The global financial crisis and the declining oil prices hit the Gulf Cooperation Council (GCC) countries of Saudi Arabia, Kuwait, Bahrain, Qatar, the United Arab Emirates, and the Sultanate of Oman with full force in 2008. External and fiscal surpluses declined sharply while GCC governments strongly expanded their fiscal balance sheets as well as injected substantial liquidity into the vulnerable banking systems. This has contributed towards sustaining growth and stabilising the financial system across the GCC (see Khamis et al. 2010).
Local currency bond markets have increasingly become an alternative funding source in several emerging economies (Dalla and Hesse 2009). These markets are playing an important role in the provision of finance to emerging-market governments, financial institutions, and corporations, which were largely shut out of international financial markets during the global crisis, and in reducing their dependence on the banking sector. Local currency bond markets in East Asia and South America have grown significantly since 1997 and have played a key role in providing alternative source of funding during the recent financial crisis. Bond markets in the GCC have lagged behind however. Bond markets were considered unnecessary in a region with an abundance of liquidity and capital from oil and gas revenues and relative easy access to international capital markets.
Local currency bond markets are gaining momentum in the GCC with the Dubai International Finance Centre (Saidi et al. 2009) recently publishing an important and timely paper on its importance for the GCC’s development strategy. In this column we examine the importance of building viable local bond markets for the GCC region and what potential lessons can be learnt from East Asia.
Lessons from East Asia
The size of the East Asian bond market has grown from $500 billion in 1997 to $3.9 trillion by June 2009. East Asian countries have been at the forefront of bond market development. At the end of 2008, East Asia accounted for 55.4% of total outstanding value of local-currency bonds in emerging markets (see EAP in Figure 1), followed by Latin America (24.3%, LAC), Eastern Europe (10.2%, ECA), South Asia (8.4%, SA), and Sub-Saharan Africa (1.7%, SSA). At the end of 2008, the East Asian bond markets accounted for 6.3% of the world bond market.
Figure 1. Trend in local currency bond markets in emerging markets by region 2000-2008 ($ billions)
Source: BIS, Dalla and Hesse (2009)
The bond markets in East Asia have grown rapidly for several reasons. Following the 1997 financial crisis, governments in East Asia issued a large amount of local currency bonds to restructure the banking sector and revive the corporate sector. With their access to international markets cut off, the corporate borrowers in the region were forced to explore alternative sources of funds in domestic capital markets. Issuing bonds in local currencies enabled them to restructure their balance sheets and reduce the currency and duration mismatch. The governments created supported the market infrastructure for both the primary and secondary markets. These actions led to the development of robust government bond markets and less dependence on foreign currency borrowings as governments and corporations were able to borrow almost exclusively from the local bond markets.
The growth of the East Asian bond market is an outcome of concerted efforts made by policymakers in the region. In 2003, the ASEAN+3 group of countries launched the Asian Bond Markets Initiative (ABMI) to accelerate development of domestic bond markets. Through its initiatives1, the ASEAN+3 carried out a broad range of reforms ranging from unifying government bond issuing authorities to simplifying corporate bond issuance procedures for bond issuance by domestic and foreign entities.
Regulatory reform efforts gained momentum at a March 2009 ASEAN+3 summit where a new Asian bond market roadmap was adopted (ASEAN+3 2009). The roadmap facilitates demand for local currency-denominated bonds, and recommends legal framework and infrastructure improvements for bond markets in the region. A regional guarantee facility was launched in April 2010, and a regional bond clearing system, Asiaclear, is being contemplated. The Asian Development Bank acts as the secretariat of the ASEAN+3 and disseminates information on the East Asian bond market through its Asianbondonline website.
Figure 2. East Asian bond markets (outstanding $ billions)
Source: BIS and authors’ calculations
The growth of East Asian bond market has been broad based with all countries recording notable growth during the last six years (Figure 2). There are five markets with outstanding bond values exceeding $100 billion. China has emerged as the largest market with outstanding bonds valued at $2.3 trillion with this growth facilitated by the increased sophistication and liberalisation of financial markets and monetary policy. As a percentage of GDP however, corporate bond markets in Malaysia, South Korea, and Thailand are much larger than China (Dalla and Yoo 2008).
East Asian countries have been highly successful in developing their bond market through collaborative efforts. Their experience should be considered by the GCC countries as such initiatives would help accelerate policy reforms through sharing of experiences and peer pressure.
State of play in the GCC economies
In the GCC the dominant source of financing is bank lending. Financing through debt securities constitutes only a small fraction. For example, the share of debt securities in the Middle Eastern capital markets is only 5.6%, while bank assets and equities account for 94.4% of finance (IMF 2009). A narrow domestic production base, family business ownership, and the dominant role of oil in the overall economy with accordingly large fiscal swings are some relevant factors that might explain the slow development of debt (and also equity) capital markets in the GCC economies. Nevertheless, in recent years the GCC economies have seen an increasing amount of corporate and sovereign bond issuance (both traditional and Islamic) as shown in Figure 3. While total debt issuance in the GCC dropped sharply in 2008 following the onset of the global financial crisis, 2009 has seen a strong rebound.2 But compared to many other emerging market countries in East Asia and elsewhere with a strong track record in both foreign and domestic currency bond issuance, overall GCC debt issuance is relatively small (see NCB Capital 2009 and Saidi et al. 2009 for an overview of recent developments in GCC debt markets).
Figure 3. Total value of outstanding bonds 2004-2009 ($ billion)
Source: Saidi et al (2009)
Several factors contributed to the recent buoyancy in debt issuance in GCC countries besides governments’ crisis-related issuances to the troubled financial sector. First and foremost is the sharp contraction of bank credit to private sector. Whereas credit to private sector grew by 30% annually in 2003-08, credit growth decelerated to less than 4% in 2009 (IIF 2009). Domestic credit stagnation along with a sudden drying up of foreign capital inflows have compelled corporations and government entities to rely on alternative sources of funding. Banks have also become increasingly risk averse to lending – as a result of their limited access to funding, lower leverage after the crisis, and lack of confidence. The sharp decline in GCC stock markets during the crisis also highlighted the need of domestic bonds as an alternative asset class for individual and institutional investors.
The bright spot of the GCC debt markets has been the emergence of the Sukuk market in recent years, even though Sukuk issuance has sharply declined during the global financial crisis and again after the near default of the Nakheel Sukuk. With the majority of Sukuk issuance being local currency denominated they are now able to provide an alternative source of funding while also helping to sterilise large capital inflows. In addition, the Nakheel episode will hopefully provide more legal certainty, transparency, and a more robust sukuk infrastructure.
Prospects for the GCC’s bond market
It is clear that the GCC’s bond market is at an early stage of development and governments will need to take additional measures – including some difficult political decisions – to accelerate the development of these markets. The sovereign benchmarks are largely missing due to the fact that there has been no regularity in sovereign bond issuance in the four largest GCC economies partly due to the large oil-related fiscal swings. Only Bahrain and Oman have a system of sovereign bond issuances at regular intervals through their respective central banks.
Another problem with the sovereign bonds has been the timing of issuances. The issuance of government debt securities usually follows a countercyclical pattern whereby (new) issuances drop during boom years as fiscal balances improve and pick up during bad years as fiscal balances deteriorate. For example new issuance of government bonds declined dramatically during the oil price boom of 2003-2008. A steadier issuance of sovereign bonds across the yield spectrum will provide domestic bond market with better risk free benchmarks that can also be used for pricing corporate bonds.
The countercyclical nature of government bond issuance is suboptimal. During boom times, liquidity is abundant, and with the lack of adequate monetary tools such as a Treasury bill market, long-term local currency sovereign bonds can play a crucial role in absorbing surplus liquidity from the markets. This in turn could help reduce pressure on inflation. Sovereign bonds issued during the boom time can be repurchased during bad times when oil prices are lower and domestic private markets are suffering from lack of liquidity. Such a procyclical policy of public debt management can be a part of a broader macroeconomic stabilisation programme. To be effective, it would require some significant political will by the GCC governments to essentially issue bonds when they don’t have to. Since 1998, both Singapore and Hong Kong have been issuing sovereign bonds to create benchmarks without any funding requirements.
Following the examples from the Asian experience, GCC central banks and governments could play a larger role in coordinating their activities in developing and fostering domestic bond markets with a focus on building the market infrastructure of the primary market. This would include:
- risk-free interest-rate benchmarks;
- a well-functioning primary dealer system (i.e., a network of financial intermediaries);
- efficient trading platforms;
- secure clearing and settlement systems;
- a diversified domestic and foreign investor base;
- and establishment of a central information system to disseminate bond-market information.
Although debt markets in the GCC are at early stage of development and face several challenges such as lack of clear regulatory frameworks, market intermediaries and infrastructures, the potential for future growth is great. As Saidi et al. (2009) argue, there are many compelling reasons for the development of domestic debt market in the GCC such as the continuing importance of infrastructure and housing finance which would strongly benefit from deeper debt markets. As Asian corporations witnessed during the Asian Crisis, the drying up of funding from banks during a crisis period can have dire consequences – the diversification into equity and especially debt financing can therefore provide GCC companies alternative funding possibilities. While the development of viable corporate and sovereign local currency debt markets will be a long and multi-dimensional process in the GCC, the necessary “plumbing” work should be urgently launched. Robust local currency bond markets would also facilitate the conduct of monetary policy in GCC countries. Finally, a well functioning bond market will add stability to the domestic financial markets and create a buffer to weather volatile international capital flows in equity markets.
Authors' note: The views expressed in this column are the authors’ and do not necessarily represent those of the IMF, IMF policy, George Washington University or the Qatar Central Bank.
ASEAN+3 (2009), “Press statement on the Global Economic and Financial Crisis, Cha-am, Thailand, 1 March 2009”, 1 March.
Dalla, I and JH Yoo (2008), The Korean Bond Market-The Next Frontiers, Korea Securities Dealers Association.
Dalla, I and H Hesse (2009), “Rapidly growing local-currency bond markets offer a viable alternative funding source for emerging-market issuers,” VoxEU.org, 13 October.
IIF (2009), “GCC Regional Overview”, Institute of International Finance, 28 September.
IMF (2009), Global Financial Stability Report, October Update, Washington.
Khamis, M, A Senhadji, M Hasan, F Kumah, A Prasad and G Sensenbrenner (2010), “Impact of the Global Financial Crisis on the Gulf Cooperation Countries and Challenges ahead”, Middle East and Central Asia Department.
NCB Capital (2009), “GCC Debt Capital Markets: An Emerging Opportunity”, March.
Saidi, N, F Scacciavillani, and A Prasad (2009), “Local Bond Markets as a Cornerstone of Development Strategy”, Economic Notes No. 7, Dubai International Financial Centre, December.
1 Under these initiatives, six working groups were set up to create an enabling environment for bond market development at the national and regional levels. These groups cover the following areas: (1) New Securitised Debt Instruments; (2) Credit Guarantee Mechanisms; (3) Foreign Exchange Transaction and Settlement Issues; (4) Issuance of Bonds Denominated in Local Currency by MDBs, foreign government agencies, and multilateral corporations; (5) Local and Regional Rating Agencies and Dissemination of Information on Bond Market; and (6) Technical Assistance Coordination.
2 The total 2009 issuance in the GCC of $84.4 billion includes Qatar’s support for the troubled assets of its banks as well as in the UAE the federal and Dubai government large borrowing from the central bank and Abu Dhabi. So the overall increase in the debt amount outstanding would have been significantly lower in 2009 without the crisis measures by the Qatar and UAE governments but still higher than the 2008 debt issuance.