Saudi Arabia issues first sovereign bonds since 2007, more to come

Saudi Arabia has issued its first sovereign bonds since 2007 to cover a budget deficit created by low oil prices, launching a series of debt sales that could reshape its financial markets.

The government sold SAR15bn ($4 billion) of bonds to local banks this year, Friday’s al-Iqtisadiya daily quoted central bank chief Fahad al-Mubarak as telling reporters.

The report did not reveal financial terms or say exactly when the sales occurred, or whether the local currency bonds were sharia-compliant, which would allow them to be bought by Islamic banks.

But they mark a big shift in Saudi policy. Until this year, the world’s top oil exporter focused on paying down its public debt, which totalled just 44 billion riyals at the end of 2014, about 1.6 percent of gross domestic product.

While a few state agencies or state-controlled firms have issued bonds in the past few years, the government’s last sovereign development bond was issued in 2007.

But because of the plunge in oil prices since June 2014, Riyadh faces a huge budget gap this year, which Mubarak said was expected to exceed the originally projected 145 billion riyals. The International Monetary Fund has estimated the deficit will be about 20 percent of GDP, or approximately $150 billion.

So far Riyadh has mainly been running down its financial reserves to cover the deficit; Mubarak said the government had withdrawn 244 billion riyals from reserves in 2015.

This has cut the foreign assets held by the central bank, which is the kingdom’s sovereign wealth fund. Its net foreign assets — mostly U.S. dollar bank deposits and bonds — fell to $672 billion in May. The start of Saudi bond sales means pressure for the reserves to fall may now decrease.

“We will see increased borrowing in the coming months,” Mubarak was quoted as saying, adding that the deficit would be financed by both reserve drawdowns and bond issues.

DEBT MARKET

Mubarak did not estimate the size of future bond sales. But cash-rich Saudi banks have plenty of room on their balance sheets to buy government debt, suggesting that initially at least, the sales will not tighten banking system liquidity much.

Commercial banks had 1.65 trillion riyals of deposits at the end of May, against 1.31 trillion riyals of lending to the private sector.

Significant amounts of the new bonds are unlikely to find their way into the hands of foreign investors, since local banks tend to hold bonds to maturity and yields on Saudi bonds are too low to interest many foreigners.

But a major sovereign issuance programme could buoy the financial sector in other ways, by giving Saudi banks the highly rated assets they need to meet global Basel III liquidity requirements, and by stimulating the domestic debt market.

Regulators want to encourage companies to issue bonds as alternatives to bank loans, which now dominate corporate fund-raising. This would spread corporate risk beyond the banking system, making the financial sector more healthy, and provide more channels for a growing investment industry.

A regular supply of government debt could pave the way for more corporate debt issues by creating benchmark prices and developing a commonly accepted yield curve.

“Issuance at this stage is intended to reach two goals: create alternative sources of revenue, but also reinvigorate the debt market,” said John Sfakianakis, Riyadh-based Middle East director at fund manager Ashmore Group.

“For the development of debt capital markets, issuance should continue and involve a variety of buyers.”