Funding the deficits (PDF)

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The main theme in the region is the issuance of bonds. Saudi Arabia’s market regulator the Capital Market Authority launched the Sukuk and Bonds Market. Saudi officials have stated foreign investors will be able to invest in the bond and sukuk offerings. Oman announced it will be issuing a sovereign bond to fund its budget following a 56% drop in oil revenues in Q1 this year. Also, UAE officials have announced that they will be launching the first sovereign bond without giving any further details

With the oil price outlook more uncertain this year as opposed to the high oil prices in 2008, Gulf States are expected to run fiscal deficits in 2009. This is the right approach, as infrastructure projects need to continue despite the economic downturn. Higher government spending will help pick up some of the slack in the economy. This will also have longer term benefits for Gulf economies as better infrastructure can lead to productivity gains in the future. Deficits, however, need to be funded and GCC states will be using the bond market to fund their deficits. It is worth noting that these bonds will be USD denominated. This is because regional debt capital markets are not deep enough and local currency liquidity is relatively tight. Issuing local currency bonds right now to fund the deficits could drain liquidity and crowd out the private sector.

However, Gulf countries need to gradually move towards funding themselves in local currencies. This also applies to the UAE. According to UAE officials the UAE is planning to issue its first sovereign bond. No further details have been made available; however the fact that the UAE will seek a sovereign rating suggests that the bond issuance is more likely to be in foreign currency (ie USD) rather than AED. Even though a foreign currency bond will help the UAE fund its budget without draining local currency liquidity, it will not help with the longer term needs of the country. Longer term the entire region would benefit from deeper debt capital markets that will make it easier for corporates in the region to fund their operations in local currency, providing alternative sources of funding. And for this to happen, establishing a local currency government benchmark yield curve should be a priority.