Mature Debt Markets Can Bring Stable Access to Capital for MENA Governments and Corporates, Says DIFC Economic Note

The development of debt markets can enhance the ability of governments and corporates in the Middle East and North Africa (MENA) region to raise funds efficiently and cost-effectively for infrastructure and development needs, according to the latest Economic Note issued by the Dubai International Financial Centre’s (DIFC) Economics Unit. 

Released today, the DIFC Economic Note 7 titled ‘Local Bond Markets as a Cornerstone of Development Strategy’ says that an active and liquid local currency debt market brings several benefits including stable access to capital; diversification of monetary policy instruments; improved resource allocation; creation of a yield curve for the pricing of financial assets and tailoring risk management tools; and increased choices for both retail and institutional investors.

Dr. Nasser Saidi, Chief Economist of the DIFC Authority said: “The development of local currency debt markets represents a vital investment in the economy, similar to any other public investment. Even in the absence of a pressing need among governments to borrow, the creation of a debt market is a key milestone on the road to the development of an advanced economy.”

Benefits of well-functioning debt markets
The debt market provides an instrument for the banking system in the region to manage liquidity and risk in an effective manner; and allows central banks to control liquidity. Diversification of financing and investment options contributes to the stability of financial markets and to greater corporate and government transparency. Furthermore, the development of debt markets promotes market discipline, transparency and accountability because governments, companies, and projects financed through tradable bonds are subject to constant scrutiny by market participants.

In the GCC region, debt markets can also generate financing for much needed infrastructure projects. Dr. Saidi said: “With GCC countries investing heavily in infrastructure, which according to estimates requires some USD2.3  trillion in financing, it is opportune to raise this financing through debt securities that are based on future cash and revenue flows, as is the case in project finance.”

In addition, well functioning debt markets will help reduce dependence on bank finance at a time when the banking sector is in a process of deleveraging,; diminish macroeconomic and financial vulnerability from energy price fluctuations by providing governments with an alternative source of funding to smooth out volatile revenues; enable monetary policy by providing central banks with a market for open market operations; and be the cornerstone of housing finance through an active mortgage market. All these make local currency bond markets a cornerstone of development strategy.

Factors hampering MENA debt market development
In many advanced and emerging economies, debt markets represent the leading channel of liquidity for governments and financial institutions. However, the MENA region has traditionally had a low dependence on debt markets. According to a recent International Monetary Fund report, while debt securities make up 38.9% of global capital markets, they make up just 5.6% of Middle Eastern capital markets.

Markets in the region are still underdeveloped, with a lack of breadth, depth and liquidity, a low investor base and the absence of a clear legal and regulatory framework. Other critical issues include the lack of a credit rating culture, unsatisfactory market transparency; the lack of benchmarks, long maturities and a broad spectrum of institutional investors; and the absence of a derivatives market for managing interest rate and credit risk.

Over the last few years, the Dubai International Financial Centre (DIFC) has sought to plug some of the infrastructural and regulatory gaps that are hampering the development of a liquid and deep debt market in the Middle East. Through NASDAQ Dubai, DIFC has put in place a financial platform incorporating international best practices and promoted transparency by establishing global standards in the regulation of issuers and post-listing disclosures.

Signs of resurgence
In the wake of the financial crisis, the debt market has emerged as an attractive financing alternative in the GCC region. Tightened access to liquidity; losses in the region’s equity markets; and the prohibitive cost of long-term bank borrowing in the face of the global liquidity crunch has led to a substantial increase in debt market activity.

The Economic Note observes that during the first ten months of 2009, the volume of GCC bonds and Sukuk reached $60.8 billion, a substantial increase from the previous year when the total volume had dropped by about 40%. The GCC’s corporate debt market is going through a revival while the sovereign debt market –conventional and Sukuk- is re-emerging strongly after the crisis in 2009.

Strong Government Commitment Required
The Economic Note stresses that the development of a deep and liquid debt market in the MENA region requires proactive efforts from government authorities, regulatory bodies and market participants. Governments need to implement a proactive debt management programme and ensure a large and diversified issuers base. A focused issuance programme of government securities is essential to establish benchmark bonds.

Money markets and financial derivative markets should be developed alongside the debt capital markets to facilitate liquidity management by both central banks and investors. Furthermore, regulatory authorities need to nurture markets by creating an efficient and market-friendly regulatory environment.

The development of a debt market in the GCC will have profound implications for global financial markets, the Economic Note observes. With time, a deep GCC debt market could come to represent a key component of the new emerging international financial architecture, allowing international investors to tap liquidity available in the Gulf region.