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GCC inclusion in JP Morgan's bond index could lead to $30bn of inflows

(8/6/2018 8:13:00 AM)

The inclusion of Arabian Gulf region into JP Morgan’s widely tracked emerging market government bond gauge could lead to $30 billion of inflows and lower borrowing costs for the individual states, according to a new report.

The inclusion in the Emerging Market Bond Index will make the region’s debt market access easier, Bank of America Merrill Lynch said in its latest Global Emerging Markets Weekly report. Saudi Arabia, Qatar, the UAE, Kuwait, and Bahrain sovereign bonds will make up a sizeable portion of the index, between 10-11 per cent of the EMBI, it said. The GCC states are expected to be included next month, according to Reuters.

“Potential EMBI inclusion is a swing factor for GCC credit [except Oman],” according to the report. “Sovereigns will also now be able to issue debt to a new audience of emerging market credit-focused investors, which should increase primary [debt] demand.”

In theory, flows could reach $40bn, which should be supportive for credit performance in the coming months. BofAML estimates the real number to be closer to $30bn since many EMBI funds appear to already hold off-benchmark GCC sovereigns in their portfolios.

Sovereigns in the region, home to about a third of the world’s proven oil reserves, have increasingly tapped bond markets in recent years to fund their fiscal deficits in the wake of the three-year oil price slump. Borrowings from international markets have also helped the Gulf states continue to push for growth in their energy-dependent economies as they implemented social and economic reform measures.

Saudi Arabia, the world’s biggest oil exporter, set the emerging market record with its debut $17.5bn sovereign bond in October 2016. Abu Dhabi made a comeback to the bond market with a $10bn bond issue in October last year, while Oman in January tapped the market with a $6.5bn issue.

Gulf states have issued a quarter of all new debt sold by emerging markets in each of the last three years, according to a Reuters report. They now account for 14 per cent of total emerging market debt stock, according to the report.

Some of the sovereign bonds are currently trading at relatively wider spreads compared to their similar-rated peers, on the back of the high level of issuances in recent years and geopolitical risks.

However, BofAML said with a supportive oil price backdrop, “we think EMBI inclusion can finally push spreads tighter”. Bahrain is emerging as the biggest beneficiary of EMBI inclusion as it will provide not only large inflows as a percentage of debt outstanding, but is also likely to be crucial for future external financing needs, according to the BofAML report.

“One of the clear benefits of being a member of a major benchmark is that investors generally have at least some exposure to each country (particularly if it is reasonably large like Bahrain) to avoid deviating too much from the benchmark,” the report explained.

The National