The plunge in oil prices from mid-2014 has been a serious setback for all oil producing countries but for the members of the Gulf Cooperation Council the effects have been dramatic. From a comfortable position of current account and budget surpluses for more than a decade, GCC governments suddenly found themselves in 2015 with large deficits and sizeable financing needs.
While GCC governments financed deficits by drawing on large accumulated reserves and ample bank deposits, there was also renewed borrowing, including from the capital markets.
The GCC countries’ current and prospective financing needs may not be large relative to the size of their economies or their financial assets, but their reorientation towards market borrowing provides an opportunity to examine the potential of the local debt capital markets. In the GCC, these have lagged behind emerging-market peers, and remain a relatively under-developed segment of what are otherwise modern and fully globalised economies.
For more than a decade until the oil price collapse, GCC governments had been ramping up public spending at double-digit annual rates, while also recording current account and budget surpluses. With the collapse of the oil price, the GCC economies quickly shifted to deficits of nearly 10 per cent of GDP in 2015 and 2016.
The outlook to 2020 is for fiscal deficits to gradually decline as consolidation measures take hold and oil prices inch higher. However, consolidation could lag and future oil prices may not match forecasts. Sovereigns will need to continue borrowing to fund ambitious capital expenditure plans, especially for infrastructure and energy. Similarly, facing tighter liquidity conditions and costlier bank credit, corporates will need to turn increasingly to the capital markets through bond issuance and IPOs.
Bond and Sukuk issues by GCC borrowers before the oil price collapse had been relatively modest. In the five years to 2014, issuance averaged only $23bn annually, or 1.5 per cent of aggregate GDP. From the start of 2015 to the first quarter of this year, the annual average has jumped to $57bn, with sovereigns being the principal borrowers.
Accounting for a smaller share, corporates also doubled the amounts raised in 2016 from the previous year. Sukuk issuance remains weak, hampered by a lack of clarity and consistency in regulatory regimes, transparency issues and under-developed secondary markets.
Among the six countries in the GCC, Saudi Arabia has the most developed debt securities market, while the UAE and Bahrain are not far behind. Stock markets in all GCC countries are well developed and reasonably well regulated, and should continue to provide a good source of funding for corporates and, through privatisation, for sovereigns and quasi-sovereign entities.
To build on recent progress in making the local bond and Sukuk markets effective catalysts in the region’s growth and diversification, GCC authorities would do well to focus on the following critical areas.
First, in setting out their funding plans, sovereigns should endeavour to extend and vary the tenors of debt securities on offer to help build sovereign yield curves to guide the market. Second, the authorities need to encourage the growth of investment banking to facilitate market making, promote a trading culture and ensure market-sourced liquidity when needed.
Third, remaining restrictions on foreign ownership of domestic assets should be gradually eased in line with local laws and traditions. Fourth, appropriate trading infrastructure, supported by robust regulatory frameworks, needs to be established. Finally, the narrow investor base needs to be broadened by promoting the growth of the insurance and reinsurance sectors and by easing regulations governing pension funds’ investment policies.
The development of well regulated, efficient, and liquid capital markets in the GCC would bring numerous benefits. By diversifying funding sources, capital markets relieve pressures on banks and mitigate systemic risks. By helping to draw in outside investors, capital markets could also enhance the governance and competitiveness of local companies.
A well-functioning bond and Sukuk market in the GCC would also facilitate the conduct of independent monetary policy if and when the time comes to de-peg the currencies. Such a market would also underpin financial stability by providing a ready supply of high quality liquid assets to serve as collateral for banks participating in monetary operations and in the interbank markets, and in beefing up banks’ liquidity buffers.
Finally, capital markets for debt as much as for equities could be effective vehicles for citizen participation in economic growth and, especially important for the GCC countries, they could be a powerful channel for promoting financial inclusion and equitable growth.
George Abed is Distinguished Scholar in Residence at the Institute of International Finance in Washington. gabed@iif.com