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Project bonds could open new opportunities

By KHALIL HANWARE JEDDAH: Finance Minister Ibrahim Al-Assaf has said that the Kingdom will not need to tap into its reserves this year to finance additional budget spending. However, he said Saudi Arabia is considering whether to issue Islamic or conventional bonds to help fund specific projects.

He pointed out that robust oil prices had helped to fill state coffers. "We have higher expenditure than projected, but we have higher revenues than projected," Reuters quoted Al-Assaf as saying in Abu Dhabi.

Commenting on Al-Assaf's remarks, Paul Gamble, head of research at Jadwa Investment , said: "High oil prices and production mean that revenues should stay above spending this year and as a result the government budget will remain in surplus. We forecast a surplus of SR226 billion this year, equivalent to 11.2 percent of GDP. Therefore, there is no need for the government to draw on its foreign reserves or issue any debt."

He added: "Issuing project debt would be a helpful strategy, as it would diversify the sources of funding for government projects, create a benchmark for private sector issuers and provide an interesting opportunity for investors. In addition, holding project finance loans is much less attractive for banks under new banking regulations (Basel III) than holding project bonds, which are treated more favorably on a bank's balance sheet."

The Saudi government has little debt; the International Monetary Fund has estimated gross public debt will fall as low as 7.1 percent of GDP this year. The Riyadh-based Jadwa Investment has calculated that the Kingdom could run a budget deficit of 10 percent of GDP for the next decade without issuing any debt and still have substantial reserves.

"Well, government borrowing via the issuance of fixed income instruments, or sukuk in this case, will give the government some form of 'financing breather' especially if there is an exceptional case of moral and political obligations in the region," Basil Al-Ghalayini, chairman of BMG Financial Group, said.

Furthermore, Al-Ghalayini said: "The issuance of government-backed sukuk will be healthy for the debt capital market in the country as a secured treasury-type instrument. There are several infrastructure projects such as airports, railways, etc, already under execution, which qualify to be financed via the sukuk instrument. If you add the rating feature by one of the highly credible agencies, these sukuk will be even attractive to institutional investors globally."

According to Saudi Arabian Monetary Agency's (SAMA's) statistical bulletin for the second quarter of 2011, the central bank's net foreign asset reserves have climbed steadily to SR1.86 trillion from SR1.75 trillion in the first quarter.

About bonds plan, Jarmo T. Kotilaine, chief economist at the National Commercial Bank, said: "The idea of project bonds is both interesting and very attractive. Saudi Arabia's strong fiscal position means that the need for conventional sovereign issuance is minimal in the foreseeable future."

However, Kotilaine said: "The government can play an extremely important role in building the domestic capital markets by facilitating the issuance of project bonds or sukuk to fund its massive infrastructure pipeline. This would engender numerous important benefits. It would create an important new instrument enabling a wide range of investors to take part in funding one of the most compelling growth opportunities in the region. This would be especially welcome for the region's growing institutional investors who naturally seek longer tenures. The government's actions would have important side benefits in developing and standardizing products and structures. Through different tenures, the government could effectively create a benchmark yield curve, thereby encouraging other issuers to tap the market more cost-effectively."

Al-Assaf told Reuters debt issuance to help cover expanded budget spending was not on the cards. But he said 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 sukuk 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."

Kotilaine said additional opportunities will come from the housing market area, especially after the mortgage law is implemented. The example of Malaysia above all has demonstrated the critically important positive role that government-related entities can play in driving forward the development of the broader capital market. Khazanah Nasional and Cagamas Bhd are notable examples in point. "Having a developed asset class of project bonds and sukuk would doubtless further enhance the attractiveness of the Kingdom as an internationally important investment destination. After a while, it could also accelerate and smoothen project implementation by making it less dependent on the government's fiscal position. Of course, for the government it would make it easier to resume sovereign issuance, should this ever be deemed necessary," Kotilaine added.

© Arab News 2011