A downgrade of Saudi Arabia's sovereign debt by Standard and Poor's at the weekend may contribute to a gradual repricing of the Gulf's international bonds to lower levels as they reflect risks created by low oil prices. S&P pointed to factors which could undermine bond prices across Gulf Arab economies in coming months and years: the way in which cheap oil is opening up state budget deficits, and the difficult choices which governments will need to make to bring the deficits under control.
Gulf bond yields have risen since oil plunged last year, but for some investors, they still reflect an era when state Treasuries were overflowing with fresh infusions of oil money, banks were flush with cash and economies were growing strongly.
All of those conditions have now disappeared to a significant degree, but that may not yet be fully reflected in secondary market bond prices.
An April 2023 sukuk from state-owned utility Saudi Electric, for example, is trading at 3.31 percent, well inside a May 2023 bond from Chinese state oil firm CNOOC, which is at 3.80 percent. CNOOC is rated Aa3 by Moody's and Saudi Electric has an equivalent rating from Fitch.
Meanwhile, US dollar sukuk issues last month by Saudi Arabia's Arab Petroleum Investments Corp (APICORP), Qatar Islamic Bank (QIB) and Dubai's Majid Al Futtaim (MAF) drew only modest interest from international investors.
Middle East investors took about 80 percent of the APICORP issue, 68 percent of QIB issue and 42 percent of MAF deal. The ratios in the first two cases were much higher than levels being seen just six months or a year ago.
To some fund managers, that indicates the structure of the investor base has changed for the worse, and that it is only local investors who are now keeping prices up.
"A relative lack of new issuance, combined with a market dominated by buy-and-hold investors, means that we have probably not widened as much as we should have given the changing risk profile in the region," said Abdul Kadir Hussain, who oversees about $1.2 billion in assets as chief executive of Dubai's Mashreq Capital.
"However as the MAF new issue showed last week, investors are no longer chasing paper the same way they did last year."
S&P cut its rating of Saudi Arabia's long-term foreign and local currency ratings by one notch to 'A-plus/A-1', keeping a negative outlook.
The other two major agencies have higher ratings for the kingdom - Moody's is one notch higher with a stable outlook, while Fitch is two notches higher with a negative outlook - and it is not clear that they will imitate S&P.
The Saudi Finance Ministry said the downgrade was unjustified and terminated its rating agreement with S&P, forcing the agency to classify its assessment of the kingdom as "unsolicited".
Nevertheless, the downgrade may be a step towards a more sober assessment of Gulf debt in coming months. The gap between the Saudi Electric and CNOOC 2023 bonds suggests spreads could move some 50 basis points.
A senior banker at an international bank said a repricing of 30-50 bps would be required for Gulf bonds to resume being attractive to international investors in emerging market debt.
Buying support from local banks may slow that adjustment, but their ability to buy is decreasing; interbank money rates in most of the region are rising as flows of new oil money into the banks dry up, and as money is diverted into government bond issues used to finance budget deficits.
At the longer end of the yield curve, where local investors are much less active, Gulf debt is already wider than similarly rated bonds. An April 2043 sukuk from Saudi Electric is quoted at 5.73 percent, against 4.68 percent for a May 2043 bond from China's CNOOC.
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