* Premium 200-300 bps a decade ago, now in low double-digits
* Change in pure sovereign spreads is most dramatic
* Western monetary easing partly responsible
* Deepening market, falling political, economic risk also
* Premium could still grow again if global conditions change
By Archana Narayanan
DUBAI, June 19 Long a key feature of the Middle
Eastern bond market, the "Gulf premium" is fading and may vanish
entirely as soon as this year if the region continues to gain
ground as a mainstream investment destination.
The premium is the mark-up that issuers in the Gulf have to
pay over developed-country issuers when they sell similarly
rated paper. It has existed since the birth of a significant
flow of international bonds from the Gulf about a decade ago.
It is attributed to a range of factors, especially the
geopolitical uncertainties, unpredictable government policies,
poor information disclosure and shaky corporate governance
standards in the six-nation Gulf Cooperation Council.
And in the past, the premium was substantial; a decade ago,
a highly rated issuer in an oil-rich economy such as Abu Dhabi
or Qatar might expect to pay a premium of 200 or 300 basis
But it has been narrowing steadily over the past couple of
years as the Gulf's bond market has deepened and foreign
portfolio investors' concerns about the region have eased
somewhat. In recent weeks the premium has almost disappeared -
and some think it could do so entirely.
The Gulf premium "has shrunk and normalised over the past
few years on the back of improving fundamentals as well as
increased investor demand," said Mohieddine Kronfol, chief
investment officer for regional fixed income at global asset
manager Franklin Templeton Investments.
"Strong relative performance and rapid market development
should support the GCC as an attractive investment destination
for regional and international investors looking to optimise and
diversify their portfolios."
The trend was underlined in dramatic fashion last week when
United Arab Emirates state telecommunications operator Etisalat
sold $4.3 billion worth of U.S. dollar and euro bonds
in four tranches, the region's biggest corporate issue ever.
It also set a record for the cheapest pricing - it was the
first time that any Gulf issuer, including governments, priced a
bond in the double digits above mid-swaps. The Qatar government
achieved 115 bps over mid-swaps with a five-year sukuk in July
2012, and a 10-year trade from Abu Dhabi National Energy Co
in April 2014 was at that level.
Etisalat bonds have tightened in the secondary market since
its sale and on Thursday, its $500 million of bonds maturing in
June 2019 were bid at 2.32 percent.
Dollar bonds from U.S. telecommunications firm
AT&T, maturing in March 2019, were bid at 2.24 percent.
Rated A3 by Moody's, AT&T is three notches below Etisalat, so a
significant Gulf premium still exists - but it is small compared
to what it would have been a year or two ago.
The gradual narrowing of the premium over the last few years
can be seen in the spread between 10-year dollar bonds issued in
October 2010 by Qtel International Finance, part of
Qatar's state-run telecommunications firm, and South Korea's
The spread of the yield of QIF, rated A plus by
Fitch, over the AA minus-rated Exim Bank has shrunk
to 15 bps from 45 bps at the end of 2010.
For pure sovereigns, the premium has shrunk even faster. The
spread of Abu Dhabi's dollar bond maturing in April 2019
above Canada's December 2019 U.S. dollar bond
has narrowed to 16 bps from 28 bps at the end of
last year, even though Canada at AAA is rated two notches higher
than Abu Dhabi by Standard and Poor's.
Several reasons are behind the narrowing. One is outside the
Gulf's control: the plunge in global interest rates and drastic
easing of Western monetary policies over the last several years,
including the European Central Bank's decision this month to cut
its deposit rate below zero.
This left foreign investors hungry for yield and willing to
bid up the prices of Gulf bonds in a way they had not done
before. Some local institutional investors followed suit.
"Investors' hunger for fixed income assets, improving
fundamentals and a supply-demand imbalance combined have caused
the Gulf premium to shrink over the past few years - hence
global and regional investors are having to accept the new
pricing norm," said Chavan Bhogaita, head of alternative
investments at National Bank of Abu Dhabi.
Other reasons are specific to the Gulf. The slow broadening
and deepening of the region's bond market has made it more
attractive for foreign investors by improving liquidity.
Meanwhile, the rich Gulf states have done well -
surprisingly well, in the eyes of some foreign investors - in
riding out the geopolitical and economic turbulence of the past
Their treasuries swelled by high oil prices, they have
banded together to prevent the Arab Spring uprisings in North
Africa and the Levant from causing serious instability in the
Gulf. So some foreign investors have cut their assessment of
political risk, for the medium term at least.
The bond market's confidence in political stability has been
evident in the past two weeks, as GCC spreads and credit default
swaps have barely moved while insurgents threaten to dismember
Meanwhile, the volatility in emerging markets over the past
year has focused on countries with big current account gaps and
budget deficits. Because of its oil earnings, the Gulf has huge
surpluses in both respects, making it seem an oasis of economic
stability in the emerging market universe.
Another factor is the Gulf's progress towards improving
information disclosure and corporate governance. There is a long
way to go, but authorities are working towards that goal in the
UAE, Saudi Arabia and Qatar. The debt restructurings of Dubai's
state-linked firms have revealed previously undisclosed data on
how the emirate operates, though much remains secret.
"While significant improvements in the UAE's statistical
base are underway, important shortcomings remain," the
International Monetary Fund said in a report last month.
Some traders think the momentum of spread compression is
strong enough for the Gulf premium to vanish in coming months -
though others think that even if it does disappear, it could
reappear when global economic conditions change.
Kronfol said further, sustainable spread compression would
depend on the region addressing structural issues such as
governance standards, capital market regulation and bankruptcy
regimes. These issues still prevent pricing from being entirely
in line with developed markets, he said.
One big risk for the Gulf, and all emerging markets, is the
prospect of U.S. interest rates starting to rise next year,
which could suck money back to Western markets.
The Gulf's currency pegs to the dollar should limit this
risk, but even so, Gulf economies will for the foreseeable
future remain heavily dependent on one commodity, oil, and they
will be part of a volatile international environment.
"The supersized Etisalat corporate bond was issued with the
lowest spread of any Gulf bond above mid-swaps ever. That is
pricing for perfection, and fails to discount the political risk
that is inherent in the region," said Daniel Broby, chief
executive at Gemfonds, a global emerging market specialist.
(Editing by Andrew Torchia)