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MENA CDS activity of late is eerily reminiscent of the risk “contagion” caused by investors questioning Dubai’s debt-servicing capabilities in late 2009 when [irrational] fear spilled-over to Abu Dhabi as well even though the latter’s fiscal integrity was never seriously in question, a fact later confirmed when it underwrote a bailout.  But if such objective measures are largely ignored in the market of default probability perception, perhaps it should come as no surprise that more nuanced, subjective ones such as the differences between the historical, social and economic dynamics of say, Saudi Arabia versus Egypt, also fail to be carefully analyzed.  Even The Economist’s latest stability rankings, for instance (see chart)–the result of ascribing a weighting of 35% to the share of the population that is under 25; 15% to the number of years the government has been in power; 15% to both corruption and lackofdemocracy indices; 10% for GDP per person; 5% for an index of censorship and 5% for the absolute number of people younger than 25–seem inadequate.  An accompanying piece, for instance, notes that in Saudi Arabia (whose marginalized Shia population is, unlike in Bahrain, a relative blip) the unity of unrest seen elsewhere may be structurally unlikely: “Building an opposition movement is difficult in Saudi Arabia.  [While] grievances are plenty: about living standards, poor schools, lack of jobs, the government is adept at using repression, propaganda, tribal networks and patronage to divide and weaken any opposition.  Middle-class liberals are wary of democratising steps that might give more power to anti-Western Islamists.  State-backed clerics have denounced the Egyptian and Tunisian protesters, and issued fatwas against anything similar in Saudi Arabia.  Only in the [admittedly oil rich] eastern province—home to a large Shia population—is there much tradition of protest.  But community leaders there are cautious, and desperate to avoid any accusations that they are a ‘fifth column’ for Iran.”  Barclays too notes that addressing how immediate tensions in the region may unfold is at least partially dependent on a given military: “Bahrain’s military is almost entirely composed of Sunnis and there is a significant foreign element in the ranks as well. Hence, they may be more willing to brutally suppress dissent than their Egyptian counterparts and the regime may not be as concerned about possible splits within the officer corps,” it wrote to clients.  That said, perhaps such “nuance” is just noise from the collective market’s point of view.  The real concern for Saudi Arabia may not be the emotional state of its Shias but rather the physical soundness of the 18-mile-wide strait Bab el-Mandab.

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According to various reports, central bankers from Saudi Arabia–whose capital Riyadh is slated as the home of a planned future regional central bank–are increasingly pessimistic as to the odds of the once much bally-hooed 2010 transition to a single Gulf currency and monetary union across the six-member GCC.  This despite the fact that prices rose 10.5% in the Kingdom in April, the fastest pace in over three decades, and UAE inflation touched the 20-year peak of 11.1% last year.  In the meantime, dollar pegs forced various countries to mirror declining U.S. interest rates despite windfall oil profits and domestic price increases.  Yet certain countries, such as Kuwait and Syria, have already dropped their dollar ties.  Moreover, there is scant evidence that dropping the peg did much for Kuwait’s inflationary pressures.  Some analysts reckon, for instance, that inflation is less tied to fuel and more tied to factors such as food prices, construction materials such as cement, and other key commodities.

Meanwhile, investor confidence in the Gulf is predicated upon a hearty balance of payments which is predicated largely on resources such as crude oil or, in Qatar’s case, LNG.  Yet as OPEC noted last fall, “retreat of the U.S. and European economy has a negative affect on the balance of payments in GCC countries.”  That is to say that investing on the basis of the region’s reserves is still just a proxy on global demand.  The real question may be at what point said demand rests less on the West, and more on the BRICs.  Until it surely does, Gulf finances arguably remain flimsy and its markets will be that much more volatile.

A short piece in this week’s Economist focuses on the Gulf’s “nascent” bond market, which comprise only 3% of the world’s capital markets (debt in general makes up one-third). Global sukuk sales halved last year and were pretty moribund in the first quarter of 2009. That said, recent activity suggests not only resilience, but the seeds of a long-term trend that will grow into liquid secondary trading and provide a benchmark for private sector firms. For instance, PLUS Expressways Bhd., Malaysia’s biggest toll road operator, sold 600 million ringgit ($171 million) of Islamic bonds due May 2023 last week in order to repay maturing debt. A week earlier, Aldar Properties, Abu Dhabi’s largest developer sold $1.25 billion of 5-year notes, becoming the first UAE real-estate developer to issue debt after prices tumbled. Concurrently, Dubai Islamic Bank, the emirate’s biggest bank, announced a $50.6 million buyback of its sukuk maturing in 2012.

Abu Dhabi-based Etihad Airways announced that it expected revenues to grow 24% to $3.1 billion this year as the company takes deliveries of 11 aircraft and boosts passenger numbers by adding at least six new routes.  “We are taking a bullish approach in 2009 despite tough market conditions,” Etihad Chief Executive James Hogan noted.  There are risks, there’s a global recession and we are seeing weakening currencies, softening demand worldwide, volatile oil prices.  But 2009 and 2010 are also years for Gulf airlines to continue to grow.”

That said, world airlines are set to lose $4.7 billion in 2009 as a result of shrinking passenger and cargo demand, industry body IATA said. The International Air Transport Association had estimated in December the industry would lose $2.5 billion in 2009. “The state of the airline industry today is grim. Demand has deteriorated much more rapidly with the economic slowdown than could have been anticipated even a few months ago,” its Director-General Giovanni Bisignani said.

International Petroleum Investment Company (IPIC), an Abu Dhabi-based investment company, announced on Monday that it has been assigned Aa2/AA/AA long term credit ratings by Moody’s, Fitch Ratings and Standard and Poor’s, with a stable outlook.  “While we have no immediate plans to raise external capital, the ratings will facilitate future engagement with the debt capital markets if IPIC wishes to pursue this,” commented its managing director, Khadem al-Qubaisi, who added that the ratings were a means of “reinforcing strong corporate governance principles and enhancing transparency.”  According to one analyst, the ratings are “a signal that [state sovereign] funds are eager to keep spending and [are] willing to borrow to increase their buying power.”

IPIC’s ratings acquisition comes on the heels of a similar move by another Abu Dhabi investment arm, Mubadala Development Corp, which issued its first annual report last week and also recently announced plans to set up a medium-term bond program.  According to news agencies, “both companies have taken on billions of dollars in debt to fuel their growth in recent years, some of which soon needs to be refinanced.  That sets them apart from the secretive and far larger Abu Dhabi Investment Authority (ADIA), which likens itself to a pension fund and is not understood to seek out external sources of funding.”

Most importantly, the move is a another step in the early maturation of Gulf fixed income, on both a state and corporate level.  In March, Abu Dhabi raised the first $3bn of a $10bn sovereign bond program to secure funds for state entities and to help develop a domestic bond market, while Qatar and Bahrain followed suit.  Pundits at the time noted that such benchmarks are vital to the emergence of local credit markets, as corporate issuers in the region can ultimately price their own debt against them.

The Gulf Cooperation Council (GCC) will realize faster growth in the Islamic bonds (sukuk) market and “tap into the massive potential that the segment hold” by adopting regulations and measures such as credit ratings, say analysts. “Sukuk is important when it comes to overall financial market. The region, with its huge capital needs, but [only] a small debt market needs to look into opportunities,” said Kamal Mian, Head of Islamic Finance, Saudi Hollandi Bank. While the GCC holds a significant share of global sukuk market (estimated at $130 billion, Dh477bn) when it comes to volume, regulations and policy guidelines are relatively sparse, especially when compared to Malaysia, according to Moinuddin Malim, Head of Corporate and Investment Banking, Badr-Al-Islami, Mashreq. Malaysia, with its proper regulatory measures and incentives, has managed to create a success story of its sukuk market and “investors from various countries such as Korea and Japan too are going there to issue sukuks”.

“Rating for sukuks in Malaysia is mandatory. Besides, they have created a platform to quote sukuks on a daily basis so people would know the fair value of the instrument,” said Dr. Mohd Daud Bakar, Managing Director, Amanie Islamic Finance Learning Centre. “The government in Malaysia has also incentivised issuances when it comes to the taxation aspect of it,” he added. “From the day of issuance to redemption, everything is clear.” Analysts also point out that credit enhancement structures in bond market can be used for sukuks as well and should be studied.

A recent report issued by Fitch Ratings concludes that the more challenging operating environment has negatively affected prospects for retail banking in the Gulf Cooperation Council (GCC, consisting of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE), although the degree of severity will vary.  Fitch views the potential risks from retail lending as high in the UAE (particularly Dubai) and Oman, moderate in Bahrain, Kuwait and Qatar, and low in Saudi Arabia.

The report notes further that the most negative impact could be realized in the UAE, particularly in Dubai, because the UAE retail sector is the largest in size and UAE retail loans grew the quickest in the GCC.  Dubai’s economy has been hit especially hard by the global recession, as the UAE has an exceptionally high proportion of expatriates, at more than 80% of the population (90% in Dubai).  Expatriate residence visas are nearly always linked to employment in the GCC; rising redundancies are therefore likely to result in higher defaults as expatriates leave, Fitch notes.  Furthermore, the regulation of retail loans is not as tight in the UAE compared with certain other GCC markets.

Risks is also high for Omani banks as their relative exposure to retail lending is the highest in the GCC, at 38.5% of end-2008 banking system loans.  In addition, Fitch views the levels of leverage available to retail customers as among the highest in the GCC, and regulation of the retail sector as not as tight compared with certain other GCC states.  Finally, the negative impact from retail lending will be least severe in Saudi Arabia, where the market is relatively strictly regulated; demand is sustained by a large, growing young indigenous population rather than expatriates; and the local economy has been more insulated from the impact of the global recession than many other GCC states, though declining energy prices are of concern.

Debt markets in the Gulf received a further boost when it was announced that Dolphin Energy, whose majority shareholder is the Abu Dhabi-owned Mubadala Development Co., raised $2.59 billion from 23 banks, including the United Arab Emirates National Bank of Abu Dhabi and Abu Dhabi Commercial Bank, Saudi Arabias Samba Financial Group, and global banks BNP Paribas and Standard Chartered.

The 10-year loans have a margin of 275 basis points over the London interbank offered rate (Libor) for the first three years, 300 basis points up to year six, and 350 basis points for the rest of the term.  Dolphin Energy is purportedly also seeking an Islamic loan deal that it hopes to finalize by the end of April – and has issued a request for proposals to prequalified banks to underwrite a bond of between $500 million and $1 billion in mid-April.  Dolphin may then alter the amount it borrows from the commercial banks in June once it knows how much money it has raised from the bond and Islamic facility.

Mubadala, the state-owned investment vehicle of the Abu Dhabi government, will soon launch its first corporate bond sale–the latest sign that government companies are returning to the debt markets.  The fund plans a series of meetings with investors in Europe and the U.S., according to a report circulated among bankers at Citigroup, Goldman Sachs and the Royal Bank of Scotland, who have been hired to arrange meetings.

The news comes some three weeks after Abu Dhabi successfully issued a $3bn bond, its first in 21 months and part of a larger $10bn issuance, which was more than twice oversubscribed.  Maturities ranged between five and 10 years.  Not long after, Qatar followed with its own $3bn issue.  Moody’s rates Mubadala, the Abu Dhabi National Energy Company (Taqa) and the Tourism Development and Investment Company (TDIC) at “AA2”, the same level as their sovereign owner.

Mubadala’ sale will be part of a larger medium-term note program that will permit later bonds issues without further delay.  Moreover, the sale represents the first issuance of corporate debt in the Gulf since last summer, when Taqa issued its last bond.  Taqa has about US$7 billion (Dh25.71bn) in outstanding bonds.

In a further sign that local companies are returning to debt markets, Sorouh Real Estate, Abu Dhabi’s second-biggest property developer by market value, announced today that it planned to raise Dh2bn through syndicated loans.

Financial Times reported this morning that according to Niu Dun, China’s deputy agriculture minister, Beijing will distance itself from nations such as Saudi Arabia and South Korea by choosing to depend on its own land for self-sufficiency in grain.  China is the world’s biggest agricultural economy and its largest consumer and producer of cereals.  The growing trend by some to snap up foreign farmland is seen as a response to last year’s spike in agricultural commodity prices and trade restrictions which lead some to question the long term viability of the global food market and to proactively seek alternatives.  For example, Pakistan is now offering 1m acres of farmland, to be protected by a special security force, for lease or sale.  Gulf Arab nations, heavily reliant on food imports, have reportedly expressed interest.

JGW

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