The question of whether the debt levels are sustainable is hard to answer
Global economies are struggling in the covid-19 pandemic. That is not surprising. But are we underestimating the challenges?
Tens of millions have lost their jobs and many businesses have lost trillion of dollars. But the losses have been massaged by the government money poured into the financial systems across the globe generally underwritten by debt capital markets. While the increase in borrowing is a solution today, it may be the problem tomorrow.
It goes without saying that another global debt crisis would further destabilize a world that is likely to be combating the effects of covid-19 pandemic beyond 2020. Despite an extraordinary global effort to quickly develop a vaccine, the reality is that there is still no vaccine and, if there was one, it would take time to develop a sufficient global supply and convince the global public to return to their pre-covid-19 lifestyle.
When markets tumbled in 2008 and the financial crash devastated the globe, the aftershock was a sovereign debt crisis in Europe from 2010 to 2012. The European Union’s (EU) so-called weakest members (Greece, Italy, Ireland, Portugal, and Spain) struggled to escape default on their government debt and the collapse of their economic systems.
Now, as borrowing has quickly soared in the Middle East, investors are quietly taking notice. Downgrades by rating agencies to a few of the countries due to increased “liquidity risks” only further stirs the concerns and rumor mills.
The Middle East has many lenders content to provide more capital
The Middle East has been highly active in debt capital market this year. The region’s more economically risky countries—Bahrain and Oman—have tapped international capital markets this year at opportunistic times. Bahrain raised $2 billion from the bond markets in May and received an additional $1.8 billon from the $10 billion Gulf Cooperation Council (GCC) support package agreed in 2018 primarily with Kuwait, Saudi Arabia, and the United Arab Emirates (UAE). The country also increased its debt ceiling 2 billion dinars ($5.3 billion) in 2020 which clearly signals to the market a plan to raise additional debt in the future. Oman received a one-year $2 billion bridge loan from a group of international and regional banks, which lenders expect will be repaid through money raised from a future bond offering (likely in 2021)
Although Bahrain and Oman pose greater risk to the regional financial system, let us be clear: everyone is watching Saudi Arabia and the UAE. Back in April, Saudi Arabia sold $7 billions of bonds to strengthen its finances when the world was in strict lockdown and energy prices had nosedived due to the oil price war (and rapidly falling demand). The offer raised eyebrows back then because it was the second time in five months that the world’s largest oil exporter tapped international capital markets. In December, the country sold a $29 billion stake in energy behemoth Saudi Aramco through the largest IPO in history.
Saudi Arabia has also introduced various cost-saving measures to stabilize its balance sheet. Back in 2018, the government introduced a VAT and reduced fuel subsidies which created the local version of a public stir. But the government tampered public complaints by introducing a cost of living allowance for the nearly one million public employees at the time, budgeted at 1,000 Riyals (c. $267) per month. With the tripling of the VAT to 15% back in May and the scrapping of the cost of living allowance, the low tax nature of the kingdom has surely changed.
On top of the $7 billion raised from bonds in April, the kingdom has raised roughly an additional $20 billion through various government entities. Nothing suggests the borrowing will slow as the country also increased its debt ceiling back in March from 30% to 50% percent of GDP from 2022 on. The question for Saudi Arabia will be how it manages foreign reserves and cash amid $40 oil and global financial uncertainty. Some analysts assume more cost-management measures (i.e., austerity) will come. Yet, it is hard to speculate on any potential crisis because the Crown Prince Mohammed bin Salman may simply be borrowing to pay for his 2030 Vision for the country.
The same optimism may be hard to conjure for the UAE. A report from the S&P last month raised eyebrows when it estimated Dubai’s debt at nearly 290 billion dirhams ($79 billion), which included Dubai’s local bank borrowings in the calculation. The debt burden may amount to roughly 77% of GDP, which places the emirate in the territory of South Africa and Oman (based on estimations by the International Monetary Fund (IMF)). The latter comparison by analysts is more for shock value as South Africa and Oman are countries facing known issues with their debt loads.
Still, if we are to focus on the Moody’s and S&P calculations, then the estimated additional 167 billion dirhams ($45.4 billion) of debt (a figure largely attributable to the government related entities (GREs) of Dubai) is the real point of discussion. (As a reference, the prospectus for Dubai’s $2 billion bond offering in September placed the emirate’s debt at 123.5 billion dirhams ($33.6 billion)). The approach by the rating agencies is notably conservative with their analysts highlighting the reality that investors cannot assess the complete financial picture of GREs because they are generally private and unrated by agencies.
That said, the overarching question, as it relates to sovereign debt for all of the Middle East, is whether the combination of the ‘standalone’ sovereign debt—that debt which is directly held by the state—and the sovereign debt related to GREs should be a concern. The GRE discussion generally focuses on the sectors in which the GREs are most active.
For example, aviation has suffered during the covid-19 pandemic. Many Middle Eastern countries has national airlines that, while heavily supported by local travelers who should be there in the long run, have lost significant money this year. For those airlines dependent on long-haul international travel (i.e., Qatar Airways, Emirates Airlines), there is increased concern based on the negative impact of covid-19 on global travel. That said, both Qatar Airways and Emirates Airlines have quickly adjusted to the current environment. Emirates Airlines, for example, does not expect to resume services to all its 157 pre-lockdown destinations until the summer of 2021. Real Estate and shipping / logistics, all of which have faced challenges in the current environment, are also major exposures for many Middle Eastern GREs.
This is not Europe but there are similarities
The Middle East will rightfully say this is not Europe. The systemic risk to Europe caused by the troubles of multiple struggling countries in 2010 is forever woven into the EU political and economic discussions. It is hard to forget when Greece was allowed to restructure its debts and then-head of the European Central Bank (ECB), Mario Draghi, vowed in July 2012 that the ECB would “do whatever it takes” to ensure other countries in the EU would not default. Draghi’s words bought some time with borrowing nations trimming deficits as the ECB theoretically guaranteed the debt for the struggling countries. It was good deal as confidence grew and financial risk decreased…but that unexpected deal between EU nations has always been fragile and dependent on steady economic growth across the region. The jury is still out on whether this grand bargain will hold up during the aftermath of the covid-19 pandemic. GDP, according to a study by Capital Economics, is expected to contract 10% in France, 15% in Greece, 18% in Italy, and 15% in Spain.
Although not the same European storyline from start to finish, investors will remember February 2009 when Abu Dhabi came to the rescue of Dubai. The central bank of the UAE bought $10 billion worth of Dubai’s five-year bonds which confirmed the worst-held secret in the region that Abu Dhabi would support its neighboring emirate. Investors will also remember 2018 when Kuwait, Saudi Arabia, and the UAE deposited $1 billion into the central bank of Jordan and pledged $10 billion to support Bahrain as both countries faced financial troubles. These deals may not have the feel of European bargains, but they had the similar effect of Draghi’s words in 2012. The deals were reached on conditions that included both countries reaching balanced budgets by 2022 and reducing public debt ratios. Covid-19 clearly has made this a challenge in the Middle East (for many countries) as it has in Europe.
There remains the question if the debt levels are sustainable
Budget deficits are increasingly a challenge for some Middle East countries in the covid-19 environment (as expected). Low growth in 2020 is the norm as contracting economies are the financial storylines of the covid-19 pandemic. Budget deficits are consequently the byproduct of shrinking economies.
Yet, for many Middle East countries, this is not the first budget deficit, i.e. the previous examples of financial support by Middle East partners. Bahrain spending exceeded revenue in the first half of 2020 at a level that exceeded its deficit in all of 2019. Oman’s pre-covid budget already assumed a deficit of 7-8% of GDP with oil at $58 per barrel. The Omani deficit skyrockets with prices in the $30 range and the pandemic undercutting demand.
Sovereign debt levels accordingly have trended upwards for many countries in the Middle East prior to 2020. It is this combination of successive budget deficits and growing levels of government debt that will raise investor concern in the short term. But is this a problem? Sovereign debt levels are trending up everywhere yet there is little discussion on sustainability. Questions of sustainability are circumvented by many political leaders with speeches and messaging focused on doing what is necessary to combat the pandemic or get people back to work.
If the question could not be avoided, there still would not be a clear-cut answer on sustainability of debt levels for most countries today. Capital markets continue to lend to the Middle East and beyond. Most investors assume 2021 will be an improved year and that borrowing countries can always refinance their debt in the future…Oman’s bridge loan this year is a perfect example of this base assumption in capital markets. The bridge loan assumes Oman will be able to go to bond markets in 2021 to repay the bridge loan.
Financial support (or rescue depending on who you ask) is built into the formula too. If Italy struggles today, the market will expect support to come from other EU countries. In its rating report, Fitch argued that Bahrain will require further financial backing from the GCC countries (likely Kuwait, Saudi Arabia, and the UAE again) which “it will receive given the country’s small size and strategic importance.” It is hard to be concerned when rating agencies naturally assume financial support from neighboring countries.
The true reality of assessing the debt levels in the Middle East is that the process is both clouded by (a) limited visibility into GREs and (b) an inability to navigate and comb through the financial interconnectedness of countries. The assumed inherent brotherhood of the GCC states usually makes analysts get comfortable around point (b). Despite private bickering between regional countries on security and sovereignty, the relationships between the Middle East countries are stronger than many western analysts may appreciate. Thus, although the debt numbers may raise fair questions on the sustainability of oil dependency and the welfare state, the situation looks viable in the short-term and there is little to suggest that the region will let any state fall on its face (maybe except for Iran). That is an assuring thought until it is not true.
