The bullish case for the GCC’s sovereign bonds and sukuk

Yuri Gripas/Abaca Press/TNS/Alamy via Reuters Connect

Jerome Powell, the Federal Reserve chairman, gave the green light at Jackson Hole for Fed interest rate cuts that begin at the September Federal Open Market Committee conclave.

The Bank of England, the European Central Bank, the Reserve Bank of New Zealand and the Bank of Canada have already eased policy rates this summer. 

Global monetary easing provides a benign macro backdrop for the GCC’s sovereign bond and sukuk markets. I would accumulate duration risk in the most liquid issues of the highest credit sovereign issuers in the Gulf.

This leads me to Saudi Arabia and the UAE, two of the three biggest issuers of sukuk in the global capital markets; Malaysia being south-east Asia’s pre-eminent sukuk issuer and debt trading hub.

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This year has been historic for the Arab bond and sukuk markets in terms of its sheer growth rate, the volume of sovereign new issuance and secondary market trading, and the acceptance of green bonds as a credible investment instrument. 

It is no coincidence that Saudi Arabia has replaced China as the dominant sovereign issuer in the global emerging debt market league table.

The kingdom’s oil export revenues declined to three-year lows as its role as Opec+’s swing producer and the de facto central bank of crude oil necessitated voluntary output cuts over and beyond its formal Opec quota.

In addition, oil prices have not responded as dramatically to the Gaza war as they did to the Russian invasion of Ukraine in February 2022. Then, Brent spiked to $135 a barrel before the Biden White House sold oil from its strategic reserve stockpile. 

Successive geopolitical shocks related to the wars in Gaza, Lebanon, the Red Sea tanker shipping lanes and even a drone and missile exchange between Israel and Iran have not taken Brent above $85 a barrel on a sustained basis.

Brent now trades at $79 a barrel, significantly below the $108 level that Bloomberg Intelligence economists believe is Saudi Arabia’s current budget breakeven price. Saudi Arabia also has significant security commitments to regional allies such as Egypt, Jordan, Morocco, Bahrain and Pakistan.

Saudi Arabia has the fiscal space to issue new debt on a colossal scale since its public debt-to-GDP ratio is still below 30 percent and its $1.1 trillion GDP economy is projected to end 2024 with a 3 percent budget deficit.

Riyadh's budget deficit necessitates at least $13-$14 billion of new bond/sukuk issuance in both 2025 and 2026.

Brent's inability to trade above $85 in the wet barrel market is a testament to the synchronised global economic slowdown in the US, Europe and China.

With LME Copper at $9,060 a metric tonne, down 17 percent since late May, it is rational to conclude that the red metal, known to Wall Street cognoscenti as Dr Copper due to its role as an advance indicator for the global industrial/construction cycle, is flashing a recession SOS.

This is now confirmed by 10-year lows in iron ore – the pure play commodity that defines steel production in the US and China.

The kingdom could well be forced to increase output cuts as the dominant powerbroker of Opec if Brent falls below $65. The scale and diversity of Vision 2030 funding ensure that Saudi Arabia will remain the largest issuer of bonds/sukuk in the Eurobond and SR note market.

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UAE debt assets are coveted by North American, European and Asian institutional investors as 96.5 percent of sukuk/bond issuers boast an investment grade rating. Meanwhile Abu Dhabi owns $1.5 trillion in sovereign wealth assets, three times the size of the $500 billion GDP Emirati economy.

UAE banks also exhibit strong liquidity metrics that make them natural buyers of Emirati new issues in both the Eurobond and local UAE dirham debt capital markets.

We are now seeing a surge in green bond issuance that was inevitable after the UAE announced several strategic climate finance initiatives as the most recent Cop28 host. It is thus no surprise that green bonds were a significant component of the UAE's $2.25 billion sukuk issuance in the first half of 2024, second only to Saudi Arabia.

Global debt capital markets are also receptive to multibillion dollar jumbo sovereign deals from the GCC. Saudi Arabia's $5 billion sukuk was oversubscribed and placed with banks and institutional investors from London to Zurich, Frankfurt to Tokyo and Boston to Singapore.

However, Bahrain's $1.7 billion sukuk was primarily placed with GCC investors who grasp the nuances of the island kingdom's financial umbilical cord with Riyadh. The classic example of "Riyalpolitik".

Saudi Arabian sovereign debt is undervalued since it yields 40-60 basis points more than similar rated credits from Poland and Chile. 

Long duration Saudi and UAE sovereign debt is thus primed for capital appreciation as the Fed's easy money pivot at Jackson Hole means lower US Treasury bond yields as the global economic slowdown accelerates.

High yield credits like Bahrain and Oman will find more buy-side resonance in the GCC's banks, family offices, insurers and Islamic finance houses.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah