The Borrowing Spree

THE FUNDING: GCC states have tapped on local and international markets to fund their ambitious development projects.

Arab Gulf oil exporters to issue more debt in 2017

By Martin Dokoupil 

Arab Gulf oil exporters are likely to continue borrowing heavily from international markets over the coming years as fiscal gaps in most countries are expected to remain large with a marked recovery in oil prices not on the cards for the foreseeable future.

But facing a collapse in oil prices is nothing new for the six Gulf Cooperation Council (GCC) states—Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain—whose economies have extensively relied on exports of crude to finance a breakneck modernization over the recent decades. During the so called 1980s oil glut, Saudi Arabia, the world’s leading oil exporter, saw its budget plunge into the red for as many as 17 years in a row between 1983 and 1999, despite a 1990 spike in crude prices caused by Iraq’s invasion of Kuwait.

A more recent fiscal challenge came in 2009, when the global financial crisis sank hydrocarbon prices on the global market.
“This latest weakness in oil prices is definitely more severe than the region experienced back in 2009,” says Krisjanis Krustins, Associate Director Sovereign Group at FitchRatings in Hong Kong.

“The intervening period has been a mixed blessing.”

On the one hand, oil prices floating north of $100 per barrel in 2011-2014 boosted fiscal and external reserves of the GCC countries, but on the other also encouraged expansion of spending on social programs, mainly in Saudi Arabia and Bahrain, following a wave of social unrest in the Middle East.

For example, the Kingdom, which had traditionally overspent its budget plans by around a quarter in the last decade, boosted its government spending by an average 14.4 percent between 2011 and 2014, according to Newsweek Middle East’s calculations based on the official finance ministry data.

Last year was the first after 12 years of consecutive and mostly double digit spending increases when the Saudi government expenditures actually fell by 12 percent.

The Kingdom’s revenues, where oil still accounted for a hefty 72 percent of the total, dived by as much as 41 percent to 615.9 billion riyals ($164.1 billion) in 2015, leading to a deficit of 362.2 billion riyals, the largest gap in Saudi history.

That shows how hard it is to cut back the spending largesse of previous years when the benchmark Brent crude floats around $45 per barrel, way below the levels that GCC states need to balance their budgets, leaving them saddled with significant budget gaps.

This year alone, the combined fiscal deficit of the GCC countries is likely to reach $150 billion, or 12.8 percent of combined gross domestic product (GDP), Standard & Poor’s Global Ratings estimated in an October research note
“We forecast that the cumulative funding requirement could be as high as $560 billion between 2015 and 2019,” the ratings agency said, adding that the majority of this huge figure is related to Saudi Arabia.

The GCC members are expected to mainly use debt financing to cover their upcoming funding needs, but tighter domestic and international liquidity conditions could complicate such plans.

“International liquidity conditions have been favorable this year, but we expect they could gradually deteriorate should the U.S. Federal Reserve Bank increase rates, which we expect will start in December of this year,” according to ratings agency Standard & Poor’s.

“The implications of these scenarios are not just relevant for GCC sovereigns with large annual external financing needs, but also for those with only limited available assets to use as funding, such as Bahrain and Oman. Both situations could result in higher interest costs, which could add to the pressure on fiscal expenditures and increase gross debt, save for the implementation of further consolidation measures,” it said.

The Saudi kingdom, the top Arab economy at $646 billion, has already borrowed heavily from the international market for the first time in its history this year.

Saudi Arabia is said to have raised $17.5 billion in international debt, that was a record bond sale from an emerging country in October. The order book was a whopping $67 billion.

According to the Saudi Ministry of Finance, the bonds “are dollar denominated,” while bankers say the debt will be repaid over a span of five to 30 years.

The IMF estimated the Kingdom’s gross debt at 14.1 percent of GDP in 2016, up from 5 percent last year. And though Saudi Arabia has borrowed from its local market in the past, with a total internal debt reaching $11.8 billion or 1.6 percent of its GDP, as per the Finance Ministry’s numbers in October, yet, the significance of this new international bonds’ issuance comes at a time when oil revenues have significantly declined and tapping unto new sources of cash has become more than necessary to finance development projects and ambitious modernization plans, including the Kingdom’s Vision 2030.

The Saudi issuance followed a $9 billion issue from Qatar in May, the Abu Dhabi emirate’s $5 billion offering in April and $4.5 billion from Oman.

Saudi officials have also told Newsweek Middle East that the Kingdom will likely be borrowing from the international markets as well as internally going forward, mainly via initial public offerings of its more lucrative businesses such as the Silos and Flour Mills, and Saudi Arabian Airlines, aside from ARAMCO’s anticipated IPO.

Kuwait, on the other hand, financed its 2016 deficit from the general reserves, as its “Finance Ministry is studying the possibility of adding an article to the 2016-2017 budget which would give the government the option to finance its deficit via borrowing from local and international markets next year,” Khalifa Hamada, Kuwait’s undersecretary minister of finance told Newsweek Middle East earlier this year.

Apart from Bahrain, the regional debt issuance on international markets had been relatively infrequent in the past with the recent bond sales showing the extent of how profound the turn of fortunes is.

And the borrowing spree is set to continue over the next five years as only Kuwait and the United Arab Emirates are seen to return to modest budget surpluses in 2017 and in 2019 respectively, thanks to an expected improvement in oil prices, October estimates of the International Monetary Fund show.

Covering the fiscal gaps is likely to include a funding mix of asset drawdowns and debt issuance, S&P’s projects, expecting Qatar and Bahrain to finance vast majority of their deficits through debt. On the contrary, Kuwait is likely to use mostly assets, while Oman, Saudi Arabia and Abu Dhabi typically have a fairly even split of asset and debt financing.

“The Sultanate will continue to borrow as long as there is a deficit. We hope that in the coming years there will be less and less borrowing from the international market,” Oman Central Bank Executive President Hamood Sangour Al Zadjali told Newsweek Middle East on the sidelines of a financial conference in Muscat earlier this November.

Asked whether more international borrowing was likely this year, he added: “This year, the government has all of what it has required. Maybe there’ll be local borrowing by issuing bonds in December, about 150 million rials ($388 million), because there is a bond maturing so the government is going to replace it.”

Non-OPEC oil producer Oman is expected to see a budget shortfall of 13.5 percent of GDP this year, down from 16.5 percent in 2015, the International Monetary Fund’s (IMF) regional report shows. That should gradually decline to a deficit of 4.2 percent of GDP in 2021, the Fund forecasts.

The much less oil-reliant emirate of Dubai, where crude sales account for less than 10 percent of the overall local government’s revenue, has been absent so far from the international debt market, last issuing a sovereign bond in April 2014.

“We continue to monitor the developments in the capital markets and actively meeting with banks and investors. Any future issuances would be on an ongoing basis as per our budgets and requirements,” Abdulrahman Al Saleh, Director General of Dubai’s Department of Finance told Newsweek Middle East.

Dubai’s Department of Finance has a cap of $11 billion approved by the Supreme Fiscal Committee under its Euro Medium Term Note and Sukuk issuance programs, Al Saleh said, adding that his department was currently working on capital expenditures required in preparation to host Expo 2020 in Dubai and the requirements of the 2017 budget.

Although the GCC countries have cut their budget spending by around 10 percent in 2015 and by a similar margin again this year, the IMF and analysts estimate further measures to rein in expenditures will be much more difficult.

“We estimate that the collapse in oil revenues forced GCC governments to cut spending collectively by around 10 percent last year, but the average breakeven oil price remains at around $76 per barrel,” says Farouk Soussa, Head of Middle East Economics for Citi in London.

“With oil currently at $45 per barrel and unlikely to surpass the $65 mark in the coming few years, this means that governments have a lot more adjusting to do,” he tells Newsweek Middle East.

In an unprecedented belt-tightening move, Saudi Arabia announced in September that it would slash ministers’ salaries by 20 percent and curb overtime bonuses at 25-50 percent of basic salaries for public sector employees among other saving measures. Such measures are politically sensitive in the country, where the ruling family often delayed reforms to its generous welfare state in the past to avoid stirring unrest among the population.

“As we move forward, it will be harder to reduce spending. Because some of the easier things to cut, which is postponing capital projects, has already been done,” Masood Ahmed, the outgoing IMF director for the Middle East and Central Asia Department, said at a presentation of the regional outlook in Dubai in October.

In its 2016 budget statement, the Saudi finance ministry said it would adjust energy and water subsidies over five years. The Kingdom has also announced a series of proposals to trim its heavy dependence on oil such as an initial public offering of the state-controlled oil giant, Saudi Aramco. Other GCC countries such as the UAE and Kuwait have already cut energy subsidies in the past or announced plans to limit them.

“Expenditure cuts are likely to continue, but will eventually come up against constraints such as the wage bill, social and defense spending and the like, meaning that fiscal consolidation will increasingly have to focus on raising non-oil revenues through taxation and other fees. This traps economic growth in a double pincer of lower fiscal stimulus and rising costs,” Citi’s Soussa says.

So far, on the revenue side, the budget strain has already revived a long discussed plan of the GCC countries to introduce a value added tax across the bloc. The UAE federal government has announced that it would introduce a 5 percent value added tax on certain goods and services in January 2018.

DOF’s Al Saleh says that besides this Value Added Tax (VAT) plan, there were no additional taxation or tariffs envisaged to increase or diversify government revenues at this point.

“However, revenues may be impacted by growth in certain existing tariffs and by growth in the overall population and economy. We keep reviewing the revenues from time to time and only increase if there is a genuine need,” he adds.

Asked how resilient Dubai’s public finances were in the current low oil price environment, Al Saleh explains: “DOF runs a current account surplus constantly; therefore, there are no major liquidity risks. DOF’s current revenues cover its current expenditure and hence the fiscal situation is comfortable.”


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