Saudi Arabias $17.

5bn bond sale has lessons for debt market

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https://www.ft.com/content/92158e52-95f4-11e6-a80e-bcd69f323a8b

Saudi Arabias ambitious plan to chart a course away from oil dependence and
towards a more diversified economy is off to a flying start with a blockbuster
$17.5bn debut sovereign bond sale (http://next.ft.com/content/b4f1f1da-95e6-11e6a1dc-bdf38d484582).
Investors shrugged off concerns about the prospect of the sustained oil slump
translating into years of anaemic growth, aggravating social concerns and a backdrop
of regional tensions.
The lure of investing in a large economy with little debt that has never before issued a
dollar-denominated bond, piqued global interest. Investor orders reached $67bn,
enabling Saudi Arabia (https://www.ft.com/topics/places/Saudi_Arabia) to borrow
more and more cheaply than initially suggested.
As bankers pat themselves on the back and officials plan their next move, here is what
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Saudi Arabias $17.5bn bond sale has lessons for debt market

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we learnt from Saudi Arabias first sale of international debt.

Emerging market debt is still in fashion
This has been the year of the megabond, with the three largest sales of emerging
market sovereign debt in history coming within the space of a few months. At
$17.5bn, Saudi Arabias bond eclipses Argentinas (http://next.ft.com/content
/10066178-0550-11e6-a70d-4e39ac32c284) $16.5bn sale in April, making it a record
issue for an emerging economy. It far outweighs neighbouring Qatars $9bn bond
sold in May.

The order book was also sufficiently large to enable the country to raise the amount it
planned to sell from $15bn and tighten up prices. Investors had expected Saudi
Arabia to sell 10-year debt at a 50 basis point premium to Qatar, which carries a
higher credit rating.
Instead, the new 10-year bond was sold at a yield of 3.25 per cent, only 30 basis
points above Qatars. Five-year debt came with a yield of 2.375 per cent, while
30-year bonds were sold at a 4.5 per cent yield. Investors say the bond was received
well in secondary markets, with prices slightly up in initial trading.
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While Saudi Arabia made a concerted effort to target a western audience, flying some
of its top officials to London, Boston, New York and Los Angeles to make the case,
Richard House of Standard Life Investments says demand was probably accelerated
by external factors beyond its control.
Interest rate cuts and central bank bond buying in the west has driven $12tn of
government bonds to trade at negative yields. As a result, after the hiccup caused by
the US rate rise in December and worries about China at the start of this year, money
has surged back into emerging markets (http://next.ft.com/content/6c04a842-55ad11e6-9664-e0bdc13c3bef).
There is a lot of demand for anything with a yield, says Mr House. Very few EM
bond sales have gone badly this year.
That said, some EM investors were ambivalent towards Saudi Arabias sale. The
10-year bond yield was far lower than the average yield on emerging market bonds
tracked by JPMorgans emerging market bond index which is currently 5.2 per
cent. As a G20 economy with an A rating from Standard & Poors, Fitch and Moodys,
the country was almost too good a credit for them.
I didnt participate there are other countries in the region that offer more value,
says Claudia Calich, emerging market fund manager at M&G.
Max Wolman, senior investment manager at Aberdeen Asset Management, says: The
bond sits awkwardly between developed and developing portfolios.
And the rates were not overly generous.

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Long-dated debt is still hot

One of the most peculiar aspects of Saudi Arabias debut on global bond markets was
that it sold more 30-year debt than five or 10-year debt. Of the $17.5bn issued, $6.5bn
was sold to investors who will not get their money back until 2046.
EM investors typically prefer shorter-dated bonds which reduce the risk of
unforeseen circumstances damaging their chances of being repaid. Saudi Arabia is
not without risk. The country is an undiversified oil economy accustomed to a world
where crude prices are double the current level. The non-oil economy has ground to a
halt and is on the brink of its first full-year of contraction since 1987.
Saudi Arabia also sits in a region suffering geopolitical tension and without enough
jobs for its youthful population. The kingdom is accused of ideologically fostering
Sunni jihadism, and has now become a target for Islamist extremists Isis.
But the appetite for 30-year bonds echoes a trend across global markets, where
demand for long-dated debt has been flattening yield curves (http://next.ft.com
/content/f87fc01a-2edc-11e6-bf8d-26294ad519fc).
The culprit is central bank policy, particularly that of the UK, Europe and Japan,
where interest rates have been cut back to record lows and mass bond-buying
schemes are in place to try to lift growth and inflation.
Before Saudi Arabia issued its bond, officials visited a number of countries in Asia

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(http://next.ft.com/content/ba0895b0-6f95-11e6-9ac1-1055824ca907), including
Japan, to meet investors. Bankers close to the deal told the Financial Times in August
that investors, such as pension funds and insurance companies in the region, were
planning to put down large bids for the bonds and that they were particularly
interested in longer-dated debt to match their long-dated liabilities.
Saudi Arabia is serious about reinventing its economy
The kingdoms decision to launch its first dollar-denominated bond was driven by one
thing: oil. The largest economy in the Middle East is still heavily reliant on oil
exports, meaning the crash in prices from more than $100 a barrel in 2014 to as low
as $30 at the start of 2016 has inflicted serious damage.
In response, Saudi Arabia has created an ambitious plan to reduce the role of the
state, cutting public wages, cancelling infrastructure projects and planning the
worlds largest IPO in Saudi Aramco.
Selling dollar-denominated bonds is part of the same vision, and sets a benchmark
against which other entities can raise their own debt. By 2020, Saudi Arabia expects
its debt to reach 30 per cent of GDP, from less than 8 per cent now.
But to do that, officials are aware that they will have to become more comfortable
with a greater level of transparency. Gregory Saichin, chief investment officer for
emerging market bonds at Allianz Global Investors, said Saudi officials were acutely
aware of the changes needed, and called the bond roadshow polished.
They spoke about making the government more accountable and improving
transparency while stressing the size of the economy and near lack of existing debt,
he says. They pushed every button investors wanted to hear.
However, some investors complained that representatives were cagey about their
views on the outlook for oil, preferring to talk about plans to trim the fat from
government spending than discuss contingency plans for possible future oil price
falls.
And most observers remain deeply sceptical about the governments ability to
reinvent the economy, no matter how strong its commitment to the task.
Unfortunately, this bond is not about preparing for the future so much as paying for
the excesses of the past, said one seasoned observer in the Gulf. The investors havet
understood this, and dont really believe in the changes for reform but they do
understand low interest rates
This bond is just the beginning

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In the lengthy bond prospectus, and at investor meetings, Saudi officials were clear
that the kingdom intends to use this sovereign bond as a jumping off point for a flurry
of deals. The country expects to issue as much as $120bn of debt in the coming years.
This a deliberate change in terms of their long-term financing plans, says Rick
Harrell at Loomis Sayles. They will look to come every or every other year to
international markets.
The sale of debt may have broken records for an emerging market issuer, but it will
only finance about a third of next years budget deficit, calculates Jason Tuvey,
Middle East economist at Capital Economics.
That, though, should mean the kingdoms foreign exchange reserves are unlikely to
fall much beyond their current level in the coming years.
This should dampen any lingering concerns that the riyal will be devalued, he says.
The governments debt-to-GDP ratio will rise as a result of the bond sale but, given
its low starting point, it is hardly on a worrying pathand if were right in expecting
oil prices to edge up over the coming years, then most of the spending cuts needed to
rein in the deficit and stabilise the debt ratio have already happened.
Additional reporting by Eric Platt
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