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Saturday, 29 March 2008

Bonds and sukuk may be the right tool

(GulfNews, 29 March 08)

The regional bond and sukuk markets are in the ascendancy. That is an understatement. They are positively robust - despite the recent subprime jitters - and it could not have come at a better time for the region.
The normally laidback Gulf monetary policy machinery is furiously at work these days. Governments are grappling with the inflation monster and many analysts see this as a golden opportunity for the authorities to set up a monetary policy that is not subservient to external forces.
"By having a pegged currency you are tying your hands and cannot hope to have a credible monetary policy. Monetary policy infrastructure requires independent interest rate setting institutions and money and bond markets," says Mohieddine Kronfol, managing director of asset management at Algebra Capital.

Apart from populist fiscal policies, the rational response should be to develop robust monetary instruments and a strong debt market to help absorb liquidity in times of high inflation.

Catalyst for change

Can the Gulf states turn this challenge into a catalyst for change and use strong bond markets as a monetary tool?
Indicators suggest that the groundwork is being prepared. A recent Standard & Poors report, quoting Zawya figures, show that the sukuk market alone will reach $100 billion in the next few years. Moody's see funding potential of up to $50 billion over the next 12 to 18 months, much of it driven by corporates.
This may give the impression that the Gulf governments have been sitting on the sidelines all this time, but nothing can be further from the truth.
"Two decades ago, regional governments made a conscious decision to promote the scope and scale of the private sector in regional economies," says Kronfol. "The fruits of that policy are large and competitive corporates that are funding themselves in regional stock and bond markets - with respect to debt, the phenomenon began in earnest after 2004 when non-bank institutions came to the market in a significant way, like DP World, Aldar and a whole host of players in the syndicated loans and international bonds arena. Now we see corporates are driving issuance and leading the way."
Philip Lotter of Moody's agrees that Gulf corporate bond market has demonstrated that it can prosper without an active monetary policy, but it does limit the government's ability to exercise independent influence over supply and borrowing costs.
Another reason for the debt market's attraction is the lackluster regional equity markets in the past two years.
"The poor regional stock market performance over the past two years has undoubtedly encouraged many companies to diversify their funding base away from equity issuance at 'depressed' share prices," says European Islamic Investment Bank's Doug Bitcon.
Despite the benign conditions, the bond markets have not fulfilled their greatest aspiration yet - helping regional governments develop monetary tools.

Unfulfilled potential

"We need to have mature financial markets and it is essential to have a bond market in the region, even though there is not much flexibility in the rate of movement," says Marios Maratheftis, Standard Chartered's regional head of research, who has been championing an independent monetary policy for some time. "We want to see changes in forex rates, but we understand there is no appetite for depegging."
Gulf governments are reluctant to step up and take the monetary policy bull by the horn. For example, Saudi Arabia has an efficient local bond market but the government has no appetite to depeg the currency from the dollar. As a result, the market has become smaller and less liquid over time.
The markets have started to see local currency bonds from Jebel Ali Free Zone Authority (Jafza) and National Bank of Abu Dhabi, and more will come to the market, but it is not an optimal way to operate, says Kronfol.
"To develop domestic money and bond markets, and be in credible position to debate abandoning the US dollar peg, GCC governments have to pass necessary laws, articulate medium and long-term policies and continuously promote their markets until they are deep and liquid."

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