• UAE to issue AED80-100 billion of sovereign debt by year end… According to press reports, the UAE plans to introduce a law that would allow it to issue federal government debt. Once ratified by the national assembly and rulers in six to eight months, the central bank would initially issue AED80-100 billion worth of AED denominated debt. While it is still early to quantify the impact of this, we believe the development of a federal bond market in the UAE is favourable for the banking sector’s liquidity, spreads and capitalisation. UAE banks are well positioned to absorb this issue. As of 4Q2015, UAE banks had AED140 billion in CDs with the central bank, and excess deposits (loans-deposits) of AED85 billion. While we see the development of a domestic sovereign debt market as encouraging, we urge caution in light of the challenging macro dynamics. Our preferred picks in the UAE are FGB (Buy), ADCB (Buy) and ENBD (Buy). The Q&A in Section II tackles key aspects of the planned sovereign debt.
• …creating an alternative avenue for banks to channel their liquidity UAE banks would be eager to participate if the rate and duration of these bonds are attractive in terms of the prevailing market conditions. Pricing and maturity details are unclear at this early stage. The availability of domestic sovereign bonds would encourage UAE banks to reallocate liquidity into the UAE from investments overseas (AED129 billion as of December 2015). It would aid in compliance with Basel III liquidity regulations by increasing an option of eligible liquid assets in which banks can park their liquidity. It should be yield accretive, as banks are likely to swap their excess cash holdings with the higher yielding bonds. Capital adequacy is likely to improve as risk weighted assets decline when banks switch to sovereign bonds (zero risk weight) from corporate bonds (risk weight of at least 20%).
• First step in building a local bond market Initially, the draft law would provide smaller emirates with cheap funding options as they would benefit from Abu Dhabi’s strong balance sheet. The suggested range would potentially increase gross debt levels by 4.6% to 5.7% of GDP in 2017 though general debt levels would likely still remain relatively low at c20% of GDP. On a more general macro level, the draft law is a key step on the road to establishing a local bond market – by building a yield curve – which would provide the economy with diversified funding – away from a concentration of short-term bank borrowings – and help enhance monetary policy transmission. This is in line with authorities’ previous measures to cap concentration limits for lending to government bodies and measures to facilitate issuances of corporate bonds and sukuks.

Shabbir Malik
Mohamed Abu Basha