Tapering will be a challenge for both Fed and the bond market

By Dr R Seetharaman Global bond issues fell by more than 4% in 2013, to reach $3.66tn. The concerns of US Fed tapering impacted bond raising plans in 2013 on account of significant volatility in interest rates. The US 10-year bond yields crossed 3% in December 2013, on account of positive indicators in the US economy and the announcement of tapering by the US Fed.

At the beginning of 2013 it was at 1.757%. The Fed’s balance sheet before the crisis was at $850bn and is now close to $4tn. It has kept low interest rates since 2008 and resorted to quantitative easing mechanism in recent years to revive the US economy.

There are expectations that US 10-year yield can even go beyond 3.5% in 2014. However, it will witness significant volatility, depending on the timing and quantum of tapering done by the US Fed.

Unwinding the tapering is not only going to be challenging for markets but also for the US Fed. The communication strategy of the US Fed will be critical.

If the recovery of the US economy is faster in the 1st half of 2014, it can surprise the US Fed as well. The fiscal challenges of the US economy may also have an impact on the US Fed action.

The GCC bond issues have reached more than $45bn in 2013, out of which close to 50% was from Islamic bonds. The major conventional bonds in 2013 were issued by the emirate of Abu Dhabi, the emirate of Dubai, Investment Corp of Dubai, Qatar National Bank and Saudi Basic Industries.

The major Islamic bonds in 2013 were issued by Saudi Sovereign, Sadara Basic Services, Investment Corp of Dubai and Dubai Islamic bank.

Qatar Central Bank has come out with quarterly bond issues since March 2013.

Global sukuk deals were down in 2013, compared with that in 2012. The global sukuk sales were worth only $43bn in 2013, whereas it had exceeded $46bn in 2012.

GCC issues have contributed more than 50% of the global sukuk till date. The perpetual sukuk have become an important instrument in 2013 since the first such issue by Abu Dhabi Islamic Bank in November 2012.

Four perpetual sukuk have since been sold in the GCC as companies have used them to shore up capital, without hurting their creditworthiness, since the instruments are treated as equity on the balance sheet.

The sukuk demand is expected to pick up in 2014. The tapering of monetary stimulus by the US Fed will create volatility in interest rates in 2014.

Both the pricing and the timing of issues will be challenging on account of this volatility. The GCC will have more than $30bn of bonds and syndicated loans maturing in 2014, and refinancing requirements in the region can bring demand for bond issues. The long-term infrastructure spending requirements in the GCC will also encourage bond raising.

The IMF estimated that about $64bn of debt held by Dubai and government-related entities (GREs) will come due between 2014 and 2016 on account of debt restructuring deals done in the wake of the last crisis.

This includes some restructured debt and the $20bn provided by the UAE Central Bank to Dubai as part of the post-crisis support facility. There are expectations of roll-over of this facility.

Abu Dhabi sovereign has $1.5bn due to mature in April 2014, but has not issued debt since its debut deal in 2009. Their substantial cash reserves and the borrowing practices of its GREs indicate that a new bond to replace maturing obligation is not certain. However, Abu Dhabi GREs and corporates are expected to tap the bond market in 2014.

Since June 2013, the Qatar Exchange had announced the trading of government bonds issued by Qatar Central Bank. It was a step towards launching a market for corporate bonds.

Bond being a new trading instrument on the Qatar Exchange, there is a need to hold seminars and knowledge-sharing sessions. The development of yield curve is necessary for a bond market. Fixation of benchmarks for bonds is also essential. To address hedging requirements, the development of an interest rate derivatives market becomes vital.