Crude Realities

The Persian Gulf's debt binge creates a 'vicious circle' on the Arab Peninsula

Saudi Crown Prince and Interior Minister Mohammed bin Nayef gestures during the meeting of Gulf Cooperation Council (GCC) Interior Ministers in Riyadh, Saudi Arabia, April 27, 2016.
Faisal Al Nasser | Reuters

A borrowing bonanza in the Middle East is laying bare just how varied the risks are on the Arab Peninsula.

In Qatar, billions of dollars in recently raised sovereign debt will help to accommodate soccer fans when FIFA comes to town. In Bahrain, bond proceeds are expected to keep a lid on simmering social unrest.

A second year of low oil prices has left the Arab states of the Persian Gulf with lingering budget deficits, forcing them to borrow money from international lenders. While the six nations of the Gulf Cooperation Council are often discussed as a whole, their experience in debt markets and the implications of the borrowing binge for each country is anything but uniform.

Some Gulf states have strong credit ratings but lack experience managing big debt loads. Others are avid borrowers but could see their costs rise as debt becomes larger in proportion to their economic output.

The borrowing also comes as Gulf nations embark on ambitious plans to diversify their economies to become less reliant on oil. Moody's warned in August that the short-term relief brought by borrowing could cause Gulf states to delay much-needed reforms.

OPEC's decision last week to cut oil production will also bolster the Gulf nations, but Moody's warned the countries would "continue to face economic, fiscal and external challenges" even as crude prices recover to a range of $50 to $60 a barrel.

With oil prices expected to remain relatively low for years, the International Monetary Fund projects the annual deficits for the Gulf Cooperation Council and Algeria to total $900 billion between 2016 and 2021. Meanwhile, government debt is expected to grow from 13 percent of these economies last year to 45 percent in 2021.

The implications of taking on more debt vary across the Gulf Cooperation Council, comprised of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.

Among the nations with little experience in international debt markets is Saudi Arabia. The kingdom raised $10 billion in loans from a consortium of banks this spring and set a new record for emerging market debt issuance in October with a $17.5 billion sovereign bond sale — its first ever.

Kuwait is also gearing up for its first sovereign bond issuance next year, and is expected to raise about $10 billion.

They are starting to put themselves into a bit of a vicious circle because the higher their debt to GDP goes, the worse that reflects on their credit rating.
Coline Schep
Eurasia Group Middle East and North Africa associate

Moody's is closely watching how those countries develop the institutions and management practices to service their new debt, said Steffen Dyck, a senior credit officer at the ratings agency.

"You can issue debt but the question is also how you manage this debt," he said.

One nation with a proven history of managing debt, according to Moody's, is Qatar. It has raised $43.3 billion in sovereign debt and syndicated loans in the last decade, according to data provided by Dealogic.

Earlier this year, Qatar drummed up a record-setting $9 billion in sovereign debt. That is not only being used to plug a deficit — estimated by the World Bank to reach $8 billion this year — but also to keep up a brisk pace of infrastructure spending as it prepares to host the 2022 FIFA World Cup.

Despite their varied experience managing debt, analysts typically see few immediate red flags in Kuwait, Saudi Arabia, Qatar and the UAE.

But Bahrain and Oman are a different story.

The two nations have lower credit ratings and face higher risks of social unrest than other Gulf states.

Discontent makes it difficult to significantly cut civil service salaries or lay off bureaucrats, but if Oman and Bahrain do not cut spending, it will be hard for them to improve their finances, said Coline Schep, an associate in Eurasia Group's Middle East and North Africa practice.

"They are starting to put themselves into a bit of a vicious circle because the higher their debt to GDP goes, the worse that reflects on their credit rating," she said. "That is going to be making any future borrowing for them more costly."

That said, Bahrain can continue to depend on support from Saudi Arabia. Riyadh intervened when the Arab Spring swept through Bahrain, and the Saudis continue to worry about their neighbor's restive Shiite Muslim majority, Schep said.

The Trump effect

Some of the Gulf countries appear to have met their funding needs for the moment, but others are expected to go back to the well in 2017.

U.S. bond yields have been on the rise as investors anticipate an interest rate increase from the Federal Reserve as early as next week. Expectations for an easier path to tax reform and infrastructure spending after a Republican sweep of the White House and Congress only add to the case for higher rates and a stronger U.S. dollar.

That environment sets up potential capital outflows from emerging markets as money returns to safe haven U.S. bonds. It also increases the cost of borrowing and servicing debt for developing nations.

The election of Donald Trump, an unpredictable businessman with a protectionist streak, also raises questions for riskier investments such as emerging market debt.

Donald Trump is seen playing golf on a billboard at the Trump International Golf Club Dubai in the United Arab Emirates on August 12, 2015.
Karim Sahib | AFP | Getty Images

"While, in principle, higher U.S. growth should have positive spillover effects on [emerging] economies through increased trade, this picture is murkier this time around given the uncertainty about Trump's intended trade policies," JPMorgan said in a report.

If the market gets a milder Trump who focuses on domestic policy, risk sentiment may be positive, said Anthony Simond, investment analyst at Aberdeen Asset Management. But if Trump enforces the high tariffs on foreign goods he has threatened, and if he rips up international trade deals, sentiment may turn south.

That is particularly important for Gulf state bonds, according to Simond. Because many of them are not bundled into major emerging market debt indexes, they do not have a "natural investor," he said.

"When times are good, when people want diversification, people might go to the Middle East," he said.

"When times are bad, maybe that marginal demand for the bonds isn't there."