Market analysis: Confidence despite the slide

November was an important month for many GCC countries as oil prices slid closer to the break-even prices on which government budgets are calculated.

The decline in Brent oil prices (by almost 20 per cent over the month) was exacerbated by Opec’s decision not to cut production. However, financial markets remained relatively buoyant in many other regions. The drop in oil prices was perceived as helping the economies of oil-importing countries in general, and monetary policy in most places remained accommodative.

Despite the decline in oil prices and volatility in regional equity markets, bonds in the Mena region outperformed the JP Morgan Emerging Market Bond Index, with the S&P Mena Bond Index returning a fairly healthy 0.4 per cent in US dollar terms.

Saudi Arabia’s HSBC purchasing managers’ index reading for October remained strong at 59, although it dropped from the historic high registered in the previous month. It was thought possible that Saudi Arabia could run a budget deficit next year if oil prices remain under pressure and the government does not alter fiscal policy.

Showcasing the effect of the declining oil prices, Kuwaiti government revenue fell 4.4 per cent in the first half of the current fiscal year as oil income, which accounts for 94 per cent of state revenue, dropped 5.3 per cent.

However, GCC governments in general appear to have the resources to maintain pro-growth spending, with Kuwait increasing government spending by 19.6 per cent in the six months to end September this year compared to the same period the previous year.

The relatively good performance of the UAE equity markets last month was helped by the October HSBC PMI reading for the country, which reached a record high of 61.2.

Taking advantage of the revived economy and a surge in liquidity, Dubai World proposed to settle ahead of schedule a US$4.4 billion tranche of outstanding debt due next May in return for an extension of the 2018 tranche of $10.3bn until 2022. The restructuring proposals were perceived as positive for UAE banks, as it would allow the banks to reclassify Dubai World loans on their books as performing and immediately improve their provisioning coverage ratios.

Our positive medium-term outlook for the Mena bond markets, and especially for GCC countries, has been predicated on strong non-oil growth and sufficient fiscal strength to weather short-term negatives.

The performance of bonds in the region during the difficult month of November is a testament to the region’s resilience.

Furthermore, we do not believe that the slide in oil prices will prove sustainable. The consequences of any lasting fall in oil prices will be felt by producers elsewhere before they are felt in GCC countries, which mostly have low public debts and large current account reserves.

The possibility that some countries may end up reporting fiscal deficits if prices continue to slide is certainly a negative, but we believe such a development might bring new, interesting issuers to the bond market. Low oil prices may also trigger a range of structural reforms in areas such as fuel subsidies, taxation and financial market development.

The main oil producers have deployed surpluses from recent years in efforts to diversify their economies away from hydrocarbons. We expect the recent oil market volatility to stimulate their efforts further. We thus expect robust capital programmes to remain in place, but possibly stretched over longer periods.

Among the main oil exporters in the region – Kuwait, Qatar, Saudi Arabia and the UAE – some have built budgets around lower break-even oil prices than others. However, all of those countries, in our view, remain fiscally robust, with central banks and sovereign wealth funds that have accumulated substantial foreign reserves.

Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments (ME)