GCC bond issues aim to keep oil revenues in the region

From 2002-6 the GCC countries earned $1.5 trillion, mainly from hydrocarbon exports of which around $540 billion was saved, according to the Washington based Institute of International Finance. Of that sum $460 billion was invested overseas and some $80 billion locally.

The total accumulated external assets of the GCC amount to $1.6 billion, says the IIF, compared with China's foreign exchange reserves of $1.1 billion. It is hardly surprising then that the recycling of petrodollars back into the global economy has returned as a major theme for investment bankers for the first time since the 1970s.

In this context GCC Islamic bonds are the latest in three asset classes to put petrodollars to work in the local economies. Money can be invested back into local stock markets, both directly and through initial public offerings and rights issues.

Stock market crashes

But the stock market crashes of last year, after a classic boom-to-bust cycle, mean that this route is presently closed. Indeed, the largest GCC bourse in Saudi Arabia hit a 31-month low this week and some analysts think prices are still too high.

Real estate sales through the promotion of mega projects has also boomed but investor appetite for this asset class in also now waning as the quick profits of the early years have disappeared and concerns have emerged about the long term financial strength of some secondary developers and long delivery delays.

That leaves Islamic bonds as an investment class for local investors, and in the first six months of this year Islamic debt issues have totaled over $10 billion. Government-owned and state-controlled companies have been the main bond issuers.

Bonds welcome

This is to be welcomed. The absence of a corporate bond market in the GCC has long been a restraint on regional expansion, and the reliance on excessive equity ratios in major projects has limited their scope.

But the bond market brings with it a market discipline for borrowers. For a start they will need to remember to earn enough from their investments to cover the dividend or profit share payable to bond holders.

Bond holders will also focus on the value of the underlying asset, and can choose to dump their investment back onto the bond market if they are unhappy at the outlook, depressing bond prices.

Yet in the context of the GCC bonds are often a mechanism for governments to invest oil revenues back into their own state-owned companies. They are the ones buying the bonds and often the owners of the companies borrowing the money.

That might appear ridiculous but actually it is an efficient market mechanism to ensure that companies compete for resources and that money flows towards the best projects in the best locations.

Efficient resource allocation

No market is ever one hundred percent efficient but bond markets do allocate cash much more effectively than the alternative mechanism of bureaucrats in committees. Or at least all those committees are now in competition with each other through the mechanism of the bond market.

However, the bond market has an Achilles heel in terms of rising interest rates. Rising interest rates send bond prices lower. So what is the attraction of buying Islamic bonds with a fixed rate coupon at a time of rising global interest rates?

That is clearly a question that is going to tax the ingenuity of GCC bankers but there are solutions available such as making bonds convertible into shares at a later IPO which we have already seen used for the $3.5 billion DP World sukuk in Dubai.

This is after all a circular process and the asset investment cycle moves from equities to real estate to bonds and then back around again. And it has surely been a glaring anomaly in GCC economies that bonds have been so underdeveloped. But then the same could also be said for equities and real estate.