Article / 15 November 2017 at 11:30 GMT

Weekly Bond Update: Saudi crackdown may represent an opportunity

Fixed income Specialist / Saxo Bank
Denmark

  • The Saudi crackdown has caused a shockwave across the bond market
  • Lebanese government bonds are the worst performers
  • The Crown Prince's plan may push Saudis to an economy less dependent on oil
  • Weakness in the region may present an opportunity for investors

By Althea Spinozzi

The world is closely watching the Saudi crackdown and wondering about the ultimate goal of Crown Prince Mohammad bin Salman. 

After making public its 2030 plan, it is clear that the young crown prince has a desire to return to moderate Islam, which he's shown by being instrumental in the decision to allow women to drive and allowing tourists to visit archaeological sites built before the Islamic era. 

Certainly nobody would have expected him to put friends and family in jail. 

Yet, confined behind the doors of the luxurious Riyadh Ritz Carlton hotel, there are around 30 people whose bank accounts are worth approximately $800 billion combined, which the government is freezing until further notice.


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Saudi Arabia’s Crown Prince Mohammed bin Salman viewed allowing women to drive
as a key plank of reforms. Photo: Shutterstock 

Bond selloff

The uncertain future of the region provoked a general selloff in the bond market and the cost of Saudi Arabia credit default swaps increased more than 20 basis points last week as investors panicked after they realised the weak equilibrium in the region might be lost if tensions heightened.

The big sufferers are the weaker names such as EA Partners, a special purpose vehicle linked to Etihad Airways, which was downgraded to CC in October this year by Fitch. After the downgrade, the 2021 notes were quoting above 80 cents on the dollar while now they trade in the mid-70s offering a yield above 15%, two points more than before the Saudi crackdown. 

Even better-rated companies such as Saudi Electricity (A2) took a hit widening up to +25bps for the longer notes with 2044 maturity. Government bonds of the region were under the weather with Bahrain and Oman. Bahrain 2029 now trades +40bps points wider and Oman 2027 trades +30 bps wider. Saudi International bonds in USD corrected slightly with the 2047 note yields up by +25bps while the shortest maturities corrected 15/20bps.

To make the situation even more complicated, Lebanese prime minister Saad Hariri resigned from his post from Riyadh. Saad holds Lebanese as well as Saudi citizenship and he appears to be still at his house in Riyadh with his family.

Lebanese government bonds suffered the most, widening up to two points across the curve hitting a 9% yield on Friday last week. During the weekend it appears there were conversations with Saad Hariri who says that he will return to Lebanon soon – yields have since stabilised around 8%.

Investors are obviously panicking because any change to the status quo of a country may pose a threat to the repayment of their investment. However, the crown prince has no interest in putting the status quo of the Saudi monarchy in peril.

I believe that Mohammed bin Salman is taking steps to protect the elite and not to extinguish them. The crown prince doesn’t have any reason to imprison powerful individuals as he doesn’t run the risk of being deposed. This is because unlike other monarchies, the extended Saudi royal family doesn’t have direct constituencies among the population that can organise against the monarch and overthrow him. Thus the greatest threat to the monarchy would be a revolution from below that would wipe out the entire royal family and would put the country and region at risk. 

Through a revolution from above, the king can strengthen the power of the elite as equilibrium is brought back to society once the government has taken control of assets that were acquired by powerful people through corruption. 

Many of these assets directly touch the Saudi population as they include land and properties that at the moment are quite costly as they are in the hands of a few. Once these terrains have been handed back to the Saudi government land prices should go down, providing the lower social classes an opportunity to enter the property market.

Mediocre economic data

Since oil prices collapsed in 2014 the economic situation of the country deteriorated as foreign currency reserves diminished (they fell from $700bn in October 2014 to $550bn in September this year) and the GDP growth has contracted from 3.65% in 2015 to 1.40% last year and is predicted to record 0% growth this year. 

Saudi’s mediocre economic data support the idea that things have to change and once the government has taken back the assets that the corrupt have gathered over the past few years it will be in a better position to make the needed investments in technology and education.

Vision 2030

The grand plan of the crown prince is called “Vision 2030” where he intends to cut the country’s dependence on oil. It will need further investments aside of those confiscated and this is the key reason why he will do everything he can not to spook investors.

He has demonstrated that he cares about the financial markets as last week it was reported that government-linked investment funds were buying shares in order to avoid a widespread selloff.

Even though Saudi Arabia wants to step away from being an oil-dependant economy, the recovering oil prices may play in its favour. Even in an environment of extremely low oil prices as we witnessed in 2016, the country can make money from oil production. Saudi Arabia benefits from having no taxes on production and pools of oil close to the surface, making it easier to extract.

All of this points to there being good opportunities arising from a widespread weakness in the Saudi bond market in the region. Nonetheless investors should prepare to withstand a long period of volatility in the region as equilibrium is restored.  

— Edited by Gayle Bryant

Althea Spinozzi is a sales trader at Saxo Bank.

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