Five factors that can shore up debt markets in Dubai

It is six years away, but already Expo 2020 is stimulating increased economic activity across Dubai. To anyone living and working in Dubai, the signs are apparent. Investment in infrastructure in advance of the Expo is already helping to accelerate Dubai’s resurgence as a regional trade hub and as a magnet for regional capital.

However, it is unlikely that Expo 2020 alone will drive the much-needed development of the local debt markets. Even though spending on new projects and initiatives to service the projected influx of visitors could require the issuance of high-yielding bonds, and even though limited funding from the debt markets is already under way, the Expo will not be the principal driver for the bond markets over the next couple of years.

Instead, five other factors will be central.

The first of these factors is global regulation. The implementation of the Basel III requirements for bank capital could further reduce the involvement of European financial institutions in long-term lending in the GCC. With European banks having broadly withdrawn from regional project financing after the financial crisis, a significant portion of the required infrastructure funding is expected to be financed through project bond issuance, providing new opportunities for the growth of the local debt markets.

Second, there is renewed and strong investor demand for GCC bonds. Continued economic growth and robust fundamentals have created demand from regional and international investors for high-quality paper from the GCC. That has allowed issuers to tap international markets at record low coupon rates and extend their debt maturity profiles. Accommodative central bank monetary policies around the world have helped, with record low interest rates resulting in record low sukuk yields.

Third, strong government support for the growth of Islamic finance in the UAE will become an increasingly significant factor in driving debt market growth. The Dubai government’s plans to create a global hub for Islamic finance is in part a response to demand from investors seeking paper from high-quality issuers in the GCC.

The fourth factor is that more innovative funding solutions are also becoming more common in the region. Majid Al Futtaim’s issuance of perpetual hybrid securities last year is just one example of the more innovative solutions that local corporates are employing to diversify their funding portfolios.

Fifth, the diversification of corporate funding is also an important issue. Across the region, overreliance on short-term, uncommitted bank borrowing remains a significant risk. As corporate governance has improved, alongside the adoption of world-class financial management practices, local corporates are increasingly realising the risks of this exposure and investigating the diversification of their financing through tapping the bond markets. Tightening spreads on bond yields have also added to the attractiveness of debt for issuers.

Taken together, these five factors will undoubtedly play a significant role in supporting the development of the local debt markets over the next six years. However, on their own they will not provide a “silver bullet”, nor be sufficient to ensure the markets’ sustainable, long-term growth. Specific intervention will be required.

The UAE authorities have already made progress through direct intervention in driving development of the local bond markets. Last November, the Central Bank of the UAE announced a revision of its banking regulations, capping concentration limits on the amount of credit that domestic banks can extend to local governments and their related entities. These loans are now capped at 100 per cent of the lending bank’s capital base. Assertive implementation and monitoring of these rules should support the growth of debt markets, as it will help a number of GREs (government-related entities) look towards the conventional bond and the sukuk market for funding or refinancing.

Additionally, targeted intervention through the introduction of mandatory pension funds for expatriate workers could play a major role in the long-term growth and development of the local debt markets. This injection of capital would not only be an important source of funding for domestic bond markets, as pension funds consider reallocation away from equities. More importantly, the development of mandatory-funded pension schemes has the potential to bring additional liquidity to the markets. This initiative already has a successful precedent in Singapore.

But it will take intervention on the scale of Asian governments in the 1990s to effect material, positive long-term change. After the Asian financial crisis in 1997, Asian governments took deliberate steps to strengthen their bond markets.

Even sovereigns with a structural fiscal surplus, such as Hong Kong and Singapore, strongly expanded their sovereign issuance. These actions provided a “risk-free” benchmark sovereign yield curve and investment alternative.

Stuart Anderson is the managing director and regional head for the Middle East at Standard & Poor’s Ratings Services

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