Lower oil prices could lead to groundbreaking changes in the region’s financial markets that will leave a positive legacy for future generations.
The fall in the oil price has challenged the region like never before. The good news is there are some positive signs that the authorities are using it as a catalyst for reform.
These changes should accelerate the process by which the regional asset markets become deeper and broader.
The region has been devoid of a significant bond/sukuk market partly because liquidity was so easily available. Banks, often flush with deposits, could easily fund most projects locally. The region’s major companies would often think that it was unnecessary to go through the cost and inconvenience of trying to attract foreign capital.
The world has changed. With low oil prices, regional liquidity has dried up.
Governments and local companies now may need to seek out international investors to fund their deficits and future growth. There is scope for the upsizing of the regional bond and sukuk markets to put the region more on the map for foreign investors.
At a $30 oil price, we estimate that the total Gulf Cooperation Council budget deficit could climb to $160-170bn. The cumulative gross financing needs of governments alone could be around $150bn and herein lies the opportunity for the authorities to allow the development of the bond and sukuk markets while maintaining their adherence to prudent debt management.
Contrast the GCC funding needs with the $157bn of total outstanding Eurobonds issued by the GCC and the opportunity to scale up the size of the local markets is clear to see.
Such a scale of potential issuance, relative to the existing size of the bond and sukuk market could be seen as a worry. However debt-to-gross domestic product ratios in much of the region are in single digits. There is a long way to travel before the region sees debt to GDP ratios above 60 per cent, which is typical for much of the rest of the world.
Equity markets too should benefit from a greater breadth of companies coming to the market through initial public offerings or from strategic investors reducing their stakes in businesses.
We may have to wait for equity market conditions to improve as few companies will wish to issue equity with valuations low by historical standards. However there is the scope for more companies to come out of private ownership and to use the equity market as a source of international funding.
Better diversified markets with more consistent liquidity could bring longer term commitment from international investors to the markets. In current market conditions, international investors tend to be transitory rather than committing for the long-term.
The development of the equity market could be a great shop window for the region, showing international investors that there is more to the economy than oil. The ongoing government efforts to industrially diversify their economies would be enhanced if more international capital was applied.
This may require that private companies, often owned by merchant families through generations, would need to sell some shares in their businesses and ultimately give up control. Emotionally that might be a challenge, but such a change in the ownership structure of local industry is one that most economies move through as they emerge bigger, stronger and better diversified.
The reforms and change in the regional economy will also require institutional change. To be fair, the region has been set on this path for some time. The efforts of many countries to have their equity markets included in higher order equity indices such as the Morgan Stanley Capital international indices have required the adoption of international standards of regulation and governance.
The more that local governments and corporates tap international investors for funds, the more that the region will need to become more efficient in its securities markets. The numerous stock exchanges and regulatory regimes across the region only complicate the lives of international investors. Reform that brings uniformity would be most welcome.
In summary, we believe the fall in the oil price should act as a catalyst for an acceleration of the development of Middle Eastern asset markets. The more the region has to seek out pools of foreign capital, the quicker that the local markets will develop into well diversified deeper asset markets.
The scaling-up of local asset markets should ensure that foreign capital stays for longer and that the region cements a stronger more diversified link with international investors.
Gary Dugan is chief investment officer of Emirates NBD