Mohieddine Kronfol, the managing director of asset management at Algebra Capital, sits in his office in the Dubai International Financial Centre, looks at the table of numbers on his computer screen and shakes his head in puzzlement. Judging just from these numbers alone, investors might think that lending to some Dubai companies - Nakheel, Tamweel and Dubai Holdings, among others - is a very risky proposition. But Mr Kronfol, a veteran of the region's markets, thinks that is absurd. He is confident those companies enjoy not only the backing of the Dubai Government but also very likely the federal Government, if it were ever to come to that.
Yet he points out that it costs about US$970,000 (Dh3.6 million) a year to insure $10m worth of Dubai Holdings debt against the loss incurred if it defaults any time in the next five years, up from $189,000 a year in April. That is even more than insurance against what a Lehman Brothers default would have cost in the run-up to its September collapse. For him, bizarre figures like these do not signal that those companies are about to fail. They are signalling something altogether different: that the region desperately needs a bond market, or at least one far bigger than it now has.
Because the GCC does not have a fully fledged debt marketplace, where large numbers of local buyers can invest their money in bonds and sukuk - or Shariah-compliant bonds - issued by UAE companies, the tiny number of transactions that do take place can happen at absurd prices, the product of desperate sellers meeting with almost no buyers. As prices on Nakheel debt have fallen, for example, yields on bonds set to mature next year have reached 32 per cent. In a normal market, that would qualify them for the title of "distressed debt".
Yet by Mr Kronfol's reckoning, it is not that Nakheel is in serious danger of default. The problem is that the market is simply too small - and too dependent on investors from outside the region - to accurately reflect the realities of the region's economy and the companies that operate here, he argues. "What happens in the market when you don't have a bid and you have sellers? Prices start getting distressed, and this is where we are today," he says. "When you're not looking at a very developed capital market, it's not always a good reflection of the underlying economy."
Mr Kronfol, who helped found Algebra Capital's fixed-income division, is not alone in his thinking. Developing more advanced capital markets is "an extreme necessity" for the region right now, according to Salwa Hammami, an economist at Arqaam Capital. "All of the GCC countries should work on developing their debt markets so that companies can start diversifying their sources of funding," she says.
"The development of deep and liquid markets for debt securities in the UAE would certainly help ease the liquidity constraints, as well as the funding costs, facing domestic companies," says Mohammed Jaber, an economist at Morgan Stanley. Nakheel, for example, is not happy about where its debt is trading. "The current market pricing is not reflective of the credit quality of the Nakheel sukuk," says a Nakheel spokesman. But the problem is bigger than Nakheel, or any other company, or even so-called Dubai Inc. It is posing a threat to the economic model that the region has been betting on: the public-private partnership in which government-controlled enterprises increasingly behave like private sector companies. For that to work, the spokesman says, debt markets have to work, too.
Despite their oil wealth, GCC countries including the UAE still rely heavily on international lending to finance costly infrastructure and property projects in the long term. "What people don't understand is that what drives a lot of the growth in this part of the world is really debt financing. For every $1 for equities, you have about $9 in debt that's being raised," Mr Kronfol says. The root of the problem is that only a fraction of Gulf investors buy local bonds and sukuk. "The retail investor in this part of the world essentially channels his money into real estate and equities," says Mr Kronfol. "If you look at the total assets under management in the region... less than 2 per cent of that is in debt. Everywhere else in the world, the debt portion is a multitude of what you would have in equity."
With local retail investors almost non-existent, only the local banks are left to pick up the region's debt. But banks are experiencing a credit crunch themselves and cannot afford to buy all the bonds that international investors have been offloading. Now that international investors have lost their appetite for Gulf debt, it has put the region's entire financial paradigm at risk. If the Government has to bail out its large corporations, the country will have to effectively abandon its famous model of blending private enterprise and government support that has created so much growth during the past decade, Mr Kronfol says. In that case, there would be no more public-private partnerships and the discipline of the market would evaporate. "You would just have a bloated public sector."
That was one reason the GCC failed to invest its windfall during the last oil boom effectively. The region has ample wealth to invest. "The question is: 'how do you channel that into these markets?'" The answer, he says, is that the Government needs to step in and start issuing bonds. Most GCC governments do not need the money, but issuing bonds would provide investors with a benchmark against which other debt could be evaluated, as well as provide a safe alternative to property and stocks.
Once it got rolling, the market could give local companies access to funding from regional retail investors, who normally shunt most of their savings into stocks and property. During a credit shortage, this would also decrease the likelihood of corporates defaulting. And it would give investors opportunities beyond property and stocks. That, in turn, would make the property and stock markets less volatile.
"If inflation is 10 per cent and a bank would only pay you 1 per cent [for your deposits], you become much more willing to invest in any real estate project, so those projects sometimes start becoming not very rational," Mr Kronfol says. email@example.com