Saudi Arabia’s ambition to tap global bond markets in 2016 has international banks lobbying hard for a place on the deal, competing to convince Riyadh they can secure the best borrowing rate for what is expected to become a new benchmark in Middle Eastern debt.
But amid competition for market share between oil producers pushing oil prices to multiyear lows and fellow oil-exporters Nigeria and Azerbaijan looking to emergency bailouts, the kingdom is being advised to tread carefully.
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Credit investors say the size and rate of Saudi Arabia’s first sale of international bonds will depend on three things: the price of oil, the kingdom’s financial reserves and market volatility.
If pressure on all three eases, the kingdom could make one of the most successful debuts on bond markets. If they collide, the sale may be limited to an unremarkable few billion dollars borrowed at a higher rate.
Until now, the world’s largest producer of oil has managed to fund public spending while incurring little external debt and amassing reserves.
Now that oil prices are close to $30 a barrel, down from more than $100 in 2014, and military spending due to involvement in Syria and Yemen is increasing, Saudi Arabia is burning through its money.
Foreign reserves fell to $640bn last year from $737bn in 2014, leading some to question whether the riyal’s peg to the US dollar is in jeopardy.
For 2016, Saudi Arabia has announced a budget deficit of $87bn. Plugging that gap without depleting foreign reserves requires drastic action.
King Salman, who succeeded to the throne last year, and his son, deputy crown prince Mohammed bin Salman, have already reduced price subsidies and mooted a public offering of shares in state-owned energy group Saudi Aramco, the world’s largest oil-producing company.
Andrew MacFarlane, of BNP Paribas, estimates the company could be worth around $2tn-$3tn, meaning that if the country sold just 5 per cent of the company, the receipts could fund the government’s deficit for a year.
However, the float has no deadline and plans are vague. Making use of capital markets to borrow funds has been suggested as a more immediate plan.
Officials have already said that Saudi Arabia’s public debt, which reached just 44bn riyals at the end of 2014 — about 1.6 per cent of GDP — could hit 50 per cent of GDP by 2020.
Local markets have already been fired up. Last year, the country sold its first domestic currency bonds since 2007, selling 15bn riyals ($4bn) to local banks. Issuing in local debt is cheap, but to expand the pool of creditors and avoid overwhelming local investors, dollar-denominated debt is also being planned.
Credit strategists at two banks estimate the first dollar-denominated bond could be about $5bn, possibly split into tranches, with the first issuance unlikely to have a long maturity.
While this will make only a tiny dent in the deficit, the bankers say it is wise to start small at a time when investors are noticeably wary about the kingdom’s ability to service its obligations.
Last month, credit rating agency Standard & Poor’s reduced Saudi Arabia’s credit rating one notch from double A minus to single A plus. The cost of insuring existing Saudi Arabian local currency debt against default has doubled in the last year.
According to one banker at a major European bank, a Saudi bond issued tomorrow would incur a 200 basis point premium above equivalent US bonds, meaning a five-year borrowing rate of 3.34 per cent.
Researchers elsewhere put the country’s prospective borrowing rate lower.
Oxford Economics expects new Saudi bonds to be issued at a yield 100 basis points over equivalent US treasuries, a five-year rate of 2.34 per cent, while analysts at Bank of America Merrill Lynch say the country’s bonds would likely trade a little wider than Qatar’s, which has a dollar-denominated 2022 bond yielding 3.05 per cent.
Dollar-denominated debt issued by state-controlled Saudi Electricity, which has a bond due in early 2023 that yields 3.82 per cent, are also being used to come up with theoretical rates for the sovereign offering. One banker at a major European bank said Saudi’s possible five-year borrowing rate could be close to 3 per cent.
“Saudi Arabia won’t have any problems accessing international bond markets,” said Steven Hess, lead sovereign analyst for Saudi Arabia at credit rating agency Moody’s, which recently opted not to cut the kingdom’s credit rating.
“But I don’t expect them to issue eurobonds in the first quarter of the year while markets are so volatile. Then again if oil prices stay where they are then the need to finance the deficit plans could be accelerated. The size and price is going to depend a lot on external circumstances.”
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