Portfolios: QE2 To Spur Gulf Issuance, But Losses For SWFs
Published Wednesday, 10th November 2010 05:17 am - © 2010 MNI News
MNI Fixed Income Bullet Points delivers real-time commentary in concise bullet point format. Learn more
By Brai Odion-Esene
WASHINGTON (MNI) - Although investors in the Gulf region remain cautious, bearing in mind the defaults and debt restructurings seen within the Gulf economies the last 18 months -- including sukuk, the chase for yields due to low interest rates in the U.S. has created a window of opportunity for the Gulf's top-tier issuers.
However, the Federal Reserve's new $600 billion Treasuries buying program is widely expected to drive down the value of the U.S. dollar, meaning capital losses for Gulf sovereign wealth funds and central bank reserves invested in dollar-denominated assets.
According to Emmanuel Volland, a senior director within Standard & Poor's Financial Institutions department, the impact of the Federal Reserve's additional monetary easing is expected to translate into better prospects for debt issuance in the Gulf, Volland said, in both conventional and sukuk (Islamic) bonds.
"There is some significant pickup that we've already noticed and that should continue for the foreseeable future," Volland told Market News International in a telephone interview, "although not returning to pre-crisis levels."
Issuers will be eager to benefit from the low interest rate environment, he said, while the drop in interest rates in mature markets will attract investors to higher yields in the GCC markets.
However, Gulf issuers are likely to offer more conventional debt to investors, as opposed to sukuk, Volland said. "The market perceives that there is a window of opportunity that exists now, which could last for some time but maybe not for too long ... so there are a lot of issuers that are rushing to issue debt," he said.
"And it's much faster to issue conventional debt instead of structuring sukuk," he added.
In addition, Volland said the market continues to be "quite selective," attracted towards issuers that are more institutionalized, with stronger credit ratings, or with close ties to the governments.
"So I think that the tier-2 players ... or those in sectors that have been impacted more by the crisis will still find it difficult," Volland said.
One gulf economist, however argues that on the whole, the benefit of QE2 to bond issuers is "negligible," and the main effect of QE2 is likely to be felt via the weakening of the dollar vs. other major currencies.
The downside from the Fed's actions, warned Ala'a Al-Yousuf, economic consultant and former chief economist for Bahrain-based investment bank Gulf Finance House, is that the assets of sovereign wealth funds, central bank reserves, and a lot of portfolios are denominated in the U.S. dollar. The absence of corrective measures by central banks, he said, means there will be capital losses incurred.
"They will have to look at the alternatives -- where can they park large sums of money. Do they go to European sovereign or corporate bonds? Or should they be buying alternative assets?," he told MNI.
But with a landscape that is less than encouraging, most investors are willing to put up with negative real interest rates and a weak dollar, Al-Yousuf noted, with viable alternatives "few and far between."
With that in mind, the Gulf economist continued, investors remain discriminating in the current environment. "With the recent experiences of defaults and corporate distress in the Gulf, including massive restructuring of Dubai debt ... investors will be very cautious," he said.
So there is no guarantee, according to Al-Yousuf, that bond issuers in the Gulf will look increasingly to tap the market and take advantage of the demand for higher yielding assets.
It is not a "one to one" kind of relationship he said. Corporates in the Gulf that are strong enough, "and have a good story to tell," will issue debt anyway -- whether there is QE2 or not.
Al-Yousuf said for those currently unable to raise funds in the capital markets, that has more to do with their internal problems -- or business models -- as opposed to a lack of liquidity.
"Banks throughout the region are flush with cash," he said. "Central banks are sitting on a lot of deposits put there by banks."
In a similar scenario to that being witnessed in the U.S., Al-Yousuf said Gulf banks are not lending because a lot of corporates in the region do not have the credit standing that they used to; a situation that is unlikely to change even with the introduction of QE2.
The longer-term issue, he believes, remains the decision of Arab Gulf countries to peg their currencies to the dollar. He noted that while "merchandise exporters" like China and Germany face pressure from the U.S. in the context of global imbalances, Gulf states "have been given some kind of exemption because they are commodity exporters."
Sooner or later, however, Al-Yousuf predicted that Gulf states will have to decide what is the appropriate exchange rate policy for the next 10 to 20 years, when China and other emerging economies are becoming more significant compared to weakening or stagnating industrial economies.
They need to start thinking about transitioning away from the dollar-peg, he said, broadening its ties to include not just the euro, but maybe in the longer-term, some BRIC currencies.
Inflation is also another area where the Fed's action could feed through, with Al-Yousuf noting that with more monetary stimulus from the U.S. central bank expected to push commodity prices higher, Gulf states will once again have to deal with the challenge of imported inflation.
"They don't have the tools or the clear policies or mandate to address that," he said.
However, according to research by French bank Credit Agricole, Gulf economies are on a recovery footing and inflation rates are not a concern in most of the region like they were in 2007-08.
In an emerging market report published Monday, the bank noted that at that time, there was a disparity between the U.S.'s struggling economy (forcing Fed rates to fall) and the then-booming economies in the Gulf. Now, "Economic cycles are no longer completely out of sync, with loose monetary policy serving the interests of both, and hence upholding the viability of Gulf dollar pegs."
With regional governments in the Gulf still struggling to re-engage the private sector in the development process and attract foreign investment, Credit Agricole said weaker Gulf currencies would better enable the countries to promote tourism as well as tradable sectors like manufacturing, and pick up capital injections from European and Asian companies.
And even with the current phase of dollar weakness, a return to double digit inflation in the Gulf economies is unlikely through to the end of 2011, it said. Saudi inflation is likely to average 5.3% this year and 4.7% in 2011, while UAE inflation should not exceed 1% in 2010 and 3.1% next year.
And as for fears of imported inflation due to a weakening dollar, the bank said it does not expect imported inflation to pass through immediately, since Gulf economies denominate more than 60% of their letters of credit in the dollar. Additionally, inflationary pressures among key trading partners -- more than 50% of Gulf imports are from China, Japan, the Eurozone and the U.S. -- have also not reached alarming levels.
** Market News International Washington Bureau: 202-371-2121 **