This post is part of an AGSIW series on Saudi Vision 2030, a sweeping set of programs and reforms adopted by the Saudi government to be implemented by 2030.
Saudi Arabia’s unprecedented bond sale to international investors raised $17.5 billion in October. The timing was impeccable. Given Donald Trump’s victory in the U.S. presidential election, markets could be bracing for several months, or more, of volatility and uncertainty. While the immediate reaction for U.S. debt issues is an expectation that Trump’s infrastructure spending promises could result in higher yields for U.S. Treasury bonds, there is also the uncertainty of his comments during the campaign that made light of possible U.S. default on debt payments. Governments rely on international bond investors to make long-term fiscal plans, and to cover short-term fiscal deficits. A government’s ability to project confidence, its reserve assets, the capacity of its business environment, and the structural reforms and policies to demonstrate a commitment to an economic vision are the essentials of debt pricing. It is never an exact science, but rather an exercise in risk analysis. Saudi Arabia accessed capital markets at a moment, just weeks ago, that now seems tranquil in comparison to the tumult the presidential election has generated.
The Saudi bond was the largest issuance of a U.S. dollar-based bond by a sovereign and the largest 30-year bond offering categorized by investors as “emerging market” debt. Indeed, it is a very large debt sale for a developing economy, certainly for emerging market debt, though Saudi Arabia doesn’t neatly fit into either of those categories. The Saudi economy is larger and more industrialized than most cases of emerging market debt; its currency has been very stable; it has a very low debt to GDP ratio; and its domestic bank sector is well-developed. Few would anticipate a Saudi debt crisis as occurred in Argentina in 2001-02, or a need for a comprehensive debt alleviation scheme like the Brady bonds for Latin America after the 1980s debt crisis.
Saudi Arabia is in a class of its own, though its neighbors Qatar and the United Arab Emirates are following the kingdom’s lead to access eager international bond investors. Compared to regional peers like Egypt, Saudi debt becomes very attractive. Lumping Saudi Arabia into emerging market debt cases may be a good sales strategy by investment banks earning lucrative fees for arranging the debt sales, but it can also skew the fundamental risk analysis. The investment in Saudi Arabia’s future 30 years from now takes some substantial faith in the ability of the government to reform labor markets (especially moving nationals out of the public sector), increase productivity, and diminish the government’s reliance on oil exports as the major source of fiscal expenditure.
The New FDI in Saudi
Earlier in 2016, Saudi Arabia had been able to raise debt within the domestic market, leaning heavily on domestic banks to purchase government bonds. The Saudi domestic bank sector and private sector firms, particularly in construction, remain the most vulnerable business entities to the economic transition underway. The question of who is buying the new bonds, especially the 30-year international issues, is salient as these investors are betting on the long-term success and stability of the kingdom. JP Morgan was the lead arranger on the recent international bond sale, and the firm has reported to clients that as many as a quarter of purchasers of the long-term debt are from Asia. U.S.-based investors showed consistent interest in both the short-term debt of five-year bonds and the 30-year tranche, as purchasers of over 40 percent of each.
This investor interest reveals some important shifts in the strategic and economic outlook on Saudi Arabia coming from the East. While U.S. investors, especially fund managers, retain the largest appetite for Saudi debt, the links with Asia signal longer-term financial commitments, and mutually beneficial investments, particularly in Saudi infrastructure and industry. The U.S.-based investors are largely hedge funds that are likely to unload or trade the debt over the short term. The level of anxiety these investors display as they react to shifts in U.S.-Saudi relations over the coming months will be another important indicator of both the strength of the Saudi economic reform agenda and the strength of the U.S. engagement with the Gulf.
Not surprisingly, many of the new infrastructure and energy investments planned for Saudi Arabia’s Vision 2030 initiative are finding willing partners from Asia, including South Korean, Japanese, and Chinese firms and financial institutions, to build and operate a number of major industrial projects from power plants to railways, to banking and joint investment funds in new technologies. There could be a displacement underway, in which new, foreign firms with their own sources of capital may be more willing to place bids for Saudi government contracts that domestic institutions and firms will find harder to undercut. The new foreign direct investor in Saudi Arabia has short- and long-term stakes in the transformation of the Saudi economy, and is willing to devote time to relationship building. Likewise, Saudi Arabia is eager to strengthen commercial ties with the largest consumers of its oil exports.
Saudi Arabia may have been either prescient or incredibly lucky to go to market before the U.S. election, as uncertainty about a Trump administration’s economic and foreign policy will continue to rattle investors for weeks to come. In any further capital raising from Saudi Arabia, other Gulf Cooperation Council states, and other Middle East and North Africa governments this year and early next, political risk analysis is bound to weigh heavily, another repercussion of the U.S. presidential election.