DUBAI: A proposed Islamic bond issue by Saudi Arabia is important not so much because it would raise money for the country — the kingdom does not need the cash —but because it could serve important monetary policy goals.
By making the first substantial issue of government debt for several years, authorities could pave the way for more issues if they chose. These could become a useful means to soak up funds from banks and prevent inflationary pressure from rising.
Also, the issue could help Saudi corporations sell bonds by creating a new sovereign pricing benchmark. More bond issues by companies would reduce their reliance on bank loans at a time when the global financial crisis is making foreign banks more wary about lending.
The Saudi Arabian Monetary Agency (SAMA) is talking with local and international banks with operations in the kingdom about issuing a riyal-denominated sukuk as early as in the first quarter of 2012, banking sources told Reuters.
The sukuk would not be issued directly by the government but would instead be marketed by either a governmental agency or a state fund, several of the sources said, speaking on condition of anonymity because the government has not yet made a formal announcement.
Key details have not yet been decided, including the tenor of the bond, whether the sukuk will carry a fixed or floating profit rate, and the size, said a banker familiar with the talks. As with other domestic Saudi debt issues, it is expected that foreign investors would not be able to buy the bond because of restrictions on their activities in the country.
The issue would mark something of a policy shift for Saudi Arabia, which has been reluctant to issue much government debt since the level of state indebtedness became a problem in the 1990s, rising above 100 percent of gross domestic product.
But a bond sale early next year would be in line with previous comments by Finance Minister Ibrahim Alassaf, who told Reuters in October that while debt issuance to help cover expanded budget spending was not on the cards, issues of Islamic or conventional paper for specific projects were being considered by the ministry.
"We are considering specific project sukuk or bonds — a productive project that could issue sukuk. For example, the airports which are a very good investment," he said.
"We can issue sukuks to be financed from the receipts of the airport or this specific project. If there is a need for government guarantees, then we will look into it."
Liquidity
Saudi Arabia has boosted government spending sharply this year to pay for social welfare projects, partly in response to political unrest elsewhere in the Arab world. That has pressured its finances; Shawkat Hammoudeh, a former economist with the Organization of Arab Petroleum Exporting Countries who studies petrodollar flows at Drexel University in the United States, said the break-even point in its budget — the oil price needed to ensure a budget surplus — would rise from $66 a barrel two years ago to $88 this year and $93 in 2012.
Even so, the government appears far from any need to issue debt; SAMA forecast on Monday that Saudi Arabia would post a budget surplus of 185.3 billion riyals ($49.4 billion) in 2011, with at least one analyst predicting an even bigger figure next year because of high oil prices.
The country’s gross public debt will fall to 7.1 percent of GDP this year from 9.9 percent last year, the International Monetary Fund has projected. Even if global oil prices fell from current levels above $100 to below the budget’s break-even point, the government could avoid issuing debt by drawing on massive fiscal reserves estimated at some $280 billion.
"The Saudi government doesn’t really need the money as they have plenty of reserves from oil revenues," said a banker with knowledge of the talks on the proposed sukuk.
The issue would, however, help to soak up idle liquidity in the banking system that has been created by strong economic growth and huge oil revenues. There are limited opportunities for this money to be invested domestically, creating concern that it could be placed in overseas assets made more risky by the global crisis.
"The Saudi government wants to suck liquidity from the local market as it becomes dangerous with all this money available and lots of cheap assets around the world," said another banker who is involved in the talks.
Qatar took a similar step in January this year, issuing a 50 billion riyal ($13.7 billion) bond to local banks to raise funds for development projects and drain excess money from its banking system.
The Saudi sukuk issue is also a way to address the inflation outlook. Inflation is not at the moment a problem — it was 5.2 percent in October, well below a record high of 9.9 percent hit in 2008 — but M3 money supply growth accelerated to 14.4 percent in October from 11.9 percent in September. The IMF has warned that Gulf central banks may in future need to adjust monetary policy to head off inflationary pressure.
Normally, a central bank would respond to an inflation threat by raising interest rates, but Saudi Arabia pegs its currency to the US dollar, making it difficult to hike rates without attracting destabilizing inflows of money. Absorbing money with government bond issues is another way to tighten money market liquidity.
Corporations
At the same time, a sukuk issue by the government — or a series of them, fleshing out a full yield curve — could spur more riyal-denominated corporate bond issues by creating a commonly accepted pricing benchmark. There are outstanding sukuk from quasi-sovereign, government-backed firms such as Saudi Basic Industries Corp. and Saudi Electricity Company, but trading in them is generally thin so they are of limited use as pricing guides.
"It’s very important as whenever we take a company to market, there are issues as there is no benchmark," said a debt capital markets banker in the country.
Paul Gamble, head of research at Jadwa Investment in Riyadh, said: "If you look at the balance sheets of companies in the kingdom, they are overly reliant on bank and equity finance, so having a more active debt market will be beneficial."
He added that issues of government sukuk with long maturities could also benefit banks.
"One of the issues that banks face is an asset-liability mismatch, where they lend long-term for projects — perhaps for 10 or 15 years — but don’t have long-term investments to balance this funding against.
"Insurance companies in the kingdom also have long-term commitments but little suitable with a long-term maturity to invest in."
The government has earmarked as much as 400 billion riyals to be spent over a five-year period on infrastructure projects, and banks will be expected to help fund much of this. A more active local currency bond market could ease the pressure on them.
It might also help Saudi banks adjust their balance sheets as they prepare for the global introduction of Basel III banking standards over the next several years. With high capital levels, Saudi banks are not expected to have a problem meeting minimum capital adequacy ratios, but maintaining liquidity standards will require them to keep stocks of "high-quality liquid assets"; the new Saudi sukuk will presumably be one such asset. –Additional reporting by Asma Alsharif in Riyadh and Rachna Uppal
