to $74 billion issued during the whole of 2015. The stock of outstanding bonds in the region grew by 24 per cent in 2Q16, its fastest pace in five years, to stand at $335 billion.

With public sector financing needs expected to top $120 billion in 2016, GCC sovereigns continued to tap debt markets for funding, leading the issuance of new debt in 2Q16. Sovereigns accounted for close to 75 per cent of gross issuance during the quarter, issuing $27 billion.

With liquidity concerns at the forefront, some governments avoided domestic currency issues in favour of international offerings. Appetite for the debt was strong, with Abu Dhabi, Qatar, and Oman, comfortably selling $16.5 billion worth of international bonds. Saudi is looking to capitalize on this momentum and is seeking to offer international investors $10 billion in foreign currency bonds, if not more. This follows its successful bid for an international syndicated loan of similar magnitude.

Financial institutions actively tapped debt and interbank markets for funding in 2Q16 on the back of declining deposits and increased government issuance. Regional banks saw a pick-up in issuance over the quarter, raising $6 billion; this was their largest offering in four quarters, as they increasingly turned to market funding.

With deposit growth slowing across GCC banks, loan-to-deposit ratios have been under pressure. At the same time, competition over short-term funding saw pressures mount in the interbank market, with rates trending upwards. Saudi Arabia’s 3-month interbank rate jumped 42 basis points during 2Q16 and 68 basis points year-to-date. In a bid to ease pressures, some central banks have adjusted their liquidity and reserve requirements, as seen in Kuwait, Saudi Arabia, and Oman.

Uncertainty in global markets and oil prices has muted non-financial sector activity in recent years. Although up on the quarter, with healthy issuance activity of $3 billion in 2Q16, NFS issuance, has been anaemic over the last 8 quarters (3Q14-2Q16), averaging $0.8 billion per quarter, compared to a quarterly average of $4.2 billion from 3Q12 through 2Q14.

While GCC debt growth is expected to remain robust on the back of large financing needs, external economic risks may dampen appetite for it. Further US policy rate hikes in 2016 and 2017 and increased global market volatility, such as continued repercussions from Brexit or a sharp slowdown in the Chinese economy, could see appetite for emerging market debt diminish. Upward pressure on the US dollar, and in turn all GCC currencies, may also discourage investment in GCC debt if their offerings are mispriced. – TradeArabia News Service