EMTA Forum in Dubai - Feb. 29

Experts at EMTA Dubai Panel Review Adjustments in “Longer for Lower” Reality

EMTA’s Sixth Annual Forum in Dubai was held on Leap Day, February 29, 2016, and drew a crowd of over 100 EM market participants. The event was made possible by the support of Barclays, BNP Paribas, HSBC, Nomura and Standard & Poor’s.

Wike Groenenberg of BNP Paribas led the event’s first panel of sell-side experts. She asked speaker Simon Williams (HSBC) for his thoughts on the global economic environment, so as to provide context for current MENA market challenges. Williams acknowledged that his firm’s
call for 10-year US Treasury yields, at 1.5%, was relatively bearish, while taking he reiterated that HSBC still expects US rates to decline to such levels. A Chinese slowdown was clearly taking place, although Williams did not expect a hard landing, “So the question is-- what will happen without US and Chinese growth; that is why we are anxious over the next 12 to 18 months,” he concluded.

Moving to the MENA economies, Groenenberg asked how oil-exporting countries were adjusting to new global realities. “The outlook is very concerning, not only because of large budget deficits and financing needs, but mainly because of the lack of clarity regarding the path of adjustments to what is the new normal of ‘lower for longer’ oil prices,” stated Alia Moubayed of Barclays. While fundamentals could support higher oil prices in the 2H, she calculated that even at $60 per barrel external financing needs could well be over $170 billion in the region for 2016-2017. While some actions were possible to address budget shortfalls she estimates at $125 billion in 2016-17, such as the introduction of VATs and Oman raising corporate tax rates, financing needs would still be quite large and will exacerbate an already tight liquidity problem in some GCC banking systems.

Walid Haram of Nomura discussed how GCC sovereigns could fill their budget shortfalls. He noted that reserves could be drawn down, but emphasized the need for privatizations. “The state needs to exit from the main industries in Saudi Arabia, the UAE and Qatar…they need to get out of managing companies, and they also need to work on their taxation systems,” he argued.

Williams voiced frustration that economic reforms would likely be a “multi-year, multi-decade even, project.” He compared such potential changes to Thatcherite Britain, and pondered “can these countries cope with that sort of stress?” Moubayed summarized that “we all know that change does not come too fast in the region; but what is entirely different today is the strategic environment in these countries: Chinese growth, the oil market, the geopolitical landscape…”. She labeled herself as neither overly optimistic, nor too pessimistic, and expressed confidence that at least some reforms could occur, while recognizing the prospect of drawn-out and complicated reforms could deter investors from GCC credits.

The panel also discussed potential Saudi external debt issuance. Haram did not expect Saudi Arabia to tap the external debt markets, and would try other avenues first. Moubayed noted that there are a myriad of “institutional readiness and capacity issues” that must be addressed, while on a medium-term horizon, Riyadh would have to convince the markets that it has a credible macro-fiscal reform plan in order to avoid further downgrades. “Finally, I don’t think they will issue debt when oil is at $20 or $30 per barrel….instead it will tap the markets when oil starts trending up, likely in the 2H.”

Stuart Anderson (Standard & Poor’s) provided the viewpoint of a ratings agency, reminding attendees of ESMA regulations on the pre-announced timing of sovereign reviews. Recently, his firm had downgraded a number of sovereigns under the permitted exception of event-driven ratings changes. With their own internal oil calls of $45 per barrel in 2017 and $50 per barrel in 2018, Saudi Arabia’s rating had been dropped recently by two levels to A-, with a stable outlook.

The prospect of an SAR devaluation was addressed by the panel. Haram commented that the Saudi leadership would be more concerned by the prospect of popular unrest and rising import prices than by the benefits of a devaluation to address its budgetary issues. He suggested that Central Bank reserves would be used first to avoid social upheaval, especially when the conflict with Iran was pre-occupying the country. Other speakers concurred, with Moubayed noting the potential disruptions if needed reforms were not carefully sequenced. “Something has to give, to address the huge terms of trade loss,” warned Williams. Anderson noted that Iran might precede Saudi Arabia in diversifying its economy away from oil; and acknowledged that a floating Saudi riyal exchange rate might bolster the country’s creditworthiness in the long term, but in the short term his firm acknowledged the stability of a pegged rate and the financial reserves available to support it.

Reversing roles, Moubayed asked if it might be reasonable for Oman to devalue first, “and we could see it as a devaluation candidate.” Moderator Groenenberg replied that, because such action would add further pressure for a Saudi devaluation, Riyadh would likely support the Omanis rather than by “allowing” for an Omani devaluation. Anderson suggested that a geopolitical rationale might exist for keeping oil priced in dollars, and the SAR pegged to the USD.

On other potential MENA issuance, the Saudis were eager to develop their domestic market, stated Anderson, who noted his firm has applied to open a Saudi branch in response to potential market growth. “The question is, who will be investing,” he pondered. He also expected Iran to “come on stream,” with sovereign, bank and corporate issuance, largely geared to European investors.

Finally, Groenenberg turned to the oil-importer credits, and asked if countries such as Tunisia were now attractive. Moubayed viewed Morocco as a “good story fundamentally.” Tunisia would benefit from Western interest in keeping the country stable, “as the unique success of the Arab Spring and as a critical element in international efforts aimed at addressing the crisis in Libya.” Speakers expressed concerns over Turkey’s potential ratings downgrade and political environment, despite benefiting from lower oil costs. Egypt had missed an opportunity and although GCC support would likely be provided to avoid a catastrophe, “the country is struggling to get investor attention,” according to Williams.

Dino Kronfol (Franklin Templeton) moderated the event’s investor panel. Kronfol noted that many of the issues identified as top risks at the 2015 panel remained investor concerns –low oil prices, China’s economic slowdown, US rates, corporate defaults and geopolitical issues. What factor concerned investors most, he asked.

Manoj Mahadev (Bank ABC) asserted that, “oil is the most important market risk; everything else is related to it, and is a function of the oil price.” He added that US rates were likely to increase 50 bps in 2016, with another hike likely next year.

In contrast, Emirates NBD Asset Management’s Usman Ahmed identified the Chinese economy as the main risk to the market. “If there is a Chinese hard landing, all the other factors will be affected,” he stated, while specifying that a hard landing was not his base case. As for oil, Ahmed argued that demand had not dissipated, and was the not the reason for the commodity’s price decline; instead the low price was based on too much supply. He agreed that US rates would be hiked by 50 bps in 2016, and would have no effect on EM debt prices.

Long-serving panel veteran Abdul Kadir Hussain (Mashreq Capital) opined that, “the number one risk, which is un-analyzable, is geopolitics, and is related to oil.” Hussain listed the conflicts in Syrian and Yemen, as well as Saudi-Iranian rivalry, as the most obvious geopolitical concerns in the regions. Addressing concerns on China, Hussain voiced confidence in Beijing’s ability to weather recent economic turmoil. “They are smart people, who know what they are doing…they have enough policy tools available to them…and I do not expect a hard landing either,” he commented. In contrast to other speakers, Hussain asserted that US rate hikes were “off the table,” and that US rates could be going down rather than up.

Waha Capital’s Mohamed El Jamal argued that low prices for oil, proxy wars (rather than direct conflicts) and a Chinese soft--but not hard--landing were already included in market prices, and that hedging tools could counter those concerned by US rate increases. Thus, “the big fat tail risk is geopolitics,” he concluded.

Kronfol invited investors to discuss the views on the earlier sell-side session. Hussain voiced concern that the first panel had been “perhaps too dark.” Oil-exporting governments were in fact taking actions to address budgetary issues, such as the consideration of remittance taxes, and the UAE’s adoption of a VAT. Pension funds and others could be tapped for financing, and bond issuer s would be willing to pay higher prices to place new debt (e.g. Bahrain), he added. Ahmed suggested that despite sell-side panel pessimism on the economic outlook, attractive valuations existed. “On the equity side, we are looking at P/E ratios from 2008-2009 levels,” he said.

Kronfol asked if speakers believed in the inevitability of MENA oil exporters offered new debt to finance budget gaps. Mahadev pointed out that issuance has already begun in some of the local markets, as in Saudi Arabia. A new higher premium must be paid and a new normal on issue pricing would be forthcoming.

Ahmed argued that bond financing would be low, as many issuers were accessing the European syndication market for refinancing needs. Although the GCC market had historically been composed of mostly sovereign and quasi-sovereign issues, corporates might place debt this year as well. El Jamal pointed out that, with CAPX plans being axed, most issuances would be for refinancing.

On the effects of negative interest rates, Ahmed believed that “the jury was still out” on whether they had been a useful tool to boost the European (and Japanese) economies that had adopted them. He added that, “if too many major Central Banks adopt negative interest rates—and thus lowering their currencies—it becomes pretty much a self-defeating currency war.” Hussain noted that economists generally believe that negative rates hurt banks, and corporates could be crowded out as banks funded sovereigns and quasi-sovereigns.

The panel also addressed other market risks, including speculation on payments on coco bonds. “If there is a slight chance a payment gets deferred, it will led to a fire sale, and babies will be thrown out with the bathwater,” according to Ahmed. In the year of a US presidential election, Hussain expressed concern that American political rhetoric didn’t bide well for GCC countries; “it seems like the US is trying to disengage from the region.”