Middle East: Saudi raises doubts as well as debt

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Investors should not get too carried away by Saudi’s bond market triumph: there is still much that can derail its long-term strategy.

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Last month, Saudi Arabia entered the international bond market for the first time in its history. True to form, the Kingdom went big: the deal was the largest dollar sovereign ever, raising $17.5 billion.

Investors absolutely loved it. Within hours, the book was oversubscribed by nearly $50 billion, and demand hardly dropped when the issuer cut the margins on the debt. All three tranches of the deal tightened in secondary trading over following days.

Appetite was, in a sense, unsurprising: in an environment where yields are still so depressed, investors are desperate for large emerging market transactions offering some return. But that alone cannot explain the infatuation with a debut of this magnitude. 

Just as in the case of Argentina’s $16.5 billion deal earlier this year – the previous largest dollar sovereign – investors bought into a political idea: in the case of Argentina, that the election of President Mauricio Macri would usher in a new liberal era for the country’s troubled economy; in the case of Saudi Arabia, that the Kingdom’s increasingly prominent deputy crown prince will shift the economy away from oil, and toward modernity and diversification.

Both are gambles. And Saudi Arabia’s is perhaps the riskier of the two. The Kingdom’s 14-year economic reform programme – ‘Vision 2030’ – was released just six months ago, and is therefore hardly tested. Going as far back as the 1940s, oil has been an outsize contributor to Saudi Arabia’s economic might, and geopolitical standing. Weening the Kingdom off oil – a goal already embraced in previous reform programmes that have been largely unsuccessful – will be a fraught endeavour.

And the position of the deputy crown prince, Mohammed bin Salman Al-Saud, is also uncertain. Though King Salman has named him second in line to the throne, bin Salman is only the fifth oldest of the king’s surviving sons. In a royal family where members constantly jostle for power, his legitimacy as heir could be called into question – which would then jeopardise the Vision, apparently his brainchild and a plan which he has publicly championed.

Tame response

The reforms also look to change the way Saudis live, removing numerous state subsidies, pushing citizens to be more productive members of the economy, and introducing VAT. (VAT is to be rolled out across the whole of the Gulf Cooperation Council countries in 2018.) So far, apart from some demonstrations against rising gas prices, the population has reacted rather tamely to new policies introduced as a result of the fall in the price of oil. Saudi business people claim the population understands sacrifices must be made to prepare for the future.

But as policies become increasingly harsh, there is no telling whether the population will take the changes without protest.

Saudi Arabia faces other challenges, too. Among them, the recent passing in the US of the Justice Against Sponsors of Terrorism Act (JASTA), which enables victims of the terrorist attacks on 9/11 to sue the Kingdom – a drastic change in the law that could have wide-ranging consequences on US-Saudi relations, and on Saudi assets in the US, which reportedly total $750 billion. 

A banker who accompanied Saudi Arabia on its international roadshow tells Euromoney that investors not once brought up the subject of JASTA, which at that point was no longer front-page news: a worrying complacency on their part, if true.

For Saudi Arabia, the bond is great news – if it does not raise debt, the Kingdom risks burning through its $600 billion of reserves in just six years. For bankers, too, the bond is a godsend – Saudi Arabia may prove to be the biggest cash cow of the new century. After the largest recorded dollar sovereign, Saudi Arabia looks set to deliver the largest ever initial public offering, with the partial sale of state-owned oil company Aramco.

But for investors, the benefits are less certain, and certainly contingent on the success of Vision 2030 – a tenuous premise that however generated a bond book of $67 billion. So enamoured were the buyers with this new issuer’s long-term plans that they piled into even the bond’s longest, and largest, tranche – $6.5 billion due to mature 30 years from now. They broke into applause at the end of the New York presentation of the deal, according to a banker present. 

Investors may want to temper their ardour somewhat.