In what could pave the way for the UAE to create its first sovereign bond the Emirates' Federal National Council has passed a public debt law to limit government debt to 25 per cent of GDP.
Legislation sets scene for Federal bond sales
The UAE's top legislative body has passed a public debt law that paves the way for the country's first Federal Government bonds.
After yesterday's announcement, Obaid Humaid al Tayer, the Minister of State for Financial Affairs, said at a Federal National Council (FNC) session a bond sale could happen at the end of next year or early in 2012. The funds raised would be used to plug a Dh3 billion (US$816.7 million) budget gap "only if necessary", he said.
Approved by the FNC this month, next year's Federal budget contains a Dh3bn deficit. It envisages Dh41bn of spending against Dh38bn of projected revenue, which has led to speculation that a bond could be on the way to finance the difference.
The Government has long been weighing the sale of bonds to secure financing for government departments and provide a benchmark for private companies thinking about bond sales of their own. While Abu Dhabi, Dubai, Ras al Khaimah and other emirates have sold debt to international investors in the past, the Federal Government has never done so.
A programme of federal bond issuance "has been called for by bankers, economists and ratings agencies for years", said Michael Grifferty, the president of the Gulf Bond and Sukuk Association, an industry body that promotes the development of regional debt markets and consults with governments.
The Government was making "technical preparations" for a bond issuance, he said, including establishing mechanisms for trading the securities and gauging demand. Given the time it would take to put those cogs in place, he said, he "would be surprised if that were ready to roll out now".
Federal bonds for the UAE would be similar in some ways to those issued by Singapore and Hong Kong, which have sold sovereign bonds for years even when running government budget surpluses, economists say. The point of establishing a regular programme of bond sales, they say, is to reap the rewards of deep and liquid debt markets. That aim contrasts sharply with countries such as the US, which is forced to sell bonds to finance its deficit.
"The debt market in the GCC, and especially the public debt market, has not been very developed because the need to borrow simply hasn't been here," said Fabio Scacciavillani, an economist at the Dubai International Financial Centre. "Usually, governments have surpluses, not deficits, especially over the last few years. Nevertheless, it's important to create a debt market. Usually, the debt market is started by government issuances, then the banks price their bonds along the government yield curve, and then corporations usually come after banks."
The public debt law passed yesterday now awaits a final sign-off from Sheikh Khalifa, President of the UAE. In addition to removing legal impediments to federal bond sales,the law prescribes a limitation on Government debt to 25 per cent of GDP or Dh200bn, whichever is lower.
That sort of management, Mr Grifferty said, revealed the fundamental purpose of the law, which goes beyond merely setting the stage for bond issuances. "It's not only about issuance of debt," he said. "What it really does is it gives a sound basis for risk management at a federal level and across the country. It's a best practice before you get to issuances."
Once the issuances do happen, observers are hoping a healthy trade in the bonds springs up and establishes a yield curve. The yield curve reflects returns on investments in safe government bonds at a range of maturities. It is important because it forms a basis from which banks and private companies can decide how to borrow and what rates of interest they must pay to do so.
"When you have this federal bond issuance, it becomes a step towards establishing a benchmark," said Giyas Gokkent, the chief economist at the National Bank of Abu Dhabi.
Federal bonds, he said, would also give the Central Bank another tool with which it could intervene in markets to influence interest rates and banks' lending activities.
Selling federal bonds may not be an entirely straightforward matter, however, according to a banker in Dubai who has worked on emirate-level bond sales. It was not clear, he said, "whether the Central Bank would be in position to put in place the infrastructure for settlement" of bond payments.
"Whether or not there is international demand, the last thing investors want is operational risk with a framework that has not been tested," said the banker, who declined to be named. "They've been working on these type of things, but it takes longer than … you may think if they want to develop an infrastructure."