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DEVELOPMENTS IN THE BOND MARKET
(THE SAUDI ARABIAN EXPERIENCE)
ARAB MONETARY FUND
SEMINAR
THE DEVELOPMENT OF BOND MARKETS
IN ARAB COUNTRIES
UAE – ABU-DHABI
10 – 11 MAY 2005
PRESENTED
BY
SALEH AL-AWWAD
INVESTMENT ADVISOR (SAMA)
Developments in the Bond Market
(The Saudi Arabian Experience)
I - Introduction
Saudi Arabia’s
Government bond market has a short history. The Government launched
issuance of debt securities in June 1988 to finance state budget
deficit. Corporate bond issuance is a recent phenomenon in the context
of business expansion and the newly emerged trend to diversify funding
resources away from bank credits and syndicated loans.
II - Government Bond
Market
A -
Objectives
Since 1983 Saudi Arabia has witnessed fiscal budget deficits
except in the years of 2000, 2003 and 2004. From 1983 to 1988 the
budget deficit was financed out of state reserves. Since mid-1988,
Government of Saudi Arabia, represented by Ministry of Finance, has been
projecting its borrowing requirements and raising finance by mobilizing
domestic savings. Being fiscal agent, SAMA offers Government debt
securities to the domestic market. There are no restrictions on
foreigners buying government securities through the domestic banks.
B - Instruments of
Government Bond Market
§
Government Development Bonds (GDBs)
GDBs, issued since June 1988, carry fixed coupons payable
semiannually. GDBs are offered to banks and other financial
institutions every month in 2, 3, 5, 7 and 10-year maturities (by
tapping each issue twice a quarter). Until December 1998, GDBs were
priced off US Treasuries. Thereafter they were priced off the one-year
Riyal Interbank Bid Rate (SIBID) to reflect domestic money market
conditions. GDB pricing benchmark was changed to US Dollar interest
rate swaps in November 2000 due to the yield curve inversion in the late
1990s and US Dollar interest rate swaps being an alternative investment
to GDBs.
With the advent of auction
system in March 2004, pricing of GDBs is currently determined by
Government financing needs and market demand. Given budget surplus in
2003 and 2004 and huge domestic liquidity, there has been a skewed
supply/demand situation. For SAMA and banks, 2004 was a period of price
discovery. Ultimately, the market conditions and the Government’s
fiscal improvement dictated that GDB pricing should have a tighter
spread vis-à-vis US Treasuries. GDBs are offered on a yield basis (AIBD
calculation) with semiannual coupon payments.
§
Treasury Bills
In November 1991, Bankers Security Deposit Accounts (BSDAs or
Central Bank Bills) were replaced by Treasury Bills so that the proceeds
of T/Bills could be used for deficit financing. T/Bills are offered
every Tuesday of the week in various short-term maturities (1, 4, 13, 26
and 52 weeks). Banks & other financial institutions use T/Bills for
short-term cash flow management. BSDAs were identical to T/Bills but
their availability remained restricted to banks, and the proceeds were
not available for deficit financing.
§
Floating Rate Notes (FRNs)
FRNs were introduced in late December 1996 to broaden the
universe of available instruments and diversify the price risk. In
developing countries where banks play an important role in mobilizing
domestic savings, FRNs suit the banks’ balance sheet structure,
particularly in a rising interest rate environment. For the issuer,
FRNs are financing tools attracting longer maturities at short-term
funding cost. FRNs are offered every month in five and seven year
maturities at a variable coupon linked to 3-month Saudi Interbank
Offered Rate (SIBOR).
C - Form of Obligation,
Denomination & Settlement
Government debt securities are issued in book entry form in
Saudi Riyal 1million denomination because of low cost and ease of
administration. For retail buyers, the minimum purchase is Saudi Riyal
50,000. SAMA is the principal custodian of all Government securities
while banks are sub-custodians of their customer holdings. All
Government debt instruments are settled on a spot basis (T+2).
D - Infrastructure
Saudi Arabia has an efficient clearing and settlement
infrastructure. Saudi Arabian Interbank Express (SARIE) is an advanced
payment system based on real-time gross settlement (RTGS). Shares are
traded via an electronic trading system (TADAWUL) which provides a
continuous, order driven market. Bonds are currently traded via
telephone and Swift system. SAMA is now working with the Capital Market
Authority (CMA) for inclusion of bonds in the electronic trading
platform.
E - Zakat & Tax Treatment
Government securities are exempt from zakat provided they are
held for at least one year by Saudi investors. Zakat exempting was
meant to create a broad based demand for Government securities, develop
a secondary market and fund budget deficit cost effectively. As for
foreign investors in GDBs, there is no withholding tax on coupon
payment.
F - Liquidity Support
SAMA uses repos as the main operating instrument for managing
system liquidity on a day-to-day basis. Holders of Government debt
securities can enter into an overnight repo agreement with SAMA for up
to 75% of their gross holdings. SAMA’s overnight repo facility is
available at the market-rate announced to the banks on a daily basis.
Banks are in the process of finalizing Master Repo Agreements for
conducting interbank repo transactions.
G - Secondary Market
In Saudi Arabia, secondary market for government securities
has a limited turnover due to a narrow investor base with a buy & hold
bias, cultural considerations and limited market making resources. The
growth in Saudi Arabia’s primary market size is not necessarily a
reflection of liquidity in the secondary market.
III - Corporate Bond
Market
Corporate debt issuance
is a recent phenomenon in Saudi Arabia. Saudi ORIX Leasing Company was
the first to issue SAR 50 million corporate debt in March 2003, followed
by Saudi Hollandi Bank’s issuance of subordinated debt for SAR 700
million in late 2004 (privately placed). The first Eurobond US$ 600
million was issued by Saudi British Bank in March 2005. With SABIC and
Saudi Electricity Company in the pipeline for issuing Islamic Sukuk this
year, other corporates/banks may soon try and test this funding route.
The recently introduced
capital market law and the formation of the Capital Market Authority
should augur well for further developing the domestic bond market.
According to the relevant article in corporate law, “the total amount of
bonds that a company may issue may not exceed its paid up capital.” The
corporate law is currently under review by the Shura Council. Saudi
Arabia’s local currency sovereign rating by S&P (A+) and by Fitch (A)
has paved the way for corporate ratings and corporate issuance in the
domestic market.
IV - Future Prospects
§
Primary
Dealership
Efforts are being made to
make Government debt securities market a reasonably liquid market for
trading and benchmarking of corporate debt securities. With the
introduction of auction system, the next step is to appoint primary
dealers to foster a better sense of commitment and a wider distribution.
§
Investor
Base
Banks and a few financial institutions are the main investors
in Government Securities. Hopefully, the arrival of investment banks in
Saudi Arabia and development of infrastructure should help broaden the
investor base and make Government securities more appealing.
§
Role of
SAMA
Central banks play a defined market making role in Government
debt instruments. Majority of them do not buy Government Securities
directly from the primary market. Emerging market central banks
undertake open market operations for public debt management and
switch/swap programmes for banks. SAMA, which accommodates market
requests for asset swaps on a discretionary basis, may seek to broaden
its brief to include open market operations.
Conclusion
Government debt securities have served well the objective of financing
Saudi Arabia’s budget deficit. Currently, with the budget surplus, the
emphasis is to develop a secondary market and create liquidity in the
instrument. A well-developed Government bond market facilitates the
conduct of monetary policy and provides the benchmark for pricing
corporate bonds.
rf/amf-seminar/gen |
