UAE’s dirham bonds to set up foundation for a robust debt capital market

Dubai: The launch of local currency bonds by the UAE will be a gamechanger in the country’s debt capital market development, setting up a national benchmark and a yield curve.

The UAE Central Bank is scheduled to conduct the first tranche of dirham-denominated treasury bonds auction worth Dh1.5 billion on May 9.

Auctions will repeat in June, August, September, October and December. The ministry and the Central Bank of the UAE will sell bonds with two-, three- and five-year tenures. They are targeting a sale worth Dh1.5 billion ($400 million) at each auction.

Debt capital market

The UAE’s entry into a public debt programme was marked by the issuance of Federal Debt Law in 2018. The debut Federal bond issuance was in October 2021, with the transaction denominated in US dollar. (Several of the emirates had run dollar bond programmes in the past.)

The size of the UAE’s DCM is around $245 billion. Outstanding dirham denominated bonds and sukuk stands just about $31.6 billion or 12.8 per cent of the total, with issuance mainly from the central bank and other government agencies. The volume of outstanding dirham sukuk reached $1.5 billion at the close of Q1-2022.

Setting a benchmark

Analysts say the most important aspect of the domestic bond issuance is that it will drive more local entities to tap dirham denominated debt. According to Bashar Al Natoor, Senior Director, Global Head of Islamic Finance, “This step is expected to help build the domestic yield curve and provide a pricing reference for dirham-denominated bonds, sukuk and loan products.”

Dominance of bank funding

In the GCC, non-sovereign debt capital markets represent the smallest aspect of financial markets and have huge potential to emerge as a key funding source for the private sector.

For GCC banks with a strong and sticky deposit base, there has been little incentive to tap domestic debt, making their fund raising in domestic debt capital markets narrow and shallow.

As for corporates, the absence of a local benchmark combined with easy availability of bank financing based on strong corporate relationships and relatively easier process of raising funds through syndications worked as alternatives.

“Historically UAE’s bank [funding] market has been abundant with liquidity, thanks to a strong deposit base dominated by low cost current and savings account deposits,” said a senior banker.

The liquidity squeeze that followed the global financial crisis in 2009 saw many regional governments looking at debt capital markets as a serious alternative to bank funding, especially for long term capital expenditures. The prolonged slump in oil prices between 2014 and 2019 followed by the pandemic’s impact on the fiscal positions of many governments catalyzed the move towards developing debt capital markets.

Market stability

Analysts say a well-developed DCM is key to the stability of financial markets and gives opportunity for investors to diversify their portfolios with fixed income products.

“The development of the domestic DCM is a benefit for smaller UAE-based domestic issuers as the international DCM is not generally open to them because of greater complexities, issuance cost, additional disclosure requirements related to dollar-denominated debt,” said Al Natoor.

Banks to gain

The dirham bonds would give conventional banks an option to invest their spare liquidity. This will be an additional risk-free source of income.

Issuing domestic securities could increase the pool of domestic securities that qualify as high quality liquid assets (HQLA) for the Basel III liquidity requirements of banks and financial institutions.

Domestic debt markets have a big role in liquidity management and effective channeling and prioritizing of fund flows into various sectors of the economy.

When large scale government projects could obtain alternate sources of funding through debt capital markets, banking sector liquidity could be routed to other sectors. Also, “In a typical environment like in the UAE, large corporates tend to overshadow SMEs and start-ups in obtaining funds because of their size, credit standing and relationships they have with banks,” said a local banker.

According to the International Monetary Fund (IMF), domestic debt market will be a key element in ironing out fiscal imbalances caused by oil price volatility.

“Government would have a domestic funding source [in DCM] to tap if needed. This would help them diversify sources of funding and reduce reliance on bank financing, external borrowing or withdrawals from sovereign wealth funds,” the IMF said in its latest country report on the UAE.

Yield curve

A yield curve is a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates. The slope of the yield curve gives an idea of future interest rate changes and economic activity.

A yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is used to predict changes in economic output and growth.